How to preserve your wealth in these uncertain times
By
Dominic Frisby Apr 29, 2009
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Hang on to your cash...
An old university friend of mine phoned me up for some financial advice this week. She has some big decisions to make and she's not sure what to do.
Her predicament is a tricky one, and made trickier by the Government's economic policy. But it touches on problems that we all face right now – how can we know what to do with our money when we're faced with uncertainty in almost every area of our lives?
So here's what I told her...
The Bank of England is forcing investors to take risks
Back in 2002, my friend bought a small house in a London suburb, with a 75% mortgage. She refurbished the place and added an extension. By summer 2007, its value had doubled.
However, the recession has chipped away at her income which has now more than halved from when she bought the property. She's struggling to make ends meet - by the time she's paid her mortgage, bills, and living costs, she is spending more than she earns. This has eaten away at her savings and she now finds herself with an overdraft that is creeping up and gnawing away at her month by month.
She saw this coming and a year ago put her house on the market, planning to downsize. But she was unable to sell it and her asking price followed the market down. However, with the spring bounce we are seeing in the housing market – the builders' stocks are up, mortgage approvals are up (from low levels), estate agents are reporting invigorated interest from buyers - she has had three offers for her house and accepted the highest. She's given back half her gains, but she'll still have a nice pool of cash.
Not a bad position to be in, you might think. But what should she do with the money now?
She can't afford to take risks with it. She has young children, so protection and wealth preservation is the order of the day. Once upon a time she could have rented somewhere to live and used the interest on her capital to pay the rent. But now she wonders, 'What's the point of having all this cash if I don't get any decent interest on it?'
It's a good point. With these criminally low interest rates, the Bank Of England is practically forcing her to do anything with that money other than save. But she doesn't want to speculate. She's never bought a stock in her life and doesn't want to start now, given the state the economy's in. She can see that company earnings are falling and that stocks will fall with them. Nor does she want to put the money into her business, for similar reasons.
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She can also see inflation in her every day life. Asset prices, such as houses and stocks, built on debt, may be falling, but items we buy with cash, such as food, are not. She can see the falling purchasing power of the pound. And she can see that our policy-makers are debasing it through quantitative easing. So she doesn't want to hold pounds either.
She thinks the US has the same problems we do, so is worried about the dollar, while, being part-Irish, also fears the problems facing the euro. The mere mention of yen, Canadian dollars or Norwegian krona sets her nerves jangling. They're too risky for her, she feels, and banks make it hard to own foreign currency.
Avoid property
So she's thinking of buying another house. "Please don't!" I beg her. If, by some miracle, our economic policy works, and we come out of recession and deflation is avoided, interest rates will have to go up. There is no other way for them to go. That will be bad for house prices.
But if – as I believe is more likely – UK economic policy fails, then there is going to be more unemployment, wages will fall further, business will stagnate and credit will continue to deflate. There will be less money to spend and that will be bad for house prices too.
In other words, house prices will fall whether the economy sinks or swims. As I have said before, this is a dead cat bounce in housing, nothing more. Policy-makers are trying to engineer this bounce from too high a level and it will prove unsustainable. The house-price-to-earnings ratio, at 4.4, is barely below pre-crash, 1989 levels. It needs to get back at 3x earnings before we can consider whether the bottom is in.
I recently spoke to Robin Griffiths, the technical strategist at Cazenove, and he said: "The bottom is not in. The golden rule about bubbles and bubbles bursting – and it was a bubble – is when the bubble bursts you eventually get back to the same level you were before the bubble started. On that basis, there's another 50% down to go. Now, of course the property market is not one homogeneous entity. There's a genuine shortage of certain types of homes, such as starter homes. But if you're talking luxury mansions in smart parts of town you can knock a million or two off those without even blinking".
Where should you put your money?
So where should she put her money? There's only one place left really. It's shiny, it's yellow and it rhymes with 'mould'.
"What? All of it?" she asks. "No, not all," I say. "The old Wall Street saying says, 'Put 10% of your net worth in gold and hope it doesn't go up'. You might allocate a bit more than that, given the underlying fundamentals. And if you complete your house sale quickly, you'll be in time to catch the summer low."
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