Don't limit options: sell before you have to

By MARY HOLM

Q: You said, in a recent column, "On retirement, while you should move money you'll need over the next few years into a fixed-interest investment, the rest could stay in the share fund for quite a few more years".

Why move your share market money through a fixed-interest investment? Why not take it straight out of the share fund?

On average the fixed interest investment will have a lower return. Why reduce your return?

Are you afraid of negative dollar cost averaging?

More to the point, why does my grandmother want to sell all her shares on retirement, buy a fixed-interest investment, and live on the income?

Why can't she live on capital gains?

Presumably she wants to preserve her capital so that I can inherit it. But surely I will inherit more if she stays in the share market?

And, Nan, if you read this article, don't worry about me. Spend your money on your own retirement. I'm looking after mine.

Good on you. Many retired people live too frugally so they can leave money to their family. I like to see the younger generations discouraging that.

But the main point of your letter got me thinking, until I talked to some investment experts.

It seems that returns on shares aren't superior enough to justify putting your grandmother in a position in which she must sell shares to get her income, regardless of what's happening in the share market.

"The secret of investment is never to be a forced seller," says one expert.

If your Nan sometimes has to sell at particularly low prices, that can badly hurt her overall returns. She needs to keep her options open.

The expert suggests your grandmother, and others in retirement, should hold the money they'll need in the next three years in cash, including term deposits.

Money they expect to spend in the next two to 10 years should be in corporate bonds, and money to be spent after seven years - or perhaps left to others - should be in shares.

For the average family, with a mortgage-free home, there's no need for more investment in property.

The overlaps in periods are to allow for differing risk tolerances and to give flexibility.

To maintain the suggested asset allocation, over the years your Nan will shift money from shares to bonds and from bonds to cash.

To some extent, that second move will be taken care of when bonds mature.

But she will also need to review her position - perhaps once or twice a year - with the idea of selling shares and perhaps bonds.

Here's where the flexibility comes in.

She can sell if market prices are reasonable. But if prices are low, she can put off the move until her next review.

What's this? After my saying over and over that nobody should try to time markets, I'm now suggesting they do?

Not really. This is a much longer term, more general market view.

Let's say, for instance, that Nan was reviewing her situation after last September's sharemarket plunge.

Many experts at that time were pointing out that shares have pretty much always rebounded within a year of such drops. Nan might have noted that, and delayed her sales for a few months, or even a year or two.

Why not? If she had started the previous year with, say, three years of income in cash and seven years in bonds, there would be no rush to top up those "accounts". She could do it when the markets had recovered.

In answer to your comment about negative dollar cost averaging, I'm not afraid of it. But it does have a couple of drawbacks:

* With normal, "positive" dollar cost averaging, you invest the same amount regularly, regardless of what's happening in the share market.

That amount buys more shares or units when prices are low, and fewer when prices are high. That brings down your average price, which is great.

But the opposite happens when you're selling investments. You sell more when the prices are low, which brings down your average gain.

* With positive dollar cost averaging, it's not so bad when the market falls. Your loss is only a paper one. When the market recovers, you do, too.

With negative averaging, when you sell in a down market, you've turned a temporary loss into a permanent one.

Despite all this, it's still good to sell gradually over time.

If you need money for a specific item in, say, five years, you don't want to risk selling the lot at that time, in case it's in a market downturn.

It's better to plan to sell portions, perhaps six monthly or yearly, so that at least some of your sales will be at high prices.

And, with time up your sleeve, you can be a bit flexible about when you sell.


* Mary Holm is a freelance journalist and author of Investing Made Simple. Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or e-mail: maryh@pl.net. Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number. Mary cannot answer all questions, correspond directly with readers, or give advice outside the column.