Investing your student loan

Q. I am an 18-year-old male heading into my first year of university. I feel it is time I took my money matters more seriously.

I will be taking a student loan of about $6000 a year, not including my $150-a-week living expense. I do not qualify for a student allowance and, because I am a fulltime student, my earning capacity will be limited to about $100 a week.

As mentioned, I can also borrow $150, but it will be added to my student loan. I have the luxury of having all my interest written off and have savings of $4000.

Where is the best place my money can be invested?

Perhaps start a small business? Invest it in bank bonds? Shares?

A. There are two issues here. The first is moral; the second financial.

Student loans are interest-free while you are studying. Should you take out a loan that you apparently don't need and invest the money - presumably repaying it when the interest charges begin?

It means taxpayers are subsidising your investment. Is that fair?

Perhaps more importantly, the growing realisation that some students are doing this will put pressure on the Government to remove the interest-free feature. That would particularly hurt poorer students, who need the loan money to live on.

Only you can decide whether that bothers you.

Assuming you - and anecdotal evidence suggests many others too - go ahead with your plan, where should you invest?

Any time you borrow to invest, you are gearing. And gearing is beneficial only if you make a higher total return - income and capital gain - than the interest you pay.

With most loans, to obtain that higher return the investor has to go into property, shares or a share fund.

But with an interest-free student loan, of course, any return is higher than the interest rate. You could put the money in bank term deposits and still come out ahead.

This is fortunate, because there's another difference between student loans and other borrowing: in most cases, an interest-free student loan lasts for only a few years.

As I've said many times, any time you are investing for just a few years it's wise to avoid property or shares. Their values are volatile. There's a fairly big chance you could lose money over a shortish period. And losing money is ugly when you have borrowed to invest. When you sell the investment to repay the loan, you're left owing more money.

To avoid that possibility, I would recommend term deposits or perhaps high-quality bonds. For more info, see today's last Q&A.

You also wondered about starting a business.

Small businesses vary hugely. But most take lots of time and, if you're studying fulltime, you won't have heaps of that. They can also soak up lots of money and don't necessarily ever deliver profits.

In other words, the risks can be even higher than with property or shares.

Still, I hate to discourage an entrepreneurial spirit. If you can fit a business into your schedule that doesn't use much student loan money - perhaps something that uses your brain power - go for it.

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Q. In your top article on February 12 you wrote: "With a $40,000 deposit, you could get a $100,000 apartment."

Where can you get an apartment for $100,000?

What city are you living in? Invercargill? Baghdad?

For someone who gives advice on finances you seem to be totally out of touch with the property/apartment market.

A. Come now! I checked no less a source than the Weekend Herald's Real Estate section before I wrote that sentence. There are apartments selling for less than $100,000 in Auckland.

What's more, many Herald readers - perhaps including the young man who emailed his question to me - live in smaller towns. In some of them, you can probably get an apartment for $60,000.

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Q. Thank you for your answer to my question on February 12. I am still a little curious as to why I wouldn't put money into bonds or debentures within a one to two-year period, or even over six months.

They seem to have a better rate than bank term deposits.

A. Good question.

For the benefit of others, this reader wanted to know where to invest while saving for a house.

I replied that term deposits were good for one or two-year investments. "But beyond that, it's probably worthwhile to go for the somewhat higher returns you can get on high-grade fixed interest investments such as corporate bonds or debentures. Avoid lower-grade products, though. A default could prove more disastrous than a share crash."

My reasoning was that, for shorter periods, bonds or debentures are probably not worth the hassle or the transaction costs.

After talking to Simon Gerrie, of NZX firm ABN Amro Craigs, though, I realise I might have been too conservative. For one or two years, you might come out quite well ahead with high-quality bonds.

While the brokerage on bonds is sometimes included in the yield, Gerrie's firm and some others usually disclose the brokerage as a separate fee - a percentage of your investment or a flat price.

Whatever way it's done, what you need to know is what your return will be, after all expenses, so you can compare that with term deposits. A good adviser can help you work that out.

Gerrie makes another point in favour of bonds.

If you decide to buy your house earlier than expected, you can sell a bond before maturity.

You may get less than you paid for it if market interest rates have risen since your purchase. On the other hand, you may get more if rates have fallen. And you always have the option of holding until maturity and getting back the principal plus interest.

That's more flexible than term deposits.

Look into bonds, then. But I do want to stress that bit about sticking with higher-grade products. Get an NZX adviser to help you assess the risks.