Prudence can be overrated - enjoy!

Sometimes borrowing is worthwhile to get what you want, even if you already have some money saved, writes MARY HOLM.

We have a mortgage-free house valued at $350,000, no debts and $45,000 in a managed fund that's been going backwards for the last two years. We have been investing for only two years, at $1000 a fortnight.

We want to buy a camper van for $58,000. We have enough cash plus managed fund money to buy this.

Should we:

* Borrow the $45,000 against the fund, or

* Withdraw from the fund?

We are also due for an inheritance of around $200,000, but this is tied up in probate and could be years away.

We can continue saving in the fund at $1000 a fortnight, and could easily pay a loan back at the same rate.

What should we do - break the investment or borrow the money?

The prudent move would be to wait for the inheritance, and buy the camper van with part of that.

But prudence can be overrated. You're in a reasonably strong financial position - particularly if you expect to be saving $1000 a fortnight for a good many years yet.

If that's the case, you might as well buy the camper van now and get out and enjoy it.

So how should you pay for it?

In your case - but only because of your particular circumstances - I think you should borrow.

Normally, borrowing and investing at the same time are rather risky. Unless you earn more on the investment, after tax, than the interest you're paying on the loan, you lose more than you gain.

Three or four years ago, if you were investing in world shares or a managed fund with a heavy world share component, it was easy to make much higher returns than your interest rate.

But investments in shares or funds holding shares can also have negative returns, as you know only too well.

Having to pay interest on a loan while you watch your investment lose value is a bit like having your camper van break down as you return from a rained-out holiday.

And that could happen to you.

On the other hand, if you've had two years of bad luck in your managed fund, it might be your turn for a good year or two. Who knows?

If you can cope with taking that risk, go ahead and borrow $45,000.

You'll probably find the cheapest way is with a mortgage, rather than a loan against your managed fund.

Get a floating rate mortgage that you can pay off without penalty if the inheritance comes through.

Here's why I support your taking out a loan:

* Getting out of the fund might cost you brokerage or exit fees.

* If you get out now you've lost on the investment.

That might put you off continuing to invest in the fund. And, despite your short-term experience, a managed fund is probably the best long-term investment for you - especially if it pays low tax and charges low fees.

* You won't be in debt for long.

You say you could easily pay back $1000 a fortnight. That means you could repay a 6.7 per cent mortgage in a year and 10 months.

If you could stretch to paying $1200 a fortnight, you'd be out of debt in a year and a half.

And it could be even sooner, if the inheritance happens.

P.S. I presume when you invested in the managed fund that you didn't expect to want to use the money for a camper van in just two years.

Your story is a good example of why it's not a good idea to put short-term money in shares or a fund that holds shares.

In a recent column you mention the system and advantages of dollar cost averaging.

You do not mention broker fees. My understanding is that discount brokers charge a minimum of about $40.

Therefore $120 invested monthly buys only $80 of shares. And, if the share price remains constant, at the end of the year only $960 of shares is held.

On the other hand, one deposit at the end of the year of $1440 would buy $1400 of shares.

You make an excellent point.

Transaction costs - brokerage, entry and exit fees, commissions and so on - can make all the difference between what works in theory and what works in practice. I should have thought of that myself.

For those who missed the January 26 column, dollar cost averaging means you regularly invest the same amount in shares or a share fund, regardless of share or unit price.

You end up buying more shares or units when the price is low, and fewer when it's high. That means the average price you pay is lower than the average market price.

However, as you point out, that doesn't take brokerage into account.

Still, the situation isn't as bad as you say, for two reasons:

* You can buy small quantities of shares on-line for as little as $20. At that price, you might want to buy, say, every four months rather than once a year.

It will cost you $40 more, but you might more than make up for that with your savings from dollar cost averaging.

* In my example, a couple of weeks ago, I wrote about investing in a share fund, rather than directly into shares. That's because people who save regular amounts are more likely to be buying into a unit trust, superannuation scheme or other type of share fund.

And almost all of those funds have drip-feed facilities, which let you regularly deposit, say, $100 a month or more.

They charge an entry fee, but it's usually a percentage of your investment. And 1 per cent of $120 a month is the same as 1 per cent of $1440 a year.

For share fund investments, then, dollar cost averaging works particularly well.

Dollar cost averaging seems to violate the "time in the market, not timing" adage.

If markets tend to rise over the longer term, isn't it best to have as much invested as soon as possible? And if we should not attempt to time the market, how can a strategy which sets out a fixed schedule of timed investments be promoted?

One of the great advantages of dollar cost averaging is that you're not trying to time the market.

If you're timing, you're watching market movements and trying to buy when prices are low, and sell when they are high.

If - as I suggest - you set a fixed schedule of purchases or sales, and then stick to it regardless of what the market is doing, you're doing the opposite of market timing.

Your other point, that it's best to have as much invested as possible, has validity.

If you receive a lump sum and want to make a long-term investment into shares or a share fund, you could say that the sooner the investment is made the better.

On the other hand, you'd feel a bit sick if you invest it all at what turns out to be a market peak.

That's why I suggested two weeks ago that you might invest a twelfth of the money each month for a year, or a quarter of the money every six months for two years.

In the meantime, put the rest in term deposits that mature when you plan to invest them.

It's true that, because average share returns are higher than average term-deposit returns, more often than not you'll lose a little with this strategy. And occasionally, if there's a market boom in the period, you'll lose quite a lot.

But it's a risk-minimising strategy. It reduces the chance that you'll lose a great deal if the market plunges in the period.

And research shows that most people hate a big investment loss more than they love a big investment gain.

You also benefit from buying more shares or units when the price is low, and fewer when it's high.

A useful adjunct to the Rule of 72 is to know that all you have to do to become a millionaire is to take $1 and keep doubling it up 20 times over.

However, the Rule of 72 implies that, if you start with $1 and you earn on average 10 per cent a year, it is going to take something like 144 years to become a millionaire.

Hence the need to have a lower goal, or save hard to start with more.

Think about the lost opportunity every time we spend a dollar!

OK, I'll admit I couldn't resist checking it out on my calculator. And you're quite right.

Your adjunct certainly shows the power of compounding.

But it's a bit depressing for would-be millionaires.

Even with a return of 10 per cent, as you say, it will take a dollar 144 years to turn into a million dollars.

And 10 per cent is a higher long-term return, especially after taxes and other costs, than we should expect.

Still, as you say, if you start with a lower goal and a higher savings amount, you can do OK.

And that's especially true if you keep adding to your savings over the years.

(The 72 Rule says that if you divide 72 by a percentage return , you'll get roughly the number of years it will take for your investment to double.)

* Mary Holm is a freelance journalist. 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.