Published by Kauders Portfolio Management, Authorised and regulated by the Financial Services Authority
My weekend reading included a "human interest" story*. A Mr and Mrs Judge had an inheritance and thought they might use it to repay their mortgage. To us, that seems eminently sensible. The mortgage and a car loan total £93,000.
Some "expert" financial advisers gave their views. They all warned against repaying debt, preferring investment instead.
The sums show that advice to keep cash in the bank and pay much more interest on borrowed money would clearly be foolish:-
Average cost of debt (including car loan), say, 8% (no tax relief)
Net return on cash for a higher rate taxpayer, say, 4%
So, net cost of keeping debt and cash of £93,000 =£3,720 per annum.
This is the hurdle that must be overcome when investing. But investing also incurs costs, probably 2% per annum if initial costs are spread over 5 years. The total profit required is therefore £5,580 per annum, or 6%, just to break even overall. The chance of that happening consistently for some years is pretty poor. In fact, the double hurdle of borrowing cost and investment cost means that, unless there is a sustained bull market, Mr and Mrs Judge will be working to keep the financial services industry in style.
Obviously these financial advisers have not considered that a major bear market may now be inevitable. The advice to gamble that borrowed money in an environment where falling share prices are increasingly likely is, as Sir Humphrey might have put it, "courageous". Mr and Mrs Judge should pay off all their borrowings and keep their remaining cash intact. In a recession, which will be with us quite soon, they will need every penny of it.
Oh, by the way, we would not accept Mr and Mrs Judge as Clients. Our Client agreements include a client warranty that they do not have significant borrowings.
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© Kauders Portfolio Management 2000
* see The Daily Telegraph, 16th September 2000