‘No one ever factors in the effects of inflation,” writes correspondent Delys Reed. Over the past 40 years, Reed continues, this has devalued people’s savings to a fraction of the money’s original purchasing power relative to the nominal sum invested. Last week I wrote about interest rates in response to points Reed raised. This week I deal with the rest of her questions, which focus on inflation. “As I see it, this is how many businesses make their money. For example, about 10 years ago a friend bought a funeral-in-advance for $3500. When she died recently, the funeral actually cost $10,000. “Annuities, life insurance, residential village units – lots of things seem to rely on the same principle. At the time it’s paid in it’s worth good money, but 20, 30, 40 years down the track if one collects on it, it’s worth but a small fraction of what one originally thought it would provide.”
Reed goes on to point out that friends who invested in rental properties have done well. The rent earned has taken care of the mortgages and now represents income for the owners for life. When their children inherit the properties, they in turn will be assured of high living standards – private schools, beach homes, residential villages in old age. “Surely it’s all about creating income streams for oneself and one’s family.” Inflation is the main reason New Zealanders have been so keen on investing in property – it generally acts as a hedge. Many businesses make money from inflation because they have the use of your money over extended periods. With any kind of insurance, the only way you will preserve its value is if you continue to top up your premiums to make sure the investment keeps pace with price growth.
I don’t know the details of Reed’s funeral-in-advance example, but people buying such a product need to ensure it will deliver what they expect. Such a policy should provide a certain level of funeral, and that probably means your premiums will have to rise each year to keep pace with rising costs. Using another example, insurance companies provide replacement policies for cars. But if you bought the car new and it is now 10 years old, you will be paid the market value of a 10-year-old car, not a new car. Buying into a retirement village is a complex matter that can’t be dealt with in a few sentences. You generally buy a right to occupy. When you or your descendants sell, the village operator subtracts expenses from the sale price – often including the costs of refurbishment or redecorating. Retirement village marketing has strict rules, but people contemplating such an investment need to make sure they fully understand what they are buying.
Property remains New Zealanders’ No 1 investment choice because it has generally been inflation-proof. In addition, compelling tax benefits have further increased rental returns, although the Government recently tightened some of these. People often buy houses to let because it is something they know about, can manage without outside help and can borrow against. Banks will lend money to buy a house, but not shares in a company, the rationale being shares go up and down in value, but houses don’t. But past performance is no indicator of what might happen in the future. Some houses and apartments have fallen in price over recent years, or they have been difficult to sell or let. Being a landlord is hard work – no one likes having to deal with tenants who call at all hours to complain about something not working, don’t pay the rent or cause damage. Owning and managing rental property is not a money tree. As with any investment, it’s about doing your homework – buying and managing well – to preserve and enhance your investment.
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