Investing house deposit funds for unknown period of time

aroominyork

I am helping my son invest £84k which he will use for his first house deposit. He will complete his doctorate at the end of 2019 and then plans a career in academia so there’s really no knowing if he will need the money after another two, five or ten years.

I asked him to choose his risk appetite, counting cash as zero and equities as 10. He said halfway – 5 – though I thought that seemed a little high so we settled on 4. I turned this into a maximum of 336 ‘risk points’ per £1000, ie 84*4.

He has £25k in premium bonds (risk zero) and £30k in VLS40 ISA (inc £4k in LISA). I put the VLS bond element as risk 5 so VLS40 counts as risk 7, which means he has used 210 risk points on this £30k. That leaves 126 risk points for £29k he now has available to invest from a recently matured fixed term cash bond.

I think p2p is a good option as it offers a higher risk/reward option with the risk being no greater over a short period of time. I gave Ratesetter (one year market) a 3.5 risk score and suggested he puts no more than £15k into it since the p2p model is untested in a downturn. That would leave £14k, perhaps a mix of more VLS40 and a regular cash bond eg 1.95% for a two year bond.

I’d like to sense-check this so would appreciate any views on this method and the risk scores. Thanks.

Voyager2002

First point: there is an enormous risk difference between individual shares in one or a few companies, and a diverse equity portfolio (giving exposure to hundred of companies around the world in different economic sectors). So your method of scoring risk needs some refinement.

aroominyork

He would not invest in equities other than through a multi-asset fund such as VLS, so while Uruguayan SMEs would be more risky, for his purpose I see no problem setting 10 as the equity component of VLS. Likewise setting a risk score for the VLS bond component.

bowlhead99

aroominyork wrote: »

I’d like to sense-check this so would appreciate any views

Happy New Year!

Sometimes an outside perspective is useful so I took the salient points from your post and re-wrote them with a different slant.

My son may invest his money for two to ten or more years because we don't know when he will want to buy a property.

I asked him what his risk appetite was, from nought to ten. He didn't know, so decided it should be half way, at five. I decided he was wrong, and told him he should be four. He didn't argue.

I arbitrarily allocated a score of ten to a portfolio of equities of several thousand large companies weighted to the ones listed in the UK. I then arbitrarily allocated a score of five (higher than the risk score I'd told my son he could handle) to a diversified portfolio of global investment-grade bonds hedged to sterling, carrying low credit risk and with a heavy allocation to government bonds/treasuries.

My son may need the money in two years as he might want to buy a property when he finishes his doctorate. Although anything can happen to markets in two years I decided that over a third of his money (£30k) should be put away into the VLS fund which is a little over half invested in bonds at a risk score higher than what he can handle and little under half invested in equities at a risk score more than twice what he can handle. Hopefully he won't panic and sell out in a market downturn. And I'm satisfied there won't be a market downturn happening in the 2 years or perhaps 5 years from now that it takes him to be ready to buy the property.

As I suspect the shortest amount of time in which my son would need the money is 2 years away, I decided to invest £25k in cash products. I selected premium bonds, in which the headline 1.4% rate is an average of what all holders achieve, including the ones who win the million pounds jackpot. With £25k invested, and a 1 in 24500 chance of winning a prize per £ per month, he'll win a prize per month unless he's unlucky - and it will only take 1.4 million months to play it long enough to expect to win the jackpot and achieve the stated 1.4% 'interest rate'.

He probably won't win that jackpot, more likely the minimum prize 98% of the time, so really the rate is something like 1.2%, considerably lower than inflation. He is not a high rate taxpayer and has plenty of personal savings allowance so doesn't really need the special feature of this return being non-taxable. But it will be fun for me watching his account to see if he's lucky enough to get more prizes than that average instead of being unlucky and getting fewer. As it's his money and not mine, it's not me who's missing out on the 1.85% he could get on a 1-year £25k deposit at Investec, or the 1.95%+ that I mentioned he would be able to get at a range of other institutions on a two year fix.

As peer-to-peer lending has only been in existence through times of improving economic conditions and broadly declining interest rates and not been tested in an economic crash, I don't have any long term historic data to carry out a proper risk profile of it. I'll arbitrarily assign a risk score of 3.5 to the Ratesetter one year market. That's lower than the risk that I decided my son could handle on his whole portfolio. Still, it makes me nervous so have told him to cap it at £15k. I haven't suggest he spreads the £15k over a range of providers to guard against platform risk, because I don't really understand the potential risk of the p2p sector and it's untested so I'll just put my head in the sand on that one.

That will leave £14k that I don't know what to do with. So, I'm thinking of just telling him to bung half of it in a bank deposit account with zero investment risk (the best option if he needs the money in two years) and the other half in an investment-risk-based product like that mixed asset equity-bond fund from Vanguard (a suitable option if he goes through the full ten years without needing the money).

My son is relatively clueless on these matters and I can't expect him to use his PhD research skills to learn about money management or the options available in the UK financial services sector. It's better I give him my wisdom by telling him what his risk tolerance is, arbitrarily allocating risk scores to financial products and deciding how he should deploy the funds. He will generally just go along with what I say; he doesn't want to get a MSE account for himself, or take much interest in investment matters to be in a position where he has his own strong views or is able to robustly challenge his parent who possibly had a hand in building the £84k in the first place... But I will enjoy the parent-son bonding that results, as we set up a plan and see it through for better or worse.

I was wondering if anyone could offer some guidance as I think what I am doing makes sense but hopefully the people on MSE will be more likely to know what date my son would like access to the funds than I am or he is. That is the bit I don't think we have really addressed. Other than what his risk tolerance truly is, by reference to his attitudes toward finding himself with a relatively larger or smaller pot when the two-to-ten-year period was up.

ValiantSon

Perhaps I'm just being a bit thick, but all of your risk scoring appears to be based on plucking a number out of the air and then creating an equation that appears to make it mathematically sound. This is further compounded by you downgrading your son's own personal (pluck a number out of the air) risk assessment because you decided that he is actually more risk averse than he thinks he is. I'm not convinced this has any more value than simply taking a punt (other than diversification).

It is clear that your son is in no real position to know when he is likely to need access to this money. The very shaky employment landscape for fledgling academics is certainly not going to help him. Job security is a thing of the past in that sector, until a person has reached quite a way into their career. Add to this that not only is he likely to be on short term, and possibly part time, contracts, but he may well also find himself moving around the country to find the best opportunities. This certainly makes planning for a house purchase rather difficult. Consequently it is questionable whether investment in the markets is a good bet or not. There is no hard or fast answer here, but I would suggest that with £84,000 he is in a good position to risk a fair proportion of his capital over the medium-long term, but we are probably talking here about more like ten years plus. At a rough guess, I'd suggest that keeping 40-50% as cash would be a "safe" move.

If it were me I'd ditch the premium bonds as I see little value in them. How many wins has he had since holding them, and how much has he won? I have a few premium bonds that were bought for me as a child by my parents and grandparents. In the last c.40 years I have won four times, totalling £100 on a bond holding of around £100. Imagine what compound interest would have done to that £100 over 40 years!

VLS40 is quite a risk averse fund for someone who is (I assume) in their early 20s to be investing in. If he really is that risk averse then fine, but he would likely see much better returns over the medium-long term if he invested in a higher proportion of equities. Going for a 70% equity / 30% bonds split would probably serve him better over 10 years plus. Investing £42,000 in a multi asset tracker fund at this kind of ratio would help him grow wealth long term, without being too exposed to capital risk. (Even better if it was held longer and de-risked over time).

Doing this would still leave him with £42,000 in cash. Maxing out interest paying current accounts would certainly be a start (although he may struggle to open some as he is currently not earning, I assume). If he could open these then 5% on £2500 at Nationwide and 3% on £1500 at TSB would handle £4000 of this, with access to the regular saver at 5% with Nationwide on £250 p/m. (I'm assuming he doesn't have a lot of direct debits to make it worthwhile pursuing others, but if he does then £20,000 in Santander 123 at 1.5% is still a good deal if the account fee is covered by the direct debits). From here I'd look at only 1yr fixed rate bonds with banks as the rates are nothing special and may be a bit better in 12 months time - if they aren't then they're probably not going to be appreciably worse - the miniscule amount of extra interest earned on a 2yr bond isn't worth the potential loss if rates do improve. This cash would then be more or less available for a deposit on a house when he is in a stable enough employment position to purchase, giving him over 20% for a deposit on even a £250,000 house (outside of London and the surrounds that would be a very substantial property for a first home buying on your own).

Oh, and as for P2P, by your own admission, you have no real way of knowing how this may perform if there is a downturn. It is a very risky strategy for someone who is so apparently risk averse.

aroominyork

And a happy new year to you too, bowlhead. Your wisdom aside, you gave us a great laugh. The only inaccuracy is that premium bonds are his pet investment, not mine.

The salient point, raised in your last para, is the uncertainty of when he’ll need the money. ValiantSon answered that is his second para and fairly suggested it’s likely to be closer to ten than two years. But that’s the nub of it: how do you invest when not you, not I and not StudiousSon know the answer?

My ‘method’ is not meant to be a scientifically sound, more accurate, long term version of FE risk scores, but is a way to give a little structure to an inexact science for someone who... how shall I put this... is relatively clueless on these matters and who I can't expect to use his PhD research skills to learn about money management or the options available in the UK financial services sector and who doesn't want to get a MSE account for himself, or take much interest in investment matters to be in a position where he has his own strong views or is able to robustly challenge me.

So for one more stab at it: if you could not answer the ‘when will he need the money’ any more accurately than we can, what would you do? (ValientSon – your suggestion of half in 70/30 and half in cash scores 357 risk points on my soon-to-be-copyrighted method.)

ValiantSon

aroominyork wrote: »

So for one more stab at it, if you could not answer the ‘when will he need the money’ any more accurately than we can, what would you do? (ValientSon – your suggestion of half in 70/30 and half in cash scores 357 risk points on my soon-to-be-copyrighted method.)

Well it sounds to me like the "357 risk point" 70/30 investment and half in cash is reasonably close then!

Honestly, if it were me, then I would keep 40% as cash, but ditch the premium bonds as they are a massive waste of money and time. I'd save the cash in a mixture of interest paying current accounts (especially Santander 123, assuming the direct debits cover the fee), with a regular saver or two thrown in for good measure to maximise the return, and a one year fixed rate bond at 1.85% to be reviewed annually. If the current accounts aren't an option then the best paying easy access savings account could be used instead. I'd also look to maintain a similar level of cash moving forwards, i.e. c.£35,000.

Meanwhile I would put the rest in an easy to manage investment portfolio (as he doesn't sound like anything else would be appropriate), such as VLS80 (if he feels a little less risk averse) or half VLS80 and half VLS60 to create a 70/30 split. I'd also encourage him to drip feed any spare cash into this portfolio over the intervening period.

aroominyork

So he made a decision. Bowlhead (alongside the ribaldry) focused us and ValientSon resonated with his view of what the future holds for a fledgling academic. We decided on £5k in Ratesetter (he is not drawn to p2p but for £150 bonus in a year this is worth it) with the balance split between cash (two years @ 1.95%) and VLS60.

A possible scenario is that he wants to buy a place when the stock markets have taken a dip. OH and I might be in a position to loan him the amount invested in equities (currently (£84-£5k)/2=£39.5k*0.6=£23.7k) until the markets have recovered. To do this we’d need to be able to sell the bond component of the VLS but keep the equity component invested, so they need to be separated by investing as 60% in VLS100 and 40% in VLS0.

But which Vanguard fund provides a 100% VLS bond element? When I isolate the bond element of VLS it returned about 20% cumulative over the last five years, whereas Vanguard’s hedged global bond index returned 15.63% which isn’t impressive. If there is no VLS0 fund, what do people think about going for a cautious strategic bond fund, eg M&G Optimal Income or Fidelity Moneybuilder which both returned c.28% cumulative in five years?

Thrugelmir

whereas Vanguard’s hedged global bond index returned 15.63% which isn’t impressive

Hardly surprising given that Central Banks have been hoovering up Sovereign Debt. Reducing yields to pitifull levels.

ValiantSon

Glad to hear that some decisions are being made and it looks like there is a positive way forward in helping your son to manage his investments.

Vanguard don't do a 100% bonds LifeStrategy fund. Would VLS20 even be to much equity exposure? If it would then fair enough. Everything needs to be within the individual's comfort zone. I'm les famiiar with M&G or Fidelty funds you've mentioned, so feel it best to let others contribute from a position of greater knowledge.

Best wishes.

Eco_Miser

But which Vanguard fund provides a 100% VLS bond element?

There is no VLS0, but Vanguard have 20 bond index funds, VLS20 uses 10 of them = https://www.vanguardinvestor.co.uk/investments/vanguard-lifestrategy-20-equity-fund-gbp-gross-accumulation-shares/portfolio-data
He could use those directly.
Alternatively, he could buy VLS60 now, sell it when he wants to buy a home, and buy VLS100 with a proportion of the realised cash.