Lee wants to invest $100,000 he won. He knows all about inflation and wants to invest the money so that it earns a capital gain. he also wants the money to be both secure and quite liquid. He wants to marry his girlfriend of 3 years, Tina, when he has a few thousand $ in the bank. He wants to be able to afford the house Tina has been admiring in a new subdivision. (a) make a list of Lee's investment priorities. (b) how should he invest to achieve his goals? (c) if you were his investment advisor, what advice would you have for him?
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c) Don't get married ....
But seriously ;-)
what do you reckon, 00Gibb00 ?
a) investment priorities.
consider - for Lee's current situation in life and his life plan, in the short term it's get married and in the short-to-medium term it's buy that house Tina is hoping for. Those are big commitments.
I'm going to assume in the next 6 - 24 months, no longer; and I'm going to assume he will need all of the $100,000.
He can't gamble the money he will need to purchase the house with, it's got to be relatively safe.
1) Make sure the principal, or at least a very large portion of the principal (equal to what he will need for the house or the down payment on the house), is not at risk and will be returned.
2) Make sure this portion will be available when needed for the house purchase, i.e. not locked up in a 1yr term deposit
3a) Invest some or all of it on an investment that has a decent chance of generating a return / a capital gain
3b) Invest some or all of it on an investment that is inflation-protected (the time horizon is not long though).
On a secondary note, these 3 requirements are in tension - you can't have all 3: capital gain, liquid, security of principal.
In my opinion:
b) invest it how:
He should invest the bulk of it in inflation-protected debt of the highest credit quality. For example the TIPS / Series-I treasuries (USA) or Index-linked Gilt (UK).
He could then invest the remainder for some hope of capital gain, in something liquid. either:
- A portfolio (diversified) of Blue chip equities, or a stock-market index fund / ETF
- A real-estate linked investment trust / ETF
both of these will offer inflation protection and the possibility of gain (but not guaranteed). The latter has the benefit that it hedges against sudden increases in property prices (if property prices go up by 25%, so should his real-estate linked ETF).
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c) I think advice is covered by a) and b), i.e.
don't risk all the $100,000, it's money you'll need shortly in order to get married and purchase the house. Consider your risk appetite, and your time horizon. Your time horizon is relatively short (in my assumption).
oh, and buy a ring. ;-)
Thanks for the great reply. Most of my confusing stemmed from the fact that I was unsure if a house was considered a short-term or long-term goal; making a down payment in the short-term makes more sense. I also find that the book I'm using doesn't really explain the investment options very well; for example, they just use the term bond without explaining what that really is (I'm a biology major with no business background). Other than that I think I was sort of on the right track, but your post helped me clear my head and organize my thoughts a bit better. Thanks!