The following guest post on buying a property overseas is by Rick Todd of Expat Investing. These are Rick’s views, not necessarily mine — so let us know what you think in the comments below.

Most people who are in a position to buy a property overseas are buying for their retirement or because they live abroad.

Only the wealthiest investors can afford to buy a property overseas and then hire someone to manage that property while they live elsewhere. For the rest of us, the option to buy a property abroad is intimately tied to our work and our time after work.

The traditional view of property

Until recently, the purchase of property was seen as a reliable investment that was sure to go up over time and to make its owner a decent profit upon its sale.

Yes, there were those unlucky few who bought home next to a uranium mine or a new expressway and saw it depreciate in value, but for most investing in property was a great way to get rich.

And then came the crash.

Many markets worldwide saw property plummet as in many cases property prices were closely correlated with most other asset classes in the global market crash. In many countries, particularly in such places as the United States, Spain, and places over-reliant on property sales like Dubai, the property market will not recover for years if not decades.

Property is no longer seen by everyone as an investment, and to many now it is probably not viewed as a necessity to purchase. In many parts of the world, most people rent property throughout their lives and suffer no consequences at all.

In my opinion the crash has taught us a valuable lesson: speculating that a property will appreciate in value is very risky.

It is not a given that it will appreciate enough to be worth selling, either now, or far into the future. However, I believe the purchase of a property, regardless of the location, does serve a purpose: it can act as a hedge against inflation.

Property as an inflation hedge

Most property is purchased in the form of a personal residence and most personal residences are purchased with bank loans that fix a monthly payment for a considerable period of time, say 15-30 years. [In the UK shorter fixes or variable rates are still more popular, but they shouldn’t be! – Ed].

During the life of the mortgage the payments stay the same but inflation begins to act. While the initial payments on a home loan will probably be more than the monthly rent on a comparable place, as the years pass and inflation affects the local currency more and more, the fixed monthly payment made on the home loan stays the same. Someone renting property over the same period sees their rent increasing year after year.

The result is that over time, a home owner saves a tremendous amount of money. By the time the loan is paid off, the home expenses are related only to maintenance and taxes. When a person with a paid off property reaches retirement, the home is not a burden on the person’s retirement savings, and their house or apartment can continue to be lived in or sold to further fund a retirement.

Of course, this only works if property is purchased with a long term fixed rate loan, and the person who buys it intends on keeping it for a long period of time. Someone who moves frequently will find it difficult to accomplish.

A worked example

In the past 100 years, the UK has experienced about four per cent inflation annually on average. The US has experienced a little over three per cent. So I’m going to assume that a stable developed economy experiences about three to four per cent per year.

So let’s say Person A buys a property for the long run, and Person B decides renting is the way to go for the long run. Both Person A and Person B are going to live in identical properties.

• Person A pays £1,000 a month in rent.
• Person B agrees to a loan (with 20 per cent down payment) with a monthly payment of £1,500.

The premium Person B pays per month is a reflection of buying into a healthy market, when most properties are purchased.

If we assume that a landlord is going to raise your rent annually to at least match inflation, we can expect a four per cent rise in rent per year which would directly affect Person A. Person B has locked in his monthly payment with a long term fixed rate loan.

So Person A pays £1,040 per month in year two, Person B continues to pay £1,500 per month. In year three Person A pays £1,081.60 per month, while Person B continues to pay £1,500 per month. This continues with Person A’s rent compounding upwards by four per cent per anum

In year 12, Person A begins to pay more than Person B, when Person A’s monthly rent hits £1,539 per month, and Person B’s rent is at the same £1,500 per month.

By the end of the twenty year period where Person B has finally paid off his loan and is paying nothing monthly, Person A can expect to be paying at least £2,106.80 per month in rent.

I have only adjusted the rent for inflation and I have not added any arbitrary raises in rent a landlord might ask for over and above inflation.

As you can see, the savings are considerable for a person who is willing to commit to ownership for the long run. But anything less than a decade or so of ownership isn’t worth it. In short, if you are investing in a home, you are asking yourself to predict that you will have a stable income over the next decade and a half in order to see yourself to a profitable result.

These rules also apply to someone who wishes to move overseas for their job. An expat who intends to stay for years in their new country is better able to buy a property than an expat who is going to move from country to country.

Also, someone who is older and closer to retirement may not want the burden of a home loan when they retire with a shorter time horizon than someone in the beginning or middle of his career. The purchase of a home is probably more realistic for someone younger.

Currency risk

Of course, the purchase of property overseas makes you an unintentional player in the currency market.

If you purchase in a developed country, I would argue that your risk of currency depreciation for your property is low. Is it likely that a developed country will revalue their currency in order to pay off external debt? No.

Historically, the countries most likely to default have been developing economies. The world’s largest developed economies have not really defaulted since the Second World War, and the low interest rates on their bonds reflect the market’s confidence in their credit worthiness. Even if they were to default, the IMF and other countries would quite likely bail them out, as we have seen in Greece.

In developing economies, it’s a completely different matter. Buying a overseas in a developing economy is where you take on the most currency risk.

If you buy a home in a developing economy that devalues its currency, the first group that is going to be scared away from purchasing your property is going to be foreign investors. You may list your property in your home country’s currency because that’s all you’ll accept, but unless the property has a lot going for it, many potential buyers may be scared off if there’s been a recent devaluation in your property’s country.

Buying property for retirement

What about buying a property overseas for retirement? I think it’s extremely risky and not a good idea.

• When you retire, you retire on a lower income that is often reliant on investments. These may no longer grow substantially as you are not increasing them through a salary.

• People in retirement are generally in worse health than those who are working and younger, and the burden of a new property can take its toll.

• Ownership can act as an anchor if you wish to move back home for any reason.

In short, my advice to people who are thinking of moving overseas is to put themselves in the uncomfortable position of predicting what they will be doing for their next few decades. Are they planning on staying in the same place?

If yes, then buying a property is a good idea. If no, forget it. And if you are retiring and moving abroad, rent a place instead

Rick Todd posts at Expat Investing where he writes on such topics as to whether retiring abroad is right for you.

My regular weekend ramble, then it’s on to a list of great reads.

Every morning seems to bring a new personal finance headline these days.

Last week it was high-earning sole breadwinner families and those on excessive benefits who saw their handouts cutback. This week it was the turn of super high-earners, who now face a cap on their pension contributions:

Tax relief on pensions will be limited to contributions of £50,000 a year, down sharply from the current ceiling, which is five times that. However, there had been suggestions that the limit would be nearer £30,000 a year, which would have hit many on relatively modest incomes who had many years of service with their employer.

Higher-rate taxpayers will also be allowed to keep tax relief at their highest rate on pension contributions up to the £50,000 limit. There had been fears that the Government would restrict tax relief to 20pc for everyone.

I think on balance the move is perfectly sensible, even if it is odd coming from a Conservative-dominated Coalition. Liberal Democrat voters should stop bleating and be proud of the difference their party is making to the deficit-reduction balancing act.

As for the £50,000 cap, well the idea of tax relief for pensions is to stop people being a burden on the State in their old age, NOT to enable Fat Cats and Cityboys to stash away absolutely enormous amounts of money free from the tax man’s grasp. The move doesn’t cap the ultra-rich person’s ability to invest for their future, just the tax rebate the State gives them for doing so.

But it would be unwise to be too smug. Only 100,000 high-fliers are estimated to be affected by this new rule (and the FT is already pointing out ways around it) but you don’t have to wait for long for something else to come along to clobber you in the current climate.

I had feared ISA limits might no longer go up with inflation, but the Treasury has clearly decided it’s a cheap middle-class perk, and thanks to runaway CPI inflation it will raise the limit to £10,680 next year.

That’s good news if you aspire to be one of the emerging band of ISA millionaires. This week’s pension cap move does introduce a niggle into the idea of using ISAs to fuel a pension, however.

Currently you can transfer ISA savings into a pension pot at a later date if the rules or your circumstances make it sensible, and pick up 20% or 40% tax relief on the way. But the new £50,000 cap will limit that traffic.

New investors might smirk at the idea of a £50,000 a year transfer being ‘limited’, but money invested in equities can grow like Topsy over time – whatever our recent history indicates!

[continue reading…]

I believe the simplest way to start investing is with a cheap and easy mix of cash and an index tracker.

Banks and financial advisers prefer to sell more exotic products, such as Guaranteed Equity Bonds.

You’ll have seen the adverts:

Invest in the Filchet and Philander Guaranteed Equity Bond Issue Mark 4! Your capital is not at risk (unless the stock market drops by 32.5% between August 13th 2012 and January 22nd 2014) and after five years you’ll get 33% of the gain in the FTSE 100 index (unless it’s up over 75%, in which case you’ll get the 2/3 of any gain over 21% plus half the number you first thought of). You can cash in your bond-thingie at any time, provided it’s a third Friday of either April or October on every odd year from the day you bought the bond.

I exaggerate, but you get the picture. I don’t like these guaranteed equity bonds (GEBs) for many reasons:

• They’re opaque – The average person doesn’t know how they work, or why.

• They’re a lie – ‘Guaranteed’, ‘equity’, and ‘bond’: Words chosen to reassure widows and the guardians of orphans, but these products are actually constructed out of derivatives and options! Hence the weird hurdles like ‘the FTSE must be over 5223 on such a day’, as well as extra counter-party risks.

• They’re confusing – While some of these so-called bonds may offer a good balance of risk versus reward, they’re invariably sold to people who couldn’t tell. In fact, I’ve never met a guaranteed equity bond owner who can explain to me what they’ll get under what circumstances.

• They’re expensive – Not just in terms of the gains you give up for potential security of capital (which may be fair enough) but also the hidden fees rolled into their arcane structure.

• They’re inherently flawed – Most give you a return based on the value of the stock market on some particular day, or if you’re lucky over the average of a few months. But stock markets are volatile, so ill-suited to this. Buying a product where the return is dependent on the level of the index over a few days in five years time is like choosing a spouse based on what you think you’ll get for Valentine’s Day in 2017. You might have five good years followed by a week long crash, yet still be forced to cash out.

People are drawn to these bonds, though, and it’d be arrogant of me to dismiss that. The urge for capital protection is strong, rightly or wrongly.

And when it’s money someone may get just once in his or her lifetime – perhaps an inheritance, or a redundancy payout – who am I to tell them they should be braver with the stock market?

Instead, I’ll tell you a neat way to get capital protection, while still getting the chance to make money from a rising stock market.

How to roll your own Guaranteed Equity Bond

What I’m going to suggest isn’t rocket science.

Guaranteed equity bonds promise to return the sum of money you put into them (ignoring inflation). But you can use cash savings and a stock market tracker fund – plus a calculator – to create the equivalent of a guaranteed equity bond, provided you’re not investing vast amounts of money. ¹

Your DIY guaranteed equity bond consists of two parts:

Part A: Sufficient cash in a fixed rate savings ISA

This is the component that guarantees you get your capital back. Out of your lump sum investment, you put enough cash into the ISA so that when the compound interest is rolled up you’re left with the same lump sum that you started with.

Part B: Invest the rest in an index fund

The money left over goes into a stock market index fund. Whatever the stock market does over the period, that’s your return on your lump sum.

A worked example

Let’s say you have £5,000 to invest for five years. The two steps are:

• Part A – Work out how much of the £5,000 to save as cash
• Part B – Invest whatever is leftover from that in the stock market

Part A: The cash component

Suppose the best five-year fixed ISA savings rate you can find pays 5%.

You can either use maths to work out how much you’ll need to put aside in cash to ensure you have £5,000 left at the end, or you can do what I’d do and simply play with the Monevator compound interest calculator to find the right amount by guesswork:

In this example, the number of years is “5”, the amount added each year is “0”, and the interest rate is “5”. Put your guesses into ‘Initial Amount’ until the Result is £5,000. (If Result is more than £5K, lower the initial amount, and if it’s less than £5K, raise it until it’s as close as can be).

Through trial and error you should soon find that an initial sum of £3,918 saved at 5% will give you £5,000 (and 14p) in five years time.

That is your part A. You put £3,918 into the ISA and let it compound for five years, and get your £5,000 back in five years time.

Part B: Investing the rest in a tracker fund

The leftover money that you don’t need to save as cash – £1,082 in this example – goes into part B, a stock market index fund.

You want to choose the cheapest index fund you can find to keep costs ultra-low. Your best bet as I write would probably be the HSBC All-Share Index Fund, which has no initial fee and charges just 0.27% a year.

Choose the accumulation option so you automatically reinvest the 3% or so in dividends you’re due back into the fund each year.

Returns from the DIY pseudo-GEB

Here’s a few examples of how your returns could pan out, depending on how the stock market performs over the five-year period.

Market return* after five years:	-30%	0%	30%	50%	100%
Cash component after five years	£5,000	£5,000	£5,000	£5,000	£5,000
Equity component after five years	£757	£1,082	£1,407	£1,623	£2,164
Your returns:
Total value of your DIY ‘bond’	£5,757	£6,082	£6,407	£6,623	£7,164
Gain** on your initial £5,000	15%	21.5%	28.5%	32.5%	43.5%

* The index rise or fall plus your reinvested annual dividends. **Return to the nearest 0.5%

• From looking at the table, you can see in my worst case scenario, where the market is 30% down after five years, you still make a gain on your lump sum.

• In fact, if the market was completely wiped out and your index fund went to zero, you’d still get your £5,000 back (assuming banks were still standing!)

• On the other hand, when the stock market (plus dividends) doubles, you make less than half that rise with a 43.5% gain. The cash is a drag on your returns.

This latter point illustrates the price of security. In fact, you need your index fund to make at least 30% over five years for your returns to be better than leaving all your money in cash. ²

But at least this way you do get exposure to potential big gains in the stock market, without risking a nominal loss.

Benefits of this ‘DIY’ Guaranteed Equity Bond

I’m not claiming this cash-and-index combo will deliver better returns than every GEB going. That’s not why I’m suggesting it here.

Rather, I’m putting it forward for the following advantages:

• Simple to understand – Everyone knows what a cash savings account is, and an index tracker fund is as simple as stock market investing gets.

• Cheap – Savings accounts are free, and tracker funds are the cheapest way to invest in a diversified basket of shares.

• Transparent – You can see exactly how much money you’ve got at any time. There’s no hurdles or precipices – if the market drops your fund will go down, and vice-versa.

• You’re in control – You don’t have to sell out of your tracker fund after exactly five years if the market is in a slump. You can wait for a better opportunity. Equally, if the market goes up very quickly in the first year or two then you can take some money off the table if you choose. You get nothing like this hands-on choice with a standard GEB.

I’ll have more thoughts on this DIY guaranteed equity bond in part two, such as how you can modify it to take slightly more risk for more reward. I’ve closed comments for this article, so we can have all the discussion about the pros and cons in one place when the piece is concluded.

1. The size limit comes about because we need tax-free returns from the cash to make the maths work, so the cash component must be under the £5,100 cash ISA limit.[↩]
2. £5,000 in cash at 5% for five years would be worth £6,381.[↩]