Investment advice appreciated!

[Aurelius]

My sister recently started studying at university.

 

After taken my advice, she has taken on a student loan. This student loan will give her appr. $550 a month. Her studies will take 5 years.

 

The loan will cost her 4% per year while she studies.

Post university the loan will cost = the national discount rate (0% presently) + 1%.

 

She will have to pay it back within 11 years after graduation.

 

The plan is to invest the loan while studying and thus have a very cheap loan after she is done with her studies.

 

If she would get 4% annually while studying it would be a success. Safe returns are more important than going for maximum returns.

 

I have some ideas where to invest her money, but I would really like to hear your suggestions...?

[thepupil]

Does mark to market/duration risk matter?

 

If not, I would humbly recommend preferred stocks of high credit quality REITs, decent banks, and the safest perpetual instrument I know of: Tri-Continental Corp Preferred which pays 5.3% and is incredibly well covered ($40MM preferred which is in front of $1.3B of common)

 

 

https://www.google.com/finance?q=NYSE%3ATY-&hl=en&ei=oLeyU-j4BITKqQH7nICgDA

http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/94012

 

Edit: Just reread your post and realized the loan is basically a fixed (at 4%) to floating instrument, making my recommendation of perpetual preferreds inappropriate because of the risk of rising rates

[Ham Hockers]

 

If she would get 4% annually while studying it would be a success.

 

 

No taxes?

[writser]

Frankly I think it's just a bad idea on multiple levels. Maybe there is a huge tax incentive however.

[beerbaron]

I would not do that. If by some means she has less money in 5 years than now she will be very mad at you. 4% is an ok hurdle but not low enough to invest in 5Y treasuries... which would make it a riskless arbitrage.

 

I find that helping people make money without managing yourself is a negative risk return. If you are right you get very little benefit and if you are wrong you could ruin the relationship.

 

BeerBaron

[Guest wellmont]

the best laid plans of mice of men / often go awry /

[zippy1]

I would not do that. If by some means she has less money in 5 years than now she will be very mad at you. 4% is an ok hurdle but not low enough to invest in 5Y treasuries... which would make it a riskless arbitrage.

 

I find that helping people make money without managing yourself is a negative risk return. If you are right you get very little benefit and if you are wrong you could ruin the relationship.

 

BeerBaron

second that!

Ben Graham ruined the relationship with his sister I think during the great depression....

[peter1234]

If I understand the situation, it is a total of about $33k in monthly increments of $550. With these sums, trading fees will be important.

 

Markets are currently not cheap, so not sure what I would advise a new investor.

Certainly must be able to withstand a 20% drawdown in any year.

 

Agree with other posters that this is a risky proposition. If you read Hussman and others, he would tell you that probability for  :'( is high.

 

Nevertheless, here are some thoughts:

Easiest would be adding to a total market index every month (say Vanguard).

Mutual fund wise, could select something with a value or small cap tilt.

 

Possible Funds (some might be closed), need to check minimums and fees.

Third Avenue Focused Credit

Fairholme

Akre

Artisan

FPA Crescent

Oakmark Small International

 

If she is new to investing, I would probably stay away from individual stocks and might go with something that is not very volatile.

[Liberty]

I find that helping people make money without managing yourself is a negative risk return. If you are right you get very little benefit and if you are wrong you could ruin the relationship.

 

BeerBaron

 

Totally agree.

[Guest deepValue]

Are there any penalties for not paying any principal or interest before the 11 years are up? If not, this was a brilliant idea and any asset that rises with inflation should be profitable. If repayment begins after five years, it may still be a decent risk assuming she gets a decent job out of college. At worst, she might be a few $k in the hole, which is rounding error for grads who get decent jobs. If she's down 20% after 5 years and wants to be absolutely safe, she can sell her positions and use the remaining $26k to make payments and would have to save maybe $2k/year to make up the gap. But it's really hard to be down 20% over a five-year period if you're even halfway prudent (especially since she'll be averaging in to whatever assets she buys).

 

I'd suggest Vanguard 500.

[merkhet]

A few questions:

 

(1) Do you want to pay the loan off after 5 years?

(2) Is the interest rate fixed or variable after the first five years?

 

If it's a low and fixed rate loan for 16 years, and your sister has other funds available to her in order to support her through her studies, then I don't really see the problem with investing the money over that timeframe -- so long as you don't immediately need it after 5 years to pay down the loan.

[Aurelius]

To expand on the loan specifics.

First year payments run for up to 5 years on 4%. 2nd year for 4 years on 4% etc.

 

After graduation she'll have 15* years to pay back @ national bank discount rate + 1% (present cost is 1%). It can not be delayed further. She will have to pay fixed amounts each month or pay back sooner if she wants to (which would defeat the whole purpose this plan…)

*I was wrong. Payback period within 15 years after graduation, not 11 years.

 

On tax incentives:

Non other than she will be able to deduct interest payments for years 1-5 when she starts to pay back.

 

Beerbaron:

If possible she will transfer money to me each month automatically. I will then invest it for her.

 

deepvalue:

Her start salary is at the minimum presently $6650 a month in her future profession.

 

merkhet

The ideal scenario would be to compound at 4% (or more obviously) while studying. That way she will have a fixed 15 year loan which would be very cheap. Compounding at lower rates than 4% could still make the overall loan very attractive. 

 

---

I am a little surprised about the worries lots of you have. I am thankful for your concerns. This means I need to talk more with my sister.

 

This just seems like a deal too good to pass on. At least if you did it for yourself.

 

Two scenarios:

1) She has graduated and has compounded at 3-4%. This will save her quite a bit of money when she will need to borrow money for a place to live. (Probably 2% is also fine… haven't done the math)

 

2) Assuming she is down 25%, which is going to be hard averaging in**. In this case she could leave the money for investments for a further 15 years at a very low cost while paying back the loan.

**To be conservative she wouldn't have to invest the year 5 loans in equities. Instead just put it into her bank account.

 

[Hielko]

It might rationally be a good bet, but that doesn't necessarily make it a good idea. What's your sisters risk tolerance? Wha't's the downside for your relationship with her if this plan doesn't work out?

[Zorrofan]

Are there any penalties for not paying any principal or interest before the 11 years are up? If not, this was a brilliant idea and any asset that rises with inflation should be profitable. If repayment begins after five years, it may still be a decent risk assuming she gets a decent job out of college. At worst, she might be a few $k in the hole, which is rounding error for grads who get decent jobs. If she's down 20% after 5 years and wants to be absolutely safe, she can sell her positions and use the remaining $26k to make payments and would have to save maybe $2k/year to make up the gap. But it's really hard to be down 20% over a five-year period if you're even halfway prudent (especially since she'll be averaging in to whatever assets she buys).

 

I'd suggest Vanguard 500.

 

What about something like Canadian banks (3.5 to 3.8% yield), FFH in case all H@ll does break loose and those hedges pay off (roughly a 2% yield) and finally some OAK (7.8% yield and invests in distressed situations).  my concern with the S & P 500 would be what happens if there is a black swan (europe?), Ukraine, Iraq etc etc.....

 

cheers

Zorro

[Guest deepValue]

Are there any penalties for not paying any principal or interest before the 11 years are up? If not, this was a brilliant idea and any asset that rises with inflation should be profitable. If repayment begins after five years, it may still be a decent risk assuming she gets a decent job out of college. At worst, she might be a few $k in the hole, which is rounding error for grads who get decent jobs. If she's down 20% after 5 years and wants to be absolutely safe, she can sell her positions and use the remaining $26k to make payments and would have to save maybe $2k/year to make up the gap. But it's really hard to be down 20% over a five-year period if you're even halfway prudent (especially since she'll be averaging in to whatever assets she buys).

 

I'd suggest Vanguard 500.

 

What about something like Canadian banks (3.5 to 3.8% yield), FFH in case all H@ll does break loose and those hedges pay off (roughly a 2% yield) and finally some OAK (7.8% yield and invests in distressed situations).  my concern with the S & P 500 would be what happens if there is a black swan (europe?), Ukraine, Iraq etc etc.....

 

cheers

Zorro

 

The stock market will probably nosedive sometime within the next five years. The money invested this year and next may earn poor returns, but money invested after a crash will generate higher returns. If she gets to year three and the market is still rising, she'll want to re-assess her investment plan depending on how much is due and when. Rolling puts might be an option as well. There are just so many ways to make this loan profitable for the borrower.

[Vish_ram]

Your sister would have learnt something about the market, interest rates, fed etc after 11 years; something that the university can never teach. Now that's an education.