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Beginners’ guide to investing II
In the second instalment of her hands-on guide, Margaret Lomas looks at the risks involved in investing in property and dispels some common myths
‘‘All investors have a different capacity to withstand loss based on the amount of money they have to lose, the capacity they have to earn money to replace any loss, and the time they have left available to earn’’
It never ceases to amaze me just how many people fail to understand that buying property, like any other investment, carries risk and that each property type has a different risk level.
Buying shares or managed funds is easier – your financial planner is required to carry out a risk profile to determine your attitude to risk and to recommend assets accordingly. Yet when we buy property, few people attempt to match property types to their personal needs for safety and so they often make inappropriate choices which may turn out badly.
When the topic of risk is raised, most people automatically assume that this means ‘losing everything’, which is unlikely. In financial terms, however, risk can be divided into three categories: the chances of losing your money; the extent to which returns may vary from expectations; and the safety of an investment vehicle in comparison to others.
When investing, the most common thing people worry about is that they will lose everything. For some, this means their life savings. For others, it may be their home or retirement funds. While you can, and people do, lose their money when choosing an investment, the chances of losing everything is usually limited. There could, however, be a loss of the original value of your money, and in rare cases, the loss of all you invested. It would be rare to end up owing more than you originally invested, unless it was a truly bad choice.
When you buy property, you have no guarantee of success. But you always have the property, which limits the risk of total wipeout compared to other vehicles.
Before deciding to invest in property, you need to be aware that returns can vary from expectations. Often the returns on any investment may be enthusiastically quoted or could be based on present market conditions rather than the examination of likely future market conditions. Sometimes people invest based on past performance. This can be a trap, especially when the normal economic cycle (boom, downturn, bust, up-turn) is not taken into account.
The time you have available in which to invest also impacts on how safe you perceive an investment to be and on how it may perform for you. It’s possible for two people with exactly the same amount of funds, choosing the same investment vehicles, to experience two entirely different results. Timing for any investment is key, and the amount of risk you take should directly correlate with the amount of time you have available to ride the market’s highs and lows.
All investors have a different capacity to withstand loss based on the amount of money they have to lose, the capacity they have to earn money to replace any loss, and the time they have left available to earn.
There is no question that things were easier in our parents’ days. They never had to feel envious when their neighbours were buying their third investment property while they were too frightened to buy their first. This was mainly because no one was buying investment properties. They all just plodded along building their first homes then paying them off to retire on what was rightfully theirs – the old-age pension.
So, it stands to reason that when they became parents, from a financial perspective they taught us only what they knew. As far as they were concerned, we didn’t need to know much about money – how complicated did it really get? All you had to know was that you worked, you saved, you borrowed for your family home and you paid your bills on time.
What this means for many adults today who otherwise are able financially to begin an investment portfolio is that they are still guided by investment myths which simply are not appropriate for now. Let’s take a look at some of these myths.
Myth 1: You must be debt-free before you begin an investment portfolio. Our parents hated debt because their parents taught them to. Today, waiting until you own your own home debt-free may mean you miss the boat completely. The way to deal with this myth is to know that personal debt is bad debt, but debt which secures income producing growth assets is good debt. As the asset grows, you only need to repay what you borrowed, and you can keep the rest to fund your retirement.
Myth 2: You need cash lump-sums to invest. In the past, only those with a lot of available cash invested. Banks were not as amenable to property investors, and so few people thought about borrowing to invest. The beauty of property as an investment today is its acceptability by banks as a security for borrowing. That being the case, once you have entered the market with your first cash deposit (usually via a purchase of an owner-occupied property), even low growth on property will mean that you can leverage again and again over time, even if you never have any actual cash to do so.
Myth 3: Capital growth is the single most important feature of an investment property. Without doubt, capital growth is important over time. However, your sole reason for investing in property should be to hold on to it for as long as you can so you can gain the maximum amount of growth. To do this, cash flow aspects of the investment today should be more important to you than its potential growth rates, since the ability of a property to support its own costs is what will keep you in the market.
Myth 4: Your family home is a financial asset. These days, choosing to view your family home as an asset can be a mistake as it allows you to forgo preparing adequately for your retirement. If you do not want to end up having to sell the family home and move outside your neighbourhood to liquidate cash to live on, then you must accept that your home will remain a liability until you choose to use it to leverage into other income-producing assets. For many, this will mean dealing with fear of debt now, and understanding that another day you wait may be another you waste.
Myth 5: You need to be a risk taker. Perhaps the biggest misconception about investing is that you need to be a risk taker or highly intelligent and astute to succeed. Almost anybody with any level of income can put together some form of investment portfolio, and most probably include property in that portfolio. The key is to become informed. Ask questions and read as much as you can. Consider all viewpoints. Start today and don’t procrastinate.
Understand it may not run smoothly and at times it will seem that the adversity is just too great to overcome, but slowly and surely your portfolio will grow and prosper. And, most importantly, you will have taken the responsibility for your future into your own hands.
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