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The Six Absolute “Must Ask” Questions Before You Invest …BECAUSE WHAT YOU DON’T KNOW CAN HURT YOU From The Series The Retirement Planning Time Bomb… AND HOW TO DEFUSE IT Tony Sandercock wetalkmoney Contents What’s This Book About? 3 How Can I Lose Money With This Investment? 4 How Will This Investment Help Me Achieve My Objectives? 8 Can I Easily Get Out Of This Investment? 10 How Much Do I Expect To Earn On This Investment (And Is That Realistic)? 12 Does This Investment Make Sense After Fees And Taxes? 13 Does This Investment Fit In With What I Already Have? 15 What Next? About The Author 2 Title of the book 16 17 Welcome Ignorance about investing is not bliss… it’s expensive. What you don’t know about investing will cost you money. But the cure is simple – proper research. Proper Research is what separates the professional investor from the amateur. Amateur investors act irresponsibly by risking their hard earned dollars on hunches, articles they read, recommendations from product salesman or hot tips, without first performing due diligence. This approach is just asking for trouble. Professional investors do the opposite. They take a long, hard look before putting a cent of capital at risk. Yes, it can be painful and sometimes difficult, but getting answers to the tough questions up front can save you from expensive losses down the road. There’s simply no substitute for proper investment research because it’s what you don’t know about the investment that will cost you. Make sure you don’t miss a trick with these 6 “investor savvy” questions. The Six Absolute “Must Ask” Questions Before You Invest 3 Research Question # 1: How Can I Lose Money With This Investment? This question is so important I’m tempted to throw away the remaining five questions and just keep repeating this one over and over. You don’t properly know an investment until you understand all the ways you can lose money with it. I can’t overemphasise the importance of this question. You must first focus on the return of your capital, and only then concern yourself with the return on your capital. The first question when analysing any investment is to find all the ways you can lose money by identifying in advance all the major risks that can lead to losses. Once these risks are fully identified, the second step is to minimise these risks wherever possible. The Six Absolute “Must Ask” Questions Before You Invest 4 Step 1 – Identify the risks How many ways can you lose money? There’s a lot! Don’t get too concerned, we’ll talk about the ways that you can manage them later, but your first job is to identify them all. There are plenty of traps for the unwary, but for practical purposes, they can be sorted in to a few major categories: 1. MARKET RISK - The risk that comes from just being part of the investment markets. For example, if the share market falls sharply, it’s likely that almost all shares will go down in value. The same goes for the property market and most other investment markets too. 2. SPECIFIC RISK - The risk that comes from owning an individual investment. If it’s a share, that could be how well that company is managed. If it’s property, it could be the amount of unforeseen maintenance needed. 3. LEGISLATIVE RISK - The risk of the laws changing that will affect your investments. Changing superannuation rules is a great example of this, as are potential new negative gearing rules for investment property. 4. INFLATION RISK - Inflation eats in to the purchasing power of your money whether you are invested or not. So it is a stealthy risk that can erode the value of a portfolio year after year. Cash in the bank earning rates of interest lower than inflation, is the best example. 5. CREDIT RISK - The risk that a borrower defaults on your loan. For example, that loan you made to a family member – it’s the risk that you won’t get your money back. 6. LIQUIDITY RISK - The risk that you may not be able to sell the investment at short notice due to the illiquid nature of a particular investment. An example of this is commercial property, that can some times take a long time to sell. 7. OPPORTUNITY RISK - The risk of losing the income or earnings you could have made on one investment because you did something else that wasn’t as profitable. An example of this might be if you bought an investment property in one location and you miss out on the capital gain that you could have achieved if you had bought the property in a better location. The Six Absolute “Must Ask” Questions Before You Invest 5 Step 2 – Manage Those Risks There are a number of things you can and should do to manage the risks associated with investments. These include, but of course, are not limited to: Making sure your investment strategy meets your investment objectives and financial situation Understanding the nature of the investment you are making Investing for at least the suggested minimum investment timeframe for a particular investment vehicle Regularly reviewing your investments The diagram below demonstrates the risk reward relationship of four of the more common types of investment: IGNORANCE About Investment Isn’t Bliss – It’s EXPENSIVE Diversification is a key strategy to reducing risk, which is just a fancy way of saying “Don’t put all your eggs in one basket”. It means holding many different investments. This way, a loss in one market, is offset by gains in others, producing a more stable and reliable return overall. A well diversified portfolio will also allow you to capture positive returns, no matter where they occur. The Six Absolute “Must Ask” Questions Before You Invest 6 Your Risk Profile We all have different attitudes toward risk. Think about how comfortable you are with the possibility of losing money, how long you have to invest and how you emotionally deal with market ups and downs. You need to consider investments that balance your appetite for risk with their ability to reach your financial goals. This is a decision that is very specific to you but it is an important one as you want to able to sleep at night. Only you can determine your 'sleep at night' factor. There are a wide range of tools available to determine risk profile. Before you start using them remember that risk profiling tools can: help you understand how you feel about risk clarify your understanding of your tolerance for risk provide you with a general illustration of how people with certain risk profiles may choose to diversify their investments Never be a substitute for personalised and specific advice tailored for you Explore the links below to the various risk profile tools. We suggest you pick a couple so that you can compare results. FinaMetrica BT Investments ASIC MoneySmart Rest Industry Super Below is a table that will explain some of the common terminology. Investment style Your primary investment goal is.... Conservative Capital protection You require stable growth and/or a high level of income, and access to your investment within 3 years. Cautious Capital protection You require fairly stable growth and/or a moderate level of income. Your investment term is 3 years or more. Balanced Capital growth You can tolerate some fluctuations in the value of your investment in the anticipation of a higher return. You don't require an income and you are prepared to invest for 5 years or more. Moderately aggressive Capital growth You can tolerate a fair level of fluctuation in the value of your investment in anticipation of possible higher returns. You don't require an income and you are prepared to invest for 5 to 10 years. Aggressive Long-term capital growth You can tolerate substantial fluctuations in the value of your investment in the short-term in anticipation of the highest possible return over a period of 10 years or more. The Six Absolute “Must Ask” Questions Before You Invest 7 Research Question # 2: How Will This Investment Help Me Achieve My Objectives? Sound like a silly question? The old adage, “If you don’t know where you are going, you will probably end up somewhere else,” is as true of investing as anything else. Your investment objectives might be to maximise profit while minimising risk, or just achieving a particular return or even receiving a certain amount of income. But it’s not enough to just have a portfolio objective – you must have a personal objective too. Why? Financial success is a lifelong process. The only way you’ll stay the course long enough to succeed is when your investment strategy fits your budget, your interests, your skill level and your lifestyle goals – that is a recipe for success. My 25 plus years of talking to people about their money has proven to me that if you have clear objectives, you do better with their money. Clear objectives give you purpose, direction and focus. The Six Absolute “Must Ask” Questions Before You Invest 8 Goals Are Your Internal Success Mechanism Goals Setting is said to be the most researched theory of motivation in the field of organisational psychology. Most of us understand the importance. Yet so few of us actually do it! Do a Google search, there is information everywhere. So if you haven’t been through the process, it can’t be from a lack of material. Here’s 3 observations: 1. One characteristic that sets apart the peak performer in any aspect of life is their intensity. They are goalsetters. They are motivated by compelling, burning, internal goals. It comes easy to them, because they love what they do. 2. Money is a shallow motivator. The thoughts by which successful people establish their goals might be the good they can bring to other people or to be the best that they can - anything but money. Yes, there has to be a payoff for you, but if you want people to come on the journey with you, it's got to be bigger than you. 3. A popular view is that we become what we think or believe. Change your thoughts, change your life. It’s a seductive concept. But if you’re struggling with financial hardship, it will take more than an attitude adjustment to move you from suffering to joy. Success is directly connected to action. You have to keep moving. The best way to feel better about a situation is often just to make that first move in doing something about it. There are any number of approaches you can take. Just google "goal setting", and there are tools, tips and information everywhere. Do some research and choose one that suits you. Personally, I like SMART Goals but there are plenty to choose from. What matters most is that you actually do it. The Six Absolute “Must Ask” Questions Before You Invest 9 Research Question # 3: Can I Easily Get Out Of This Investment? Always begin with the end in mind. Why? Because not every investment will be right forever. Times change, investments change, you change. You had a reason for buying an investment, and when those reasons no longer apply, it’s time to move on. By knowing your reasons in advance, there’s no confusion or hesitation with the sell decision. I can not think of many investments that I wouldn’t sell if circumstances required it. Your job as an investor is to understand what those circumstances are, so that you are ready to take action. The Six Absolute “Must Ask” Questions Before You Invest 10 Know When to Hold ‘Em, Know When to Fold ‘Em Most people who ask about when to sell are often staring at a big loss. What do you do? Many would say not to sell “until you get your money back”. This is a common response to a poor investment. The pain of losing a dollar is so much greater than the joy of gaining the same amount. In fact, our need to avoid a loss can be so great, we can become incapable of sound judgement. So what should you do if you are staring at a big loss. Do you cop it and move on or hang on and hope it will bounce back? Well, that all depends on your circumstances. However, I have an observation to share after watching a lot of people lose a lot of money on dud investments deals over the years. Time does not turn a bad investment into a good one. The reality is, that money is gone. IGNORANCE About Investment Isn’t Bliss – It’s EXPENSIVE You can anchor your expectations on getting back to where you started, but what you paid for that investment is irrelevant to the next buyer. All you can deal with is the here and now. The question to ask yourself is, given what you know about the investment right now, being its growth potential, its income, risk, affordability and so on, would you buy that investment today? Another time to look at the makeup of your portfolio is when your circumstances change. Retirement is the classic example. Investments that make up a great wealth creation portfolio, may not be the best investments to support a retirement income stream. A retirement income portfolio is best when it has liquidity, flexibility and security. Not all growth assets have those characteristics, hence the need to re-evaluate in the lead-up to and upon retirement. The Six Absolute “Must Ask” Questions Before You Invest 11 Research Question # 4: How Much Do I Expect To Earn On This Investment (And Is That Realistic)? Early in my career, a couple of very powerful phrases were drummed in to me: 1. “The share market has averaged 12% over its history.” 2. “Property doubles every 7 years” They stuck in my head, and may have even made their way in to my vocabulary very early on. But are they true? The answer is that both of these statements are ridiculous. Let’s stick with the share claim. I took some time to ask some industry colleagues their thoughts on this issue. A small number say 10%, and a great deal of them say somewhere in the range of 8% before costs and taxes. “If someone is relying on a 12% return to get them to retirement or pay for their kid’s schooling and that return doesn’t materialise, they are in a world of hurt with very limited and unattractive options. 7% (assumed rate of gross return) allows me to focus on what a client can control: their savings rate,” noted one fee-only financial advisor. Download here a brilliant resource that provides historical performance for most share and fixed interest markets over any time period. The Six Absolute “Must Ask” Questions Before You Invest 12 Research Question # 5: Does This Investment Make Sense After Fees And Taxes? Successful investing is about what ends up in your pocket. And depending on the investment you have, it can sometimes be hard to nail down exactly what you’ve earnt after all the costs and taxes are taken in to account. But you need to. While moves in the market are temporary, costs are permanent. Over time, they can put a real dent in your wealth plans. That's why you MUST be mindful of fees and expenses. Studies show that cost is actually the single best predictor of future investment performance for some investments. Leading research organisation Morningstar even found that cost predicted the future performance of managed funds better than their own widely-used star rating system. The Six Absolute “Must Ask” Questions Before You Invest 13 Case Study Meet our investor, Bill. He is single and earns $100,000 per annum. He has three investment strategies – a residential investment property, share trading account and a managed These same rules apply to his share trading. Bill bought some shares for $10,000 two years ago which are now worth $20,000. His broker is fund invested in International Shares. Congrats Bill, great suggesting to take a profit and invest work!! Let’s now drill down in to each of these strategies that in the next “big thing”. and see how costs and taxes impact his profits. Let’s look closely at that. Fees and Bill bought his property for $400,000 a few years ago. He has Capital Gains Tax add up to around just received a firm offer for $500,000. He’s found dealing $2,000. with tenants a real hassle and figures that a $100,000 profit might be worth taking. Let’s look at that a bit closer. What is his true profit after fees and taxes? What did it cost him to buy it? - $10,000 in stamp duty, transfer, legal and bank fees. What did it cost him to own it? The rent didn’t cover the So that means that the new investment will need to earn that $2,000 just to cover the cost of the transaction. That’s a rise of 10% just to break even!! expenses, so after tax, he paid $10,000 from his own money What will it cost him to sell it? – About another $15,000 in Read more here about the costs and real estate agent fees and other costs benefits of share trading What about tax? – This is an investment property, so capital gain tax applies. $12,000, thanks very much. That’s a total of $47,000 in costs and taxes, or nearly half the growth of the property. Even so, the $53,000 profit is money he would not otherwise have had, which is great. But what looked on the surface to be a solid profit of 25%, is in fact a lot less. Maybe Bill should consider keeping this property for the long term, so that those costs can be spread out over many more years. Let’s now look at his managed funds. Bill has invested in a large actively managed International share fund. An active manager is trying to beat the market return by actively buying and selling shares. This results in higher fees and higher taxes. Markets have been strong in recent years, so on the surface, Bill’s fund seems to have performed well. But an investor can only spend the post-tax, postfee investment return, which can be significantly lower than the headlines would suggest. Read this article to understand how high turnover funds are weighed down by these higher costs and taxes. The Six Absolute “Must Ask” Questions Before You Invest 14 Research Question # 6: How Does This Investment Fit In With What I Already Have? No investment decision should ever be viewed in isolation. You aren’t just buying a share or a bond or a managed fund or a rental property - you are buying an additional piece of your personal investment jigsaw puzzle. And each piece must interlock. Just because it looks good on its own does not mean it will fit in well with what you already have. In my experience, more wealth is destroyed by poorly balanced portfolios than any other cause. Yes, apples are good for you, but if that’s all you eat, you’ll eventually get sick. The Six Absolute “Must Ask” Questions Before You Invest 15 Next steps There you have it! Investing can be a successful or disappointing experience, depending on how well you do your research. Getting the answers to the tough questions up front can save you from expensive losses down the road. A quick review of the six “must ask” research questions is: 1. How can I lose money with this investment? 2. How will this investment help me achieve my objectives? 3. What’s my exit strategy? 4. How much do I expect to earn on this investment (and is that realistic)? 5. Does this investment make sense after fees and taxes? 6. How does it fit in with what you already have? That list is just a start. You could write an entire library of books on the subject. My goal with this EBook was to arm you with some of the more important due diligence questions that can help you avoid the most obvious and expensive errors. I hope it helps you. The Six Absolute “Must Ask” Questions Before You Invest 16 About The Author What do tough but fair parents, a World War 2 veteran, football coaches and business mentors have in common? For Tony, they all had a key role in molding him into the person he is today. They showed him the importance of honesty, integrity, discipline, hard work and most importantly, taking a genuine interest in people and helping them improve their lives. It was this desire that led him to start his first financial services business is his early 20’s and eventually move on to take up a national manager role with Australia’s fastest growing financial advice firm. As a truly independent advisor, many of Tony’s clients have come to him frustrated at the lack of trust in the financial industry. Too many planners put their own interests ahead of their clients. As there is no conflict of interest in the relationship, Tony can give his clients the best, impartial and objective advice to help them reach their goals. Others are confused and paralysed by fear, not knowing where to start or what to do. With his uncanny ability to separate what is important from the noise, he simplifies complex decisions leaving his clients with a clearly defined path to retirement. "I have been in the accounting industry for close to 25 years and have been very sceptical about the true value of the financial planning industry and the real value that planners provide. During this time, I have searched high and low to create a connection with someone who treats the clients like I do and I feel will be there to listen and work with their clients to achieve financial and life goals. Tony is the closest person I have found who shares my values of client care and service and in my opinion is not your typical financial planner" Ian Judson, Brisbane QLD The Six Absolute “Must Ask” Questions Before You Invest 17 IMPORTANT INFORMATION This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each individual and investor are different and you should not act on this information without speaking to a financial, tax or legal adviser, who can consider if the financial products and strategies are appropriate for you. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. See full Terms and Conditions here. Tony Sandercock is Authorised Representative No. 287974 and TTLB Investments Pty Ltd ABN 22 600 525 764 trading as wetalkmoney is a Corporate Authorised Representative No. 467267 of AspectFP Dealer Services Pty Ltd ACN 091 004 885 AFSL No. 225738 of Unit U6, 68-70 Old Princess Highway, BEACONSFIELD VIC 3807. From The Series The Retirement Planning Time Bomb… AND HOW TO DEFUSE IT wetalkmoney 18