Planning for Investment Success

I have so many people visit me and ask the most beautifully innocent question: “How do we go about planning for investment success?”

I usually, after offering some motivational words, suggest they attend a weekend workshop and consider their options after taking on some education.

This has prompted me to write this article about how to go about such planning "in a step by step way."

At the start I must mention that I have no idea how long this article will end up . . . just that post by post and chapter by chapter, I will continue to submit sections up until I think the ‘message’ has been covered. (Perhaps this might be a weekend workshop – expressed in words )

Please feel free after each submission by me, to post replies / questions. As usual, it will be more interesting if we do this on an interactive basis.

CHAPTER 1 - Getting Started.

The correct mindset – the initial focusing event.

Ultimately I think it all starts with a certain mindset . . . a decision basically that you want to do something about your life and circumstances. Usually there has been an event or trigger that gets you thinking that you ought to do ‘something.’

I was fortunate to be exposed to the financial world at a young age (16 years) but even so I think the main trigger event for me was on hearing that my wife was pregnant with our first child. Suddenly a new sense of responsibility towards something other than our frivolous lifestyle set in and I decided that I better start focusing on things aside from the next party we might be attending. I remember coming home and saying to my wife: “I’m tired of being poor.” Our naïve intuition decided that we had to buy a home by the time this baby was born . . . which is how we got started. (Our first real asset.)

My first question then is: What was your trigger event that made you start planning for investment?


Assessing your situation:

The most basic position is when you start with zero, or very close to nothing. . . and it gets a bit more complicated thereafter.

For most people who start with very little an ‘idea’ of what might achieve a result is a good start. Back to my initial start, both myself and wife were on reasonable incomes, the problem was that the money ‘just went’ - on lifestyle . . . socializing, cars, clothing and holidays! (Well you are only young once ) We worked out that if we saved most everything over the next 7 months, we would scrape up enough for the deposit on a first home. (Yes, homes were not insanely expensive back then!) Also the tax system was different to here in Oz, and I was able to defer most tax in that year and put it all into the growing deposit required.)

However, this might not be possible for everyone so the initial thoughts might be about saving money until you have enough to acquire some assets. (After all, it is the assets that will make you wealthy.)

Some questions:
How to save?
Where to save?
What asset/s to buy?

Hmmmmmmm, I see that this article might overlap with some of the existing posts . . . I will leave it to Sim’s discretion how he incorporates the ‘bigger picture.’

How to save:
I read in an earlier post that a great method is by way of a salary deduction directly to another account / avenue. Imagine you received a 10% (or more!) decrease in wages . . . and had to adjust to a new way of living. Sounds terrible I know (choosing what to do without), but the dream of the ultimate goal usually more than makes up for this.

In any event, whatever method one chooses . . . zero savings compounded will always equal zero, so the mental commitment of a savings figure (whatever can be afforded) is a great start.

Where to save?
Assuming you have no other assets, then the choice might be to save as a cash vehicle (bank or building society / bonds etc) and then depending on your risk profile and time horizon you might consider shares, options and so on.

Everyone will have their own idea of what might present the best medium in which to save. Hopefully there will be many responses to this question: “Where to save” that other forum members will share with us.

For someone starting out I usually recommend shares with leverage. (Margin loan.)

I will continue this article with some justification (pros and cons) on using leveraged shares . . . next time.

In the interim it will be interesting if others might contribute their thoughts about what has been covered so far . . . and we can build from there.

Regards,

Steve

PS: Is is good to be back and contributing

Great to have you back with us Steve - looking forward to more posts in this series on planning.

Just wondering.... why isn't this in the articles section? Is it because of Steve's preference for open dialogue? Are they going to be added to the articles section once completed? Just wondering, so I don't waste my time cutting and pasting into a word doc.

Anyway, great post (as usual) Steve. I must say that my personal preference for saving is also to put money into shares and margin that amount.

As far as how to save... well, read an article by Brian Tracy a little while back, which was (surprisingly) pretty lite on. However, did get one bit of info from it that was defintiely worth it. It was aimed at people that want to save but feel they 'can't' for whatever reason.

What Brian suggested was for people who find it difficult to save to put aside 1% of their pay each week/fortnight/month/whenever. Once they became comfortable with that, they put away 2%, then 4% then 6% up to (he suggested) 10%. Seems to be a good way to do it I reckon.

At the same time however, I think the discipline of saving is what really separates those who 'dream' of doing something from those who actually do something. Doesn't guarantee success of course, but like Steve said, 'zero savings compounded will always equal zero'.

Mark.

Thanks Steve for that post. I'm looking forward to what assets to buy. What comes first the chicken or the egg (property or shares).. I appreciate you are busy with the end of sept distribution and the extension of the Navra fund until the 21st October, however, it would be great to have an update on living on equity and rental reality. Hey, it's all good fun

Bob

Looking at the 1st 2 questions:

1) how to save? Self-discipline has to be the key.

The maths is simple: Income must exceed Expenditure, it's the psychology that people find hard...particularly when the savings seem so small to start off with and it would be so much more fun to ... buy that car, take that holiday...(insert consumer spending item here).

So what's the key to getting the right mindset? I'm no shrink, but I suspect you must develop a deep and powerful motive for saving. For example...you might REALLY hate your day job. Whilst it's perhaps not too constructive to be driven by hate that could be the fuel for you saving and then investing to be able to change jobs.

Alternatively you could be driven by FEAR, namely fear of retiring on the pension, fear of not being able to provide for your family, fear of being poor.

Hopefully some people will find their motivation in the positive things which they WILL have in the FUTURE...more time with family and friends, the ability to buy the things they want, have the freedom to choose their activities etc...

I guess ultimately what I'm saying is this. Whilst emotion generally has no place in the investment decision making process, a deeply emotional motivation is probably necessary to be able to lay down a deeply ingrained habit of saving and investing for the future if one doesn't have that habit already.

On the 2nd question, "where to save?", I think it happens in stages.

Once you establish a pattern of saving into a bank account and have some cash savings in a transaction bank account, people tend to then establish an online "high" ahem, interest rate account eg INGDirect, BankWest etc and move money into that.

Once the balance starts to build up a bit into the multiples of thousands comes the crunch time. Speaking to a many work colleagues about this they then tend to go one of two ways. Either they crack under the pressure of having more money than they've ever had in the bank and blow it on a holiday or a car or 3 designer dresses and matching shoes and handbags etc etc OR they start to question whether things like shares or managed funds could be for them...

Ultimately keeping your money in a managed fund or shares will probably provide far superior returns than keeping it in the bank due to the fact you have growth potential as well as income generation...but the critical factor is TIMEFRAME. When will you need to access that money? If you have a definite requirement for most or all of that money within a short period then shares may NOT be the right medium due to their volatility. That higher return comes with added risk, ie the risk of losing capital value...which you don't have with a bank account. If you don't need the money anytime soon, and it's not a trifling amount then shares/good managed funds obviously are the way to go...due to their inherent liquidity.

ps. with performance for the quarter for NavraInvest at over 9% so far...it definitely seems like dollar cost traded shares are the best place to save!!!

I believe that the correct mindset and motivation are the most important factors when it comes to investing.
When hubby and I were childless many eons ago (well it seems that way at times!) we decided to go overseas and do the big European trip for 6 weeks.
We spent the equivalent of a deposit on a house at the time, but have never regretted it for a single minute
Funnily enough, once we made the decision to go, without much in the bank, it only took us 8 mths to save up the cash. Motivators really are needed to reach that goal.
For me, investing is all about the possibilities of enjoying both the jobless future and also the here and now, hence the need to invest in both long term assets and income producing investments.

Nigel, you're so right about the self-discipline, as it's easy to fall into the trap of spending more than you earn, or increasing the spending when your income increases.
Sim's articles on saving also have some great tips for the starters and those less motivated when it comes to investing.
I also consider it crucial to help your own children from a very young age, by stressing that "putting away" is a necessary part of earning money. My three all receive pocket money, and we have recently negotiated that they have to bank at least a third. Sometimes they bank more, depending on their mood at the time

Actually it is at 10.67% net (29/09/05)

Welcome back Steve....

Your trigger was finding out your firstborn was arriving soon? Yep......I can partially relate to that.........and the pressure doesn't seem to reduce any as they get older(and more expensive!)

I don't know if my 'trigger' was really an isolated incident though but rather a gradual realisation that life is short and that finances can play a useful part in allowing you certain choices. Having a large bank balance is certainly not my number one priority in life as there are many more important things.......however......I think it would be remiss and maybe a bit lazy of me if I didn't learn more about a tool that could provide certain opportunities for me and my family.

How to save? Where to save? What asset/s to buy?

I guess this changes as time goes by. Right now my priorties are paying off non-deductible debt and increasing my asset base. Many nice things can happen when these two things progress.

Besides my individual saving, I'm getting a huge buzz out of trying to teach my eldest daughter a few 'savings' tips and it's amazing how well thet respond at such a young age. When she saved $1000(which she did over about 2 years) she was allowed to buy some Units in a Managed Fund.
Tonight we were just going through a beautiful example where we compared what she gets from her Bank Interest(2.61% pa including 'Bonus' Interest ) and we compared this to her current share investments(9.81% net this quarter so far ). Even at her age........you could see the little light bulb appear over her head when she saw the differences.......

Our Trigger was the discovery of my wife's degenerative eye condition, combined with the fact that we had paid off our PPOR and the pair of cars we bought after we paid off the house...

Savings - we never got into the habit of spending all our income, so I guess paying the 18% interest rates (80's and early 90's) was a good thing in that respect. We always had automatic savings systems in place (deductions to a savings account, Xmas club accounts etc.)

Mindset - we actually started investing after attending a seminar (telemarketers - "silver suit brigade") on why to invest in 2000, but I don't think our mindset was fully developed until 2003 - after some education seminars (free) by Wise Investments (yep- they sell you properties later, TNSTAFL!) and going off on my 2nd bout of RSI in 10 years gave me time to get bored and pick up Rich Dad Poor Dad. That REALY started a reading frenzy - mostly mind set stuff including Kiyosaki, Napoleon Hill and John Burley then branching out into Peter Spann, Waxman, Sugaes etc. (hmmm must do post for booklist! - 2nd Hmmm must do booklist for self!! )

Although we bag the "silver suit brigade" for telemarketing us and pressure sales, they did us one service - changing our fear factor from fear of investing (and loosing money) to fear of NOT investing (and being broke in our old age!!), our mindset has developed a long way since then and the wealth of opportunities has multiplied expodentially - we now see them everywhere, wheras before we could not see them for the fear!

CHAPTER 1 - Getting Started. CONTINUED

I had previously mentioned utilizing the MF with a margin loan as a medium in which to save and promised some justification.

First up let me say that post the ‘trigger event’ that gets you started, it doesn’t matter where you save as long as you make a start!

Now savings plans can be at the very conservative end of the risk scale . . . in a bank or building society. I am covering old ground here, but these are IMHO too conservative.
Reason being that the return at say 5.0% p.a. less tax barely matches inflation. (In which case you are not really getting ahead.)

The scenario I am portraying is a first time investor trying their best to accrue a first deposit for a property. I suggest an aggressive savings program so as to achieve the result ASAP.

It is all about creating the maximum efficiency with the use of each dollar.

Imagine $1-00 invested:

Well $1-00 returning 5% p.a. will equal $1-05 at the end of the first year.
Now there are no guarantees that a managed fund will produce better or worse than the 5% result, however if we look at the historical return of say the S&P 200 index you will see a return of approx 12% p.a. over the medium to longer time period.

The assumption one might make then is that over the medium to longer term, one might hope to then achieve the market average = 12% p.a.

In which case:
$1-00 returning 12% p.a. will equal $1-12 at the end of the first year.

Power of compounding:
$1-00 growing at 5% compounding = $1-63 at the end of 10 years.
$1-00 growing at 12% compounding = $3-11 at the end of 10 years. (Nearly double)

Okay so the principle is that yes the MF might be at a higher risk profile, but the reward is much greater. The other way to look at it is in terms of time. The question is how much quicker would the MF achieve the same result as the bank?

Answer:
Bank = 10 years
MF = 4 years and 4 months.

And what will the price of a property be in 4 years and 4 months compared to the price of the same property in 10 years?

Now if this principle is starting to make sense, then why not push the boundaries even further. (Within an acceptable risk profile.)

Saving with a Margin Loan: At 50%

So instead of having $1-00 working for you at 12%, you could have $2-00 working for you at 12%, with the cost of $1-00 at 8%

Result over 10 years:
$2-00 growing at 12% less $1-00 at 8% compounding = $4-41at the end of 10 years.
Or in years: It will take only 3 years and 3 months to achieve the same result!!

I rest my case on the fact that the extra risk is worth the time value savings achieved when buying the same property in approx 3 years as opposed to waiting 10 years!

Scenario looks something like this:
Property Price: $400,000 (TODAY)

Assuming property growth at 7% p.a. average.

3 years time:
Property Price = $490,000 (Deposit required at 10% plus costs of 5% = $73,500)

10 years time:
Property Price = $786,860 (Deposit required at 10% plus costs of 5% = $118,029)

Not only would the property require an extra savings of $44,529, but if you had rather been able to acquire it at the 3 year mark . . . instead of having to save the extra $44K you would have made the extra equity growth of $296,860!! (Which incidentally is enough for another 2 deposits!)

This is why I suggest saving with a MF and a margin loan.

What asset/s to buy?
It is all about where one might achieve the best growth potential including leverage.

I generally suggest leverage at 80% for property and 50% for shares.
Of course you can get loans at 90% on property (and more!) but you will pay LMI and on shares you can get margin loans up to 70% (80% including the 10% buffer) but I generally advice the lower risk profile.

A first time investor might go to 90% on property just to get a ‘foot in the door’ and then slowly attempt to get the leverage down to a more comfortable level.

Property at 7% average growth with 80% leverage is > Shares at 12% growth with 50% leverage.

Example:
Property: $1-80 at 7% = $1-93
Shares: $1-50 at 12% = $1-68

So in general I recommend that investors start with property and 'value add' with shares. (I will of course discuss value adding with shares in a later chapter.)

Initially until you have accrued enough for the deposit and costs you might then save in the MF + margin and then buy the property as soon as you can.

If you have the deposit and costs then you would buy the property straight up. (Within Rental Reality etc, etc. . . . another chapter for later )

. . . Chapter 2 (Assessing the efficiency of your current portfolio.)