We all work hard for our money. Hence, we should all make the most of it and invest it wisely. Below are five principles you should understand and consider before making any investment.
1. Buy a house or pay down your mortgage
This may not be an investment as such, as it does not generate income, but it is a goal that I think is definitely worth mentioning.
As soon as you have a sufficient deposit and a regular savings history, you should aim to buy a house. If renting, why pay rent, when that money can be used to pay for your own house? Although there is nothing wrong with renting, it is only worthwhile if you are able to use your excess money to invest wisely. However, the majority of us are just not that disciplined. By having a mortgage, you are forced into regular repayments, a form of forced savings.
Over time, your mortgage will decrease in size, and your home will have increased in value. Any equity (the difference between the value of your house and what you still owe the bank) can then be used for further investing.
For those that already have a mortgage, paying down the loan is in itself a form of investing, as you are virtually receiving a return equivalent to your mortgage rate.
2. Start early and understand your investments
Robert Kiyosaki, author of Rich Dad Poor Dad states that assets put money into your pocket. Liabilities take money out of your pocket. Therefore accumulate assets and reduce your liabilities. It is that simple. Assets include property, shares, cash, and fixed interests (e.g. term deposits and bonds). Liabilities are those bad debts such as credit card debts that don't get paid off in full, as well as personal loans to fund cars, holidays, and your lifestyle.
If you have liabilities, aim to pay that down as quickly as possible. Once you have a house, minimal liabilities, and some equity, aim to buy some assets. Start this as soon as you can.
When investing or accumulating assets, only invest in those that you understand. If someone tells you about the next share price that is going to shoot up, do your own research first and find out why. Don't just take their word for it. If you don't understand how a company works or how it makes money, how will you know it is going to do well and the share price will go up? If someone asked you why you think your assets make a good investment, you should know it well enough to be able to explain it to them.
3. Risk, return and investment time frame.
The basic rule is that the higher the risk of an investment, the greater the return on your investment. Everyone's risk tolerance will be different. For example, a 25 year old just out of university would probably be willing to take on more risk than a 50 year old with a family.
Determine how much risk you are willing to take on and invest accordingly. Financial planners will be able to help you with determining your risk profile. Generally, shares and property are
higher risk, but in general, provide greater returns of around 7-10% per annum. Cash and fixed interest securities (as mentioned above) generate lower returns of 3-5% per annum, but you are at lower risk of losing your money.
When considering where to invest, you must also take into account the time frame you are willing to invest. If you need the money within a year, you are better of investing in low risk assets such as a term deposit. If you have a longer time frame, say 5 years, you can afford some more risk, and thus shares may be a better option.
This is simply not putting all your eggs in one basket. As mentioned in the above paragraph, there are many asset classes to invest in. Not only should you invest in different asset classes, but aim to diversify within each asset class. For example, buy properties in different areas, or hold shares from different market sectors such as resources (mining) and financials (banks).
By diversifying, you will reduce your risk of losing or making a loss on your investments. Try to have most of your investments in the growth assets (those that increase in value over time) such as shares and property. By having too much money in cash and term deposits, you run the risk of losing or barely retaining the original investment value, once tax and inflation are taken into account.
5. Gearing or leveraging.
This simply means borrowing to invest. By gearing, one can magnify their investment gains, but can also magnify any losses as well. It all comes down to investing wisely, researching and reducing risk. After the Global Financial Crisis, most people in Australia are going through a period of deleveraging (paying down debts), and this in itself isn't a bad way to invest either.
Only borrow to invest if you can afford it. Don't overstretch yourself, because there will come a time when interest rates will rise again, and the last thing you would want is to be forced to sell your investments.
This highlights some really valid points for buyers, especially first timers who are more than likely to be more cautious about property investing.
This articlehttp://bit.ly/I5GaJx demonstrates some of the processes mentioned, in order to get onto the property ladder. With opportunities such as these, it illustrates the importance for buyers to understand the financial processes included, for example solicitors and application fees, so that these can be included when you’re budgeting.