A good place to start is defining what I mean by a ‘good’ investment or asset, as some people feel Gold is a good investment, or lately Bitcoin (although I disagree on this as not regulated yet, so be wary on this score). So, this article is my personal view from years of research of past investment masters and wealth gurus where those principles are still as relevant today as they were 100 years ago.
So to me, a ‘good’ investment or asset does two clear things, firstly it usually provides an income stream, and secondly it will provide growth over the medium to long term. As the overall aim for financial freedom is your investments providing you an alternate income stream, so you don’t have to work if you don’t want to. If you want to work, that is fine but it’s great that you can do it now because you enjoy it, rather than you have to.
While a car or boat may be a high-value asset, it is more likely a lifestyle choice (so ‘bad’ in investment terms), as its value started to drop the moment you took it away from the dealer, and it doesn’t provide any investment income like property or shares do. This is why also Gold doesn’t cut it for me as while it can increase over time, you only realise the value if you sell it, as it does not provide an ongoing income stream.
The one caveat to all of this is your own home. This can be categorised as a good investment simply as you need to live somewhere and it’s better in most cases to not be paying rent to someone else. Your own home also has tax advantages in not being liable for capital gains tax when you sell it.
So here are my 8 Golden Rules when building an Investment Portfolio.
- A good investment strategy will be consistent with your risk profile and tolerance. There is little point in making higher risk investments if it will lead to you having sleepless nights whenever there is a dip in the sharemarket. Hopefully the more you learn on this subject will give you greater comfort in making higher risk/higher return investments when appropriate.
- A good investment strategy will incorporate diversity, by which I mean a mixture of asset classes (e.g. property, shares, cash), and further diversity within those, such as a shareholdings across markets (Australian and international), a range of industries or across a number of managed funds. Please never invest all your money in one company!
- Always apply most of your investments to good quality investments. For shares, for example, this means blue chip companies: businesses that have stood the test of time and that will largely ride out the ups and downs of the market. For direct property investment, this means buying a well-built property in a good location that will be attractive to prospective tenants.
- Try to invest for the long term – usually seven to 10 years or more – where you can (that is, where it matches your goals). Usually the longer you leave your investments, the better position they are to ride out any market short term volatility. This is particularly the case with shares. As a rule of thumb, it is wise to expect a market drop about one in every seven years for property and around one in every eight to 10 years for shares. After the 2008 sharemarket fall at the onset of the Global Financial Crisis, it was 12 years until the next market drop in 2020, which was associated with oil and the COVID-19 pandemic. Historically that is a long time between significant market falls.
- Look for a combination of income as well as capital growth. When we are talking about investments for post-work financial freedom and independence, your ultimate aim is to have enough income generated by your investments and your superannuation to replace your salary.
- If your risk profile and tolerance allow it, don’t be afraid of using good debt to your advantage. Debt used wisely can help you build an investment asset base more quickly than if you rely solely on your own savings. This tactic is most commonly used for property investments due to the tax advantages of negative gearing; however, it can also be used with other asset classes such as shares or managed funds.
- Any good investment strategy has a tax component, so try to take advantage of tax minimisation opportunities where they are available.
- You should invest to suit your own personal circumstances. This information can only ever be general and is not advice. As everyone’s risk profile or tolerance for risk is different, everyone’s tax situation is different, and everyone’s goals are different. You should seek the specific advice of a financial adviser/coach or other appropriate professional before making any significant investment decisions.
Hope that all makes sense and helps when looking at your next investment or asset choice.
One last comment is if I was to add an overlay to these 8 golden rules, it would be these two important points:
- You will have heard or read this before, especially in advertising of investment opportunities: ‘Past performance is no guarantee of future performance’. Just because it performed well last year there is no certainty it will do it again, so it is another important reason to diversify.
- Take advantage of ‘compounding returns’ and ‘time’ to turbocharge your investment savings. It is the core aspect of any good plan to know where you are invested, for what return, and give it time to succeed. That’s why I like superannuation as for most people it is a 30-year time frame from when they start. So having the right investment fund, over that period can double or triple your investments rather than just leaving it in the ‘default’ fund. Refer to my previous article for an explanation on superannuation and picking the right type of investment under your super fund.