Warning: Don’t make your strategy fit your investments (or let anyone else do it)

One of the biggest mistakes that people make is they make a few investments and then, after a few years/decades, try and figure out what their strategy looks like. That is, they build their strategy around their assets. Many financial services and property businesses do this too. They design or market investments that suit their client demand and, as a result, compromise investment principals/fundamentals. As I explain below, strategy must always come first.

Sexy investments sell

The most successful way to sell investments is to market them using the two primary emotions of fear or greed. An investment that promises high returns with little risk will typically have great appeal to the mass-market. The problem is that sexiness and fundamentals are almost always inversely related. Fundamentally sound investments are usually dry, dull and boring. Therefore, it is difficult to get people excited about them. However, shiny objects attract a whole lot more attention.

The fastest way for a financial services business to attract more investors is to market sexy investments. The problem with this approach is that whilst it might deliver short term profit (to the business – probably not the investor), it is at the expense of creating long term value for both the business and the investor.

Be sceptical of businesses that market investments

No one trusts used-car salespeople. The reason is that we are well aware that their goal is to make a sale and they might say or do anything to achieve that goal. It’s not that they are the enemy or bad people. It’s just that we have a very healthy level of scepticism for anything they say or do.

The same is true for any financial services business that markets investments. Their goal is to highlight the benefit of their investments and pitch to you why it is perfect for you. Therefore, you must maintain a healthy level of scepticism. If you want to find someone you can trust, find someone that has nothing to sell you (other than their advice).

Here are two different examples of what I’m talking about:

  • Because borrowing capacity has tightened, some property advisers are now recommending their clients invest in regional locations – because they no longer have the borrowing capacity to invest in blue-chip locations. However, these same businesses have in the past communicated that regional locations have inferior investment prospects. It is clear to me that businesses like these keep changing their advice to fit customer or market demand. Instead, I believe that you must have the integrity to sick to what you believe is right and attract the clients that can afford to invest. A reputable business should never adjust their advice to accommodate the market or client demand. My advice is always; if you can’t afford to invest in an investment-grade property, then do not invest in property. Simple.
  • Some fund managers offer ‘high conviction’ share market investments. These are managed funds that invest in a small, concentrated portfolio of holdings (so they have high concentration risk). Often, these funds have high turnover too – meaning they buy and sell stocks regularly triggering tax and expenses. As such, almost their entire investment return is in the form of income and capital gains i.e. very little capital growth. Therefore, whilst the headline investment returns might seem attractive, they are very tax-inefficient which makes them financially inefficient because you lose half of your return each year in tax.

Would you swim to Europe?

Swimming has a lot of positives. It doesn’t cost anything. It is good for your health. Many people find the activity enjoyable. However, everyone realises that they cannot swim to Europe. They have to take a plane to get there. This might sound like a far-fetched analogy (and it really is), but it highlights the foolishness of investing in an asset without considering if it will help you achieve your goals?  Analysing an investment without the context a strategy provides is a sure way to make a mistake.

When contemplating an investment, you must consider two important things:

  1. Is it a quality investment? That is, does the investment possess all the sound fundamentals to deliver the expected investment returns? Is there an overwhelming amount of evidence that this asset or methodology will produce the expected returns?
  2. Will the nature of expected investment returns (i.e. quantum and combination of income and/or capital growth) help you reach your goal as efficiently as possible?

The above two considerations are objective – there is often little subjectivity involved.

Strategy development is actually simple

If you don’t have a strong asset base (i.e. net worth) then you must invest in assets that will help you achieve this. To do that, you need two things. Firstly, you must let the law of compound capital growth do all the heaving lifting. This means investing in assets that provide a high and sustainable level of capital growth over the long run. Secondly, borrowing (safely) to invest will allow you to speed up the benefits of compounding capital growth.

If you already have a strong asset base and you are relatively close to retirement, then your focus should be on (1) generating a balanced amount of income and capital growth and (2) investing in a way that protects your capital (i.e. reducing your investment risk).

Once you know what you need (i.e. either a strong focus on capital growth or more of a focus on income and capital preservation), is will be easier to identify and select assets that will help you achieve your goal. Of course, you might still need help developing what mix of assets you should aim for. However, this approach will definitely help you avoid investing in the wrong assets – thereby avoiding the most common investment mistake people make.

Always select assets that fit your strategy

You must start with a strategy first.

A strategy is simply the steps you need to take to achieve your goal. Your goal could be as loose as “retire by age 60 on $100,000 of annual passive income?” – it doesn’t have to be more complex than that.

Having a goal and strategy gives you a context for making investment decisions. That is, you can ask yourself; “if I do X, Y or Z, does it bring me closer to achieving my goal or further away from it”. A simple calculation should help you answer that question e.g. what will this property’s income and equity be in 17 years’ time?

If you want to learn more about this, grab a copy of my book Investopoly. The reason I wrote the book was to help people follow a set of rules so they could figure out their own investment strategy. If nothing else, it will help you avoid making costly mistakes (by highlighting what to not invest in).