The True Cost of Investing Inaction
The conversation was borne out of the fact that the local marketing is going crazy, and it’s quite difficult to get your foot in the door now – especially after sitting on money that you could’ve invested years ago.
– the importance of measuring the opportunity cost of your investments,
– dealing with uncertainty in investing, and
– recognising the changes in your risk profile.
00:00:00 – Intro
00:02:06 – Measuring the Opportunity Cost of Your InvestmentsRead More
00:07:04 – Dealing with Uncertainty in Investing
00:11:59 – Recognising the Changes in Your Risk Profile
00:15:59 – Final Thoughts
Recently, I think we’ve all pretty much become aware that keeping solid cash reserves is super important.
I’m certainly not arguing against it because I do believe it’s important to continue holding onto cash that can carry you through tough business times and economic turbulence – especially if you’re an investor.
You only need to tune into the news right now to see all the commentary on pending inflation and stock market crashes.
So, it’s important to have several defensive measures and strategic fingers in a few pies to carry yourself through those periods without a major dent in your wealth-building activities or your portfolio.
That’s why I want to unpack the concept of inaction around investing.Read More
Measuring the Opportunity Cost of Your Investments
The very first thing that people need to understand is that putting cash reserves aside and stockpiling money for the sake of it is only useful to a point.
At some point, you’re going to need to start measuring the cost of having money just sit around. When you measure opportunity costs, you’ll need to shift your focus to the internal rate of return.
What could your money be doing?
Don’t focus on the rate of return of growth of a particular asset. For example, the Australian and New Zealand real estate market has exponentially grown over the last few quarters – some investors are looking at 20% per annum.
But what I’m saying is – don’t focus on that number! Instead, focus on the number in terms of what return you’ve achieved on your cash.,
Suppose you go out and you purchase $100,000 worth of property and you’ve contributed between $10,000 and $20,000. If that’s the case and the asset increases in value, measure the return on that contribution because comparing the internal rate of return will give you your ability to compare how much your money would make just sitting at the bank.
So, the true cost of investing in action is about getting granular and good at measuring what the comparative rate of return is between having your money sitting around while you wait for a ‘perfect’ opportunity versus doing the hard yards and finding the right investment to park your money into that’s going to give you a great rate of return.
Another reason why you should shift your focus to the internal rate of return is that you can get a substantially better internal rate of return in the property market compared to the share market.
When you do that, it becomes apparent why property crushes the share market in terms of returns. It’s considered highly risky to leverage and get margin loans within the share market. In contrast, banks will happily allow you to leverage inside the real estate market all day long.
Over the last 80 years, the share market return has averaged 11.4% and the property has averaged between 11% and 12%. So, the rate of return on the asset class is similar, but the internal rate of return on your money will be exponentially higher on the property because you’re able to leverage it.
That’s why people like me, who have never been spectacular income-earners, have had significantly better returns than if I just stuck my money in the share market.
So, make sure you can measure the opportunity cost of your investment and continue to contrast it. When you start to compound the difference and measure it over time, you’ll see it starts to become a substantial amount of money. The loss is even more if you consider the velocity of taking those returns and reinvesting them.
Example: What Stockpiling Could Cost You
I have a friend who had done really well in business and was starting to stockpile her money in offset accounts against the mortgage. That effectively put her in a position where she had no mortgage, and she was relieved to be in a position where her living expenses were pretty light, and she was living quite comfortably.
She eventually realised that she had very little money in her superannuation account, and she didn’t want to be the primary person running her business forever.
So, when we sat down and started to measure what she could have done with the money that she stockpiled, she realised that she had lost millions and millions of dollars in capital that she could have built up in all sorts of investments.
Dealing with Uncertainty in Investing
I’ve spoken to so many people who understand the purpose of investing and why it’s such an important aspect of building wealth, but they struggle with a need for certainty or the desire to have a 100% guarantee that they’re doing the right thing before investing their money.
I completely understand it. And that’s why people end up stockpiling cash.
The challenge comes in when there is such an avalanche of information out in the marketplace, and everyone is vying for your attention around the topic of wealth building. And each person is advocating for their strategy, be it managed funds, land packages, developments and blue-chip properties.
So, it can get super confusing.
And the reality is that if we had enough money to take a bite out of all those cherries, we’d be laughing. We wouldn’t be stuck in this sense of feeling overwhelmed and confused about what our next step should be. But, unfortunately, buying real estate is super expensive.
Part of the journey to becoming a proficient property investor is your ability to distinguish between good deals and bad deals. You need to be able to identify who is informing you and educating you with the intent of legitimately helping you on your journey.
It’s also important to recognise when you’re suffering from analysis paralysis and the need to bust out of that without succumbing to the fear of missing out.
The innate quality of investing is that you’re never going to have 100% guarantees. So you need to focus on the investment criteria that will tick your goal boxes because that will give you the green light to proceed.
I had clients who had a dream of buying in a particular part of the country, but they had been agonising about the perfect property they wanted to buy. Every single property wasn’t quite right. And now that we’ve seen ridiculous runaway capital appreciation over the last 12 months, their capacity to enter the market has dropped to zero. There isn’t any scope for them to enter the market.
I caution against putting all your faith in someone else’s opinion on whether an investment is good or bad. Staying in the driver seat and making informed decisions is super important in dealing with uncertainty.
Property is really expensive, so you can’t afford to put a foot wrong, but you also can’t afford to just let the money sit there and postpone those decisions.
Recognising the Changes in Your Risk Profile
The third point I want to make in the context of the true cost of inaction is that you need to recognise that your risk profile changes over time.
While there are some investors who are hair-raising risk-takers their whole lives, most people struggle to take risks as they get older. If I think of my own journey as an example, the sorts of risks I was prepared to take in my 20s and 30s are significantly different to the risks I’m prepared to take now.
By 2008, we had built a reasonable portfolio of properties, and we were starting to get to the point where we paid off our house. We had a reasonable portfolio of properties that were doing quite well. I had a couple of lemons in amongst them, but on the whole, we were doing really well.
And then we bet the house on one development deal with someone who turned out to be very crooked, and we ended up losing the house and all the money we invested. We’d refinanced out of our paid-off house to go into that deal, and we lost it all.
It took quite some years to regain my footing and diagnose our mistakes in doing that deal. But eventually, you recover and get on with it.
I’m sharing that story because there is absolutely no way that I would make that kind of investment at this point in my life.
So, there’s a huge emphasis, for me, on small bites of the cherry.
I can take on a development of similar size to the one in 2008, and now it’s only a small percentage of my overall wealth, so I don’t feel that level of risk or exposure that I might have felt 13 years ago. That’s because my risk profile has changed.
People tend to overlook this concept of their risk profile changing over time. But, it’s important to continue to assess where you are in your journey and what risks you’re prepared to take at the particular stage.
Unfortunately, I’ve coached and mentored many people who’ve made some big decisions later on in their wealth creation journey because they’re trying to make up for lost time, but they weren’t necessarily equipped to make those decisions.
Suppose you’re in a situation where you are further down the track and haven’t taken as much investing action as you would have liked. In that case, the first thing you have to do is start with some education and don’t necessarily try to take on investments that will make up for lost time.
Focus more on growing your knowledge base and then starting with some simple investments that you completely understand.
This conversation around inaction was borne out of many other conversations with investors who are lamenting the fact that they’ve sat on a lot of cash or lazy capital over the last five years because they were waiting for the ‘perfect investment.’
Now, the local marketing is going crazy, and it’s quite difficult to get their foot in the door. So there’s some anxiety around their inaction.
But, I’m a true believer in ‘it’s never too late’ – there’s always ways to recover financially and get back on an even keel.
The thing that I would like to emphasise, though, is that it doesn’t matter how successful your business is or whether or not you’ve created a cash cow; you have to be thinking about your Plan B – how are you going to create the ultimate insurance policy?
In my world, that insurance policy is creating an income stream that will continue to flow from multiple sources regardless of whether the market goes up, down, or sideways.
Because if you play that game, you will be on a completely different level and trajectory to those businesses that feel the rollercoaster of all the changes in government and the ups and downs of the traditional property and share market.
If you’re interested in understanding how to create wealth through alternative strategies, please check out my programs, where I help you catapult your investment income and blend strategies to shave decades off your timeline to financial freedom.
Or, you’re welcome to get in touch today, book a call with me, and I would be happy to talk you through it – no obligation!
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