Investing in Real Estate - How to negotiate the price

This is the seventh post in my 'Investing in Real Estate' series and will answer the question: How do I negotiate the price of my house.  The last thing we covered in the series was information you should know before you negotiate so I am going to presume at this point that you have some or all of that information.

There are many different approaches to negotiating for a real estate investment.  A lot of this has to do with your personality.  I (probably like most people) am not really comfortable playing hardball and I get really frustrated with games so the method I outline below is the simplest way to negotiate for your property  which allows you to walk away relatively quickly and easily if your offer is not accepted.

To reiterate previous posts, at this point you should know:

• Approximately how much the property is worth from comparable sales in the area taking into account the type of property as well as how much you can / should pay for this property to be a good investment (see my post on whether a property really is a good deal)
• You should know why the seller is getting rid of the property because this improves your bargaining position - if you know how much they are willing to sell it for (as opposed to how much they want) so much the better

There are a few rules for negotiating a house purchase that you should never ever ignore.  They include

1. Never ask the real estate agent what the price is.  You come off as an amateur if you do this and the real estate agents tend to walk all over you.  Do your own research into comparable sales and how much you think the house should be worth.  If you have managed to get how much the owner is willing to sell it for (see my previous post again) then this is a redundant question anyway.
2. Never appear over-interested in the property.  This property may be exactly what you are looking for and may be your 'dream investment' but if the real estate agent or the seller knows this then there is no way known you're going to get a good deal.  Always let the agent know that this is just one of several you are looking at and don't appear over interested (this includes when you make your offer)
3. Never get emotionally involved.  This is an investment - always remember that.  People pay too much for personal residences because they get emotionally involved in the property.  If you think of a property like any other investment you will not get too attached.  I promise you that no one gets emotionally attached to a particular savings account.
4. The way you dress is important.  I think people often forget this one.  What you want when buying a property is to give the impression that you can afford it relatively easily but not that you are so well off that you can afford to pay over the odds.  This ensures that your offer gets noticed but you do not get scalped.  Tracksuit pants is unacceptable but going in a suit is going to sink you as well.
5. Be confident and ask all the necessary questions up front:  Again this comes down to establishing the power in the negotiation.  If you are confident the other party is less likely to play games with you and asking the right questions up front ensures that they know that you know what you are talking about.

Below I'm going to outline how you should proceed in a negotiation

1. Make all offers in writing.In many jurisdictions real estate agents have an obligation to take all offers in writing to the vendor.  With verbal offers you have no idea if the offer actually has reached the vendor and you often end up bidding against yourself.
2. Include all conditions that you want in your original offer: This includes conditions like building / pest inspections as well as finance clauses and other get out clauses that you require.  Note that the more get out clauses that you put in the less attractive your offer becomes.  Some conditions can make your offer more favourable though.  For example if you offer a shorter settlement period then a vendor is more likely to look favourably upon your offer.
3. Make an offer slightly below where you think you will get it. People like to think that they have gotten a good deal so if you have to raise your bid for them to accept it then you want your initial offer to be below where you want to get it (I always leave about 5 - 10% for negotiation)
4. Never bid against yourself: Real estate agents will almost always tell you that there are other interested parties out there that are offering more.  As you have not seriously low balled the offer you should not feel tempted to keep increasing your offer.  If there really are people out there willing to pay more than you are then you are simply not going to get the property
5. Be prepared to walk away.  This is one of the most effective negotiating techniques.  If you reach a point where the deal is no longer good for you then walk away.  There is always another deal around the corner.  Further if you find that the agent / vendor is now chasing you then you are in a much better negotiating position so you can if you want lower your bid (no one says that bids always have to go up)
6. Beware auctions:  Auctions are where you are likely to get stung.  In some jurisdictions there is no cooling off period for auctions where you can change your mind.  Also people get caught up in the bidding atmosphere.  I attend auctions but prefer to find one where the auction has failed as the vendor tends to be much more open to negotiation after a failed auction
7. If you have made an offer that is good value and you have done all your research then sign the contract and complete the deal  Investors always get second thoughts with investment properties because of the amount of money involved.  If you have done your research then ignore these feelings and go ahead and sign the contract

Never forget that there are heaps of good investments out there and that perfect investment that you missed out on because you 'didnt offer enough' will be replaced by another.  I made offers on four properties before I bought my first one and people often go through the process many many times before they get one that works for them so keep trying.

I'd be interested to know if anyone has other tips of negotiating for investment properties so if you do please comment and I'll be happy to update my advice above.

Investment psychology: Follow your convictions

The hardest thing to do as an investor is to invest against the market.  There is a certain comfort in doing what everyone else is doing - the 'pack logic' for lack of a better expression.  However the really good returns from investment don't come from these investments - they come when you have gone against the market.

The catch in the above statement is that the market needs to have been wrong and you need to have been right.  As this is an unknown it requires conviction on your behalf in your valuation thesis and in your own abilities.  I was watching a documentary recently on Warren Buffet and almost everyone has heard of his concept of 'Mr. Market'.  That the best time to invest is when the market is offering you a price that is either too high (that is when you sell) or too low (when you buy).  Underlying the ability to take advantage of this is an investors conviction that they have done the legwork and have the 'fair price' in their mind.

While the concept seems rather simple and easy to follow, in practice it can be quite difficult which I know from personal experience.   I was invested in the US S&P500 index last year because I thought the market as a whole seemed cheap because sentiment there was terrible (and I had the benefit of not living in a country and share market that was experiencing a bull market) and the exchange rate was working in my favour.  I invested in this market however a few months later saw the value of my holdings slide ~10%.  I actually knew that this made the price of the index ridiculously cheap and I should have piled more money into it.  However I didn't because I found it too hard to swim against the tide of negative sentiment.  It is even harder when you are talking about a more risky investment (e.g. a micro cap stock) because this is when the thought of throwing 'good money after bad' keeps entering your mind even though you have done all the necessary analysis.

Note that it is just as hard to stay out of the market when you think it is overvalued.  This is because as it keeps going up you are acutely aware that others are making money in the market and perhaps you should be as well.

If you can develop an internal fortitude though and an ability to ignore sentiment then you can profit handsomely.  Note that this comes with a big caveat - often the market is right and you are wrong and you need to be willing to admit that you are wrong and exit bad trades. 

Interactive Brokers' new user friendly interface

In previous posts I have outlined the pros and cons of using Interactive Brokers.  One of the major cons was that it was the least intuitive brokerage system I had ever used for several reasons including

• You had to log on separately for account management / statements etc versus the webtrader system
• Their tabs system for both trading and getting statements was terrible.  It would take much longer than was necessary to find even basic information.

However in the last month interactive brokers has overhauled its user interface to make it much more user friendly.  When I logged onto the account management part there was a section for me to go to the full webtrader, or if I wanted to I could just put through a quick trade.  Further the options were easy to navigate and everything was in a logical place.

Although this update was well overdue it makes the system a lot more user friendly (especially for those who are not full time traders).  This combined with the unbelievably low trading costs (especially for stocks listed on international exchanges) means that in my view interactive brokers is now the best broker in the market by a long way. 

Note that although I believe it is the best broker out there 'on balance' this does not mean that the system is perfect.  My major gripe with interactive brokers is still the fact that a trader is unable to participate in dividend reinvestment plans through interactive brokers.

How do I research shares?

This is a post for beginners on how to research shares you may want to invest in. I wrote this post because a friend of mine (who does not invest regularly) sent me a list of 4 shares she was considering investing in but it turns out she had not done any research in the companies and didn't know how to.

This post will cover the minimum amount of research you must do before you invest in any shares. If you are not willing to spend the time doing this research you should really just invest in indexes. They offer share market returns without the need to keep up to date with individual companies (on the downside you can never outperform the market)

Read the annual and interim reports for at least 2 years

• In a country like Australia or the UK this will be 4 reports - 2 annual reports and 2 half year reports, In the US you will have more like 8 reports for the same period


• You do not need to read the whole report in detail - but reading a number of reports from the same company will give you a feel of the company as well as what is important to it and what drives its results.


• What sections should I read in an annual report? The essential sections to read in an annual report include the management commentary on how the business has gone and the financial statements. The notes to the financial statements give them a lot more colour and you will find yourself referring to them constantly to see what things mean (e.g. the borrowings section will have a note breaking out all the borrowings of the company)

Try and read broker and industry reports

• It is often hard to get your hands on a broker report however your stock broker should provide reports on companies in your home market


• The best way to search for industry reports is to google for them. You will be amazed at the free information that you can find on various sectors of the economy. There are often in depth news articles which will cover exactly what you are looking for


• Broker reports with their 'buy' and 'sell' recommendations should never be taken at face value. Brokers are right as often as they are wrong. You are using their reports to get a better understanding of the company you are looking to invest in.


• Industry reports, like broker reports should be used to inform your understanding of the industry and where your target company sits

Research the companies competitors

• You want to know how much competition the company has and how effective it is


• Do this by looking at their disclosures / financial statements if they are a listed company or just by going to their website and having a look at what they offer versus the company you are looking to invest in


• Also you may find that one of the competitors is in fact a better investment

Always research your companies with an open mind

• Often when we research for the purpose of investing we are only researching those companies which we are already interested in


• The danger in this is that we are looking for information which proves our thesis. I prefer to search for information which disproves my thesis to make it easier to cut companies where the investment does not stack up.

The research is not a one off task

• You should be constantly keeping up to date with the companies you invest in. It is easier however once you have done the initial research because then all you need to do is read the reports as they get released which takes a lot less time

All of this research may sound like a lot of work but there really are no shortcuts. If you start taking shortcuts then you have less of an understanding than the next investor in the market which puts you at a disadvantage. I recommend doing the above as a minimum amount of research. If I have missed anything let me know and I'll add it to the post as I am hoping this will be a useful resource for beginners.

Tips for investing in Chinese stocks: Protection from fraud

Just a very quick post from me today on the risk of investing in Chinese companies. This article, which first appeared on bloomberg, is a great summary of the problems associated with investing in China.

The biggest problem investing in Chinese stocks is the lack of transparency. All the advice that people give about doing research etc. about your companies, and reading the reports carefully and keeping up to date are useless if you are being lied to. Many Chinese companies (as outlined in the article) have had their auditors resign and / or have had to delay releasing their results over disputes with their auditors.

There is no easy solution to this problem. You may want to just avoid investing in China or if, like me, you see real value in some of their sectors and in being present in this growing market then consider doing the following:

• Add a fairly steep discount to your valuations to account for the fact that the results may not be completely truthful


• Always read the auditors report. For companies listed on the ASX, NYSE, Nasdaq etc I rarely bother but in China it is essential to see whether the auditor has given it a clean bill of health. Also check out who the auditor is and make sure they are a large firm with a good reputation


• Try and reconcile company reports on how they are going with the broader Chinese market. If you are investing in a small company try and find big reputable companies that are operating in the same space and see what they say.


• Contact the IR person and get a feel for how believable they are. You may think that as a small investor you will never get a response - but as long as they don't know how much you have to invest they will generally answer your questions...note take these answers with a grain of salt


• Research what other investors are saying - often other investors have actually gone to see the operations of the company you want to invest in. If it is dodgy most will have something to say about it so look for this information

Basically you are trying to find reasons not to invest in the company. If you don't come up with anything substantial then consider going ahead and investing but always keep the risk in the back of your mind and acknowledge that you are getting a higher return for taking a risk that others are perhaps not prepared to take.

The Real-Time Small Business Experiment: Introduction

This is the Introduction to a series which will follow in real time my attempts to make money in the world of 'small business'. Because this is a real time series I suspect the posts will be less frequent than my other series (such as my real estate investment series) as I will be updating my progress as I go through the experiences.

I am probably trying to start a business for different reasons to most. Some people are trying to replace their job with a business or are trying to earn significantly more money than they could from their job. I think I am one of the lucky people that (currently anyway) truly loves their job. I am not looking to replace it - I am looking to see if I can create another income stream (in addition to paid work, passive income from my stock / real estate / cash investments).

I was particularly motivated by the book The Adventure Capitalist by Connor Woodman (I have linked to it below) when he sells all his possessions and goes on an around the world trip seeing if he can double his money in a year by buying and selling goods around the world. It is a simple concept and one I want to see if I can replicate for myself.

The broad goals from this exercise are:

• Generate $1,000 per month, pre-tax additional income from a business


• Work no more than 5 - 10 hours per week on the business


• Achieve the above within 1 - 2 years

Investing in real estate: Before you negotiate

This is the sixth part of my investing in real estate series and with what you should do before you start to negotiate the purchase.


Now that you have determined the house (or if you're lucky enough - houses) that fall within your investment criteria and the price you are willing to pay for them you are left to negotiate the price - however this is a lot of information you need before you begin this process.


In an ideal world this would be the backdrop to the negotiations

• You would not have revealed anything about your valuation or how much you want to spend


• You would know the price that the seller wants as well as their lowest price


• You would know how urgently the seller needs to sell

It is actually a lot easier than you think to get a lot of this information (especially if you are willing to spend the time and effort).

Never ever reveal how much you are willing to spend or how much you can spend

Never forget that real estate agents work for the vendor - not you. Their aim is to maximise the sale price (and thus their commission) and this is the one piece of golden information that you should never give up. They will tend to suss it out in different ways by asking seemingly innocent questions such as:

• What price ranges of properties are you looking at?


• How much do you like this property?


• Where do you work / what do you work as (they will back solve to how much they think you can spend)?

Getting the information you need is easier than you think!

Although real estate agents are working for the vendor they are as susceptible as anyone to letting things slip. In fact as many are just trying to make a sale at any price they will often tell you things they know you shouldn't just so you put a bid in.

Questions you should ask include:

• Why are the vendors selling? You are looking for a desperate seller so you can get a cheaper price - good real estate agents will avoid answering this question but many will answer it straight off the bat


• Are the seller's expectations regarding the price are reasonable? Never ever ask for what the seller is looking for - see my next post on negotiating the price. This question will let you know how frustrated the real estate agent is with the seller and how much he is likely to tell you about them. It may also tell you that they are desperate (if you didn't get an answer to the above question)


• Get any other information about the sellers that you can. Most of it will be useful but just occasionally you will find out a piece of information that will be gold (such as they have already bought their next house and need this one to settle)

Do not ask these questions as a list as it will put a real estate agent on notice that you are fishing for information they shouldn't give out. Work it into your conversation.

A lot of real estate websites will reveal some of the information you need as well. An annoying trend in real estate advertisement is the price reads $POA (price on application) which means you have to contact the real estate agent. There are ways of getting around this and seeing what the sellers ideal selling price would be (no seller puts what they actually expect). On www.realestate.com.au if you right click and select "view source" and then search for the word "price" it will come up with a price band that the website uses to rank their search results. Other websites are like this as well so it is always worth giving it a go.

Beware false information

Real estate agents will give you false information all the time! Take every piece of information with a grain of salt and see if it fits with the whole story. The information most likely to be false includes:

• Price the vendor is willing to sell for: Agents regularly under quote what the vendor actually wants to get people interested.


• Interest from other bidders: Agents almost always pretend there is another bidder. This is especially true when the negotiation process has started. Often there is the temptation to bid against this phantom bidder - in fact all you're bidding against is yourself

Price comparison websites: Friend or foe

This is actually a post I've been meaning to write for a while. Everyone has probably noticed the proliferation of price comparison websites on the Internet. They deal with a wide variety of products and services including:

• Insurance: Car, home, life, travel insurance


• Interest rates: home loans, savings account rates


• Airfares


• Retail energy prices


• Web hosting


• Beer (in case you think I'm joking check this site out: http://www.boozle.com.au/)

Why is it worth being cautious about price comparison websites?

While price comparison sites should theoretically be impartial regarding their outcomes there is often the suspicion (and I have heard as much from several insiders) that many sites are incentivised to promote certain companies and products. Moreso some will not list companies who do not pay them. The worst examples I have seen of this are web hosting comparison sites - have a look at a few and you can tell who their main advertisers are from their search results. While I am not suggesting that all or even most sites are like this, the fact that you will rarely know is sufficient enough cause for the consumer to be wary.

How should I use the sites?

Where the sites really do become useful is as a starting point for further investigation. For example for flights between two locations it is worth using an airfare comparison website to find out which airlines fly between these two points (especially for international flights) and then go to the airline website to book through there. Most often you will no longer need to pay the booking fee charged by the price comparison website.

What type of products are best suited to these sites?

Price comparison websites are best used for homogeneous products (i.e. the product does not differ greatly from supplier to supplier). I would argue that interest rates are the best example of this while insurance (as I have mentioned several times before) should rarely be bought on price alone as the reputation of the company regarding claims is almost as important.

Conclusion

While there may be trustworthy price comparison sites out there it is always worth having a certain level of scepticism / distrust so that you do not get caught out by the dodgy ones. I suggest always looking at the main companies websites and make your own price comparison list (which you will often find yields you better outcomes than the original price - it also avoids the fee that many of these sites charge when you book through them).

Investing in real estate: Is it a good deal at THAT price?

This is the fifth part in my Investing in Real Estate series. By now you are at the stage of weighing between several different options. This post attempts to outline how to work out if the property you are going for is a good deal / the right price.

Step 1: Find out what the gross rental return in your market is

Don't look at net returns. There is a remarkable amount you can control between gross and net. At the moment all you are looking for is the average rent in the area you are looking to purchase (remember from the last post we have narrowed down our search to a few surrounding suburbs) and the prices of those properties.

Take the rent on the type of property you are looking for and divide it by your property price to get your gross yield. A worked example below

• Assume $400,000 property typically rents for $350 a week


• $350*52 = $18,200 p.a.


• 18,200 / 400,000 = gross yield of 4.55%

A big caveat in this step is not to be lazy. Don't just get the median house price and the median rent. If you are looking at 3 bedroom, 2 bath houses then get the rent for those houses (same goes for apartments etc).

Step 2: Estimate the capital growth in the area you are looking to buy

This is by far the hardest step. Historical growth rates typically mean very little and in all honesty you can be as analytical as you want but because growth in home prices are typically determined by sentiment (especially among home buyers who do not have return criteria) as well as things like government policy, incentives, job availability, gentrification etc it is really hard to get an accurate number for this.

You should remember some rules of thumb though which include

• Inner city / 'popular' areas capital values grow faster than outer less popular areas


• Access to amenities and jobs really do drive growth


• Don't base your investment decision on what 'may' happen in an area because your investment is then predicated on that outcome and not on the inherent merits of the property

A growth rate of 4% - 5% p.a. is not outrageous and I use it for my calculations

Step 3: Work out what return you want and the time period you expect to hold it for

People have unrealistic returns for investments which is why they are surprised when they find they their 'high return' investments also have high risks attached to them. If you moderate your investment expectations you will find yourself making better investment decisions. For investment properties I want my return to be 8 - 10% net return.

I also use a 5 - 10 year time horizon (though in all reality I will probably hold for longer than that)

Step 4: Do the math

Find out what the typical costs are for an investment property of your type in your area. No rules of thumb here - you really need to be doing the work here. Don't listen to books that give you broad brush answers. ALSO do do this in excel - it's an iterative process and you will need to change the purchase price until it falls within your return!

Using the example above:

• Assume that pre-interest costs are 25% of gross rent: $4,550


• Income (pre-interest): $18,200 - $4,550 = $13,650


• Assume you gear the property to 80% = $400,000 * 80% = $320,000 debt


• Assume an interest rate of 7% = $320,000 * 7% = $22,400


• Loss for the year = $8,750


• If your jurisdiction allows negative gearing and you get ~30% back on tax then your actual loss for the year = $8,750 * 70% = $6,125

I realise that this is a long post to work out how much to pay but given the cash you are paying out it is work that you really should do

Continuing with the example above

• Assuming we hold the property for 5 years


• Property value increase = $400,000*(1.04^5) - $400,000 = $486,661 - $400,000 = $86,661


• Selling costs assume 2.5% = $12,166


• Capital return from property value increase: $74,495

• Assuming rents increase by 3% p.a. you would get total rents of $96,626


• Net rents (after costs but pre interest) = $93,184*75% = $72,470


• Interest over the period would be a simple interest calc = $22,400 * 5 = $112,000


• Loss after interest = $39,530


• Tax adjusted loss (as outlined above) = $42,112 * 70% = $27,671


• Take into account the income you could have made on this cash that you have lost over the years = $3,110


• Net income loss over the 5 years = $30,781

• Total gain / loss: $74,495 - $30,781 = $43,714


• Return: $43,714 / $80,000 (originally invested) = 1.546419 ^ (1/5) -1 = 9.1%

Thus at this purchase price the investment is within the criteria. This is why doing it in excel is so important. If it did not fall within your criteria then you would need to adjust your purchase price until you got to a one in which it did. It is fairly easy to set up a basic excel file to do this. If there is sufficient interest (through comments etc) I will post one online so you can play around with the assumptions yourself.

Share purchase plan's - When things don't go to plan

In a previous post I outlined the benefit of share purchase plans and how they were often a great way to make 'free' money.

The example I used was the SPP that I was then participating in - the QBE SPP. This particular plan allowed you to apply for more than your proportionate share and as the price of the share was trading above the SPP price it was as guaranteed a profit as one could normally get.

However where the above conditions exist almost all investors will see the same thing and I'm fairly sure most applied for over allocations. The result was a scale back which I expected however QBE scaled back allocations to such an extent that it was possible to actually lose money in the process (which I did). A summary is shown below:

Original expectations

• Shares originally held: 32


• Shares applied for: 1,401 ($15,000 worth)


• Expected profit on SPP shares: ~$2,400

Actual outcome

• Shares actually allocated: 3 ($32.10 worth)


• Cash refunded: $14,967.9


• Gross profit on SPP shares: $6.90


• Days cash held by company: 17


• Lost earnings on cash (@7% p.a.) = ~$49


• Actual loss: $42.10

While the loss was annoying and not substantial, compared with the expected profit it was quite a big variance. I did a bit of research and such a big scale back is almost unheard of so I was a bit unlucky with this one. The rationale for investing in SPP's still holds however the lesson from my experience here is that you should always keep in mind that a massive scale back like this can result in a loss for the investor.

Investing in Real Estate: House hunting

This is the fourth part of my Investing in Real Estate series and the focus of this post will be how to effectively house hunt. At the broadest level investors only really have 2 concerns:

• What budget do I have for this investment?


• What yield am I looking to get?

Unfortunately this can make house hunting a nightmare as these can yield several suburbs / towns or even cities which conform to the minimum requirements that you seek. Further it is rarely possible to run a screening tool either from real estate listings as each area has it's own rental market (i.e. within the same city you may have some areas which are currently strong for rental properties while others are very weak)

I have put together a checklist of questions / suggestions that an investor should look at before looking at any properties or calling an agent:

1. What is the amount that I can afford to invest in this one investment? (note that this is very rarely the maximum you can afford). Once you have this price get rid of all areas with a median price above your price point. I don't necessarily believe that you should buy around the median like some authors teach but simply that you're more likely to waste your time on properties that are out of your price range.


2. Am I more interested in capital growth or yield? This is an especially important question in countries which allow negative gearing (such as Australia). There is often (though not always) an inverse relationship between the two in property markets. This will dictate whether you look at inner city house / land type properties (high cap growth / low yield) or whether you look at outer suburbs or inner city apartments (high yield / lower cap growth)


3. How good am I at doing repairs / maintenance and do I want to do this? Quite simply if you are not a very handy person or you tend to pay others to do your repairs etc don't bother looking at properties that require a lot of work. They may look cheap but unless you can do a lot of the work yourself you may just end up in the same spot as you were before


4. Try and target renters areas. There are some areas that are typically inhabited by renters and have a high number of rental properties. This is a good thing! Areas such as those around colleges / universities or even those which tend to have yuppies or young families tend to have a constant level of demand.


5. Once you have answered the above questions limit yourself to 3 or 4 suburbs which are around each other. This saves on travel when you are searching but also means that you will narrow your prospects quite quickly. You will also get a feel for the area and what is good and bad in the area (especially those streets that are good or not so good)


6. Figure out what the specifications are of the property you want. Be really specific and once you set this you can be flexible but it will focus your search. Also real estate agents are typically more likely to be helpful if you say you want a 3 - 4 bedroom, 1 bath, low maintenance with access to schools etc rather than saying 'I'm looking for an investment property'. You'll actually find you get shown properties before they are even advertised


7. Call every agent in the area and let them know what you are looking for. Also tell them that you are not interested in anything that doesn't fit your criteria. They will get the idea that your a serious and experienced investor (even if your not) and you'll only get shown relevant properties.


8. Go and look at every property which fits all of the above requirements. You're now at a stage where it is not wasting time any more to look at every property because you know exactly what you want and you know what is good and what is not.

If you follow the above 8 steps it will save you a lot of hassle in the property search process. You may not get the perfect property even if it is for sale because there are always going to be people that will pay more / too much.

In my next post I will outline the negotiation process.

Alternative Investments: Initial Thoughts

Over the Easter long weekend I had the chance to sit back and think about my investment strategy generally. I believe that while it is good to have a plan and to stick to it - it is equally as important to assess this plan as time goes on (my inability to stick to my personal expenditure cap is a good example of a plan that isn't working)

The question I pondered was whether I was limiting myself to too narrow a field of investments (that is stocks, property and fixed interest securities). Nearly every general investment book I have ever read has a chapter on what they call 'alternative' investments which tend to include things like:

• Coins


• Paintings / art


• Stamps and other collectibles


• Gold and other precious metals

While I do possess some of these (such as a stamp collection I inherited from my great grandfather) it has never been for an investment type purpose. The more I thought about these types of investments the more I became convinced that although you may get good returns on them they were inherently risky for several reasons.

1. The return on an 'alternative' investment is totally dependent on the supply and demand situation for that product in the future. There is simply no other way of making money out of these investments. This is not the case with traditional investments - for example on a stock or property while the value in 10 years time is important, in most cases you should be receiving some sort of income (e.g. rent / dividends) in the meantime


2. If you are investing in these items you have to be doing so full time. While I (and I imagine most people) would like to think that we are are good at appreciating a piece of art I have no special knowledge about what the demand for such a product may be in the future or where tastes are trending. Some people are blindly willing to trust valuers of reports which say what is going to be in vogue in the future but that is much like blindly trusting a broker report or hearing stock tips on the street. I have said it before but you should fully understand every investment you own.


3. Gold and precious metal investment is a field that is very hard to get ones head around as there are so many things that impact the price of these products. If I use the example of gold - it is so hard to forecast with any accuracy the type of return you can expect from an investment in gold. Not only is the supply side hard to forecast (i.e. how many more gold deposits are there to be found) but the demand side is impacted by so many different things such as the level of hedging (which itself is impacted by general sentiment, the value of the USD etc), the level of speculation in the commodity itself, the demand for jewelery (especially out of India) and a host of other factors.

The conclusion I came to was that I am not going to make investment in these products part of my investment portfolio as there is too much uncertainty and I do not believe it is possible to get the relevant level of knowledge to invest in these products. If I buy these products they will form part of my 'personal expenditure' on collectible items that I enjoy.

Expenditure Tracker - March 2012

Like February 2012, March was a terrible month for keeping up with my expenditure goals for the year. My personal expenditure was too high which meant that the amounts I could allocate to my different savings plans were too low.

A summary of my expenditure for the month is shown below:

• Share investments: $16,291 ($12,911 over)


• Home loan offset account: -$13,149 (14,749 under)


• Personal expenditure: $4,700 ($3,200 over)

On a cumulative basis (January - March 2012) the accounts are as follows

• Share investments: $22,416 ($12,516 over)


• Home loan offset account: -$10,523 ($15,352.78 under)


• Personal expenditure: $10,151 ($5,651 over)

The big redistribution into shares was from the QBE SPP which I have posted above previously and I do not expect to receive my full allocation so there will be a flow back into my home loan offset account in the next month. The rest of the under investment in the home loan offset account is explained by the over expenditure once again.

Next month will be particularly bad for personal expenditure as my credit card bill is very high and I have to pay for some airline tickets as I have booked a holiday for the end of the year. I'm trying to work out ways to increase my income. I will post any ideas or strategies that I have and the results from them.

Making money from Share Purchase Plans (SPPs)

A common way for companies to raise money in Australia (though I have heard it is not as common overseas) is via a non renounceable entitlement offer (often called a share purchase plan). I will go through an outline of what an SPP is and how you can profit from it as a retail shareholder

What is a share purchase plan?

A share purchase plan (or entitlement offer) is a right given to all existing shareholders in a company to purchase for a defined price extra shares in the company (normally at a significant discount to the current price). This is a cheap way for companies to raise funds from the market as it does often does not involve a full prospectus.

The entitlement offer is normally offered to both retail and institutional shareholders with the institutionals setting the price during the bookbuild period (1 - 2 days after the entitlement is announced) and the retail shareholders being offered this same price with more time to make the decision (up to a month later in a lot of cases)

Should you participate in a SPP?
In a word - yes as long as you have the money and you still believe in the company. This is because if you don't you will have your proportionate shareholding in the company diluted. If you take up your proportionate share at the lower price then you are just as well off.


How to make money from an SPP
However the real way to make money from SPP's is by buying in excess of your proportionate shareholding. I will use an example that recently applied to me. The company was QBE Insurance an ASX listed company:

• Original number of shares held: 32,


• Original purchase price: $33.00


• Original purchase value: $1,050


• Share price pre raising: $12.00


• Value of shares held (pre raising): $400


• Existing profit / loss: $(650)

As is pretty evident above this is one of my less successful investments and it was bought while I was university prior to the GFC. I kept it as a reminder to always do my research and also to remember that markets fluctuate a lot so even if you think you're making a good decision some returns will be out of your hands.

As luck would have it QBE recently decided to do an equity raising where a shareholder could subscribe for $1000, $2000, $5000, $10000 or $15000 worth of shares at a price of $10.70 subject to a scale back if there was an oversubscription.

As I outlined above the way to make money from these investments is to buy a greater than proportionate share of the investment as it will usually trade between the original price and the issue price. For QBE it was even better because post the institutional raising it was trading above the original $12 (it was trading around $13) which gave the investor certainty around profits.

So if I continue my example from above

• New shares bought ($15,000 @ $10.70) = 1,401


• Total shares now owned = 1,401 + 32 = 1,433


• Total amount invested = $15,000 + $1,050 = $16,050


• Average purchase price = $11.20


• Current share price = $13.00


• Total book profit = $2,579.40

Thus by getting my full allocation of shares and selling at market price I would change a $650 loss into a $2,600 profit. Note that any scale back of the investment would reduce this profit but even one share allocated to me would reduce the loss that I currently had.

The one big thing to note is that if you don't participate then you are providing the profits for others who do participate.

March 2012 net worth - $233,000 (+2%)

Assets: $588,000 (+1%)
Liabilities: $355,000 (-0.2%)
Net worth: $233,000 (+2%)

As expected, I did not have a significant increase in my March net worth primarily driven by high personal expenditure which meant that I could not allocate as much to my investments. The net worth this month was not driven so much by one or two items but rather several smaller movements including:

• An automatic increase in the cash allocated to my employee share investment plan


• A slightly lower credit card balance (as posted before my car service unexpectedly cost much more than budgeted for) - hopefully I will get some significant gains next month as this amount rolls off


• Share market returns were marginally positive

I looked back at my February 2012 net worth and noted that I had predicted negative returns due to my high personal expenditure and it certainly would have resulted in this had I noted had mandated savings / investment plans such as the government mandated superannuation scheme as well as my participation in my company's employee share investment plan.

For April I am predicted relatively flat returns once again. My credit card bill will continue to take significant amounts of cash and I have just booked an overseas holiday which I will need to pay for in April. Against this I am forecasting some strong returns from a share purchase plan which I participated in which I will outline in the coming days.