Why haven't I bought a second investment property?

When I first thought about buying an investment property I imagined that it would be the start of a property portfolio that would grow incrementally over time.  However almost 5 years after buying my first investment property I still only have one property.  Why haven't I bought more and why am I not some sort of young property baron?

My decision not to buy more properties was by design...

I actively decided not to buy more investment properties.  I could have done it several times and I definitely had the finances to do it.  My decision to stick to one investment property (for the moment) was by design and not through laziness or lack of opportunity.

I want to own a diversified portfolio of assets

My desire has never been to be a property baron.  Whilst I do want to be financially secure / well off and to reach my $90 million target I don't think that this needs to be within one investment class.  I want to own property, shares, bonds and alternative investments.

Owning an investment property puts a whole heap of your assets in one bucket.  Even if you can use a small deposit and use your cash to buy shares your actual exposure to the property market is still incredibly high.

If you want to own a physical property the fact is that you will be overweight that asset class for a very long period of time until everything else can actually catch up.  One of the reasons I haven't bought another investment property is that I was building up my other portfolio of assets during the last 5 years.

Your own home is an investment in the property market

When I was young I was very taken by Rich Dad Poor Dad.  I thought provided me with incredibly revelations that I had been completely missing before.  Once I did a bit more research and actually educated myself a bit more I realised that the book actually provided very little other than an idea of "you too can be rich".  

One of the core ideas that Robert Kiyosaki pushes in that book is that your home is not an asset because it takes money out of your pocket each month.  On face value this seems to be a true statement.  How many of us actually make money from our homes?  However the more I thought about the less I believed in this statement.

Your home is an asset.  You can spend too much for an asset, you can over-invest in an asset and you can over-capitalise an asset.  And most importantly not all assets put money in your pocket each month.  If you invest in physical assets (such as gold or oil or silver) they will typically take money out of your pocket each month due to storage costs and they certainly don't give you any cash until you actually sell the asset.  This is the same for your house.  Also owning your own home helps you avoid a cost - i.e. rent.

In fact your home is often one of the most tax advantageous investments you can own (in Australia).  You don't have to pay capital gains tax on your home and it is exempt from almost all forms of asset tests.

I don't own my own home (one that I live in) yet but it is definitely on the horizon. When I buy this home it will be an additional exposure that I have to the property market...and I will need to balance my other investment classes before I even think about buying property #3.

I can own additional property exposure through listed property funds and companies

I have written about buying listed property funds and companies before.  The major benefit of them is that you can buy them in small parcels and get exposure to sectors of the property market that I wouldn't normally be exposed to.  The major disadvantage of these types of investments is that you have much less control, the ability to leverage this investment is less and you have to pay fees on top of the natural costs.

I actually have a fair bit of exposure to the property market through listed funds although I have been reducing this lately.

The market doesn't look attractive to me at the moment

I'm a bit believer in value investing.  That is - putting my money to work where I believe there are fundamental traits which will make the investment more valuable in the future (even if these take a little while to realise).  At the moment I can't justify buying another property and increasing my exposure to the market.

If there was a crash or an amazing buying opportunity came my way I would not hesitate to go for it...but this does not seem likely in the current market and in the near term.

Over time I will probably buy more properties...but not right now

I don't have a problem with property investments in general.  In fact I think they are some of the easiest to understand and to own however like all investments you want to understand why your investing in something and have a thesis about how and when it will make you money.

Over time I will probably buy more properties and continue to hold onto them however this is not the right time for me.

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Resurrecting my alternative coin investments plan

A couple of years ago I wrote about my first foray into alternative investments.  I purchased my first set of collectible coins which were then followed by another set a few months later.  Every month when I get my wage I put away $50 to keep investing in the coin collection with the idea that every few months I will buy a selection of coins.

Unfortunately I didn't stick to my plan...

Unfortunately my plan didn't quite work out. I did faithfully put away the $50 almost every month but when it came to actually buying the coins...well that always got put off for another day.  Honestly the reason was probably that they are such a small part of my portfolio that I just ignored it and would keep putting it off.

As a result I had hundreds that I had allocated for alternative investments sitting in a bank account (earning close to nothing).

...but I am committed to having an alternative portfolio...

I keep tossing up whether this alternative portfolio is worth pursuing it at all.  The amounts I am committing to it are very small and it is rarely going to get a significant amount of my attention.  I also don't want to commit a large amount of money to it because frankly I'm never going to want to be an expert on coins.

However I do

The US Government Shut-Down has me reconsidering my sector allocations

I posted recently that I was rather disappointed that the markets had not over-reacted to the news of the US government shut down and I was hoping that it would go a bit nuts and that there would be a buying opportunity.  It appears that I may have missed some short term gains as the market rebounded significantly in the days following the apparent resolution of the crisis.

Below is a chart of the US share market (represented by the S&P500) and how it performed in the lead up to (in anticipation of) and during the shut down as well as the strong rebound post the shut down.  Although the market did slip early on the market did not really over-react however as outlined before, perhaps people are celebrating too soon.

However...before you think that everything is back to normal...

The solution the US government comes to appears to be a short term solution - i.e. the government is only being funded until January 2014 and the US will once again have to raise their debt ceiling a month later.  Although I try and keep abreast of US politics for financial reasons (and because the drama is frankly more interesting than anything I have in Australia) I do not have a deep understanding of what it would take to resolve the situation.

It seems to me that the US politicians are going to be shooting themselves and the US economy in the foot if they continue to govern and negotiate through crisis tactics. Further it is pretty to easy to see why it is bad for the US economy and share market to continue to do so.

If both domestic and international (e.g. me) investors are unsure about when these types of crises are going to hit again we are going to require a greater premium on our investments (such as interest rates) or demand a higher return on our shares to compensate for the fact that the market seems to blow up every few months based on the newest drama created by US politicians.  This means that borrowing costs for the US government are going to be higher than they would ordinarily be and the share market is going to bake in a discount to account for the fact that there is more short term volatility.

What does this mean for my investment strategy?

Although the share market has responded significantly since the announcement of the short term resolution to the crisis, the US dollar has

What should I do with my bonus?

People in many industries (including finance) get paid on a salary + bonus structure every year.  However because of what it is called, even if a bonus is relatively certain and you know the approximate amount you are going to receive, people still treat it as a windfall rather than as an ordinary part of their income.  I would argue that you should plan to spend and invest your bonus in much the same way you do your ordinary income - spend a part of it, save/invest a part of it and put some aside for a rainy day.

What is the problem with treating a bonus like a windfall

There are a couple of major problems with treating a bonus as a windfall which include

• No one really plans for a windfall which means that most people, when they receive one tend to blow it or invest it haphazardly.  Just think about what you have ever done if you have one a cash prize or received a modest inheritance - most people do not do sensible things with it
  
• Even if you do invest it...lump sum investing is always more risky.  There are others (and I fall into this category all to often) who treat the bonus like a windfall and know we should invest it but then go out and do it in one hit so we don't have piles of cash lying around.  The big problem in this is that we may not be doing this when we have a great investment idea and if we stick it in something like index funds then you're effectively saying that this was a cheap point in the market
  
• People rarely stick some aside for a rainy day.  I have never been a 'rainy day stash' kind of person however I've realised that having a small amount of cash that doesn't get touched except in extreme emergencies is a valuable thing.  Putting aside a very small amount of income every month can help you build up this slowly and bonuses (where you have excess uninvested capital) offers an opportunity to top this up

How do you plan for a bonus?

The simplest answer is to plan to spend and invest your bonus like any other budget.  However you need to put less into personal expenditure as your regular income normally covers this and more to saving and investment.  Here are some steps which

High Interest Savings Accounts are starting to pay very low rates

Interest rates are probably the one financial metric that almost everyone has a handle on.  People generally know the official cash rate and also know what they are paying on their mortgage as well as the rate they are getting on their savings.

Conventional wisdom is that decreasing interest rates are good - but this is only for those who have loans - if you have cash savings (especially in bank accounts) - then you are disadvantaged when the official cash rate comes down.

Australia is now starting to experience what many in western economies have been experiencing for a while - interest rates so low that the amount you earn (even on high interest savings accounts) that you are barely keeping up with inflation and you are certainly not earning a decent return on your invested capital.

Check your high interest accounts - you may be surprised how low the rate is

I have a high interest account which I use primarily for expenditure smoothing and I realised recently that I was only receiving 2.5% p.a. on this account.  I did a quick check of other high interest savings accounts and I realised that they had all come down as well.

The best rates I could find were introductory rates which were around ~4.5%.  I have written before about how to roll the best introductory rates available which should help you keep the rate up if you really want to stick with savings accounts.  However these accounts were limited as well - some of them had maximum cash levels for the high rate (e.g. you would only get this high amount up to $10,000) while others would not let you withdraw at all or required a minimum deposit each month without any withdrawals.

The first thing that you need to do is to check your current high interest savings account - find out whether you are getting a rate of interest that you are happy with.  I would suggest that anything less than the inflation rate (~2.5%) is not

The Fundamental Problem with Index Funds

It is never a good thing to be so enamoured with a financial product or investment that you cannot see it's flaws.  All of us know this and it may feel like I'm stating the bleeding obvious however it turns out that I had one blind spot - index funds.  I love index funds - I have written about them on several occasions and they are the cheapest and easiest way for a novice investor to access the share market in a cheap way that neither under-performs or outperforms (before fees which are rather small) the market generally.

This ultimate diversification and market performance for in a low cost listed product seemed like the perfect product.  Admittedly you could never by definition do better than the market but unless you have a pressing need to earn superior returns then a portion of your portfolio should definitely be in it.

So what is the problem with index funds

From the title of this blog post and my introduction you know that there is a big fat 'but' coming up.  Nothing I wrote above is actually untrue however whenever you invest in a product you should always know what the downside is.  It turns out the downside in index funds is how the market is actually measured.

Full credit goes to Joel Greenblatt in his book 'The Big Secret for the Small Investor' which I reviewed yesterday for pointing out the one major flaw in index funds.

Almost all major index funds such as the S&P500 in the US and the ASX S&P 200 in Australia and the FTSE in the UK are market capitalisation weighted index funds.  That is the largest stock accounts for significantly more of the index than the smallest one.  I explained the difference in my post on the difference between the Dow Jones Industrials Index and the S&P 500.

Because they are weighted by market capitalisation this means that you own more of companies with larger market capitalisations and less of those with a lower market capitalisation.  The major problem with this is that if you are a value driven investor such as myself what you end up doing is (through the process of market weighting your index or by buying into one) you are buying more of the expensive in favour sectors and stocks and less of the cheap out of favour stocks.

A value investor would actually seek to do the exact opposite - you want to

More tentative steps into the world of coin collecting (for investment)

A few months ago I wrote about how I overcame my uncertainties and purchased my first collectible coins for investment purposes.  For full details about my rationale and the rules I set myself see my post here.  I just bought my second set of coins and have outlined the details below.

A quick re-cap of the rules and rationale

I am not going to make this a core part of my portfolio but it is an investment class that I hope to build up over the very long term.  To this end I am only going to be contributing $50 a month to the coin collection.  There are a few reasons why I am not going to be spending hundreds of dollars a month on this investment class:

1. I know very little about what drives the value of collectible coins
• I truly believe that people should only invest in what they understand
• I understand at a basic level what causes the prices to move with collectible coins however I do not have the same level of knowledge that I do in the property or housing markets
  
2. I thought about storage and insurance
• Coins are a physical product and like all physical products they need to be stored somewhere
• I am comfortable having a few hundred to a few thousand dollars of coins in my house...but more than that would start to make me nervous
• Also the space considerations need to be taken into account
  
3. They don't generate any income
• Physical commodities do not

Positive Dilemma: Is it an issue if your property becomes positively geared?

In Australia, one of the biggest benefits of investing in property, or borrowing significantly to invest in any investment class (including shares) is the presence of negative gearing.  That is, you can claim a portion of your losses (your effective tax rate) back against your other earned income.

Although a loss is always a loss negative gearing allows you to

• Supercharge your investment returns by investing less cash and using leverage to maximise the growth in your invested capital
• Have lower holding costs while you wait for capital growth to give you the returns mentioned above

How to investment properties become positively geared?

There are several ways that this can happen without you even noticing it:

1. You have been paying down a little bit of principal every month or have been contributing to an offset account and your interest bill becomes lower than the rent
• This is a really common way for investment properties to become positively geared
• You have managed to save so well and pay down your debt so aggressively that your investment property is now throwing off cash to you each month
2. Interest rates have fallen
• Typically we pay more attention when interest rates are rising because we know that we probably need to contribute a little bit more each month
• However when interest rates are falling most people do not tend to take as much notice
• It is entirely possible for interest rates to fall so much that your property goes from negatively geared to positively geared very quickly
3. The rent you charge goes up
• It is perfectly normal to increase the rent you charge ever year
• Because the incremental amount is so small (i.e. typically $5 - $10 a week) we tend not to notice it on a month to month basis 
• However over a few years it definitely narrows the gap between what you are paying in interest and what you receive from your tenants

Why does this cause a dilemma?

There are several investment books (which I don't like) which bemoan the fact that people are so focused on negative gearing and promote the idea that positively geared properties are ideal because 'they put money in your pocket each month instead of taking it out.  This is only right at a very simplistic level.

However it is not so simple if you think about your whole portfolio, instead if this investment in isolation.  What you should actually think about is: 

What the opportunity cost of having your funds invested in this property versus in another product?  

As I mentioned earlier what negative gearing allows

Superannuation is not an investment class...it is an investment vehicle

I was browsing a news website recently and noticed an article which went through the basics of maximising your superannuation for when you retire and the first point the author wrote was to remember that superannuation was not an investment class - it is actually just a tax effective vehicle.  I agreed with the point so didn't spend much time on it.  When I came to the comments section below though I noticed that there were a fair few readers who posted comments disagreeing with this notion as they had most of their retirement funds invested in superannuation.

This post will go through why superannuation is NOT actually an investment class and why the author of the article was quite right in describing it as an investment vehicle.

You do NOT invest IN superannuation...you invest THROUGH superannuation

The biggest misunderstanding comes about because, like me, many people use superannuation as a set and forget type investment.  Most often they are invested in the 'core' or 'balanced' strategy at their fund and the superannuation provider invests their money for them and if they check their superannuation at all it is to make sure that the employer is contributing their funds and to (occasionally) check the balance.

They therefore view superannuation as an investment which whose value they are contributing towards and the valuation of which fluctuates like a normal investment class.

However this is the wrong way of thinking about superannuation.

Superannuation is actually just a tax effective vehicle set up by the government to encourage (and force) people to save for their retirement.  You don't actually invest in the superannuation.  You invest in underlying assets such as shares, property, fixed interest, infrastructure and other alternatives through a superannuation vehicle.

Superannuation is much like a managed fund (which is also a vehicle).  Most people understand that they are not actually investing in a managed fund.  Rather they are giving their money to a fund manager to invest in shares or property or whatever other strategy their fund may have.  Superannuation is much the same.  You are giving your money to a superannuation fund to invest in the same asset classes that you could otherwise invest in outside of your superannuation.

The only difference between investing through superannuation and investing in these asset classes yourself is that:

1. You are not able to withdraw from your superannuation account until you reach retirement age (unless there are very special circumstances)
2. You get significant tax breaks for investing through super instead of investing on your own (e.g. lower taxes on money invested through superannuation)

It is easier to think of superannuation as a vehicle if you remember how self managed super funds work.  This is where you manage your super yourself and invest your superannuation money in whatever you want to invest in (rather than how the superannuation fund invests your money).  It is easy to see in this case how the actual investment classes are the shares, property, alternatives etc. that you invest in rather than the vehicle that you set up yourself.

It is actually an important distinction - and one that forces you to think about what your super fund actually invests in

People who think about superannuation as an investment ignore the fact that they should be actively thinking about what their superannuation fund invests in.  Although I do not advocate doing it too often, you should really think about what sector allocations you have within your superannuation fund and switch it to suit your own risk profile and views.  

That is, a person early in their career should not have the same superannuation choice as one who is nearing retirement.  If you think of superannuation as a blanket investment you are possibly going to ignore the fact that you should be thinking about what and where your money is invested.

How do you think about your superannuation and do you view it as a separate investment class or just as one way in which you invest?

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May 2013 Sector Allocations: An opportunity in resources?

Readers of my expenditure tracker posts would know that I have seriously under-invested in the share market recently as it moves from one high to the next.  I am, at heart, a contrarian investor who loves stocks and other investments which are cheap because they are out of favour.  Those investments which should, at some point return to a normalised value.

As a result of this investment bias (make sure you know what your investment bias is) I have found it increasingly hard to put my money in the areas which I know well (that is, infrastructure, property and industrial share investments).

I confess that I have not paid a great deal of attention to resources stocks over the last few years.  The resources boom and their popularity in the market meant that I never really paid them much attention.  However I recently noticed that these stocks have not gone along for the bull run that the non resources stocks have had.

The chart below shows the relative under performance of the S&P/ASX 200 resources stocks (the green line) versus the broader S&P/ASX 200 index (the red line).  The difference is stark:

Some of the factors that have caused resources stocks to under perform include:

• Concern about growth in China
• China has been the big driver of the resources boom over the last few years and a lot of valuations were based on continued strong demand from China
• Although there are signs that Chinese growth is moderating, the swings in share price on quarterly GDP numbers are truly staggering
  
• A significant fall in the gold price
• The gold price is one that I will never ever understand
• There are so many things that drive it, from demand in India to the risk aversion in the market and people using it as a risk hedge
• The fall in the gold price smashed gold stocks (understandably) however also seems to have dented confidence in other companies which have no gold operations whatsoever
  
• A hunt for yield
• There has been a real push for money to find a home in high dividend yielding stocks and investments, so much so that many infrastructure stocks trade at massive premiums to what their fundamental values would suggest based on the fact that they have a good yield
• Resources stocks typically have much lower yields and the hunt for yield appears to have hurt these stocks in the process.

I know very little about modelling resources stocks

I know the absolute basics but unlike financials, industrial and infrastructure stocks I have no real experience or track record in modelling resource stocks.  However, the ~30% under performance in the last year is tempting me to enter the space.

I have decided to