4 Questions Every Investor Must Ask

Ernie and Bert have been best mates since childhood. Almost inseparable. When they were younger they made a pact they would get rich together. They figured their wealth, combined with their cooking skills and good looks, would one day make them a good catch.

Now in their mid-twenties, they would like to buy their first investment property together. However they don’t want to make the same mistakes one of their other mates, Oscar made a few years ago. Oscar bought a property for tax purposes and now he regrets it.

Ernie and Bert are smart too. They know that if you want a better answer you need to ask a better question. To help get them started, I give them four questions I believe every investor should ask. These questions apply to both property and shares.

1. What is your end game and why?

Sometimes what you want and what you need can be two very different things and many investors are not aware of this. You cannot hit a target you cannot see. Clarity is power.

2. Are you investing for yield or capital gain?

Quality blue-chip investments provide the best yields and often appreciate in value the most over time. Growth usually follows yield. The problem with chasing capital gain only is you must sell it to realise its value which incurs capital gains tax and then finding somewhere to reinvest. Back to square one. It also involves a timing and selection risk. Ernie and Bert looked at each in agreement.

3. What is the net yield?

Incredibly, many investors never calculate the net yield (income less expenses) on their investments and then wonder why its return is so disappointing. This is very common amongst property investors.

E.g. An investor buys a property with gross rent of $500 pw and forgets to minus the expenses to work out their net return (yield). If you assume a cost base of approximately 25-30% (recommended) this property will have a net yield is $350 (30%) BEFORE interest and tax. Bert’s eye’s popped out when I mentioned this.

4. Is the investment decision tax based?

Never buy an asset for tax purposes. A good tax saving property may be a dud investment. Good quality earnings and growth prospects must come first, always.

I also explain to Ernie and Bert that negative gearing can be very costly. It’s a fancy term for weekly loss which must eventually be recouped in the capital value of the investment when you sell. It’s one of the reasons why I suggest holding a property for two property cycles.

Also, a common mistake made by some investors is to borrow money to purchase an asset only to find out it is not tax deductible because the investment is non-income producing such as a block of land. Ernie and Bert were unaware of this. Ouch!

Ernie and Bert felt more confident after our little chat. They also had a better understanding of why Oscar has been so disappointed with his negatively geared property. He bought for tax purposes only.

I like Ernie and Bert. They’re great guys. Could be a good catch one day too.

What do you think? Leave your comment below, I’m sure the boys would love to hear from you.

Back Paddock – were you aware it’s brain awareness week? I was listening to Ita Buttrose on Monday and if you’re interested in doing a 21 day challenge for building healthy brain habits go to www.yourbrainmatters.org.au Its very good.

Have a great week!

Adam