Choose investments that are strong yet stable

As the world works its way down the road to recovery, savvy investors are asking, “what’s the right type of investment for the new financial era?”

They understand that the economy is recovering, interest rates will increase and inflation is likely to return, due to our government borrowing money and pumping it into the system.

This means that investors who parked their money in the safety of bank deposits will start looking for a new home for their funds - a safe haven that is a hedge against inflation. Many will turn to the security of a market they understand - residential property - and then property markets will really start to take off.

In this new financial era inflation will reward borrowers who acquire appreciating assets using depreciating dollars, but disadvantage savers as the value of their money goes down over time. This will set the stage for another significant property boom as more investors will turn back to assets that store value, like residential property, which increases in value during inflationary times.

If the global financial crisis has taught us anything, it’s that we need to start taking a different approach to money and how we value it, procure it and use it.

So back to the original question - what’s going to be the best investment in the years ahead?

One thing is certain: there is no such thing as a perfect investment. If somebody tells you they have found “the perfect investment” be very sceptical and ask lots of question, because chances are they’re trying to sell you something you just shouldn’t buy.

The things I look for are:

• liquidity (the ability to take your money out by either selling or borrowing against your investment);
• easy management;
• strong, stable rates of capital appreciation;
• steady cashflow;
• a hedge against inflation; and
• good tax benefits.

When you look at the major categories of investments, you will recognise that not many fit the bill when it comes to all five of these criteria.

The recent world financial crisis and the new era of money we have entered means that you’re going to have to invest in assets that are both powerful and stable.

By powerful, I mean that to act as a hedge against inflation they must have the ability to grow at high, wealth producing rates of growth. In other words, you’re going to have to be able to leverage or borrow against them.

By stability, I mean your investment should grow in value steadily and surely without major fluctuations in value.

Many investments are powerful and many are stable, but only a few are both. Prime residential real estate is one of the investment vehicles that has both power and stability in spades.

Now that doesn’t mean it’s perfect, because property is not as liquid as many other investments. It can take months to get cash out of your property portfolio, if you sell your properties. Or you may be able to get cash out quicker by borrowing against the increasing value of your property, but even this can take a month or so to organise.

While some might see this as an issue, I would argue that a relative lack of liquidity is one of the virtues of property as an investment vehicle. Why? Because the only way for an investment to achieve liquidity is to relinquish some of its stability - if it is liquid (easily sold like shares) it is more likely to have wide, more volatile fluctuations in value.

Let’s examine this concept a little more closely by looking at the stock market. The stock market is another potentially powerful investment vehicle because you can borrow against your purchase of shares (buying on margin). But in order to achieve the liquidity the stock market provides you give up some stability. Share prices are volatile and fluctuate up and down and then down and up again. Sure you can get your money out quickly, but you also run a bigger risk of making a loss.

What about putting money into a savings account? This type of investment is both very liquid and pretty stable, but it won’t give you a wealth producing rate of return.

If I had the choice (and I do), I’ll take stability (lack of big swings in price) over liquidity every time. Over the last two turbulent years of the world economic crisis, my real estate portfolio has grown in value but has been relatively illiquid - it would have taken time to sell up. However over the same period, shares that were very liquid decreased in value by 30, 40 and even up to 50%. I will stick with property any day.

Many financial planners recommend ‘when-to’ investments, which means you have to know when to buy and when to sell. Timing is crucial with these investments: if you buy low and sell high, you do well. If you get your timing wrong though, your money can be wiped out. Shares, commodities and futures tend to be ‘when-to’ investments.

I would rather put my money into a ‘how-to’ investment such as real estate, which increases steadily in value and doesn’t have the wild variations in price, yet is still powerful enough to generate wealth producing rates of return through the benefits of leverage.

While timing is still important in ‘how-to’ investments, it’s nowhere near as important as how you buy them and how you add value. ‘How-to’ investments are rarely liquid, but produce real wealth. Most ‘when-to’ investment vehicles (like the stock market) produce only a handful of large winners but there tends to be millions of losers. On the other hand, real estate produces millions of wealthy people and only a handful of losers.