Too often, people jump straight to wanting to invest their money in ‘something’ that will provide a good return. In the absence of a plan, they can purchase the wrong asset in the wrong entity with the wrong expectation as to how long they need to invest for. This ends not so much in disaster, but unmet expectations and disappointment.
We have a cultural obsession with chasing performance returns when we are choosing our investments. Anyone who has used previous performance returns as a selection criteria for new investments will know that historical returns are no indication of future returns.
The question must be asked: does chasing performance returns make you rich? Answer: No. Why? For years everyone has been chasing performance returns but not too many people have achieved what they thought they would with their investments.
The reason for these poor outcomes is that they have been focusing on the wrong thing. It’s not the performance return that makes you wealthy but how much capital you have had working for you.
Say what? Let me give a simple explanation.
If you have $50,000 invested in the share market with an average annual return of 10% your investment will be worth approximately $400,000 in 21 years’ time.
If you have used that $50,000 as a deposit on a property valued at $500,000 which has an annual return of 7% (say, your home) the property is worth approximately $2 million in 20 years’ time or $1.55 million after the $450,000 debt has been paid off (assuming interest-only for ease of maths).
This very simplistic example shows that, through some leverage, getting more capital working for you at a lower performance return may have a better outcome compared to the smaller pool of capital working for you at a higher performance return.
I see many clients who have bought a basket of shares, one investment property, and are making extra contributions to their superannuation. When we project forward the estimated size of their pool of capital at retirement they simply do not have enough capital to support the lifestyle they expect. The problem is not that they have poor performing investments, but that they just do not have enough investments working for them.
There is no quick-fix solution. The key here is we need more people planning earlier in their lives to ensure that they have enough capital working for them to give the outcome they wish for in retirement.
Read more from Andrew Zbik on the CreationWealth website.