In March 2009 there were a lot of long faces on investors – share markets, property markets and bond markets had all ridden a depressing downward slide for close to two years. The outlook was improving but nobody seemed to know if the light at the end of the tunnel was actually an oncoming train.
We believe that investing is a lot like farming – you get some great years, some average years, and the odd drought along the way. Like droughts on the land a financial drought is only a matter of ‘when’ it happens and not ‘if’.
It might not occur this year or next year or it might not occur for another ten years but rest assured it will occur. Now (if not every year) is an important time to reflect on your investments and get your head in the right space for what is coming.
Gaining an insight into family’s finances over the last 20 years I’ve regularly been asked is now a good time to invest and get out of cash, or is now the right time to sell and get into cash?
Each question on its own is exceptionally difficult to answer. But the task of getting both questions right is impossible.
Accepting that financial droughts happen we’ve found that the wealthiest invest with a purpose and not just for the sake of it. The result is a happier, healthier life with a lot less worry. If you’re expecting consistent and great returns and you don’t want to worry about your money then you need to read on.
Spend with a purpose
Every investment you have needs to have a purpose, in other words if you have money in a bank account then it needs to be for a dedicated reason that is specific to you and not a general idea of ‘well it’s safe there’.
We advise clients to have three areas of spending purpose – 1. Now 2. Shortly and 3. Later.
Now is any spending you have upcoming in the next five years is what sits in this area. Things such as groceries, utilities, fuel, car maintenance, annual holidays etc.
Shortly is the spending destined for the next ten years, typically larger in their price tag. Think new fridge/washing machine, new car, overseas holidays, school fees etc.
Later What comes later? Hopefully retirement, being debt free, maybe that once in a lifetime holiday or purchase of a business. Anything that is going to take ten years or more of dedicated saving to achieve.
Invest with a purpose
From spending purpose we can draw parallels with investment purpose and start to ‘quarantine’ the three spending purposes into three areas of investment risk. I like to call these time-based-tanks of risk.
Tank #1 is for all of your ‘Now’ money and the risk taken needs to be very low. This is exactly where your bank account and term deposits come into their own. Invest monies here for no longer than five years.
Tank #2 is for all of your ‘Shortly’ money and risk can be a little higher but not much. You could use a term deposit here but considering you will have a little more time (up to ten years) and you should be adding to it regularly then perhaps bonds/fixed interest investments could be more appropriate.
Tank #3 is for all of your ‘Later’ money. Risk and return needs to be higher as you won’t be using this capital for at least ten years and you need to get better returns. When I say ‘risk’, I’m not talking about ‘horse 7, race 6’. I’m talking about quality businesses listed in Australia and around the globe.
Don’t sell the farm in the middle of a drought!
Market crashes are only devastating when you’re forced to sell your investments at the worst possible time. Using tanks as my metaphor allows us to think of a farmer who has plenty of water in reserve and can afford to wait for some rain to make the grass grow, the cattle fat and the decent buyers to come out of hiding.
If you sell the farm in the middle of a drought then what price do you think you’ll get?
Keep enough in tank #1 and tank #2 and you can stay happy and relaxed when the financial drought comes and tank #3 drops a little lower.
When you’re next talking money with someone and they say they’re not sure if they have enough left in the tank, ask them which tank they’re talking about.