Investment

Property as an investment vehicle needs to be judged against other forms of investment, taking into account all those factors which are of prime importance. Although property is a special case in that most of us need to invest in it either as a place to live or work, it is unlikely to be, and indeed should not be, the only place to have your money. These are some of the important factors to consider:

• My Investment Philosophy - what is the rationale behind my wealth creation strategy: is it based on sound analytical business and ethical principles, taking a long-term view, or am I to take the gung-ho, devil-may-care get-rich-quick approach where raking big risks and bending a few rules on the way is acceptable? 
• Return on your Investment - this takes two forms: (1) the income or yield the investment gives you on a regular basis, and (2) the capital appreciation or growth you get during the time you hold the investment. The two of these combined is known as the Total Return.
• Risk and Uncertainty  - investing your hard earned capital is a scary thing at first. It's even scarier to borrow funds and invest them as well, knowing that the risk involved is only your own calculation of the probability of getting a good return and your capital back in tact. There's always the uncertainty of unknown and unknowable events occurring which might ruin the whole thing.
• Liquidity - the ease and certainty with which you can withdraw your funds into cash. A bank or building society account is relatively risk free and liquid in that you can withdraw your funds without notice. Stocks (equities) likewise are relatively liquid in that you can telephone your broker and instruct him to sell on any working day - the sale will be completed within hours - but they are not risk free. Property, on the other hand is an illiquid investment: it can take months or even years to dispose of a property asset, making it difficult sometimes to time the sale to your advantage.
• Time Involvement - How much of your time is going to be taken up in managing your investment? Unless your money is in cash investments or a managed fund you are going to need time to research and manage your investments be they stocks or properties. This is fine if you are a full-time investor, or you are retired, but most of us do our investing whilst managing a family and a full-time career.
• Your Age, Time Horizons, Wealth and Attitude to Risk - these are important factors which are personal to you. It's inevitable that when you are young your investment funds are low, but maybe you're prepared to take more risks. In your middle years you may have more income and funds but also more family responsibilities so only medium risks are acceptable. In your later years, hopefully having built-up your funds, you have more capital, but you don't want to risk losing too much because time is not on your side to build it up again. You may, depending on your total wealth and requirements at any stage in you life, take a portfolio approach. Here, a smaller or larger portion of your wealth is in higher risk, high potential return investments and may be spread across many investments.
• Taxation and your personal circumstances - Are you a high rate taxpayer? Is your spouse earning, or can you claim all of his/her personal allowances against joint investment income? What are your retirement plans and what about Inheritance Tax? Would it be worthwhile investing through a company? These are all quite complex questions and will depend on your own personal circumstances and future plans - you may need some professional advice. It's always a good idea to plan your exit strategy as soon as you can, preferable even before you invest.

So you're looking for the perfect investment: one with low risk, high income, high growth prospects, high liquidity, minimum management time and low tax. Sadly, it's very unlikely you'll find all of these in one investment. You have to trade off these factors against each other, and if you want to balance your risks and returns you need to consider a portfolio approach. See Figure 1 below.

This model shows the relationship between risk and return. At zero risk you might get, for example a cash deposit, a 4.5% return on your investment. But in these types of investments there's no capital growth, so 4.5% is all you'll get and then you need to take inflation and taxation into account. With inflation running at say 2.5% to 3% a year, year on year, the value of your capital is gradually being eroded. Take away your tax and with a cash investment you don't have much left, if anything.

As you move to the higher risk investments your potential returns increase. All of these higher risk investments will demand more management involvement that the simple safe cash investment, but the more time you are prepared to put in in terms of research, monitoring and management, the more you are likely to get back in terms of income and capital growth combined - your total return.

Some people are lucky enough to have the resources to start investing young, but most are in their 30s, 40s or even 50s before they have the time and the savings to start investing seriously. An investment priority should always be your own home and getting on the so called housing ladder - no easy achievement for younger people as they often have student and other loans to pay off in their 20s.

Your own home is perhaps one of the best investments you can make, giving you long-term security, capital growth and some generous tax breaks. It also gives you a growing equity stake (collateral) which you can use to borrow against for increasing your asset base in the future.

It's beginning to dawn on all of us that we can no longer rely on the state or our company pensions to adequately provide for our needs or desires in the future. Younger people (generations X & Y) are likely to have to work longer before they can draw their pensions, which are likely to be far less generous than the Baby Boomer generation had before them. It's going to be more important than before to think through your savings and investment strategy - to develop your knowledge on investment and finance and to have clear goals and targets.

Having decided on the need to save and invest, you should devote some time to study: to understand the principles and techniques and to understand yourself. Are you willing to take some risks (can you sleep nights?) or are you more conservative and risk averse? Have you got time to be active, or would a passive investment strategy suit you best, say investing in managed funds? Would you be investing for income, capital growth or a mixture of both? Are you looking at cash savings, bonds, shares, property or other assets like commodities or works of art?

There are three very important principles to bear in mind about investments: (1) Compound Interest (2) Cyclical Markets (3) Gearing.

(1) Compound interest - Albert Einstein famously referred to the power of compound interest as the "8th Wonder of the World". This highly underrated concept is the real power behind investing. Take the figues in the table below taken from Barclay Capital's Annual Equity Gilt Study. This table shows annual real (inflation adjusted) returns over a variety of periods for different types of asset.

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