Another look at Leverage

In earlier articles in this series, we have been discussing the “inputs” that will be required for an Investment Strategy, talking about the different ways that money, time and knowledge will be required to plan, implement and manage an Investment Strategy and how these factors may impact on the outcome of that strategy.

In the previous article, we looked at the impact of using other people’s money to help fund the purchase of an investment asset, and explained that, by using other people’s money, we could get a greater return on the amount of our own money that we invested and/or we could purchase an asset that we would not have been able to afford just using our own funds.

But why stop there?

We have already identified that an investment strategy will require us to contribute some of our own money, time and knowledge, and that we can use other people’s money when we are either looking at an investment strategy which requires more money than we have available, or where we are looking for a higher return.

So what about using other people’s time or knowledge? In other areas of life, we understand the idea of using other people’s time to save our own, whenever we pay someone to mow our lawn, clean our windows or deliver our groceries. These are tasks where we have the required knowledge, but we can make a choice to use some of our money to pay someone to do something for us which will save us time. We are swapping money for time.

The idea of using other people’s knowledge may at first seem less familiar, but when we pay a medical specialist for a 15 minute consultation, we expect to pay a much higher fee than we would for the types of services listed above. While we may have the time to attempt a diagnosis of a medical condition, we recognise the need to use our money to pay someone for knowledge which we do not have. We are swapping money for knowledge.

So how can these ideas be applied to investing?

Let’s say that you had decided to invest in a share portfolio. You could use your own time to learn about the stock market, analyse a number of companies’ shares and decide which shares to own, and then repeat the process on a regular basis. Or you could engage an investment advisor to assist with setting up the portfolio, and then go back to them each time you wanted to review your portfolio. Instead of using your own time to gain the required knowledge and make investment decisions, you would be paying for the advisor to make the decisions for you using their knowledge. Or you could go one step further and engage them to manage the portfolio on an ongoing basis, still paying for their knowledge, but now paying for more of their time, so that you need to spend less of your own time on managing the investment.

Another alternative would be to select a managed fund and rely on the analysts employed by the fund to use their time and knowledge to make decisions about the shares in the fund.

In return, you would expect to be charged a management fee. Each of these approaches requires different amounts of your time and knowledge, and different amounts of time and knowledge from other people, which have been obtained in exchange for some of your money.

In an earlier article, we identified that the purchase of property as an investment requires knowledge across a range of different fields, and you are faced with a series of decisions about whether to use your own time and knowledge ( or possibly devote your time to gaining the required knowledge ) or whether paying for someone else’s time and knowledge would deliver a better outcome. For example, you could spend time and money to read books and/or attend seminars or courses to gain knowledge on how to locate, select and purchase an investment property. A key consideration is how much time and money it will take to get to a certain level of knowledge, compared to the cost of engaging a specialist professional.

Another consideration is that not all knowledge comes from books and courses; some can only be gained from personal experience.

In this context, think about your own level of experience in locating and selecting investment properties, arranging mortgages, negotiating a purchase price or bidding at auction and compare it with the amount of experience gained by someone who does it for a living.

The use of other people’s knowledge could enable you to select a better-performing investment asset, secure that asset at a lower price, obtain a more effective finance structure, or possibly avoid the purchase of a “dud”.

Any one of these factors could be expected to deliver a superior long-term investment outcome.

Although all Investment Strategies will require some input from the investor, the use of other people’s time and knowledge in the planning, implementation and management of the strategy can have a dramatic impact on the outcome an investor receives in return for their own contribution.

Empower Wealth’s Personal Wealth Management Program includes sophisticated tools to allow you to see the effect of investment strategy decisions by modelling the effect of all the factors which influence the long term financial outcome of an investment, to give you the numbers you need to make an informed decision about your financial future.

If you would be interested in seeing how these tools and techniques could be applied to your own personal financial situation, please come and see us for a free one hour consultation.