How to Protect your Portfolio from the Inevitable Storms?

Today what I want to talk about is How do you protect your portfolio from the inevitable storms that you will face if you want to play this game for the long term?

We’ve just had a world record here in Australia—we’ve had over 25 years without a “technical” recession, which means that no other developed economy in the world has actually done that. So it’s easy to think that the good times will last forever. I mean, we’ve just had a great property boom on the east coast of Australia, we’ve had low interest rates for some time … it’s easy to think that the sun will shine this bright forever.

But there are a few things that we can do to protect our property portfolio from the inevitable ups and downs that come from being through a cycle.

 

The first one—the number one piece of advice that I give to any client is asset selection.

It’s unbelievably critical. I remember investing myself through the GFC back in 2008—I remember helping my clients investing back then—and as I’m driving around in my car, I’m noticing something. I’m noticing that, in terms of investment grade, the C-grade properties, and some of the B-grade properties, had ‘For Sale’ signs at the front. The C-grade properties often had two or three ‘For Sale’ signs in the same street!

Generally, what this means is you’ve got “zero”. You’re not negotiating or selling in a position in strength; you’re actually selling in a position of weakness.  But, as you continue to drive around the suburbs, you notice that the A-grade properties have no ‘For Sale’ sign at the front—they weather the storm much, much better.

So my advice is always: asset selection is critical. We’re looking for properties that have enormous owner-occupier appeal because that’s what drives the market; we want to get taken along for that ride, and we want to avoid properties that are susceptible to volatility. The obvious one, for example, is if we invest in a mining town, everything’s great when the mining is booming; but now, as we currently stand, the mining boom’s come off, and some of those investors in some of those towns are feeling the pain enormously.

So my number one rule for getting through the storm is to make sure that your asset selection is critical.

 

Number two is focus on the profit and loss rather than the balance sheet.

This is an accounting term essentially meaning: focus on the day-to-day cash flow of your portfolio rather than the day-to-day change in value of your portfolio.

I’ve been investing now for a long, long time and I’ve spoken to people who are investing for 30 years, 40 years, 50 years … if you ask them about the growth on their balance sheet, it’s not a linear line. It’s actually going up, may have given a little bit back; it’s gone up. But, overall, the trend is up. And the overall trend is exponentially greater the longer they hold it than when they first purchase it. They’ve had a few ups and downs along the way—so don’t get caught up if, in the moment, property values on the front page of the paper, or all of the news headlines, suggest that they’ve come off a bit.

Because, ultimately, if you’re investing for the long term it’s irrelevant because what is actually important is: you get the asset selection right, which we talked about before, but make sure that our cash flow is okay now so that we can actually get through the storm.

To do this, you need to manage your cash flow.

Not only that; think about the things that are going to happen in the next few years such as maternity leave, you want to put your kids through university, whatever it is—but if we’ve “cash flowed” these events effectively, prepared for them, we can weather the storms of the fluctuating balance sheet. Because we know we’re playing the long game.

 

Number three, another thing to keep in mind, is don’t play red or black.

By that; don’t gamble, don’t overcommit financially and take a punt on something you think “might come off”. These interest rates won’t be this low forever.

There’s been changes to the lending environment, which means “being very aggressive” two or three years ago, now makes some of those people very, very vulnerable in terms of their lending structure and their lending strategy. Banks look out for the “5 Cs” … and being “compromised” isn’t one of them.

So, don’t play red or black.

Don’t play the gambling card.

Do a methodical and well-thought-out strategy and approach, which takes into account what we talked about—getting the asset selection right, and making sure our cash flow is well looked after.

 

Number four, my next point, is buffer.

Through the storm if we’ve put quite a buffer in place which takes into account six to twelve months’ worth of expenses that we have, it will give us the peace of mind to know that we will be okay to trade through any sort of flattening out of the cycle and in negative news that comes.

It means we won’t have that white-knuckle ride.

It also means that the portfolio is strong and we won’t have to get into a position that cash flow is tight and therefore we have to sell in a position of weakness. It’s the really important thing.

 

My last point about going through the storm, is if you get those first four right … you can actually be opportunistic.

When it’s a booming market people would just love the opportunity to buy really great assets without competition. Well, when we go through a storm those conditions actually exist.

You can buy really great properties with less competition, which is what we hope for during the boom, but when it comes around we get nervous and we don’t actually want to buy.

But if we’ve done those things right—we’ve protected our portfolio, our cash flows are right, we’ve got a buffer in place—we can actually take advantage of the opportunity that comes from the storm environment. Because you’re actually investing for ten or fifteen or twenty years so you’re not going to get caught up in the minutiae of what’s going on now!

So if you do all of those things right, you can take advantage. It’ll only be five years from now you look back and say, “Look at those great assets that I bought in a time that was quite difficult for the economy in general.”

So there’s the few things that I think people can do to weatherproof their portfolio, to make sure that they’re going to be okay.

In conclusion, really what you want to do is plan for the worst but be optimistic about the best.

By that, I mean: keep your mindset right to keep moving forward and building the portfolio for your long-term financial security.

If you do plan for the worst and make sure that your foundations are strong, you’re going to be one of those few people that don’t fear the headlines, that don’t fear the storms that are coming.

Because you’re playing the long game and you’ve set your portfolio up correctly from the beginning.