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Michael Pope Blog post by Michael Pope

The Impact of Time

In a previous article, we began discussing the “inputs” that will be required for an Investment Strategy by talking about the role of money. Another key factor in any investment will be time, and time influences the outcome of an investment strategy in a number of different ways.

The Investor’s Time

The first aspect of time that we need to consider is the amount of your personal time that will be required to start up an investment and the amount of time that will be required to manage that investment over its lifetime. A simple investment such as a Term Deposit with a Bank will take very little of your time – typically a few minutes at a Bank Branch or in front of a computer to set up the Term Deposit will be all that is required, with no requirement to spend any further time to manage the investment through to maturity.

Other investments may require more of your time. You may need to spend some time with a Financial Planner who is looking after a Share Portfolio or Managed Fund investment strategy for you, or you may decide to put in some additional time and establish and manage such an investment yourself. You may take it one step further and buy and sell Shares or other financial instruments on a more frequent basis – monthly, weekly or even daily – or you may choose to become a “day-trader”, buying and selling financial instruments multiple times during the course of a day. Each of these alternative approaches will require different amounts of your time.

Investing in Property will require you to spend some time researching and selecting the property that you wish to purchase, as well as time to arrange the actual purchase, whether at auction or by private sale. Most people will choose to engage the services of a managing agent to minimise the amount of time required on an ongoing basis to manage the property, but there will still be some time required to oversight the investment and make decisions about such things as maintenance, rental increases, etc.

 

The Investment’s Time

The second way in which time influences the outcome of an investment strategy is related to the length of time that an investment is held. In an earlier newsletter, we discussed Capital Growth and the idea that most wealth building strategies will rely on the power of compound growth to drive the increasing value of the wealth base, that is, the growth in any year adds to the value of the asset and increases its value.

To illustrate why this is important, we used an example of $1,000 in a Term Deposit at a Bank receiving Interest at the rate of 6% per year. Each year you would expect to receive $1,000 x 6% = $60 in Interest and after 10 years you would have received a total of 10 times $60 or $600. This is often referred to as “simple” interest.

However, if you had added the Interest you received to the value of the Term Deposit and reinvested it, instead of taking it in cash, then at the end of the first year, you would be investing $1,060, and you would expect to receive $1,060 x 6% = $63.60 in Interest. Over a ten year period, your Term Deposit plus Interest would grow to $1,790 – an increase of $790, over 30% more than in the case of simple interest. Continue this on for a 40 year time horizon and our $1,000 will have become more than $10,000 – no additional contributions, just the power of compound growth at work.

However, this miracle of mathematics needs time to do its job. In this example, the amount of interest received in year 40 is $582, nearly 10 times the $60 received in year 1. But the key point in this example that most people don’t realise is that if you were to delay starting by one year, it is not the first year’s interest ($60) that you miss out on, it’s the last years ($582), as the compounding will only continue for 39 years instead of 40.

When selecting Investment Assets as part of a wealth building strategy, we are looking for a similar outcome. We are looking for assets which increase in value year on year, based on their value at the time, not on their value when they were purchased. So we will look at how the value of a share portfolio or an investment property portfolio has grown from one year to the next, and we will be looking for that value to grow on a compounding basis.

And so the same logic applies – the growth of the portfolio value in the last year will be substantially greater than the growth in the first year, and it will be the last year’s growth we lose for every year we delay getting started. So regardless of your choice of strategies to build wealth, if compound growth is a part of the strategy, the earlier that you get started the better the long term outcome will be.

So comparing the impact of alternative investment strategies is not just about the choice of assets – the timing of buying and selling investment assets also needs to be taken into account to determine the potential returns achievable, and this can be an important factor in determining the choice of investments which are best suited to meeting a person’s investment objectives.

Empower Wealth’s Personal Wealth Management Program includes a sophisticated Wealth Projection Simulator which allows you to see the effect of investment strategy decisions by modelling the effect of these different timing decisions, together with all the other 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’re 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 by registering on our website or just give us a call on 1300 123 842 ( 1300 1 ADVICE ).

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