10min read
PREVIOUS ARTICLE Investors are making quick pro... NEXT ARTICLE How negative gearing works...

By Jimmy B Prince, author of ‘Tax for Australians for Dummies’

Whenever I run wealth creation courses I always emphasise to my students that building wealth is not a difficult exercise. The hard bit is having confidence in your ability to make a decision, and that will ultimately come from understanding what you’re doing.

Potential investors often come to me and say ‘I’m keen to invest in the share market but I’m scared of losing money’. Welcome to the club! No one likes losing money. I can still remember the first time I entered the share market. Within a couple of weeks of buying my first company the share price fell sharply, and I quickly saw my wealth fall 25 per cent. It wasn’t a nice experience and I was afraid to tell my wife. As the company I bought was a quality blue chip I convinced myself the need to be patient. Over the intervening months the company’s share price recovered and I made a handy profit when I sold it. By the way, it’s interesting to note the company had increased 700 per cent since I sold it.

Five basic steps

Before you invest it pays to consider the five basic steps discussed below:

1. Understand what you’re doing

An acquaintance of mine eager to enter the share market and take advantage of a seemingly unending rise in the market contacted me and said in an excited voice ‘I’m very keen to get into the share market; can you quickly explain what shares are?’ When I get these types of inquiries I always think of that infamous statement reputed to have been uttered by the American Showman P.T. Barnum ‘There’s a sucker born every minute’. So what should you do?

A. Try to understand the investment’s characteristics.

This is especially the case if you’re offered the opportunity to invest in a complex investment structure concocted by some financial genius. Or you come across an advertisement endorsed by a famous sporting personality or entertainer that looks just too good to believe (for instance ‘earn up to 25 per cent per annum!’). Wherever possible you should read the prospectus. This is a legal document that must be issued by companies wanting to raise finance. It will set out what the company does and other matters required by law.

B. Check whether there’s an established and regulated market that will allow you to buy and sell your investment in an orderly manner. This’ll give you some degree of confidence that there are proper mechanisms in place to reduce the possibility of getting ripped off.

C. Check how long you need to wait before you’re likely to get your initial capital back. It’s no use putting money into an investment that cannot be readily sold and converted back into cash. This could be the case if you plan to invest in some obscure investment scheme.

If you find after you do this exercise that you still don’t understand what you’re doing or the task is overpowering; the answer quite simple – why bother.

2. Identify the benefits

The next step in the process is to identify the various benefits you stand to gain. Remember, an ideal investment is one that has the capacity to increase in value and pay you a regular income flow. Investing in quality blue chip companies listed on the ASX and/or buying property in good locations are examples of the type of investment that can deliver these benefits to you.

3. Examine the risks

The free online English dictionary defines risk as – ‘The chance that an investment’s actual return will be different than expected. This includes the possibility of losing some or all of the original investment. It is usually measured using the historical returns or average returns for a specific investment’. Speaking from personal experience, we could also add to this definition – ‘and the possibility of incurring much pain and anxiety’.

Keep in mind the risk of losing ‘some or all of the original investment’ starts from the moment you hand over your money to someone to use or invest on your behalf. If you want to build wealth and more particularly increase your capital base and income; there are inherent risks that you need to be aware of. For example, as started previously the advantage of investing in shares and property is that they can give you capital growth opportunities and pay regular income. Although this sounds great, the trade-off here is you could lose ‘some or all of the original investment’ if prices fall sharply as was the case in 2008 and 2009. To add salt to the wound your income (for instance dividends or rent) could decrease or cease if your company performs poorly or your property becomes vacant. On the other hand, if you decide to take the ‘safe option’ and keep your money in a bank; your capital will not grow. There’s an inherent risk if you persist with this policy that the purchasing power of your capital will decrease due to inflation and income flows could fall if interest rates fall (as happened in 2009). If all else fails and you decide to keep your money under your bed, the inherent here is you could get robbed or your house could burn down!

When dealing with risk keep in mind the old investment adage of spreading your risk over a number of investment options. This means buying investment assets such as shares in leading companies from different sectors of the Australian economy and buying property in good locations.

4. Understand the tax issues

Every financial transaction you enter into has a tax implication. This is because you’re liable to pay tax on investment income you derive (for instance interest, dividends, rent), tax on capital gains you may make on disposal of your investments, and a 10 per cent goods and services tax on your purchases and sales. It could also influence your decision when to sell and take a profit (or loss). For example, if you buy and sell an investment asset (for instance shares) within twelve months and you make a capital gain, the entire gain is taxed; but only half the gain is taxed if you sell an investment asset you had owned for more than twelve months. Further, certain expenditure you incur and interest on money borrowed to buy investment assets that generate revenue is tax deductible; and you could tap into some handy tax offsets (for instance dividend franking credits and a superannuation pension tax offset).

You should also to be aware of the different ways you can structure your financial affairs. For instance you can buy investments in your name, in partnership with your spouse or partner, in a company or trust structure or in a superannuation fund. A qualified accountant, tax agent, solicitor or financial planner can help you select a suitable entity that’s right for you.

5. The winning edge

Many years ago I saw a western where our hero was challenged to a gunfight. Before he would take up his position and start shooting he would always check where the sun was. By strategically standing with his back to the sun he had forced his opponent to face the sun which meant he had a winning edge.

Every one has a winning edge in his or her closet. The secret is to find your winning edge and exploit it to the best of your ability. For instance, it may be in the form of some significant material advantage or that ‘X’ factor such as a strong desire to succeed and make it happen.

So if our hero can do it, I’m confident if you decide to put your mind to it and find your winning edge, you to can do it!

Other articles in this week’s newsletter

The secret ingredient to share price gains

18 Share Tips

Five steps to building wealth

Where the world’s richest live

Stock of the week

Self-managed super funds & tax exemptions

Stocks & Stats to watch out for this week

More breaking news