Know the Downside Before You Invest

By Jason Fittler

When you look to investment you must assess all the different risks involved in your chosen investment.

You need to understand what can and will go wrong.

Most investors are only focused on the upside of the investment. When things go wrong this leads to irrational decisions. And irrational decisions can cause loss of capital. 

Investments will fluctuate; this is the nature of investments. To be successful you not only have to understand this you also have to have considered this before making the investment.

Let’s look at some examples:

Investment Property

There are a number of downside risks in relation to investment properties:

1. Interest rate increase

2. Property price fall

3. Rental prices fall

4. Occupancies rates drop

4. Cash flow

The largest risk sits with cash flow making it the key downside risk when considering investing in property. Many things can affect cash flow but the main risk is loss of income.

An investment property generates small or negative cash flow. The investment needs your income to be sustainable.

What happens if you or your partner loses your job? Will you be able to pay the mortgage, rates, insurance, repairs and maintenance on your investment property?

Consider your future employment stability before buying an investment property.

If you have to sell the property in a hurry can you handle the loss? What is your exit plan?

Shares

Shares are generally cash flow positive and so the downside risk is total loss of capital.

Shares generate dividends and do not need any further cash input once purchased. The loss of your job would not affect your ability to continue to hold that share investment.

With shares the company in which you are invested in can go bankrupt. This will result in you losing all your capital invested. This is the main downside risk when investing in shares. As such you need strategies around this risk:

1. Never invest all your money in one company. Invest in at least 20 different companies to reduce the risk. If you do not have the funds to invest in 20 individual companies then look at an index fund, which provides the same exposure.

2. I prefer not to gear into share investments. But if you must then you can reduce the risk by gearing against a property. Keep the margin loan to 30% of the value of the investments or use warrants to reduce your exposure.

3. Education is the key. Know why your invested in the particular company and keep up to date with the latest information on the company. It is normal for the value of a company to fluctuate based on the many different factors. If you understand this there is less chance of you selling at the wrong time.

If you would like more information please call me on (07) 4771 4577.