Throughout our lives, we are faced with several investment decisions. It might start off with a car in high school or college, and then go on to a house. It might be retirement investments, a business, a boat, vacation home, etc. In any case, I have found it is helpful to have a framework to evaluate these investments, so their value goes up and you and your family can enjoy life from a more financially secure position. This framework can really be applied to most any investment from trading historical coins to refurbishing antique cars.
So here are my 16 tips for evaluating your investments:
You should have an interest and enjoy what you are going to be investing in
. In general, you will do better with active investments where you can participate rather than passive investments where you sit on the side lines and watch.
You need to be knowledgeable of the market
. Typically, there are two viewpoints: 1) the micro market view (How is the neighborhood doing?) and 2) the macro market (How is housing doing in my part of the country?). The macro markets are often tracked by economists and go through four distinct sinusoidal phases. You should know where in the cycle your market is. You do not want to buy in when the market is at its peak. Ideally, both at the micro and macro market levels there is a good probability for appreciation and growth. Knowledge of the market is also determined by who has access to the information and the speed at which you can gain access. Those with access to market information on a real-time basis will be at an advantage. Often a trusted advisor (good broker, friend) can help with access, speed, and judgment concerning market information.
It is important to understand how liquid the market is
in which you will be making an investment. How many buyers will be available and in what time frame if I want to sell?
You should also know the current volume of trading
. If it is heavy, it might be too late to get a good deal. In general, it is not good to follow the masses.
5. Conduct your due diligence
. As they say, “the devil is in the details.”
Take ownership and study the details. It will help you in your negotiations later. It is normally a good idea to have a pre-sale inspection by an unbiased inspection group. Know the risk factors and how much volatility in pricing there is.
Know your transaction costs to close the deal: sales tax, broker fees, title, insurance, etc. Sales tax is usually the number one consideration. Closing costs are a bad thing because they do not add value to your investment purchase.
Know the time period you plan to hold on to your investment. If it is very short, then the transaction costs might eat up any return on the investment.
Determine if you can fix-up or refurbish the item you are purchasing. Oftentimes, the value added through refurbishment can far exceed the direct costs.
This is a great way to add value and enhance your future selling price.
You have to get in the game to play, but don’t bet the farm. If something goes wrong on your investment (which realistically it will 10% to 20% of the time), have enough financial resources so you can play the game again. Trust your gut instincts on how good the investment is. Often you will have more knowledge than the so called “industry experts.” Don’t leverage yourself too high with debt. Make investments from savings rather than loans if possible.
[caption id="attachment_5898" align="aligncenter" width="630" caption="Cycles of Market Emotion - You take the most risk when you buy high, and the least risk when you buy low."]
Know the historical appreciation or depreciation over the last few years of the item in which you are investing.
Calculate your projected operating and maintenance costs. These are often overlooked. Know if there are a few items that dwarf the others like labor or fuel costs. Look at these costs for the projected time period of the investment, and compare it to the initial capital purchase. Annual operating and maintenance costs are often much higher than you think.
You should really calculate your total cost of ownership, which is the initial capital purchase plus your operating and maintenance costs, for at least three (3) years or the timeframe of the investment.
11. Reward or return is proportional to risk.
The key is to use your knowledge to reduce the risk relative to the other buyers and still have relatively high returns.
Make sure you have the time and bandwidth available to properly manage your investment. There is a lot more to it than just the initial purchase. If you don’t watch your investment over time, you might miss the most opportune time to sell the investment.
13. Make a mathematical model or spreadsheet
on how you think the whole investment will turn out from beginning to end. Show your calculations to others who are knowledgeable in the industry and have them critique your projections.
When purchasing you should be comfortable with the seller (trust) and know a fair price range. It is important to negotiate and close the deal with a relatively low purchase price. Market intelligence and good negotiations are important to obtaining a low purchase price. If you can find out about the item or property before it even goes on the market, you can sometimes close the deal before others even bid. If there is a range of prices, it is better to be closer to the bottom of the range when you purchase. This way you will have more buyers available when you sell. Have patience. Don’t be afraid to walk away from the deal
if it doesn’t fit your investment criteria.
Generally, you want to sell when everything is going good (market is high) to maximize your selling price. Don’t wait until the market drops or things begin to depreciate to begin the selling process. Maximizing your selling price is very important.
Finally, be patient.
It is generally more of a marathon than a sprint with investing. It is enticing to read about the single hit investment miracles, but in my experience, it tends to be the unglamorous singles and doubles over a long period of time that get you where you need to be.