Growing your personal wealth through different investment classes
Over the last 25 years as a chartered accountant in public practice I have had the opportunity to work with literally thousands of small business owners. Some have been highly successful and amassed significant financial wealth and others have failed spectacularly. So what are the lessons that can be learned from this experience that can be used to grow your own personal wealth?
WHITE PAPER SERIES Presented by Quest Apartment Hotels By Tony Rossiter of Holmans Accounting
It is important from the outset to understand this article is not intended to provide financial advice but rather to identify some of the key traits of financially successful individuals. A casual conversation with a financial advisor will reveal that they deal in four main asset classes. Cash, fixed interest securities, Shares and Property. A deeper investigation will reveal each asset class has multiple variations for example shares or equities will include derivatives such as options and futures, property has options including residential, commercial and industrial. The options are almost endless.
There is however a fifth asset class that your financial advisor will not generally talk about and that is the asset class known as business. The Australian Bureau of Statistics advises that there are currently 2.2 Million actively traded businesses in Australia. Generally when we think of business we immediately turn to the big ones, the big four banks, the big miners and Insurance and Telco giants.
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The reality is that the vast majority of businesses are small family owned businesses that we continuously interact with in our daily life.
So if we consider the now five different asset classes which ones are going to deliver the best opportunity to grow personal wealth? It is at this point your financial advisor will start to talk about risk and the correlation between risk and return. That is, generally speaking the higher return you demand from an investment the greater the risk you must be prepared to take that the investment might fail. The first two asset classes, cash and interest bearing securities are relatively straight forward, low risk, low return. However you are never going to achieve substantial personal wealth investing in a pile of cash or even the best performing interest bearing deposit you can find. The reality is that your investment in these asset classes will be lucky to keep pace with inflation.
SHARES AS AN ASSET CLASS
Moving on to shares and their derivatives things start to get a bit more exciting. Interestingly when you invest in shares in most cases you are in fact buying into a share of a business. Typically a very small share of a very large business. On average shares will deliver a better return than the first two asset classes offering a combination of a return of profits or dividends and an increase in value or capital gains. The average return achieved over the last 10 years was 5.5% which was dragged down significantly by the Global Financial Crisis and the corresponding dramatic fall in the Australian Share Index.
Shares have some appealing advantages particularly for novice investors. Typically they are a very liquid investment which you can buy and sell within minutes at a known price. Information on the performance of the business is publicly known and you have the right to vote on important decisions at an annual general meeting. However for a real entrepreneur the limitation is the lack of control.
As one of many thousands of shareholders you are never really going to be able to influence the decision making of the business and you are beholding to the decisions made by the board of directors and their CEO.
PROPERTY AS AN ASSET CLASS
Similar to shares property also has the potential to deliver both income returns and capital gains. An investor in a direct ownership of property has ultimate control over what property they own, how it is managed and when it is sold.
However the transaction costs associated with a direct property investment are substantial, stamp duty, legal fees, and Agents Commission to name a few. In addition, direct property investments are not liquid and it can often take months to sell and realise your investment.
The limitations of property around liquidity and the high transaction costs can be reduced substantially by taking an indirect investment in property via a listed property Fund. There are a number of listed funds that invest in a portfolio of real estate allowing you to buy and sell within a short timeframe. A listed Property Fund will also have the added benefit of being able to diversify across multiple properties in different markets around the country and even internationally. However by investing in a list fund you are handing control over to a Fund manager and they don’t work for free.
INVESTING IN BUSINESS
Having owned my own successful business for the last 16 years it is an asset class that is close to my heart. Fundamentally different to the above mentioned asset classes in that typically a business is not only an investment but it is also a source of employment for the business owner. While it is possible to have a passive investment in a business such as a silent Partnership by far and away the most successful small businesses are owner operated. Typically the small business owner(s) will also possess a strong passion for business and an entrepreneurial spirit that drives their desire to grow and innovate.
So how does an investment in a small business stack up against the other asset classes? Typically in a
successful small business you will receive an income from the profits generated by the business, similar to rent on property or dividends from shares. In addition a growing business will increase in value over time and can deliver a capital gain when sold. However unlike property and shares the business owner will also have a career and an opportunity to receive a salary to match. Control of the business and ultimate responsibility for the outcome rests with the business owner and they have the opportunity to share in all the rewards.
A summary of the key aspects of the 5 Asset classes described is as follows:
Before we all rush out and buy or establish our own small business it is important to understand the risks. The Australian Bureau of Statistics (ABS) tells us that 60% of small businesses fail in the first 3 years. Further it is understood that the most common cause of business failure is a lack of planning and in particular cashflow planning.
To the right individual the risk is well worth the opportunity to create their own path particularly if they are able to identify and mitigate the possible risks before they get started. One way to do this is to acquire a business with systems already in place and a successful track record of delivering outstanding performance.
Often a systemised business with a proven track record can be found in the form of a franchise business. Whether it is a business selling lawn mowing or hamburgers we have all used the goods and services of a franchised business and appreciate the quality and consistency of their products.
Often a successful small business operator will come from the corporate world, perhaps they have climbed the corporate ladder and a ready to find their own path. They may be ready to own their own business but lack the experience in business ownership. A new small business owner operating a Franchise should enjoy a running start by buying into the systems developed by the Franchisor that have proven successful outcomes. Typically the Franchisor will also provide a mentoring role guiding the business owner on how best to implement the franchise systems to achieve the best comes. Despite this systemised approach the best franchises will still leave room for the entrepreneurial business owner to make their mark on the business.
Whatever your plan for growing personal wealth, be it investing in a term deposit or buying a substantial business it is important to undertake your research or Due Diligence and make an assessment of risks and rewards relative to alternative asset classes.