By Steve Waters
Most people like to think important financial decisions rely on a logical interpretation of facts and figures. But I believe one of the biggest drivers in economics is, in truth, the swings and roundabouts of human psychology.
Emotions in the process can’t be denied. Ask anyone who paid a ‘special premium’ for a home because they’d loved it since they were a kid and finally had the chance to make it theirs. Or outlayed a touch more for a renovation project because their loving grandparent’s house was also Art Deco.
So, we make decisions to act using a mixture of analytical thinking and gut instinct. The process often involves running the numbers on a potential investment, then sitting back, taking in the whole picture and reaching a verdict based on how we ‘feel’ about the opportunity.
In fact, most buyers regularly underestimate how much stock they place in intuition concerning a property investment, particularly when asked outright. We all like to think we buy entirely with our head, not our heart – but this is rarely the case.
From what I’ve observed, there is one concept in investor psychology that helps ensure smart buying decisions are made.
It’s the realisation that the state of your wallet dictates the state of your mind – and, fortunately, this is one thing you can control through strategic planning.
Have you ever needed to get across town while running late for an important appointment? It can be like the universe is working against you. You seem to catch every red light, then follow a learner driver, get hemmed in by a large truck and to find yourself stuck at roadworks. All the while your frustration builds and blood pressure rises.
Make the same journey when the pressure isn’t on, and it feels like the trip is a breeze. The radio’s playing, there are views to enjoy and delays seem non-existent. No worries – just go with the flow and arrive at your destination relaxed.
In truth, both trips may have taken about the same time, but being in an anxious state of mind makes the whole journey a trial.
Worst of all, in this wound-up mindset you start making bad choices. Perhaps you’ll sneak through a stop sign or make a dangerous U-turn to help shave off precious seconds. All of these could end in disaster, just because you put yourself under stress.
The same principal applies when making investment decisions. When you’re placed under financial pressure, seemingly easy choices become a chore and risks become minimised all in the pursuit of some sort of quick outcome.
Think about the times you’ve come across a house listed for sale where the agent informs you the ‘owners have already bought elsewhere and need to sell.’ If it’s been sitting a while, then those poor vendors are going to start seriously considering all offers in an effort to offload the home.
The reverse is true too. Having the ability to say ‘yes’ or ‘no’ to a potential opportunity without the pressure of time and finance puts you in the driver’s seat. Are they asking too much for a property, or being unreasonable on contract conditions? No bother – walk away and look for the next one.
The peace-of-mind wallet is one that buys you time to survive when life takes unexpected twists. Lost a job? Lost a tenant? Interest rates increase? Changes to the household budget? No worries. You’ve factored that in and have plenty of runway until the next opportunity arises. Illness in the family? A healthy wallet lets you stop work and care for loved ones.
Healthy wallet fundamentals
A healthy wallet means different things to different people, but here are a few fundamentals I believe apply.
Firstly, you should have a liquid buffer in place that will service your pre-tax investment debts for at least one year. That means assessing the difference between all the income and all the expenditure (including loan servicing) on your investment properties, and having a year’s worth of that put aside. In this calculation, I also add a margin to the interest rate of a percentage or two, and I reduce my rental income by 20% to allow a further contingency amount.
You also need to have a buffer for household expenses. Work out what it would cost you to survive for, say, three months and add this to your investment-servicing war chest.
Now park this total fiscal safety net where it does you the most good, but is still easily accessible at short notice. For, some people, that will be a share portfolio of blue-chip stocks which can be sold in an emergency. For others, it will be sitting in an offset account reducing the interest on your home loan.
Having this buffer in place will bring huge relief and help you think clearly about your next investment moves.
If you get sick or lose your job, whatever it may be, your buffer will keep the debts at bay and ensure you can put food on the table while you get on with finding new employment. Interest rates rise unexpectedly? No panic, you have the buffer available to service the debt while you shop around for a better deal.
The security of a buffer in emergencies is great, but where it really comes into its own is when you need to make decisions about your portfolio. You will feel no pressure to offload assets at the wrong time due to unforeseen circumstances. Why? Because the buffer has you covered.
What’s more, if an exceptionally great opportunity comes along, you can think with a clear head about whether to proceed or not. Your healthy wallet removes the clouds of doubt and lets you concentrate on the all-important numbers.
Once you’re in control, the investment world blows wide open for you and opportunities seem to fall into your lap.
The healthy wallet is a simple notion that is easy to get underway and pays psychological dividends right from day one.
Here are some links to other blogs discussing cashflow management:
Five Essential Tools for Active Investors
Why Defensive Investing Will Always Win