Money rules are a personal thing. They are your rules. You may have rules you were conditioned with (by parents, teachers, family, peers) and you probably have set some money rules for yourself. Unfortunately, there is no set formula for establishing money rules... especially money rules specific to your investments. This article will give you some ideas for setting your own money rules. You will probably continue to tweak them for years to come as your investment strategies change, as you continue to learn from experience, and, as in my case, you occasionally get burned or learn the hard way.
These rules are provided as a starting point for you to develop your own money rules. As you develop your own, we would love to hear from you. Please drop us a comment at the end of this article.1. Remember, everything is negotiable:
When presented with an investment opportunity, negotiate terms that work for you rather than accept a deal as presented. (Click this link to see our post on the art of negotiation.)2. Never use pro forma numbers in your cash flow or acquisition analysis:
In this rule we define pro forma as financial projections. For example, if you are buying an apartment building, you want to use the current financials for the property, not the pro forma financials. Brokers are famous for using pro forma analysis when presenting a real estate property or business for sale, and for basing the asking price on those projected numbers. Pro forma numbers will include items such as potential market rent on an apartment unit (after renovations, for example), management costs under new management, utility costs when residents pay a portion of utilities, etc. These are what we call "the grass has been fertilized" numbers, and they are, quite possibly, wishful thinking.3. Know your exit strategies before you make the investment:
Your exit strategy is how you plan to capitalize on your investments. For example, will you sell a stock, sell or refinance a property, cash in a fund after retirement for tax benefits, etc? You need to understand your exit strategy when you make the investment! It is possible, and advisable in most cases, to have several exit strategies in place. Determine who gets paid what and when. When planning on how to capitalize on an investment, use pro forma financial analysis conservatively and judiciously.4. Diversify your portfolio:
Establish what type of diversification you desire to have in your portfolio. For example, you might target diversification as follows: Real Estate 40%, Business and prom notes 20%, Stock Market 15%, Oil and Gas 10%, Cash 15%. Having a strongly diversified portfolio will protect you from short-term fluctuations in each asset class. These percentages are only examples, you'll find wildly differing opinions depending on whom you talk to.
Have short-term and long-term plans for your investments, to include cash flow, passive income, equity growth and capitalization on your investments (how you get your money out).
One other important item to consider here is your liquidity needs. This is one reason why we suggest you have cash as a part of your asset portfolio. You do not want to find yourself in a situation where you badly need funds and they are tied up in a long-term hold.
Do you need to feel in control of your investments? How much time do you have for hands on management of your portfolio? We've been able to find a good balance through experience and have, over time, decided on what we enjoy doing. For example, we invest in oil and gas, which has been a fairly passive investment involving very little of our time. When we began investing in real estate, we started with single-family properties and found it took too much of our time because of the hands on management involved. We later moved to apartment buildings which supported the hiring of a professional management company, thereby freeing us up to continue to acquire assets and to manage those assets rather than being involved in property management on a daily basis.6. Decide what ROI is acceptable to you:
What type of return on investment do you require? Are you comfortable with a 7% annual return on investment? Your rules might state the following; prom notes must earn a minimum return of no less than 10% ROI per annum, while real estate must produce a minimum of 5% cash flow and an equity gain of 10% annually. Once you establish these rules don't vary. If a deal comes your way that does not satisfy your minimum requirements, don't do the deal.7. Don’t follow the crowd:
Never invest in a deal just because everyone else is doing it. This rule speaks for itself. It is easy to fall into the trap that if everyone is doing something, it must be good. The danger here is that you are unlikely to do your own due diligence if you believe the group, or crowd has already done it.8. Verify, verify, verify:
Always complete due diligence and inspections of numbers, books, reports and data. Obtain everything in writing. Speak to others that have experience in a particular asset class and compare numbers. Ask for references and follow through by contacting those references.
Run the numbers and make sure you believe they make sense. If you are not confident in running the numbers get someone on your team to do this for you and have them give you their evaluation of the deal. Have the proper tools and know how to use them (or a team that does). These tools will include analysis and financing spreadsheets, due diligence checklists, etc.9. Take advantage of tax benefits:
No matter what you are investing in, you need to clearly know what the tax implications and benefits are (both on your investment and your current income). When you invest, be aware of the tax implications not only for the current year, but also for the following years and for the day you exit your investment. With a well-diversified portfolio you will be allocating the tax advantages over many assets. Use a CPA or tax attorney to assist you in reviewing how your investment returns will impact your tax rate and your regular income.10. Be certain you fully understand the investment:
Read the documents provided. Create a list of additional documents required by you. For example, when looking at a business investment ask for all financials in addition to an offering memorandum; documents such as cash flow statements, balance sheets, profit and loss statements, pro forma analysis, etc., will assist you in understanding how an investment will perform.11. Don't try to time the market:
This is just too hard to pull off. By this we mean, don't try to second-guess the timing in a market. Don't try to guess when a real estate market has reached it's peak or bottom, the same is true of the stock market. By the time you realize a market has moved, most of that movement has already taken place. No matter how tempting, do not forgo diversification to jump into a "hot" asset class with a large portion of your investment dollars.12. Don’t invest more money than you can comfortably afford to lose:
Know your worst-case scenarios and determine if you can ride them out. Take calculated risks. Be sure you have an emergency fund. Follow your money rules religiously.
Always remember, no one knows your investing psychology, goals, priorities, risk and comfort levels more than you do. This can be a fun exercise if you realize it does not need to be done over night, and can be a fluid, learning process.
Theresa Bradley-Banta, co-creator of BigFishTopsDogs.com, is a musician, award winning graphic artist, mentor, entrepreneur, blogger and owner of multiple businesses. You can visit her blog @bigfishtopdogs.com.
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