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Now is the time to avoid these 3 potentially risky investments – Pete Wargent

Stocks and property are both asset classes which offer tremendous potential to build wealth for the long term as long as you have a sensible plan.

However investment risk is not a simple concept, since it largely relates to the risk tolerance and time horizon of the individual investor.

For example, I wouldn’t be planning to sell existing share investments presently, since my strategy is a long-term one based around growing dividend income, but that doesn’t mean that tipping all your money into the share market immediately is a good idea for someone else.

Here are three places which could be risky to invest your money:

1. Mining town property

I hail from a part of the world which once thrived and then dived as a result of mining fortunes, and my experience tells me that I would never buy an investment property in a mining town.

I don’t care what the headline yields are, or even if prices might go up a bit in the year or two ahead, I’m a long-term investor and I’ll simply never do it.

Mining towns can only ever really be assessed on a case by case basis, but as a general rule, mining investment (i.e. mining construction) took off about a decade ago and is now about to enter a period of rapid decline over the coming few years.

sp-ag-160914-graph1

I remember well from my days working in the mining industry that people can become tremendously excited by the prospect of a new resources project and its impact on property values, without ever truly understanding just how few people will ever relocate to the area in question for the long term.

Remember, it generally takes fewer people to operate a mine than it does to construct a project, so now may be a very poor time to take such a plunge.

Tales of mining projects being wound up and property prices collapsing are legion. Even last year positive cashflow property experts were still recommending places such as Port Hedland as a place to invest, despite sky high median house prices of around $1 million (!!) and the huge potential for land release and new supply to come to the market.

I believe that sometimes people tend to over-complicate real estate as an investment. Be guided by common sense – where will people want and need to live for decades to come?

Where is there a scarcity of land to be developed?Here’s an example of what I mean. This is a satellite view of Port Hedland and South Hedland:

Port Hedland and South Hedland

The region is truly a fascinating one to visit, and I’d highly recommend it for anyone who is interesting in the mechanics of mining operations.

This aerial shot above gives you a basic idea of where the housing is located as related to the coast and the resources ops.

What I do not see, however, is a scarcity of land! Let’s zoom out a little.

Pilbara

We could zoom out further still, but I suspect you already get the picture. There is more land available in the Pilbara than could ever be inhabited. New suburbs may be created on a whim and land scarcity can only ever be artificial.

I’ve picked out Port Hedland as an example, but you might just as well read ‘most regional towns’.

By way of comparison, below are some of the locations I consider a great long-term investment in Sydney.

One caveat: I steer well clear of suburbs where there are few height restrictions on residential building, or locations which are in the process of being rezoned from industrial to residential (there are plenty of these near the airport at the moment).

Instead, look to suburbs where the supply is effectively fixed.

Sydney

I know that demand will be high and still growing in 15 years time since there will be around 1 million (1,000,000) more people in Sydney.

And I also know that very little land will be released in these locations, since to all intents and purposes, there is none to be released.

I believe that median prices could potentially remain high in areas like Port Hedland, but remain very sceptical as to whether existing stock could increase in value ahead of the inflation rate in perpetuity.

2.  Off the plan property

I’ve bought off the plan property before, and it can work as a strategy at certain stages of the property cycle.[sam id=40 codes=’true’]

Now is not that time.

The new dwelling stock in cities like Sydney is far too expensive to warrant interest from investors seeking a return.

While off the plan property may be appealing since it is shiny, new and easy to let, and because on-paper depreciation allowances can be high, new property will not be new in 15 years time (so it will, in effect, depreciate) and therefore it generally makes much more sense as an investor to buy well-located, established stock.

Not only can investors choose established stock in mature, leafy suburbs (as opposed to rezoned industrial locations where much of the new supply is located), they can do so without paying a material premium, which is not a luxury off the plan buyers have at this time.

3.  US stocks

What a half decade the share markets have had in the US!US stocks

Source: Bloomberg

The above graphic is the S&P 500 five year chart, showing the index essentially at a record high, give or take one trade.Even on a forward PE ratio, valuations are now at 16 times, so if you consider yourself to be a value investor, you’d presumably now be looking elsewhere for investment selections.

That’s not to say the market won’t go higher over the longer term – it certainly will, in fact – rather just to note that if the US economy keeps improving over the next couple of years the Federal Reserve will taper off its stimulus, markets will begin to price and forthcoming rate hikes, and there could be a rapid repricing of securities as a result.

As always in the share markets, if your strategy is to time the market, there’s an ever-present risk that you’ll get it wrong. A long-term approach based upon dividend income is far more straightforward for most.

Summary

These are just a few ideas and suggestions which should lead to deeper consideration.

Stocks and property are both asset classes which offer tremendous potential to build wealth for the long term as long as you have a sensible plan.

The most important thing is to have a proven strategy for a long term time horizon and to stick to it with discipline and patience.

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About

Pete Wargent is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. He’s achieved financial freedom at the age of 33 - as detailed in his book ‘Get a Financial Grip – A Simple Plan for Financial Freedom’. Pete now manages his investment portfolio, travels and works as a consultant in the finance industry from time to time. Visit his blog


'Now is the time to avoid these 3 potentially risky investments – Pete Wargent' have 2 comments

  1. Avatar for Property Update

    April 11, 2014 @ 7:49 am Hamish Blair

    With interest rates at record lows in the US, no wonder stocks are at 16x forward PE.

    The PE ratio = 1 / (Required rate of return – expected growth)

    So even if growth was only say 2% pa (inflation style), this means the required rate of return on average is 8.25%. This is still a reasonable risk premium over the risk free rate.

    If and when US interest rates eventually rise I would expect the forward PE and therefore stock price to drop. Plus this differential in the interest rates between the US and Australia is keeping our exchange rate high – the A$ would also drop if and when the US raises their interest rates.

    Reply

  2. Avatar for Property Update

    April 11, 2014 @ 8:13 am Pete Wargent

    Hamish, yes indeed so. Markets are clearly trying to second guess how stimulus will be tapered back. I see the NASDAQ shed 3.1% overnight…on good news. DJIA down 266 points too.

    Reply


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