Getting your head right – 3. Understanding risk

Whenever you are contemplating any form of investing, an imperative step in the process is to assess and wherever possible, mitigate risk. Really, there is no investment strategy that is without risk, so risk assessment needs to become a part of your investing process, no matter what investment vehicle you decide upon.

assessing-property-investing-riskThere are a two components of risk that we will be looking at:

  • Assessing your own risk profile
  • Assessing the risk of the property investing strategy

Assessing your own risk profile

There are many things that can go wrong when it comes to investing in property:

  • You can’t find a tenant for your property
  • Tenants can stop paying the rent
  • Tenants can trash your house
  • Your renovation blow out the budget
  • The property market can stall or even drop
  • Your development project can be delayed and holding costs eat your profit
  • You lose your job and can’t afford the mortgage

Now, although you’d be pretty unlucky to experience all of these, it is not unlikely that you will experience one or more of these occurrences.

I have had several occasions where properties have been untenanted and also where tenants haven’t been paying and I’ve had to evict them. Anyone whose listened to the Everyday Property Investing podcast knows this!

So, are you cut out for investing in property?

Will you be able to sleep at night with the decisions that you have made and the consequences and situations that can eventuate?

You need to take a look at a few factors in order to assess your own risk tolerance, factors which should not only include your level of comfort with risk but also:

  • Your age
  • Whether you have dependents
  • Your level of experience
  • Your available investing funds
  • The time you have to spend on investing
  • The level of involvement you wish to have

Some time ago, we developed a risk profile quiz to help you assess your own risk profile. Take a moment to run through this quiz and consider the factors included to determine your risk profile.

You can access the risk profile quiz here. 

Why your risk profile is important?

So now that you have an idea on the level of risk you are comfortable with, what does this mean to you as a property investor?

Well, this can help you to develop a strategy that will enable you to reach your investing goals (you do have investing goals, right?!) in a way that is comfortable for you. You need to match your personal characteristics and circumstances to the strategy you choose.

Of course, as we discussed earlier, all investing has risk, however, some types of investing has a lower risk that others. For example, a simple buy and hold strategy generally has less risk associated than a strategy which involves developing property. Generally. Of course your buy and hold strategy becomes more risky if you are buying in mining boom towns or if your buy and hold strategy involves highly negatively geared property at a very high loan to value ratio.

See what I mean?

Even within a particular strategy you need to dig deeper to assess the risk of the particular situation and then even the individual property deal.

When it comes to low risk property investing, your general buy and hold strategy, where you’ve researched a location and property, where you have reasonable rental yield and cash-flow which is sustainable to you, where you have maximised your potential for capital gains by choosing a location with good location factors (such as proximity to schools, shops, facilities, transport, diversity of industry, infrastructure development) is probably the most low risk that you’ll find.

Faster paths to wealth are often those with greater risk. These could involve investing in boom mining towns, renovating and flipping and property development. These strategies may appeal to those with a greater risk tolerance and may provide an accelerated path to wealth creation.

So what’s the point of it all?

In the next part of our foundations series we’ll look at setting your goals. You need to determine your goals, which include your timeframe to achieve these goals and then determine how to get there. You’ll need to employ one or several strategies for investing that allow you to get where you want to go and fit with your personality to enable you to get there and still sleep at night along the way!

In this early stage of educating yourself about property investing, armed with the knowledge of the sort of risk profile you have you can now assess each of the types of investing strategies and determine if these fit with you and will form part of your game plan.

 

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