Most people evaluate investments through three dimensions: risk, reward, and fees or costs. We can all agree that risk, reward, and cost are important to understand before you get into an investment. The problem is that an investment is about a lot more than its strict market value through time. An investment is something you may want to sell, withdraw cash from, rely on in times of need, or leverage. Two investments with the same risk, reward, and fee/cost profiles could perform very differently in any of these scenarios. Then there’s taxation- different investments are taxed differently.
We believe in analyzing every asset that you own, understanding the strengths and weaknesses of each, and then optimizing your portfolio to serve you better. Investments aren’t just about risk and reward. They’re about how your money will serve you in all the different situations that your encounter from now and through the rest of your life.
That’s why we developed an approach called RATES. RATES is a framework you can use to quickly and thoroughly evaluate any asset, to make smarter decisions with your money.
There are five metrics to evaluate when considering an investment: return, accessibility, tax-efficiency, expense, and safety.
The perfect asset would score 100% on each of the five metrics. It would offer incredible returns, be 100% accessible, be completely un-taxed, have zero expenses, and be completely safe from the possibility of loss.
Of course, no such asset exists! The best you can look for is an asset that does well across each of the five metrics.
Let’s take a quick look at each of the five metrics.
Return is the metric most commonly utilized by investors. The problem with how most investors look at return, however, is that they don’t consider enough possible scenarios to accurately evaluate the returns an investment is likely to achieve.
Accessibility may be the most overlooked metric. Can you put your hands on the money in less than 72 hours? How long will your money be tied up for? Can you use the asset as collateral to generate liquidity? Are there penalties involved if you try to withdraw money early? These questions can mean hundreds of thousands or even millions of dollars to you over the years.
Tax-efficiency is how much tax you can expect to pay on your investment. One common myth out there in the investment world is that it’s better to defer your taxes until retirement rather than pay them now because your income will be lower when you retire. For a variety of reasons, your taxes are often higher when you retire, even though you no longer have income taxes from your job! It’s important to consider the tax implications of every asset on your balance sheet.
Expense is what it costs for you to have the asset. What fees and transaction costs are involved? Many mutual fund investors are surprised by how low their returns are. One cause of low mutual fund returns is hidden fees that never appear on your statements. Just as importantly, what opportunity cost does an asset entail? If you invest $1,000,000 in the stock market, you now have less money to invest elsewhere. Typically you can borrow on margin up to 50% of the value of your investment in stocks, which means that your opportunity cost, in this case, would be $500,000. You have $500,000 locked up in stocks, and $500,000 available to invest elsewhere through margin. Other investments may feature higher or lower opportunity cost.
Safety is your protection against loss. How likely are you to lose how much money, in what circumstances? Investors who were overexposed to the stock market in 2008 found out very quickly the importance of planning for every possibility.
No one asset has the perfect RATES profile for every situation. That’s why it’s important to perform a RATES analysis for every asset you own, and every asset you consider investing in. If you go fishing and take a golf club instead of a fishing rod, you’re not going to catch too many fish. So too, if you choose an asset whose RATES profile is not right for your situation, the consequences can be very expensive.
Unfortunately, most investors are only comfortable with four asset classes: stocks, bonds, cash, and real estate. They never learn about the other asset classes available to them and consequently come up short.
We believe that investors should not be married to any particular asset. We evaluate each asset according to RATES. Then we evaluate your entire balance sheet by rates. When you look at your balance sheet as a whole, what kind of returns can you expect? How accessible is your money? Is your balance sheet tax-efficient? How expensive is your balance sheet? How safe is it?
If you don’t know the answer to these questions, we’re happy to assist you.