Interactive Investor

Tax, contrarian investing and other wealth builders

7th December 2018 13:28

Peter Alcaraz from interactive investor

Former lawyer and City money man Peter Alcaraz talks us through some examples of building techniques where financial alchemy arises, and grabbing game changers with both hands.
 

Peter Alcaraz read law and economics at Durham University and spent 24 years advising small and mid-sized companies on mergers, acquisitions, IPO's and fund raisings, first as a lawyer and for the last 20 years in corporate finance. At the age of 46 after reaching 'O' he left city life to write, study, travel and spend more time with his wife and two daughters. His first book, The Wealth Game - an ordinary person's companion was published in 2016 and has become a staple among wealth managers, business schools and private individuals wishing to develop their personal finance skills.

Somewhere in the course of playing the wealth game, alchemy or plain good fortune arises. Perhaps a high-definition insight, a flash of brilliant inspiration or a deep sense of confidence, purpose and balance. In a single moment or over time, like the grit in an oyster, a pearl forms.

This potential exists in all of us and playing the wealth game creates the conditions and space for its release. Cultivating physical and mental discipline and other qualities needed to banish poverty-promoting behaviours clears the path and helps us to see clearly as an objective viewer rather than through the distorted prism of the subject. Put simply, we change...

Anyone of course can be led by the first thought that enters their head and daydream their way to wealth or any other prize but this is delusion born of ignorance and desperation, a blind hope. Such infatuation springs up and vanishes just as quickly, but the kind of hard-won good fortune that I’m discussing is made of sturdier stuff and really does make good things happen.

Here are some examples of building techniques where financial alchemy arises:

Buy, hold, and buy again

Gear up your personal balance sheet through residential mortgage secured against quality property to the highest level you can comfortably and safely afford, and pay down the debt as rapidly as possible, allowing for investments in tax-free equities like pensions and ISAs. 

Don’t sell your assets unless you can recycle the after-tax proceeds into higher-returning appreciators. Releverage as soon as you are able to buy more property or shares. Continue for at least two or three cycles to build a portfolio of assets.

Contrarian investing

Target a good quality appreciator that is out of fashion, unloved by the market and not attracting much buyer interest. How you find it doesn't matter; you might spot an out-of-favour property region or stockmarket segment and then hunt out a suitable asset, or you might find the asset first and then wait for it to become unloved. As you become more commercially and market attuned you naturally begin to notice pockets of market weakness, and your antennae tune in to interesting opportunities.

Once you think you have found the right contrarian investment opportunity, evaluate it to be sure that it's sound. The key to success in this technique is buying fundamentally good assets, ones that can deliver income and capital growth over a long period without too much effort and that won't fall down or disappear. 

If an asset passes this, test your view that it is unloved by offering a low price while at the same time making yourself the most attractive possible buyer on every other count—have ready funding, the ability to deal quickly, and so on. Stay emotionally detached. Wear down reluctant sellers with charm and persistence.

For the ordinary person, this works best with residential property where you can see and understand what you are buying, check out the surrounding area, value it, and deal directly with a private seller. The signposts for these situations may be quite well hidden. Half the battle is being awake and mindful, because contrarian means exactly that—doing the opposite of others. The chance may be no more than a yet-undiscovered area next to a popular one or an upcoming infrastructure or regeneration project that isn’t yet reflected in prices. 

Artists and craftspeople are excellent barometers of where to look. They have a knack for spotting cheap but convenient areas to inhabit, and over time, their presence alone can stimulate buyer demand, new investment, and price increases.

In the case of quoted company shares, the opportunity arises when markets succumb to fear and forced selling; the share prices of excellent, well-managed companies or funds get swept down in the current and can start to offer great medium-term value.

This strategy is as old as the hills but often forgotten in the rush for instant gains. It does require liquidity (ie having ready cash or access to loans), but you can achieve this in the central and final phases of the game and beyond. It changes your perception of economic downturns, currency or debt crises, bank failures, wars, and other contributors to market mayhem. As long as you maintain a cash buffer to ride out the storm and are not over indebted, these are times of great opportunity. The assets you buy now will jump in value and deliver mouth-watering returns when stability resumes.

It is easy to get drawn into a debate about timing, but this is best avoided. In contrarian buying, you don't look for the top of the market but the bottom, and it doesn't matter if you miss the absolute bottom and buy one side or the other, as long as you're reasonably close; prices may fall a little further, or they may already have bounced slightly. It is sheer luck whether your timing is spot-on or not, but the trick is to be there or thereabouts and not buy too early. Wait for prices to be 15-20% below their peak—preferably even lower.

Stockmarkets tend to break these loss barriers very quickly and then pause for breath before deciding what to do next. Bounces on the way down can be short lived and trick you into buying early, so patience is called for. If in doubt, wait, because genuine buying opportunities are more frequent than you might think. In my working life, there have been at least four: 1987, 1992, 2000–2001, and 2008–2009. I missed the first two, lacking confidence and cash, but by the third, I was standing by for action. I feel that there may be another one not too far away.
 
Residential property prices are slower to respond and more predictable. According to Halifax Building Society, average home prices in greater London have fallen in only seven out of the last thirty years: 1990–1993 and again in 1995, 2008, and 2009. The biggest single annual fall was 11.8% in 2009. I try to buy in the second or third year after a fall by which time sellers of quality properties tend to have accepted a lower price environment but buyers at large aren’t re-entering the market. Earlier opportunities can arise from overgeared, distressed sellers, but, particularly with speculators or those who got into the market late, their products are often poor. Real quality generally takes time to shake loose.

Never confuse this kind of contrarian investing with the completely different strategies of buying distressed assets and then fixing them or buying ordinary assets and somehow making them more valuable; these require different skills and a hands-on approach.

Go where the money is to earn it, and go to where the money isn’t to buy depreciators and consumables

I love this method; it's so simple and effective. And in a world of connectivity and globalisation, it is relatively easy. London's magnetic quality to workers is testament to this, as are thousands of immigrant workers throughout Britain and other developed nations who send money home to their families. Where you live and work can have a greater effect on your wealth than what you do and how well you do it. All these factors set boundaries to your earning potential as an individual.

Conversely, your earnings go much further when spent in places where money is in short supply and prices are low; you can live like royalty and indulge. Travel and internet shopping have opened up a world of opportunity.

Buy assets where the wealthy buy them

You won't get far in the game by buying assets that those with money don't want and aren't likely to in the future. The notion of spotting the next big thing and getting in ahead of the pack is appealing but hard to achieve and it is too opportunistic to be relied on as a core strategy. You are better to monitor the movements of global capital: to what cities, countries, and asset classes the money flows or has flowed historically. Go there in pursuit of quality assets. Information on this subject is easy to obtain from wealth managers, international estate agents, and stockbroking firms.

Proactive tax planning

The British love to knock the wealthy. Does it stem from our innate sense of fairness, justice, and support for the underdog, or is it just chippiness? Perhaps it's because so many people with money make themselves hard to like. If it's not self-obsession and distorted values, it's unscrupulous or antisocial behaviour that harms people or the environment. And nothing irks more than seeing those with power and means paying taxes at lower rates than ordinary working people - or, in some cases, avoiding them altogether. 

The trap for the ordinary person is succumbing to grumbling inactivity which is pointless and distracting, rather like bemoaning banks and bankers. It is negative and dispiriting and achieves nothing. A better approach is to adopt one of three universal options when faced with something you don’t like: make a stand and fight it, join the other side, or ignore the issue completely.

In the game of pot building, taxes are an enemy and it serves your financial interests to become a clever tax planner. This is an overlooked gem amongst pot-building techniques and fully available to anyone.

After a lifetime of ignoring the subject or muddling through, I started taking tax advice only in the last year or two before reaching O as part of a complete systems overhaul and 'spring-clean'. A lawyer friend introduced me to a former tax partner of one of the big four accounting firms who had recently left to advise the partners of a national law firm on their personal affairs and who was also taking on a limited number of outside clients. Able to tap into the resources of his clients to stay up-to-date and seeing more real-life issues in a week than I might in 10 years, he has been a gold mine.

Every autumn we meet for an hour or so over coffee to have a creative brainstorm. The meeting always begins with my updating him on changes in the family finances or circumstances over the year and raising a few questions if I have any. Sometimes I turn up with no agenda and almost doubting whether the trip will be worthwhile. He questions, probes, and suggests until I am tired of talking and writing and we part for another twelve months. The trip home is spent summarising my notes into a short list of possible tax-planning actions that I mull over, sometimes for months. The whole process is absorbing and fascinating, rather like seeing a specialist medical consultant to explore tailored ways to improve my health.

During the year ahead, we might have one or two e-mail exchanges when I seek advice on specific issues, but no more. I keep all my own tax records and complete the family's personal returns and our limited company accounts, VAT, and corporation tax returns online, at no cost other than my time. 

Long ago I learned to keep all low-level administration away from expert advisers. It is not interesting for them or cost-effective for me. Outsourcing such tasks also leads to disconnection from the issues and the habit of passing responsibility to others which impedes self-improvement. For a few things, you say, "Trust experts," but for most, you say, "Trust myself."
 
I have never calculated the actual financial benefits of his advice but a quick 'back of the envelope' confirms gains of well over ten times the cost of his very modest fees over the last 10 years. Independent financial adviser firms at last seem to be waking up to the fact that tax planning and advice is real value add to private clients who already have some level of investing knowledge.

The areas that have been most fruitful to me have been splitting assets with my wife and children; using all our annual reliefs, pension, and ISA allowances in full; managing assets to minimise income and capital gains tax; accounting for all expenses I can offset and utilising all available losses; and since giving up employment, channelling any money making activities through a limited company with a simple bank-account structure to make reporting easy; utilising trading expenses and capital allowances; and managing distributions to stay below higher-income tax thresholds.

As well as having tax-efficient family wills I have recently started actively managing down inheritance tax liabilities for the next generation.

My practical guide to tax is as follows:

a.    Set as a cardinal obligation the duty not to pay more tax than is required. It is incredibly easy to overpay without realising

b.    Find a genuine expert on tax with the resources to stay up-to-date, and build a long-term relationship

c.    Have at least one tax-planning meeting each year

d.    Spend time playing with different scenarios to optimise all-around benefits

e.    Read around the subject to fill in gaps or raise further questions for the tax adviser

f.    Do all tax filings online

g.    Keep impeccable records, and archive paper ones from the cabinet to the attic every few years

h.    Use every relief and tax-saving method offered by government that fits your situation and that doesn't direct you to areas of investment that you don't understand

i.    Utilise all costs and losses that can be used to offset tax, creating income if necessary to utilise them by turning an asset into a productive one

j.    Declare everything—a clear conscience is priceless. No brown envelope from HMRC will ever cause the slightest heart flutter

k.    Avoid non-standard tax-saving schemes designed for the prime purpose of reducing or avoiding tax. These are a recipe for worry, moral recrimination, and adviser fees. HMRC increasingly challenge and overturn these schemes loading interest, penalties and grief to the original sum due

l.    Avoid complexity wherever possible—trusts, offshore companies and other such vehicles can tie people in knots, wasting years of their lives. They rarely work fully as intended and are always high cost.
 m.    Challenge the tax authorities if they get it wrong, which they frequently do. They are public servants and human.

Understand skimming versus overall wealth creation, and apply each appropriately

Skimming is a zero-sum game. This means that any gain or loss you make is matched exactly by an equivalent loss or gain by other participants in the game. For example, a buyer makes £100 profit on a share sale, while the seller has lost the opportunity to make that profit by selling. Great wealth can be derived by redirecting assets from others to you. Look at the former Soviet Union. To do this, you need to know where the wealth is and how to access it. Similarly, service providers, agents, brokers, or other intermediaries can amass large sums by skimming a small portion of capital as it flows around the system.

Overall wealth creation, on the other hand, is a not a zero-sum game, because the total amount of utility or usefulness in circulation increases as a result of your action. This route, too, can deliver great wealth, as proven by many inventors and business builders.

How does your wealth-generating activity split between each category? Think about how and from where your wealth can be derived. Your asset base can become an excellent skimming tool.

Game changers

These are big opportunities that arise maybe once or twice in your lifetime and move the dial for your net worth. The scale of these moves can be intimidating but the potential rewards life changing.

Playing the wealth game sharpens your senses and skills enabling you to spot these titans when they come. They generally don't appear with a sign marked ‘gigantic financial opportunity,’ and it’s easy to miss them if you are looking the other way or are too busy to notice.

Spotting game changers is one thing; grabbing them with both hands is quite another. Fear, unwillingness to suffer any inconvenience, over-analysis and indecision or inertia are a few of the enemies of opportunity and I have seen people beset with these pass up game changers and never quite get over it. Not only did they miss the chance to move the dial financially, but they know they missed it.
 
Where do these gifts come from? They are generally tailor-made for you; not off-the-shelf products fit for all, and they are born from the personal circumstances that you, in part, create. Thomas Jefferson is reported to have said:

 "I'm a great believer in luck, and I find that the harder I work, the more of it I have." 

An opportunity that you can’t take is called fantasy so the trick is to get into a position to take it. You need to create the conditions.

Most of this involves money as these bets stretch you to the outer limits where the margin between a deal happening or not is wafer thin, a tiny proportion of the overall cost. At a different time, it would seem like pocket money. Whoever tells you that the small things don’t matter—and a surprising number of financial experts do—is overlooking the power of cause and effect compounded over time, and forgetting the fine line between success and failure.

A motivational speaker once said that "winning is a game of inches," and I often reflected on that as I crawled along the slow lane. Any Olympic medal winner or musical virtuoso is testament to hard yards not only putting them in the game but also enabling them to grab the prize. When you pull off a great wealth generating deal, observers generally focus on the transaction itself: "How did you find that?" "What luck!" "What a great price!" "You'll make a fortune out of that one!" It is easy to overlook the slow, inch-by-inch progress you have made over years to get into the position where you could pull it off.

Shortage of money may not be the only problem. Reaching out and grabbing the biggest opportunities requires nimbleness, flexibility, and speed. Those weighed down by lifestyles, clutter, convention, and obligation or who are unfit through prolonged inactivity can only watch helplessly as the boat sails by. If you want an argument for travelling light, here it is.

And what are these deals or situations? For me, they were residential property with improvement potential and the stockmarket downturn of 2008 combined with central bank money creation which delivered an extraordinary money-making opportunity for those with assets and cash to invest. For others I know, they have been the opportunity to own a meaningful stake in a valuable business.

If it's all so easy, why don't more people in their 40's or 50's reach O? Read next time to find out...

Peter Alcaraz is a freelance contributor and not a direct employee of interactive investor.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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