WHAT MAKES A GOOD INVESTMENT?
The five criteria of a good investment
We are all increasingly inundated, on a daily basis, with investment proposals from self-styled “experts”, whether financial advisers, investment coaches or, worse, influencers, all of whom believe – and this is indeed what they have in common – that they have found the winning formula for making a fortune, and who deluge us with press articles, emails, videos, solicitations and investment advice in order to achieve their ends.
Each of them seeks to convince you of their analysis in order to make the best investment, with the particularity that their advice changes as suddenly as the news: real estate, bonds, equities, private equity, cryptocurrency, etc.
The reality, however, is different.
While there is no definition as such of what must or may be regarded as a “good investment”, it is nevertheless possible to determine which criteria a quality investment must meet in order to give full satisfaction to its investor.
We have identified five of them : inflation, profitability, peace of mind, security, time.
Inflation
The first criterion that a good investment must meet is, above all, to be higher than inflation net of fees (i) and of tax (ii).
Take an example: if your capital-guaranteed investment yields +1,5% a year gross but inflation stands at 2% in the same year, then in practical terms you lose 0,5% of purchasing power every year and, contrary to the appearance of a positive figure (+1,5%), you are in reality growing poorer slowly but surely, year after year.
Second example: if your investment this time yields +2,2% gross of fees and of tax but still with inflation at 2%, you might this time be tempted to believe that you have gained +0,2% a year (which is admittedly little but at least remains positive).
Unfortunately, you are forgetting the fees and the tax which in reality eat into your performance of +2,2% and reduce it. Thus, if your investment carries 0,5% of fees under its contract and tax of 30% in your country of tax residence (France or the United States, for example), then your gross return of +2,2% falls to +1,7% (which is already below inflation, still at two in our scenario), while that remaining +1,7%, gross of fees but not yet of tax, will then be taxed at 30% by your country of residence, that is, in our example, a further 0,51% that will go in tax. In the end, the balance net of fees and of tax will therefore be a return of +1,19%, still less than inflation over the same year.
The result: you are still losing money.
The first criterion is therefore clear : inflation must be beaten by a wide margin, including fees and taxation, in order to preserve your purchasing power and increase your wealth.
The return
This second criterion is, obviously, the simplest and the most self-evident of all, since it concerns the legitimate and normal expectation of gain that every investor hopes to obtain from his investment.
Naturally, the higher it is, the more attractive it is.
But this criterion alone, fundamental though it is, must not obscure the importance of the others and must never, on its own, govern an investment choice.
It is moreover the net return that must be taken into account, far more than the gross return.
Serenity
The third criterion – most often underestimated by investors in search of performance – yet indispensable over the long term: peace of mind.
Indeed, the peace of mind attached to an investment is fundamental over time, owing to the volatility attached to certain asset classes.
How, then, can an investment be contemplated over the long term if it is not in keeping with your principles, your values and your capacity to withstand significant variations in your capital? If you can no longer sleep because your investment has lost 10, 20, 30 or even 50% of its value in an instant, owing to market fluctuations, political tensions or any other event, then it is definitely not a good investment for you, whatever its expected return in the long run.
Profitability and the building of wealth must not come at the expense of your quality of life, your health and your peace of mind.
Internal and external security
A fourth criterion, underestimated even more often than the previous one: the internal and external security of your investment.
On the ground of external security, this is what happened, in particular, to the investors in Yukos, whose majority holders were grouped together within GML Ltd.
What is referred to as « the Yukos case » relates to an arbitration award rendered in a dispute between GML Ldt, which brought together the majority shareholders of the oil company Yukos, and the Russian Federation. In 2005, GML commenced arbitration proceedings on the basis of the Energy Charter Treaty adopted at The Hague on 17 December 1991 and entered into force in 1998, in particular its article 13, which prohibits expropriations without adequate and effective compensation, after the principal assets of Yukos had been transferred to Rosneft and Gazprom, controlled by the Russian Federation, on the basis of accusations of fraud and tax irregularities against its chief executive, Mr Khodorkovsky, a political opponent of the President of the Russian Federation. This situation led to the bankruptcy of Yukos, a company created by decree in 1993 on the ruins of the USSR, and to the imprisonment of its executives, leading to a ruling against Russia by the ECHR in 2011, and to its dismantling.
Although the Russian Federation was ordered to pay by an arbitral tribunal in 2015, the awards could never be enforced and the investors were never able to recover their money.
This example relating to the Russian Federation is not an isolated one, and identical situations have arisen with other States and in other contexts.
One lesson should nonetheless be drawn from these past experiences: even the most profitable investment in the world is worth nothing if it is not secured and does not guarantee its investor a certain return.
This security is moreover not only political or geopolitical but also concerns the personal situation of the investor who, if he has debts (tax, social security, family, professional, etc…), or were to incur such debts during the life of his investment, could have his assets seized, foremost among them his most profitable investments. Indeed, what is the point of holding the best investments in the world if everyone, including the State, can seize them from you at the first opportunity?
This is what is known as internal security.
Here the fiducie (the French-law fiducie) brings a twofold advantage and answers these issues perfectly, by guaranteeing that the assets are beyond the reach of seizure while entrusting responsibility for that choice to the Fiduciaire who, being more experienced, can avoid this type of pitfall and protect the investor.
Time
Fifth and last criterion of a good investment: the time its management requires.
This criterion, underestimated by those with modest wealth, is in reality the most closely examined and the most important for high-net-worth individuals, since it determines the time and the involvement that such an investment demands in order to ensure effective and optimal monitoring.
Take the example of real estate (held directly), which is without doubt the worst possible investment in terms of the return / time ratio.
If you have 300.000 euros to invest and you choose to invest them in real estate, you may reasonably expect a return of between 2,7 and 6,5% gross of tax, which is, on the one hand, not extraordinary in itself compared with other investments, but which will in addition require you to see to the regular upkeep of the property (i), rental management – move-in/move-out, inventory of fixtures, rent receipts, reminders, debt recovery or even eviction proceedings, refurbishment, etc. (ii), the risk of unpaid rent, (iii) insurance, (iv) bringing the dwelling up to standard so as to comply with the local regulations of the country in which the property is situated, (v) the search for tradespeople and companies able to carry out the works and to supervise the sites and (vi) attending the general meetings of the co-ownership council, not forgetting (vii) all the other unforeseen events (a water leak on Sunday at 22H, air conditioning breakdown, an electrical problem, etc.), (viii) or indeed neighbourhood disturbances and disputes with the town planning department or the Municipality…
All these steps, which accumulate and follow one another (sometimes exponentially where several properties have to be managed), represent not only money (which eats into the profitability of the property) but above all time, your time, which is never renewed and which, when you devote it to managing a property, logically cannot be used for other activities that are potentially more profitable or more fulfilling.
Consequently, if an investment costs you too much time each month, each week or each year in relation to its return, it is technically not a good investment.
Naturally, you may delegate that management to a third party, but this will incur additional costs which will further reduce performance and therefore, necessarily, the appeal of the asset class.
You will have understood that the perfect investment must be able to free your mind of all constraints and, ideally, enrich you without your having to do anything.
What could be better than a transfer, every month, every quarter or every year, into your bank account, with nothing to manage and the freedom to enjoy life to the full?
The combination of these five investment criteria is what we, as fiduciary avocats, consider to be a good investor, and it is therefore the investments that we identify and select for our clients within our contracts and other fiduciary funds.
In conclusion, there are no good or bad investments strictly speaking, but rather types of investment that are compatible or not with the profile, the history, the plans and the expectations of each investor, according to their personal situation and the economic context in which they find themselves.
This constant evolution of the financial sector makes it all the more essential to be well supported and well advised when it comes to investing the fruit of a lifetime’s work.
The fact that you have savings does not mean that you should invest them in any way whatsoever.
Frequently asked questions: what is a good investment?
What are the criteria of a good investment?
A good investment rests on five criteria: protection against inflation, return, peace of mind (simplicity of management), internal and external security, and time (the investment horizon). The balance between these criteria matters more than performance alone.
How can one protect oneself against inflation?
To preserve the purchasing power of one’s capital, preference must be given to assets whose value rises at least in line with inflation: equities, real estate, real assets. Leaving one’s savings idle in cash exposes them to a silent erosion.
Should return or security be given priority?
The two must be balanced according to your profile. A high return is generally accompanied by greater risk. A diversified asset allocation makes it possible to target a satisfactory return while keeping risk under control.
Why is time essential in investment?
Time smooths volatility, allows compound interest to work and reduces the risk of loss. A long investment horizon permits a more dynamic allocation and therefore a higher potential return.
How should a substantial capital be invested?
A substantial capital cannot be invested in just any manner: it requires a diversified asset allocation, suited to your objectives and to your horizon, together with regular monitoring. The support of a professional secures these choices.
The House of Harlington since
2006