Every Asset Needs a Purpose

I have a friend who is a very good golfer and at one time was the distribution manager for McGregor golf equipment. He absolutely loved the game and golf equipment, and we had a lot of fun as golf partners.

After going to a golf equipment convention in the USA, he came back with the option to take up a Mizuno agency. He was really keen to do it and convinced me that there was a gap in the market. His plan was that I should invest the capital for the stock, and we set up a business distributing Mizuno golf equipment.

The business struggled from day one and we persuaded ourselves that it was just teething problems. At one point I invested further as we changed strategy.

It took a while for me to be honest with myself, but when I finally did, I realised that the truth was that I was supporting a friend and trying to make a business out of a hobby. These conflicted and confusing objectives were costly.

 

It’s easy to confuse the purpose of assets
“In any If you don’t know the purpose of an asset, you can’t determine its required return and therefore the most appropriate and optimal strategies. It’s easy to get confused. As every asset or venture requires money, whether it satisfies an emotional purpose or not, the investor would ideally like at least a return of that money.

Psychologically, it’s very difficult to accept a loss in return for satisfying an emotion. It is equally difficult to accept an inferior return – so it’s often justified as something else.

Every asset should have a purpose, and the owner should know and understand its purpose. It’s okay to make a choice where a financial return is forfeited for a return in some other way. It’s not okay to have an expectation of a good financial return, as well as satisfy emotional needs.

 

Four broad categories
There are four broad categories of assets: lifestyle assets, investment assets, speculative assets, and business assets.  The simplest test of whether an asset is for lifestyle is whether the owner would dispose of it for an alternative if a better return was available. Few people would dispose of their homes to invest for a better return. A boat, car and farm land often fit into the same category.

Investment assets are assets from which market returns are expected. The decision is usually a probability-based one and the benchmark is the market index.

A speculative asset purchase is one based on an opinion rather than probabilities. There is an extra layer of risk, and a return over the market is required.

Business assets have additional layers of risk and cost and therefore need additional reward. Besides the high risk of failure (statistics show that only 33 per cent of businesses survive 10 years) but also time and concentration risk, they therefore need a return above speculative assets.

 

Leads to unnecessary losses
Confusion is common and costly. For example, a business that’s actually a job – often small professional services ‘businesses’ have no value without the partners. The partners convince themselves that it’s a business with value. For example, an interior design business owned by one person that employs two. The owner charges fees based on time or project. It’s a job.

An investment property that is actually a lifestyle asset. I recently had a client who owns two apartments that are generating a very low yield. The justification given is that eventually each of the children will take over as the primary residences. So they are actually lifestyle assets.

A business and investment that’s actually lifestyle. Picture an aircraft business with commercial land that can’t be developed, and a manager who is a close family friend. The business isn’t making money and requires regular injections of capital. It’s a lifestyle asset.

 

A lack of clarity results in waste and unnecessary anxiety: trying to save face, a breakdown in relationships, and the loss of money are just some.

The second tranche of capital that I invested in the golf business was really to save face, and a friendship. In the end, I couldn’t save face and the friendship was damaged, as neither of us were happy when I ended the adventure. Understanding the type of asset I was investing in, from the beginning, would have avoided all the subsequent hard lessons learned.