Monthly Archives: February 2009

A new way to look at your home …

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There is a new way to look at your home, and if you do it, you will never make a financial misstep again – at least when it comes to the biggest personal purchase that you are ever likely to take …

… but, I warn you: your wife may not like it 😛

You see, we tend to describe our homes as an ‘investment’ but the reality is far different: we buy emotionally and we justify rationally.

The truth is: we [most of us] want a home … then we want a bigger one … always, just a little/lot more than we can actually afford. And, to be totally truthful … I not only succumb to this line of thinking myself, I actually encourage you to do the same!

I subscribe to the old-fashioned notion that you should buy your own home – even if it means breaking my rules to get into the home in the first place – as a way of ‘forced savings’ …

… but, once you are in your first home, I then want you to rationally examine the true current resale value of your home, and the equity that you have in it (i.e. what the home is curently worth against what you currently owe), at least ONCE EACH YEAR, to ensure:

(a) that you don’t upgrade until you can afford the payments, and

(b) that you put any excess equity to work for you.

But, these rules are only ‘proxies’ for what you should be doing, if you could be trusted to manage your money rationally, instead of emotionally …

… if you could be trusted to treat your home – at, least from a financial aspect – as a house:

You should charge yourself rent!

This is the only way to ‘prove’ that your house is an investment. It lets you know two things:

Am I living beyond my means?

To find out, simply ask yourself these two questions:

(a) How much rent could you get on your house if you rented it out? Ask a Realtor or two … scour the listings in your local paper … look it up on rent.com … do this properly!

(b) What rent can you afford to pay, according to the 25% Income Rule?

If (a) is more than (b) then you have a problem … you are living beyond your means: either increase your means (e.g. get a second job; charge your children board; etc.) or decrease your living (e.g move out; rent out a room; etc.).

Am I investing wisely?

This one is easy; if you charge yourself rent, you can see if your property is positive cashflow or negative cashflow …

You have some ‘advantages’:

– You have a great tenant

– Your tenant has a great landlord

– You get to tax deduct your mortgage

– There’s no tax to pay on the ‘rental income’ … it’s all in your head, remember? 😉

To find out if you really are investing wisely, simply ask yourself these two questions:

(a) How much return on my money (i.e. equity currently in the house) could you get if you sold the house and reinvested the equity elsewhere?

(b) What rent would you have to pay (remember that you want to take the lower of your current rent or what the 25% Income Rule allows) if you lived elsewhere?

If (a) is more than (b) then you have a problem … you are investing badly: either sell your house or see if pulling out some equity and investing helps.

If the answers don’t please you, and you are unwilling to make the necessary changes, then the 20% Equity Rule and 25% Income Rule are still there to stop you from getting into too much financial trouble … make sure you obey them! 🙂

Good deal or bad deal?

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No, this is NOT another ‘Howie Mandel-style’ game show … I’m done with that series (aside from a couple of wrap-up posts, still to come)!

But, this will be my last reader Poll for a while, so I want you to sit down for 3 minutes and make a commercial decision with imperfect information:

Time for a fun ‘hypothetical’ … I’m not really asking you to invest with me [AJC: I want you to learn to invest with somebody far more capable: yourself!] …

I would like you, and a number of other people, to join me in a real estate project [remember: this is hypothetical].

It will be very low risk, because it’s a very well-established commercial strip-mall in a great area, pretty much fully rented with lots of good tenants with long leases left to run and for the last 10 years has produced a reasonable – perhaps not stellar, but certainly highly respectable – profit with very low maintenance costs, tenant turnover, etc., etc.

No catches, here, really … it will be a general partnership, I will be the managing partner and you can join the group of passive investors already committed.

So, let’s look at the deal a little:

Your share of the investment will cost $100,000 and for that you get 10% of the $1,000,000 project (incl. financing/closing costs) … it’s a very inexpensive strip mall 😉

We expect reasonable capital appreciation over the life of the project (up to 10 years, although you can sell out anytime before then, and we will guarantee both a buyer and then-current market price for your share).

The property will return about $9,000 a year (net operating income per 10% share), but we think it’s best to keep aside some as a contingency against vacancies, maintenance, etc., etc.)

So, we will guarantee you (secured by the project itself) $7,500 income each year for at least the next 10 years indexed to 7.5% of the current value of the building (but, NO LESS than the $7,500 p.a. guarantee) v the $3,000 or 3% that a bank will currently give you, and which does not grow. Of course, you may have others ideas in mind for the money, but I hope you will invest with us … after all, here, your income is guaranteed!

In summary: an ultra-low-risk ‘bricks and mortar’ investment returning a MINIMUM 7.5% p.a. on your original investment (increasing in line with property value increase) … you will get your money back, just from the guaranteed distributions that the project will pay you, over 13 years and you STILL get 10% of any appreciation in the building!

Deal or no deal?

How fast is frugality?

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save-v-invest

I love it when I read interesting posts on the personal finance blogs and other forums … take Mighty Bargain Hunter‘s view that frugality is the fastest way to a better bottom line:

It shouldn’t be the only way you’re improving your bottom line, but it does give results, fast.

For someone who already has their finances under good control, some money-saving activities are simply too little payback for too much time … [but] what about the people who aren’t as well off?  Maybe they’re making $40k or $50k, but have a lot less saved up than they probably should for their age.  This is the situation for which packing your lunch, buying generic, buying used, skipping Starbucks, and clipping coupons will help.

And it helps immediately.  The week you take lunch to work at $2 a day instead of hitting Subway at $5 a day, you’ve improved your bottom line by $15.  Boom.  Or brew your coffee in the morning instead of hitting Starbucks.  $10 per week.  Boom.  Instant gratification.

Building up income streams takes longer, especially the kind of income streams you want (passive ones) … higher income may be better in the long run, but that’s the long run.

Frugality is here and now.

Businesses have taken this view for a long time now … they call it cost-cutting 🙂

Usually a business that is spending its time cutting costs is a business that you should selling out of, not buying into …

… it’s current finances may begin to look great, but its future may be bloody awful (that’s why it’s busy cutting costs!).

On the other hand, a GREAT business invests in their future (sales and marketing, product development, R&D, production, etc.) while managing their costs.

So, let’s put it to the test: how fast is frugality?

Well, to find out, I put four scenarios into the Magic Excel Blender and here’s what it spat out:

Save: If you earned $100,000 a year and cut corners so that you could save 20% to stick in your mattress, at the end of 20 years, you’d have $400k stashed away.

Invest: If you only managed to save 10% a year and spent your time investing the proceeds wisely (@ 8% p.a.) you’d end up with $460k in (say) stocks.

Save + Invest: But, if you did the sensible thing and invested your savings instead of stashing it under your mattress (in other words, save 20% then invest it @ 8% … hardly rocket science), you’d end up with more than $920,000 after 20 years, and still have dividends each year to live off … a much better result for only a little extra work together with some belt-tightening.

MM101: However, if you did the really sensible thing, and built up your income (so that you can afford to reinvest the dividends), saved well (at least 20%, but only of your original level of income), and invested both the dividends and the savings wisely (@ 8% p.a.) after 20 years you’d have over $2.5 million.

Frugality may be quick (in that we can afford to pay a bill; pay down a pressing loan), but will never make us rich …

… that’s why we take a multi-faceted view to personal finance:

Making Money 101 – to ensure that our costs are under control and free up some cash to help us invest in MM201

Making Money 201 – to grow our income by investing what little cash we may have (to begin) wisely and maintaining sound MM101 ‘habits’ to ensure that we have ever-growing streams of investment income, keeping our growing personal ‘needs’ (read: expenses) in check, so that we can eventually reach our Number

Making Money 301 – to manage our Number (i.e. our nest-egg) so that it lasts as long as we do, while living the life that we have designed for ourselves, not the life that others have resigned us to.