Managing your life through the rear-view mirror …

Not many people are rich, so following COMMON financial wisdom can’t be all that it’s cracked up to be, can it?

Case in point: paying down your mortgage is a subject that always gets a rise out of my readers.

I see it very simply:

If mortgage rates are currently 5%, what investments can give you 5% + whatever margin you feel you need to compensate you for risk?

How ‘risky’ is that risk? And, what do you stand to lose?

Some people, like Executioner, look at the 100% risk/loss scenario:

Although I’ll concede that it is unlikely that a broad index fund would ever drop to zero, it’s not outside the realm of possibility.

Sure, it’s not outside the realms of possibility, but has it EVER happened?

What’s the worst 30 year return that the stock market (as represented by, say, the entire S&P500), a basket of ‘blue chips’ (say, Coke + Berkshire Hathaway + GE + IBM etc.) have returned, or any solid piece of real-estate (be it residential or commercial)?

I’m betting that it’s not zero … not, by a long-shot!

But, maybe the rules have suddenly changed?

Neil thinks so, at least when it comes to house values:

House appreciation used to be a sure bet, but it isn’t any more.

But, I can’t help wondering … we used to say: “the market is going UP, blue sky everywhere … the rules have changed, it’s going to keep going UP”.

And, that thinking, of course, lead to ridiculously high valuations of both stocks and RE … and, a correction had to come.

And, it did. Big time!

Now, we seem to be saying: “no 8% returns for next 30 years [Executioner]” or “House appreciation used to be a sure bet, but it isn’t any more [Neil]” … “the risk/reward balance is different now [I made this one up]“.

So, I can’t help wondering:

If this is really the case … if things really weren’t different BEFORE (i.e. the market couldn’t keep climbing) are they really different NOW (or, can the market really keep falling?) …

… or, are we just guilty of doing more ‘rear mirror’ personal financial management?

I can’t give you the answer … only 30 years of ‘future history’ can do that!

But, if things haven’t suddenly changed PERMANENTLY – if the fundamental principles really haven’t changed – then, isn’t a ‘down market’ a GOOD time to buy?

Or, is that just the way that Warren Buffett thinks?

And, I know one which side of this coin I’ll be betting on

Financial rock’n'roll …

I don’t think that I ever mentioned it at the time, but I went to Warren Buffett’s Annual General Meeting in Omaha in 2008.

It was like going to a rock concert … without the music.

It was held at some football stadium, which was packed with 30,000 (maybe more?!) people and Warren Buffett and his long-time business partner, Charlie Munger sitting at a table with three large video screens behind them (just showing Warren and Charlie sitting at the table … only MUCH larger!).

They basically spent the day munching on Sees Candy (peanut brittle, I believe) and sipping on Coke …

Warren invites all the ‘international visitors’ [AJC: That's anybody who registers with a foreign passport as their ID ... I have a US driver's license, of course, but I heard that there were 'extra benefits" to registering using international ID] to a meet and greet.

This meant bringing anything that you bought from his trade show in the huge conference hall attached to the stadium (he has stands from a number of the 70+ businesses that he owns) and he and Charlie will shake your hand and sign it one item that you bought.

But, he stopped doing that – after 2008 – because there was a line of 1,000+ people waiting to shake his hand and get their signature. I know this, because when I got to him, the World’s Greatest Investor spoke to me!

He said (looking visibly paled): “Are there many more people in this line”. Sadly, I had to say there were …

Still, I got my $5 T-shirt signed, and had it framed with a couple of Warren Buffett and Charlie Munger playing cards (!), a couple of pictures that I printed from a web-site after googling “warren buffett”, and my round official entry badge.

Which has nothing to do with anything other than Bill McNabb – who replaced the famous founder of Vanguard (with their famous, low-cost Index Funds), John Bogle, who also seems to afford ‘rock star status’ with fans of his investing philosophy (which, naturally centers around buying and holding Index Funds) calling themselves Bogleheads and acting more like rockstar groupies than investing disciples – recently said that one “essential ingredient” in the investing and advice business, is:

Simplicity, which is exemplified by the “Five-Minute Rule” first coined by Richard Ennis of the pension consulting firm Ennis, Knupp: “If you don’t understand the thesis underlying an investment in five minutes or less, take a pass.”

This equally reminds me of a recent story of a company that a friend of mine was CEO of that existed solely to build, manage, and sell tax-advantaged agricultural ‘investments’:

Basically, this company did complex deals with rural land-owners, farmers, and so on to plant certain crops and sell shares to private investors; the advantage to the investors being (a) immediate and attractive tax-deductions, and (b) future (i.e. 10 to 30 year) capital returns … trees take a LONG time to grow!

Given that one friend was their CEO, another one of their key operations directors, and a third an enthusiastic ‘professional’ (counting, amongst others, my wife as his client) who positively represented the project to a number of my affluent friends who were also his clients, you may ask how much I invested in the company.

The answer is ZERO.

You see, I don’t invest in anything:

1. That eats or grows (because eventually it will stop eating, stop growing, and will die),

2. Uses tax-advantages as one of its key features (because I don’t mind paying my fair share of tax and governments have a sneaky habit of changing the tax rules),

3. Because of the 5-minute rule (if I don’t IMMEDIATELY understand it, I don’t buy it … and, truth be told, I don’t IMMEDIATELY understand much).

Postscript: because of the Australian drought, many of the trees did die, and the government did change the tax rules, and the company did go broke … and, many of my friends did lose 100% of their investment.

And, I still don’t understand the business 5,000,000 minutes later

Do the rules need to change?

Please keep sending your questions and comments either via e-mail [ ajc @ 7million7 . com ] or via the comments; I answer as many personally and/or here as I can …

… for example, Mike asks:

Are your rules of thumb like making 15% year on year in the stock market still true in an environment when treasuries and inflation is so low?

One of the reasons pension funds are blowing up left and right is that there are assumptions on portfolio rises of 8% per year… so should you be pulling down those numbers of expected returns?

This is a great question … so much so, I’m wondering why anybody hasn’t challenged them before, considering the current market.

Yet, my answer would be – and was – and is:

We’re not concerned, here, with what stock markets are doing now, [not] like pension fund managers and traders are …

The reason is simple: we’re not trying to invest to achieve the greatest possible returns now, as traders and pension fund managers hope to achieve …

… we’re here simply to reach our [large] Numbers by our [soon] dates.

By ‘large’, we’re talking $7 million (give or take a few million) and by ‘soon’, we’re talking 7 years (give or take a few years).

We’re not talking this year, or even the next, or the next, or …. we’re totally focussed on that end result.

Besides, traders and fund managers who chase the market fail … and, fail miserably

Here’s what happens to ordinary folk who try and time the market, because they are worried about [temporarily] low returns or are chasing [temporary] high returns:

This shows that no matter what gyrations the market had over the last 10 years – as shown by the green area – the typical investor never managed to keep up – as shown by the blue area – not by a small margin, but by a HUGE CHASM, managing a return of only 1.87%

Think about it: the average investor (that’s you and me) only managed less than a 2% return, over the 10 year period 1998 to 2008, when the market returned over 8%.

That’s worse than simply sticking your money in the bank!

[AJC: to show it's not just a function of the current market, this huge discrepancy also held true for Dalbar's earlier study]

And, if you think that’s because the average investor is a know-nothing dolt and you can do better; here’s what professional fund managers managed to achieve:

2.7% … that’s the best that even the professionals could manage.

Why?

Because both professional fund managers and investors (yep, even those who BELIEVE that they are buy/hold long-term investors) switch in and out of the market, altering their strategy [AJC: a nicer phrase than greed and panic] as markets rise / and fall … obviously, timing things terribly.

That’s why when I talk about investing – and, the associated rules of thumb – I look at the average returns over a long period. I sometimes even advocate looking at the lowest average returns over a similar period.

Yes, if your Number is soon, then you will need to look up my references (they are sprinkled thoughout my posts) and choose more appropriate estimates and take your chances along with the rest of the speculating masses …

… but, for planning your Number and then acting out your strategy you can – and, probably will – do much worse than simply following my ‘rules of thumb’.

After all, I have made $7 million in 7 years – and, this blog is all about helping you do the same – using these exact, same strategies that I teach here.

* Footnote: in the interests of full disclosure, here’s what I told a reader on Monday:

I hope that everything here rings true; I try and give all stories from personal experience. But, not everything happened for me in a nice, clean order: for example, I only found out about the 20% Rule a couple of years ago.

Sometimes, I simply have no choice but to talk from personal experience about ‘rules’ that I found out about a little too late

Is he really a clever dude?

[Disclaimer: Artist's rendering of AJC ... any resemblance to other bloggers living or dead is purely coincidental]

Have you noticed that I don’t have a category for debt on this blog?

[AJC: you can click on any of the keyword/categories in the orange header-banner above to see a list of blog posts focusing on that subject]

It’s not because we don’t talk about debt, as we clearly do …

…. it’s because, to me, creating or paying off debt is just the same as investing (after adjusting for tax: a dollar saved in interest, is the same as a dollar earned in interest or investment income, right?).

That’s why I was genuinely interested in finding out what was going through fellow-blogger Clever Dude’s mind when he loudly proclaimed:

We’re Free of Consumer Debt!!!!!!

As of today, we have paid off all $113,000 of our student loans, auto loans and credit card debt.

We are debt free!!!

My fellow blogger is right to be proud of his achievement … but, does that make it the right investment choice?

Check it out:

He paid off $113k … now, this is no small achievement, some people don’t even save that in their entire lifetime! Still I couldn’t resist asking Clever Dude for some details:

The rate on the student loans was 6.25%. The 2nd mortgage is 7.875%. First was 5.25%.

I chose to pay off the student loan because it was more manageable and I could get it off the books faster than the 2nd mortgage. Mathematically, the 2nd mortgage makes more sense until you factor in the tax deduction which brings them down to about equal.

I also wanted to know a little about his current net worth (after the mammoth debt-payoff feat) – nosey, aren’t I?! Anyhow, Clever Dude was happy to share:

Don’t mind the math as I rounded:

Cash: 17%
Investments: 37%
Home Equity: 6%
Autos: 17%
Personal Property: 12% (if I could sell it all right now)
Whole Life Insurance: 5% (yep, I got it, it’s expensive, but I’m not giving it up!)

So, Clever Dude has ‘invested’:

-> $113k in loans returning (by avoiding having to pay) around 6.25% after tax

-> 17% of his net worth in cash returning (I’m guessing here) 2%?

-> 6% of his net worth in his home returning some unknowable amount in future (potential) capital gains

-> 5% of his net worth in insurance ‘investments’ of dubious value after (often) exorbitant fees

-> 29% in (presumably) depreciating ‘assets’ such as autos and personal property

Now that he is debt-free, what  will drive Clever Dude’s investment strategy from here on in? He says:

Investing and savings are next up in our planning. Honestly, we’ve spent so much time just thinking about debt, we haven’t spent much time on the future. Now is the time.

Now, I’m not here to pick holes in Clever Dude’s investment strategy as he had a strategy and moved mountains to achieve it – not to mention, that we know so little about Cleve Dude’s true financial situation that we are in no position to advise / criticize …

…. but, I do want to use this example to show why following a blind – and, in my mind totally arbitrary – investment goal such as “reducing debt” is not always the best idea:

Clever Dude has only 37% of his net worth in investments right now (OK, he is working on his Master’s Degree, so he has had other things on his mind) and has limited the bulk of his net worth’s returns to only 2% to 6% (or so) by almost-totally focusing on paying debt.

Why?

So, that he can start “investing and saving”!

Now, does that make sense to you?

A (post)Vacation Question – Part III

Now that we’re back from vacation I can retain my blogger’s right to semi-anonymity, yet risk little by answering Mike’s [and, some of our other readers'] question:  ”Which beach in Australia is this?”

Noosa in Queensland.

After discussing the real-estate ‘deals’ of Bill the shaved ice man, and Massimo the ice-cream man [AJC: did I mention him?], while buying – naturally – shaved ice and icecream, as one does when in Noosa on vacation, now that we were finally home and ready for a change of scenery …

… we discussed bank-financing of real-estate on our way back from buying ice-cream at the 7-Eleven store not far from our own home

The conversation went something like this:

Son: “Why has the bank invited you to their private corporate box at [a certain upcoming international sporting event]?”

Father: “Well I have a lot of money on deposit with them”

Son: “But, they have to pay you money [interest], aren’t their important customers the ones that they lend money to and who have to pay the bank money?”

Father: “Good point!”

So, I explained to my son that I am now both a borrower and a lender to my bank:

- As a lender, they pay me roughly 3% on the money that I have sitting in their bank,

- As a (recent) borrower, they charge me roughly 7% (interest + bank fees and charges) on the money that they lend me.

Son: “So, they only make 4% interest … is that enough for the bank to make money on?”

Father: “Don’t feel too sorry for the banks!”

As I explained to my son, the bank is like any other business buying a product for $3 (or, in the bank’s case, borrowing money for 3%) and selling that same product for $7 (or, in the bank’s case, lending money for 7%):

They are operating on (at least in this example) a 133% Gross Margin.

Most people DREAM of having a business that operates on 133% Gross Margin …

… of course, the banks have costs:

- They have to carry stock (i.e. pay interest on funds deposited) even if they don’t sell it (i.e. lend it) … unlike a ‘normal business’ the bank has these great treasury departments who simply put this ‘spare money’ into the short-term money market and earn interest,

- They have the usual staff, office lease, and overhead expenses of any other business,

- They have the risk of fraud / credit default on the money that they lend out.

All of this is factored in to produce a Net Profit that is amongst the best of any type of business (GFC aside). This got my son thinking:

Son: ” So, why don’t you put your money in a safety deposit box and lend it out to other people instead of letting the bank make all the profit on your money?”

Well, as I explained, I actually do: I have a finance company of my own, and we look at our finances this way; the interest that we charge our clients is treated as ‘fees’ … we divide that Fee Income (very roughly) into three parts:

- 1/3 goes to pay the bank’s interest and fees on the money that we borrow from them to lend to our clients,

- 1/3 goes to pay our staff, rent, and overheads, leaving

- 1/3 which goes to our [AJC: my] profit.

This is strikingly similar to the ‘standard’ restaurant formula:

- 1/3 goes to pay for the raw material [AJC: pun intended :P ],

- 1/3 goes to pay their staff, rent, and overheads, leaving

- 1/3 which goes to their profit … of course, that’s the theory but the reality for restaurants and many other businesses is vastly different (but, that’s a subject for another post).

So, why don’t I do what my son suggests for the bulk of my money?

Simple: I don’t have the ability to handle the credit / fraud risk!

But, the bank can because they have the people, the systems, and the sheer bulk of money out there which effectively spreads their risk (IF they have followed sound credit lending policies ….enter housing crash and GFC).

Later on this week, though, I will tell you how YOU can become the bank … without the risk.

Stay tuned!

How to invest 101?

This video is way too basic for my readers [AJC: if it isn't, please stop reading now! ] …

… BUT, it’s a great video to show to the children in your family.

Let me know what you think?

Do I need The Money Guy’s help? You tell me …

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A few days ago, in a discussion about the merits (or otherwise) of financial advisors, I made an admission:

I’m having a hard time finding advisors and mentors who can move me to Making Money 301 (protecting my wealth) …

If you read the article, you’ll begin the see why … in the meantime, Rick kindly offered a suggestion:

Yes! I suspect that there are few people that have $70 million of their own, and fewer still with a long track record of protecting it! You might have to settle for someone with a lot of experience managing other people’s money that has the right mindset to protect your wealth.

I’ve found that Brian Preston’s podcasts has given very solid MM301 advice: http://www.moneyguy.com/. If I had $7 million to protect I would ask him or someone like him.

But, WJ proffered the opposing view:

You gotta be kidding.

Asking Adrian who have made $7million himself to send his money to someone who have not made that much money from his supposed expertise?

The only way that advisor is getting rich is from the management fees he’s getting from those clients of his.

My philosophy is simple. If I want to get rich thru properties, I will want to look for someone who have done it thru properties. So, in order for me to trust the advice of the financial advisor, he must show me that he has already achieve financial independence thru investing(not thru giving advice). That is totally different.

I’m stuck!

Who is right? Should I take The Money Guy’s advice or not …

… to help you decide, here is the link to his web-site:

http://www.moneyguy.com/

Please show me the way by voting on the poll above and perhaps leaving a comment below …

Would you trust your money to this man?

Lots of people trusted this man with their money, but more on that later …

First, I want to tell you about The Finance Buff who wants to offer you personal finance advice … he also wants to know how much you’re prepared to pay, claiming that there’s an under-serviced market here for inexpensive, unbiased personal finance advice:

Usually an under-served market exists when there is a big gap between what customers are willing to pay and what it costs to produce what they want. I suspect that’s the case in the financial advice market.

[But,] I’m willing to help others with their personal finance questions. I don’t necessarily have to make much money from it (my full-time job covers my living expenses), but I do want to at least cover my cost of regulatory compliance and liability insurance.

With most things, you pay peanuts and you get monkeys …

… and, that may be the case here:

I am not a financial advisor. I do have personal opinions, sometimes strong, ignorant, or biased. Everything you read here on this blog is the author’s personal opinion, not financial advice. I am by no means an expert on anything. I don’t intend to mislead, but my facts, figures, and calculations can be incomplete, inaccurate or plain wrong.

Of course, that’s just his legal disclaimer … because, after reading the quality of The Finance Buff’s blog, that may not be the case at all … it could indeed be quality financial advice at a bargain price!

On the other hand, looking for a top-of-the-town advisor and paying the commensurate high price may not get you the kind of quality financial advice that you would expect, either.

Alberto Vilar [pictured above], 68, co-founder of Amerindo Investment Advisers, faces up to 20 years in jail after being found guilty on all 12 counts of fraud and money-laundering against him. Hailed as heroes by their clients, they made fortunes for themselves in management fees. [But,] their fortunes plummeted at the same time as the dot-com bubble burst. They were arrested in May 2005 after a client, heiress Lily Cates, claimed they had stolen $5 million from her.

Price [does not equal] Quality when it comes to personal financial advice.

For that reason, I don’t recommend that you put your money into the hands of any advisor; in fact, I recommend that you do not seek a personal financial advisor at all … rather, you should look for a personal financial mentor.

There is a difference:

ad⋅vis⋅er

–noun
1. one who gives advice.
2. Education. a teacher responsible for advising students on academic matters.
3. a fortuneteller.

men⋅tor

–noun
1. a wise and trusted counselor or teacher.
2. an influential senior sponsor or supporter.

Would you rather trust your financial future to the book-learned “fortuneteller” who will promise to give you a bucket-load of fish …

… or, would you rather trust it to yourself, with the support of the self-made “wise and trusted counselor” who will teach you to fish?

[ AJC: There is another difference: a true mentor won't ask you to pay for anything more than a lunch or two ]

Whether you are looking for an advisor, or a mentor, or you don’t care which because you think the difference is moot, after satisfying yourself of their integrity and character, here is what I would look for:

1. If I know my Number and Date, then I would look for a mentor who has made 10 times as much in about half the time, and

2. Doing exactly what it is that I need to do in order to achieve my required annual compound growth rate.

Choosing an advisor and/or mentor by asking these typical ‘financial advisor double-speak’ questions can’t do you any good; you see:

They can’t be aligned with the way you think … instead, they need to be aligned with the way you want to think.

I’m having a hard time finding advisors and mentors who can move me to Making Money 301 (protecting my wealth) … now do you see why?

7 miljoonaa 7 vuotta

… that’s just my way of saying hei [hello] to my Finnish readers!

It seems that I have a few because I’ve been tracing some backlinks to my blog and found this one: http://www.taloudellinenriippumattomuus.com/ which (thanks to Google translate) asks if I am one mg/ml of the investors?

Now, this is a very clever way [AJC: if you understand metric measures, such as 'milligrams' and 'milliliters'!] of challenging us to decide if we are the ‘one in a thousand’ investors who can actually make money trading in the stock market [AJC: presumably, this is a Finnish blog focusing on trading stocks?] … in fact, in this article the author is specifically discussing Day Traders; now, day trading is something that I have never attempted!

Probably for good reason …

The author cites a Taiwanese study that found that (after costs) only 0.16% (or 1.6 per thousand) of Day Traders actually made a profit!

So, why do the other 99.84% do it?

Well the author says (or quotes, I’m not sure which):

While day traders undoubtedly realize that other day traders lose money, stories of successful day traders may circulate in non-representative proportions, thus giving the impression that success is more frequent that it is. Heavy day traders, who earn gross profits but net losses, may not fully consider trading costs when assessing their own ability.

Now, this is very interesting because you could insert almost ANY speculative activity (e.g. flipping real-estate, investing in gold and futures, FOREX, options, stock trading, speculative business ventures, etc., etc.) in place of the words “Day Trader” and I think you will be able to draw the same conclusions:

1. The vast majority of speculators lose money,

2. Of those that do make money, most of those will realize that they, too, are actually operating at a loss if they take into account the true costs of their time, money, operating expenses, etc.,

3. However, the ‘losers’ keep chasing their losses because of the VERY FEW real success stories (and, the plenty of fake/scam/exaggerated ‘success’ stories) that become too well publicized and glorified.

For our other Finnish readers, I should probably also acknowledge references to this blog on another personal finance site (actually, a forum): http://keskustelu.kauppalehti.fi/5/i/keskustelu/thread.jspa?threadID=137213&start=15&tstart=0 for an interesting discussion about what to do when your mortgage is finally paid off; it seems that one of the readers has been tracking my ‘rules’ on this subject:

And the capital not used optimally if the housing is free of debt. Harvat yrityksetkään toimivat kokonaan ilman velkaa. Few firms are not entirely without debt. Tällä kaverilla on kaksi hyvää sijoitussääntöä: This guy has two good investment rule:

http://7million7years.com/2008/02/04/how-much-to-spend-on-a-house/ http://7million7years.com/2008/02/04/how-much-to-spend-on-a-house/

1) Asunnossa kiinni olevan oman pääoman osuuden tulisi olla < 20% net worthistä 1) The apartment attached to the capital base should be <20% of Net Worth
2) Kaiken muun kulutustavaran (auto, huonekalut ym.) osuus net worthistä on oltava < 5% 2) All other consumer goods (car, furniture, etc.) accounted for net Worth must be <5%

Nämä takaavat sen että >75% omaisuudesta on jossain tuottavassa käytössä, kuten vaikka osakesalkussa tai sijoitusasunnoissa. These will ensure that> 75% of the property is a productive use, such as even though the stock portfolio or investment homes.

Minulla täyttyvät molemmat ehdot, mitenkäs muilla palstalaisilla? I have met both conditions, palstalaisilla How did the other? En edes laske autoa ym. pikkusälää mukaan henkilökohtaisen taseeni loppusummaan. I do not even calculate a car, etc. small stuff “personal taseeni the final sum.

Thanks for a great summary, Jni, Google Translate isn’t perfect, but I’m sure my readers will get the gist

BTW for those who haven’t worked it out yet, 7 miljoonaa 7 vuotta is how you would say 7 million 7 years in Finland.

The Myth of Multiple Income Streams …

For a while now the web has been a’twitter with ebooks spouting the idea of Multiple Income Streams …

… literally, here is an example from Twitter:

Multiple Income Streams is the ONLY way to Achieve Extreme Wealth …

I’m not so sure that was true for me – hence it can’t be ONLY

But, is it true even if we substitute ‘usually’ for ‘only’?

Again, I don’t think so … in fact, I feel that most people achieve a very high level of INCOME from just one of their ‘multiple streams of income’ (that is, even if they have more than one) … for me, it was very much an 80/20 thing:

- One of my businesses produced $1 million a year EBITDA (earnings before bullsh*t),

- The other produced $200k a year (still does).

Now, for those who are astute, you will see that I twisted the original statement from ‘wealth’ to ‘income’ … and, as we all know by now:

Income [does not equal] Wealth

So, this is what I think: you don’t necessarily need multiple streams of income, but you DO need a place to store the income earned – and, it’s the wealth that “passively” builds up there that creates the true wealth (at least, it did for me i.e. my businesses fueled my property investments, and THAT’S what took me to my first $7 million) – and that more equates to my Perpetual Money Machine concept than it does to the usually espoused Multiple Income Streams Fallacy … they may seem the same, but they are very different:

Build your Perpetual Money Machine and prosper!