The story of banking ….

Forget the “banks make money from thin air” assertions at the beginning of this video, but watch the cartoon rendition of the creation of the modern-day banking system for an understanding of how banks really work.

While it is true that the dollar is no longer backed by gold (in 1933, President Franklin D Roosevelt suspended the standard and revoked gold as universal legal tender for debts), just remember that each George Washington is still backed by “the full faith and credit of the United States government” … now that should be enough comfort for anybody 🙂

The end of capitalism?

I love Michael Moore, he can make shotguns in the hands of teenagers seem like a bad thing …

… and, now he’s on to big, bad, ol’ Capitalism.

I wonder how much of the proceeds of this film he’s donating to equalize wealth across the American population? And, I wonder what he’s proposing to replace capitalism with?

If you’ve seen the movie, or have any for/against ideas of your own, let us know by dropping a comment …

Are we all broke sheep?

[pro-player width=’530′ height=’253′ type=’video’ image=’http://api.ning.com/files/GLRPkozxKqsAOEDs*Rd06n1g0GC8wifx-HvjXsxwOlpn2Skpsbb8pRzsH82CNjTMI47lPVU2MHMBsp*V8xitlm6Ts5H*DgTL/BrokeTheMovie.jpg’]http://www.youtube.com/watch?v=N-4Z7xKq4lU&feature=player_embedded[/pro-player]

This should be an interesting movie [thanks to KC for the link!] … interesting because I’d love to know how they plan to fill up theaters with a documentary on the economy.

Expect it to be filled with wonderfully breathy comments like “Warren Buffett has more in common with a great poker player …” Oooooh! 🙂

Money Makes the World Go Around …

It’s sad, but true … it seems that money does make the world go around.

It’s what seems to drive people to make – lose then make – lose … and, so on … their money. It becomes an end rather than merely a means.

But, I have a slightly different view:

1. FIRST decide WHY you need the money … I call this Understanding Your Life’s Purpose

2. THEN decide HOW MUCH money you need in order to do whatever it is that you need the money for (and, by WHEN) … I call this Calculating Your Number

3. FINALLY, when you DO get to your Number, STOP and LIVE YOUR LIFE.

Measuring my performance against the Edelman 'secrets' …

Ric Edelman book 

I’m going to do TWO things today that I don’t normally do …

1. I’m going to review a book, and

2. I’m going to do it by using a review of that book on another blog (The Simple Dollar, a Personal Finance blog that I happen to like … a lot)!

Why?

The book review outlines some of the ‘secrets’ suggested in the book … and I would like to give you some insight into how I think …

… so, here goes (everything in italics is from the blog post): 

Ordinary People, Extraordinary Wealth pledges to contain “the eight secrets of how 5,000 ordinary Americans became successful investors – and how you can too.” Intriguing subtitle. I can’t wait to dig in, so let’s get started. Looking Into Ordinary People, Extraordinary Wealth:

Secret #1
They carry a mortgage on their homes even though they can afford to pay it off.

Edelman basically argues that the concept of a mortgage being a bad thing is a relic of the 1930s, where banks would foreclose on a house on a whim, and the negativity associated with mortgages has hung around this long even though there are a lot of protections for the borrower today.

I bought my most recent house without a mortgage … I had plenty of cash, but I simply plonked it down. But, I have two rules around this:

1. The 20% Rule – never have more than 20% of your net worth invested into your house at any one time; for MOST people this means that you will HAVE to take out some sort of mortgage, and

2. Even if you meet # 1. (I do … most people don’t) don’t be afraid to use up to 50% of your home’s equity to support other buy-and-hold investments.

So, recently I took a $1 mill. line of credit on my home (about 50%) to plonk into my Scottrade account (I use margin lending in there, as well, so I am really taking some additional risk with my home equity that I shouldn’t be taking).

Secret #2
They don’t diversify the money they put into their employer retirement plans.

The subtitle struck me as quite odd at first, as it seems to fly in the face of common sense. Edelman’s advice, though, is actually pretty common – put your retirement money into a diversity of stocks. In other words, select an index fund or two of stocks in your retirement plan and just dump all of your savings into it.

Firstly, 401K’s are a tool of the poor: if you are young, you want to invest as much as you can outside of your 401k so that you can exert some control (a self-directed fund is another matter entirely – PROVIDED that you borrow money against your invested equity to leverage into investments).

And, if you are old, you should have so much money in outside investments that your 401k is just icing on the cake (I confess that I have NO IDEA how much is currently in my 401k-equivalent).

Secondly, diversification is also a tool of the poor and uneducated; even Warren Buffet recommends low-cost Index Funds over other forms of investing for the uneducated … but Warren doesn’t diversify. Neither do I.

Secret #3
Most of their wealth came from investments that were purchased for less than $1,000.

Basically, Edelman states that people who became wealthy did it not by having a ton of money right off the bat. Instead, they just invested a little bit at a time – less than $1,000 a pop. They just did it regularly.

Hmmm … this is a hit-or-miss one for me; a LOT of my money came from businesses that I started with No Money Down. But, a lot came from other investments, as well … most recently an office building that I bought for $1.4 million (25% down) that sold for $2.4 million less than 5 years later.

Secret #4
They rarely move from one investment to another.

The question then becomes what should one invest in? Edelman doesn’t offer a direct answer here, but does suggest that the only clear way to lose is by rapidly shuffling your money around from investment to investment.
The route to success is to buy and hold, not to move like a jackrabbit from investment to investment, losing most of your gains to brokerage fees and taxes.

Another strange one …. you see, to me the VERY DEFINITION of INVESTMENT is something that you buy-and-hold … that’s the strategy that I use in two different ways:

1. To Get Rich Slowly (but surely), and

2. To KEEP my money, once I’ve made it.

But, you can’t just save your way to the sorts of investments that will make you rich; you need to find the money to make those Buy-and-Hold investments by INCREASING YOUR INCOME.

Other than getting a pay rise, working overtime, or holding down 2 or 3 jobs (all of which suck, if you ask me … especially the pay rise if it requires grovelling for 18 months to get it), ONE WAY that I can think of to increase your income is to TRADE …

… that means rapidly moving in/out of ‘investments’ such as stocks (trading stocks or options) or real-estate (flipping). It’s not really INVESTMENT … if it’s RISKY, it’s BUSINESS … but you have to take some chances along the way IF you want to get rich.

Secret #5
They don’t measure their success against the Dow or the S&P 500

Instead of using various metrics like the NASDAQ to judge their investment success, they look instead at whether or not their investments are actually achieving the results they need in their life. So what if the S&P 500 has an up or a down day? What’s actually important is that your investments are giving you the returns you need
.

Couldn’t agree more; I have more than $1 million invested (or trading in/out) in the market at any point in time and I don’t track the indexes other than to assess the MOVEMENT of money in/out of the market AFTER the fundamentals tell me that I am ready to buy (or sell).

Secret #6
They devote less than three hours per month to their personal finances.

I think this concept relates very well to the
“training wheel” conceptI talked about a while back. Basically, Edelman is correct in stating that the people he’s talking about do spend three hours or less a month on their personal finances, but these are people who already have a firm grip on their financial state.

I’m a terrible budgeter …. I’m probably the only multi-millionaire who ever had their American Express card taken away from them for forgetting to pay the bills (really!) … not highly recommended, but if you increase your income and invest well, personal finances actually take a back seat (and, my wife now controls the houshold accounts!).

Even when I was starting out, I only ever did one budget … actually, I tracked EVERY SINGLE EXPENSE for just one month … that was enough to tell me where I was and I already knew where  I needed to go

Secret #7
Money management is a family affair involving their kids as well as their parents.

If there’s one point that Edelman really hits out of the park in this book, it’s this one. You’re doing nothing but hindering your children’s financial education by keeping them oblivious to money
.

 My wife and I started teaching our children about money very early and I’m happy to say that they both understand the basics, saving 50% of their pocket-money and only spending what they need to.

My 13 y.o. son seems to have an entrepreneurial-flair having his own successful eBay business (he earns more from this than his pocket-money brings in) and even runs his own books and accounts (using Quickbooks). He researched this and set it all up himself … other than gentle encouragement, I can lay no claim to his success 🙂

Both our children know that they will need to find their own way in the world … we will nurture and educate, and that’s about it (financially).

Secret #8
They differ from other investors in the attention they pay to the media.

In other words, they ignore the talking heads on CNBC or the thousands of stock tips floating around out there for the most part. Why? Because it’s information overload and it’s not particularly useful to most of the people Edelman interviewed for this book
.

I don’t read the financial press … too boring.

Anyway, to make money, you need to be contrarian (BUY when stuff is cheap … ) … you can only do that if you have the guts to buy when everybody else is lining the windows to jump off the ledge.

How do you match up against the Edelman ‘secrets’?

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Will low interest rates and inflation eat up the interest the bank pays you on your CD's?

Absolutely!

Here’s how to think about banks and cash … consider your time-frame first:

SHORT TERM

If you are keeping your money in the bank to save for something important (hopefully, for a deposit on an income-producing property?) over the next few months or two or three years, then don’t be overly-concerned about the interest rate or inflation. I keep a HUGE amount in the bank right now because I sold out of some investments and am staying ‘in cash’ for a short time through the current market.

MEDIUM TERM

If you have a large’ish sum that you are building up for something major in say 3 to 5 years, then a better ‘savings account’ would be a low cost Index Fund … as you save enough to meet the minimum investment criteria, drop it in … just be prepared to hold for at least the MEDIUM TERM

LONG TERM

If you are, say, 7 to 70 years before retirement, you in the investment mode of your life, and (a) are unlikely to have your cash in the bank, and (b) are crazy if you do! Over 7 or more years, yes, ridiculously low investment returns (and, to a lesser extent inflation) will eat your future alive! Put your money into any mix of Index Funds, Business Opportunities, Real-Estate Investments, Direct Stock Investments – keep away from Mutual Funds – as suits your personality profile and desire to get rich vs merely keep up with the Middle Class Joneses.

SUPER LONG-TERM (a.ka. Retirement)

Here is where that low interest / inflation combo (even if inflation is just 2% or 3%) will eat you alive … be prepared to be retired for a long time, say 30 – 50 years (even if you die young, at least your spouse and kids will be happy with their nest egg!) … you do NOT want your money running out before you do.

If you have a lump-sum, there’s only a few choices:

– Put it all into an Index Fund and only draw down 2.5% – 3.5% each year to live on.
– Put it all into income-producing real-estate and spend no more than 75% of the rent (after paying down mortgages and building up a suitable buffer to guard against ‘problems’)
– Put it all into TIPS (inflation-protected Treasury Bonds) and happily live off all the interest that they pay you every 6 months
– Implement a Bond laddering strategy, such as the Grangaard Strategy, which claim to be able to let you live off 6.6% of your lump sum at retirement every year
– Any combination of the above that suits your needs and ‘investment personality’

Each of these strategies is relatively “inflation-proof”, in that you get to increase the amount that you take out every year as a ‘wage’ to live off, and pays more interest typically than the bank will give you (expect maybe, the bonds … you pay a ‘price’ for the inflation-hedge).

Hope this helps?

When is investing gambling?

I was browsing a new finance forum the other day and came across a great question from a self-confessed ‘beginner investor’.

He asked:

“Where can I learn how to trade with a few thou for the short term (<3mo) with greater than 20% return. I’ve never invested anything. I know that long term investing seems much easier from what i’ve read ie. value investing with stock screens, but what is another good strategy? I am looking for a strategy, teacher, website, anything to start learning, but with a goal of putting money in the market. I’m not interested in funds or managers.”

That, my friends, is called ‘gambling’ not ‘investing’!

You see, when evaluating ANY so-called ‘investment strategy’ you have to consider the return that you can make against ‘market norms’ …

… which is a very simple way of saying “if I can do it … and I don’t have any SPECIAL INSIDER KNOWLEDGE that makes me SPECIAL … then why isn’t EVERYBODY doing it?”

The answer is, of course, is: it’s simply NOT possible … otherwise EVERYBODY would be doing it, already!

… unless you get extremely lucky (which is why what you want to achieve is called ‘speculating = gambling’).

A friend and I had a similar conversation the other day …

He is becoming a professional speaker and consultant; he has already made a great start by writing and self-publishing a book and already has some paid speaking engagements.

BUT, his target is to earn $200k next year … just from speaking/consulting, as a near-beginner!

So I asked him: “How many corporate executives, with expertise in your specific area [customer service] earn anything close to your $200k target right now?”

He said: “Not many … that’s a BIG corporate salary …”

Next, I asked him: “How many of them could write and speak about customer service?”

He answered: “Probably a lot more than you’d expect, especially if they knew that was $200k on the line …”

“Exactly!” I said, almost jumping out of my chair: “So, why would any of them work for somebody else, if they could simply write a book then earn $200k … with the added benefit of lots of travel, flexible hours, and no boss?”

“Hmmmm” he said, his brain obviously (finally) ticking over: “They wouldn’t!”

Which was exactly the point that I was trying to get across:

It simply CAN’T be DONE, by the average person … otherwise, they would all be doing it!

Of course, there are PLENTY of speakers and consultants earning $200k or way more – as there are plenty of people in all areas of ‘investment’ (stocks, options, currencies, futures, real-estate, business, etc, etc) earning outstanding returns even in a crappy market – but …

… they generally have SPECIAL INSIDER KNOWLEDGE that makes them SPECIAL … or, they work MUCH harder than anybody else and/or they get extremely LUCKY …

So, what would you tell our ‘Beginner Investor’?

I would say, when evaluating any opportunity or even your own investing goals and strategy consider:

1. Are you investing – in which case, you should expect ‘normal’ rates of return over the long haul, or

2. Are you really gambling – in which case, the sky is the limit … but, the ground could equally rush up to meet you …

depending upon how lucky you get.

BOTH have a place in your journey towards $7million in 7 years (or whatever target you set for yourself)  … it’s how I did it …

 

But, always be very clear on when and why you are investing and when and why you are gambling.

 

I’d like to hear your views …

I think I'm revealing the whole 'secret' of money …

In my first post I briefly alluded to the 3 stages of money: I call them Making Money 101, 201, and 301.

Starting next week, I’m going to write one post a week on each of these stages …

 First, though, let me tee up how I think about making money … serious money … say, $7 million in 7 years.

Making that sort of money – for most of us who don’t inherit, win, steal, speculate, gamble our way to that much moolah – is a long journey …

It’s not so bad when you consider that 99% of people can’t SAVE their way to $1,000,000 in 20 years … but, my point is that it’s still a journey that takes quite some time.

So, if you were to go on a long journey (besides taking a change of shorts) what would you need?

Three things …

1. A destination

You would need to know where you’re going … for a short, local journey, you probably need an address … for a long, global-scale journey, a country and city would be a nice start.

2. A map and compass

If it’s a local journey, you will probably need a street map … although, very simple instructions from somebody who knows the way will probably do.

But, if it’s a global-scale journey, the trip will most likely be broken down into stages for you by your travel agent, and you will need a series of  ‘planes, trains, automobiles’ maps, telling you how to get from HERE to THERE.

 Also, it would be a good idea to have a compass to tell which way is UP when you read the maps!

3. The Rules of the Road

Now, it would be nice to get to where you’re going without being arrested. If it’s a local journey, you can probably use common sense (although, it’s still best not to jaywalk).

But, if it’s a global scale journey, the rules may be totally different at different stages of the journey (you DO know that the Brits drive on the other side of the road, don’t you?).

Well, making money is a journey as well … therefore, you need …

… three things:

1. A destination

When it comes to money, your destination is in two parts (a) HOW MUCH you need, and (b) WHEN you need it. The when is usually in terms of WHEN you stop working, but it need not be; and the HOW MUCH is determined by how well you want to live when you get there (1 star? 5 star? In between?).

2. A map and compass

Your map will be the three stages of your financial journey (getting debt free and starting a savings plan; ramping up both your income and your investments; keeping your money once you get wherever ‘there’ is for you) and we will cover all of that over the coming weeks.

Your compass will be your Investment Net Worth (we’ll discuss the difference between this and your ordinary, old ‘net worth’ later this week).

 3. The Rules of the Road

Like every good ‘rule book’ the Rules of the Finance ‘road’ is a thick one! I’ll be giving you many of these rules over the coming weeks and months in the cyber-pages of this blog; an example of a Financial Rule is the 20% rule of investing in your own home …

… there are many, many more. By learning these Financial Rules, you can shave YEARS off the time it takes you to get rich.

This blog is here to show you how!

Let's not confuse 'saving' with 'investing' …

My point is simply this:
IF your retirement plan is on track, then keep doing what you’re doing.
But, the vast majority of people can’t simply SAVE themselves into their ideal retirement; they have to INVEST in their future.
I call it ‘investing’ – investing in our future – but, if starting a part-time, work-at-home business, experimenting with actively trading stocks or options [not my personal choice], renovating then holding an income-producing property, etc. is ‘speculation’ to you …
… I simply say:

Bring it on baby!