April Fish!

It’s that time of year again, when work (ex) friends, school buddies, corporate marketing departments, and bloggers everywhere bring out their best ‘April Fools Day’ pranks.

Oh, what fun!

But, the French call it “poisson d’Avril”, the Dutch call it “Aprilvis”, and the Italians call it “Pesce d’Aprile” all which refers to the very funny prank (!?) of sticking a little fish to somebody’s back and everybody calling out “April Fish!”

Oh, the French have such a good sense of humor

All of which brings me to the April Fool’s day joke that we play on ourselves … the ‘joke’ is on us when we read important information – or, come acrosss a good idea – and, fail to act on it.

The joke is on us when, by failing to act, we delay (perhaps, fataly so) our Number and are eventually forced to compromise our Life’s Purpose.

So, what ideas you have picked up from this blog – and, tried out for yourself (for better or worse) - in the 2+ years that I have been writing it?

What has worked for you (and, why)? What has not worked for you (and, why not)?

Share yourexperiences here, in the comments, and let’s have a good chuckle together

Even more on the debt-free fallacy …

I’m not a Ramsey fan, and I am equally not a fan of pithy statements that are supposed to make us financially secure, both for the simple reason that they are unlikely to help me – or, you – achieve a Number (i.e. retirement nestegg) amount that is large enough to live my – or, your - Life’s Purpose.

Now, if you don’t have a lot of travel and free time associated with your own Life’s Purpose, then you may be able to live nicely off $50k a year indexed (assuming that you have a $1 mill. nest-egg, in today’s dollars)  … but not me!

I aimed for – and, achieved – a $7 million in 7 year target (starting $30k in debt) because that’s what I decided that I needed (actually, calculated) … and, this blog is written primarily for those who want to achieve the same.

So, it shouldn’t come as a great surprise that I both agree and disagree with Jesse – the Debt Go To Guy- who says:

Risking $1,000 a month on a possible 8% return instead of a guaranteed after-tax ROI of 5% by paying down mortgage debt is NOT such a “Duh” decision. If you do get 8% you must pay taxes, and if you live in a state like CA, then after taxes you’re about even. Plus you have slippage… transactional fees etc for the investment / trade. So risking your $1,000 a month on 8% instead of a guaranteed after tax return of 5% is not always so smart, and a bad example.

People with double-digit interest rates on credit card debt, especially the many folks paying 20-30%+ interest, are not likely to find a better investment opportunity in their entire life than inside their own liability column. Every dollar in debt paid off is a guaranteed after tax ROI of 20-30%. Warren Buffet, Peter Lynch and Sir John Templeton would all agree and even George Soros couldn’t produce a better ROI over time. What makes you think someone in debt could pull off such a stunt?

OK, that’s sound commonsense advice and hard to argue with:

- Sort your debts into high interest and low interest, and have a good crack at the high interest ones first, because the money that you save on interest is probably way higher than you could earn elsewhere. A dollar saved is a dollar earned, right?

- Now, when comparing the lower interest debts and investments, you really need to look at all the factors, such as risk, taxes, costs, etc. Often, it will be paying down the debt that wins, although I would be surprised if paying down a 5% mortgage ‘wins’ over any sensible RE, value stock, or business strategy in terms of serious wealth building.

But, I don’t really think that “Warren Buffet, Peter Lynch and Sir John Templeton would all agree and even George Soros couldn’t produce a better ROI over time”. I know that Warren Buffett has produced 20%+ compound returns, and George Soros didn’t become a billionaire on less than 20% – 30% compounded returns.

That doesn’t detract from Jesse’s statement that “every dollar in [credit card] debt paid off is a guaranteed after tax ROI of 20-30%” and I do agree that it would be almost impossible for anybody except [insert: Forbes Rich 1,000]

But, here’s where I disagree with Jesse:

I think Dave Ramsey provides sound advice for most people, and while I think it’s better to expand your means and increase your income instead of living like a popper, his advice has proven to help many hundreds of thousands of people to stop paying interest and start earning interest, and that’s the key.

- readers attracted to this blog are not in the same position (at least, no longer wish to be in the same position) as the ” hundreds of thousands of people” that Dave Ramsey has helped, and

- “stop paying interest and start earning interest” is not the key to reaching a large Number by a soon Date.

Look, there is nothing intrinsically right or wrong about paying interest, it’s merely a by-product of a loan that you have taken out. Just make sure that the loan produces more income than the interest expense that you paying, by a wide enough margin to account for the risk, taxes, and costs that may be involved.

This is a ‘no brainer’ when you realize that a rental property can produce income (assuming that your calc’s prove that it is all worth while … by no means the case on all – or even many – properties), and it is equally a ‘no brainer’ when you realize that borrowing money on your credit card to buy an LCD TV produces NO income, so why would you do it?

But, it takes a giant leap to suddenly realize that – for any existing debt that you may already have – paying down debt on a mortgage that costs you 5%, or a student loan at 2% may not be such a brilliant idea when an investment that can produce 15% compounded comes along and you now need to decide where to put your cash: into paying off those loans (to blindly achieve a ‘no interest’ outcome) or into the investment (hopefully, to produce an income-producing asset with excellent cashflows).

Of course, we’re making an assumption that reasonable people can achieve reasonable investment returns … but, if you think those kinds of investments are almost impossible to come by, take another look at:

- Value stocks (read Rule # 1 Investing by Phil Town),

- Real-estate (read Multifamily Millions by Dave Lindahl),

- Business (read The E-Myth Revisited by Michael Gerber).

[AJC: and, if these all sound too scary for you, just remember that over a 20 to 30 year period a low-cost index fund that tracks, say, the S&P500 will return circa 11% to 12% (yes, before taxes and ultra-low fees), and - if you are worried about risk - has NEVER produced less than an 8% return over 30 years]

I didn’t become a multi-millionaire by blindly entering into debt, but neither could I have become a multi-millionaire by blindly avoiding it … debt, for me, was a tool that I used sparingly, yet wisely.

I recommend that you do the same :)

I am no longer a student …

I can’t offer advice for my younger readers as to what they should do with their lives (right now!) as I am no longer a student of anything (other than Life and Finance) nor am I young

… but, I would recommend that you take this guy’s advice EVEN if it seems to come at the expense of your short-term personal finance goals.

So, let’s say that you do take 3 months off to volunteer abroad:

- It will probably cost you airfare and clothes, insurance, shots, etc .

- But, it may not cost you a lot in (spartan) food and (even more spartan) accommodation

And, you can probably Net Present Value the cost of these items PLUS the foregone income from your Summer Job.

But, I can simplify the cost as probably putting you one year behind in your financial life (of course, you can compound this out to a large number later) and the extra work that you will need to do next year to catch up with what you spent.

However, what about the Life Experience that you have earned? The Fresh Outlook that you have gained? The Favorable Karma that you have built up?

Priceless!

It’s not ALL about money, you know

Peer to Peer Lending. A 7m7y tool?

In my last post, I suggested that banks are profitable businesses because they have such a large mark-up. If they’re so great, my son asked, why don’t I simply plonk my cash into a safety deposit box and dole it out to willing borrowers like some kid with a lemonade stand?!

Why not, indeed?

The simple and obvious answer is risk, which the bank handles, I said to my son, with a combination of volume (to spread risk), people (to manage risk), and systems (to assess and ‘price’ risk).

However, Rick Francis offers perhaps a better-lemonade-stand-solution (?) … Peer-to-Peer Lending:

There is a fairly easy way to become the bank- peer to peer lending. It doesn’t remove the risk of default but does allow for diversification and there is a framework to asses the risk. They break loans into many small pieces that different individuals fund, so you don’t risk too much on any one loan.

Yep, P2P Lending certainly helps to address one of the banks’ three mechanisms for handling risk: you can spread your loans (the bank lend $400k many/many times over … you lend $40 many/many times over).

But, what about the experienced PEOPLE? It can take some time/trouble to sift through all of those loan apps listed on the leading P2P sites, as Jake points out:

P2P lending requires you to pick through hundreds of loan apps, and filter it to the set that you believe has the best risk / return ratio.

Then you have to diversify – invest in many loans so that a single default will not wipe you out. I think that you should invest no more than 1% of your portfolio into a given loan – so lets say you need to invest in at least 100 loans. Unfortunately, that requires you to pick through probably 1,000 applications hand-by-hand (you already discard the vast majority based on search criteria).

That’s frankly just too much work to be worth it, no?

it’s worth it for the bank, but probably not worth it for you and me (even though you can filter/sort the loan applications by various criteria) ‘just’ to get that 10% return that Rick has experienced …

And, we still haven’t addressed the risk management SYSTEMS that the bank applies, what does P2P offer there? Many sites, as Rick pointed out, offer some sort of FICO-based ranking, but banks rely on a lot more than that (for example, where’s that little thing called ‘collateral’?!) …

The only compensation for these last two (PEOPLE and SYSTEMS), that I can see, is that P2P borrowers may not want to default for a combination of:

- Getting locked out of the P2P sites … perhaps a similar mechanism to eBay’s Rating system is available?

- Perhaps it’s enough that P2P borrowers appreciate the opportunity that they have been given and don’t wish to abuse it by defaulting?

It is perhaps these two reasons that help to explain why micro-lending in 3rd world countries has such a low default rate?

But, it’s the simple logistics that Jake pointed out that put the kibosh on P2P for me …

Have you had any experience with P2P and would you use it again?

A Vacation Question – Part I

As we bask in the sun, a couple of interesting financial questions popped up, both voiced by my 15 y.o. son.

The first was as we picked up our rental car and were offered the choice between the ‘standard insurance’ with its $3,300 deductible (regardless of fault!) to which I said “yes please” just as the guy next to me (receiving the similar offer for his rental car)  just as immediately said “yes please” to the alternative offer of ’reduced deductible’ insurance for an additional $29 per day.

“Why is it that two people can immediately make opposing financial decisions” was the gist of my son’s question (actually, it was “why didn’t you pay the extra $29 a day, too, Dad?”). 

Well, it isn’t because I know that car rental companies rake in approx. 25% of their profits from their insurance scams … I mean, schemes … it’s because he is thinking MM101 and I am thinking MM201.

If you don’t have the $3,300 (actually, an extra $3,000 because the ‘reduced deductible insurance’ still leaves you to pay the first $300 of any incident) then the decision is reasonably simple:

Can I afford to pay the daily rental INCLUDING the extra $29?

- If YES then rent the vehicle WITH the reduced deductible coverage.

- If NO, then you can’t afford to rent the vehicle, so you had better look at the bus/train option.

Now, the other guy probably would have had a heart attack if he had to fork over an unbudgeted $3k all of a sudden – as would my son, with his limited eBay-plus-allowance income – but, not me: $3k is a figurative drop in the 7m7y financial ocean.

So, I have a different set of questions because I CAN afford to pay the $3,300 deductible … easily, even though I wouldn’t like to pay it:

What is the daily cost of the waiver? How many days will I be renting for? What is the likelihood that I will have an accident in that period? How much will I be ‘saving’ in deductible if I do have an accident?

Now, three out of the four questions are trivial, and I was able to simply explain to my son that over a three day rental, the extra daily charge would cost me close to $100 and ‘save’ me $3k if I happen to have an accident.

But, what about the likelihood of having the accident? In my son’s (and, perhaps the other renter’s) eyes, the answer was “very likely” … but, the truth is that I don’t know for sure, making this potentially a very hard ‘actuarial’ problem to solve.

[AJC: in fact, I do know that the chances of a policy holder making a claim on their insurance policy is about 14% ]

But, there is another – more financial – way of looking at this situation … one that works for most complicated financial problems where a critical piece of information may be missing: find the break-even point.

In this case the break even point is trivial to calculate: it’s simply to calculate how many days of additional charges it would take to ‘pay off’ the additional $3,000 of the deductible.

The answer is: $3,000 / $29 per day = 104 days (rounding up a little).

So, my thought process was simple:

- Can I afford the $3k deductible? No doubt about it!

- How likely is it that I will have an accident in less than 1/3 of a year? Not very likely, considering that my last ‘bingle’ was so long ago that I can’t remember it.

Clearly it’s a bad bet … and, obviously so otherwise the rental companies wouldn’t offer it

Now, this obviously applies to all insurance situations, so you don’t need to be an actuary. Instead, and as I told my son, think about the worst case scenario:

- If you could afford to cover it in the event that it came up, don’t sweat it,

- But, if you can’t afford to cover the cost, then you have no choice but to insure it or risk your financial health.

Until you reach 7 million, insure it or don’t do it …

… a financial lesson to warm the cockles of many an insurance brokers’ heart

What’s wrong with this ad?

Aside from the obvious [AJC: Believing that you can turn $1k into nearly $6k in just 2 weeks is obviously stupid, right?] …

… there’s a basic reason why you are doomed to failure with FOREX (i.e. foreign exchange) trading activities. First, though, let me explain what FOREX is for those who don’t yet know:

The foreign exchange market (currency, forex, or FX) trades currencies. It lets banks and other institutions easily buy and sell currencies. The purpose of the foreign exchange market is to help international trade and investment. A foreign exchange market helps businesses convert one currency to another. For example, it permits a U.S. business to import European goods and pay Euros, even though the business’s income is in U.S. dollars.

In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The foreign exchange market is unique because of … the extreme liquidity of the market [and] the variety of factors that affect exchange rates. As such, it has been referred to as the market closest to the ideal [i.e.] perfect competition.

My dire ‘doomed to failure’ prediction comes about because of that last sentence: FOREX “has been referred to as the market closest to the ideal [i.e.] perfect competition”.

Think about it: for every dollar, drachma, or rupee that you buy … somebody has to be on the other side selling. And, since you are ‘betting’ on the relative strength of one currency versus another, you are effectively betting opposing arguments.

You have the same points spread on the ball game, but you are betting on opposing teams … one winner, one loser.

Now, who do you suppose has better information? You, or the other guy?

Who do you suppose has better FOREX training and more experience? You or the other guy?

You are the amateur, the other guy is (probably) the professional who does this for a living …

Now, you can argue that people are trading currency because they are moving country, so the ‘relative strength’ argument doesn’t apply … or, that they are government agencies moving in and out of foreign positions for stability and political reasons … or, that they are corporates moving funds between various international subsidiaries …

Which all be true and yet another reason why you are gambling and they are expertly managing their portfolios.

The same double-sided coin argument applies to options trading … indeed, most other forms of trading: you bet one way and the person on the other end of the transaction has bet the other way. And, they probably know what they are doing …

… best case is that they are equally naive as you

One winner, one loser.

So, that means that 50% of the traders out there must be winning and the other 50% losing?

Well, the stats – somewhat surprisingly – tell a different story; cast your mind back a few weeks, where taloudellinenriippumattomuus  mentioned a Taiwanese study that found that (after costs) only 0.16% (or 1.6 per thousand) of traders [AJC: in this specific case, Day Traders, but I doubt whether FOREX or stock option traders fare much better] actually made a profit!

I’m sure that plenty of our readers have made – and lost – relative fortunes trading; if so, I’d love to read your comments …

The rule of 70 …

Other than a tenuous link to my previous video on compounding, the only reason that I am showing this video is because of this guy’s uncanny similarity to a famous physicist, Julius Sumner Miller, who graced our television screens with his quirky mix of science and entertainment when I was still growing up [AJC: yes, we did have televisions, even when I was a child ] …

… not the only reason, because this video also shows you the power of the rule of 70.

Before you get too excited with the power of compounding, just remember that each doubling (at the 7% compounding rate that he is talking about) takes approx. 10 years:

- in 40 years, you double your money 4 times; so if you start with $100k, you end up with $1.6 million,

- if inflation runs at 4%, this also means your $1.6 million is only ‘worth’  (because this causes your money’s value to halve every 70 / 4 = 17.5 years) a bit less than $400k

… sorry, but when you’re working in 10 year chunks, time really begins to get the best of a single human being’s working life

PS the very first computer program that I ever wrote – on paper tape, with holes punched in it – was to calculate the grain of rice-on-chessboard story that is mentioned here

PPS I know of this rule as the Rule of 72 … perhaps 70 is easier to remember? In any event, it makes not a great deal of difference over a decade …

The Myth of Compounding Interest ….

Albert Einstein was wrong … the financial experts are wrong … and, we’re about to debunk perhaps the greatest – and, most misleading – of all finanical ‘truisms’ …

… and, you’ll be able to say that you read it here first

You see, the cornerstone of almost all personal finance books and philosophies is the so-called ‘Power of Compounding Interest’ … if you need a primer, check out this little video that I ran last Sunday: http://www.youtube.com/watch?v=qEB6y4DklNY

There is no disputing that compounding interest has immense power, but only when compared to so-called simple (or ‘flat’) interest; use the Rule of 72 (that Albert is writing on the blackboard) to see for yourself: simply divide any old interest rate into 72 to see how many years it will take to double your money …

… for example, at 10% interest, you would double your money in just over 7 years.

Neat.

Neat, but useless …

You see, Luis gently reminded me of this blog’s “motto”:

Now, find out how you can make $7 million in 7 years … no scams, no schemes … just good old financial advice!

As Luis pointed out, we aren’t trying to double our money in 7 years … we’re trying to make $7 million in 7 years!

Unless you’ve already got $3.5 million in the bank, you simply won’t get there … and, if you do have $3.5 million in the bank, you’re not reading this blog, you’re reading the one about “How to get to $170 million in 7 years”

You see, in order to work, compounding interest needs a key ingredient … one that we don’t have much of:

Time.

In order to produce a large outcome (say $7 million) – starting from a small base (say $50,000) – compounding needs BOTH a high compound growth rate and a lot of time.

For example, if you start a business that has the potential to deliver an annual compound growth rate of 50%, you still need to wait 13 years before you reach the magical $7 million.

If you choose a more ‘mundane’ investment, such as managed funds that might deliver a 9% return (after fees), you could wait 38 years and still barely crack your first million.

And, if you manage to save 30% of your salary (say, $50k starting salary, growing 3% per year) and invest it in those same managed funds, you should manage to crack the $1 million mark in ‘just’ 21 years, and you will be well on-track to write your own blog: “How I enslaved my way to $7 million in just 40 years”.

Compound interest isn’t a ‘force’, it’s an effect that occurs when you simply sit back and don’t do anything!

Do you think you should be handsomely rewarded for that? Do you seriously think that sitting on your hands will propel you into the top 1% of Net Worth in, say, the USA?

Or, is your goal simply to save your way to the biggest Number that you can achieve before you are retired? If so, compounding is an effect that you should study very closely.

But, this is a blog about how to get Rich(er) Quick(er); it’s for those with Large Numbers / Soon Dates …

…  to us, compounding interest is slavery … if this is your prime investing strategy you enslave yourself to a life of work and frugal living, running the risk that being able to truly live your Life’s Purpose will remain just a dream.

A primer on compounding interest …

If you want to understand the difference between ‘simple’ interest and ‘compounding’ interest – and, if you want to understand why it makes a difference as to how often you compound that interest – then watch this video (until the presenter starts writing with a blue pen … from that point on, only watch if you are a mathematician) …

The key to wealth?

You’re probably attracted to this blog because you want to get wealthy … and, if you’re anything like I was (and, now still am for ‘professional interest’) you probably read any and all decent books on personal finance in the hopes of finding those very ‘keys to wealth’.

But, you’re probably wasting your time …

The key to wealth isn’t to be found in this blog or any other blog, book, seminar or boot camp. Not convinced?

Well, Millionaire Mommy Next Door poses the one question that you should be asking:

If the answer to wealth is revealed between the covers of the books proliferating in bookstores, why aren’t more people wealthy?

Just brilliant, thanks for an outstanding post, Millionaire Mom!

So, why aren’t more people wealthy?

Why do I think that you’re probably wasting your time reading all of those books/blogs on personal finance …

… including this one?!

The answer, of course, is equally simple:

It’s not what’s in the books that counts, but what you do with the information.

I work on this blog daily; I give you the information – factual and ‘as it happened’ – that I really used to make $7 million in 7 years.

What have you done with this information, so far?