The $7million Real-Estate Rule

Yesterday’s post, The $7million Real-Estate Question(s), was aimed at the first-time investor, perhaps stuck on making their first real-estate investment (not home) purchase decision by the – perhaps too many – factors that they would need to consider.

In essence, what I said is: in a commodity market, buy the commodity at commodity prices … and wait!

Wait for what?

Ideally, forever … but, at least until the values have improved.

But, what kind of real-estate are commodities?

Houses and apartments in most areas are commodities; small multi-units (duplex / triplex / quadraplex) can be, too. Anywhere where there are lots of them near each other …

… preferably lots for sale, and fewer vacant [AJC: Too many vacancies can show an area that’s declining in population and/or jobs (with job growth being, by far, the most important of the two) … we don’t want that!].

Also, for residential property (that you don’t intend to live in) you really need to go for an area that will/can appreciate as it can be very difficult – if not impossible – to get them to cashflow-positive on a reasonable deposit (say, 10% – $20%).

Even so, my first two $7million Questions showed you the right type of market to buy in … which is, right now!

But, when evaluating more complex real-estate transactions, such as: commercial apartments (6 and above); offices and factories of all sizes … surely the The $7million Real-Estate Questions are not enough?

And, surely you are right …

These types of properties are sold as ‘businesses’ in that they have:

a. Income (or rent)

b. Expenses (or outgoings)

c. Taxes (unfortunately)

d. Profit/Loss (or Net Operating Income)

I will run you through how to analyse some of these types of property in future posts; for now, I want to tell you one way to assess these types of Investors’ Real-Estate that is NOT as important as you may be lead to believe, and another way that is MUCH MORE IMPORTANT.

Because commercial property runs at a profit (or loss) and has an Income Statement, people tend to buy (and sell) these types of rel-estate on the basis of their financial statements alone …

… and, not on the sale of comparable buildings around!

This is critical to understand – as it is totally opposite for the types of residential real-estate that most of us are used to.

The second thing to realize is that these buildings sell on a variety of bases, but usually the ‘expert’ real-estate acquirer will assess the Net Operating Income during Due Diligence and buy for a multiple of that … there is usually a multiplier [AJC: that the real-estate books that you read will all say is around 10 … but, these days in many of the hotter markets in the US and overseas, it will be as high as 12 to 16 – or even more when things get crazy].

This is called a Capitalization Rate or simply Cap. Rate.


This is just another way of saying that when you buy the building, it will return 10% of the Purchase Price (for a cap. rate of 10) by way of Net Operating Income (which should improve as you increase rents).

A larger Cap. Rate when you talk “times” (or smaller when you express it as a %) is BAD for purchasing (but, great for selling if you can increase the rents a lot!); here’s why:

A 12 times Cap. Rate means that a $1,000,000 property will only return (NOI or Profit) a little over 8%

A 16 times Cap. Rate means that a $1,000,000 property will only return (NOI or Profit) a little over 6%

So, a serious investor will pull out all the numbers, take a look at the Cap. Rate and make a decision whether to buy (obviously, there will be a lot of other factors … this will drive the financial decision).

How will they typically make that decision?

Well, they’ll compare the % return to what the cost of funds are … if they can make enough to cover the mortgage … then they’re in. So, with a Cap. Rate of 8% and Mortgage Interest rates at, say, 7%, it’s slim … but, they’re in front!

Cap. Rates are really useful, when you can a property for, say, $1,000,000 – add $50,000 of renovations that allow you to increase rents by 10% … all of a sudden, your property is now worth $1,100,000 – a 100% Return on your $50k rehab. investment!

But the Cap. Rate alone doesn’t give you the true picture for the original purchase decision … there’s a MUCH better way to look at the financial decision … first, here’s why:

A. Your investment in real-estate is only the deposit – typically 25% (plus Closing Costs) on commercial

B. The Bank’s investment in real-estate is the mortgage – typically 75%

But, you get the ‘return’ or the Net Operating Income on the entire building

Because of this wonderful benefit of buy-and-hold, income-producing real-estate, the ‘right’way to value an investment is by it’s return on what YOU put in: it’s called your Cash-on-Cash Return.

So if you put in 25% deposit on a $1,000,000 building with a Cap. Rate that’s returning 1% over the mortgage rate, then you are getting:

1. 8% return for the 25% that you put in, plus

2. A ‘free’ 1% for each matching 25% that the Bank puts in – since they put in the other 75% that’s another 3% effective return.

All of a sudden that ‘small’ 8% return that seems only a little above the bank’s interest rate of 7% swells into a real 11% Return on your money [AJC: most investors will look for a return on their money (in real-estate) in the 10% – 20% range; this requirement will increase as Mortgage Interest Rates increase] … and, we haven’t even counted on any appreciation, yet (!):

i) As Rents increase, so does your return because YOU don’t have to put in any more money … inflation does all the work for you!

Example: if interest rates remain the same (and, they will because you DID fix them, right?), but the rents go up a mere 4% per year over costs (and, they will because you DID put a ratchet clause in the lease, right?), in just three years the building’s 8% return will swell to 9% …

… and your cash-on-cash return will jump to 9% + (3 x 2%) = 15% – try getting thatin CD’s, Bonds or Stock Funds!

ii) As the building appreciates, so does your future return, even though you can’t cash on this right now (unless you refinance, of course).

Example: If cap rates don’t change (that, unfortunately, is up to the market), the 4% increase in rents will ALSO increase the value of the property by 4%. Which sounds great, until you realize that you only put up 25% of that …

… so, YOUR return increases by 16% – try doing that with Stocks!

Now, how does a 30% return (half now, half when you sell) sound to you? And, what happens if you hold for a little longer?

You do the math!

The $7million Real-Estate Question

I’ve posted recently on the importance of real-estate to your portfolio …

… only ‘important’ of course, if you intend to retire on more than the Pauper’s Million 😉 Well, at least important enough that you probably need to find a good reason NOT to invest in it (e.g. can’t stand the stuff; market is too crappy; can’t find a deposit; etc.)

So, how do you tell a good real-estate investment from a bad one? There are so many variables:

1. Purchase Price – This varies by type of property and area

2. Deposit Required – This varies by type of property and Lender

3. Mortgage Repayments – This varies by type of property and Lender

4. Comparable Returns – What would other investments produce?

5. Comparable Risks – How risky is this investment v. other uses that you put your money to?

For the new real-estate investor, these factors are almost impossible to accurately assess, so investing in real-estate usually comes down to:

(i) What kind of real-estate appeals to me as an investor? Residential – Houses; Residential – Condos; Residential – Multifamily; Commercial – Apartments; Commercial – Offices; Commercial – Retail; Vacant Land; and the list goes on

(ii) What area/s am I interested in? For most real-estate ‘noobs’, that means their local neighbourhood, town, city, or possibly state.

(iii) What price range can I invest in? For most this is dictated by Type of Property, Deposit Available, Income available to service the loan, and the Lender’s Rules

Which is all well and good, but here is how most real-estate investors ACTUALLY invest:

They see something that they like and can afford, and:

a) They buy if they are not too chicken, or

b) They pass if they are … well, you know … cluck, cluck cluck.

Since, I am usually scratching in the yard myself, please don’t consider this an insult 🙂 I actually think that this is a perfectly reasonable way to buy real-estate IF you first (more bullet-points!) ask the $7million Questions:

A. Is the market off its high?

B. Do you at least understand the type of property that you are looking at – and, the area – and consider it a reasonable buy (i.e. you don’t think you are paying ‘top dollar’ to get in)?

C. Are Interest rates off their highs?

D. Can you can afford the payments?

E. Ideally: Will the property be cash-flow positive (or very close to it)?

F. Can you (will you!) hold on to the property for a very, very long time?

Here is the basic principle:

Certain types of real-estate (certainly the entry-level types that most beginners would look at) are virtual commodities … you can pretty easily assess their value (and, potential rents) by looking up a few databases (Zillow, RealtyTrac, Loopnet, and/or newspapers.

There are more intelligent people than you and I out there who actually know how to assess this type of stuff … just trust a ‘commodity market’ to price reasonably accurately and you can’t buy too wrong.

One of my first acquisitions was a simple little condo … the market had been low but was starting to appreciate (how did I know, my 20 year-old nephews told me … they had just bought two condo’s in the same area!).

I didn’t know very much about the values, but I found a condo that was going to auction (actually, the most common way that condo’s were sold in this particular location) and the real-estate agency was from out of town, so I figured that they would attract fewer buyers than an well-advertised local agent would.

The only other keen buyer appeared to be a young builder: I could tell by his overalls, ass sticking out, and his trusty tape measure in hand.

So, what did I do? I just bid at the auction until it came down to just him and I … and, I kept bidding slightly more than him, until he stopped bidding!

I figured that HE knew how to do his sums and HE would not overpay … so, the max. I could overpay is by the amount over his bid that I would have to bid. Risky: you betch’a! Did it work: you betch’a!

His advantage: any rehab would be ‘at builder’s cost’ (I at least knew this would relatively minor … kitchen / bathroom / carpet / paint / lights / knobs). My advantage: Time … I could afford to hold.

In fact, we still own this condo and it has done very nicely thanks … it’s the only single condo left in our portfolio.

But, you could do even better: if you are prepared to do what most other (lazy) people won’t do – which is turn over a lot of rocks and put in a lot of low-ball offers before one is accepted – then you might actually out-smart the so-called ‘smart investors’.

So, how and when to get started?

For those who are following along, you will realize that the current market satisfies $7m Questions A. and C. … a bit of work will help you decide on $7m Question B. … and, your Lender will pretty quickly sort you out on $7m Question D.

$7m Question E. is the one that will give you the most difficulty … as you may not know how to estimate the costs (loss of rental; utilities; Repairs and Maintenance; etc. etc. … if that’s the case, don’t worry TOO much:

TIME (which is why you hold for a long, long time) will cure most ills … and, my $7m Questions … will protect you from disaster.


Lock in the current low interest rate for as long as the lender will let you!

That will help TIME help the MARKET do its thing … which is get the property/s to appreciate and the rents to rise 🙂

Now, if you can do the analysis that a ‘seasoned’ real-estate investor can do … well, go do it … you will make more money / faster, if you do.

But don’t let fear and ‘paralysis by analysis’ stop you … just use the $7 Million Dollar Questions, and …

Good luck!

Are you in the habit of saving or are you in the business of investing?

If you’re in Colorado, tune your dial to KRYD FM tomorrow morning (that’s May 22) @ 7.15 am when 7 Millionaires … In Training! hits the airwaves!!

If you listen in, you’ll find out that I have a face for radio and a voice to match … c’est la vie …

Take note that I said OR … I didn’t say AND …

In fact, most financial writers/bloggers/commentators take it as a ‘given’ that you will do exactly that: save a certain % of your salary and plonk it into your 401k to get the company match and have it invested in the restricted group of managed funds offered by your employer and/or 401k provider.

They’ll recommend that you dollar-cost-average your way into, say, a low-cost Index fund … and, you’ll be surprised to know that I agree and so does Warren Buffett:

What advice would you give to someone who is not a professional investor? Where should they put their money?

Well, if they’re not going to be an active investor – and very few should try to do that – then they should just stay with index funds. Any low-cost index fund. And they should buy it over time. They’re not going to be able to pick the right price and the right time. What they want to do is avoid the wrong price and wrong stock. You just make sure you own a piece of American business, and you don’t buy all at one time.

Now, I agree that this is indeed an elegant and simple long-term SAVING strategy for the Average Joe who thinks that they can save their way to wealth … $1 million by 65 … whoohoo!

But, if you want more (and, you probably should), then you have to move to Part B i.e. get “in the business of investing” …

That usually means one – or, for the rare genius, a combination of – four things:

1. Get in the business of running a business (that’s what Warren Buffett does … contrary to popular belief, he is primarily a business owner … he owns or controls 76 major businesses!)

2. Get in the business of learning about and selecting a FEW individual stocks (that’s what Warren Buffett does … he owns / has owned stock in Coca Cola, Kraft and many others)

3. Get in the business of learning about and actively investing in real-estate (that’s what the rehabbers, flippers, foreclosure experts, etc. do)

4. Get in the business of climbing/clawing/backstabbing your way to the very top of the corporate ladder (that’s what America’s Fortune 500 CEO’s do)

Usually, it means choosing just ONE of these as your main Making Money 201 path to income – at least, that’s what I did – then choosing a SAVING strategy to convert that income to passive assets to keep your wealth growing and fund your eventual retirement:

I was in a corporate job for nearly 10 years … after about 6 years, even though I was doing ‘very well’ (for my age, position, seniority, etc.) I realized that Option 4. wasn’t for me – I would never become a CEO of somebody else’s company.

I didn’t know much at all about either 2. or 3. but I did have a sudden urge for Option 1. – so that’s what I chose!

My first business was a bit of a ‘sleeper’ – it started its life as a very small (and new … I joined one year after inception) family business and grew fairly slowly. Because it was barely breaking even, I bought the family out and managed to get it to grow rapidly and substantially. I still keep it 15 years later, although, it has run very well without me for a number of years now.

I used the profits from that business (the nice little cash-cow that I turned it into) to fund a few start-ups, most of which I subsequently sold.

But, when all of these business were running, I SAVED a good proportion of the profits in various ‘savings’ vehicles: mainly real-estate and a little (at that time) in stocks … none in funds.

Why do I say ‘saved’?

Because I didn’t ‘actively invest’ in them … I wasn’t in the business of investing … I was simply in the habit of saving. I happened to select a non-standard mix of savings vehicles to put my money into (e.g. real-estate and stocks, rather than CD’s and Funds) … then I held on to them … and let time (and the markets) take care of the rest. Because I could put so much in, I eventually got so much out.

It was a Making Money 101 strategy.

My % returns from the businesses were spectacular … my % returns from my ‘savings’ were ordinary … yet, each played a critical part in my current financial success. Interestingly, my overall $ returns from both were excellent!

In the last few years, as I geared up for my ‘retirement’, I have revisited these options and moved away from business and to investing … because I gave myself so much exposure to both real-estate and stocks over the years, I have built up the skills in both to allow me (for some time, now) to actively (as well as passively) invest in both as a Making Money 301 wealth protection strategy.

But, if you want to become financially free, at a relatively young age, with a relatively decent passive income (you’ll have to plug in your own numbers), then you will need to find one of these four options that interests you, and hope that it delivers spectacular returns for you …

… for most people, Warren Buffet and I also agree that it’s unlikely that it will be in stocks, at least according to this little exerpt as reported by Soul Shelter (whose brother, Charles,  attends Berkshire Hathaway events in Omaha each year) who relayed this anecdote from Buffett’s 2006 shareholders’ meeting”:

One shareholder asked a question along the lines of ‘how should I study investing in order to build wealth in my spare time?’

Buffett replied that, for most people, the bulk of their income is going to come from earning power in their chosen profession. Therefore, from the standpoint of building wealth, free time is better spent sharpening one’s professional skills rather than studying investing.

This statement applies directly to my Option 4.; it equally applies with a little modification to any of the other options (e.g. Option 1: … for some people, the bulk of their income is going to come from earning power in their chosen business. Therefore, from the standpoint of building wealth, free time is better spent sharpening one’s business skills rather than studying investing).

In other words, select where you will make your money, and focus all of your energy, research, and attention into that … focus!

Of course, if you’ve decided that your financial future lies in the business of investing then here’s what you should do:

Do not as Warren says … do as Warren does! 

PS We were featured in the Q&A for the latest Carnival of Finance; visit it here:

Meet The Frugals and The Moguls

There are two groups of people in this world:

1. The Frugals – those who live their lives frugally, scrimping & saving their way to the Magic $1,000,000,


2. The Moguls – those who think saving is for pussies and are busy scheming their way past $10,000,000.

What’s wrong with the Frugals:

i) $1,000,000 (or even $2 Mill. or maybe even $3 Mill.) will not be enough for MOST people, you simply can’t SAVE your way to Wealth

ii) Being Debt Free – the Holy Grail of the Frugal World – is a false target that actually serves to keep you poor

And, we all know what’s wrong with the Moguls:

i) Wealth isn’t measured by some arbitrary lump sum – be it, $1 Mill., $5Mill. or even $10 Mill. (OK, I admit, $100 Mill. sounds tempting but, and here’s the point: ONLY because I don’t already have it!)

ii) There’s no such thing as a ‘Get Rich Scheme’ otherwise we’d ALL be doing it ALREADY – you know, word gets around 😉

Now, here is the Shocking Truth – OK, Boring Homily –  you NEED to be a Frugal in order to STAY a Mogul …

The Frugal and Mogul are the same: one is the caterpillar, the other is the butterfly!

If you don’t develop the good ‘frugal’ habits on the way UP, you will quickly lose your money and slide all the way DOWN.

So, here’s what you need to do:

1. Get in the habit of spending 10% – 20% less than your earn NOW

2. Eliminate all NEW Consumer Debt and pay off any high-interest existing debt

3. Buy your own house and position yourself according to the 20% Rule

4. Start a business (online, offline, full-time, part-time, trading, flipping) – take SOME risk

5. Invest at least 50% of the excess cash that your business activities spin off into PASSIVE Investments

6. Do not drastically increase your lifestyle until the income from Passive Investments (indexed for inflation) ‘catches’ up to your required standard of living

7. When it does, retire!

Frugal / Mogul … two sides of the same gold coin … which ‘one’ are you?

Who is the Devil's Advocate's "devil's advocate"?

Have you noticed whenever you have an idea that goes against the mainstream (as most of my good ideas seem to) that people always pop up to rain on your [idea] parade?

They often justify their negativity under the guise of that old cop out: “oh, I’m just playing the Devil’s Advocate” … meaning that you get to listen to their endless diatribe. If you’re unlucky, they just may succeed in having you ‘come to your senses’ [a.k.a. miss yet another opportunity]. 

My response usually is: “In that case, I’m the Devil’s Advocate’s Devil’s Advocate! ;)”

… which means, this time I get to explain why their [contra]-ideas are dumb, and they get to sit there and listen!

I particularly like to play Devil’s Advocate’s Devil’s Advocate with the typical Personal Finance mantras as published in so many PF books and blogs – and, we have already covered a few, with a whole lot more to come – because so many of them are so self-limiting.

I go the idea for this post from a PF blog that I like, Bargaineering, who has a whole section called Devil’s Advocate … I have reprinted a section from his latest roundup, and have included the links in case you want to review the actual articles [AJC: I haven’t had time to review them all, yet]:

I have a few good ideas in store for future articles but I wanted to do a little roundup, in part for myself to see all the topics we’ve covered, so that you could join in the rock throwing against mainstream ideas.

  1. Don’t Invest in the Stock Market
  2. Cancel Unused Credit Cards
  3. It’s Okay To Ignore Your Problems
  4. Ignore Personal Finance Experts
  5. Don’t Have Kids
  6. Buy More House Than You Need
  7. Don’t Move From Job To Job
  8. Get A Store-Branded Credit Card
  9. You Don’t Need College to Succeed
  10. Four Reasons You Should Get A PayDay Loan
  11. Don’t Get Married
  12. Buy That Home Warranty
  13. Adjustable Rate Mortgages Are Awesome!
  14. Pay Cash for Everything
  15. Don’t Budget to the Penny
  16. Invest In Your Company
  17. Say No To Credit Card 0% Balance Transfer Arbitrage
  18. Why Roth IRAs Are Bad
  19. Lease A Car, Don’t Buy It
  20. Don’t Just Buy Index Funds
  21. Don’t Optimize Payroll Deductions
  22. Rent Forever, Don’t Buy A Home

My view?

Great ideas – in fact, I made a fortune by FOLLOWING ideas # 4, 6, 13, 15, 16, 18, 20, 21. ;)

Here’s how I look at it:

Follow conventional thinking and you’ll get conventional results.

Follow Unconventional Wisdom, and you just MIGHT get rich, too (but, don’t be stupid about it, because you will probably remain poor) … but, you need to throw in some ’special sauce’ as well [AJC: that’s what this blog is for].

Nothing wrong with following good advice … nothing wrong with ignoring it, either … I’ve made money both ways – just be sure you know WHY you are following/ignoring it!

Here are the Top 4 Personal Finance Myth’s that I will be doing my very best to destroy over the coming weeks:

1. ‘Bad Debt’ is to be avoided at all costs!

2. Your house is NOT an asset or Your house IS an asset!

3. Max. your 401.k and other Retirement Accounts

4. You can [and, must!] save your way to wealth

5. The Magic Number is $1 Million

… a whole plethora of ideas for us to explore!

But, first a word of caution:

If your target is just an amount like $1 Million to $2 Million in 15 – 30 years, then you do NOT need to read any further – this blog is NOT for you and you will get far more benefit for your time invested by reading here, here, and here, or probably ANY of the places listed here instead.

However, if you are going to join me on this exploration of Anarchic Personal Finance Ideas – and be the Devil’s Advocate’s Devil’s Advocate – then let me know which DUMB 😉 ideas that worked for you, so far …

Business for sale?

As you know, I’m a member of Networth IQ – and quite an active member, at that! I love reading and answering questions … 

[AJC: you’ve probably already seen that from the detailed responses that I try and give commenters on my posts on this blog … try me, if you have a question … I just won’t give direct personal advice, because I am not a qualified professional, but I will give general advice if I think it will benefit all of our readers]

… and this unique site provides a great platform (as does Tickerhound, which provides a great Q&A forum on everything from stocks to real-estate).

For those of you who aren’t members of Networth IQ, here is an exerpt of a great question:

I found a business for sale that has generated the following free cash flows since 1998.

1998 – $3,426.0 Mil
1999 – $3,949.0 Mil
2000 – $4,917.0 Mil
2001 – $7,133.0 Mil
2002 – $6,077.0 Mil
2003 – $8,333.0 Mil
2004 – $8,956.0 Mil
2005 – $9,245.0 Mil
2006 – $11,582.0 Mil
2007 – $12,307.0 Mil

The current owners are asking $183.49 Bil, …. I don’t have $183.49 Bil, but they said that they would sell me a smaller portion of the business if I wanted … Should I buy?

I like this question on two levels:

1. It’s a neat reminder that when we buy stocks, we’re not just buying ‘bits of paper’ … we’re buying a small piece of a real, live business!


2. It gives me an opportunity to show you the sorts of questions that I would ask – and the types of information that I would be looking at before buying into this – or any – business.

According to Warren Buffet (or sources who purport to know how he works) the intrinsic value of a business is in its discounted cashflow.

That is, a business is – or should be – a cash machine … what’s the reason for owning it, if not to get some cash out?

So, in the above example, we should be able to decide if the business is worth $183.49 Billion (not knowing the company in the above excerpt, I am assuming that this number represents the entire current market capitalization of the business) by discounting the cash-flows shown above …

… a quick look at the most recent cash-flow figure shows that it is currently producing $12 Bill. cash per year (probably growing, if history is any guide); that would mean about 15 years to get our money back … yuk.

Now you know why the stock market is generally a fool’s game … I would by far prefer to invest in my own business, or buy a private one at ‘only’ 3 to 5 years free cash-flow (better yet, Net Income), and grow it … then float it myself!

Or, at least sell it to a public company who can immediately ‘claim’ 15 times my Net Profit (hence, give me 7 to 12 times my Net Profit).

But, if we are going to play ‘the stock market’ game, what would we need to know before we can make an informed decision about ‘investing’ in this stock?

Hmmm …
As I pointed out, the free cash-flows on their own say nothing …
For example, I recently sold two similar businesses: one had been going for many years and generated ‘free cash flows’ [now that’s an oxymoron!] of $1 mill. and the other was less than 2 years old and had yet to make a dime.
Yet, I sold them both (separately) for about the same price! So, there must be more to the valuation of a business than Free Cash-flows, right? Absolutely!Let’s start with Return on Invested Capital:
I’d like to know what it has been for this company (and, the industry) over the past 5 years? I’d like to see an improving trend in excess of 15%, please.
Then, is the company growing?
Cash Flow is just one measure (but, what about operating cash-flow … have they made any strategic purchases / major capital expenditures /etc.), so what about the 10 years trends in: Earnings? Book Value? And, what about plain, old Sales?
I’d like to see a history of growth (min. 10%) in all of these …Now, how is there debt situation?
How long will it take them to cover their long-term liabilities from ‘Free Cash Flow’?
I’d like to see no more than 2 to 3 years.
Do the people who run the company own stock? Are they buying or selling?
Tell me about the company: do they have a ‘sustainable competitive advantage’ (what Warren Buffet calls a ‘Moat’ … but, that’s too much water for me!).

Do I believe this company will be around for the next 100 years … do I really want to buy THIS business in THIS industry?

Lastly, if I like the answers to all of the above (unlikely … so far I’ve only liked the answers to similar questions for 7 companies out of the 5,000+ that I can currently buy a ‘piece’ of) …

…. then how CHEAP can I get this thing!?
PS I made the ‘other’ category … waaaayyyyyy down at the bottom of the 150th Carnival of Personal Finance … whoo hoo!

How much interest do you earn on one million dollars?

Welcome new readers!

Here are three of my favorite posts to get you started; if you want to find out:

1. If $1 million will be enough to retire with, then click here, or

2. How much house you can afford, then click here, or

3. Why buying a new car is such a losing proposition, then click here.

Otherwise, please enjoy this article, then bookmark my home page (click here) and come back often …


How much interest do you earn on one million dollars?

This was the question that Clint at Accumulating Money asked in a ‘classic’ post – I commented on it earlier this year and still receive click-through’s two or three months later. It must be a very popular question!

I’m not sure why, because it implies that people are happy to just have their life savings ‘sit’ in CD’s …

… but, here’s the answer to the “million dollar” question courtesty of Accumulating Money anyway:

So, to answer the question, how much interest do you earn on One Million Dollars (assuming a 4% interest rate, compounded monthly)?

One Day – $109.59

One Month – $3,333.33

One Year – $40,741.54

Five Years – $220,996.59

Ten Years – $490,832.68

Twenty Years – $1,222,582.09

I think this related question asked by Afroblanco at Ask Metafilter – repeated on Get Rich Slowly (which is where I picked it up) – really goes to show how The Savers (as opposed to The Investors) think:

What’s the safest possible thing that I can do with my money?” :

I take bearishness to an extreme. Having witnessed the 2000 tech crash, I have no faith in the stock market or the US economy. I keep all of my money (USD) in a savings account. However, with the recent financial turmoil, I have a few questions:

  1. Is it conceivable for the FDIC to fail?
  2. If so, is there a place where I can put my money that will be safer than a savings account?
  3. What’s the safest, most risk-free way for me to save money and not get killed by inflation and the tanking US dollar?
  4. If there is a safe way for me to save money and not be punished by inflation and the depreciating dollar, is there a way that I can do this without having to stress out and micromanage my finances? I don’t want to be checking the finance page and making adjustments every day.

Even though I follow finance news, I’ve never done any investing or money management other than socking money away in my savings account. I’m a n00b, I admit it.

OK … I confess …. I am like our friend, Afroblanco … very risk-averse; yet I have become rich by understanding that it is actually safer to invest than not.

The GREATEST RISK that our friend can take is NOT TO INVEST … inflation will just eat up any bank deposit/CD strategy.

Take Accumulating Money’s example above:

One million dollars approximately doubles in 20 years … but, inflation will halve its buying power!

Think about it, if the average bank interest rate is 4% (pushing the value of your savings UP) and inflation averages 4% (pushing the buying power or value of your savings DOWN), what have you gained in 20 years?

Nothing …

Now, if you just push your savings into a low cost Index Fund that averages, say, an 8% return over the 20 years, then the same 4% inflation means that you should effectively DOUBLE the value (or ‘buying power’) of your million dollars over 20 years.

But, Afroblanco is even better off BUYING The Bank [i.e. investing in the Bank’s stock] than putting his money in The Bank. The risk of failure is about the same (if the bank fails you will lose the money that you have IN the bank’s vault as well as the money IN the bank’s stock), yet, as long as he has a long-term view (minimum 20 to 30 years), the former strategy will make him rich and the latter broke.

If the bank stock averages just 12% average growth over 20 years – as any well-picked Value Stock, can easily do – then Afroblanco won’t just double the buying power of his money ONCE, he will get to double it TWICE … that’s $4 million AFTER the effect of inflation (or, the $1 million grows to $10 million in ‘raw’ dollars).

What about risk? Aren’t bank deposits FDIC Insured?

[AJC: Well, yeah … up to a paltry $100kof course, you could open up 4 bank accounts at 4 different banks  … but, $400k is hardly what I hope my readers are aiming at!]

But, inflation is a much bigger risk: 100% certain to eat up your money … and, would the Federal Government (the same entity backing the FDIC) allow a Major US Retail Bank to fail?

I guess we’ll find out in the next few months!

If you don’t believe that’s likely, then isn’t your money just as safe in The Bank as it is in the bank?

[AJC: think about it 😉 ]

And, doesn’t The Bank’s stock at least meet the overall market returns which averaged 8% p.a. for the past 100 years … what have bank deposits averaged in that time? 3%? 5%?

The point here is not necessarily to buy stock in The Bank … rather it’s to think about Investing rather than Saving …

Before suggesting WHAT to invest in, we need to know HOW long is our friend is expecting his money to last? Assuming that our friend is a hands-off investor, here’s what I suggest as the lowest-risk strategies possible:

If less than 30 years, then TIPS are a an option – PROVIDED that he can live off the inflation-adjusted interest (unfortunately, very unlikely in the current low interest environment – but, in 5/10 years, who knows?).

If 30 years or more, then a low-cost Index Fund is ideal for a hands-off investor. There has been NO 30 year period since the recording of the stock market indices where the market has not produced a positive return well above inflation.

If he is more hands on and/or more knowledgeable, then I would recommend no more than 4 or 5 well-selected individual stocks and direct investment in real-estate, for any time period 10 years or greater.

Inflation forces us to invest … because of this, inflation is our friend!

Applying the 20% Rule – Part II ( Your Possessions)

In my precursor post called Applying the 20% Rule – Part I ( Your House), I defined the 20% Rule and the 5% Rule as follows:

You should have no more than 20% of your Net Worth ‘invested’ in your house at any one time; you should also have no more than 5% of your Net Worth invested in other non-income-producing possessions (e.g. car/s, furniture, ‘stuff’). Why?

This ‘forces’ you to keep the bulk of your Net Worth in investments i.e. real assets (stuff that puts money into your pocket … not stuff that drains your finances)!

As a reminder, I represented this as a simple formula:

20% (max.) for your house + 5% (max.) for all the other stuff that you own = 75% (min.) of your Net Worth always in Investments

I also pointed out in that article how the Current Market Value of Your House will usually go up over time (current market conditions aside) but, the Current Market Value of Your Possessions will usually go down over time (collectibles aside!).

Whereas houses generally appreciate … possessions generally depreciate!

Now, as much as I hate to point this out (because the ‘frugal blogging community’ will probably fry me!) you can actually use this interesting financial anomaly to buy more stuff

… and, according to the $7million7year ‘philosophy’ the process of making money and getting rich should sometimes mean ‘delayed gratification’ but should never have to mean ‘no gratification’!

That means, that when starting out you may have to buy what you need and maybe even buy a house and generally screw yourself up financially (that’s where the ‘frugal blogging community’ comes in handy, because they will show you how to minimize – perhaps eliminate this risk – even better than my basic Making Money 101 Principles can help you).

If you do, by following my Making Money 101 steps and reading (and following) as many of these posts as possible, you will get yourself on the right track and find that:

 1. Your House fits the 20% Rule,

2. Your Meager Possessions fit the 5% Rule,

3. And, you are sensibly Investing the rest!

What now … well, pat yourself on the back and wait … until:

i) You have saved up enough cash to buy whatever it is that you are salivating over – repeat after me: we will never borrow money to by depreciating ‘stuff’ again – and,

ii) You have revalued your stuff (eBay and Craig’s List are two excellent sources of ‘current market valuations’ for all sorts of ‘stuff’) and found that they have lost so much value since you bought them that they now total less than 5% of your Current Net Worth, and

iii) The (hopefully, now increased) equity in your House still fits into the 20% Rule – and, you have applied everything in Applying The 20% Rule – Part I (Your House) if it doesn’t, and

iv) If you do buy the ‘New Stuff’, the total Current Market Value of your Possessions still fits into 5% of your current (hopefully, by now increased) Net Worth.

…. if you can check all of the above ‘boxes’ … go ahead and buy it, guilt free – you deserve it!

Now, the astute investors out there will have realized that if you increase your Investment Net Worth (i.e. the minimum of 75% of your Notional Net Worth that you keep in income-producing INVESTMENTS) – as you should, by an average of 8% compound a year or better – you will be able to increase the other 25% that is in your home equity and possessions to match!

In other words, you will (if you so choose) be able to match an increase in lifestyle arising from a better financial position …. life doesn’t get any better than that, does it?

How much to spend on a house?

In a previous post, I weighed in with my thoughts on the Rent v Buy question. The answer for most people, at some stage in their lives, is to … buy.

But, how much to spend?

Boy, this is a biggie! I mean, your house is usually your biggest personal purchase. So, here goes …

You should INVEST no more than 20% of your Net Worth into your house!

[To calculate your net worth, try this calculator at , then come back and read on, because you need the second half of the equation …]

The ‘20% Rule’ tells you how much of your current net assets you should INVEST, it doesn’t tell you how much house you can actually afford to buy …

… because, houses can be financed!

So, the 20% rule tells you how much deposit you can afford. And, the bank will then tell you how much you can afford to borrow (unfortunately, they won’t tell you how much you SHOULD borrow … only how much you CAN borrow).

Put your deposit + mortgage together, and there’s your house!

For example, say that you have saved $200,000 and it is sitting in the bank. And, assume that you have a job, but no other income or assets. Then you can afford to put down a $40,000 deposit on your house; the bank will look at your income and tell you how much you than then afford to borrow.

Why 20%? After you ‘invest’ another 5% of your Net Worth in ‘stuff’ (car/s, furniture, possessions), it means that you are never investing LESS THAN 75% of your Net Worth (that would be the $150,000 that you have left in our example) in income producing assets (like investment property).

It also tells you that you should never build up more than 20% of your Net Worth as equity in your own home without then borrowing against the remaining equity to invest.

So you should conservatively revalue your house at least every 3 – 5 years and withdraw any excess equity and add it to your investment pool!

If you can’t afford to trade up to a bigger house without breaking this rule … don’t trade up! When you get rich later, you’ll be happy you waited now.

But, if you can’t buy your FIRST (very small!) house without breaking this rule, then buy it anyway … as soon as you have enough equity, borrow against it to invest in long-term, income-producing assets, and keep rechecking this post.

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Should you rent or buy?

Should you own or rent? I have seen a lot of rubbish written on this subject … stuff like “renting is just dead money” or “a house is a liability” … so let me set you straight:

 If you are just starting out, up to your eyeballs in debt, unemployed, or you just can’t afford a house right now, it’s simple: you just rent.

If you already own a house, don’t sweat it, keep owning.

 And, if you are ready, willing and able to buy your first house, or you are thinking of trading up (or, down) …. here’s my advice:

Put aside the emotional decisions and just consider the financial impact, and that is: your house is the ONLY way that most people will ever get off the launching pad to financial success …

Why? Because, you are building up equity over time (even a flat or falling real estate market eventually climbs back up again) …

… but – and here is the key – ONLY if you are prepared to put the equity in your house to work for you … that means, borrowing against the equity in your house to INVEST.

Now, if you are buying a house with 10% – 20% down, this won’t be until you pay it down a little and the market picks up a little.

But, when you do build up enough equity in your house to borrow against, you’d better be prepared to do it! If not, then you are FAR better off just renting and investing the money you save on mortgage payments every month …

… if you’re not prepared to even do that, stop reading this blog … you will never be much better off than broke.