Are polar bears left-handed?

Here’s some interesting ’information’ that I picked up:

Apparently, all Polar Bears are left-handed.

Well, it seems that there are two types of people in this world: those who will now run off and propagate this ‘fact’ at trivia and pub nights, and those who will go and check their sources.

I’m in the latter … now, I’m not obsessive about it, so this information ‘seems’ right, but I’ll let a polarbearophile prove me right or wrong with these Polar Bear Myths:

- A hunting bear will cover its black nose while lying in wait for a seal.

Canadian biologist Ian Stirling has spent several thousand hours watching polar bears hunt. He has never seen one hide its nose, nor have other scientists.

- The great white bears are left-pawed.

Scientists observing the animals haven’t noticed a preference. In fact, polar bears seem to use their right and left paws equally.

- Polar bears use tools, including blocks of ice to kill their prey.

Scientist Ian Stirling believes that this assertion can be traced to unsuccessful hunts. After failing to catch a seal, a frustrated and angry polar bear may kick the snow, slap the ground — or hurl chunks of ice.

- A polar bear’s hollow hairs conduct ultraviolet light to its black skin, thus capturing energy.

This theory was tested—and disproved—by physicist Daniel Koon.

- The polar bear has a symbiotic relationship with the arctic fox, sharing its food in exchange for the fox’s warning system.

Not only is the bear-fox relationship not symbiotic, the little foxes often annoy the bears. An arctic fox will sometimes tease a bear by darting in to nip at its heels and will sometimes try to drive a bear off its prey.

- Orca whales prey on polar bears.

This has never been observed.

- Polar bears live at both poles.

Polar bears, of course, live only in the circumpolar North. They never encounter penguins, which do not live in the same regions as polar bears.

[AJC: Polar bears = Arctic and Greenland; Penguins = Antarctic, Australia and New Zealand. Get it??!!]

Source: http://www.polarbearsinternational.org/bear-facts/myths-and-misconceptions/

So?

Well, if this is how many myths polar bears can generate, imagine how many there are about our favorite subject: personal finance?!

Here are just some that I have tried to dispel on this site:

- The myth that entrepreneurs are driven by greed

- The myth that a high income equates to wealth

- The myth that diversification is one of the most important personal finance tools around

- The myth that retirement planning centers around replacing your income

… and, I have written many, many more (just type the word ‘myth’ into the search box at the top of this page).

What myths (personal finance or otherwise) have you recently had cause to question?

Advice for a new multimillionaire!

I guess I am one of the few personal finance writers qualified to answer this interesting question that came to me the other day:

What advice would you give a new 32 year-old multimillionaire that you wish you had known at that age?

Firstly, don’t overestimate your wealth.

Spectrum (a Chicago-based consultancy that specializes in understanding the High Net Worth individual and family) surveyed a number of people whose net worth was in the $1m, $5mill, and $25m+ ranges about how much money that they would need in order to feel wealthy.

Almost invariably, the answer was: “about double”.

Having lived through the ups and downs of wealth, I think I understand the reason:

Wealthy people spend capital. What they should be spending is income.

That’s another way of saying that it’s very easy to live beyond your means no matter how much money you have.

Here’s how to control your wealth:

1. Take your capital and divide it by 20. That’s roughly how much you have a year to live off (if you’re going to live on bonds and savings, well, divide by 40 instead).

2. Invest 95% of the capital as though it’s the last money that you will ever see (because, it most likely is).

3. Be Rent Wealthy, not Buy Wealthy. Rent Wealthy means that you rent what you need: want to holiday in Aspen? Rent a villa … but do not, under any circumstances, buy one. Want to travel? Go First Class but do no buy the plane!

[Note my rule on personal 'capital purchases' (eg houses, cars, boats, etc.): only buy something when it makes absolutely no sense not to]

4. How you invest your money during Life After Work (a.k.a. early retirement) is VERY different to how you might invest your money while you’re still trying to build your fortune:

- Pre-retirement investments include: businesses, francises, property development, share trading, and so on.

- Post-retirement investments include: TIPS (inflation-protected bonds); dividend stocks; 100% owned commercial real-estate, and so on.

The sad reality is that most people who make multimillions that young do it by chance: inheritance, lottery, corporate payout.

Even when they do manage to earn it (as I did), not many people can make the mental switch from high-flying entrepreneur/investor/big-wig to conservative investor … in order to survive post ‘Your Big Windfall Event’ you’re going to have to make the switch.

… another man’s poison!

To some people, it seems that I promote high-risk strategies. For example, long-time reader, Josh says:

I wondered over to your blog to see what’s new and after reading a few posts I realized why I don’t visit anymore, and it’s because your articles are drenched in pro-debt/leveraged strategies. This is something I don’t agree with and don’t practice. I do understand the mathematical ramifications of using debt to leverage yourself, it’s just something I plan to do without.

Firstly, what Josh is saying isn’t quite true …

… in fact, I don’t recommend debt to anybody. What I have said is that I don’t believe in the anti-debt lobby.

There’s nothing evil about debt per se, it’s if/how/when you apply it that counts.

For example, I have variously had:

a) a little debt: on my various buy/hold properties

b) a lot of debt: in my finance company (for a finance company, cash is like stock … you need as much of it on hand as possible)

c) no debt: all of my other businesses were ‘bootstrapped’ and self-funded

I should point out that Josh is a stock investor; he has made a small fortune (turned a couple of $k into one $m or so while still at college) buying pharmaceutical ‘penny stocks’ … I wonder how many people would consider that risky?

One man’s ‘sensible investment strategy’ is surely another man’s poison

Why sell property?

Richard sent me an e-mail [ajc AT 7million7years DOT com] asking:

I have read through most of your past posts. 2 questions come to my mind. Hope you can clarify.

1) You always tag a 30% return for real estate. If one puts 20% down on a prop and add in all the closing costs, capital up front will be like 25%. Assuming a 6% capital appreciation like you like to use, I don’t see how you can come out with 30% return on capital. My assumption is that we breakeven on cash flows. I did the calculation a while back and I think 15% is about the max.

2) I read that you have sold off your commercial properties and are looking to get back in. Why do you sell it of if real estate investing is for the long term? Can’t you refinance to tap into the equity and use it for other investments? Why do you want to “time” the market? Transaction costs are heavy in RE.

Let’s deal with the first part of the questions first: 30% is a very hard ask for any traditional investment, let alone real-estate. But, it can be done … if you’re a highly geared and successful [read: lucky] property developer.

More typical maximum investment returns can be seen in the following table:

By putting Franchises into this table – which many would consider more business than investment (but, I treat as an investment IF you can be an absentee-owner and acquire multiple franchises under the franchisor’s rules) I guess that I’m framing that you need to do a lot more than simply buy your own home and pay off your own mortgage to get these kinds of returns.

Real-Estate sits in the middle of this part of the growth table and, I agree with Richard, is probably closer to the 15% compound growth rate end than 30%.

But, the key question is: how does this kind of growth occur?

It occurs because of leverage:

1. Financial leverage – You can use the bank’s money  to gain a ‘free additional compound return’. Here’s how it might work:

You put 20% (or $20k) down on a house that costs $100,000 (ignoring closing costs for the sale of simplicity).

IF property only increased by 6% per annum, as Richard suggests (it’s actually a historical, US-wide growth rate quoted by a number of analysts in the past), and mortgage rates are around 4%, then the house will increase in value by $6k, but your mortgage will cost you $4k (actually, only 80% of that, since you put in $20k cash). Fortunately, this is a rental, so let’s say that you earn another $4k (4%) in rent.

Your total return is $6k, which doesn’t sound like a lot for a $100k asset (but DOES sound like Richard’s 6%), but you forgot one thing: you didn’t put in $100k … you only put in $20k, which you have just grown to $26k (in some mix of cash and/or equity) which is an ‘easy’ 30% return.

Now, you may not have picked this up, but who said that you needed to put down 20%? If the bank, fair enough …

… but, what if the bank allowed you to go with 10% (or, $10,000) down? Then your return almost doubles.

Even so, because real-estate is rarely cash-flow positive in the early years and appreciation isn’t always all that you expect, you need to add other kinds of leverage.

Here are some examples:

2. Knowledge leverage: If 6% is the average increase in home values across the entire country, do you think that you may be able to do better with a little research? For example, could you choose an urban area rather than a rural area (urban areas typically grow faster than average, and rural areas grow less)? Could you choose an upcoming neighborhood to invest in (one with lots of new families moving in, rather than one with an aging population where people are moving out)? Could you choose a high-demand location (one near a beach, near a park, near transport, near schools, near a mall, and so on) rather than one near factories and warehouses?

3. Value-added leverage: Could you take the least-loved house in the street and add value by: adding a bedroom? Painting the house? Cleaning up the garden? Upgrading the kitchen and bathrooms?

4. Opportunity leverage: could you find a house that nobody wants and buy it at a discount before it even comes onto the market? Could you find a poorly managed rental and be a little more hands-on in terms of looking after the property and tenants in order to increase rents over time?

Any ONE of these factors could positively influence your compound growth rate well over the averages. Combining as many of these factors as possible could positively hit your real-estate returns our of the ball-park.

As to the second part of Richard’s question, he is quite correct: buying real-estate and holding for the long-term is usually the right strategy.

However, circumstances may arise where that strategy does not make sense: e.g. I owned my office building, but once the business was bought and the tenants (my former company) moved out, I didn’t want to hold the commercial property while I was overseas and look for tenants.

In hindsight, I should have kept it.

The problem with financial advice – Part II

Why do you see a financial advisor?

ONE reason that people go, is because they expect that the financial advisor has great modeling tools, so they should be able to calculate your financial position and future needs with great accuracy.

What if I told you that doing your own financial planning using the simplest possible online tools and financial spreadsheets would get you closer – much closer – to your real financial needs than any ‘typical’ financial advisor can? What if I told you that is exactly the reason why I do my own financial planning using those exact same simple online tools and financial spreadsheets?

But, what if I told you that most financial advisors routinely underestimate your retirement needs by ~80%?

Would you even pay for such ‘professional’ financial advice again?

Need proof?

Well, a week ago I covered the first of best selling author, Dan Ariely’s comments about financial advisors, but he then goes on to say:

In one study, we asked people the same question that financial advisors ask: How much of your final salary will you need in retirement? The common answer was 75 percent. When we … asked where they got this advice, we found that most people heard this from the financial industry. You see the circularity and the inanity: Financial advisors are asking a question that their customers rely on them for the answer. So what’s the point of the question?!

In our study, we then took a different approach and instead asked people: How do you want to live in retirement? Where do you want to live? What activities you want to engage in? And similar questions geared to assess the quality of life that people expected in retirement. We then took these answers and itemized them, pricing out their retirement based on the things that people said they’d want to do and have in their retirement. Using these calculations, we found that these people (who told us that they will need 75% of their salary) would actually need 135 percent of their final income to live in the way that they want to in retirement.

This is a really important point; let’s say that your expected final salary is $100,000 in today’s dollars.

Then at 75%, you would need a nest-egg of $75,000 x 20 = $1,500,000

But at 135%, you would need a nest-egg of $135,000 x 20 = $2,700,000

[AJC: the '20' in the above calculations comes from my Rule of 20; see this early post]

That’s a shortfall in your retirement of $1,200,000 … more, if your expected ending salary is over $100k.

Now, what if I told you that I think your shortfall is not likely to be $1.2 million, but closer to $2mill – $3mill or even more?

I’ll let you know how I think you should calculate your true retirement needs in the next – and, final – post in this short series, because knowing what you’re aiming for now will stop a LOT of disappointment later

How to structure a real-estate partnership?

MoneyRunner asks:

A friend and I are in the process of writing an operating agreement for an LLC and I’ve got a question for you. We have raised capital for the down payment on an apartment building. I have raised $15,000 ($10,000 my own and $5,000 from family) while my friend has raised $25,000 (all from family). We both have a 50% ownership in the LLC. Once we start to produce income, is it fair to distribute funds according to initial capital invested? Is it even possible to do 50/50?

Firstly, I don’t like buying long-term assets in partnership … times change … longer times change even more

For example, to help a friend out (really!) my wife talked me into buying a half share in a downtown property. In ordinary circumstances it would have been a great, long-term hold.

However, two brothers-in-law had gone into partnership to acquire it and some years later one of the brothers-in-law wanted OUT. The problem was, the other B-in-L couldn’t afford to buy him out, and didn’t want to sell.

These sorts of decisions break up families … and was threatening to do exactly that to this family. Our friend, the third brother-in-law (and the only one of the three NOT involved in the deal) asked us to help out by buying out the one B-in-L who wanted to sell.

And, that’s what we did: bought 50% of a building that we know that we can never sell without causing the same situation to erupt again. My wife talked me into in … that’s my only excuse

But, if you still DO want to go into partnership, here’s what I suggested to MoneyRunner:

All is fair and possible in business and investing … as long as you both agree!

You will most likely need a shareholder’s agreement drawn up by your attorney, if the equity and/or profits are not to be split equally.

However, a simple way to deal with your situation is:

1. Both put in $15k as capital (it makes no difference HOW or WHERE you each got the money).

2. Let your friend put in the extra $10k as a loan.

3. Agree a rate of interest (say, mortgage rate plus x% e.g. if the current mortgage interest rate that you are paying on the property is 6%, your friend might get 10% for his $10k).

4. Split the equity and remaining profits (i.e. rent MINUS mortgage + interest owing to friend + expenses) 50/50

Here’s why you will still need a shareholders agreement:

- Rules as to how/if/when your friend’s loan is to be repaid,

- Rules as to who can force a sale of the property and how you deal with each other’s share in the property in the event of a dispute.

However, there are other ways to enter a ‘partnership’ that stop all of these issues:

My first real-estate purchase was with a friend of mine who found a new condo development in foreclosure; the bank was selling off the individual condos. My friend thought that we would get a better deal if we bought two condos together.

… and, we did!

We negotiated a price of $55k for each condo.

How did we deal with the partnership issue? Simple!

We each bought one codo in our own names. Then, when I stupidly decided to sell (I was still young and reckless, and this was my first ever real-estate purchase), I didn’t need to ask him. I sold it for just over $75k about 2 years later [AJC: But, it would be worth closer to $500k now, 25 years later] … not a bad deal, and no stress on our ‘partnership’.

The problem with financial advice – Part I

Now, I’m just some semi-anonymous blogger, so what do I know, right?

So, sometimes it’s nice if I can point you to others who share my opinions on controversial financial matters [AJC: I write almost exclusively about controversial financial matters ... why write something that's already in 5,000 other blogs, therefore, has a 99.9999% chance of being wrong?!].

For example, my opinion on financial advisors is that they are a waste of money.

But, Dan Ariely, a behavioral economist and author of two best-sellers, including Predictably Irrational, agrees:

From a behavioral economics point of view, the field of financial advice is quite strange and not very useful. For the most part, professional financial services rely on clients’ answers to two questions:

• How much of your current salary will you need in retirement?
• What is your risk attitude on a seven-point scale?

From my perspective, these are remarkably useless questions — but we’ll get to that in a minute. First, let’s think about the financial advisor’s business model. An advisor will optimize your portfolio based on the answers to these two questions. For this service, the advisor typically will take one percent of assets under management – and he will get this every year!

I agree with Dan when he says:

Not to be offensive, but I think that a simple algorithm can do this, and probably with fewer errors. Moving money around from stocks to bonds or vice versa is just not something for which we should pay one percent of assets under management.

Now, this is targeted at funds managers (both retail and institutional) as well as those who charge fees and/or commissions to prepare similar financial advice.

Remember, funds tend to fall short of the market in performance over time, by about how much they charge in fees …

Lesson: if you really want to short-change your financial future by investing in funds and over-diversifying (two sure ways to die broke), do what Warren Buffett suggests and invest in super-low cost Index Funds:

A very low-cost index is going to beat a majority of the amateur-managed money or professionally-managed money.

In the next part of this special three part series, I will show you how most people short-change their retirement by 60%,

A formula for investing in real-estate …

People are always looking for “magic formulas” to get rich. Even I’ve had a go at sharing mine …

But, when it comes to real-estate, the formula is simple: buy/hold/reinvest.

That means:

1. Buy positive cashflow ’20% down’ real-estate in an area that can appreciate

2. Hold on to it until it does appreciate

3. Refinance using the extra equity plus any accumulated rental profits to create your next deposit

4. Goto 1.

Here is a guy who has a very conservative (and, sensible I might add) real-estate investing strategy [AJC: for those who take the trouble to read the whole post, they will find the 'magic formula' they are looking for]:

I went from zero to more than one hundred units between 1977 and the early eighties by seeking tired rental property owners with free and clear buildings who were willing to finance the sales.

The early eighties was a financial climate not too unlike that today in there was really no mainstream lending occurring. It was the savings and loan crisis, Jimmy Carter and 18%+ FHA mortgages.

At the time I paid a bit more than the properties were “worth” in cash. But I operated with a buy and hold strategy so the properties became free and clear off the rents while providing me an above average income. We still own almost every property we purchased in the past 33 years.

In the early 2000′s every kid entering the business had Excel spreadsheets with estimated returns that would have them richer than Bill Gates in a decade. Every waiter, barber and auto mechanic you ran into was on their way to be the next Donald Trump or so it seemed.

Even buddies of mine called me a “dirt farmer” because I wasn’t taking advantage of easy lending and apparent ever expanding market, rather I stuck with the hard work of landlording. But the prices were unsustainable compared to rent. So I kept with what I knew worked and withdrew from buying. Between 2002 and 2010 I bought just three properties, two of which were commercial units for our own businesses. I’m still here and they all went belly up.

Usually you can’t go wrong if you are headed in the opposite direction of the majority. So that means today, with everyone shunning real estate it is probably a good time to buy, just as it was in 1982.

This year I reentered the market , but only on limited basis as there are some good deals, but for the most part the market still is in somewhat of a free fall.

My math in the beginning, which remains so today is: Assuming that you financed the whole purchase at 12% for 15 years, even if you paid cash, the property had to net $100 per month per unit after all expenses including at least $100/unit/month for maintenance. Did I get every deal? No, but why own if ownership will not help you reach a financial goal.

[AJC: 12% is very conservative; if you used 8% in the USA and 10% in Australia you would still have plenty of margin for error; remember, this guy was investing in an era with 18%+ interest rates]

It may not be ‘get rich quick’, but it is sensible

The right time to speak to a professional …

I have previously gone out on a limb to say that it’s very difficult (actually, I said impossible) to pay to get good commercial / investing advice.

Why?

Unlike a doctor, accountant, or attorney who can only give themselves so much self-help [AJC: unless the doctor's a hypochondriac; the accountant's an embezzler; or, the attorney's a criminal]  …

… any “investment / business advisor” really worth listening to is probably making too much money for themselves to waste their time advising you on how to make money.

On the other hand, on rare occasions, you can find such high-quality advice:

- You can find a mentor; somebody who’s been there / done that and is willing to counsel you one-on-one

- You can buy stock in a company owned by such a person e.g. Berkshire Hathaway; by investing in BH (for example) you are ‘paying’ Warren Buffett to look after your wealth as a by-product of looking after his own.

WARNING: if you ever receive a bill from either of these types of people … run for the hills! They are not whom they seem

But, there is a time when you DO need to seek – and, pay for – financial advice; to illustrate, here is an e-mail that I recently received:

Heh Adrian, do you think you can help and ole lady, who has been swindled more time that you can count, now unemployed (forced retirement), drowning in debt with but 1.1 million in property assets and 80K in bank that I am using to live off but it will only last 11 months with what I am paying out? I am 66 my husband (also retired) is 68.

It was our two financial advisors that got us into some of this trouble. We Lost our retirement investment through their recommendations. Even our other real estate investment (2 raw land and 1 condo) are now worth less than the remaining mortgages.

[My last] $80k is not just spending money; it is also supporting those mortgages, which I can’t sell due to the market.

You see, the time to pay for GOOD financial advice is when you think you might be in financial trouble (even if it was BAD financial advice that got you there, in the first place).

That’s why I don’t like to seek advice about WHERE to put my money.

But, this reader DEFINITELY needs to seek urgent professional financial advice!

She should get a recommendation from a friend to a fee-based advisor and/or accountant and just ask them to help her make some immediate decisions about her current structure: e.g. should she (can she) walk away from her mortgages? How much can she budget for the next 12 months in living expenses, and so on?

Then she’ll need to start learning (reading this blog is a good start) how to make real money, all over again …

What would you do in her situation?

You don’t need to become a barber to become rich …

Darwin’s Money shares a story about his barber that shows how anybody can become rich; here’s a trimmed down version of Darwin’s assessment of how his barber became rich:

• Real Estate Mogul – He owns multiple rental properties.  He started off small and kept rolling his profits into more and larger properties.
• Business Savvy… and Patient – He knows the real estate market very well and he waits for deals to come around.  He’s patient.
• Frugal – Just through some casual observations, it’s evident he’s a frugal guy.  He dresses modestly, he doesn’t take extravagant vacations, and he doesn’t drive a fancy car.  The combination of multiple streams of income and frugality make for a huge net worth in your later years.
• Small Business Owner– Like all smart business owners, he gets other people to work for him and generate income and offset his costs.  Rather than just running a one man barbershop, he has a couple other barbers working there.

This looks likes an great observational report … I’m not certain that Darwin actually asked his barber how much money he has or how he made it?

I’ll do the reverse; I’ll tell you how I made my money … it’s much the same as the barber, but I think it’s the order that’s critical:

Business Savvy, Impatient, Small Business Owner – I started by becoming a small business owner, then trying to become business savvy. But, it was a slow path. When I finally hit rock bottom (business-wise) and found my Life’s Purpose, hence my Number, I suddenly became impatient. In fact, this was the turning point for me: as I accelerated my business growth, I accelerated my income, which is the first key to becoming rich.

Frugal – Now, this is where most high income earners go wrong: as their income increases, they become looser with their money. It should be quite the reverse: in dollar terms it’s OK to (in fact, you should) reward yourself by increasing your expenditure [slightly] in $ terms. But, and this is the secret, you should be decreasing your expenditure in % terms. While it’s fine and dandy to be frugal while you are still on a low and/or fixed income (i.e. job), it’s actually critical to become more frugal in relative terms as your income increases.

… and Patient Real-Estate Mogul - What to do with the rapidly increasing bank balance? Well, you could put it in mutual funds (but the fees are too high and/or the returns are too slow), stocks (but, they are not leveraged enough), or other businesses (but, you run the risk of spreading yourself too thin). For me, the best compromise between the leverage of a true business and a passive investment is – and remains – investment-grade real-estate. This is where being patient finally kicks in, because buy/hold real-estate is subject to the vagaries of the market. But, I had a primary source of growing income, so I didn’t need to touch my real-estate investment income until I finally began Life After Work.

So, my assessment is that Darwin is right, but the order is wrong.

Oh, I also think that you can substitute small business ownership for any high income potential (e.g. highly-paid professional; CxO-level employee; consultant; etc.) with the only catch being that you miss out on the potential capital gains that owning a business may offer – on the other hand, you may be able to negotiate yourself a nice golden parachute …

How well do you think this simple strategy could work for you?