Tag Archives: Investing

Would you take financial advice from this man?

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Here’s an article about some guy who’s lost his house: http://www.consumerismcommentary.com/the-financial-planner-who-lost-his-house/

Sad, yes, you say … but, not to be rude, you also say … so have hundreds of thousands of others during this global financial crisis 🙁

But, if you look closely, you’ll see a small difference between this guy and the rest: this guy should have known better.

You see, he’s a financial advisor …

… and, not just any financial advisor, he’s a New York Times financial columnist/blogger!

What’s even more interesting is that he’s prepared to use his own tale of woe (as is Consumerism Commentary in his follow up piece to the original NYT article):

to explain how people continue to behave irrationally about money even when they know better. It’s a good indication of why a healthy approach to your finances requires much more than knowing, “spend less than you earn.” We’d like to think that building wealth is as simple as that, but if that were true, anyone who could do simple arithmetic would be financially secure over time.

Hello?!

Doesn’t anybody see what’s really wrong with this picture?

Consumerism Commentary tells us:

Carl Richards is one of today’s best writers focusing on personal finance

This is after Carl admitted to the world that he lost his house because he “behaved irrationally about money” …

If the BEST financial advisors can lose their houses … how have the average ones mismanaged their’s … and, how badly can the worst ones screw up your life?

And, would you have known about Carl’s screw-up if he didn’t come forward and tell us?

Who are you seeking financial advice from? And, how can you really be sure … ? 😉

Make money when you buy!

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There’s an old saying that you may have heard. It’s used particularly in relation to real-estate, but it can be applied to many forms of investment. It’s:

You make money when you buy, not sell.

One of my new readers asked me to explain what it means:

Could you expend on this statement a little or maybe you have some related blogs about this on your site? “…buy at the right price you make money when you BUY not when you sell.”

I don’t think I’ve ever written explicitly about this age-old investment adage, because it’s almost a tautologogy …

… after all, an investment is something that you should never need to sell!

To me, a true investment is something that generates ongoing income. So why would you ever sell it?

Any ‘asset’ that you buy, specifically to sell to (hopefully!) generate a profit, is in reality a SPECULATION, not a true investment.

Business makes these kinds of speculations all the time: buying trading stock (or labor) with the expectation [read: hope] of selling it at a sufficient price to generate a healthy profit.

Businesses take a calculated risk in doing so, hoping that the potential profits justify the risk, but …

… 90% of business owners are wrong!

They say that 9 out of 10 businesses fail within their first 5 to 10 years. They fail for lots of reasons, but one of the main ones is that these simply cannot make enough money when they sell due to competitive pressures, new products, outdated manufacturing techniques, low volumes, etc., etc.

As investors, we cannot afford to make the same mistake, otherwise we are just gamblers – gambling that: red will hit more times than black; we will roll a natural 7; AAPL stock will go long this month; Las Vegas house prices will continue to climb.

On the other hand, as true investors, we have to buy well, then hold on for the long run.

It is the income from our investments that makes us rich (by funding our dream lifestyle), not the amount that we could sell the investment for.

How about you? Are you an investor or gambler? Do you see the difference?

Installing an ATM in your business …

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I met a small business owner a few weeks ago …

He was a smart young guy [AJC: aren’t they all?] who was setting up his own Internet design studio, building Internet-based software projects for other business owners.

His business is essentially a professional service business, and my advice to him was pretty much the same as I give to all professional service business owners (consultants, accountants, attorneys, doctors, etc.):

Except in rare circumstances, you don’t have a business, you have a high-paying job … with perks!

[AJC: the perks are around the tax benefits that attribute to business owners but not to paid employees; ask an accountant for examples.]

Most of these kinds of businesses don’t scale very well i.e. they can’t grow very large; they rely on the owners’ personal exertion (sometimes called ‘partners’); and, either can’t be sold, or can only be sold for small multiples of annual profit or turnover.

In short: you can’t rely on selling these businesses to fund your retirement.

But, what they do generally provide is income …

Because they are professional services, the owners are able to sell their own labor – and, those of their employees – at high multiples, usually generating excellent recurring revenue.

And, because they often take years of hard work and relationship building over many, many clients they can be quite “bullet-proof” (if well managed) in terms of providing that income reliably.

This was certainly the case for the young guy that I met.

Even though his agency was still quite young/small, it was already generating a nice income and showing signs of growing well.

My advice for him was to grow his personal income very slowly (this is advice that I would give to any business owner), and to pull as much money out of the business as possible (this is not advice that I would give to other business owners) …

… my advice was to treat the business as his personal ATM

[AJC: but not to the detriment of the business, or his partners, employees, clients, backers, etc.]

But, my advice was not to spend that ATM-cash on personal lifestyle building (homes, cars, vacations, etc.), but on passive investments.

I recommended that he use that cashflow to fund an aggressive investment portfolio, outside of his business: one that would one day grow to replace his personal income as generated by the business.

When the day comes that his passive income surpasses his personal business income, he becomes free.

What would you advise?

How to increase sales …

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If you’ve chosen ‘business’ as your primary vehicle to reach your own $7 million in 7years, then it’s best that you focus on increasing the amount of profit that you get to take home each day, week, month, and year.

To non-business readers this may sound like obvious advice, but you would be amazed at how many business owners focus on two numbers:

1. Sales Volume – usually expressed as “my business turned over $2.3 million last year”, and

2. Profit Margin – usually expressed as “my business makes 7% net profit, before tax”.

These may be key numbers for a large business – particularly if listed on a stock exchange, because the market punishes stocks that don’t grow their sales (sales $) fast enough, with comfortable margins (profit %) – however, for a small business …

… these are simply ‘vanity metrics’.

The only number that really counts is:

3. Net Profit After Tax – usually expressed as “Last year I took home from my business $738,000 in my pocket”

This is the number that you get to spend and / or invest (preferably the latter) each year, and the one number that you want to grow year-over-year.

So, when aspiring or new business owners ask me:

What is the best way to increase sales volume for a small business?

I say:

According to Jay Abraham (master marketer), there are only three ways to increase sales volume:

1. More customers (customer acquisition e.g. marketing, advertising, referrals),

2. Higher sales per customer (up-selling and cross-selling e.g. bundled offers),

3. More sales per customer (customer retention e.g. backend products)

You only need small improvements in each to make major improvements in your overall sales volume i.e. a 10% improvement in each area means a 33% increase in sales volume, overall.

An example strategy (for, say, an eCommerce site) that encompasses all three elements might be to:

1. Improve your Google search rankings and run some Adwords and FaceBook ad campaigns to bring in some new customers.

2. Create some bundled packages and add some special checkout offers to entice some of your customers to increase the size of their order.

3. Capture their e-mail addresses and send out special offers once every 6 weeks to encourage some repeat sales.

If you are very successful with your bundled, checkout, and e-mail discount offers, you might find that your % profit margin slips slightly, but that your overall sales volume increases significantly.

More importantly, the amount of net profit – i.e. cash that you get to take home in your pocket – goes up dramatically, meaning that you have a lot more cash available to invest in stocks and real-estate.

Then, it won’t be long before that $7 million in 7 years starts to look pretty achievable.

Before you can find the answer …

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Yes. Before you can find the right answer, you need to know the right question.

So it is with personal finance: most pf bloggers will answer a whole variety of questions:

– How can I become debt free?

– How can I pay off my credit cards?

– How can I save for retirement?

– How can I be more frugal?

BUT, these are not the questions that you need to be asking … at least, not at first.

No, there are only TWO questions that you need to ask. The first is in two parts, and it simply asks:

a) How much money do I need to support the life that I truly want to live? And, b) when do I want to begin?

I have a hypothesis about the typical answer to these questions, but the truth is that for every human being on this planet there is a different answer:

For some, it may be that they are happy doing what they are doing today, and are happy to keep doing it until they drop. For, them personal finance begins with maintaining their current lifestyle (which probably revolves around maintaining their employment) and staying healthy.

It probably also means learning all the lessons about personal finance that the blogosphere has to share: living below your means, eliminating debt, cutting up your credit cards, paying off your home, setting aside an emergency fund …

My second question – which I’ll come to in a moment – is moot for these lucky, satisfied, job-secure, working-class few.

But, my hypothesis is that most people are not satisfied with their current lifestyle … that you are not satisfied with your current lifestyle … that you:

– Want more time with your family,

– Want to indulge your hobbies and interests,

– Want to travel more,

– Want to be more relaxed and healthier,

… and, the list goes on.

And, I’ll wager that the limiting factor for you, right now, is money.

But, I’ll also bet that with a little thinking, you could come up with a salary that if a rich uncle were to pay it to you, would allow you to stop working full-time (or, altogether) and fund your ideal lifestyle.

I’ll also take a stab that ‘salary’ would bear little resemblance to your current salary.

But, if you can take an educated guess at what that ‘salary’ would need to be, I can tell you what your Number is (the answer to the first half of my first question) simply by telling you to multiply that amount by 20.

Let’s now assume that you have no rich uncle and have to amass this amount yourself …

How long will you give yourself to reach your goal so that you can begin to live the life you really want to live before you are too old to enjoy it?

I gave myself just 5 years to reach my Number of $5 million; in the end, I made $7 million in 7 years, starting $30k in debt.

[AJC: keep in mind that the longer you allow to reach your Number, the larger it will need to be because of the effects of inflation. For example, whatever Number you come up with today, you will need to add 50% if you aim to reach it in 10 years, and you will need to double it if you are prepared to wait 20 years … just to keep up with inflation.]

Which brings us to the second most important question in personal finance:

How am I going to get there?

For example, in order for me to reach a $5 million target in 5 years from a virtual standing start:

– I had to learn how to invest (I had no investments and no idea HOW to invest or WHAT to invest in)

– I had to turn my business around (it was breaking even, at best)

– I (more importantly, my family) had to sacrifice our existing life: we had to move overseas, my wife gave up her career, my children their friends, we all gave up our families for the 5 years we were away from home.

But, we all agreed that it would be worth it, because we had already answered the first question (both parts).

How about you?

 

Are polar bears left-handed?

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polar bear

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!

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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!

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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?

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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

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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 😉