Tag Archives: Investing

It’s impossible to pay for good advice …

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This is not just a provocation … I think it’s true.

It may not be true in some technical professions: think of a doctor or an accountant … you pay for advice and you expect it to be good (after all, she’s got a PHD right?).

Even then, how do you know it’s good advice?

After all, in most cases, you’re hardly expert enough to judge 😉

Should you be worried?

Not  unduly. After all, those articles about the accountant who diddled his clients books is something that you only ever read about. It never happens to you. Right?

What about the guy in the picture to the left? Would you go to him for advice on a healthy lifestyle?

The picture is of a statue, but it bears an uncanny resemblance to a doctor-friend of mine, whose picture I can’t show for obvious reasons; he’s actually a top vascular physician and surgeon.

So, best case, quality of advice is difficult to determine.

But, it’s downright impossible to pay for good, personalized financial (or business) advice!

A simple example: if you want to grow a successful business, can you pay a consultant to tell you how?

Of course not! If they knew the ‘secret’ to building a truly successful business, they would be busy doing it for themselves.

The best you’ll get is some clown offering cheap advice 😉

Let’s try personal finance: people ask me how to select a good financial advisor:

The first thing that I ask them is how much money they want (and, by when)?

The answer is usually $7m7y (or, some other large Number / soon Date).

The next thing that I ask is how much of their own money their chosen advisor has made following the same recommendations that he is giving to them?!

I made $7million in 7 years, but it’s impossible for you to pay me for advice; I give it away … because I want to.

Still not sure?

OK, let’s say you want to invest in stocks.

Who do you want to pay for advice: (a) somebody who’s read about investing in stocks, or (b) somebody who’s made a lot of money investing in stocks?

If (b), why are they taking paltry fees from you?

Oh I see … they aren’t just taking fees from you, they have a managed fund. They’re not really taking money for advice, rather earning a fee for running the business of managing a huge bucket of money (including your tiny drop).

Even so, let me ask you another question:

Who do you want to pay to manage your money: (a) somebody who’s made a lot of money investing in stocks?, or (b) somebody who’s made the most money investing in stocks?

If (b), then who’s made the most money investing in stocks?

Obviously, it’s Warren Buffett (with George Soros a good second … but, if you said John Bogle you fail because he made money through his business of selling his low cost index funds to the masses, not from investing his own money in them).

So, if you want to invest in stocks, you can’t buy the right advice, because nobody’s selling … and, if you want to invest in some kind of fund you can’t pay for the best advice available …

… but, you can tap into that advice for ‘free’ just by buying Berkshire Hathaway stocks.

If I wasn’t going to manage my own money – listening to plenty of ‘advice’ but, ultimately taking my own counsel – that’s what I would do!

The Pay Yourself Twice Wealth Strategy!

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As you have no doubt worked out for yourself paying yourself twice is in itself just a stepping stone to financial success.

Let’s just quickly recap for new readers:

The likes of David Bach (The Automatic Millionaire) like to tell you that you needn’t do much more than ‘pay yourself first’ (i.e. save) 10% – 12.5% of your gross salary in order to live an idyllic life (well, at least retire well) … going so far as to call this “A Powerful One-Step Plan to Live and Finish Rich”.

The reality is that this is actually a dangerous financial strategy to pin your financial future on.

Whilst the idea of saving money is to be commended – in fact, saving is absolutely necessary – the sad reality is that you would need to pay yourself first 75% of your gross income, starting now and continuing for the next 20 years, just to maintain your current standard of living in retirement.

Clearly, my solution – which is to Pay Yourself Twice 15% of your gross salary – does little to bridge the gap.

Of course, it’s what you do with the money that counts:

I assume that your current ‘pay yourself first’ savings are going into some sort of employer sponsored, tax-advanatged retirement plan …

… which we already know cannot possibly be enough to support your current lifestyle in retirement, let alone set you up for that hammock in the Bahamas with free flowing Pina Coladas that you crave 😉

However, I do want you to keep your retirement fund going – and growing – because it is insurance, if all else fails.

But, it’s the “all else’s” that will make the difference between an austere retirement in 20 – 40 years or a certainly more memorable (and, very early) retirement with $7 million in 7 years … or a happy medium, if that’s more your speed.

And, that’s why you need to Pay Yourself Twice:

– Once to maintain this insurance policy, and

– The second time to build your investing war-chest.

If the power of compounding at bank to mutual fund rates of return (i.e. 4% – 10%) is not sufficient, then it stands to reason that you need to start investing at (much) higher compound returns.

This means building up a modest starting capital amount and ‘rolling the dice’ with higher risk / higher reward investments e.g.

A few minutes with a good compound growth rate calculator will (a) confirm how well your current strategy is doing against your desired retirement needs, and (b) tell you how deep into the above table you need to dive to bridge the gap.

It goes without saying – so, I’ll say it anyway (!) – that I hope that you all succeed with your investments, be they in stocks, real-estate and/or businesses. However, if you should fail … well, by continuing to Pay Yourself Twice, it won’t take too long to build up enough starting capital to have another go.

And, it might take one, two, five times before you are successful …

All the while, you have a 20 year backup plan (by also continuing to pay yourself first) just in case 😉

The problem with P2P lending …

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I am not a fan of peer to peer lending, so please forgive me, when Glen Millar of Prosper – one of the leading P2P lending sites – sent me the following e-mail, if I didn’t fall all over myself with excitement:

As a personal finance blogger we thought you might have interest in Prosper (www.prosper.com) and peer-to-peer lending.  You may know that Prosper was the first peer-to-peer lending marketplace in the US.  In 5 years, we have originated over $215 million in loans on our site.

In fact, here’s what I said in my reply:

Oops!
http://7million7years.com/2010/01/13/peer-to-peer-lending-a-7m7y-tool/

My argument in that post was about risk; Glen responded with a link to the following:

The basic argument being that Prosper manages loss/risk better than competing P2P sites through their proprietary rating system which “allows [Prosper] to maintain consistency when giving each listing a score. Prosper Ratings allow you to easily analyze a listing’s level of risk because the rating represents an estimated average annualized loss rate range.”

Which is all well and good until it is YOU that suffers the statistical loss/es (you can get unlucky and lose on a number of your loans); I don’t know about you, but I don’t like any system where I play statistical roulette without at least some measure (OK, illusion) of control.

The only control that you can really apply here is diversification: take out lots of small loans in your risk/reward categories:

In fact, if this risk-rating-system is so good, why doesn’t Prosper simply knock out the competition by adjusting the interest rate earned by the rating-weighted loss-rate and carry the risk themselves?!

But, what’s your for/against reasons?

I would like to hear both from readers who swear by P2P, and those who wouldn’t touch it with a 10 foot pole …

The myth of semi-retirement …

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We were driving through Sedona and stopped into some sort of Big Box Store to pick up some rubber beach shoes so that we could take the kids to Slide Rock.

We met a nice, older lady at the checkout and – as I tend to do with anybody and everybody – we got chatting.

Then she said something that took me totally by surprise:

She said that she moved to Sedona now that she is retired!

Retired?! Hang about, I thought, isn’t she standing at the cash register swiping my credit card?

Perhaps, reading my mind (more likely, the expression on my face), she clarified: she moved to Sedona when she retired from full-time work, and now that she is ‘retired’ (there it is again!) she only works part-time.

Why is that when you are studying – or perhaps slowly returning to the workforce post-parenthood – you are happy to tell your friends that you are “working part-time”.

But, when you reach 65 and suddenly find that you still need to work (perhaps with reduced hours, or in some sort of micro-business that you set up for yourself) you are “retired” or you are in that even less definable state of “semi-retirement”?

In fact, there are whole websites and books devoted to the subject of semi-retirement. One of those books is “Work Less, Live More” by Bob Clyatt; I bought it on the recommendation of Jacob from Early Retirement Extreme (he left a comment on this post) … I’ll be commenting on one specific aspect of this book (in fact, the very aspect that prompted Jacob to recommend it to me ) in an upcoming post.

In the meantime, Bob did confirm that I am not retired … I am semi-retired.

According to Bob, I am semi-retired because I do various income-earning activities: I still own a business; I own two development sites (and, am going though the process of having development plans approved by council); I have started an angel investing incubator (or, at least, started to put the foundations in place); have a web 2.0 startup and a book well under development.

But, if I am doing these things because I am a hobbyist, am I any different from the guy who is game fishing every other day as a hobby?

But, if I am game fishing every other day because I need the income (e.g. I take some paying clients out on my boat, or I sell the fish), am I any different to the guy who needs to have a part-time business – or blogs – because he needs the money?

In other words, isn’t the difference between working part-time and being semi-retired the need to bring in income from the activities that you undertake?

Doesn’t that change the dynamic just a little?

Even though he may enjoy the core activity, isn’t the part-time game fisherman who needs the money a little bit more upset when a trip is canceled due to bad weather (or customer cancelation) than the guy who is doing it purely because of his love of the sport?

Whether you agree or not, let’s at least agree on something … at least for the purposes of this blog:

1. If you are retired, you don’t need the money – you just do stuff for fun.

2. If you need the money, you aren’t retired, you are [insert activity of choice: writing a book; blogging; game fishing; real-estate developing; etc.] part-time.

The day that I need to consult to top up the income from my investments is the day that I am no longer just having fun: I’m working part-time.

Maybe we can coin a new term: flexi-working? Semi-working? Whatever you call it, there ain’t no retirement happening …

How about you? Where do you draw the line between work and retirement? And, does it even matter?

Wrapping up …

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You can check out the latest Carnival of Personal Finance (#298 – The Best Money Articles Online) here.

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I didn’t expect that one of my most argued series of posts would be about dividends; I thought it would be around my vehemently anti-anti-debt stance (see if you can work THAT out).

So, I’d like to wrap up that discussion with a point-by-point review of a really interesting comment left by Deek:

I see where you are coming from and disagree to a point. It depends on what your outlook is. 7 mil in 7 years of course dividends aren’t going to get you their.

But my grandfather who was a coal miner who cannot work into his 70s because of the type of job. He was able to be a dividend millionaire. When he did retire the income from dividends, his pension and social security was more than enough for him to live comfortable into his 90s and leave money for his children.

At 90 years old he isn’t going to work,build a business or mess around with real estate. He wanted to check he dividend paying stocks once a month and enjoy retirement, drink a few beers and his biggest worry was cutting the grass.

I also find it interesting you mention Berkshire Hathaway. Depending on when you look at BRK holdings they do invest a significant amount of money into dividend paying stocks even though they do not themselves pay a dividend.

This really summarizes a lot of the for/against arguments around dividend stocks, at least as raised by the many reader comments to my earlier posts, so I thought I should run my readers through it:

1. Yes, this blog is specifically aimed at those who want to make what I call a Large Number / Soon Date (eg $7m7y or $2m5y, etc.); however, in this case, I don’t think it makes any difference: investing in stocks just because they happen to produce dividends is dumb.

In my businesses, I am free to create a dividend whether the business is performing well or otherwise. So can the boards of public companies. If that simple point doesn’t win the pro-dividend lobby over, nothing will.

2. It seems like Deek’s grandfather did an amazing job! Investing in a bunch of “dividend stocks” – and, holding for long periods – is certainly a lot better than many other strategies, certainly for non-$7m7y’ers.

But, he may – probably (certainly!) – have done even better by following a Value Investing approach (e.g. such as that proposed by Rule # 1 Investing author, Phil Town). Buying and holding great stocks – ones that produce a steadily growing profit stream – is an even better way to make long-term money than buying and holding stocks just because they happen to pay a steady dividend stream. The two should be synonymous, sadly that’s not always the case.

3. I’m not suggesting that you (or Deek’s grandfather) should invest in business or real-estate etc. Although, I strongly argue that in retirement RE, in particular, provides a much more secure retirement, again for $7m7y’ers.

4. Deek’s point about Warren Buffett (“BRK holdings they do invest a significant amount of money into dividend paying stocks even though they do not themselves pay a dividend”) neatly summarizes my key point:

Like Warren Buffett, I am not against investing in stocks that pay a dividend; I am simply for investing in great businesses – or, the stocks of great businesses – regardless of whether or not they pay a dividend.

Get it?

Dividends: real cashflow or fake cashflow?

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If you’ve noticed, I made a couple of adjustments to this blog:

The first is that I have reduced my posting schedule to (generally) twice a week; I’m trying for a Mon./Thur. posting schedule, but – if you enjoy reading this blog (near-future multi-millionaires need only apply!) – your best bet is to sign up for the RSS/e-mail feed on my home page because I’m fickle … if I get the urge, I’ll post daily, or simply shift days to suit my increasingly challenged schedule 🙂

The second is that I’m posting more business-related posts (e.g. my Anatomy Of A Startup occasional series) … I am funding a series of startups with the ultimate aim of a Y-Combinator style of early stage entrepreneurship mentoring / funding program and what I am sharing in this series is real ‘special sauce’ stuff … like everything that I do, it’s usually simple but works!

Back to the first change: if I write less frequently, I’m hoping to challenge myself and my readers even more. To whit, my last post (inspired by Canadian Couch Potato’s brilliant post on the same subject) inspired a one week long comment-debate … one of the best that I have seen on this blog.

The main thrust was the debate around income v capital growth.

Jeff stated the ‘for’ argument best when he said:

The reasons why people desire rental income from real estate are the same reasons why people desire dividends from stocks…you get a cash flow without having to sell the asset at an inopportune time.

But, there’s a key difference between so-called ‘Income Real-Estate’ and its stock market equivalent – Dividend Stocks: Income RE produces REAL cashflow, Dividend Stocks produce FAKE cashflow!

To illustrate, let’s take a look, first, at income-producing real-estate:

Tenants pay rent; you pay costs; what’s left (if any) is real, spendable, excess income/cashflow that generally increases with inflation. Bad RE doesn’t produce an income. Period.

Now, let’s take a look at so-called Dividend Stocks (i.e. Company stocks that you buy specifically because they produce a nice, steady dividend stream):

Dividend-paying company sells stuff; they pay their suppliers and other costs; Good company produces profits / Bad company produces losses.

In either case, the Board meets and says “we gotta pay some dividends”.

The CFO says “But, we got bills to pay!”; CTO says “I got R&D to do!”; COO says “I got warehouses to build!”; CEO just wants to keep his job (he is hired/fired by the Board, remember) and says nothing …

The Board says: “Too bad. If we don’t look after our shareholders they’ll crucify us … even worse, they’ll vote us off our nice cushy board positions and we’ll even have to buy our own lunches!”

“Let the CEO deal with poor cashflow and working capital, insufficient warehouses space, outmoded products and technology, lack of marketing, and so on … heck, we’ll even borrow money from our provisioning funds or the open market, if we have to. No matter what, those Dividends must be paid … after all, we are a Dividend Stock!”

So, they say “no” to the CFO, COO, CTO, CMO … and, every other shmo’

Do you want your board fussing over distributing cash that it may or may not be able to spare? Or, would you rather that your Board focussed on building a GREAT company, with GREAT long-term growth and profitability prospects?

In order to answer that question, there’s one more feature of dividend stocks that we still need to examine; Kevin @ Invest It Wisely says:

The pro-dividend guys do have a compelling case that dividends grow more smoothly than the ups/downs of the markets.

To which I say, “so what?”

As we have already seen, the apparent  ‘smoothness’ of the dividend stream can be illusory.

And, what are you going to do with any dividends that you have received pre-retirement?

I presume that you are going to reinvest them so that you, too, can get to $7 Million in 7 Years (or, at least to your own relatively large Number by your own relatively soon Date).

In other words, you’ll just take that relatively nice, smooth dividend stream and throw it right back into the choppy market [AJC: Next, you’ll be telling me that you’re Dollar Cost Averaging … somebody, grab me a Tylenol, please!].

If you’re going to be fully invested in the stock market, for a number of years, then why don’t you at least buy some stocks in great companies that are going to grow, grow, grow … profits?!

If they happen to pay dividends, well great [AJC: you’re going to give it straight back to them, anyway, aren’t you?], and if they don’t, well who cares?

I mean, would you rather own “this dividend stock [that] has delivered an annualized total return of 3.10% to its loyal shareholders”? Or, would you rather own this never-ever-paid-a-dividend stock that has delivered an annualized total return of 20+% to its loyal shareholders for over 40 years?!

However, there is one special case (i.e what if you are already retired?) that I want to examine next time …

Another case AGAINST dividends …

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The graph shows the promise of dividend-investing, but Canadian Couch Potato states the reality – the case AGAINST dividends – far more eloquently than me:

Why do shareholders believe so strongly that a $1 dividend is preferable to a $1 capital gain? Meir Statman looked at this question in a 1984 article called “Explaining Investor Preference for Cash Dividends,” coauthored by Hersh Sheffrin. He also reviews the idea in his new book, What Investors Really Want, pointing out that receiving $1,000 in dividends is no different from selling $1,000 worth of stock to create a “homemade dividend.”

Even when this idea is explained to people, most refuse to accept it. Statman suggests that it comes down to a cognitive bias called mental accounting. Investors categorize $1,000 in dividends as income that they will happily spend, but the idea of selling $1,000 worth of stock is “dipping into capital,” which causes them great anxiety. This idea is deeply ingrained in many investors, but it is an illusion, because a company that pays a dividend to shareholders is depleting its own capital.

If you want to understand the arguments – both for and against – investing in so-called ‘dividend stocks’ for the sake of the dividends, you would do well to read Canadian Couch Potato’s whole blog post AND the comments … all for/against arguments are well thought out.

Here is my argument against dividends in a nutshell:

Since you can create a dividend stream yourself (“ignoring taxes and transactions costs, a stock that pays no dividend but increases in price by 6% provides precisely the same return as one whose share price rises 4% and pays a 2% dividend”), it boils down to what could the company do v what can you do with the ‘spare cash’ that the company plans to issue (or not issue) as a dividend:

1. If the company keeps the dividend:

– They could buy more inventory: if their business is a volume business, more inventory = more profits. Consumer products companies such as Kraft and Unilever are great examples.

– They could do more R&D: investing in R&D is necessary gambling on the future; often it will be money wasted (in which case it’s better off in your pocket as a dividend), but sometimes it will provide a huge payback, such as when a pharmaceutical company develops a breakthrough medication, or a venture capital firm finds the next FaceBook.

– They could invest in marketing: more marketing = more sales; pretty simply, huh? Consumer products and technology companies are classic examples; the more often they put their products in front of the consumer, the more sales they seem to get.

– They could invest in more infrastructure: more factories, more locations = more revenue and more profits. Manufacturing companies, high tech businesses, and retailers are all tied to physical infrastructure.

– They could invest the cash – Many companies (think Microsoft, Apple, the tobacco companies, and the brewers) are sitting on a ton of cash. Heck, Berkshire Hathaway is sitting on so much of it, even Warren toys from time to time with giving it back to the shareholders (i.e. by issuing a dividend); after all, if they can only get 3% while it’s sitting in the bank and you can get …? Inevitably, though, they use this cash to make a spectacular purchase that transforms the company: think Google’s $6.5 billion offer for Groupon, or Berkshire Hathaway’s $44 billion purchase of BNSF Railway.

2. If you take the dividend:

– You could buy more stock in the same company: this is the basis of the automatic ‘dividend reinvestment policy’ that most companies now offer. So, let me see … you invest in company ABC because it issues a dividend, and you use it to, what? Oh, buy more stock in company ABC?!

– You could buy more stock in another company: why invest in another company? Oh, because it provides a better return. So, why not pull ALL of your money from the worse-performing dividend paying stock, and put it all in this company?

– You could buy more stock in a bunch of companies: diversification is often seen as a good thing [AJC: by many reading “how I became rich” blogs; rarely by those writing them]. The more you diversify, the more you tend towards average market returns. Why would you want to take your cash out of a company that produces spectacular returns [AJC: that’s why you invested in the ‘dividend stock’ in the first place, isn’t it?!] in order to put your money into something that produces average returns?

– You could keep your cash in the bank: strangely enough, this one makes sense; if the company can’t do anything better with their ‘spare cash’ than give it to you, wouldn’t you rather have it sitting in your bank account rather than theirs, so that you can at least have the flexibility to make the decision what to do next, eg leave it in the bank, buy some index funds, pay down debt, or even buy back into the company stock when they get out of the ‘sit on a ton of cash with no vision for the future’ doldrums.

… but, if any of these things are better than leaving the money in the company, wouldn’t you be better off taking all of your money out of the company all in one go (i.e. sell the stock) rather than in dribs and drabs (i.e. taking small dividends)?

Let me finish off with a story:

Warren Buffett got started by purchasing a textile company and immediately canceling it’s dividends!

Why?

So that he would have more money to invest in growing the company.

Potential investors who wanted dividends invested elsewhere … those who didn’t invested in Berkshire Hathaway and became multi-millionaires!

Berkshire Hathaway still operates on the same principle: why pull money out of BH when Warren can grow your money faster?!

Anatomy Of A Startup – Part II

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As I mentioned in my first post in this (occasional) series: “building a startup is one (highly risky) way of making $7 million in 7 years!”

My first B2B (business to business) startup was 100% offline (a.k.a. B&M a.k.a. ‘bricks and mortar); it funded my entire investment strategy – you have to get your cashflow from somewhere, right?

Even though it made barely more than a wage in terms of profits, I was able to scrimp, save, twist, and manipulate my way into an unbeatable combination of Business + Real-Estate to make my first $7 million in 7 years … even before I sold the business!

Nowadays, my twin passions come together in this post: writing about personal finance + working on startups.

I still own one fully b&m business (a finance company, established for nearly 20 years) and own 50% of another (a startup selling a unique product to cafes), but my ‘passion within a passion’ is actually web 2.0 (or, more trendily known these days as ‘social media’) startups.

And, I have just agreed terms with my two partners on my latest 100% online project (I found these guys by joining a meetup group online … kind of like meeting your future wife on PlentyOfFish.com!) .

The question that will obsess you most at this stage (it shouldn’t!) is “how much equity” did each partner get?

There’s many ways to cut-and-dice the pie:

The simplest is when two or three founders get together at a party and come up – in a flash of drunken inspiration (which is exactly how my LAST idea came to fruition) – with The Idea. Then they all do a handshake and a business is formed with each holding equal shares.

It only gets complicated – killing the business and the friendships – when one of the partners doesn’t pull their weight, or when one needs to go full-time to take the idea to the next stage, or …

The other way is to recognize different contributions at the outset:

– Who came up with the idea? Let’s say that I came up with the idea, and have begun the patent process (for whatever that’s worth).

– When did you come on board? Let’s say that I found you, and need you for a specific job (e.g. web-marketing).

– Who needs to draw a salary? Some partners will need SOME money to live … hopefully, nobody’s stupid enough to believe that this is a real, paying job (yet/ever).

– How many hours a week will each partner work? What about after launch?

– What are the basic milestones?

These are the real questions that we had to address in the past week or two, and here’s how we dealt with them [AJC: the real numbers are close to the following cooked up example]:

We agreed a NOMINAL dollar value for everything:

– The idea was given a nominal value of $200,000 (normally in the $100,000 to $200, 000) range

– It was agreed that each partner’s time pre-launch (and, to a specific point after: see milestones, below) would be worth an identical amount (we chose $100k each for the sake of simplicity; not to be confused with a real salary i.e. nobody will actually draw $100k in salary, at least not for quite a while!)

– We also agreed to keep an extra ‘salary’ for an extra partner that we would still need to find to plug a gap in our teams’ combined skill-set

– We also agreed to keep an extra few $ (initially, we wanted this to be $100,000 … we settled for less) as an extra incentive for PAID staff who may come on board in the future, but not as partners

– We also agree that we needed an ‘advisory board’ of 3 members, who would split about $35,000 in nominal ‘salary’ (remember: they will take this in % equity, not in cash!)

– We then agreed who was going to get paid in real $$$ before we actually make any money, and agreed that would be only one of the three founding partners who needed $40k to pay the bills at home! That was easily dealt with by taking down his starting position from $100k to $60k

– Finally, somebody needed to come up with some cash to start the company off (seed money); fortunately, asking me to reach into my pocket to offer $100,000 was a relatively easy decision for the group.

Now, realize that these are not real $$$ (except for the $40k salary for one of the partners and my very real $100k cash contribution) …. nobody is going to get paid $100,000! Nobody is going to give me $100,000 or $200,000 for the idea! I’m only going to put in the $100k as and when/needed!

These are NOTIONAL dollar amounts:

What we did next was to add all of these $$$$ together to come up with a single total, in this case just under $700,000.

Then it was a relatively easy matter to calculate everybody’s share of the equity e.g.:

– the founder who was not drawing a salary would receive $100,000 / $700,000 = 14% starting equity

– the founder who was drawing a $40k starting salary would receive ($100,000 – $40,000) / $700,000 = 9% starting equity

– The advisory board would split $35,000 / $700,000 = 5% (we would eventually offer 1.5% each and keep the rest as ‘spare equity’)

… and so on.

Note: whatever equity is left over (remember the ‘spare equity’ for the extra founder and for future staff incentives, plus any left over from rounding down as we did for the advisory board?) is actually owned by the founders in equal proportion to their starting equity. Equally, though, as future rounds of funding are taken on, the founders will be diluted in the same proportion.

Oh, but how do we know that we will actually work well as a team?

Simple: we didn’t hand out the equity all in one lump, we came up with a vesting arrangement tied to key business milestones.

Here’s what we came up with (each founder had exactly the same vesting arrangement, as did the advisory board, just to make sure that it didn’t cost us too much to get rid of any ‘lemons’ in our team); 20% of the offered equity would be released to each founder / advisory board member at each of the following milestones:

Milestone 1:   Project Commencement (date of incorporation of (working name))

Milestone 2:   Market launch of first functional web site

Milestone 3:   Receipt of first substantive revenues (>$5,000 in aggregate from time of startup)

Milestone 4:   Receipt of >$150,000 in aggregate revenue from time of startup

Milestone 5:   Receipt of >$500,000 in aggregate revenue from time of startup

This way, everybody needs to pull their own weight until the business is truly firing on all cylinders before they ‘earn’ their full allocation of equity.

The complication will come if additional outside funding is required before these milestones are reached. Then again, if all founding partners are still on board, everyone will be affected equally (well, in proportion).

Now, why did a say this equity discussion is not important?

There’s no equity if the business doesn’t get off the ground: your prime focus, at this stage, is to make sure that you have an idea that the market wants and that you have the skills to bring to the party … and, that’s all about commitment and execution (as well as a little luck)!

If you have a startup, leave a comment to share your experience with horse trading starting equity 🙂

Copying the magician …

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Have you seen those acts where the magician calls a volunteer up from the floor, hands them a rope then says to “do exactly as I do”.

The magician walks the volunteer, step by step, through the process of knotting his rope, while the volunteer tries to copy him exactly.

Of course, at the end, the magician’s rope is neatly knotted and the volunteer has rope all over the place and looks a little foolish.

You see, the magician has some extra steps that the volunteer doesn’t pick up, or performs in mirror image, so the trick is doomed to failure for him.

Of course, it’s all good-natured fun …

… but, it’s not so much fun when it happens in real life 🙁

For example, in my last post, I outlined some steps that retirees can take to create a “zero withdrawal rate” strategy for their retirement to virtually guarantee that their money will last as long as they do:

Now, 0% does not mean withdrawal nothing, but it does mean having a sustainable, self-regenerating supply of income; this is not as hard to achieve as you might think.

For example, you can create an ongoing stream of income from:

1. Inflation protected annuities (albeit expensive)

2. TIPS (albeit a low return)

3. 100% owned real-estate (albeit, needs management)

4. Dividend stocks (my least preferred as they are sometimes a sub-par investment that tends to rise-fall with the markets).

Remember, when you retire, you want not only ZERO chance that your money runs out, but you don’t even want to get anywhere near to zero by a wide margin.

A great feat … if you can pull it off.

But, you have to copy my strategies exactly … and, to do that you need to use your powers of observation to do exactly as I do. No deviation.

So, let’s take a ‘volunteer’ from the audience, Evan, who commented:

My goal is to have a little bit of all those buckets…right now I am trying to build the dividend portfolio.

Right strategy, but it seems that Evan missed the magician’s “secret step”:

You only implement these steps AFTER you have retired (at least, after you have reached Your Number).

Your goal should be to:

1. Have a large enough nest-egg (i.e. Your Number) to provide enough to retire with, and

2. To then ensure that it (i) keeps up with inflation and (ii) never runs out.

These strategies (dividend stocks, TIPS, 100%-owned real-estate, etc.) only work for Step 2.

They typically don’t provide enough return (including growth of capital and income) to build up the nest-egg that you need, in the first place!

So, if you implement them too early, your nest-egg will be too small to begin with …

Instead, you need to find a class of investment where both your capital and your income grow (at least) with inflation.

Here’s an example using real-estate:

a) BEFORE retirement, build up a large real-estate portfolio with 20% down, and refinancing at regular intervals to build up a large portfolio over time. Reinvest all excess profits into buying more real-estate. Use a mixture of residential and commercial to provide higher growth. Add value by building, rehabbing, etc. etc.

b) AFTER retirement (or, as retirement approaches) sell down your portfolio (particularly the lower-return residential component) until you have sufficient cash to pay out the prime commercial properties in your portfolio. Your aim is to own the best rental properties 100%, with a buffer for vacancies, repairs and maintenance, etc.

c) WHEN you get too old or ill to manage the portfolio (even with the help of qualified Realtors and property managers), sell out (or, leave instructions to your attorneys to sell out) and purchase TIPS (or bonds, if TIPS aren’t available).

Three radically different investment approaches … one for each critical stage of your life.

Mr Krabs is alive and well!

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Eugene (Mr) Krabs is the Mr Scrooge of the modern age. Scrooge McDuck was there for a while, but the duck got bumped by the crab. Sorry, duck!

All of these misers got rich, not by being misers (I’m sure it helped … a little!) but, by having a business; Mr Krabs has a hamburger joint. Nice cashflow business that – perfect for providing the funds to invest in all sorts of stuff.

And, I bet he owns the building …

Mr Krabs has one other advantage over his predecessors: he reads personal finance blogs!

I know this, because “Eugene Krabs” left his secret formula for wealth in a seemingly innocuous comment on Free Money Finance’s blog:

I’ve boiled what I’ve read myself down to the following equation:

Wealth = Capital + Risk + Time

(To be clear, capital is the money you have right now to make more money with.)

Technically, any one of those factors can do it for you. For example, if you have a massive amount of capital, or if you take massive amounts of risk and beat the odds, or if you have a lot of time to build your wealth, then you can still become wealthy at the expense of the other two factors.

However, there are downsides to all of these individual factors.

Sensational stuff!

The formula itself needs a little tweaking, but ‘sensational’ nonetheless, for example it’s probably better written as:

Wealth = Capital x Risk x Time

Here’s how to make it work for you; if you are an:

– Ordinary person: do nothing … your wealth will not grow. In fact, it will decline in real terms, as inflation takes its toll. You can offset this, to a greater or lesser extent by cutting costs (including interest costs and living expenses). Whole legions of people swear by this approach.

– Reasonable person: limit your risk, and offset your limited capital by applying Time … lots of it (provided you are happy to work for 40+ years, don’t get sick or lose your job, etc., etc.), and pay yourself first to increase your capital by roughly 10% each year.

– Extraordinary person: you also make a 10% improvement, because that’s reasonable, achievable, sensible … but, you don’t make a 10% improvement in just one area, you do it – as Eugene Krabs suggests – across all three!

Look at what happens if you apply one unit of Capital, one unit of Risk, and one unit of Time: you gain one unit of Wealth.

But, what happens if you increase your:

1. Capital by 10% – let’s say by starting a business on the side and applying at least 50% of it’s net income to your investment capital?

2. Risk by 10% – let’s say by moving from investing in Mutual Funds to individual stocks (if you buy/hold one, you buy/hold the other)?

3. Time by 10% – let’s say you allow yourself 10% more time to get there?

Nobody would be too scared by making a 10% improvement in one are; so, what’s so hard about making it in three areas at the same time? If you do, you end up with 1.1 units of each of: Capital, Risk, and Time: 1.1 x 1.1 x 1.1 = 1.33 …

… your wealth doesn’t increase by just 10%, it increases by 33%.

Of course, you want to REDUCE time, not increase it, so play with a simple annual compound growth rate calculator and see what happens if you:

i) Double your Capital (increase your savings; reinvest 100% of your side business earnings; grow your side-business even more)

ii) Double your Risk (buy/sell your stocks; buy/rehab real-estate; start a ‘real’ business)

iii) Halve your Time

2 x 2 x 0.5 = 2 … how’s a 100% increase in your wealth suit you?

BTW: for the mathematicians out there, this simplistic formula is nonsense; for example, as your wealth increases over time, any ‘spare’ wealth (i.e. that you don’t spend) increases your Capital (thus compounding either/both until your Capital converges to your Wealth … but, never quite meets it), whereas Time is linear (as long as we don’t approach the Speed of Light), and Risk is certainly neither linear nor compounded.

But, that’s not important right now … 😉