Play the match game …

Posted on June 14, 2008 by Adrian

Here’s an ‘investing match game’ for you to try … simply match the active investment actions in Column A with the investment vehicle of choice in Column B (you must use each word in Column A once, and once only … you may use any word/s in Column B as often as you like):

Investment Actions		Investment Choice

Rehab’ing / Flipping		Real-Estate

Mortgaging / Leveraging		Motor Vehicle

No Money Down		Business Assets

Now, is this a trick question? If you’re honest, you probably answered:

Investment Actions		Investment Choice

Rehab’ing / Flipping		Real-Estate

Mortgaging / Leveraging		Real-Estate

No Money Down		Real-Estate

… after all, these are all ways to make money with real-estate; so did you pass the little test?

Good, because here is how they might work:

1. Rehab’ing, then flipping (quickly on-selling) real-estate

You can purchase a run-down property in a good location (usually a small house, condo, duplex, triplex or perhaps a run-down apartment complex), provide some of your own labor (or try and find a general contractor willing to work cheap) to fix up the kitchen and bathroom/s, apply a little paint and some new carpet, and … voila … you get to re-list the property and resell it for a price that covers your purchase price + rehab + profit (both yours and the general contractor). At least that how it used to be done – and, will again, sooner or later. Rehab’ing and flipping can be a useful way to generate a small lump of cash (also known as ‘chunking‘).

2. Mortgaging real-estate

You can purchase some real-estate, perhaps putting in a deposit of 10% – 20% and then using the bank’s money to pay for the balance. You can either live in the property or rent it out to help cover the cost of the mortgage (which you should usually fix so that you can be certain of your future costs). Since the mortgage payments do NOT rise with inflation (if you were smart enough to fix them), but rents do … over the long run you will earn an income and an eventual capital gain as the property increases in value. Buying and holding is a simple strategy for long-term wealth.

3. No Money Down

This is where you find a creative way to avoid paying a deposit (perhaps you don’t have the cash?) and then work with one of the other two strategies. There are people who swear by this method and others who say that there is no ethical way to use this strategy in a repeatable fashion. In either case, you use tools, like assuming an existing loan, and/or seller carry-back financing and/or finding a partner to avoid the necessity for fronting the 20% deposit yourself.

Of course, this little primer on real-estate was just a little ruse to stop you from peeking ahead …

… you see, even though I have also invested in real-estate in many different ways, here’s how I would match up those columns a little differently, based upon some things that I have actually done over the years:

Investment Actions		Investment Choice

Rehab’ing / Flipping		Motor Vehicle

Mortgaging Leveraging		Business Assets

No Money Down		Business Assets

i) Rehab’ing, then flipping a motor vehicle

Just out of college, I landed a high-flying job in the hot IT sector (yes, we had computers in the 80’s … just bigger) … when all of my friends were buying their first new car, I was selling mine, to buy …

… a 10 year old Porsche 911 (the particularly ‘hot’ S-model) for just $13,000 (she was a beauty, but more exhaust fumes ended up inside the car than outside … helps to explain the loss of a few memory cells).

The trouble is that she was that horrible bright/lime green that the German engineers thought was oh so appealing … yuk. I hired a compressor and bought some paint and materials … and, a friend who (said that he) had some experience spray painting, helped me to strip and sand the car’s exterior to bare metal then we spray painted it (in his backyard garage) a beautiful red … acrylic. We used over-the-counter enamel spray cans in a matching red to change the color of the interior of the doors, cabin, and engine/trunk because those areas were too hard to sand smooth and polish to a shine.

When we were finished the car ‘looked’ a million dollars …. needless to say I flipped it pretty quicky … selling it for $26,000. That was a decent profit for a not-long-out-of-college kid in the early 1980’s!

2. Mortgaging business assets

I mentioned in a previous post that I left my high-flying job just shy of 10 years to join my father in a very small finance business (just me, my father, and one administrative clerk); it didn’t perform very well, not even covering salaries. However, when my father got sick, I decided to buy out the family, leaving me $30k in debt.

The only problem was, that being a finance company, the business needed funding – bank funding, and a lot of it. The best solution that I could come up with was to find a bank who would treat the business assets (the ‘paper’ that we were funding) just like real-estate: I had no trouble finding a major bank willing to lend me 75% against those assets at a middling-to-high interest rate (leaving me to find the 25% deposit … by way of a partner whom I found then later bought out). The bank took no other security other than my personal guarantee … now, I have banks lining up to fund millions at up to 95% of those same assets (sub-prime or no sub-prime!) with no additional security and, now at an excellent rate.

3. No Money Down

Obviously, finding a partner for that business was a ‘no money down’ technique as applied to business, rather than real-estate. However, I came to the USA to sell some software to a related business. What I found was a business that had been family-owned for 50 years, allowed to run down, then been purchased by a large multinational for a ridiculous sum.

Naturally, the part of the business that I was interested in was not operating profitably, so instead of selling them my software and services to help them ‘fix’ the business themselves, I provided a cost-benefit that showed that they should give me majority share – for nothing – in return for taking over, and re-engineering its operations.

My team and I turned that business around in just a few, short months, and I sold my share to another public company for a huge gain (what’s the return on ‘no money down’? Infinite!) just 2 years later.

The point here is that money can be made anywhere, in any manner … all you need to apply is the NEED to achieve a certain level of financial result, the VISION to see a way to get there, and the PERSISTENCE to see it through …

… failure to do so will NEVER be for a lack of opportunity!

What are the pro's and con's of value investing?

Posted on June 13, 2008 by Adrian

I answered a great question at TickerHound posted by the staff (as they do from time to time to stimulate discussion) that I thought I should simply repeat here:

What are the pro’s and con’s of value investing? Do you think it’s a worthwhile strategy or are you more of a “efficient market” proponent?

Well, I consider myself a Value Investor in everything that I do … stocks, real-estate, etc. The only exception is in the case of businesses, I’m generally a Growth Investor or a Value Investor.

Value Investing simply means “buying something worth $2 for $1” … well, not exactly, but you get my point: buying something for less than it is WORTH.

Now, this is a critical distinction: just because something was selling for $2 last week, and is selling for $1 this week, doesn’t mean that it is a VALUE Stock … it may only be ‘worth’ $0.50 and the market may simply be driving the price down to that … and, beyond!

In fact, that same stock (really ‘worth’ only $0.50) may BECOME a Value Stock if/when the market overshoots and sends the price down to $0.25.

The problem with Value Stocks is then one of KNOWING what they are truly worth at any point in time, and only buying when they are selling for a price less than that (preferably, with a large Margin of Safety … which simply means, buying it for MUCH LESS than what you THINK it is worth “just in case” …).

Now that we have covered the basics, what is the PRO of Value Investing?

Exactly that … being able to buy something ‘worth’ $2 for only $1. I can’t think of a better, more sure way of making money than that!

Then, what is the CON of value Investing … after all, there must be some or we’d ALL be doing it?

Simple: as I said before, it’s all about KNOWING which stock that is currently selling for $1 is actually worth $2 (and, avoiding the ones that are only worth $0.50!!). And, that takes some knowledge and skill. Warren Buffett has that knowledge and skill … so do many others, to a greater or lesser extent.

One other CON – one that is, ironically enough, addressed by another TickerHound question: “Is technical analysis still applicable in a “news driven” market like the one we’re in now?”:

If a stock that you KNOW is worth $2 is currently selling for $1, is it an automatic BUY?

Well NO … you see, you KNOW it is worth $2, but the rest of the market may not!

Or, it may have BEEN worth $2 but there is something happening (maybe a pending lawsuit around a key patent, or the loss of a major contract, or … ) that YOU don’t know about because it hasn’t hit the “news” (or TickerHound) yet, but those ‘in the know’ are selling off the stock by the truckload.

So, that’s where technical analysis is not just applicable in a “news driven” market like the one we’re in now, but absolutely CRITICAL for buying Value Stocks …

… it will tell you WHEN to buy (or sell off) that stock holding, based upon what the “insiders” are doing.

If you want to learn more about Value Investing, and using Technical Analysis to know when to get in/out of a Value position, I recommend picking up a copy of Phil Town’s excellent primer: Rule 1 Investing …

… and, Good Luck!

The $7million Real-Estate Rule

Posted on June 11, 2008 by Adrian

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

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

Wait for what?

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

But, what kind of real-estate are commodities?

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

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

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

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

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

And, surely you are right …

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

a. Income (or rent)

b. Expenses (or outgoings)

c. Taxes (unfortunately)

d. Profit/Loss (or Net Operating Income)

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

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

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

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

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

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

Yippee!

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

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

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

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

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

How will they typically make that decision?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

You do the math!

The $7million Real-Estate Question

Posted on June 10, 2008 by Adrian

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

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

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

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

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

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

4. Comparable Returns – What would other investments produce?

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

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

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

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

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

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

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

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

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

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

A. Is the market off its high?

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

C. Are Interest rates off their highs?

D. Can you can afford the payments?

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

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

Here is the basic principle:

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

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

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

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

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

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

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

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

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

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

So, how and when to get started?

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

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

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

Oh, and do JUST ONE ONE MORE THING:

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

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

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

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

Good luck!

The lesser of two evils?

Posted on June 9, 2008 by Adrian

Ramit Seth of I Will Teach You To Be Rich recently arose from his bunker – where he has been holed up, busy polishing the manuscript to his latest book [publishers please!] to pose the question:

“Should I invest in CDs or a Roth IRA?”

The post was brief, and to the point:

Sherene writes:

“I am a recent college graduate and I want to put the little money I have saved (approx $3,000) into something that will give me good returns over the years. Would you suggest I get CDs or a Roth IRA?”

The two are very different.

A Roth IRA is an investment account, but once you get it, you have to put money in it and invest. You can read all about it on my article The World’s Easiest Guide to Retirement Accounts.

A CD is a type of investment, which you can buy inside (or outside) of any investment account. And if you’re wondering what I think about CDs/bonds…

It was the last line that triggered the most comments … and, of course those comments were split into four camps:

1. Pro-CD’s

2. Pro-Bonds

3. A little of both

4. Ramit, why don’t you write more 😉

But, these miss the point …

Are you an ACTIVE investor or a PASSIVE investor?

Active Investor

You will have realized that you can’t retire on $1,000,000 in 15 to 20 years. And, inflation will serve to ensure that investing greatly in either Bonds or CD’s will keep you poor.

Therefore, you will be looking for direct (maybe leveraged through margin borrowing, if you have the ‘appetite’) investments in a very few stocks that you understand and love, a business here or there if you have the aptitude and interest, and/or a few well-chosen real-estate investments.

You will manage these for growth and hold until they no longer make sense to keep, or you retire (and, want to adjust your investment strategy).

I don’t see any room in this portfolio for either CD’s or Bonds, except as short-term vehicles for parking cash while you gear up for the ‘next big thing’ do you?

Passive Investor

OK, so we don’t all want to be rich … and some of you are just window-shopping this blog (or, seeing how the ‘other half’ lives?).

Let’s say that you DO subscribe to the $1,000,000 (or even $2,000,000) in 15 – 20 year philosophy (yes, I even had some applicants for my 7 Millionaires … In Training! ‘experiment’ with that outlook … they don’t need my training; they just need Valium!) … what then?

Firstly, you will be looking to max out your 401k/ROTH certainly enough for the full employer-match; this will probably mean selecting from the list of funds available … unlikely to include Bonds (although, there may be a Bond Fund in there, somewhere) and certainly CD’s won’t be an option. So, it’s a moot point.

Secondly, you will probably be looking to invest in buying a home … saving a deposit, making payments, etc. then trading up as soon as the sun starts to shine (now, there’s a financial treadmill for you!). So, it’s a moot point.

But, Uncle Harry might die and leave you with $20,000 and you are suddenly faced with the decision: CD’s or Bonds …

…. hah, you think you got me? No way!

I would be immediately looking at becoming an Active Investor ($20k might just be enough for a deposit on that nice little rental ‘fixer upper’ down the street).

But, let’s say that you still are determined to retire late and poor … but, don’t want to be quite so poor … where would I go for advice on conservatively investing that nice little chunk of change?

Hmmm … when I look for investing advice, I usually look to the best in the business. That’s why I went to Warren Buffett’s Annual General Meeting in Omaha a few weeks ago.

At the meeting, Warren suggested that IF you don’t really know what you’re doing, you should dollar-cost average (that means put a little bit over time) into little pieces of all of “American Business” … he later clarified that to mean a low-cost Index Fund (in fact, he named Vanguard).

Why?

Well inflation will keep your CD’s and Bonds worthless … by buying and holding Index Funds (LOW-COST ones) for a VERY LONG time, the market will go up (there hasn’t been a SINGLE 30-year period where the market hasn’t averaged an 8% return) and you will stand a better chance to beat inflation …

Of course, none of these PASSIVE investment strategies will make you rich (or even financially free at a young age), but Warren’s strategy at least has a better chance of keeping you out of the poor house, and giving you a chance of retiring at 55 or 65 … IF you start young enough, and maintain the course for 20+ years!

But, what if you don’t want to invest in stocks at all … even via an ultra-low-cost Index Fund? Is it thenOK to invest in Bonds or CD’s?

Maybe, but I would much rather plonk that $20k into my mortgage!

I know that I said that it’s a dumb strategy, but it’s sure better than the CD/Bond alternative (better after-tax returns, but check with your financial adviser before doing anything!).

In fact, the only time that I would invest in:

1. CD’s – when I need to ‘park’ some money for a while … waiting for the next ideal investment to come along.

2. Bonds – when I am already rich and retired: Bonds can play an important part in maintaining wealth as part of a Making Money 301 strategy. As Ramit mentions in his comments, Bonds can be laddered (that means bought with a variety of expiry/cash-out dates).

For two great Bonds-in-Retirement strategies, read: Worry Free Investing by Zvi Bodie and The Grangaard Strategy by Paul Grangaard.

Now, let’s go and get rich!

PS For more Personal Finance articles visit: http://ptmoney.com/2008/06/09/the-156th-carnival-of-personal-finance-songs-of-summer/

Age is NO obstacle!

Posted on June 3, 2008 by Adrian

Applications for my 7 Millionaires … In Training! ‘grand experiment’ are now closed. I will be announcing the Final 30 Applicants this Thursday at 8pm CST on my Live Chat Show … if you want to follow along, I will also be announcing the next Millionaire Challenge! This will help me decide the Final 15 … now for today’s post:

It seems that blogging and personal finance is a ‘young man’s game’ …

… not so!

At least, not according to Lee, who was yesterday’s Featured Applicant for my new 7 Millionaires … In Training! ‘experiment’.

You can read Lee’s story on the 7m7y site, but I wanted to share the following with you:

Lee is a ‘tad’ older than me 🙂 and is an e-mailer, emoticon’er, and … a blogger. Go Lee!

Whether Lee joins our program from the front-lines or the side-lines, he will succeed because age is NO impediment.

Here are two related stories:

1. There’s an old ‘urban myth’ that says that a retired ‘colonel’ with no money and no prospects at the age of 70 left for a journey across the USA, living out of his car! All he had was an old family recipe for chicken that he wanted to ‘licence’ to restaurants. 1,000 restaurants and 2 years later, all he had was a trunk-full of “no, thanks!”.

Then restaurant number 1,001 said “yes!” … and, that’s how Colonel Sanders came to launch Kentucky Fried Chicken (now, KFC) … or so the story goes!

His actual story is a little less ‘dramatic’, but I really feel epitomises the path that people like Lee need to (and, can) take: ‘The Colonel’ actually started at the age of 40, cooking chicken dishes for people who stopped at his little gas-station in Kentucky.

At the time (he wasn’t a ‘Colonel’ yet) he did not have a restaurant, so he served customers in his apartment at the gas station!

Eventually, his local popularity grew, and Sanders moved to a motel/restaurant that seated 142 people where he just worked as the cook. Over the next nine years, he perfected his method of cooking chicken. Furthermore, he pioneered the use of a pressure-fryer that allowed the chicken to be cooked much faster than by pan-frying.

He was given the honorary title “Kentucky Colonel” in 1935 by the Kentucky State Governor. Ever the ‘salesman’, Sanders started to call himself “Colonel”, even dressing in the stereotypical “Southern gentleman” outfit that we are now used to seeing; he was the consumate marketer!

After the construction of a major highway bypassing his town reduced the restaurant’s business, Sanders had to leave so he took to franchising Kentucky Fried Chicken restaurants, starting at age 65, using $105.00 from his first Social Security check to fund visits to potential franchisees.

To me, that’s the real story: a 65 year-old fry-cook funding a franchise from Social Security!

2. The second story is a little more personal … highlighting the moment when I can remember being most proud of my own father.

It was my 30th Birthday and my father was at my Surprise Party (I am so thick, I didn’t notice all the cars on the street, the late arrivals hiding behind the trees, or even the balloons when I walked in … boy, was I surprised!) happy as a Dad can be.

The next day he told me that it was on the day of my party that he had been fired from his job – what made it worse was that he had been ‘stabbed in the back’: it was a finance company that he helped start for a ‘friend’, who (once my father had done all the hard work to get the company up and running with a solid book of business) reneg’ed on their deal to pay my father a 33% profit share.

Just two weeks later, at the age of 60, my father had found an ‘angel’ for seed funding and a bank for the major funding and was off and running … a feat that I was (fortunately) able to repeat just a few, short years later (and, unfortunately that I HAD to repeat … but, that’s another story).

Lee, age is NEVER an obstacle …

The Myth of Diversification

Posted on June 2, 2008 by Adrian

Important Announcement: Applications for my 7 Millionaires … In Training! ‘grand experiment’ CLOSE TONIGHT (June 2) at Midnight CST !!! This is your last chance to throw your hat in the ring …

I have been just itching to write this post … it falls straight into the category of ‘uncommon wisdom’ and will probably be jumped on by every Personal Finance author and self-appointed ‘finance guru’ out there.

All I can say is …

… bring it on, baby!

If you’ve read my posts on the only three ways to invest in stocks and the follow-up post that quoted some of Warren Buffet’s views on Index Funds vs direct stock investments, you’ll have some idea where this is heading.

But, if you’re just reading 7million7years for the first time, here it is in a nutshell:

1. Diversification is only suitable as a mid-term saving strategy – it automatically limits you to mediocre returns: The Market – Costs = All You Get … period!

Now, saving money this way, and compounding over time (a loooooonnnnnngggggg time) will put you way ahead of the typical American Spend-All-You-Earn-Then-Some Consumer ….

Just don’t confuse it with investing or wealth-building: it simply can’t, won’t, will never make you rich … nor will it make you wealthy …. nor will it even make you well-off ….

… because as long as you run, the dog of inflation is nipping at your heels!

However, it WILL stop you from being poor, broke and you may even be able to retire before 70, on the equivalent of $30k or $40k a year – not in today’s dollars, but in the inflation-ravaged dollars of the day that you retire!

But, if that’s all you need, then relax, that’s all that you need to do 🙂 But, if you need more then …

2. Concentration puts all of your eggs into one (well, a very few) baskets – it automatically gets you above average returns … if you get it right!

Investing implies taking some risk … it means choosing a vehicle (stocks, business, real-estate) … it means selecting one or a very few, well-chosen targets … it means putting your all into those well-selected targets and actively managing them for above-average market returns … until you get close to retirement.

Now, I could wax lyrical on this subject all day, every day … but, why trust me when you hardly know me and you can simply go to a source that everybody knows and can respect … Warren Buffet, who says:

I have 2 views on diversification. If you are a professional and have confidence, then I would advocate lots of concentration. For everyone else, if it’s not your game, participate in total diversification. The economy will do fine over time. Make sure you don’t buy at the wrong price or the wrong time. That’s what most people should do, buy a cheap index fund and slowly dollar cost average into it. If you try to be just a little bit smart, spending an hour a week investing, you’re liable to be really dumb.

If it’s your game, diversification doesn’t make sense. It’s crazy to put money into your 20th choice rather than your 1st choice. “Lebron James” analogy. If you have Lebron James on your team, don’t take him out of the game just to make room for someone else. If you have a harem of 40 women, you never really get to know any of them well.

Charlie and I operated mostly with 5 positions. If I were running 50, 100, 200 million, I would have 80% in 5 positions, with 25% for the largest. In 1964 I found a position I was willing to go heavier into, up to 40%. I told investors they could pull their money out. None did. The position was American Express after the Salad Oil Scandal. In 1951 I put the bulk of my net worth into GEICO. Later in 1998, LTCM was in trouble. With the spread between the on-the-run versus off-the-run 30 year Treasury bonds, I would have been willing to put 75% of my portfolio into it. There were various times I would have gone up to 75%, even in the past few years. If it’s your game and you really know your business, you can load up.

Over the past 50-60 years, Charlie and I have never permanently lost more than 2% of our personal worth on a position. We’ve suffered quotational loss, 50% movements. That’s why you should never borrow money. We don’t want to get into situations where anyone can pull the rug out from under our feet.

In stocks, it’s the only place where when things go on sale, people get unhappy. If I like a business, then it makes sense to buy more at 20 than at 30. If McDonalds reduces the price of hamburgers, I think it’s great. [W. E. B. 2/15/08 ]

So Warren Buffett seems to be suggesting that the average investor should be diversifying … not true. He is saying that unless you educate yourself, you should be ‘saving’ not ‘investing’ … but, here is what the difference between the two strategies means to you financially:

i) Warren Buffet-style Portfolio Concentrationhas produced 21% returns compounded annually since warren Buffett took the reins of Berkshire-Hathaway 44 years ago. This is how he became the world’s richest man, and created many other multi-millionaires in his wake.

ii) Common Wisdom Portfolio Diversificationas measured by an index such as the Dow Jones Industrial Average (DJIA) averages out to just 5.3% compounded annually, even though the DJIA appeared to “surge” from 66 to 11,497 during the 20th century.

When you subtract 4% average inflation from each of these sets of returns, which do you think has ANY CHANCE of making you rich?

But, it’s true that it is far better to be earning $30k – $40k (albeit in ‘future dollars’) in retirement than being flat-broke … so you need to build a safety net before you take on the additional risk that concentration implies.

Here’s how:

1. Create two buckets of money: your long-term savings, and your risk-capital.

You should first create your long-term savings bucket, as your fall-back … this means, max’ing your 401k; being consumer-debt-free; buying your own home and building up sufficient equity to satisfy the 20% Rule; and holding some money in reserve (this could be a 3 – 6 month emergency fund, or extra equity in your home that you are prepared to release in an emergency).

2. Maintain your long-term savings with the first 10% of your current gross salary, but using excess savings (i.e. any additional money no longer required to pay off debt now that you are debt-free); 50% of future pay-rises or other ‘found money’; 50% of any second income (e.g. from a part-time business) all to fund your risk-capital account.

3. Educate yourself on the investments that you will specialize in … then do your homework on the specific investments that you want to make and seek professional advice before stepping (not jumping) in.

4. If you fail … fall back to Step 2. then try and learn from your mistakes … but do try again/smarter.

Which path will you take?

Ali Baba and the … rabbit?

Posted on June 1, 2008 by Adrian

Last 24 hours to apply!!!!

Recently, I sent out a Casting Call for what I call my Grand Experiment … a real attempt to create 7 Millionaires in just 7 Years! If you haven’t applied yet, you still have time … 24 hours to be precise (applications close Midnight CST, June 2, 2008).

Now might be a great time to sign up for regular e-mail updates – that way, when something does happen, well you’ll be amongst the first to know! You can sign up by clicking here:

Subscribe to 7 Millionaires … In Training! by Email

Read on for today’s post ….

_________________________________________________________________________________

OK, I admit it … I learned as much from Bugs Bunny as anybody … even about money!

Don’t believe me, watch this latest installment from my Videos-on-Sundays series and tell me the ‘money moral’ (!):

http://youtube.com/watch?v=1oOEjssp2pE

AJC.

My biggest mistake?

Posted on May 31, 2008 by Adrian

A new tool to drive traffic to your page: if you haven’t seen Pinyo‘s new site, yet, click here now … I am predicting that it will become THE place to see what late breaking personal finance stories and blogs are hot right now!

I’m not really sure how it works, so I just submitted 3 or 4 of my posts to see what happens … I hope that you will visit PF Buzz, find them, and give each post the rating that it deserves 😉 It’s just an experiment … we’ll see how well it works … in the meantime, here’s today’s post …

I’m often asked what my biggest semi-financial mistakes were … and, I can point to some doozies:

1. I was offered the opportunity to head up a regional business unit promoting one of the first ever PC’s in the market … I said “no thanks … the future’s in mainframes!”

2. I sold 5 ounces of gold (losing money on the transaction) about a week before the 1980’s boom that took gold from $350 and oz. to over $1,800 an oz.!

3. I constantly choose to enter the markets just at the end of a major bull-run … because that’s when I happen to be cashed up.

But, my biggest financial mistake? That’s easy … not getting ‘religion’ early …

Explanation: we all know the benefit of SAVING early:

The following graph shows three investors, each of whom invests $1,000 a year until age 65. However, one begins at age 25, investing a total of $40,000; one at age 35, investing a total of $30,000; and one at age 45, investing a total of $20,000. Each earns 7 percent per year and, for purposes of this illustration, the effects of taxes and inflation are ignored.

The Power of Compounding

Source: Investment Company Institute

And, you already know my view on this: big deal … for each $1,000 invested the start-early guy saves $215k by the time he is 65 … or $2.15m if he can scrape up $10k each year from the age of 25.

That will provide the equivalent of about $30k a year (today) in retirement living (then) …. big deal.

No, I’m talking about the equivalent compounding power of starting to boost your income early … so that you can pump far more than $10k a year into your ‘retirement investments’ …

… imagine what you would get OUT if you could pump $100k a year IN?

The key is to get religion early … the ‘religion’ that I am talking about is the massive why that leads to the massive action that leads to massive amounts of money.

I can easily divide my financial life into two distinct parts:

1. Pre-Why: Until 1998 I plodded along with my little business slowly trying to grow it. I worked hard, but had no particular goal other than to try and eke out a living. My results were unspectacular, to say the least.

2. Post-Why: In 1998, I read the E-Myth Revisited by Michael Gerber; in it he recommended thinking about what I wanted my life to be like when I was ‘done’ and to think about how much money that would take (and by when).

I now had a massive ‘why’ and an ‘oh shit’ amount of money required to support it!

That’s what kicked off my $7 Million Dollar Journey.

So, what was my ‘big mistake’???

There was NOTHING that I did in that 7 years that I COULDN’T have done in the preceding 7 years, or in the 7 years before then!

If I had ‘got religion’ early, I may have reached my goal early … that little ‘financial mistake’ makes every other financial mistake that I could have made, did make, and probably will still make … pale into insignificance.

Which brings me to a comment made by Blogrdoc to a recent post, in which he says:

I seek business success primarily as a challenge and because I want more in life. Not more money, but more impact on others and being able to have fun.

When you’re a 9-5 corporate stiff like me, it’s so easy to just let life ‘happen’. For me, the motivation to get off my ass and try something different from my 9-5 is the tough part.

That was me, pre-1998 … but, 7 years post-1998, I went from there ($30k in debt) to $7 million cash in the bank … fully retired a couple of years later at the age of 49.

Mistake? Hell, yeah …

… I could have just as easily have retired in the same financial position at age 39 or 29!

At the very least, I would have had a helluva buffer against failure: Shoot for 29 … missed? Oh, well … shoot for 39 …

So, when you are still in your 20’s or even 30’s, I suggest that you try and ‘get religion’ early. Here’s how Blogrdoc might do it:

1. He could look for the real meaning in “I want more in life. Not more money, but more impact on others and being able to have fun”.

What would it mean to Blogrdoc … his FAMILY … hell, the WORLD ! … for him to have this?

What about your WHY?

Would it mean enough to you to really need it?

Would it mean enough to you that you would feel that your life was a failure if you didn’t have it? Would it be enough of a need to carry you through the 1st, 2nd, and 100th obstacle that will get in your way?

If not, stop now!

You will never have the emotional strength to crash you through the invetiable HUGE obstacles that will get in the way of you and (say) $7 million: you won’t get rich and you will ‘die’ trying …

But, If so … great … you have the WHY!!!

2. The, you should think about HOW MUCH in today’s income (as if you did it today) you will need to live the life that gives you your WHY (think about costs like travel, housing, cars, donations, etc.); also, decide if you need to quit work entirely to do it … the difference is how much PASSIVE INCOME that you need.

Remember: even if you do decide that you can still work, you may need to rerun these numbers for when you stop work entirely as well … sort of a pre-quit and post-quit plan.

3. Think about WHEN you need this to all happen by (not want it to happen by, NEED it to happen by); DOUBLE the amount of income that you calculated in Step 2. for every 20 years until the WHEN (you can prorate, eg add 50% for 10 years and so on … it wll be close enough).

Multiply by 20, 25 or 40 depening on how conservative you are and how much of a buffer you need (remember, once you stop ‘earning’, what you have in savings and investments has to last your whole life, therefore, I use 40 .. perhaps, excessively conservative) … that’s your Number.

3. Oh shit?

Great!

Now, you have the WHY that leads to the WHEREFORE that leads to the MONEY …

… and, you just may get there 10 or 20 years before I did 🙂

What the Quality of Life Index means to you …

Posted on May 30, 2008 by Adrian

First LIVE show aired last night … thanks to all of those who joined us (!) … a few technical glitches … the host wasn’t exactly Jay Leno [I don’t have as many cars as Jay, either] … some great question and fantastic chatting. Same time next week, all?

Now, for today’s post …

Today, I am reviewing – and adding to – an important concept recently introduced by mymoneyblog … a way of comparing wealth without resorting to meaningless concepts like Net Worth.

It’s a ratio that mymoneyblog has dubbed the Financial Freedom Ratio:

If someone tells you that they have a net worth of $1,000,000, you might be impressed. But what if they spent $150,000 per year? If they stopped working, the money wouldn’t last very long. However, if they only spent $15,000 per year, they might already be set for life. In other words, your income doesn’t matter. Your expenses do. It may be assumed that the two are related, but that is not necessarily true. We all have the power to disconnect the two.

I’m sure somebody somewhere has already coined this term, but until told otherwise I will call it the Financial Freedom Ratio (FFR):

By liquid, I simply mean you can sell it for cash while not affecting your expenses. (Don’t count your car if you need it for work).

I like the FFR because it is a way to compare two people who may be on different financial paths; I mean, who is better off?

The doctor who earns $250k per year (net) but spends $260k a year on mortgages, cars, vacations?

The veterinarian who earns $150k per year (net) but spends $110K and has paid off their house?

But, there is a problem, as mymoneyblog also points out:

For example, if you had $200,000 but only spent $20,000 per year you would have the FFR value of 10 as someone with $1,000,000 but spent $100,000 per year. This also calls into focus how important spending patterns are when talking about financial freedom.

You see, Ratios are dimensionless … they lose scale. Therefore, with the FFR a ‘hobo’ COULD conceivably have a better FFR than a multimillionaire!

For example: my FFR is 40 (purely based upon cash in the bank) – but, that doesn’t mean anything to you, until I also tell you one of the Scaling Numbers (either ‘liquid net worth’ OR ‘annual spending’ will do).

If we want to keep these numbers secret (the great benefit of the FFR), then we simply need to add some sort of Quality of Life Index:

As long as the QLI is greater than 1, then I agree that the FFR is a great way to share ‘financial positions’ WITHOUT disclosing how much we actually have in the bank!

It is also a great way to determine if your are on track to your ideal retirement, rather than just settling for the personal finance blogger’s curse: you will save, and save, and save until you can retire on your current paltry salary …

… the QLI forces you to assess what you really need to be able to spend in retirement and then it, together with the FFR, doesn’t let you retire until you can get there!

The only problem?

It doesn’t tell you how to do it! So, you tell me … how will you do it???

7million7years

How to make 7 million in 7 years …

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