Tag Archives: Rich

How rich do you need to be before you can buy an island?

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Normally, I avoid answering questions outside of my personal experience, so you should be able to surmise that you need more than $7 million before it makes sense to buy your own slice of paradise.

Instead, I feel that a little logic and a minute or two with a calculator will allow us to come up with a reasonable estimate:

First, let’s take a look at how much an island will set you back …

… I’m not talking something that Richard Branson might buy; perhaps something like Blue Heaven Island in Bora Bora, which will ‘only’ set you back a tropical $4,990,000!

But, buying an island is not as simple as having $5m; take it from Mike, who says:

When you are in the middle of the ocean, separated from the nearest stores, schools, and hospitals, the price can reflect that. Also, to get to and from your island requires an expensive boat.

Wise words; maybe ‘Mike’ has bought an island or two, in his time?

So, it seems, to be able to buy a “decent island” you need to have enough net wealth to cover:

1. The cost of the island

2. It’s annual running costs

3. The cost of your own home

4. Your own annual (non-island) living costs

There’s no way to answer these questions accurately without making a whole host of assumptions, but I’ll take a stab, anyway:

i) If an island costs $5m, then the annual running costs should be estimated at between 10% and 20% of the purchase price. This is purely an educated guess. Let’s say $750k p.a.

ii) If you own a $5m island, I’m guessing that your own home/s will cost the same, let’s say another $5m

iii) If you can afford a $5m home and island, I would estimate that your minimum annual living costs will be another $500k – $1m p.a. Let’s say another $750k p.a.

Applying our Rule of 20 (i.e. you can retire when you have about 20 times your required annual living expenses in the bank) you will need ($750k + $750k) x 20 = $30 mill. (PLUS: $10m for the purchase price of your island plus your home/s).

There you have it:

I think you need at least $40m net worth before even considering buying a ‘cheap’ island.

I won’t be buying an island anytime soon, how about you?

How to buy a business with No-Money Down

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You’ve heard of ‘no money down’ deals for buying real-estate, but you probably have never done one yourself. But, did you know that it’s much easier – and, more profitable – to do ‘no money down’ deals in business?

[Originally published on Biznik, the small business online network: http://biznik.com/articles/how-to-buy-a-business-with-no-money-down]

You’ve seen the late night infomercials on cable: “buy my course for only $149 (plus S&H) and learn the secrets of how to buy 52 properties this year with NO MONEY DOWN”.

Naturally, you’re sceptical – and, so you should be because ‘no money down’ deals on real-estate are far more rare than the infomercials would lead you to believe [AJC: post-financial crisis, now almost impossible] … and, some of the ways that they are done are ‘on the edge’ of ethical business practices to say the least.

That’s why I have purchased a lot of real-estate over the years, but have NEVER done a ‘no money deal’.

But, did you know that it is possible to do ‘no money down’ deals on businesses? And, not only are these deals ethical, but they can be win/win for everybody involved?

And, they can be so easy to put together that my 13 year old son [AJC: this was a few years ago, now] put  one of them together for himself!

1. Let me start with my son’s example, as it is a good illustration of how simple the process can be:

My son started a small e-Bay business, but he didn’t have the capital to meet the minimum order requirement of $100 from his online wholesale supplier.

So, he asked me to put up half the capital for that first order for him: $50. In return, he offered me 45% share in the business, which I accepted.

He made that order and sold the stock within one month and promptly bought me back out!

[AJC: he handed $50 back to me and said he wanted his 45% back; I didn’t have the heart to say “son, it doesn’t quite work like that …”]

Not quite ‘no money down’ … but, close.

Now his e-Bay business nets him a cool $30 a week (not bad for a kid who only gets $26 a month in Allowance)

[AJC: Now I’m extra sorry I handed back my equity for $50, because his latest online/part-time business – he’s still at high school – makes him $150k a year]

2. I had the opportunity to take over a defunct family business: it was a finance company that needed both working capital and bank funding (a lot of it!) to run.

Unfortunately, at the time, I had neither the capital nor the access to bank funding … in fact, I was $30k in debt. But, I did have a customer list.

So, I used the same ‘no money down’ technique that my son used: I found an investor (who happened to be a competitor, often the best place to go for help) who put up the 25% capital that the business required to get started.

I then found a bank willing to finance the remaining 75% simply secured against the ‘paper assets’ of the business.

If you think about it, this is very similar to a ‘no money down’ deal on a property: find a partner willing to put up the deposit money in return for, say, a 50% share of the future profits, and a bank to lend you the balance as a mortgage over the property.

If the business is growing, my advice is to buy your partner out as soon as you can afford to … that’s what I did: we parted good friends. Make sure you always do the same.

3. Another way to do a ‘no money down’ deal for a business is where you have an asset that a larger company needs for their own business (preferably a non-profitable division of a larger company … believe me, there are plenty out there).

Most people are happy to sell this ‘asset’ to the larger company, or perhaps consult to them, for a fixed fee. Instead, consider ‘trading’ what you have for equity. Here’s how I did it:

I had some software that I used in my business that made our operation quite profitable; I found a Fortune 500 company that had a division operating in the same niche, but in another non-competing location, and discovered that they were still operating on older technology, hence, were unprofitable.

They offered to buy my software and consulting to help turn their own business unit around. However, we instead proposed a joint venture. For the ‘price’ of the software and our expertise, we received a majority share in that business unit. No money down!

It only took us two years to make the business profitable (using our software) and, we on-sold our share soon after for a huge return. We made about 7 times more profit by trading assets for equity than a simple software sale would have provided.

4. These are the types of ‘no money down’ deals that you should be looking for if you want to get into business or if you want to expand your existing business. But, there is an even simpler way:

If you want to buy an existing retail business with an existing lease … no matter what the asking price: ALWAYS start by offering No Money Down. Simply offer to take over their lease.

Many times that will be enough to do the deal … people need to sell their businesses for many reasons (marriage, divorce, moving) and are tied to their leases. By offering to take over their lease, you are removing a major headache for them … no money down!

Now that you have seen how easy it is – and, how lucrative it can be – to buy any type of business with No Money Down, maybe you will give it a try?

If you already have, please let me know your experiences …

Real-estate: can you tell the difference?

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I know when it’s time to give up the game: when you start dreaming about it.

Last night I dreamed that I was telling a group of people the difference between commercial and residential real-estate … the one – key – difference.

Don’t worry, because I’m going to continue blogging about personal finance, but I guess I should at least bring my dream into the the real world by writing about these two classes of real-estate here:

So, what is the difference between the two? That one, key difference?

Is it price? Is it purpose (you can live in one, work in the other)? Something else?

I think it’s all of those things, and more, but I think one reason stands out:

This is residential real-estate, these two houses [pictured above] are the same in every respect:

They look the same; they cost about the same; they will provide a similar standard of living … and, they will produce roughly the same investment return over time.

This is commercial real-estate, these two properties [pictured above] are the same in one very important respect, yet:

They don’t look the same; they didn’t even cost the same; they are totally different types of properties (one is an office, the other a small showroom and warehouse) …

… but, here’s the one thing that makes them identical, at least to an investor:

They will produce roughly the same investment return over time.

You see, residential real-estate is bought/sold/valued on the basis of its utility as a home, not an investment. So, while you can choose to live in it or rent it out as an investment … ultimately, it’s all about its desirability as a future home, street, neighborhood.

Residential real-estate is roughly valued by comparison to others like it, and is ultimately favored by investors for its future value …

… even though residential real-estate is considered a ‘safe, easy’ investment, it’s a sham ; a false promise based on comfort: we all know and understand (to a greater/lesser extent) the value of residential real-estate, because we live in it. Or, if not in ‘it’ in something very much like it, probably even in a neighborhood very much like it.

But, this is false and residential real-estate is actually the most dangerous form of real-estate investment because is is largely speculation; most of the return from residential real-estate is based on capital appreciation.

[AJC: there are exceptions, of course: defence housing, rural areas, and so on … generally, though, you are trading future appreciation for lower rents now. Cashflow positive real-estate does exist, it’s just than most people don’t know how and where to find it]

Commercial real-estate has the reputation of being difficult. Of course, it’s not: you purchase a property, you find a property manager, you rent it out, you collect the rents … nothing could be easier.

And, you are rewarded in the short-term: commercial real-estate is mostly about the income that you can derive from the property. It’s current and future value are simply a multiple of that return [the capitalization rate].

The returns are usually higher, per dollar invested, than residential real-estate (although, the banks will lend less against it); capital appreciation more certain; and, it’s easier to manage (tenants generally don’t trash the place; they pay most of the outgoings; they shoulder the lion’s share of the maintenance burden on the property).

Since most people are too scared to invest in commercial (so, they fight each other – in most ‘normal’ markets – to invest in residential real-estate) overall returns, in my experience, are generally much better.

What do you think they key difference is?

How to see the future …

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A Get Rich Slowly reader shared his financial advisor’s advice when asked whether he should go with mutual funds or index funds:

“..in 2008, as banks stocks were dropping rapidly, if they were a part of an index like the S & P 500, they were still held by the fund,  while a  manager of a fund could lower the funds exposure to this sector, thus attempting to limit the downside risk to the portfolio.”

This, of course, is a classic case of trying to time the market … and, we know what happens when anybody (except for Warren Buffett and a select few others who aren’t giving you their advice) try and time the market …

… for example, the famous Dalbar Study shows that people who attempt this reduce their returns from 11.9% to only 3.9%.

In their latest report, Dalbar says:

The unprecedented ups and downs of 2011 drove up the aversion to risk and investors succumbed to their fears. They decided to take their losses instead of risking further declines. Unfortunately, as is so often the case, this occurred just before the markets started on a steady trek to recovery.

So, the idea of ‘taking bank stocks’ out of your portfolio just as they are crashing is very enticing, but simply means that you also need to work out how to put them back in when they are climbing …

… and, if you really could pick when stocks are climbing or falling, you’d be off living the high-life in Monaco.

You certainly wouldn’t be selling your advice to us ordinary folk, now, would you? 😉

Poor little rich doctor …

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A couple of weeks ago, I responded to a reader request from a young doctor who is on what can only be described as an OMG level of income:

I am a young physician (early 30s) making approximately 800k per year. After expenses and taxes, I am left with ~300k to save/invest.

Never mind the fact that he is losing approximately $500k a year in “expenses and taxes”, a $300k take home is still pretty good in anybody’s language!

There was plenty of well-considered reader debate and advice for the young doctor, including this highly-reasoned argument from traineeinvestor:

I’d suggest he continue to focus most of his energy on maintaining or growing his professional income. Time spent on side ventures and investments should be limited so that it does not interfere with the $800K professional income.

In terms of investments, given his time constraints, I’d go with a Boglehead approach, possibly supplemented with some geared cash flow positive real estate (especially if he lives in the US and can take advantage of depressed prices and long term fixed borrowing costs).

I agree on both counts:

a) When you are earning a super-high level of salary, your primary goal should be to protect that source of income. It’s a river of money: you should do everything in your power to keep it flowing!

b) However, you shouldn’t just let the money flow into the taxman’s pocket, then into yours, and then out again by increasing your spending. Instead (and in keeping with our ‘river’ analogy) you should also build a downstream dam.

And, you should only open the sluice-gates to let off a much smaller amount than is going into the dam …

Why?

Because that’s the only way that the dam gets to fill up!

This way, when the river stops flowing (ideally, at a time of your choosing i.e. early retirement, but it could be forced upon you even earlier for a variety of reasons), you can keep the sluice gates open, knowing that there’s still enough water in the dam to keep the flow running for the rest of your life.

In other words: you don’t want the dam to run dry before you do 😉

But, this is much harder to achieve than you may think, so here’s where I differ – but, only slightly – starting by reversing the order of traineeinvestor’s otherwise excellent investment strategy:

I’d go with a geared cash flow positive real estate approach (especially if he lives in the US and can take advantage of depressed prices and long term fixed borrowing costs), possibly supplemented with some Boglehead-type investments.

The reasons are two-fold:

Firstly, I’m not accepting that 62.5% (i.e. $500k) of our doctor’s $800k earning capacity can simply be wiped off in “expenses and taxes” …

… professionals are just sitting ducks when it comes to taxes.

But, by implementing a nicely geared (and, maybe even cashflow negative after depreciation allowances) real-estate strategy, there may be deductions that can legitimately increase his super-high professional’s take-home income, without falling afoul of the tax man.

This is a clear-cut case of where a professional’s advice can add huge value [AJC: not in asking “is real-estate a good investment for me” but in asking “is real-estate a good tax-advantaged but highly legitimate investment vehicle for me?”], and our doctor should not take another step without seeking such professional advice.

Secondly, he should go through every single expense with his accountant and see what he can reduce or better manage. Nobody can afford to burn $500k worth of dollar bills …

… not even a super-high-income doctor.

Secondly, real-estate (especially when prices are depressed) is just a great long-term investment.

With his $300k (and, hopefully much more once he implements some of his accountant’s tax and cost-management advice) cashflow plus any income that he receives from his tenants, the doctor can afford to leverage quite a large portfolio of such high-quality, long-term, income-producing investments.

And, it is this large portfolio that becomes his growing ‘dam’ of cash, trickling out at perhaps a $100k – $150k sustainable annual spending rate … one that he should be able to index with inflation and maintain for his whole life, whether he (one day, perhaps quite soon) chooses to work full-time, part-time, or not at all.

And, isn’t that the whole (financial) point of it all?

Why are professional athletes so horrible with money?

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In 2009, Sports Illustrated observed:

78% of NFL players and 60% of NBA players are bankrupt within two years of leaving the game.

From this Get Rich Slowly concluded:

Many professional athletes are horrible with money.

Why does this occur?

Investopedia in a recent article stated the obvious:

Athletes have a unique problem that many other professions don’t: the earnings window is small. While the more traditional careers may allow a person to work 30 to 50 years, a professional athlete will work only a fraction of that time. This leaves the retired athlete with the job of managing what they have to last for the rest of their life with only a fraction of their old salary being earned.

Whilst I agree with GRS that many sports players are horrible with money, this is simply an undistributed middle fallacy of the type:

  1. All students carry backpacks.
  2. My grandfather carries a backpack.
  3. Therefore, my grandfather is a student.

In other words, this problem is not isolated to athletes … they are just one class of people who have highly skewed earnings.

Others include anybody with what I call “Found Money”, which is my term for any one-off (or otherwise time-limited) sudden influx of cash. For example:

– Anybody who signs a major contract (athletes, musicians, actors, celebrities, even sales people or small business owners who “land that once in a lifetime deal”)

– Anybody who wins a substantial sum

– Anybody who inherits a substantial sum

… and, so on.

The Horrible Money Management Syndrome, that Get Rich Slowly incorrectly attributes to athletes, actually comes with the sudden influx of money i.e. it’s a problem with the source, not the recipient.

For example, there are lottery winners from all walks of life, yet the operators of the UK Lottery found that, on average, lottery winners had spent 44% of their winnings after just 2.5 years, which supports the anecdotal evidence that 80% will be entirely broke in just 5 years after winning a major lottery!

Whilst some sharp wits may observe that this is “because the qualifications for playing the lottery are being ignorant of the principles of mathematics” [AJC: for example, as one blogger recently observed, you are more likely to die from melting underwear than winning the lottery], my theory is that …

… you need to learn the lessons slowly on the way up, in order to stop yourself learning them the hard way on the way down.

In case any of you are planning to make a lot of money quite suddenly [AJC: even faster than $7 million in 7 years ‘suddenly’], you would be wise to heed the lessons that I taught my children when they were still very young (and, follow to this day):

When they get money [AJC: Any money: an allowance, a gift, find it on the street, etc.] half goes into Spending and the other half into Savings.

So, too, does it go for you: anytime that you get any additional money [insert ‘found money’ methods of choice: you’re a professional athlete; you win the lottery; you get a pay increase; a second job; loose change that you save out of your pockets; a gift; a manufacturer’s cash rebate; tax refund check; etc.; etc.] you Spend half and you Save half.

At least, this is advice that will tide you over until I share my Found Money System with you …

… next time 😉

How to start with next to nothing in cash and build up from there?

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Ken H asks:

I am just starting my journey to the concept of making money when you buy. Can I get more examples of what can be bought to use this concept? Where do I learn a strategy that I can start with next to nothing in cash and build up?

Great question, Ken!

The short answer is that you need a source of cashflow.

The long answer:

A high-paying job is ideal (but, only if you invest 30% to 50% of it after tax) …

… if not a high-paying job, then a second source of income.

I like the idea of starting an online business ‘on the side’ and reinvesting 100% of the profits (a) back into the business to help it grow and, whatever’s left over, (b) in income-producing investments.

The ideal investments, of course, are ones where you can get a silent partner to put up 75% – 90% of the money required. That way you can get more investments quicker.

Also, when the bank puts in 80% of the funds required to fund a real-estate acquisition, and it goes up in price by 20%, you have just doubled your money (less the bank’s interest).

And, the best ‘silent partner’ that I know is The Bank. But, the investments that The Bank likes the most – hence, they will lend by far the most on these – is good old-fashioned real-estate.

So, I would reinvest as much of my savings as possible into real-estate, and then wait 10 to 20 years (unless my business grows really fast, in which case I might wait 5 to 10 years.

Sure beats ‘working for The Man‘ for 40+ years, doesn’t it?

How to become a wealthy doctor?

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We all have this image of doctors. We believe that that they are all-knowing and well … rich.

But, is that really the case? Let’s check out what this young doctor (a new reader), David, has to say:

I am a young physician (early 30s) making approximately 800k per year. After expenses and taxes, I am left with ~300k to save/invest. However, I have been making ~40k for the majority of my working life and am completely overwhelmed as to how to handle this chunk of change (unfortunately I received no financial education in medical school…). Do you have any advice as to how and where I should allocate this money? I am worried about investing too much money in one source and would like to be fairly diversified.

You see, right here is where doctors go wrong!

Firstly, $120k – $250k net spending money p.a. [AJC: my estimate, depending on how the taxes and other expenses work out] is, indeed, quite a large “chunk of change” …

… especially when jumping from $40k starting salary.

So, the first mistake that most people in this situation make is to immediately increase their standard of living. Now, a conservative person won’t increase their living standard to $120k less 10% (because that’s what the books tell you that you should ‘pay yourself first’), but the chances are that they will raise their living standard quite dramatically.

The $40k quickly becomes $60k as they equip themselves with a new car and some extra furniture and a larger TV or two … then $85k as they move into a bigger apartment (with a view) … then $120k as they step into a more committed relationship and buy the house, school the kids, and so on.

In other words, the treadmill has a way of increasing its speed until you forget that you are supposed to be ‘rich’.

You see, David’s sudden increase in income comes under the heading of ‘found money’; I’ll post on it soon …

… actually, read it in reverse order (i.e. read the second article first).
Then, you can tell me what you think David should do?

 

Life’s tough at $250k a year …

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I was chatting to a friend last night and was amazed at his reaction to what I had to say.

The conversation went something like this:

Me: Did you see that article about the guy who can’t live on $350k a year?

Him: What guy?

Me: Oh, some guy written up in the Wall Street Journal the other day.

Him: I didn’t see the article. What about him?

Me: He’s a lawyer or law professor or something who earns $350k a year and can’t make ends meet.

Him: Yeah, I know people like that. Remember Elton John nearly went broke?

Me: Yeah [laughs]. But, that’s not what I’m talking about. He says he can’t even afford to own a house because he lives in New York … in Queens or Brooklyn or somewhere like that … and between his taxes … I think he pays nearly half in taxes … and his rent, he is really struggling.

Him: Poor him [laughs]

Me: [laughs]. Yeah I guess it seems funny. But, I actually know where he’s coming from. I own my house and my cars outright. OK, I have two kids in private school, so that’s expensive. But, we struggle to stick to our $250k a year spending budget.

Now, here’s the weird part: my friend didn’t seem surprised at all …

… like NOT being able to live on $250k a year (before taxes) when you have NO mortgage, NO car payments – in fact, NO debt at all – is nothing unusual.

I made $7 million in 7 years so, for me, spending ‘only’ $250k a year is probably being frugal.

What’s his excuse?

And, how much annual expenditure are you banking on your Number being able to produce?

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?