The Great Debt Repayment Fallacy … don't fall for it!

Posted on May 5, 2008 by Adrian

Everybody knows about ‘good debt’ and ‘bad debt’, right? And, we all know – and have committed to memory – Personal Finance Prime Directive # 1:

Eliminate All Bad Debt Now … Before Doing Anything Else!!!

This may be the current Personal Finance mantra, but, if you happen to subscribe to the same view, then read on because this post could be the most important piece of wealth-building advice that you will ever read!

But, first …

That simple and clear ‘PF Directive’ was the assumed premise behind a recent (and very good, I might add) post on The Simple Dollar that I want to delve into a little more deeply than usual because it brings out a critical wealth-building point that may not be obvious to all. In that post Trent said:

A reader wrote in recently:

I have kind of a weird situation with our 2 credit cards, and wanted to see what you thought. We have one card (Citi) with a total balance of $4,800. $3,800 of this is a balance transfer that is at 2.99% until paid off. The remaining $1,000 is at 13.49%. Of course, all principal payments are applied to the lower rate debt first. Our other card (Chase) has a balance of $5,700, and is at 0% until September 08, when it goes to 8.99%. Which card do you think is best to “attack” first?

After reading this email, I thought it would be a good time to take a more general look at comparing the debts you owe as well as how to construct a healthy debt repayment plan.

Trent then proceeded to outline a very good and pragmatic approach to dealing with these, and any other, debts … a plan that involved:

A few sheets of paper and a pen; the latest statement for every single debt; making the first list; ordering all of the debts by their current interest rate; looking for ways to reduce the rates, focusing most strongly on the highest current one; when you’ve reduced rates, making a new list reflecting the changes; dealing debts that are set to adjust in the future; directing all of your extra payments towards the top debt on the list; when a debt vanishes, crossing it off and feeling good about it; updating the list when you acquire a new debt; and, updating the list when one of your debts adjusts to a new rate

Before I weigh in on this, let me ask you a Very Important Question:

Do you really just want to be debt free or do you want to be rich?

I know that sounds self-evident, but stick with me … if you just want to be in the top 5% of the US population and retire on $1,000,000 in, say, 15 years then by all means, do the Dave Ramsey, Suze Orman, and/or Oprah ‘debt diets’:

That is, save and be debt free (including your own home) … whoohee! … by the time you ‘retire’ [read: work part-time in Costco handing out free food-samples until you’re 75], you’ll be living on the equivalent of $15,000 today and hoping to hell that the government can still afford to pay you social security!

It’s OK if you slavishly follow this thinking: it’s the Conventional Wisdom …

It’s just that if you want … nay, need … to be rich(er) and retire soon(er) then you’re going to need unconventionally large amounts of money in an unconventionally rapid timespan, and that’s going to take some Unconventional Wisdom!

You see, I believe that being debt free and being rich are [almost] mutually-exclusive!

This is a pretty controversial view, I should think … but, I will even go so far as to say that it is [almost] impossible to become rich without using debt: debt to fund your business (working capital finance and/or leases on equipment and/or leases on vehicles, etc.); debt to fund your real-estate investments (fixed interest mortgages and/or interest-only funding); debt to fund your stock purchases (margin lending); etc.

Hold on, all the Personal Finance writers/bloggers out there say:

We can put all of the above examples in the ‘good debt’ category and we already agree that they are OK …

Great!

But, then they always add:

… but, ‘bad debt’ is ‘consumer debt’ (credit cards, student loans, car loans, etc.) and we all know that our Number One Personal Finance Objective is to wipe Bad Debt out, right? After all, it’s not called ‘Bad’ for nothing! Right??!!

Well, not necessarily … sure you shouldn’t get yourself INTO any of this Bad Debt … but, once you have some (you naughty, failed human being, you), you need to mix it with your Good Debt and revisit Trent’s Plan with ALL of your debts in hand … both ‘Good’ and ‘Bad’.

Look at it this way, once you find yourself with a mix of both Good (appreciating and/or income-producing assets) and Bad (depreciating, consumer goods) Debts, the only things that matter are:

1. Paying off the Dollar Value of the Bad Debt as quickly as possible, and

[AJC: Here is the key … its in the “AND“]

2. Paying off the highest after-tax interest rate loan off first.

So here was my advice to the person who asked the question on Trent’s post:

Interestingly, in the reader’s case (if I read correctly) his ‘consolidated’ card is at a Combined Effective Rate of only 5.2% … because he can’t attack the 13% portion until he pays off the 2.99% portion I would do the following:

1. Pay off the other card first, then

2. Buy an investment using the money that he would have paid the 5.2% debt off with …

… after all 5.2% is a very low rate of interest!

To clarify: I would not pay either card when interest rates are under the standard variable mortgage rate … I would be financing new real-estate, or paying down the mortgage on my existing (IF I’m not breaking the 20% Rule). The plan I outlined above starts when the 0% period ends … until then, pay off NEITHER card IF you have a more productive use for the money!

What does this mean for the rest of us?

i) Don’t get INTO Bad/Consumer Debt … save and pay cash for any ‘stuff’ (cars, vacations, furniture, ipods, computers, etc.) that you want.

ii) Once you do get INTO Bad/Consumer Debt … don’t be in such a hurry to get out of it; compare the cost of your Student Loans; Ultra-Low-Honeymood-Rate credit-cards; Super-Low-Suck-You-Into-Buying-More-Car-Than-You-Can-Afford Interest Rate car loans; etc. against the after-tax cost of the mortgage that you have on your house and/or investment properties (or the interest rate on your Margin Loans for your Stocks; or your Working Capital Finance for your Business; etc.).

iii) Work out a repayment plan as though you were going to pay INTO that Bad/Consumer Debt … instead, pay an equivalent amount off against your highest after-tax interest rate loan across your entire Good/Bad Debt portfolio.

iv) Reevaluate at the earlier of Quarterly (i.e. every 3 months) OR when one of the interest rates on ANY of your loans changes OR [yay!] when you have paid one of your loans off.

v) If you don’t want to (or can’t) get out of a higher-interest loan early using (iii) then compare the cost of the lowest-interest loans that you have (regardless of whether they are Good/Bad) against the current FIXED interest rates for new loan on a new investment … if LESS, buy new instead of pay off old.

Remember: The Object of Personal Finance is to end up with MORE money … the object isn’t to SAVE money, PAY off debt, BUY a house, START a business … they are all just all steps along the way.

If you want to get Rich(er) Soon(er) never, ever confuse A Means To An End with The End …

… now, let the flames begin!

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Last days for ‘pre-applications’ to become one of my 7 Millionaires … In Training! Click here to find out more …

Put your money into CD's? Not exactly what we meant!

Posted on May 4, 2008 by Adrian

Last days for ‘pre-applications’ to become one of my 7 millionaires … In Training! Click here to find out more …

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Here’s another in my Money-Video-On-Sundays Series …

This clip from the popular comedy, The Office, is sad but true … how many students are also ‘investing’ their money into CD’s the way that this guy does, rather than saving and paying down debt?

http://www.nbc.com/The_Office/video/#mea=169237

AJC.

PS Take a look at the latest Money Hacks Carnival here ….

The 6% Realtor Solution

Posted on May 3, 2008 by Adrian

Last days for ‘pre-applications’ to become one of my 7 millionaires … In Training! Click here to find out more …

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To get a Realtor or not to get a Realtor, that is the 6% question …

Joshua asked a question about a recent post:

I’m planning on buying a condo soon … fixing it up a bit and renting it out … but how would someone “educate themselves daily on the market”? I keep an eye on the 30 FMR and am impressed with rates right now but I’m wondering if there’s more to this education.

If you’ve been following this blog, you’ll probably also be thinking that now might be a great time to be buying some real-estate: a house, a rental house/condo, duplex/triplex/quadraplex, retail/commercial, office or industrial … the choices abound!

No matter what you are thinking of buying, once you have done some of your own homework and narrowed down (a) the type of real-estate you want, (b) the price range that you are interested in, and (c) the area/s that you are looking at …

… then find a Realtor who will send you ‘comps’ (i.e. comparable sales) on similar sales in the area from the Multiple Listing Service (MLS).

Also, ask the Realtor for information that will help you find how the market has changed over the past couple of years … do the same with rental ‘comps’.

Also, physically look at a number of similar properties in the area/s that you are interested in before choosing one.

Of course, you can get some (most) of this information from public (many free) databases … just Google ‘MLS’ for listings of properties of the type that you are interested in, and sites like rent.com for rental rates on apartments and houses. Sites like realtytrac and loopnet are great for commercial.

But, there are some big advantages of using a Realtor:

1. Qualification – these guys are trained (more so than a ‘standard’ real-estate agent … the ‘Realtor’ designation actually means something!) and if they have worked in the market for a while, they will know what you are looking for before you do.

2. The MLS listings that they can get you are far more detailed than the publicly available ones.

3. If they own and invest in the same types of properties in the same areas that you are interested in, they can be a great resource (AJC: this should be the first question that you ask … only deal with an Investor/Realtor who already invests in the same type of real-estate that you want to be investing in, and in the same or similar area/s).

4. They will represent you in the purchase and the other guy (i.e. the one selling the property) pays their fee – they typically split commissions with the selling agent.

So, the seller’s 6% commission pays you for a ‘free’ buyer’s agent … just choose the right one … OK?

The most dangerous idea in retirement planning that I have ever read!

Posted on May 2, 2008 by Adrian

Double Dose of 7million7years! Please check out my FIRST EVER Guest Post … it’s at BripBlap, a blog that should be on your DAILY READING list: http://www.bripblap.com/2008/guest-post-education-a-curse-or-a-cushion/

In a few weeks, I was planning an ‘expose’ of a book that I read , but just came across a related post by an innovative thinker who calls himself Gryffindor (presumably, named after one of the Hogwarts Houses in Harry Potter) so I can’t resist but to weigh in now …

And, I’m going in boots and all!

First, here is what Gryffindor had to say – which I actually like because it is innovative and a little controversial:

So if an investor has 2 million at the age of 55, what does the conventional wisdom say? He could invest it and with a safe withdrawal rate of 4% count on $80,000 a year. 2 million of savings – with that all you get is a 80k a year. No wonder most people are depressed about retirement.

Now what if the investor takes a million of his nest egg and buys [a] business? She gets $200k of cash flow a year that is growing at 3% to match inflation. She can also reinvest the additional earnings from the other $1 million. She also gets some additional tax benefits of owning the business and can have some productive part-time hobby / business and not just spend her time on the golf course. It sounds all good to me.

And, here is part of my response that I posted on his blog post:

This is such an important topic that I am going to post a response on my blog [which you are now reading!] … I would really like to set up some debate on this because it is a very useful – but, potentially highly dangerous – retirement strategy that really needs to be well thought through before anybody implements.

Rightly or wrongly, some people just see me as a guy who ‘got lucky lucky in business’ (AJC: most of my $7m7y Net Worth actually came from investments … my leter/additional Net Worth came from selling some businesses), so it might seem natural when I say that Gyffindor actually appears to be onto something that is one of the central ideas in a recent book called Get Rich, Stay Rich, Pass It On.

The principle is that rich people keep their money for generations ONLY if they split their assets roughly one-third in a business, one-third in paper (stocks, bonds, mutual funds, etc.) and one-third in real-estate (incl. their own home):

Then, you might be surprised when I say that this is “the most dangerous idea in retirement planning that I have read”!?

What the book is recommending, that I find so damn dangerous for retirees, is this:

The authors of Get Rich, Stay Rich, Pass It On suggest that you need to invest, and keep invested forever, 25% – 35% of your Total Household Assets into ‘continually innovative enterprise/s’:

What we mean here by a continually innovative enterprise is one that either offers a product or service that breaks new ground or changes a traditional product or service so much that it becomes virtually new.

Now, that is something that you do before you retire so that you can retire rich … you take risks, you innovate, then you sit back and reap the profits (or sell) …

… it is not something that you get into in order to preserve wealth, which is exactly what the authors suggest:

At the lowest level of personal involvement, you might invest in a limited partnership, private equity plan, or venture capital program in which the actual management of the enterprise – possibly even the choice of the enterprise to invest in – is beyond your reach and outside your control.

Put simply: this recommendation is crazy …

… in my opinion, it unfortunately totally discredits an otherwise fine book written by authors who are respected consultants who assess the wealth habits of America’s mega-rich for the financial planing industry.

to me it seems that they are confusing the Making Money 201 wealth-building practices that rely partially on risk-taking strategies that may include a business – or, at least look a lot like a business (e.g. rehabbing/flipping real-estate; trading stocks/options etc.) …

… with the Making Money 301 wealth-preserving (i.e. retirement) practices that move you away from risk towards passive income!

So, is there a place for owning a business in a wealth-preservation strategy?

Absolutely!

I think that I speak with some authority on this: I have owned, operated, and successfully sold a number of businesses across a number of countries, many of which I owned at the same time!

I was an active owner in some and am still a passive owner in others …

Now that I am retired before 50, I am giving one part of a business away to my partner, converting another part into a ‘licence annuity’ that I will keep, and I am also keeping one other operating business as a semi-passive entity.

This last one is interesting, as it appears to support the thesis in Gryffindor’s post and the book that I mentioned:

This business is still in another country … it’s a finance company that turns over $40,000,000 per year with a only staff of 4 and nets me a cool $250k per year with about an hour’s work a month from me … I control it (through various legal entities) 100%!

Even so, here is the fundamental truth:

There’s no such thing as a PASSIVE business – as long as you own a business, you:

1. Will lose sleep every so often until it is sold or closes down, and

2. You will NEVER be truly retired.

As long as you can accept this level of semi-retirement worry and activity (which may actually HELP to keep you young!) then the Gyffindor Strategy could work for you, BUT:

i) I could accept owning in retirement: Big Name Franchises; Self-storage facilities; Mobile-home parks; Car-Washes; Your own well-established business that you are now ‘winding back on’.

ii) I would be a lot more concerned about: auto-repair and other skill-based businesses OR ‘vanity businesses’ – you know, the types that celebrities like to own (e.g. restaurants, bars, etc.).

iii) You would need to set out to have the business/es that you select run without you from the very beginning.

If you like the idea of owning a business in ‘retirement’, here’s a hint:

This strategy could hold a lot more attraction for you if you can also own the real-estate that the business operates from!

Why?

A. It assures the rental stream,

B. It assures at least some capital growth,

C. It hedges your bets against business failure (particularly if you plow excess cash generated by the business into the mortgage),

D. It provides a partial exit stream i.e. sell or give the business to management or a buyer under the condition of a long-favorable lease with upward-only ratchet clauses (rents increase at least with inflation).

A final thought:

I mentioned that I will continue to own at least one business now that I am fully retired:

– I founded this business and have owned it since 1991 … it has successfully run without my direct involvement for more than 5 years.

– I tried to sell it anyway, but it was only worth 3 times annual Net Profit before Tax … for that I will keep it for three years and take my chances!

– If I do happen to find a buyer who will pay me 5 or 6 times annual Net Profit before Tax, I will sell it.

– I do not count this business’s income towards my retirement portfolio’s ‘safe withdrawal rate’ because anything can happen with a business at any time … rather, I use the profit to build my portfolio’s total value, and spend the passive income from that.

If I do eventually sell it, THEN I will increase my portfolio’s withdrawal rate because I will have converted the business into a passive investment (cash, stocks, or real-estate).

Phew! This is one of my longest posts … so, now it’s your turn to comment!

Who is the Devil's Advocate's "devil's advocate"?

Posted on May 1, 2008 by Adrian

Have you noticed whenever you have an idea that goes against the mainstream (as most of my good ideas seem to) that people always pop up to rain on your [idea] parade?

They often justify their negativity under the guise of that old cop out: “oh, I’m just playing the Devil’s Advocate” … meaning that you get to listen to their endless diatribe. If you’re unlucky, they just may succeed in having you ‘come to your senses’ [a.k.a. miss yet another opportunity].

My response usually is: “In that case, I’m the Devil’s Advocate’s Devil’s Advocate! ;)”

… which means, this time I get to explain why their [contra]-ideas are dumb, and they get to sit there and listen!

I particularly like to play Devil’s Advocate’s Devil’s Advocate with the typical Personal Finance mantras as published in so many PF books and blogs – and, we have already covered a few, with a whole lot more to come – because so many of them are so self-limiting.

I go the idea for this post from a PF blog that I like, Bargaineering, who has a whole section called Devil’s Advocate … I have reprinted a section from his latest roundup, and have included the links in case you want to review the actual articles [AJC: I haven’t had time to review them all, yet]:

I have a few good ideas in store for future articles but I wanted to do a little roundup, in part for myself to see all the topics we’ve covered, so that you could join in the rock throwing against mainstream ideas.

Don’t Invest in the Stock Market

Cancel Unused Credit Cards

It’s Okay To Ignore Your Problems

Ignore Personal Finance Experts

Don’t Have Kids

Buy More House Than You Need

Don’t Move From Job To Job

Get A Store-Branded Credit Card

You Don’t Need College to Succeed

Four Reasons You Should Get A PayDay Loan

Don’t Get Married

Buy That Home Warranty

Adjustable Rate Mortgages Are Awesome!

Pay Cash for Everything

Don’t Budget to the Penny

Invest In Your Company

Say No To Credit Card 0% Balance Transfer Arbitrage

Why Roth IRAs Are Bad

Lease A Car, Don’t Buy It

Don’t Just Buy Index Funds

Don’t Optimize Payroll Deductions

Rent Forever, Don’t Buy A Home

My view?

Great ideas – in fact, I made a fortune by FOLLOWING ideas # 4, 6, 13, 15, 16, 18, 20, 21.

Here’s how I look at it:

Follow conventional thinking and you’ll get conventional results.

Follow Unconventional Wisdom, and you just MIGHT get rich, too (but, don’t be stupid about it, because you will probably remain poor) … but, you need to throw in some ’special sauce’ as well [AJC: that’s what this blog is for].

Nothing wrong with following good advice … nothing wrong with ignoring it, either … I’ve made money both ways – just be sure you know WHY you are following/ignoring it!

Here are the Top 4 Personal Finance Myth’s that I will be doing my very best to destroy over the coming weeks:

1. ‘Bad Debt’ is to be avoided at all costs!

2. Your house is NOT an asset or Your house IS an asset!

3. Max. your 401.k and other Retirement Accounts

4. You can [and, must!] save your way to wealth

5. The Magic Number is $1 Million

… a whole plethora of ideas for us to explore!

But, first a word of caution:

If your target is just an amount like $1 Million to $2 Million in 15 – 30 years, then you do NOT need to read any further – this blog is NOT for you and you will get far more benefit for your time invested by reading here, here, and here, or probably ANY of the places listed here instead.

However, if you are going to join me on this exploration of Anarchic Personal Finance Ideas – and be the Devil’s Advocate’s Devil’s Advocate – then let me know which DUMB 😉 ideas that worked for you, so far …

Some financial advice for the blogging community …

Posted on April 30, 2008 by Adrian

Click Here

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OK, I am a relatively new blogger … I obviously don’t do it for the money [AJC: no advertising, affiliate links, or product sales here!], but many do … or aspire to.

And, as Alex recently commented on this post, there’s nothing wrong with blogging for money:

If people like Guy Kawasaki, Dilbert’s author, and other wealthy people all put ads on their site to make money, then there’s no reason why we should not. John Chow is making $30,000 month off his main blog so there is always an opportunity to make money through your blog.

It is these Mega-Bloggers who are paving the way to [apparent] riches for the rest of the blogging community …

… but, as far back as 2006 there were already 50,000,000 blogs [holy sh*t!], growing by a mere 17,500 new blogs a day!

So, how is Joe Average Blogger actually doing? Check out this chart:

Source: Problogger

Problogger does a regular survey of their readers to see what they earn; now, this isn’t a scientific survey by any means but it does seem to give a useful indication of Blogging Earning Potential.

For example, 28% of respondents don’t earn ANY money from their blogs with another 18% earning only a pittance!

Problogger says:

A quarter of those who earn something make less than 0.33 cents per day. If that’s not a reality check then I don’t know what is.

Of course, we will categorize these bloggers not as losers, but as new bloggers who are steadily winding their way up to the giddy heights of those who earn $100 – $499 per month … and, maybe even beyond 😉

Even so, this doesn’t mean that blogging is a futile exercise in self-indulgence … right?!

Of course not … it just means that you need to seriously assess exactly why you want to be in blogging:

1. Is it for strictly non-financial reasons?

ReadWriteWeb said in a recent post:

There are many different motivations for blogging and some do not involve money. Some people have a cause they are passionate about – they want to help change the world and a blog is a marvellous way to get attention for that cause. Others don’t even want to change the world or get noticed, they are just passionate about something and enjoy writing about it – attention is a by-product.

These bloggers may have Adsense ads and Amazon affiliate links. Who wants to turn away “no effort” money, however small? Just don’t judge them by their revenue, it is a by-product

2. Is it mainly for financial reasons?

I have some advice for those bloggers who do have at least some serious financial motivation:

Blogging – if pursued mainly for its potential monetary rewards – is a business, and a pretty competitive and limited one, from a strictly financial standpoint, at that.

Like any other business, it takes: commitment, planning, execution …. and, more than a little luck!

The very few guys who do make it Blogging Big (if you call $150k – $250k p.a. earned income ‘big’) probably started early in the game, and put serious effort into growing their business.

This COULD be you … but, here is my suggestion, just in case the odds don’t favor you:

i) Blog because you want to – look at the monetary reward as a bonus

ii) Blog as a form of networking – use it to build an audience for a future product or venture (e.g. a book)

iii) Blog to build content – ‘package’ your posts into an e-book or information product that you can sell

iv) Blog to provide a little extra fuel for your investment strategy – even if you are earning just a few extra dollars a week, doing something that you enjoy, put at least 50% towards your investment strategy and compounding will take care of the rest.

v) Blog because you want to combine all of these strategies … that’s the best way to get benefit from such a usually low-dollar-per-hour-invested activity.

To me, blogging is probably a bad ‘business’ in strict return-on-time-invested terms – I would never pursue it as a business; so many other activities have the potential to return much more and scale much better … and, who the hell are you going to sell it to, anyway?

But, the ‘financial’ value of blogging (if that is the path that you are pursuing) is that you may be able you use it to eventually drive higher-dollar-per-hour outputs, elsewhere.

For the guys pursuing the blogging-to-earn-money angle, that makes blogging a great marketing tool, pure and simple!

A great example is Jason, who also left a comment on that same post:

I am using my blog to make money, but not in the way you may think. I am using it to establish the fact that I am an expert in specific areas….then when I talk to my investors I can show them the articles I wrote and how it all works. Basically to give credibility.

Next I also use the blog to sometimes promote my computer company. I have not received any sales. but it is a hope … the main thing I use it for is motivation, so that I keep going on my path to being wealthy.

So, what about me?

I may accept advertising on my blog one day … I may also write a book … but, like blogging, that is a relatively low-expected-value activity.

In the meantime, I will keep blogging simply because I enjoy sharing what I have learned in the Financial School of Hard Knocks … I have important information stored up inside me that is simply better out than in!

What about you?

Business for sale?

Posted on April 28, 2008 by Adrian

As you know, I’m a member of Networth IQ – and quite an active member, at that! I love reading and answering questions …

[AJC: you’ve probably already seen that from the detailed responses that I try and give commenters on my posts on this blog … try me, if you have a question … I just won’t give direct personal advice, because I am not a qualified professional, but I will give general advice if I think it will benefit all of our readers]

… and this unique site provides a great platform (as does Tickerhound, which provides a great Q&A forum on everything from stocks to real-estate).

For those of you who aren’t members of Networth IQ, here is an exerpt of a great question:

I found a business for sale that has generated the following free cash flows since 1998.

1998 – $3,426.0 Mil
1999 – $3,949.0 Mil
2000 – $4,917.0 Mil
2001 – $7,133.0 Mil
2002 – $6,077.0 Mil
2003 – $8,333.0 Mil
2004 – $8,956.0 Mil
2005 – $9,245.0 Mil
2006 – $11,582.0 Mil
2007 – $12,307.0 Mil

The current owners are asking $183.49 Bil, …. I don’t have $183.49 Bil, but they said that they would sell me a smaller portion of the business if I wanted … Should I buy?

I like this question on two levels:

1. It’s a neat reminder that when we buy stocks, we’re not just buying ‘bits of paper’ … we’re buying a small piece of a real, live business!

And,

2. It gives me an opportunity to show you the sorts of questions that I would ask – and the types of information that I would be looking at before buying into this – or any – business.

According to Warren Buffet (or sources who purport to know how he works) the intrinsic value of a business is in its discounted cashflow.

That is, a business is – or should be – a cash machine … what’s the reason for owning it, if not to get some cash out?

So, in the above example, we should be able to decide if the business is worth $183.49 Billion (not knowing the company in the above excerpt, I am assuming that this number represents the entire current market capitalization of the business) by discounting the cash-flows shown above …

… a quick look at the most recent cash-flow figure shows that it is currently producing $12 Bill. cash per year (probably growing, if history is any guide); that would mean about 15 years to get our money back … yuk.

Now you know why the stock market is generally a fool’s game … I would by far prefer to invest in my own business, or buy a private one at ‘only’ 3 to 5 years free cash-flow (better yet, Net Income), and grow it … then float it myself!

Or, at least sell it to a public company who can immediately ‘claim’ 15 times my Net Profit (hence, give me 7 to 12 times my Net Profit).

But, if we are going to play ‘the stock market’ game, what would we need to know before we can make an informed decision about ‘investing’ in this stock?

Hmmm …

As I pointed out, the free cash-flows on their own say nothing …

For example, I recently sold two similar businesses: one had been going for many years and generated ‘free cash flows’ [now that’s an oxymoron!] of $1 mill. and the other was less than 2 years old and had yet to make a dime.

Yet, I sold them both (separately) for about the same price! So, there must be more to the valuation of a business than Free Cash-flows, right? Absolutely!Let’s start with Return on Invested Capital:

I’d like to know what it has been for this company (and, the industry) over the past 5 years? I’d like to see an improving trend in excess of 15%, please.

Then, is the company growing?

Cash Flow is just one measure (but, what about operating cash-flow … have they made any strategic purchases / major capital expenditures /etc.), so what about the 10 years trends in: Earnings? Book Value? And, what about plain, old Sales?

I’d like to see a history of growth (min. 10%) in all of these …Now, how is there debt situation?

How long will it take them to cover their long-term liabilities from ‘Free Cash Flow’?

I’d like to see no more than 2 to 3 years.

Do the people who run the company own stock? Are they buying or selling?

Tell me about the company: do they have a ‘sustainable competitive advantage’ (what Warren Buffet calls a ‘Moat’ … but, that’s too much water for me!).

Do I believe this company will be around for the next 100 years … do I really want to buy THIS business in THIS industry?

Lastly, if I like the answers to all of the above (unlikely … so far I’ve only liked the answers to similar questions for 7 companies out of the 5,000+ that I can currently buy a ‘piece’ of) …

…. then how CHEAP can I get this thing!?

PS I made the ‘other’ category … waaaayyyyyy down at the bottom of the 150th Carnival of Personal Finance … whoo hoo!

Thinking of buying something on credit?

Posted on April 27, 2008 by Adrian

‘Need’ a plasma TV? Perhaps you ‘just’ need a new car?

There’s ALWAYS a way to find the money that you need WITHOUT putting yourself further in debt … just ask Mr Bean :

http://youtube.com/watch?v=42AHISKy2Kk

Mr Bean (a.k.a. Rowan Atkinson … played the priest in 4 Weddings and a Funeral) is not as well known in the US as he is overseas … he’s one of my favorite comedians and comedic actors.

Anyhow, I hope that you enjoyed this short clip for today’s installment of our Video on Sunday’s series as much as I did?!

AJC.

My $7 Million Dollar Journey …

Posted on April 25, 2008 by Adrian

I am a little shy, which is one of the reasons why I write semi-anonymously. It’s also so that I can share specific (and, highly personal) financial information, so that you can travel a similar road, if you are so inclined …

But, some of you want to know where I came from? How is it that I could amass such a large amount ($7 million) in such a short time (7 years)?

Fair questions.

So it is for YOU that I humbly outline my $7million7year journey …

… I count my 7 years as starting in 1998:

By then I had resurrected a defunct family business as a sole proprietorship (I was $30k in debt and living off $50k a year) and started a new one that had real potential but was draining all the cash from the first business (and then some … combined the businesses were losing about $5k a month).

We owned our own home (well, the bank owned most of it) but had zero other investments.

I was what you would call “broke … with prospects”.

1998

Since I had no idea how to fix the situation, I did what any self-respecting person would do: I lucked upon a book!

The book was called The E-Myth Revisited by Michael Gerber and I bought it to help me get out of the hole that I was in …

… not, the financial hole – I had NO idea that the book (or any book!) could help me with that – rather the personal hole (more like hell) that I was going through working in my businesses rather than on them.

[AJC: This will be the subject for another post, but I was the classic control-freak entrepreneur (I sure as hell didn’t feel like an ‘entreprenuer’ … I was just a guy seemingly out of his depth) trying to do EVERYTHING myself … therefore, achieving NOTHING]

No, the epiphany came when I did the very first exercise in that book (and, that’s why I suggest that EVERYBODY reads it … just for that chapter) and learned the most important lesson of my financial life:

My life wasn’t about my business (or my money) … my business was there to support my life.

You have NO idea how important that was to read … and, how scary it was when the book then went on to show me how to cost that life.

You see, I realized that for the life that I wanted … actually, needed … I had to be ‘wealthy’ [AJC: damn, why couldn’t I just ‘need’ to live on a kibbutz?!].

The problem was, I had no idea how to calculate wealthy.

Fortunately, soon after I happened to go to my first ever financial seminar, and the presenter told me two things (that I simply took on face value at the time) that changed my whole life’s financial outlook:

1. To live ‘wealthy’ (nice house, cars, schools, lots of travel … no work) you need at least $250,000 a year (1998 dollars) in passive income, and

2. You need to multily that number by 20 to determine the size of your nest egg.

There you have it … $5 million … my new (first!) goal … oh sh*t!

First, the problems:

i) My businesses were small / niche businesses with limited growth potential; I calculated that I would need almost 100% penetration of the largest business prospects available in order to achieve my new goal

ii) I had just LOST my second largest client, so now I was losing $300k a year!

iii) Year 2000 was approaching and my software was no longer supported nor was it Y2K compliant.

2000

I got over the last problem by rewriting my software, which gave me the opportunity to fully internet-enable it … this enabled me to totally change by business model, and we (accidentally) ended up with one of the world’s first complete eLogistics systems.

All of a sudden, the business that was losing money MADE money and we added new clients (thus getting over the second-last problem) and soon became profitable.

2001

However, as soon as we became profitable, I bought a building for over $1.25 million, on the advice of my accountant of all people … this was very scary because:

Business 1 + Business 2 + Building 1 = break-even again!

However, the businesses (now, both) started growing and soon became reasonably profitable … $10k – $20k a month by 2002 … I still only took $50k a year in salary.

Our Net Worth was now the equity we had built up in our home and office property, plus whatever residual value our businesses had; probably $1 mill. to $2 mill. In fact, an overseas listed company made us a $2 million offer for Business 2, but we rejected it (at that time) … so, our Net Worth could have been as high as $3 Million if we sold, or if somebody else would ever offer us the same.

When it comes to businesses, do you ever know your true Net Worth until you sell?

2003

We made it all the way to $7 million over the period of 2003 to 2005 simply by:

1. Repeating the process: generating profits in the business, and

2. Retaining as much of the businesses’ profits as required to maintain the businesses and grow, and

3. Ploughing as much as possible into real-estate, and

4. Keeping a lid on personal spending and maintaining zero-personal (i.e. consumer) debt other than the house [AJC: which, as I mentioned before, we eventually paid off … not that I would recommend this strategy any more … see an upcoming post for more on this].

But, we did pump as much as we could back into the business and bought a number of smaller, residential investment properties (one condo @ bought 2003 for $145k now worth about $300k, one quadruplex bought 2005 for $1 million now worth $1.75 million, and paid off our own home eventually sold for $800k, plus the office building recently sold for $2.5 million).

If you think about it, these are the EXACT SAME STEPS that every PF blogger writes about (debt free, save, reinvest) … I just multiplied the scale and was VERY CLEAR on my cashout $ and time.

But what about my opening comment:

I deliberately chose a provocative title for my blog … whilst partially true, I chose it … well … because it sounded good!

Why only “partially true”?

Well, I did make it to $7 million in the seven years between 1998 and 2005 – and, by then, my other assets probably had Net Equity of: Business # 1 ($2 million … $1.5 million in cash + whatever value the business could sell for); Home # 1 ($650k); Office ($1.25 million); Residential investments ($1 million).

So, that period sets the scene for our [more than] $7 million 7 year journey, made the good old fashioned way (grow an income stream or two, live frugally within reason, and invest, invest, invest) … and, provides many of the lessons that I had to learn the hard way, but you no longer need to.

But, ‘partially true’ because my journey has an unexpected (but, pleasantly surprising) postscript …

2006 – 2008

I had totally miscalculated the earning potential of my two existing businesses [AJC: actually, three, by then I had started a small training company with a partner, Business # 3]: post year-2000 reengineering, Business # 2 on its own was now capable of producing (and did) $1,000,000 a year net earnings (2006), almost all reinvested in some unexpected new ‘opportunities’:

You see, way back in 2002 I still didn’t know the potential of the new eLogistics-driven business model, yet I still had a $5 million bird to catch …

… so I had already put in train a parallel set of actions that saw me close a deal in 2004 to open two overseas offices (commencing in 2005) – both as ‘no money down’ joint ventures – unfortunately, there went my profits (yet again):

Business # 1 + Business # 2 + Business # 3 + Business # 4 + Business # 5 + Properties # 1 thru’ 4 = Break-Even again!

I was still only taking a $50k salary … my wife still had to work … don’t I EVER get to spend anything??!!

Finally, I sold something: Business # 2 in 2006 for more than 3 times what I was offered in 2002.

… and, the next 3 years sets the scene for an unbelieveable set of negotiations, opportunities, and manoueverings tied to Business # 4 and Business # 5 (which was the reason why we moved to the USA) selling both after only 2 years of operation, more than doubling our net worth again …

… and, funding properties # 4 ($2 mill … paid cash) and # 5 ($4mill. … churned #4 + paid cash) as well as now being able to fund my retirement at age 49.

I kept Business # 1 as well as Business # 5 (although, I soon plan to ‘gift’ my share in that one to my hard-working partner): they both run well and profitably in another country, with separate staff in separate locations, and without me … Michael Gerber taught me how – and why – to do that, too!

But, this period is not the subject of this blog:

Whilst entertaining – and, it might teach you a trick or two about negotiating (I sure as hell learned something!) and/or running a business ‘hands free’ – it hardly counts as Personal Finance, so I might just save the details of that story for ‘the one-day book’ 🙂

What is the best way to make more money? Payrise? Blogging? Consulting? Investing? Starting a business?

Posted on April 24, 2008 by Adrian

Let me fill you in on a great guest post “by FMF of Free Money Finance, a blog devoted to helping readers grow their net worth” that I recently read on I Will Teach You To Be Rich, a blog by Ramit Seth … FMF said:

I’ve faced a money making question a few times in my life and I’d like to get your thoughts on it. Here’s the question: as we all try to grow our incomes, which is better, doing more of what we’re currently doing or trying something totally new?

Here are some options I had for making money in my spare time:

Focusing on my investments — I had them fairly under control, but I needed to spend some good hours really sorting through my strategy for dealing with some past bad decisions. I knew that getting things straightened out totally would net me a decent return.

Consulting — I had a few people asking me to do some side work for them and help them out in their businesses. The per hour rates were equivalent to what I make at work if you include the benefits from my current job.

Blogging — Back then, no one thought you could make any money blogging. But it was something I could do easily and I thought it had potential.

Starting a new business — Or maybe even buying an existing business. I had a few ideas for this option, but I wasn’t sure of the time commitment (which I thought would likely be high).

Each of these, like my hobby income, had their own list of pros and cons — potential income, time commitment, “hassle factor”, and so on. But before I selected one I had to decide what was my best option — to keep doing more of what I had been doing or whether I should try something new?

As FMF went on to say: Millions of Americans face similar decisions every day.

So, which option/s would you choose? Before, I give you my opinion, let me share some personal history:

I joined one the world’s best companies to work for, straight out of college … I was sure that I would only be there for two years, then I would be able use that employer’s prestigious ‘name’ on my resume to look for an even better-paying job.

Therefore, I never even bothered joining the company’s very generous stock purchase plan (exploring my stupidity will be a great subject for a future post!).

I had a great – even wonderful career, but at Year 6 a light-bulb inexplicably went off in my head: I suddenly wanted to – in fact, simply had to – do something for myself!

The problem was, I didn’t know what that ‘something’ was …

So, it took me another 4 years to finally ‘make the jump’ (exploring my ability to procrastinate will be a great subject for a future post!) – but, what attracted me to FMF’s great guest post was that he seemed to be covering all the same decisions now that I went through then:

– Focus on my investments and/or blog: Given that I didn’t have any investments to speak of then, having spent all of my money chasing a couple of failed long-distance relationships (exploring my ability to make bad life choices will be a great subject for a future post!), and given that blogging didn’t yet exist (although, we had – just – moved past the abacus onto the slide rule stage), that left me with …

– Staying in my job: I was past the point of no return on this …. when that ‘light bulb’ finally does go off in your head, you just realize that there is virtually no amount that you can earn in a job that can make you financially free, unless your expectations are very low and you intend to work for a very long time OR you can fight your way to the very top of the corporate food chain.

– Consulting: So that left me with only a couple of choices … consulting was tempting because that’s essentially what I did for this company that I was working for, and I was pretty good at it. But, I quickly realized that consulting was constrained by time and hourly rate … in other words, I was the product that I was selling, and there was only a limited amount of me to sell. And, I would have to divide that limited amount of time between: (a) doing consulting gigs (b) finding more consulting gigs (c) administering my consulting gigs … only one of which paid!

– Go into business: So, I was left with the entrepreneurial path … the path that ultimately lead me to wealth. Why was this path so attractive? I can sum that up in one word … leverage. There is no other activity that – when it works – can produce so much cash (to fuel your passive investments!) for so little investment – other than in blood, sweat and tears – than your own business. None … period.

And, the good thing about a business is that you can minimize your risks by investing little in the way of time (start part time) and costs (bootstrap!) – if you so choose – or, you can jump in boots and all … the choice is entirely yours!

So, here’s what I recommend to all of those facing the same choices as FMF and I faced …

1. Make a decision that you will (eventually) go into your own business.

2. Prepare by (a) starting/maximizing your ‘pay yourself first’ savings plan (b) paying down bad/consumer debt as quickly as possible (c) building up a 3 – 6 month income savings buffer.

3. Minimize your risks (financial and otherwise) by starting a business on the side (blogging, writing, consulting, online, hobby-turned-into-income, manically trading stocks or options, aggressively rehabbing/flipping real-estate, whatever) … if it ‘works’ great … if not, start another …

4. Put at least 50% of the excess business income (i.e. after reinvestments in anything that will help you quickly grow the business) into your Savings/Investment Plan

5. Wait until either your business income grows enough to support you or your passive income from investments grows enough to support you.

6. Then fire your boss before he fires you! At least, it would be nice to have the option 😉

BTW: By now, I’m sure that you have picked up the fatal flaw in my original plan, back when I was still working for ‘The Man’:

If I did choose to start my own consulting practice then, I could have eventually turned it into a consulting business by hiring other consultants to do the consulting work; hiring marketing staff to do the selling; and, hiring administration staff to do the rest … there have been plenty of mega-consulting-businesses started in exactly this way (exploring my ability to fail to see the obvious will be a great subject for future post …).

… but, I think you get the point?