The true cost of debt …


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Deal or No Deal … YOU DECIDE

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In my post about debt, I said that it is not always correct to simply pay down old debt … in this post, you will see that it’s rarely ever correct.

First, let’s look at Jeff’s comments, which summarize the traditional view that it’s all about interest rate comparisons:

My opinion is to still compare your debt interest to prevailing debt rates (is it cheap money compared to what else is available?), how does inflation affect the rate (cheaper future dollars point again) and can I out perform the debt rates with the investment opportunity that is competing for this money.

Without the tax advantage, I’m more inclined to pay off the debt, i.e. lower tolerance for high debt interest.

I haven’t done any math on it…yet, but my gut feel is that 6% or higher on the debt and I’d be giving serious thought to paying off the loans.

This may be true, Jeff, if all else is equal

… but in the ‘real world’ of investing, you will find that all else is rarely equal!

You see, I don’t look at interest rate and cost anywhere near as much as I look at utility – a concept that I introduced in this post: if I am serious about investing, I am struggling to find a scenario where putting my money INTO reducing leverage (by paying down existing loans) returns more than taking on new ‘good’ debt …

…. or, leaving old ‘bad’ debt in place, as long as it is cheap’ish and, much more importantly, available!

I’m sure that our resident real-estate experts (e.g. Shafer Financial) could point you to 1,000 examples where it is still viable to maintain debt of 8% – 15%+ as long as you could find cash-flow positive real-estate that appreciates at not much more than inflation.

It doesn’t even need to be real-estate, but it does depend on what you are prepared to invest into; e.g. assuming Michael Masterson’s numbers:

  • CD’s return 4%, so I would pay down the 6%+ debt
  • Index Funds return 8%, therefore, I would be inclined to keep the debt if it were very close to 6%; anything above and we would have a more difficult decision
  • Individual Stocks return 15%; I would buy the stocks (and, probably margin borrow into them as well), but that’s just me … Warren Buffett would say ‘never borrow to buy stocks’, so you have a ‘philosophical’ decision to make
  • Real-estate (together with stocks) returns 30%; @ 6% I would keep the loan (for as long as possible!) and buy the real-estate
  • Businesses return 50%+, so I would keep the loan in place (again) and use the ‘repayment money’ to help start up

Besides the obvious tax implications (e.g. CD’s and Index Funds – depending upon whether they are inside or outside a 401k – could become ‘line ball’ with paying off the 6%+ debt (IF it were pretty close to the 6% mark) …

BUT, you have highlighted a more important flaw in my argument: this table only looks at the use of the money; what if I could get a cheaper source of funds by paying down the old debt then acquiring new?

Great argument, in theory, but let’s see how it stacks up in the ‘real world’ … the simple question is: can we refinance or otherwise acquire cheap, new debt (thus allowing us to pay down the expensive, old debt) as Jeff suggests?

Let’s see:

CD’s: I don’t see any easy way to finance except with personal loans, credit cards, a refi or HELOC over our home, so I would say let the debt ride. But, the list above suggests that this would a recipe for losing money, anyway, because of the low returns.

Index Funds: possible to borrow on margin (i.e. finance) through a brokerage account (but, not in your 401k) but only to a max. of approx. 50% so you would still need to come up with the other 50% elsewhere.

Individual Stocks: same as with Index Funds (e.g. I am 100% financed in the US market through a combination of HELOC and margin loans).

Real-Estate: usually able to refinance, so I would agree with you to “compare your debt interest to prevailing debt rates”; other than right now, 6% is extraordinarily low historically … 8% – 10% would be closer to my refinance decision-point.

Small Businesses: very hard to finance except with personal loans and credit cards, so I would say let the debt ride if you were highly enthused and confident of success.

In other words, finance is simply not readily available on most investment choices available to us.

So, the questions that you need to answer – probably in this order, Jeff – are these:

1. Do I want to get rich(er) quick(er)?

2. If so, am I prepared to increase – or, at least maintain – leverage by borrowing for investments?

3. If so, am I prepared to make the mental leap of moving to the concept of ‘pools of debt’ and ‘pools of equity’ by not actually having the debt entirely on the asset that I am acquiring?

And, more importantly:

4. Is new debt available to make the investment/purchase (if so, is it cheaper than my current debt)?

5. Does the investment/asset that I am considering acquiring return more than my current (or new) debt?

If you don’t get past Question 1. then paying down debt is the only Making Money 101 strategy that you need to be concerned with … otherwise, I don’t really see this going half-way 😉

The definition of insanity …

“Insanity: doing the same thing over and over again and expecting different results.”  Albert Einstein

Thankfully, this blog isn’t for everybody … only those who want to get rich(er) quick(er) … I’ve proved that it can be done successfully, and I am conducting a ‘grand experiment’ at one of my other sites to prove that it’s not just luck and that others can do it, too.

But, the vast majority are still in the ‘work for 40 years and hope to have saved enough’ mindset … and they have worries of their own, as this recent Gallup Poll showed:

Of course, recent economic woes are probably ‘skewing’ this a little … but, think about it – most aren’t retiring tomorrow, or even in the next 10 years, so markets will have plenty of time to boom and bust again for them.

No, the problem is more endemic: most people simply don’t think that they will be able to retire happy or comfortably – and certainly not wealthy – despite the ‘formidable’ array of ‘retirement weapons’ at their disposal:

So, if the majority of people are using these tools and the majority of people believe that they won’t work for them …


Surely, at some level, these people know that these tools – as I have been hammering home in this blog for some months now – simply won’t do the job?!

Let’s take a look:

1. 401k’s – High fees; low returns; lousy investment products on offer:

STRIKE 1 – I have never had a 401k and I have no idea what is even in any of my tax-advantaged / retirement accounts.

2. Social Security – An unfunded program; USA in the highest level of debt in history’ what’s the chances of Social Security being around in the same form when YOU retire?:

STRIKE 2 – When my social security statement arrives I chuck it in the trash without reading it, it’s irrelevant, it won’t be around when I retire, and I had this same line of thinking BEFORE I became rich.

3. Home Equity – Please! Where do you intend to live when you retire? By the time you buy and pay changeover costs etc. if you see any spare cash, it may be just about enough to pay off your remaining credit card debt:

STRIKE 3 – I live in my home equity, don’t you?

4. Pension Plan – Do you work for Ford/GM/Chrylser? Any airline? Just about any bank?:

STRIKE 4 [AJC: 4 strikes???!!! I’m an Aussie, what do I know from baseball?] Ditto to the above, in fact, I have never subscribed to an employer-sponsored pension plan, even where I have had the choice.

… need I go on?

The point is, if you know these tools aren’t going to work for you – as the majority of Americans surveyed by Gallup seem to – yet you keep using them – as the majority of Americans do – isn’t that the very definition of ‘insanity’?

Now, that’s a question that I would love to see the Gallup Survey for!?

How to easily quadruple your results!

Too much talk about Numbers, Dates and Compound Growth Rates can make your head spin!

But, Scott makes an interesting observation:

What I learned from this post and using the Annual Effective Rate calculator:

is that if I keep up my focus, work and investing for another 5 years past my 10 year date, I can drop my required compound growth rate by 3%(from 40% down to 37%), however, quadruple my number accomplished from 4 million to 16 million, and i’ll still be in my 40’s.

Incredible what taking a little more time can do for you!

What Scott says is absolutely true, but also consider:

How much does delaying your Date by 1, 3 or 5 years (say) REDUCE your compound growth rate if you KEEP your Number?

Also, what does reducing your compound growth rate do for you in terms of changing the way that you need to think about building up your nest egg?

Does it mean that you no longer need to start a business, or invest in real-estate? Will keeping your money in Index Funds via your 401k do the trick?

So, rethink your Number and Date – but NOT at the expense of your Life’s Purpose

… then, when you do get to your Date, DO allow the momentum of the activities that got you there to carry you on just a little bit further … you could double your Number, just like that!

Don’t believe me? It’s exactly what I did in the two years following my own 7 million 7 year journey 😉

Anatomy of a Commercial RE Investment – Part 2

OK – close your eyes (actually, keep them open so you can keep reading!) and imagine the complexity of analyzing cashflows and proformas for a real-estate deal north of $2.5 million

Daunting, huh?

Well, that may be how OTHERS analyze a deal, but not me … all of my deals are done on the backs of envelopes … well one clean sheet of paper. I have this one right in front of me, in my own scrawly handwriting.

On the strength of it, I have authorized my Realtor to make a written offer, with a $200k ‘earnest money’ deposit on the $2.7 Mill. office/warehouse. Sure, the proformas will come later, but I’ll get him to prepare those for the bank … while I’m at the beach or off skiing someplace!

Here’s what the piece of paper says:

Purchase Costs

$2.7 Million (incl. $100k broker commission)

$5k Building / Environmental inspections

$15k Closing Costs (legals, bank fees, appraisals, etc.)

Of these, the $5k for the inspections is my only financial risk, as I need to undertake these during ‘due diligence’ (we’ll talk about this in a future post if the deal gets that far).


$2.7 Million Purchase Price (incl. broker’s commission)

$ 2 Million to be financed

Note: this is approx. 75% of purchase price to be financed; this is high for commercial which can be as low as 60% being the maximum that the bank will fund.

$700k – so this leaves me 25% of the purchase price, or $700k, to find as a deposit.

Note: I’m sure that the owner’s won’t ‘carry back’ a note on this one, as the whole purpose of the sale is to raise cash to keep their business afloat or growing.

So, that’s the purchase / financing side of the equation, now let’s see if it can make me any money …


$175k – Rent for Tenant 1 @ $8 / sq. foot

Note: the current owners will lease 2/3 of the property for the above fee (probably 5 years, with a 3% yearly increase)

$80k – Rent for Tenant 2 @ $8 / sq. foot (we need to find this smaller tenant)

Note: the property is street front with car park, so we feel is should be easy to find a second tenant in the $6 – $10 / sq. foot price range



Note: the GREAT thing about commercial properties is that most expenses (and in a ‘triple net property, all expenses – unfortunately, this is NOT one of those) are handled by the tenant, leaving me just …

$45k Taxes

$7k Building Insurance

$10k Management Fees

Note: Rental management fees can vary from 4% – 6% of the rent if you don’t want to deal with the tenants yourself; keep in mind that commercial property is very different to residential and you won’t have as many issues dealing directly with commercial tenants – they are responsible for all repairs & maintenance … but, if the roof springs a leak, you’ll be expected to act quick! I will use an agent ( my friend).

$130k – Bank Interest @ 6.5%

Note: this is the ‘biggie’ and I haven’t spoken to any banks, yet; obviously, that’s my next port of call but my Realtor friend tells me that I shouldn’t have any problem getting funding fixed for 7 years (or a 25 year P&I loan with a 7 year balloon) around these rates. Variable can be as low as 4%, but I prefer to ‘fix my costs’.


In the final part [AJC: when I return from my ‘winter break’ on Jan 5], I’ll summarize this all for you and explain why I like the deal so much …

Anatomy of a Commercial RE Investment – Part 1

I just answered a question on commercial real-estate investing and thought that there’s no better way to explain the process than by showing …

… coincidentally, I have been working on a commercial RE deal in the $2.5 mill. price range, so I thought that I should simply share.

Warning: like most deals, this deal could simply fall through at the first hurdle. Let me explain by sharing the story so far:

All good real-estate transactions, in my opinion, start with finding a good broker who is working for you.

As it happens, I have a close friend who is a commercial real-estate broker who meets the ‘trifecta’ that I mentioned in that last post: (a) I like/trust him, (b) he works with commercial RE in the area/s that I am interested in, and (c) he invests heavily in commercial RE himself (buy/hold).

I have been pestering him for the last 4 years to find me a deal … interestingly, and this is something that you should take mental note of, he says that he is asked by most people he meets to ‘find them a deal’ but almost none ‘pull the trigger’ …

… so, forgive your broker if they don’t fall all over themselves with excitement until you actually close on your first deal with them 😉

Anyhow, finally a deal came up that seemed to fit my criteria. I didn’t even request financials at that stage or see the property: on the strength of my friend’s recommendation (it was a deal he wanted, but the $700k deposit was a bit too steep for him) I authorized him to put in a written offer.

I don’t recommend that you do this, you will pick up where this post leaves off …

Anyhow, the current owners occupy the premises (they were planning a sale/leaseback i.e. they sell the property to me, then lease 2/3 of it from me on a 5 year lease) and decided to first see if they could simply refinance their loan and take some cash out.

Naturally, in the current market this has proved difficult, so they have put the property back on the market … my friend is the listing broker, so I have first ‘dibs’ on the deal.

So, I am now at Stage 1: I have a deal in front of me; presumably, motivated sellers (we’ll find out, if they accept the new offer); and, I need to decide whether and how to proceed.

In Part 2 I’ll step you through exactly how I decided this was the ‘deal for me’ …

The allure of diversification …

There is a certain appeal to diversification, particularly when seen as a risk-minimization strategy.

Rick sums this ‘certain something’ up nicely in this recommended twist to how he would set up his own Perpetual Money Machine:

Nothing in life is without risk- but you can minimize risks by diversifying- use multiple types of wealth capacitors some properties, some stocks, even some bonds. You can further diversify with a mixture of commercial and residential properties, properties in different locations, etc.

Similarly you can diversify stocks through buying small cap, large cap, mid cap, and foreign stocks.

If you diversify you can be fairly sure that one bad event doesn’t ruin everything. Of course if the sun goes supernova all bets are off but barring that you should do fine.

And, this is certainly appealing …

… don’t forget that I have been well diversified in almost every area that Rick mentions: multiple businesses; multiple RE investments in different classes (residential; commercial; single condos / houses; multifamily; retail; office; etc.); stocks (but, no mutual funds of any kind … and, I intend to keep it that way!) … but, I don’t recommend it!


I see two problems with this:

1. You spread yourself pretty thinly – you risk becoming a Jack of All Investments But Master of None … this lack of specialized expertise (which you can, of course, try and ‘buy in’) and focus can actually INCREASE your investment risk, hence DECREASE your investment returns, and

2. You automatically consign your returns to the mean/average – not all of your investments can perform as well as your best investment …. if you are comfortable with this ‘best’ investment (or, at least one of your ‘above average’ ones) surely you would put more effort into doing more of those?

The usually arguments FOR diversification then say things like “well, look at the sub-prime and what that’s done to [Investment Class A], therefore you should also do [Investment Class B]” …

… but, they conveniently forget that [Investment Class B] tanked 5 years ago, and will probably tank even worse 5 years hence, whilst [Investment Class A] recovers.

If you diversify you run the risk of averaging your returns down.

In other words, if you can choose your investments wisely your best hedge against risk are a combination of:

a. Time: make sure you can hold the damn thing for 10 to 30 years … if you have a short investment horizon, no amount of diversification will protect you.

b. Higher Returns: if you can hold long enough, every investment worth its salt will recover – and, then some; and, isn’t a ton of cashflow a great ‘insurance’ against risk?

Of course, if you can’t choose your investments wisely, then a ‘regression to the mean’ becomes a GOOD thing … just don’t expect to get rich if you can’t develop any special expertise 🙂

Nope, Rick, my Perpetual Money Machine – which asks me to generate my active income one way (e.g. my job or business), and then create passive income in another way (e.g. stocks or real-estate)  gives me all the diversification that I need!

Accumulating 7 million dollars worth of property in 7 years?

I wrote a series of posts about how to build a Perpetual Money Machine, and Caprica asks:

I thought the title of this blog was called 7 million in 7 years, not 1 million in 20 years?

How do you go about accumulating 7 million dollars worth of property in 7 years and be in a net cash flow positive position by the end of 7 years?

Here’s how I made it to $7million net worth in just 7 years, Caprica:

But that’s not the question that you actually asked; you asked how to build up $7 Million dollars worth of PROPERTY (i.e. real-estate) in 7 years, and that’s another matter entirely.

For example, you will notice that I didn’t reach my 7m7y from real-estate alone (and, you’re not likely to be able to, either): my ‘energy source’ was a business (actually, more than one), but my ‘capacitor’ was (largely) real-estate.

If you are asking if you could build a $7 Million real-estate portfolio in 7 years, using just your income from a job (even a pretty high paying job) I would have to say “not bloody likely, mate” …

… your income just can’t ‘fuel’ enough real-estate deals to produce the annual compound growth rate that’s required!

To see what energy source and compound growth rate combination that YOU need, FIRST you must start with knowing your Number / Date:

If you need, say, “1 million in 20 years’ (and, let’s assume that you’re starting from, say, $10,000 in the bank instead of my $30k in the hole), a job (as your ‘energy source’) + real-estate together with stocks (as your ‘capacitor’) should do the trick.

But, if it’s “7 million in 7 years” you want (starting with the same $10k), then you’ll be needing a more aggressive set of ‘energy sources’ and ‘capacitors’ for your perpetual Money Machine, i.e.:

Your own business (excess cashflow) + real-estate.

It’s all in your required annual compound growth ratefind yours, and work backwards from there …

… but, Caprica – as I suspect do many of my readers, after all of this time – already understands this:

I realized after I posted my response I already knew the answer …, which was to start one or more businesses to help you generate enough money to buy your passive income source.

The New Money Pyramid

Let’s see … what are your health objectives?:

– Lose weight?

– Get fit?

– Be healthy?

– Live long?

– Look ‘buff’

– and, the list goes on …

You see, if you want to work on your ‘physical well-being‘ you have to define what that means …

… for you.

It will be different for everybody: for my wife it means eating strangely and exercising a lot. For me, it means, being totally sedentary, eating reasonably little/basic (except when I go out) and relying on good family ‘longevity genes’ (on my Mother’s side … hopefully, not my Father’s side of the family!) to keep me alive.

Yet, the government has managed to come up with (and, recently updated) a Food Pyramid that neatly sets out a plan for eating and staying healthy. Each ‘slice’ of the pyramid represents the relative proportion of each different food group that everybody should eat, every day.

But, the government soon found that this is enough to stop people from getting obesity-related sicknesses (cancer; cholesterol-related heart disease, etc.), but really wasn’t enough to make people, well, healthy.

So, they were forced to come up with this new version of the Food Pyramid

What’s new about this, latest version of the pyramid is the stick figure climbing the stairs on the left hand side, like some Inca priest about to climb the pyramid at Machu Picchu for his monthly sacrifice of the young virgin (naturally, by ripping her still-beating heart right out of her chest … but, I digress).

This signifies that you can eat the right foods all you like, but won’t achieve true health unless you also exercise your body, in moderation.

One size does indeed fit all … at the most basic level.

Similarly with your ‘financial well-being‘ – while still a long way off being the Unified Theory of Personal Finance – we can at least lay out a basic Money Pyramid that will serve one and all reasonably well … enough to at least get you started; the bonus being that it might win me some friends back from the mainstream Personal Finance blogosphere.

Take another look at the Pyramid at the top of the post, and we can imagine the various segments as being common financial wisdom like:

1. Save 15%+ of your gross income

2. Pay down (and avoid all future) ‘consumer debt’

3. Increase your rate of savings by also allocating to your savings plan at least 50% of all future pay increases and ‘found money’ (inheritances; IRS refund checks; loose change from your pockets; money saved from quitting [insert vice of choice]; etc.

4. Buy instead of renting [AJC: which Financial Pyramid are you reading?!]

5. Invest for the long-term

6. You can fill in the other slices from your choice of any/all: live frugally; diversify; create an emergency fund; and so on …

And, this is certainly the Money Pyramid being promoted by most Personal Finance writers (other than the “Make Millions with No Money Down” and other ‘financial crackpot systems’, that I liken to the totally unbalanced “No [insert unhealthy sacrifice of choice: carbs; proteins; calories; glucose; food; etc.] Diet” diets).

The problem is, it might stop you from being poor (the financial equivalent, to not being obese) but will it be enough to make you Financially Healthy … a.k.a. Wealthy (however you choose to measure that)?

Probably not, which is why I have created the New Money Pyramid simply by adding the man climbing the stairs on the side:

This signifies that you can save money all you like, but won’t achieve true wealth unless you also exercise your money, in moderation.

How do you exercise your money?

Simple: you move it around! You aim high … setting a goal that has meaning to you, then:

– You invest at greater velocity (higher return),

– You leverage (the financial equivalent to exercising with weights),

… but only to the extent that your ‘heart’ (actually, your guts) can handle – start slow, get help, build up the velocity and the leverage as you get over a period of time – and, check with your ‘doctor’ before trying this at home 😉

A journey with George …

Perhaps I just like this video because the ‘talking head’ is a fellow Aussie – although, I don’t know who he is or what his credentials are (I do know that if you watch all three of the videos listed on his blog you’ll end up with an ad for a new ‘personal finance’ educational board-game) …

… but, I do like his neat little whiteboard summary of the problem of ‘investing’ to chase capital appreciation. This was the sort of ‘wrong thinking’ that fueled the property market booms, both here and in Australia.

And, after every boom comes the bust 🙂

Looking for the Perfect Retirement Formula?


Conventional wisdom says that you can safely withdraw 5% of your Net Worth each year following ‘retirement’ (hence, the Rule of 20), but conventional wisdom is aimed at people who conventionally retire … which, I trust, is none of us 😉

However, there are essentially two conventional ways of deciding your retirement ‘income’:

There’s the percentage of portfolio method (where you always withdraw the same % of your portfolio each year) and the dollar adjusted method (where you always withdraw the same fixed $ amount, only adjusted each year for inflation).

Colleen Jaconetti, from Vanguard Investment Counseling & Research says:

The percentage-of-portfolio method can give your money a greater chance of lasting throughout your lifetime, while dollar-adjusted gives you a more predictable, inflation-adjusted withdrawal amount each year. If you’re more concerned about someday running out of money, the percentage method may be appropriate, but you’ll need to have some flexibility in your spending.

The percentage of portfolio method tends to last longer, making it more suitable for those of us who intend to retire young … and isn’t that all of us?! Colleen agrees:

If you’re retiring early, such as in your 50s, you may want to start out withdrawing closer to 4% to help reduce the risk of a long-term shortfall.

But, the problem isn’t with the method – in fact, in the first year of your retirement, they produce the same result (it’s only in subsequent years that they vary according to your then-current Net Worth OR according to inflation, depending upon which method that you choose) – it’s with the factor that you choose.

You see, 5% (or even 4%) may be too much!

These ‘common wisdom’ percentages assume average rates of return, but the market doesn’t operate in a line that simply tracks the averages … it moves around the average return randomly

… and, if it randomly moves the wrong way too early and for too long (pity those who are recently retired) you could easily run out of money in years, not decades!

So, you could instead plug your numbers into a Monte Carlo Simulation (this is a really good one) which tend to produce much more conservative withdrawal rates – more like 2.5% (hence my Rule of 40).

Or, you can go the other way and set up a Bond Laddering strategy that Paul Grangaard claims can support a ‘safe withdrawal rate’ as high as 6.6%.

Do you see our dilemma? A doubling or tripling of life-style (or a similar scale reduction, depending on whether your glass is half full or half empty) depending upon whom you believe.

This is the dilemma that you face when your retirement assets are held in bonds, Index Funds, cash or CD’s … which is why I am trying (actually, failing miserably right now) to live a $250,000 lifestyle on an income and asset-base that actually supports way more than that (I think: I’ll have to wait for the post-meltdown; post-house-purchase; post house-renovation; post-move countries fallout to clear sometime during 2009 to be REALLY sure I’m still living within my means … I think – more likely hope – I am).

So, when I find the Perfect Retirement Formula, I’ll be sure to let you know … Lord knows, if it exists, I need to find it 😉

In the meantime, I have a third method – one that makes the concept of Safe Withdrawal rates virtually irrelevant:

You invest your money in income-producing assets …

… such as, dividend-producing stocks or income-producing real-estate.

You buy the asset with little or no borrowings (which is entirely different to the Making Money 201 strategies that I recommend, but we are now in Making Money 301 – ‘post-retirement’ wealth protection mode – so things change dramatically) and gain the following two huge advantages:

1. You can live off the entire after-tax rent/dividend – with a buffer for holding costs (in the case of real-estate, this could be things like vacancies, taxes, and repairs and maintenance), if required – which is pretty much automatically inflation-adjusted, and

2. Your capital (hence estate) or Net Worth also increases pretty much at least with inflation, as long as you choose your investment/s reasonably well!

No worries about outlasting your income … and, you get to leave your heirs (and/or your favorite charity/s) the bulk of your ‘fortune’ 🙂

PS What does the image of a man running on the beach have to do with a ‘safe retirement’? I have no idea … I just googled images with the keywords ‘safe’ and ‘retirement’ and pictures of beaches and horses (lots of horses!) came up … go figure …