Author: Mr. Cheap

I’m a big fan of Squawkfox and her blog. Although always entertaining, she’s not always right (alas, I seem to be the only one who can manage that). In a recent exchange I cited her wonderful article on debt as an example of something well-written that I enjoyed reading, even though I disagree with it. She challenged me to write a rebuttal (go read her article first, this will make more sense afterwards). So, given that she likes smart men who disagree with her (I may not be able to manage the smart part, but I can make the most out of disagreeing with her), here’s my first attempt at stealing her away from her organic farming hubby (with his bulging biceps and green sensibilities: as if any woman would be into *THAT*).

To take a step back and get philosophical, debt and investment can be viewed as parts of a continuum of resource consumption. If we consume more than we produce, we incur debt: using resources before we earn them (which further restricts incoming resources, as a portion must be diverted to repay debts). If we produce more than we consume, we can invest the excess: delaying consumption of resources (which further increases incoming resources). In the middle is the person living paycheck-to-paycheck, staying out of debt (but always spending everything they earn). There is an interesting compounding effect that it gets easier to move away from the center the further you get from it (with Warren Buffet on one end and guys like Casey Serin or Debt Kid on the other).

The devil is in the details, as they say, and nuanced elements of this model can (and are) picked to death.

From this perspective, as Squawkfox advocates, it is easy to take the position that debt is bad, and investing is good. I want to be like Warren Buffet and not Casey Serin! Everyone can agree that bad debt (such as buying consumer goods on credit card or using your line of credit to go on a trip to Hawaii) is a situation to be avoided.

Where the model falls apart is that it *is* possible to borrow resources (go into debt) to increase your incoming resources MORE THAN the cost of borrowing. This is the idea behind the much misused idea of “good debt”. At it’s simplest, if you borrow money at 5%, invest it at 10% and pay back the debt with half the investment returns you’re in a good position to make some significant returns. Where the get-rich-quick crowd glosses over the details is when the 10% is a risky, speculative investment (but they still call it “good debt”) that will leave you with a massive debt (even if it’s at 5%) with no way to repay it, other than trudging off to work every day. It works out great if you’re lucky and it works out, but you’re up the creek without a paddle if something goes wrong.

HOWEVER, there are things you can borrow money for which have very low risk and a good chance of paying back far more than the interest rate of the debt. This is what “good debt” means to me, and it’s very real. The Fox hits a number of these and I’ll answer each in turn why I think they ARE good debt, even if she doesn’t.

1. Student Debt

Squawkfox presents two examples of when student debt is bad debt: studying a program that won’t help you improve your employability / expected income & overspending during your period of study. I agree with her on both of these issues. You should carefully consider the job prospects after graduation, and if they’re low for your chosen course of study, consider something more practical and keep the other interest as a hobby. If you can live cheaper (or work) while at school and graduate with less debt, of course this is a good idea.

HOWEVER, as the Fox and I have both experienced studying computer science, it gives access to jobs that MORE THAN repay the cost of education. This makes it good debt. Squawkfox repaid $17k in student debt in 6 months (point number 1 is key, in my opinion), which would have been almost impossible working a minimum wage job. There is still risk involved (I don’t think either of us is actually employed based on our CS degrees right now), but if the right degree is chosen, it has a very good chance of paying back far more than the cost of tuition and living expenses.

The US Census Bureau estimates that, over a lifetime, a high school diploma is worth $1.2 million, a bachelor’s degree, $2.1 million and a master’s degree, $2.5 million. You can debate their methodology (probably with other university grads), but it would have to be a VERY expensive school for 4 years of your life (and associated expenses) not to be worth almost a million dollars.

Not all student debt is good debt, but some of it is.

2. Mortgage Debt

The buy vs. rent debate has been going on forever (and I won’t try to settle it here). Squawkfox makes EXCELLENT points here, and I definitely don’t think all mortgages are good debt. That being said, some are. If you compare the TOTAL expense of ownership and the rent saved to the expense of renting (and the opportunity cost of not investing the savings in a diversified index fund) this tells you if your mortgage debt is good debt or bad debt.

3. Business Debt

Business debt is a very complex, and I won’t try to cover any of it here (Preet or Thicken My Wallet could do a far better job than I). The Fox mentions that many people don’t have the know-how to run a business profitably and will just drive themselves into debt for nothing. She’s right, that for THESE PEOPLE, business debt is bad debt.

For someone who DOES know how to operate a business, they can generate a better return from the business than what they pay to borrow capital, and this is good debt. A friend of mine is dating a guy who runs a Subway. He loves the business and has tons of marketing ideas, but the owner is happy with the status quo and isn’t interested. I’ve encouraged her to encourage him to buy his own franchise (he would have to borrow money to do so). He’s already demonstrated that he has the interest and aptitude to run the place. If he’s going to devote a good portion of his life to doing so (which he already is), why not buy the franchise and benefit himself instead of the hands-off owner? There is some risk (there are bad franchises, you’d have to do your research – I’d start by talking to a number of current franchisees, and NOT the ones the company refers you to), and even good franchises can turn bad, but I think the expected return for him would be higher (even factoring in the cost of borrowing) than being an employee manager for the next decade.

Sometimes it’s possible to get non-recourse investments in your business (people lend the business money that you aren’t personally liable for). This is GREAT debt, as you’re passing a lot of the risk of business failure on to your investors (who should be big boys / girls who understand the risks – don’t do this to scam people who don’t understand what they’re investing in). At the same time you’re keeping a lot of the upside for yourself.

4. Health Debt

Different people respond differently to stresses, and debt really knocked the Fox down. This is totally fair (and power to her if she avoids it for this reason alone). My mother can’t handle the gyrations of the stock market and so she keeps her money in GICs. This is the best thing for her. She’s lost potential gains over the years, but she can sleep at night (which is priceless) and can more than afford her retirement lifestyle. Perhaps for the Fox all debt is bad debt.

I’ve been debt free most of my life. In late 2006 I went into serious debt for the first time to buy a condo. The condo has paid for itself (income exceeds expenses) and has tentatively increased in value (I won’t know for sure until I sell) by about $30k. I felt the slightest twinge of unease when I was signing the mortgage documents (apparently this is typical for property virgins), and it hasn’t bothered me in the slightest since.

I started leveraging my stock account, buying dividend paying blue chip stocks (ala Derek Foster). This has been a disaster (my investment in Bank of America is down 67% and magnified my loses in a major market downturn). I knew the risks when I started doing it, and made sure it was small enough amounts that I was able to cover any margin calls. I haven’t lost any sleep over these investments. I’ve been deleveraging (mostly because I’m a low income student now), but I’d have no problem following the same strategy in the future (I wish I could be doing it right now with the current markets).

For me, these debts were good debts (from a mental health perspective).

5. Conclusions on Debt

I’m happy for the Fox if she’s happy to be debt free. Much like my mother avoiding the stock market, I think she’s paying a price to avoid debt. That being said, it sounds like she’s thought it through and has good reasons why that is right FOR HER. For other people, such as myself, going into debt has been a very worthwhile way to gain access to investments (such as investment real estate) or to construct investment vehicles (such as my leveraged stock portfolios) that would be effective in a different market environment.

So there’s my rebuttal. Squawkfox: Get in touch with me when you get sick of your husband! 🙂 Until then, I’ll be making kissy faces to your about page picture and admiring my framed pictures of your underwear.

I enjoy blogging. Twice each week, I have the chance to spend a bit of time articulating my position on a financial topic, then get a variety of smart people to respond with their $0.02 on the subject. Sometimes there will be a bit of back and forth on the day of the posting (or for really inflammatory controversial posts for weeks or months afterward).

Often the best part of blogging (for the blogger) is that we choose what is being discussed (for our own posts at least). Discussion forums become far more democratic where anyone can start a topic they’re interested in, and if they can attract enough interest, pick other readers’ brains and get some alternative points of view on the issue.

Five places I’m aware of, and have participated in conversations at, are:

1. Canadian Business Online:  This is the grand-daddy and has been around forever.  Forums are focused on topics from taxes to stock discussions, frugality to starting a business.  Derek Foster will often interact with fans (and foes) here and whatever your question is, if it’s about finance someone can probably give you a decent answer or point you in the right direction.  It’s been around FOREVER and is quite large, so it can be a bit overwhelming for newbies.
2. Canadian Money Forum:  I’m not 100% sure what their original motivation was for starting this (I would have guessed that running their successful blogs would have kept them busy enough), but the Canadian Capitalist and Million Dollar Journey started this up.  It’s like the Pepsi to Canadian Business Online’s Coke:  the choice of a new generation.  Very similar discussions, but quite a bit more intimate.  It gives a chance to interact directly with a number of bloggers as well as Canadian finance celebrities like Jon Chevreau.
3. DRiP Investing Resource Center:  This forum is focused almost entirely on dividend reinvestment plans, but because of its focus it provides AMAZING information.  Basically anything you could possibly want to know about DRiPping is answered here.  Although the site supports Canadian and American DRiPs, most of the people there seem to be focused on Canadian companies.  They also facilitate stock exchanges between users (which allow investors to cut their investments fees down to almost nothing, although it’s more time consuming than using a broker).  The veteran members are very knowledgeable about DRiPs (and willing to help), but have a tendency to be unpleasant to some rookies (and to be VERY set in their ways).
4. My REIN Space Forums:  The “Real Estate Investment Network” (R.E.I.N.) was set up by Don Cambell to sell real estate information and mentoring to aspiring real estate investors.  I heard one of his speakers at a seminar one time (and met a number of members through other venues) and didn’t get a good feeling about the organization.  The bulk of his talk amounted to generating goodwill by buying a turkey for his tenants at Christmas (wow).  It has been recommended to me on a number of occasions by other people I’ve met, so SOME people must find it worthwhile.  The forums have a public area, as well as a members-only area.  While I haven’t participated or read posts here extensively, there seems to be some good info (and knowledgeable people) posting in the public areas, so this would be worth checking out if you’re interested in real estate info.
5. It Sucks to be a Landlord in Ontario!:  I just found this recently and I think it should be required reading for anyone who wants to get into real estate investing.  Basically it’s a support group for Ontario landlords, where they swap war stories and complain about how skewed towards tenants the province’s laws are.  It’s a great resource to give aspiring landlords a dose of reality (such as how little good giving your tenants a turkey will do).  There’s a few threads where they start beating the war drum to begin advocating on behalf of the province’s landlords, but I suspect that won’t amount to much (they’ve got a pretty poor choice of a name if they want to go that route).

It should go without saying (but I’ll say it anyways) that these forums are filled with regular people who, although well-intentioned for the most part, are as likely as Mike or I to give you incorrect advice :-).

Where do you go online to chat about finances in a Canadian specific context? Any experience with these (good or bad)?  Any suggestions for sites not mentioned?

The Canadian Capitalist recently highlighted two terrific Vanity Fair articles about Bernie Madoff.  For those who weren’t watching CNN or reading papers in December 2008, Mr. Madoff operated an “asset management business” (hedge fund) that was actually the largest ponzi scheme of all time. He took massive amounts of money from rich people, famous people (like Steven Spielberg), and numerous charitable foundations.  Apparently people were desperate to invest in his fund.

The two articles, which details who Bernard Madoff is, as a man, from the perspective of his victims and his employees are great reads (normally the only part of Vanity Fair I’m interested in is the photographs of naked celebrities on the cover).  What surprised me most about him was that, according to these articles, he basically had no personality at all.  To his investors he was smiling, benevolent “uncle Bernie” and to his employees and family he was a bully.  He would be around clubs and organizations where rich people would beg him to take their money, but beyond living “the good life” the guy seems to be more of a shell than anything.  He wasn’t flirtati0us, didn’t take much interest in recreational pursuits (other than apparently cheating at golf according to Donald Trump), wasn’t a big drinker and wasn’t passionate about religion, politics or other topics of interest.  He basically existed to be a blank slate to keep money coming in, and hide what he was doing from regulators.

When this story first broke, I was visiting my parents and we were glued to the TV as more information kept coming out about it.  These articles paint a sadder story of people who have gone from being “ladies who lunch” to having to work (or move in with children) in their golden years.

Some are painting Madoff as a devil who set out to defraud his family, friends and community.  I don’t have anything to base this on, but my feeling is that the whole situation probably evolved gradually.  He might have been running investments profitably at one point (in the 80’s or 90’s is the speculation), got used to being viewed as a “market genius”, took a risk that didn’t pay off, then instead of being upfront, he hid the loss.  Perhaps he was hoping to get back “in the black” then move forward again, or maybe he just couldn’t take the blow to his ego that he’d messed up.  At a certain point he must have thought “I’m never going to be back in the black, but I’m not a young guy, maybe I can keep this under wraps until I die then leave it for other people to unravel”.  One Warren Buffett quote I like is “You only find out who is swimming naked when the tide goes out.”  The recent market drop was the tide that went out and showed that Bernie had been swimming naked.

Some people have compared Madoff to Hitler (many of his investors were rich Jewish families) which is insulting.  Comparing someone who defrauded a bunch of wealthy people to a man who attempted the systematic genocide of a race of people is offensive.  Godwin’s Law certainly applies.

There has been a number of racist perspectives on the whole deal as well.  Some anti-semites have apparently been happy that the whole situation occurred:  both for discrediting Madoff, who is Jewish, and his victims (many of whom are Jews as well and often very committed to philanthropy).  This is a blatantly ugly attitude, however some Jews have also made very racist statements claiming that “it’s especially bad that Madoff did this ‘to his own people'”.  Come on!  There are good people and bad people of all races, genders and religions.  Thinking that someone is going to be a good person because they’re Jewish, or not take advantage of the Jewish community because they’re a Jew is ridiculous and naive.  Madoff is a man who behaved badly.  His ethnic / religious identity has nothing to do with that.

Beyond being more sympathetic to Madoff than most (although I don’t think he’s Hitler or the devil, I do think life imprisonment is probably reasonable), I’m also less sympathetic to his victims than most.  Given, any time you’re robbed it’s bad.  And, it bothers me when people think it’s ok for bad things to happen to rich people because their rich.    A number of investors with Madoff lost EVERYTHING (they gave it all to him and were living off of the returns) and went from being rich to being poor.  Even if these are people who don’t have a lot of experience managing their money, it was pretty stupid of them to put 100% of their money into one investment (no matter how good they thought it was).  People did the same thing with Nortel and with income trusts.  They’re happy to cash the checks in the good times, but start howling when their luck turns.  Grow up!  If you’re retired and don’t have enough investments with ultra-safe, conservative investments (like fixed income) to get you by at a minimum standard of living, then you’re gambling with your future (and shouldn’t get much sympathy if your luck turns).  Madoff was giving consistent returns of 10-12%, which tells anyone with a brain that there’s significant risk there.

That being said, it’s remarkably easy (although crass) to tell people who have lost on investments that they were greedy.  However, Madoff investors who lost it all were being greedy (there, I said it).

What has been your feeling about the whole Madoff situation?  Do you think spending the rest of his life in prision is a reasonable punishment?  Do you believe that he was acting alone?  Should investors be required to return money they withdrew from Madoff before the news broke?

It’s been a while since we did a scam post.  Fake reputation scams happen on-line and off-line and can be one of the toughest frauds to detect or avoid.

On E*Bay it’s well known that malicious users will build up a reputation by selling small, inexpensive items (paperback books are popular) or by running an honest-to-goodness real E*Bay store.  They will follow through with the transactions and get a large amount of positive feedback.  Then they make a number of fraudulent auctions / sales and not fullfill any of them.

One of the worst (or best depending on your perspective) parts of electronic commerce is you can usually abandon an identity.  This allows the scammers to then start doing the exact same thing again under another name.

Off-line a friend of one of my relatives got burned by the real-life version of this.  He ran a computer business, and started doing business with a man for the first time.  They did a sequence of transactions, each larger than the last.  Each time there would be something unusual about the transaction, but it would work out, and he would get paid.

It turned out the con man was feeling him out, determining what he could get away with, and the maximum order size the friend could handle.  Eventually it was time to pull the trigger and the con-man managed to make off with dozens of computers without paying for them.  It destroyed the computer store owner, who abandoned his business (and his marriage) and basically had a nervous breakdown where he wandered the continent sleeping in the back of his SUV.  He was talking at one point about trying to hire a hit man, which luckily friends talked him out of.

Since these sorts of scams work by gaining our trust, there’s no sure-fire way to prevent it other than to be suspicious of everyone (which would cause its own problems).  When the friend who got conned was relating the experience to me, he remembered clearly that with each deal it seemed a bit funny.  It can be a hard thing to say “no” to someone, or to admit that we don’t understand a deal that’s being proposed.  Some people will prey on this reaction to try and take advantage.

When I was trying to rent my condo, a man showed up who was interested in a rent-to-own and we talked about that extensively (he was going to do a sandwich lease where he rents-to-own from me, then rents to his own tenant).  Discussing the details, he was very accommodating (and tried to buy me dinner).  Later, he tried to change elements of the deal that he had previously agreed on.  When I pointed out that what he was saying was different than what he’d previously agreed to, his response was “I have to admit I love the way you think , very detailed too detailed at times , just kidding” (notice that in the same sentence he’s complimenting me, then telling me that I’m “too detailed”).  He told me about 5 times that he didn’t think we should involve lawyers in the transaction (and I told him 5 times that I’d be involving a lawyer in the transaction and encouraged him to do the same).  Throughout our interactions, he also told me repeatedly how much he liked me (while it’s true that I *AM* a very likable guy, it’s just creepy to say it out loud).  I kept asking him questions and he eventually told me it was “none of my business” (when I’d asked him who he was planning to rent to).  This was enough red flags for me at that point that I just killed the deal and kept looking for a normal tenant.  I could be wrong and maybe everything would have worked on with the rent-to-own guy, but I hasn’t regretted for 1 second walking away from it.

Years ago when I went backpacking across Europe an aunt told me to trust my feelings and if I was getting a bad vibe about a person or situation to just leave.  I’ve found it was good advice when traveling, and is probably good advice for business and life as well.  There are times when you’ll be nervous about a deal, just because it’s larger or different than you’re used to.  But if you’re honestly getting a bad vibe about doing business with someone, make sure the safe-guards are in place that they won’t be able to “take the money and run” (and don’t be afraid to just not do business with them if they fight you when you try to put those safe-guards in place).

Have you ever had someone gain your trust, then steal from or defraud you?