Categories
Opinion

Offense and Defense of Wealth Accumulation

Yesterday I mentioned “Succeeding” by John T. Reed (I should write up a review for it). Another idea I liked in it is related to Offense and Defense in Football (pardon me in advance if I make mistakes, I’m not a football fan at all).

In Football you want to “meet strength with strength” (defense) and “attack weakness with strength” (offense). Basically you want to focus your strength where the opposition is attacking, and where it is weakest. Wealth accumulation is similar, except you’re playing against society.

Every time there’s pressure to “keep up with the Jones”, your wealth is being attacked. People who are being eaten alive by debt, can’t afford to live the lifestyle they’ve chosen and have to worry about money constantly, have to bring more of their strength to defend against these attacks. Strength in this case is mostly just a matter of giving these issues some of your attention and accepting the negative consequences of defending against them.

Perhaps your friends will give you a hard time about the old car you drive, or the crappy basement apartment you live in. Maybe your significant other will call you cheap when you don’t want to go out binge drinking at the club twice every weekend, maybe cultural pressure will be placed on you to send a check to your parents every month to help pay their bills. Each of these affect all of us differently, and you don’t necessarily need to stop ALL of them, but be aware that issues like this are nibbling away at your wealth, forcing you to work longer-and-harder than you would have had to if they weren’t in your life.

Meeting societies weakness with your strength is another issue that can be easy to articulate, but can be harder to do. Basically, beyond doing “what you want” for a career (fulfillment), you need to factor in how badly society doesn’t want to do whatever job you’re considering. After the dot-com boom, computer work took a nose-dive, because so many people started doing the work. Even though its vital new labour that’s needed by modern companies, it was so popularly perceived as in demand that soon their was a glut of labour being supplied (and salaries therefore dropped).

Currently in Canada and the US you can make a VERY good living in the trades (electricians, plumbers, drywallers, etc). For some reason the public wants to look down on people who use their hands to make a living, and because of this these jobs pay VERY well. If I was a young guy coming out of high school who had any interest in any one of the trades, I’d definitely be thinking about moving in that direction. Even with the massive investment that I’ve made in my mind and technical skills I’m sometimes tempted to move into the trades when I get a bill for the plumber for $250 to put in a new tap in my kitchen sink.

You can accumulate wealth by strengthening your defense or your offense. If you have a strong defense and weak offense, you’ll live like a miser. If you have a strong offense and weak defense, your cost of living will raise every time you get a salary increase and you’ll spend the rest of your life on a treadmill.

By combining both you can figure out what you truly value, earn enough money to pay for them, then have the time to enjoy them.

Categories
Personal Finance

A Mountaineer’s Approach to Risk

Years ago I did the cliche “backpacking around Europe” for a summer at university. While chilling out in a hostel in Moscow I got drinking with some Englishmen (and an Englishwoman) who were heading out to climb a mountain.

Besides downing the half-vodka, half-coke drinks (mixer was more expensive then booze) I was quite interested in picking the brains of these people who were quite enthusiastic about something bizarre (you’d have to pay me lots of money to climb a mountain of any height).

The one comment that I found most interesting, is that mountain climbers try to minimize the risk by climbing up and down the mountain quickly (in case the weather changes on them). Basically they’ve decided to do something that they supposedly enjoy, then they rush through it in case things turn bad. Weird.

I recently read “Succeeding” by John T. Reed, and in it he made a similar comment. Basically when he was young he decided he wanted to have a net worth of $5 million. While working towards this he had to get quite aggressive, and got hit very badly by a real-estate market correction in Texas. He has a similar idea to the mountain climbers: Make a conservative goal, then accomplish it as quickly as you can to minimize your exposure to risk. The more money you want to be worth (the higher mountain you want to climb), the more risk you’re going to have to take because it’ll take you longer to get to the top. So he advocates only targeting a networth goal that you’d really need, not just a big number for the sake of a big number.

It seems to me that there’d have to be “risk mitigation” approaches, where you’re aggressive for short bursts with only part of your savings in order to get to a goal, then you ratchet back the aggression and try to fortify your position. When you’re ready to push towards the next “base camp” of wealth, you put money and time aside for the attempt, talk to people who have done it before, then try to push up to it as quickly as you can.

I assume the very first base camp is income being greater then expenses. This is kind of like digging yourself out of a pit before you start climbing the mountain, and luckily this wasn’t ever a position I was in.

A Everest summit attempt would be getting onto the Forbes 400 I guess.

I’m not sure if this is a reasonable metaphor for accumulating wealth or not. My currently goal is the second base camp of passive income being equal to expenses. My “hustle” over the next 2 years could be to keep working contracts, even if they aren’t terribly interesting, keeping my cost-of-living down, buying blue-chip dividends, and trying to get a couple more investment properties similar to my current one in order to reach the first base camp of wealth accumulation (retirement basically).

At that point I can decide if going further up the mountain is interesting to me or not.

Categories
Real Estate

Getting Started With Investment Real Estate – Part 7

To start at the beginning – please see part 1 of this series.

So I had a 1st and last month’s deposit from my screened tenants, a signed lease and was happy to have the condo go from costing money to making money. Shortly after they moved in I got a call from the tenants saying that the washing machine was leaking water. I went and had a look, and quickly determined that the problem was the plumbing behind the machine rather then the machine itself.

I hit it with a couple of types of liquid plumber, and played around with an auger, but couldn’t get it flowing fast enough to let the washing machine drain. I contacted the condo corporation, and luckily enough they said this was their responsibility. The superintendent hit the drain with his auger and that seemed to get it working (he’s clearly better with his auger then I am with mine).

Next day the tenants call me and say the dryer isn’t working. It tumbles and heats up but the clothes don’t dry. They assure me that one of their fathers is a mechanic and that I need to replace the dryer. I come out and find that the vent is obstructed (so replacing the dryer would have been a waste of money). The condo corporation assures me that this ISN’T their issue to fix (go figure). After calling a duct cleaning company and getting a quote for $400 to clear the vent, I go at it myself with the auger (I’m not a “right tool for the job” type of guy) and 30-45 minutes later I’ve pulled a bird’s nest out of the vent and now have a steady stream of hot air coming out of the exhaust.

Next day another call comes in. They had done a couple of loads the day before and it had worked fine, now the dryer wasn’t drying any more (and wasn’t heating up). I talked to a few people and looked on the internet and had the idea that there are TWO fuses for the dryer, and the theory is that one of them had blown. I wasn’t able to really figure out the fuse panel (its all the old style plugs instead of the flips I’m used to). An electrician I talked to was positive that the heating element was blown and I needed a new dryer, so I head out and bought one for $400 (after taxes, delivery and paying to get my old dryer taken away). The dryer that came with the place didn’t look that old, so I was sad to see it go, but I figured it must have burnt out working away at the bird’s nest (although it seemed suspicious to me that it burned out AFTER the nest was cleared).

The delivery and installation wouldn’t go through since my ducting wasn’t metal. I had to buy duct materials from Canadian Tire, hook it up myself, and after I plugged it in and pressed the start button, nothing happened. I had a sinking feeling as I pulled out the multimeter that I’d been afraid to use before, get a battery for it, found the fuses for the dryer (sure enough there were two) and found that one of them was a 25 Amp (should have been a 30), and sure enough that was blown. I replaced it, and the dryer started working immediately.

Therefore I’d spent $400 on a new dryer, replaced the ducting to accommodate that new dryer and paid Future Shop $20 to take away a perfectly good dryer (and I could have avoided all that by testing the fuse and replacing it for $4).

Live and learn, this was an expensive lesson, but one I hope I won’t need to repeat – don’t be afraid to learn new things with home maintenance. Ignorance is VERY expensive.

My next (and final for this series) post will detail all the financial elements of the purchase and the first 6 months of operation.

(continued in part 8).

Categories
Investing

Leveraged Investments – Interest Rate Exposure

This is the third post in the “Leveraged Investments” series. Check out the previous post entitled “Leveraged Investments – The Risks”.

My biggest concern with doing leveraged investments since I have a large mortgage is interest rate exposure with respect to cash flow. In my opinion, nobody “needs” to do leveraged investing including myself which is why it is important to understand and minimize the risks. However I find the idea of it rather enjoyable and believe that I can make a profit out of it. Although I’m fully aware that the investment plan may not work out (won’t be the first time) I don’t want it to negatively affect my personal cash flow to the point where I regret doing the plan. This will mean limiting the borrowing to fairly modest amounts (compared to say the Smith Maneuver) which will limit any potential profit but it will also limit my exposure in case things go south.

I outlined in my last post most if not all of the ways that the plan could fail, however my biggest concern is interest rates since if they go up, the cash flow for the plan will go more negative and that’s not a good thing if it’s taking money from other activities that I like to do.

My assumptions for the interest rate calculations are extremely conservative and I wouldn’t think any less of someone who didn’t adhere to the same level of stringency.

My calculations:

In my mind, to calculate your interest rate exposure properly you should include all your debt so I will include my mortgage & investment loan.

Currently I’m paying $1500 / month on my mortgage. This amount is a bit much which is why we are lowering our monthly payment but we can get by ok on this amount if necessary. Regardless of what happens with the leveraged investments or interest rates, I don’t want to have to pay more than $1500 / month to cover my total debt payments

We have recently locked in our mortgage for a five year term which is important in this calculation because it is not the current amount of the mortgage that is at risk if interest rates change, but rather the portion which will still be outstanding at the time that the locked in period ends. In our case I estimate that once the five year period ends, we will owe $110,000 on our mortgage.

I’ve assumed a worst case rate of 15% interest – feel free to pick your own poison. I’ve also assumed my stocks have completely stopped paying dividends. Like I said, my safety test is stringent! I have however assumed that the tax rebate is intact and that my tax bracket is unchanged.

One more thing – I’ve stated that the current monthly maximum loan payment I am willing to handle is $1500. In five years at 2.5% inflation, that amount will be $1700.

Ok, to start off – I will owe $110k on my mortgage in five years and the interest rate is 15%, so the monthly payments will be $1447 – less than the $1700 maximum so there is room to borrow. In this case I’m amortizing over 25 years.

To add the investment interest payment to the calculation I have to account for the tax rebate, so for every dollar of investment interest, I’m only responsible for 56% of that amount. In other words I have to add 56% of the investment loan to the mortgage amount.

After playing with the numbers, if I have a $110k mortgage and a $40k investment loan then the monthly payment will be $1700 ($1500 in 2007 dollars) at 15% interest. So from that, $40k is the maximum amount I can borrow for investments.

Needless to say, this type of calculation has to be kept up to date since any changes in the rate of mortgage payments or any new debts will affect the amount available to invest.

The other limiting factor is the effect on your current cash flow from borrowing. If you were to borrow $100k at 6% and start a plan like this on January 1, your spreadsheet might tell you that your net cost per month is only $79 per month, however you might not get any dividend cheques for a few months and you won’t get the tax rebate for over a year so you need to be able to handle the gross interest payment ($500) for at least a little while. This is why I have only started the plan with $7100 so far and will be taking my time to get up to the $40k limit (if I get there at all).

Anyways, not sure how clear that is but feel free to ask questions or offer comments or criticisms!

The next post in the series is “Exit Strategies”.

Categories
Investing

TSX Dividend Aristocrats

I’d like to find a listing of Canadian equities that have maintained or increased their dividend payments for the last 20 years. I know this would include all the big banks (I think one of them skipped a dividend payment in the early 80’s, maybe I can forgive them now 😉 ). Does anyone have / know of such a list? (basically all Canadian dividend payers and how long they have maintained / increased dividend payments)? If it was a free list that’d be even better.

Thanks in advance for any links!

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Categories
Frugal

Children as a Consumer Good vs a Producer Good

Canadian Capitalist wrote an excellent post about the cost of children. As someone who doesn’t have children (and doesn’t really expect to) you might think I wouldn’t have anything to add on this topic.

You’d be wrong.

An interesting article I came across (sorry, can’t find it again to provide a link) was about the idea that historically children were a “producer good”, that is they were an investment that you expected would pay you money over time. In the early years you invest your time and resources into a baby, and as they get older they’re able to contribute an ever-increasing amount back to the family (by working the farm, helping with the family business, etc). There’s risk to the investment (it’d be ghoulish to list them all), but the expectation is that you’d more then get paid back your early investment. To this day, in developing countries large-families are often a way for parents to insure that SOMEONE will take care of them in their old age. I briefly dated a woman who’s parents came from an African country, and whenever they had an expense in their lives (like putting in a new deck at their house), they’d hit the kids up for a contribution towards it.

A Chinese woman I talked to gave all her salary to her parents, who “invested” it for her and provide her with room and board. From a parents’ perspective this sounds like a pretty sweet deal, but I wouldn’t want to be the child!

In the west in modern times, children have instead been viewed as a consumer good (costs us money we don’t expect to recoup). The general view is that a child adds far more enjoyment to your life then the monetary costs. Mike from Four Pillars comments that he’s spending time with his girls instead of “expensive dinners, sporting events, booze etc.” and he doesn’t seem to regret it (so therefore he values the time spent with his children more then what he’s given up, i.e. they’re worth more to him then these things). These days often parents are providing housing or a monthly allowance for grown children, and in many cases are reasonably happy to do it.

Something being a consumer good isn’t a bad thing. If it adds more enjoyment to your life then the other things you could purchase (for an equivalent price) with your discretionary income, then its a very wise purchase. I hope that every potential parent weighs the cost/reward of having a child and makes the right decision for the lifestyle they want. In my view a lot of misery is added to the world by parents’ NOT making this decision (and instead allowing random chance to dictate their lifestyle for the next 18 years).

I love kids and when I spend time with them I definitely find it enjoyable (they have a really unique perspective on life and say things that really make you question some of your most basic assumptions). My one fear with having my own children is that its a consumer good with a “no returns” policy :-).

Categories
Frugal

Cutting Back on Food Spending

I’ve been amazed at how much I’ve been able to save on my food spending. By simply taking my lunch every day and eating at home more often at night (and shopping at No-Frills), I’ve cut my food spending from ~$21 / day to ~$14 / day. Ideally I’d like to get it down to $8.57 / day (which is supposedly what the average single male spends), but I think future reductions will be harder then reductions so far (law of diminishing returns, picking the low-hanging fruit and all that).

Previously when I had half-heartedly checked No-Frills, they hadn’t seemed THAT cheaper compared to Loblaws. When I checked more in detail (took my receipt from Loblaws and compared prices) it was AMAZING the difference in price. $30 at Loblaws gets you a small back of groceries, $30 at No Frills gets you enough groceries that you can barely carry them home!

My currently thinking is that I’ll start budgeting myself $20 / week for eating out (which leaves $40 / week for groceries) and see how that feels. Definitely less then I’m spending right now, but might be doable (basically one lunch out and one dinner out a week).

Is $40 / week of groceries from No-Frills doable? Am I going to be eating dog food?

Categories
Investing

Leveraged Investments – The Risks

This is the second post in the “Leveraged Investments” series. Check out the first post entitled “Leveraged Investments – My Grand Plan” .

Two main assumptions for the success of my leveraged investment plan are –

  1. Interest rates staying at reasonable levels and
  2. Steady dividend increases.

Although the interest rate is tax deductible, if interest rates increase, the interest amount (the interest payment minus the tax deduction) payable goes up as well and this results in a lower profit or higher loss for the investment plan.There is certainly some room for interest rates to go up and I can still make money but if they get too high and aren’t matched by offsetting increased dividends then the plan won’t be profitable.The other problem with increased interest rates which I’ll cover in great detail tomorrow is cash flow.If I borrow too much and then interest rates increase then my personal cash flow will be affected which I would like to avoid.

I can’t do much about the risk of increased interest rates affecting the profits of this plan other than perhaps locking in the loan for a longer period of time.As far as the interest rate risk with respect to cash flow – I need to make sure I don’t borrow more than I can handle.

There are many other risks involved with this plan:

Future growth rate of dividends:If this doesn’t happen then the plan will fail.Not much I can do here other than to try to pick good companies with proven histories of both paying dividends and increasing them.Based on the last 10 years this looks like a slam dunk.But as William Bernstein wrote in Four Pillars of Investing “Ignore the last ten years” when looking at trends.I’ll have to ignore William on this one.

Investment diversification:Having only Canadian dividend stocks in your portfolio is not very diversified.This risk I can mitigate by treating the leveraged portfolio as part of my regular investment portfolio which is quite a bit larger and I can adjust the asset allocations accordingly so that the diversification is not an issue.

Capital gains:At the conclusion of this plan I’ll want to sell the stocks at a (great?)profit.If the dividend increases go according to plan and interest rates are not too high at the time of selling then this shouldn’t be a problem.However if interest rates are high and someone can earn 9% on a GIC then it’s hard imagine a stock that only pays 3% being worth a whole lot.All I can do with this one is to be flexible on when I’m going to sell.If I have a five or even ten year period in which to wind the plan down then that should help avoid high interest rate periods.

Equity risk:All equities are risky investments.The Canadian banks and other large successful companies are probably less risky than most but there is still risk involved.I believe the Canadian banks in particular are pretty safe but there is no guarantee that they will still be around in 25 years.Things that could change are the laws about Canadian bank ownership – if foreign banks are allowed to come in to Canada and compete then that will negatively impact the big five.Another thing that could happen is a one time event like a trading scandal that sinks a bank.It happened to Barings (subject of another post) and it could happen to any of the Canadian banks.

Other factors:This plan requires negative cash flow for the first several years so what happens if I end up unemployed for a long time or have to take a lower paying job?I might be regretting this plan if it’s hard to make the payments.Sure you can always sell the equities but what happens if the stocks are underwater at the time you want to sell?Also, the tax rebate won’t be as high if you are in a lower tax bracket – or are in no tax bracket at all which will change the economics of the plan.

Policy change:What happens if the interest deductibility rules change?What if dividend taxation rules change?These would have a huge impact on my plan.

Another point – if you are thinking of buying another house (upgrading) in the next decade or so and will be borrowing a significant amount to do so, then this plan might work against you because of the debt involved. I don’t know how banks treat investment loans but I would assume it would reduce the amount you could borrow for a mortgage although I guess it would depend on the value of the equities as well. In my case we’ve already moved out of our “starter” homes and won’t be upgrading for the forseeable future so it’s not really an issue for me.

Some of these risks are not all that likely and are hard to manage other than to keep the investment loan amount to a level which will allow me to be able to handle unforeseen situations.

Obviously there are a lot of potential risks to this plan but for most of them it’s hard to say how likely they are, which is why in my mind the big two (dividend increases & interest rates) are the ones to watch most closely.

Tomorrow’s post will deal with calculating how much I can comfortably borrow.