Risk, Uncertainty and Change

Firstly, I'm happy to resume my writing here with lesser time I have these days. There's concept of chefs in France which states they "cook for themselves", meaning putting up a perfect dish is more important for their satisfaction than their customers. Does it apply to me? Maybe. I have seen some people, who have so much to do in life with so little time, and still being able to dedicate some time to share some of their thoughts and knowledge. I admire these people and I think they have set a good example.

Risk and Uncertainty. These two words appear the most often when the economy is weak or when markets are performing poorly. When things are better, most us ignore these two words. Understanding the significance of these two words can help investors manage risk and limit losses.

Today in the beginning of 2012, we’re approaching 4 years since the collapse of Lehman Brothers, the catalyst which transformed what it seemed just a US subprime mortgage crisis into a full blown global financial crisis. As I mentioned in one of my earlier posts, we are no longer speaking about problems on a corporate scale like the failures of financial institutions, we are now speaking on a national scale involving governments with unsustainable debt and trillions of dollars. 4 years on, wouldn’t the problem be solved or at least is going to be? The ugly truth, it has worsened.

Globalisation and capitalism opened up countries and people like never before, the world is now more connected than ever. International trade, travelling, technology and cooperation between countries have made the world “smaller”. An email gets sent to anywhere in the world in same amount of time, people know as much of what goes on in another country as their own and people are travelling outside their country seamlessly these days.

Many years ago, people quoted “When the US sneezes, Asia catches a cold”, showing Asia’s dependence on the world’s largest economy. With even closer economic ties today and having US and Europe “falling sick” at the same time, shouldn’t be Asia be on a prolonged illness leave? The ongoing problems in US and Europe today are not ideal, Asia is definitely better off with them dong well. But something has changed dramatically over the years, the emergence of Asia as the new economy. The demand, growth and money in Asian and has propelled Asia forward in the midst of this global financial crisis. Jim Rogers said France dominated the 1800s, UK dominated the 1900s and Asia is going to do the same in the current century and beyond.

All the uncertainty present, is it still a good time for investing? The answer is simple, investing never ends, ever. I’m probably not as bullish as I was a few years back but that doesn’t mean investing stops even for a day. For people like Warren Buffett, a down market just means buying more. For people like Robert Kiyosaki, it doesn't matter as long as there is cash flow.For investors and potential investors, what is the next step to take now? Just a brief recap before that.

Another year of extreme volatility hit the markets over the last year, especially during August/September where the EU was struggling to come up with a plan with many countries needing a bailout. Debt ratings were slashed and yields were hitting record highs. And if that wasn’t enough, US lost their coveted AAA rating. You don’t even have to go very far back, that was good investment opportunity then, the panic caused excessive selling and prices took a huge dive. If you would have bought some then, you’d probably be looking at a return of at least 20%, not bad for a 4-month return. Periods as such have repeated on numerous occasions and it really presents good buying opportunities. You don’t have to be an expert to know it will continue to happen again in the future.

One of the greatest strategies ever was popularized by Warren Buffett and Benjamin Graham. The buy and hold strategy has worked tremendously well for Buffett because holding stocks for a long period allows the market to appreciate the value Buffett identifies. What if the market tanks? Buffett seldom sells, and when he sells, it is not because he thinks the market is going to tank. Buffett only sells when a stock no longer fulfills his strict selection criteria like his famous 'margin of safety' and comparative advantage. And when the market really tanked like it did in 2008, Buffett bought even more. Berkshire might not give the best returns in the market today, but the lessons are relevant and this approach has been successfully carried out for more than 60 years (Buffett’s career).A lot of people think Buffett has lost it. Read THIS. Technology stocks outperformed Buffett in the decade ended 2000, but who had the last laugh? Buffett called for a 'buy' even before the financial crisis bottomed out, was he right, you bet he was.

Dealing with the current economic climate is very challenging, periods of high volatility can even shake the seasoned investor. Hence, managing portfolio risk is very important. In simple terms, you don’t want to be caught out by unexpected events. Regardless whether the market is going much higher or is heading to another recession, you must be prepared for it.And yes it means you have to always be ready to respond the changes.

One of the most important ways is to view your portfolio as a whole, rather than focusing on each item. Your portfolio works as one and thus it is very important to adjust asset allocations and diversify it to suit your risk. This might take a few books to explain so it’s really up to you to enhance your understanding of this. A typical finance graduate might have learned this, but would have probably underestimated the importance of asset allocation and diversification. I have to be honest I never quite paid attention in class and now comes the time I am catching up on it as well. The few important words to take note; systematic risk, idiosyncratic risk, correlations and diversification.

Following the changes in the world economy, financial markets, political scene etc is quite a handful to do. Constantly learning and adapting on the go is pretty tough but there’s very little excuse because these are the inputs you need to improve yourself to make decisions. Investing is a skill, much like a game of tennis or golf. It’s the hours you put in, the effort you make and of course the motivation to succeed that takes you further. The way Nadal, Federer or Djokovic hits the tennis ball solidly with the highest level of precision and accuracy, didn’t just take a year or two to accomplish. Malcolm Gladwell wrote you can be an expert in anything if you put in 10,000 hours. If you’re still young, that might seem possible to achieve a lot more in life. If you’re not-so young, you’ll value your time even more.

There’s not many things in life as important as managing your finances. Like a garden or a pet, the extra care makes a difference. The world is moving really quickly these days, last week’s news is old news already. Like I wrote in my earlier posts, the rules of the game has changed whether you like or not. My boss told the division recently, change or be forced to change, and it’s not pleasant when you’re forced to change. It really sums up the world we live in today, it's changing very rapidly and you don't want to be left behind. Thanks for reading.

If you don’t like change, you’re going to like irrelevance even less - Eric Shinseki

 ~deyao~

Robert's Case for Real Estate and Capitalism

Financial education is just like a recipe, some people are willing to share it and some people refuse to for various reasons. Some people are afraid if they share them, they might 'lose' their exclusive-ness. Only with some exceptions, sharing your recipe is usually beneficial.

Robert Kiyosaki has been generous enough to share his story with the world. Some people ONLY see the side that Robert is making tons of money selling his books, games, seminars and other various products, and those are the people who may lose out in the current world of the information age and capitalism.We live in the world where capitalists or entrepreneurs thrive and lead, not realising this would be a huge mistake. These are the people leading the pack of being extremely wealthy because they are 'current'. Robert in most of his books explained the old theories of going to school, getting a job, buying a house and saving for retirement, he has made it clear not being 'current' is causing millions of people to lose out. Robert's books have transformed the way millions of people think and if they were all lies or a false marketing plot, he would be broke and his books would no longer sell. Today, he is one of the world's bestselling authors.

There are people who discourage me from sharing powerful tips and advice, but if a person like Robert can take the time to do it, I guess I can spend a little time sharing what I know. Ultimately, Robert is trying to bring changes through different means as it is shown not one man nor one country can make a change to this world. Leaders of the world be it Barack Obama or George Bush, can only do so much, the rest is up to the people themselves. You can have Steve Jobs or Bill Gates as your mentor, but if you don't have what it takes, you won't succeed. Many people view leaders as salvation and hope for the future and not knowing it is themselves who will determine their future.

This post will discuss on the investments people make and whether they are taking into consideration the four perspectives (earlier posts). Also, I will write about why Robert prefers real estate over other classes of investments.

In finance courses, we learn to diversify out portfolios. It means we minimise or eliminate the firm-specific risks and only expose ourselves to systematic risk. We protect ourselves by making sure we have the best risk-return trade off.  One of the biggest mistakes most investors make is diversifying over one asset class; paper assets. When the financial crisis happened in 2007, being 'diversified' or not, most investors were wiped out. Robert questioned the education the world was receiving because despite the principle of diversifying over stocks in different industries, investment grade bonds from around the world and mutual funds who are supposingly one of the best diversified investments, investors lost when the markets went down. So how can it be diversifying if it didn't protect the investor when markets headed south?

Despite numerous successful investors like Warren Buffett and Peter Lynch, there are pitfalls in equities. First of all, I would like to note I've seen equities make fortunes for many people and I personally like equities. There are millions of people today whose wealth and retirement depend on the performance of the equities market. Doesn't that sound risky? In the event the market performs badly, the investor goes from rich to poor or his/her retirement plans gets postponed indefinitely, or until the market recovers, which is never a certainty. An investor usually has no control over the markets, and allowing it to determine their wealth and retirement is just plain risky and not logical.  How about investing for the long term? Many people in the world recommend doing this but it may not be the best advice. Robert noted the lost decade from the 2000-2010 where the returns on the stock index was close to zero. Although the market MAY have a good decade ahead, there's still a big argument why equities may not be the answer to growing wealth and certainty. On a side note, the next recession might not be far away. For the case of equities, the wealth of the richest people in the world have grown tremendously over the last decade (despite the market returns), showing that success can achieved through knowledge, foresight and good decision making.

Next, you don't need to be a mathematician to know it is harder to gain after a loss. If you lose 50% of your money, it takes a 100% return to break even. If you lose 75% of your money, it takes a 300% return to break even. How can an investor take this huge risk of losing? I must note losing more than 50% is not hard in current market conditions where the markets are full of volatility and probably edging to another downturn. So think about it, how much of your wealth and savings for retirement are being determined by the equities market? Relying solely or highly on equities is too risky for anyone and believing the market will always perform the long term is being naive.

Capitalism has changed the world, it created entrepreneurs and capitalist who used their intelligence to become extremely wealthy. Many people know Thomas Edison as the inventor of the light bulb, but less knew that he was very wealthy. People wouldn't be surprised when they know this because capitalism rewards people who are unique and people who bring new ideas to the world.  The big downside to capitalism is the increasing gap in wealth. We see the world improving with so much new technology and breakthrough but rich are getting richer and poor are getting poorer. People who do not understand the rules of capitalism are being left out and only education will help them get back on track. There were two simple illustrations by Robert which delivered the message.

The first was the monopoly game. The lesson was the game is won by owning more properties than anyone and NOT by collecting $200 each round. It's very straightforward, the people who own the properties are the ones who win eventually not the people who grew on the $200.

The second was being the different side of the table. On the interview table, most people only think about BEING the interviewee, not the interviewer. This is because the education system is creating employees rather than employers. Most of us think of getting hired rather than hiring people.


The Real Estate Advantage
Robert loves real estate because it made him a big fortune. He doesn't dislike other classes of assets, he just prefers real estate. One reason being real estate fulfills his debt, taxes, inflation and retirement argument.

Debt
Real estate is probably one of the few investments financial institutions are willing provide finance. The important thing about debt is, it is "NOT your money". The biggest upside is being able to undertake investments while not being wealthy. Although this is subject to knowledge and experience, creating a portfolio of good debt generating positive cash flows is the key main advantage.

Taxes
As I wrote in my previous post, earned income in the form of salaries and wages are the most highly taxed because of limited deductions available. In real estate, the cost of financing and costs relating to the property can mostly be deducted, thus having to pay much lesser in taxes.

Inflation
In the current world of stimulus and quantitative easing, money is worth lesser by the day.  The prices of everything is going up. Although the theory of prices of real estate only going up has been completely dispelled, investing in real estate remains one of the best hedges against inflation. Real estate being 'real' reduces risk of owning 'money' which is no longer money. Higher inflation also lead to higher rents.

Retirement
I have mentioned on the uncertainty on depending on equities. Robert has proven real estate is able to ward off the uncertainty during tough market conditions. His strategy has worked through the financial crisis and is doing even better today. Robert chose his real estate which would be in demand in any market condition namely the energy sector where demand does not significantly slow. During the crisis when credit was frozen, people could only afford to rent houses. This put Robert at an even better position where he could even raise rents, increasing his cash flows and adding more real estate to his portfolio. This might be many people's answer to securing retirement.

Taking everything into account, it still does not mean real estate is the investment for anyone. Furthermore, like equities, not all real estate are equally good investments. Robert also notes it is a fantastic time to own houses in America because interest rates are at a record low, housing prices have dived and most importantly, it's a good time to get a deal on financing. For the rest of the world, whether the economy will worsen or not, investing should still be on the menu. For real estate, it's all about hard work doing research and improving your knowledge. Not having sufficient homework done can make a very good piece of real estate becoming a bad deal. Thanks for reading.


~deyao~

The Third Factor: Taxes

Links to the first two parts.
Part 1: Inflation
Part 2: Debt

It took me such a long time to finally complete part 2 and now here is part 3. This posts is will be relatively short because I am not going into detail of what you should actually do. It's like most of my other posts, I like to give you the idea of something and hopefully you would take that idea and make something out of it. A memorable quote I read awhile back

“Give a man a fish, you have fed him for today. Teach a man to fish, and you have fed him for a lifetime"

People like Robert Kiyosaki, Napoleon Hill and Warren Buffett gave me the power to make decisions and take control of my destiny. It was never a 'do this and do that', it was more of a 'what do you think you should do'. The power you gain today will carry you for the rest of your life and to acquire power it takes a lot of effort and determination. The sooner you learn how to 'fish', the sooner you will gain power.

A lot of people (including myself sometime ago) see taxes as something we pay to the government for the income we earn. We know we need to pay goods and services taxes, income taxes, medicare levies, duties and many others. What we do is we determine how much taxes we owe and pay it, end of story. Furthermore, we got our professional advisers to make sure we pay our taxes according to the law.

Tax systems differ in every country but the main function of a tax system is to redistribute wealth. Every country has an inequality of wealth problem among its population and the tax system functions to reduce that gap. So the wealthier people get taxed more than the less wealthier people.

This posts is NOT about what constitutes to income or deductions. It is about understanding the tax system well enough and to be able to exploit the opportunities under the law (Quoted from the definition of tax planning). Are we talking about the loopholes in the tax system? Not really. It is more about exploiting the parts of the tax systems which benefit particular groups, and doing it legally of course.

Like how Robert points out, individuals are the most highly taxed in the most of the countries and has the least incentives. In Australia, the highest marginal tax rate for individuals is 45% and for companies it is generally a flat 30%. That already shows an incentive to have your own company. Most personal incomes have limited deductions available and thus contributing to a higher tax payable.

Most of the time, individuals rely on their after-tax dollars to invest, which means the amount remaining after paying taxes is all they have to invest. Worst still, the investments do not take into account the cost of capital, which is the money forgone to undertake that investment. For example, the individuals do not get a tax break on the cost of using that money to invest. This means growth of investments are limited because eventhough investment returns are quite high, the base of investment is not large enough to capitalise on the high return percentage. To increase that base on investment, it requires leverage/debt.

Example 1
An individual earns $100 in salary income, pays 30% in taxes, leaving $70. $70 is invested and gains 10%, which increases to $77. After taxes on the $7 dollar gain, the individual is left with $74.90. You can see the individual gets taxed twice in the process.

The individual has paid $2.10 in taxes for the $7 gain which comes back to the 30% in taxes.And this relies on the salary of the individual.

Example 2
An individual borrows $70 and invests it at a 10% return. Assuming the cost of borrowing is 7%. $70 + $7 (gain) - $4.90(cost) = $72.10

The individual pays $0.63 (30% of $2.10) in taxes for a $7 gain.

The big difference between the two examples is the advantage of leverage. Example 1 shows the usual situation of how individuals use after-tax dollars to invests. The individual pays taxes at every level of income. Example 2 illustrates how an individual uses none of his/her money to invest and pays less taxes by getting a deduction on the cost of borrowing. Of course the cost of borrowing decreases the net profit of the individual, but the fact is the individual is using none of his/her own money to earn income. The lesson here is the tax benefits of using leverage.

I have to note again using leverage increases risk and every investor should consider their risk profile, investment and knowledge before taking on debt.

On a much simpler side. Australian residents should know the tax consequences of investing in real estate and equities as they are the most common. In real estate, there are tax benefits of taking on debt, main residence exemption, first home owners grant and claiming of various expenses relating in maintaining the property. If you pay close attention to the available deductions, you could be saving a lot in taxes.

For equities, it is important to understand Capital Gains Tax (CGT) and franking credits. Tax rates vary for individuals, companies and complying superannuation funds. Some gains may be entitled for a discount capital gains if conditions are met. Franking credits are credits attached to distribution by companies for the taxes they have paid for. Franking percentage varies on different distributions and investors should take note of this. Franking credits can reduce taxes and are entitled to refunds.

Although I said there were limited deductions to individuals, it is still worthwhile to take advantage of incentive when you have a family and children. Items such as the medicare levy surcharge, self-education expenses, family assistance (paid parental leave and baby bonus) and others could save individuals and their families hundreds a year.

For business owners, there are many special concessions for small business owners and rules for carry forward losses. These are the various benefits the government tries to assist businesses. Businesses create jobs and that is good for the economy and that being the reason businesses get more benefits from the government compared to individuals. There are many tax incentives for business owners so if you take time and understand them, it could again save you money.

I will understand if people find it hard to understand tax consequences at the start because of unfamiliarity of terms and facts. But the fact that taxes are such an important part of wealth it will be worthwhile spending the few hours learning it because of the simple fact it can put a lot of money back in your pocket. Having a tax consultant will be beneficial, HOWEVER, you STILL need to understand the facts and process yourself to be able to take advantage of tax benefits. Your tax consultant is here to make sure your tax return is in accordance to the tax laws not with the purpose to give you tax advice based on your financial position and investment profile.

Before I end, I would like to reiterate how saving some money here and there can make a difference. The compounding effect is significant when money is rolled over, over time.

'Real estate, tax laws and debt does not make you rich, it is the knowledge about them that makes you rich'
~deyao~

Part II : Debt

Debt

This is a continuation from Part 1

One of big problems in the financial world today is debt. It would be very foolish not to take note of debt because the havoc it's causing is affecting every country,even now. Because of the "creative" people in financial world, we have come across some "crazy" debt instruments and the failure of people to understand these products has caused a great deal of problems. A brief introduction, how to we take on debt or borrow. We usually borrow money from banks or other financial institutions and that is the most common way. For large institutions like corporations or governments, they are able to borrow by issuing debt. One party borrows, pays it back in the future plus interest. It all seems like an easy equation but what if the borrowing party can't pay it back? And what determines the riskiness of the borrower?

Debt is such big word that occurs at many levels and sometimes people do not see the entire picture. Borrowing and lending occurs at different levels. It can be at an individual level, a business level or a national level. Understanding debt at these levels is crucial.

Before we get there we have to understand what exactly influences the interest rate on debt? If we would like to borrow money, rationally we would like it at the lowest rate, right? But different kinds of debt give you different rates? But why the difference? One big word any borrower and lender needs to know, and that's RISK. From two extremes, the interest on credit cards (18%) and interest on a home loan (6-7%) are different. Why such a big difference, especially to a person who is going to pay the loan back anyway. The answer...risk. One of the simplest explanations is the debt on credit cards are unsecured while a home loan, the (house/asset) is secured by the lender. If a person goes bust with a credit card debt outstanding, if the person has no assets, the lender (or the issuer of the credit card) would probably write off the debt as unrecoverable. If the a person defaults on a home loan, there are safeguards in place as the asset is secured and the lender could take possession of the asset and try to recover the loan amount by selling it. A home loan is probably the lowest interest rate loan known to individuals, because it is least risky to the lender.

There are many other debt instruments available in the market and to keep track on all of them is impossible. So what I suggest is to know the ones that are frequently used.Another important thing to understand to risk and return trade off. Yes, everyone knows you need to take on more risk for a higher return. But what people sometimes overlook is whether they are compensated SUFFICIENTLY. If you've done some finance, you would have come across the efficient frontier which tells you having a portfolio on the frontier would give you an efficient portfolio (maximising returns for a given level of risk). The model is normally used for stock returns but calculations for debt or stocks are alike and it is directly applicable. So when a corporation or financial institution borrows money from you for a higher interest rate than the normal rate, does it include a risk premium and it is sufficient?

One of the best examples of a risk premium is insurance. You pay a couple of a hundred dollars a year of premium but when there's an accident or claims, you get back a lot more than the "premium" you pay. One friend asked me awhile back, how is the insurance company going to make any money in that case. Well, firstly, the insurance business is very profitable business because they have done the math in terms of estimating claims. They charge premiums based on probability calculations. One thing people fail to remember is when we buy insurance on a building, car or health, it just lowers your risk financially. You won't actually HOPE or EXPECT your building to burn down or your car to get into accident right...So the bottom line is the premium an insurance company charges you more than compensates them for the risk they are taking on (repaying claims). So here you go, the insurance company is more than compensated for the risk they are taking, hence they will be profitable. So on the other side (which is us) buying and paying the premium, we are under-compensated right? Technically yes, but it would be extremely foolish not to buy insurance to reduce risk of loss.

There are many types of debt instruments that are available to public. Debt is normally classified by its duration, short term or long term. Just a clue, when there are words like money market, bills or notes, they usually mean short to medium term. When we talk about longer term debt, you should be seeing the word bond.

Just a rule of thumb and referring to the principle of risk and return, when they are instruments that offer higher returns than the risk-free rate, there will be a risk premium, which is the difference in the price of the instrument or the interest rates paid by the instrument.

Good Debt vs Bad Debt
This section is probably the most important in my view. Debt or leverage is probably the most effective way of growing wealth. The general view is that we should reduce the amount of liabilities (debt) we have, but that should only happen in the case of bad debt. Bad debt are debts that do not generate a net benefit while good debt are debts that will generate a positive benefit. Bad debt are things like credit card or personal loans which do not provide any financial returns.I've actually written about this before in my previous posts so I won't go too in detail.

Leverage or taking on debt allows investors increase risk which achieves potentially higher returns. For example if you want to own an investment property, are you going to save up until you have ALL the money required to buy that property? The answer is no, it would take too long and you would lose out on the potential rental income.The most effective way is borrow a portion of the value of the property and start renting it out immediately. If you worked the numbers out correctly financially then you would probably have an investment with a positive net present value which means you have added value to your wealth.Debt is probably the most common tool used to get rich if managed intelligently. Leverage is also used with many other instruments to increase the potential risk/reward. For example in shares, investors may use margin loans or contract for difference (CFDs) to increase risk. Other instruments such as futures contracts involving commodities and foreign exchange can also be levered to increase risk.

The Debt Crisis
If this post didn't mention about the crisis the world is GOING through, it would be ignorant. The global financial crisis (GFC) started from the subprime mortgage market where banks handed out loans recklessly to home buyers who were borrowing more on rising housing prices. The outcome was the housing bubble bursting where people struggled to meet their repayments and flooded the market with their houses. 15 months after the start of the GFC, Dubai went into trouble. Why? They had too much debt. Building artificial islands in different shapes are cool but how did they do it when they were not even producing oil. They were optimistic on becoming a global hub, conditions were wonderful at that time and banks were more than happy to lend. The result, disaster.

In May 2010, the European debt crisis began. And most notably Greece was was in trouble. They were on the verge on default which would have disastrous for the European Union and most notably the euro (currency). The bigger countries in the EU bailed them out but the story won't end there. Spain and Portugal had their credit ratings cut at that time. What are the significance of these events? Well, didn't we learn sovereign (government) debts were riskless in finance. That assumption no longer holds and we have to be extra careful when evaluating debt we are buying. Yields may be 9% or higher, but this includes a very high portion of risk premium which is the risk of default (non-payment).

Credit Ratings
In finance courses we are taught credit ratings allow us to value a company or a country's debt. A company with a high credit rating can borrow money at the lowest rate, vice versa. So with a AAA (highest) rating, we would think the instrument is pretty save. But, an event has changed the complexities in the already extremely complex world. In April 2010, Goldman Sachs were charged for fraud in issuing one of their products. They basically repackaged subprime mortgage backed securities and sold it to the public as a AAA product. These securities were far riskier than an investment grade instrument. How did they do it? Long story short, it's fraud. Investor's lost more than a billion dollars, Goldman got away with a song (not sure it was even a couple of million dollars). To make matters worse, Goldman was trying help an ally offload these securities. Investors were defrauded and they get nothing in return. Goldman Sachs employees? They shared a pie of $14 billion worth in bonuses, how nice of them. Those investors could have been anyone, the lesson for investors is to be extra careful when evaluating securities they buy because when it comes to money, anyone could have an incentive to take advantage.

Debt Crisis in 2011
2011 might not be the year of an economic recession but it is the worst year since the GFC. Debt problems in the America and Europe has caused lots of uncertainty and economic growth has slowed. The debt crisis which surfaced in 2010 has again caused problems to financial markets. Many considered Greece a small country and brushed off the significance of their decline. With the leading countries in the EU combining, there was little fear Greece couldn't be rescued. But today, Greece is very certain to default. The other countries in trouble are Ireland, Hungary, Portugal, Italy and Spain. These countries are not that small and the impact of these countries defaulting could be massive.Italy has the third largest economy in the EU. Compared to the GFC where the US government were bailing out banks and companies, now we're talking about bailing out COUNTRIES!.It's not going to take billions of dollars but trillions of dollars! It's an ongoing issue today which would take a lot of sacrifices to resolve. A lesson to take from this is even government debt which were generally risk free are no longer the case. And the simplest principle of not spending more than you earn is evident in every of these countries.

More recently, America's credit rating of AAA was slashed for the first time. This is because the government has failed to manage its debts properly. They have raised the debt ceiling numerous times and they have not done enough in reducing their spending. America's debt to GDP ratio is heading to 100% and is the world's largest debtor. So how safe is American debt? Can it still be considered a risk free asset? There are also definitely long term implications to the US Dollar as the world's reserve currency.Even the debt of the world's largest economy is getting riskier, it's definitely important to pay close attention.

~deyao~

Make or Buy?

I learnt about this question awhile back doing management accounting and I felt this question is one of the best questions to ask yourself when making a decision. For example, you need a bicycle, make or buy? We mostly likely do not have skills and knowledge to make a bicycle so it's most likely we buy one. You are planning for dinner tonight? Eat in or out, make dinner on your own or buy it from somewhere. There's infinite examples when it comes to make or buy so I hope you get the basic idea.

A friend recently asked me why do I buy stocks/shares rather than start up a business? It came to my mind immediately it was a make or buy question. Starting up a business not only requires capital, it requires other attributes such as knowledge, management, research etc. It's certainly is not beyond a person to start a business but it is going to have a certain degree of risk. Until a person has the expertise to manage risk, the normal person usually buys. Unless you can make dinner for yourself, you do not have a choice.

Warren Buffett once said buying stocks was no different from buying a business. When you are buying a stock, you are essentially acquiring ownership of a business. Buffett as you know is a guru of buying, making his fortune in companies such as Coca-Cola, Kraft, Johnson and Johnson etc. He is one of the best examples when it comes to buying and he proves that you can actually succeed by buying. He looks for businesses with great potential and undervalued according to his analysis and buys them. His knowledge for his insurance business should also be noted.

Not every division of a great company is the best. And when it came to a video website for Google, it never took off like its other products.Google Video was nowhere. Google is the leader in the internet world and they have some of the most genius creations, but they couldn't create a successful site for videos. What did they do, they bought. They bought the world's most popular site for videos, YouTube. They paid a large sum of money for it, but it was a site they just couldn't match so they bought them out.

How about making? We've seen thousands of people creating their own companies and eventually growing them so huge and listing it in public. Robert Kiyosaki calls them the ultimate investors, people who create companies where the public wants a slice of it. People like Robert himself, Donald Trump, the Walton family (Wal-Mart), Larry and Sergey (Google) and soon to be Mike Zuckerberg (Facebook). An important term people like them like to be described as, entrepreneurs. I know there are many other prominent people I've not mentioned but you get the point. They are the king of making. Using their talents and hard work they created business worth billions of dollars. Think about Microsoft, eBay , Amazon etc, just imagine how far they can go from starting from scratch. People like them make companies and the rest of us buy them. We may not "make" a listed company one day, but rewards of a successful business can be very substantial.

So make or buy?Still a difficult decision. In terms of risk, it's a big debate. By having your own company, you decide everything that goes on and the business risk will be known and managed by yourself, there is no information asymmetry . The big question mark is expertise. If you have the expertise of making a bicycle which will cost less than the one at the shop, it should be a "make" decision. So do you have the capabilities and talents to carry out the "make" decision.

Having the expertise in buying or making can make you a lot money either way so understanding the key factors and differences is important when deciding. When you're buying a business and the business is not run by yourself, 99% of the time you would be facing agency cost. Agency cost occurs when interest of management is not in line with shareholders (owners) of the business and this will be a 'cost' to the shareholders. When you're buying a publicly listed stock, you generally do not have much control over the business and you are just hopeful the company in run properly by management and value is added to your investment.

As I mentioned, information asymmetry occurs and this can be a cost to shareholders. Management in a company generally will possess some "inside information"(non-publicly available information) which can be used to make money for themselves. Although there are laws preventing such actions, people who use this information still have means to get immunity in the form of disclosure. As a shareholder, value can be lost because insiders trade ahead of everyone and this takes a cut out of the potential profits of shareholders.

Although there are mechanisms in place such as corporate governance and employment incentives to align the interest of management with shareholders, agency cost will never be eliminated completely, which means the wealth of shareholders are transferred from them. Corporate governance has become a bigger issue lately with the collapse of big corporations, but this cannot fully solve the problems of agency especially when the directors are managers themselves or there is a lack of independence in the board of directors and management. More accountability is placed on the duties of directors but this does necessary reduce agency cost because it acts more in a form of punishment rather than being a deterrent. Thus shareholders will have to bear that risk and cost.

Almost all corporations give their employees the option to own the corporation's shares to motivate the employees. It will lessen agency cost but things like employee benefits, bonuses and perks are still coming out the pocket of shareholders. So are you comfortable with that happening?

Is agency cost minimal enough to overcome when "buying", that's probably an important question you have to ask yourself when making the decision. If you think management places too much interest on themselves, then "buying" would not be a good investment decision for you. There are many people who don't think management act in the best interest of shareholders and they stay away from the buy option. So it is up to your analysis to decide whether you can "trust" the company's management to run YOUR business. One of Buffett's most important steps to deciding on his investment is meeting with management. It is true he meets with management to see whether they are capable and dedicated enough to maximise the value of his investment. Lesson: He buys beyond the fundamentals of the business.

To succeed in your finances, you cannot avoid the make or buy decision. Some people avoid this decision completely and work for life. For the benefit of yourself, it's time to ask yourself, make or buy.

~deyao~

American Debt

My post on debt is still in the making and will not be done in at least a month. I came across this article talking about why America is technically bankrupt. And...the printing still continues.

Neil Reynolds - The scary actual U.S. government debt

Boston University economist Laurence Kotlikoff says U.S. government debt is not $13.5-trillion (U.S.), which is 60 per cent of current gross domestic product, as global investors and American taxpayers think, but rather 14-fold higher: $200-trillion – 840 per cent of current GDP. “Let’s get real,” Prof. Kotlikoff says. “The U.S. is bankrupt.”

Writing in the September issue of Finance and Development, a journal of the International Monetary Fund, Prof. Kotlikoff says the IMF itself has quietly confirmed that the U.S. is in terrible fiscal trouble – far worse than the Washington-based lender of last resort has previously acknowledged. “The U.S. fiscal gap is huge,” the IMF asserted in a June report. “Closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 per cent of U.S. GDP.”

This sum is equal to all current U.S. federal taxes combined. The consequences of the IMF’s fiscal fix, a doubling of federal taxes in perpetuity, would be appalling – and possibly worse than appalling.

Prof. Kotlikoff says: “The IMF is saying that, to close this fiscal gap [by taxation], would require an immediate and permanent doubling of our personal income taxes, our corporate taxes and all other federal taxes.

“America’s fiscal gap is enormous – so massive that closing it appears impossible without immediate and radical reforms to its health care, tax and Social Security systems – as well as military and other discretionary spending cuts.”

He cites earlier calculations by the Congressional Budget Office (CBO) that concluded that the United States would need to increase tax revenue by 12 percentage points of GDP to bring revenue into line with spending commitments. But the CBO calculations assumed that the growth of government programs (including Medicare) would be cut by one-third in the short term and by two-thirds in the long term. This assumption, Prof. Kotlikoff notes, is politically implausible – if not politically impossible.

One way or another, the fiscal gap must be closed. If not, the country’s spending will forever exceed its revenue growth, and no one’s real debt can increase faster than his real income forever.

Prof. Kotlikoff uses “fiscal gap,” not the accumulation of deficits, to define public debt. The fiscal gap is the difference between a government’s projected revenue (expressed in today’s dollar value) and its projected spending (also expressed in today’s dollar value). By this measure, the United States is in worse shape than Greece.

Prof. Kotlikoff is a noted economist. He is a research associate at the U.S. National Bureau of Economic Research. He is a former senior economist with then-president Ronald Reagan’s Council of Economic Advisers. He has served as a consultant with governments around the world. He is the author (or co-author) of 14 books: Jimmy Stewart Is Dead (2010), his most recent book, explains his recommendations for reform.

He says the U.S. cannot end its fiscal crisis by increasing taxes. He opposes further stimulus spending because it will simply increase the debt. But he does suggest reforms that would help – most of which would require a significant withering away of the state. He proposes that the government give every person an annual voucher for health care, provided that the total cost not exceed 10 per cent of GDP. (U.S. health care now consumes 16 per cent of GDP.) He suggests the replacement of all current federal taxes with a single consumption tax of 18 per cent. He calls for government-sponsored personal retirement accounts, with the government making contributions only for the poor, the unemployed and people with disabilities.

Without drastic reform, Prof. Kotlikoff says, the only alternative would be a massive printing of money by the U.S. Treasury – and hyperinflation.

As former president Bill Clinton once prematurely said, the era of big government is over. In the coming years, the U.S. will almost certainly be compelled to deconstruct its welfare state.

Prof. Kotlikoff doesn’t trust government accounting, or government regulation. The official vocabulary (deficit, debt, transfer payment, tax, borrowing), he says, is vulnerable to official manipulation and off-the-books deceit. He calls it “Enron accounting.” He also calls it a lie. Here is an economist who speaks plainly, as the legendary straight-shooting film star Jimmy Stewart did for an earlier generation.

But Prof. Kotlikoff’s economic genre isn’t the Western. It’s the horror story – “and scarier,” one reviewer of his book suggests, than Stephen King.

~deyao~

The 4 Factors In An Australian's Perspective

I haven't written about any personal finance topics in awhile, all thanks to my course structure. Anyway, it was quite the semester I anticipated. At least I knew what I was getting into and the consolation was I didn't freak out that often. I have a well deserved break now and here's one of the first few things I am doing.

I did some really interesting subjects this semester and although I went through quite a tough time doing them, I walked away quite happy. Hopefully I could somehow part some of the things I've learnt and make my writings better.

I've been wanting to write about this topic for a very long time and I finally have the time to. Robert Kiyosaki wrote about how every single person should understand the 4 factors. If they didn't they would never improve financially. He wrote his books particularly to help the Americans, whose financially well-being has been below par. But the rest of the world benefited too, people like me. He wrote about the 4 factors that made people poor. And I really felt the same after reading it and I thought it would be important to spread the message. Since he wrote it in an American context, I thought probably I could do one for an Australian's perspective.

The 4 factors by Robert are Taxes, Debt, Inflation and Retirement. He mentioned the majority of the people heard of these words before and knew what they generally meant, but they didn't know the impact of these four factors. The reason that convinced me to write on this topic was because these four factors took the most money out of people, legally. For the working class, what is the percentage these four factors take from your gross pay check? If it is below 20%, then I think you shouldn't be worried. But if it is anything above 40%, I think it is important to take note.Just imagine, before you can spend ANY amount from your pay check, 40% is ALREADY GONE. Some people just accept it and carry on with life as usual thinking they could do nothing about it, but for the people who believe something can be done and look at ways to improve their situation, they could be on their way to saving lots of money by just doing things not much differently.

First of all, I would briefly cover the four factors and some important points to note. It would take an entire book to give a comprehensive guide. What I hope to achieve is to point things to the right direction and hopefully by taking your own initiative to understanding these four factors further, you could improve financially.

*Half way through typing this, I just realised this post would be too long. So I am writing the factors in 4 parts (posts).

Inflation

The first factor is Inflation. Definition, a rise in prices in just about anything. You and I hate inflation because we have to pay more for our bills. We dislike paying more for fuel, groceries and it makes any future investments more expensive because prices keep going up. Inflation hurts the value of our money because 1 dollar today might not buy you the same thing one year later. A brief economics explanation. A rise in price is generally due to a fall in supply or an increase in demand. So which way is it? I would say both factors are evident. A fall in supply seldom occurs unless we're talking about a resource with limited supply, but a growth in demand I would say is due to economic and population growth. In short, if there's growth, there is inflation.

Australia is one of the handful number of countries in the world with a positive a 'real interest rate'. A simplified calculation is the Interest Rate minus the Inflation Rate. If it is positive, it means money is still outgrowing inflation which is still good, vice versa. If it is positive, do Australians still need to worry? The answer is yes. And the next question is obvious, it is why?

One of the reasons is if interest rates are at 4.5% and inflation is at 2.5%, you're looking at a real interest rate of 2%. Especially for people whose interest payments keep them afloat in retirement and people who hold mainly cash, 2% is a below average return. Inflation is also known as a 'silent tax'. It takes money from you without your "permission". For example, oil prices rise, you pay more at the pump, no questions asked. The pump owner sure didn't keep prices down to please customers, simply because people will pay it anyway. What if oil prices go crazy to levels back in July 2008, you would have no choice again but to "surrender" more money for fuel.

The effect of rising energy prices is huge, it trickles down to almost every section of cost of living. From housing, food, transportation and wages. Inflation destroys an economy if it is not kept in check. Growth becomes pointless if inflation grows faster. The central banks increase interest rates to curb inflation, but high interest rates is not necessary a good thing, ask borrowers that.With high interest rates, cost of financing increases and growth slows as well.Inflation threatens our cost of living, so who benefits and what can we do?

When it comes in inflation, only a small group of people in the world benefits. People who own resources/real assets. When oil prices rise, only oil producers benefit and the rest of the world loses. People who own real estate, they don't mind if house prices rise because they would gain. Imagine the wealth transfer. People who don't own any real assets, have their wealth transferred to people who do. In Australia we're talking about a huge mining boom, but how much of that wealth is actually transferred to the general population. If you don't own the mining companies, you don't benefit. If you're waiting for the government to make sure the benefits are spread across the country, this would awhile and I'm not sure how much 1 person would receive after dividing it among 20+ million people.

Inflation can a big problem, especially for people who do not own real assets. The solution is simple, you can own more real assets, earn more money or achieve a higher return on your investments. In the long run, earning more money at work is going to be difficult and achieving a growth in returns over time gets harder. Therefore, owning real assets would be the best option.

In short, inflation happens if growth occurs. As individuals, what happens to prices is out of our control. But the fact is we know inflation will happen and just by looking at inflation data for the past few years, we know inflation will not stop happening. If inflation is controlled well within comfortable levels then it is fine, but if it takes a few spikes many people will suffer. As individuals there are no certainties in economic conditions. Although Australia is a big producer of commodities, the benefit to the country as whole is only concentrated to the people who own these resources. If the price of coal or gas goes up, the owners make more money and our bills get bigger numbers. To deal with this inflationary environment, the best thing in my view to do is to hold inflationary assets; assets that benefit from inflation. I am not saying go get a house or buy stocks because everyone's financial position is different. What is best for yourself is look at the assets to you have, anticipate inflation and see whether you would be better off, worst off or maybe be unchanged. If there's room for change then make some changes in your allocation.

The next few topics would be more linked to an Australian's perspective. Inflation is a bit general to everyone so I haven't got anything specific. Hopefully the next few posts will make up for it. Thanks.

~deyao~

The Percentage Game

Person 1: Any tips on stocks?


Person 2:How about Rio Tinto.


Person 1:How much is it?


Person 2:About 80 dollars.


Person 1:80 dollars? That's too expensive.

The questions is...how can Person 1 tell it is expensive? Well, if Person 1 didn't know much about the stock, he/she is most probably wrong.

That example above is probably one of the most frequent situations I have encountered. There's this theory that large and 'expensive' stocks are priced at high absolute amounts. To a certain extent it is true most of the larger companies today have share prices that are well above $10 (In America or Australia). But in terms of value, what does that absolute share price tell us?

When 1 does not equal 1

I am very sure many people know this but there are through my experiences who still make the same statement which is most certainly not true. One example. Exxon Mobil today trades at $68 and Chevron trades at $82. Two companies which are in the same industry practically doing the same thing. Which stock is better valued? Many people will jump right into Chevron, well because it is "cheaper". Is Chevron better valued? The answer is you cannot make any conclusion at this point. Why? The share price itself tells you NOTHING! It is preposterous how people make conclusions from the share price itself.

First of all, Exxon is a larger firm than Chevron. This means if the share price does indicate the size of the firm, it is BY CHANCE. Secondly, which firm is more profitable? Does the share price tell you anything about this, absolutely not! Before I move on to my next point. What if I told you Exxon Mobil makes $1bil a year in net income? Does this tell you anything? Again the answer is NO.

Why not, isn't $1bil a LOT of money?Yes it is, but to Exxon, is that amount good? The answer is you need a COMPARABLE amount. Comparing to earnings of the last few years is a good start, but comparing it's rate of return to market/industrial estimates is what really matters (This will be discussed later).

Alright, the real story is Exxon is TWICE as huge as Chevron in market value, has a higher profit margin than Chevron. And also, Exxon made $19bil last year. So did you get fooled by the previous $1bil earnings? It does sound really good but it means nothing unless you make a meaningful comparison. Exxon is LARGER and is MORE PROFITABLE but yet it's share price is lower. A well-informed investor would know Exxon has a superior finances but it is not the only factor on choosing a stock.Lesson, the share price amount tells you NOTHING.

Hypothetical example (which is unlikely to happen in reality unless for a very good reason). Chevron has 2 bil outstanding shares and trades at $82. Let's say the firm does a stock split of 2 for 1. This means for every 1 share held, the shareholder will now own 2 shares. It will actually be called a bonus issue in reality but the "bonus" is free shares in numerical terms but not free money. This means Chevron now has 4bil number of shares outstanding which is double the amount. What will the new price be? Theoretically, the price will be halved to $41 because assuming the firm's value did not change overnight, the price of its shares should not be different. But due to the split (which does not affect a firm's value), 2 shares will equal to the value of 1 share before the split, thus being priced at $41.

Now after the split, Chevron is "cheaper" compared to Exxon in absolute share price. If you still haven't understood the fundamentals, you would have thought what a wonderful opportunity it is to buy Chevron because it has gone down in price by 50%. If you read the few paragraphs before this, you would have known $41 for 1 share now is NO DIFFERENT to $82 for 1 share before the split. This means in the world of finance terms $41 EQUALS $82. The value of each share before and after the split are the same although they are priced differently. From now on, when you look at share prices, just remember they mean NOTHING when compared in absolute terms.

Percentage Matters

Percentage allows us to make meaningful comparisons. You can own a huge company, but if it does not make money, no one wants to buy a stake in your company. We live in a percentage game. Percentage returns matters a lot more than absolute returns. Whether Chevron is priced at $82 or $41, if the share price falls/rises by a certain percentage, that is what matters. Whether the movement was $1 or $10, the percentage change is what you should be looking for. From the previous example above, had you used a percentage return for let's say return on assets. You would have known a $1bil profit for Exxon is actually a terrible return. $1bil sounds good but it's not.

So if you were interested in buying into a managed fund, what are the relevant questions for you to ask? Plain simple, what are the returns you would expect as a percentage of your your investment. If the fund has not been outperforming the market itself and it has high exposure to equities, that is probably a negative sign. As you can see I've created another question, what are the returns relative to the market? That is probably one of the most important questions.

I have not been particularly good when assessing fundamentals of companies. But just a few ratios that are important. Return on Capital, Dividend Yield, Operating Margin and Historical Earnings. These ratios will allow you to make meaningful comparisons when assessing a company's financial. On the technical investing side I am even less knowledgeable actually. But what technical analysis does is it goes beyond the fundamentals to assess a company. Analyst usually plots graph of historical prices and compares it to market's return, volume and other indexes to spot trends to determine target prices, resistance level or to time the market's trend. I'm not going through these techniques as I don't know much for now. Maybe in the future.

The main point is knowing what the share price means and ways to actually determine share price value.

Rio Tinto, Exxon Mobil and Chevron does not make you rich. It is the knowledge about Rio Tinto, Exxon Mobil and Chevron that makes you rich.

~deyao~

Conspiracy of the Rich

I came across this video and it probably gave the best unbiased explanation of the causes of the financial crisis apart from Robert's. The conspiracy is as clear as true and it is happening right at this moment. The US Congress is talking about a financial reform but the painful truth is you just can't rely on anything that has got to to do with politicians. It's up to you to educate yourself and not lose money to "scams" and "lies" of the govt.

Visit msnbc.com for breaking news, world news, and news about the economy

~deyao~

Is China all good?

China has been by far the fastest growing country in the world. A GDP of 8% during the financial crisis was just admirable. Everyone says it's the next big thing (well it already is), it will lead the world economy, it will overtake US one day? Well, I definitely won't doubt it may all happen. But when it comes to China we hear stories about its lack of transparency, pollution, human rights problem and it's absolute desire for growth at all cost. Will these problems catch up on them in the future? I came across this article which gives a brief highlight on the less rosier side of China.

The China Bubble - Greg Hoffman

Edward Chancellor, a member of the asset allocation team for Boston-based GMO and, interestingly, the author of a recent Financial Times piece on Australian property, is a financial historian and bubble expert.

His 1999 book, Devil Take the Hindmost: A History of Financial Speculation, examined past speculative manias. Perhaps you've read articles comparing the tech boom and 1990s' bull market to tulipmania in 1630s' Holland.

The difference is that Chancellor was making that comparison before the tech bubble burst, some years before Alan Greenspan claimed it was futile trying to predict bubbles at all.

Chancellor's timing may have been fortuitous. To accurately predict something once might mean little. To repeat the feat perhaps means something more.

His next major piece - Crunch time for credit: An enquiry into the state of the credit system in the United States and Great Britain - included this prescient paragraph:

''The growth of credit has created an illusory prosperity while producing profound imbalances in the British and American economies...When credit ceases to grow, the weakened state of these economies will become apparent.''

That report was written in 2005, years before the credit bubble burst. Chalk two up to Chancellor.

Third time lucky?

He's now turned his attention to China, a fertile ground for his fertile mind. Released last week on the GMO website, China's Red Flags is split into two parts.

Crisis checklist

Section one identifies speculative manias and financial crises, offering a checklist for those trying to identify bubbles in advance of their bursting. Chancellor offers 10 criteria for what he calls ''great investment debacles'' over the past 300 years (the report explains each in far more detail);
1. A compelling growth story;
2. A blind faith in the competence of authorities;
3. A general increase in investment;
4. A surge in corruption;
5. Strong growth in money supply;
6. Fixed currency regimes, often producing inappropriately low interest rates;
7. Rampant credit growth;
8. Moral hazard;
9. Precarious financial structures;
10. Rapidly rising property prices;

Although all these criteria need not be present in order for a bubble to be present, you can see where Chancellor's heading: not-so-subtly steering readers towards his own conclusion. In section two he takes each factor and applies it to the case of China.

Ponzi scheme

His conclusion is alarming; The very factors that have allowed China to grow so rapidly over the past few years despite the global slowdown - an investment boom, a credit boom, massive increases in money supply, moral hazard and risky lending practices - are all factors that investors and the mainstream press feel they can safely ignore because China is growing so rapidly.

After the past few years, we should all understand the potential negative implications of such major imbalances. But there seems to be general agreement that a ``build it and they will come'' approach is warranted in China because it keeps growing rapidly. There's a Ponzi-like element to the circularity.

Chancellor is concerned that China's high GDP growth is no longer a function of impressive natural growth. Instead, growth is being engineered to achieve high GDP numbers. It's producing a system that's unsustainable and prone to collapse.

This, in essence, is Chancellor's argument:
- Investors are adopting an uncritical attitude to China's growth forecasts;
- Because of the way local officials are incentivised, it's likely that migration of the population from country to city is much further along than the official numbers suggest. So when you hear of another 350 million internal migrants arriving in cities by 2025, many of them are actually already there;
- Hence, future productivity growth will be much more reliant on efficiency gains than urbanisation. China's record in this area isn't at all strong;
- Beijing imposes GDP growth targets on local governments. Thus, ``GDP growth is no longer the outcome of an economic process, it has become the object''. `When the allocation of resources, whether at the corporate or national level, becomes all about ``making the numbers'' then poor outcomes are to be expected';
- In 2009, Chinese fixed asset investment contributed 90% of total economic growth (an incredible statistic and a natural consequence of the previous point);
- Significant overinvestment is present in many areas. For example, capital spending in the cement industry increased by two-thirds despite capacity utilisation running at an estimated 78%;
- The efficiency of investment (incremental GDP growth for each additional unit of investment) is trending downwards towards wasteful levels;
- Interest rates have been kept way too low for decades, sparking economic growth but also imbalances and bubbles;
- China's enormous foreign exchange reserves are not necessarily a plus. As Michael Pettis pointed out recently, only two countries have previously accumulated such large foreign reserves relative to global GDP - the United States in 1929 and Japan in 1989. Oh dear;
- The Chinese stockmarket is in bubble territory. Last October, a new Nasdaq-style exchange opened in Shenzhen with 28 new listings. The minimum price rise (the laggard of the 28) rose 76% on the first day. Price/earnings ratios averaged 150;
- The residential property market also appears to be in a bubble. In Beijing, the house price to income ratio has climbed to more than 15 times, versus 9 times in Tokyo in 1990;

I've heard dozens of arguments on this matter. About half of them completely brushes of the bubble theory. Dr Doom Marc Faber predicts a high chance of an economic collapse for China this year. The fact the prices especially real estate has gone through the roof and the presence of dangerous lending practices could cause disaster. The lesson here is not about correctly predicting whether China takes a fall, but not to be completely certain about the future of China. Aussies take note.

~deyao~

Starting with a Plan

Typing this on my new keyboard, yay it feels good! Based on the past few months, I posted only once every month and I think it could be like that for awhile, well at least there's still something. Just an update on uni, I am boarding an "aircraft" this semester and it's going full swing for 5 weeks, transits for a week and goes full throttle again for the next 8 weeks. I hope I will survive. But anyway, despite the coming up busy-ness, I'll try my best to keep this blog updated. It has changed to a completely different blog in the past year because things have changed for me and this is what is happening for me.

It's already coming to the end of February, so have you planned for the year yet? Well it depends on what are you planning for. For instance, if its work, you barely need to do anymore planning after spending majority of your productive time there every weekday and sometimes on weekends. If you're studying like me, it's all about doing the usual tutes and assignment and then going through test and exams. It still requires planning, but for the coming few weeks at least. I used to do new year resolutions way back many years but not anymore. But at this critical stage of life for me, I'd probably need to put a lot more importance on certain matters.

It's another personal finance topic today and it focuses on making your wishes come true. It's about making a plan. If you're about to start in the job market, making plans now would do you good. Ok, I'll keep it simple. It's all about improving your financial well-being, nothing else. Are you doing anything to improve your financial well-being? It doesn't matter what financial position you're at now, it's about continuously improving that position. One of the best ways is to create a financial goal. I've mentioned this before.
A financial goal can be "I want to a have a million dollars in 15 years", "I want to pay off my house in 5 years", "I want to retire at the age of 40" or "I want to double my returns every 5 years". Well, there are many other goals in life we would want to achieve other than being wealthy and it is equally important you have a plan to try to achieve them.

So think of a financial goal, time frame can be anywhere from 1 to 10 years. Well every goal definitely involves reaching a certain amount. I suggest you understand compounding interest and annuity to set your targets. Learn about different instruments that will help you achieve a better return than the cash rate, at least.

Turning a person who doesn't really understand money into an investor takes a lot of brainwashing. Good brainwashing of course! The fact that many people in this world today have the wrong perception about money or don't understand how money really works is hurting their finances. A few perceptions that you should get rid off.

Wrong Quote 1)Debt is Bad (Again Rich Dad gave me the idea)
There's probably very little positives you can take when looking at stacks of bills that are due in a month, every month. But there's good debt and bad debt you should learn to differentiate. Bad debt are debts that continuously drain resources from you, just like credit card debt and mortgage of a house you live in. Those are liabilities that you have to cut down or eliminate. And then there's good debt. Debt that makes you money. As in my previous post, debt is leverage. You can buy something with less of your own money. Most commonly, we are always referring to the famous example of real estate. The fine distinction of investing in real estate is its steady cash flows. Having sufficient and steady cash flows will give you enough money every month to repay your loan and assessments. And that is how debt does you good. It's still a liability in the balance sheet, but when you net off the amount with the cash flows into the current assets, you see the benefits.

Right quote: Accumulating debt is fine as long as it is good debt.

2)"The only way I can be richer is getting a pay rise".
This quote is also very common among the working class, highly depending on their pay rise to be improve their financial position. Well I've written about this before. It is simply is too risky to depend on your paycheck anymore. And the increase in wage rates are barely fighting off inflation. The solution is to generate income from other sources. Rich Dad's Cash Flow Quadrant is probably the best book for this. For a mere USD $10, it's dirt cheap to learn about generating alternate forms of income while still keeping your job.

Right quote: I need to generate at least 2 forms of income.

3)"I can't afford it"
Changing the way we say things can also improve our actions. The choice of words we pick is also highly important. Negative statements like "I can't afford it" needs to go and be replaced with more positive and optimistic one like "How can I afford it?". So ask yourself this question when you think of making an investment. Actually all the other quotes are the quotes to avoid.

4)Investing is risky.
Well, I've had many times come across people telling me this when I recommended them investing. And many of them are still unconvinced, maybe one day they will be. I've written on many occasions that investing is like a skill. Robert says its similar to flying a plane. You can't fly a plane no matter how many books you read about it. And you don't fly and land like a pro in your first few attempts. The secret is out, all you have to do is educate yourself and do it. High risk, higher returns? Let me give you something better. When you educate yourself financially, you can earn higher returns and you can lower your risk.

Right quote: Investing is not risky, being uneducated is. (Quoted from just about every book written by Robert)

5)Leave money matters to the experts.
In a world whereby there are so many people desperate to make more money and totally motivated by money, how on earth could you hand over your money to someone? If you haven't learnt your lesson, read about Bernard Madoff and Allen Stanford. See how people have their fortunes wiped out by so called "accidents" and "bad judgments". The fact is people who work in the finance field may not be as smart as you think they are, obviously I don't mean to offend anyone (even myself), but there are also really good ones. The truth is, despite being in the finance field, not all of them can give you good advice. People are profit-oriented, why would they want the best for you, generally. Whether you're a doctor, lawyer, architect, engineer or a student. If you are willing to invest in your financial education, you can outperform at least half the people who claim to be experts. Don't rely on anyone! Take over your finances NOW! So if its even possible, please brainwash yourself.
With planning, many things can happen. If if you don't achieve the 1 million dollars in 15 years, maybe you might take 17. But that would be better than not planning at all. Everything starts small. From the first budget you did or the first cash flow statement you prepared. It's definitely hard to imagine a few thousand dollars becoming a few hundred thousand dollars. But with a well thought of and realistic plan, those fortunes you have dreamed about might not be that far away.

Right quote; This is my money and I should take control over it.

"Knowledge and composure are two important aspects of a good investor. Being a good investor not only improves your financial well-being, it also improves you as a human being"~deyao