Boss Hogg~NOBama's Blog
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Potash!
Okay, my last entry on stock investing was a bit confusing, so I hope to make this one a bit more readable. In this entry, we’re going to be valuing a stock and determining whether or not it is priced correctly, overpriced, or under priced. For this we will be examining one of my core stock holdings for about 4 years. In that time, the stock has gone from 16.24 per share to a current value of 193.89. It is my single best investment that I’ve ever made in the primary stock market. (Let’s not discuss the secondary options until we’ve got some stock investing under our belts first!) In those 3 years, I’ve had an 1193% return on investment—or 298% annually. Not bad huh? But I’m not here to brag about past successes, I’m here to help you discover future successes.
So let’s examine Potash when it was just a little company and why it was such a good buy then and continues to be good to this day. First, what the hell does Potash do? To find out this information, you can use any number of Financial Websites. Yahoo! Finance is my favorite. If you scroll down to the bottom of the page after entering POT (Potash’s ticker symbol) you’ll see a business summary. It reads as follows:
Potash Corporation of Saskatchewan, Inc. (PotashCorp) engages in the production and sale of fertilizers, and related industrial and feed products in North America. The company manufactures and sells solid and liquid phosphate fertilizers; animal feed supplements; and industrial acid, which is used in food products and industrial processes. It also produces nitrogen fertilizers, as well as nitrogen feed and industrial products, including ammonia, urea, nitrogen solutions, ammonium nitrate, and nitric acid. PotashCorp's primary customers for fertilizer products include retailers, dealers, cooperatives, distributors, and other fertilizer producers. It sells purified phosphoric acid directly to consumers of the product. The company was founded in 1953 and is based in Saskatoon, Canada.
What? A fertilizer company? That’s what the most exciting thing you’ve invested in is? Surely you must be joking, you say. Such a boring company should have boring returns. Not so. If you take anything from this entry, let it be this:
The more “boring” the investment, the better. Investing in things that people NEED instead of just WANT is a way to curb your risk. When the tech bubble crashed, I did not lose any money because I was not invested at all in technology. I’ve always lost money when I’ve invested in tech stocks. Call me old fashioned, but I like my companies to have earnings and tangible products. It keeps me from losing my shirt!
That being said, when you look to buy a company you should not really be looking at it’s per-share price. Instead, think of it like this: You are going in on a business with a guy named Mr. Market. Every day, Mr. Market is willing to sell you a part of the company at a certain price, and he is willing to buy from you at that price as well. When Mr. Market gets overexcited, he’s willing to pay you more than the company is worth to buy those shares off your hands. When Mr. Market is depressed, he is willing to sell you his shares at a discounted value from what the business is actually worth. You should take advantage of Mr. Market as much as possible, because even though he’s an emotional guy, he doesn’t mind being used and abused for some reason!
Sounds like silly advice? Straight from the mouth of the richest man in the world, Warren Buffet.
Instead of looking at the per share value, you should look at a few other pieces of information.
Number one: The Market Capitalization. This is the most important. It is the value of the current shares multiplied by all the shares outstanding. This is the value of the company. So, if you were a billionaire and you wanted to come and buy the company outright, every single share of it and have the company all to yourself, the market cap is the price tag for that. The thing is, even though you’re only buying a fraction of the company, you should look at the whole price tag whenever you buy or sell. Is the company worth more than it should be? Is it worth less? Looking at the company as a profit producing entity as opposed to a quick trade in or out is a surefire way to success in the stock market.
Number two: The Company’s Growth Record and Predictions. Growth is like crack to a stock. Potash has been growing at around 95% per annum—that’s right folks, nearly doubling every year in size.
Number three: The Company’s management. These people will be running the company that you are part owner of, so they better be up to the task! Make sure that the people running the company have their heads on properly. Make sure they’re looking out for the shareholders, aka you, the owner!
Number four: The P/E Ratio. This number is important to compare to its competitors. The lower, the better. What this essentially is is how many earnings you’re getting per the price of the share. So if a company makes 1,000,000 profit and has 1,000,000 shares issued, it is earning 1 dollar per share. This is called the Earnings Per Share. If the stock is trading at 10 dollars, the P/E is 10—the price of 10 divided by the EPS of 1 equals 10. Compare this number to the company’s competitors to see if it is within the bounds of reason. If it is trading lower than its competitors, this may be a sign of a bargain but it may also be a sign of weakness—that is why I rate the P/E ratio lower than the other information, since it does not tell you very much on its own. More important than the current P/E ratio is the Forward P/E ratio—stocks trade based on what the future holds, and more in line with future earnings than current ones. That is why an analyst upset (earnings being much higher or lower than predicted) can be a very negative or positive thing!
That’s it for now. I’ll post more later!
So let’s examine Potash when it was just a little company and why it was such a good buy then and continues to be good to this day. First, what the hell does Potash do? To find out this information, you can use any number of Financial Websites. Yahoo! Finance is my favorite. If you scroll down to the bottom of the page after entering POT (Potash’s ticker symbol) you’ll see a business summary. It reads as follows:
Potash Corporation of Saskatchewan, Inc. (PotashCorp) engages in the production and sale of fertilizers, and related industrial and feed products in North America. The company manufactures and sells solid and liquid phosphate fertilizers; animal feed supplements; and industrial acid, which is used in food products and industrial processes. It also produces nitrogen fertilizers, as well as nitrogen feed and industrial products, including ammonia, urea, nitrogen solutions, ammonium nitrate, and nitric acid. PotashCorp's primary customers for fertilizer products include retailers, dealers, cooperatives, distributors, and other fertilizer producers. It sells purified phosphoric acid directly to consumers of the product. The company was founded in 1953 and is based in Saskatoon, Canada.
What? A fertilizer company? That’s what the most exciting thing you’ve invested in is? Surely you must be joking, you say. Such a boring company should have boring returns. Not so. If you take anything from this entry, let it be this:
The more “boring” the investment, the better. Investing in things that people NEED instead of just WANT is a way to curb your risk. When the tech bubble crashed, I did not lose any money because I was not invested at all in technology. I’ve always lost money when I’ve invested in tech stocks. Call me old fashioned, but I like my companies to have earnings and tangible products. It keeps me from losing my shirt!
That being said, when you look to buy a company you should not really be looking at it’s per-share price. Instead, think of it like this: You are going in on a business with a guy named Mr. Market. Every day, Mr. Market is willing to sell you a part of the company at a certain price, and he is willing to buy from you at that price as well. When Mr. Market gets overexcited, he’s willing to pay you more than the company is worth to buy those shares off your hands. When Mr. Market is depressed, he is willing to sell you his shares at a discounted value from what the business is actually worth. You should take advantage of Mr. Market as much as possible, because even though he’s an emotional guy, he doesn’t mind being used and abused for some reason!
Sounds like silly advice? Straight from the mouth of the richest man in the world, Warren Buffet.
Instead of looking at the per share value, you should look at a few other pieces of information.
Number one: The Market Capitalization. This is the most important. It is the value of the current shares multiplied by all the shares outstanding. This is the value of the company. So, if you were a billionaire and you wanted to come and buy the company outright, every single share of it and have the company all to yourself, the market cap is the price tag for that. The thing is, even though you’re only buying a fraction of the company, you should look at the whole price tag whenever you buy or sell. Is the company worth more than it should be? Is it worth less? Looking at the company as a profit producing entity as opposed to a quick trade in or out is a surefire way to success in the stock market.
Number two: The Company’s Growth Record and Predictions. Growth is like crack to a stock. Potash has been growing at around 95% per annum—that’s right folks, nearly doubling every year in size.
Number three: The Company’s management. These people will be running the company that you are part owner of, so they better be up to the task! Make sure that the people running the company have their heads on properly. Make sure they’re looking out for the shareholders, aka you, the owner!
Number four: The P/E Ratio. This number is important to compare to its competitors. The lower, the better. What this essentially is is how many earnings you’re getting per the price of the share. So if a company makes 1,000,000 profit and has 1,000,000 shares issued, it is earning 1 dollar per share. This is called the Earnings Per Share. If the stock is trading at 10 dollars, the P/E is 10—the price of 10 divided by the EPS of 1 equals 10. Compare this number to the company’s competitors to see if it is within the bounds of reason. If it is trading lower than its competitors, this may be a sign of a bargain but it may also be a sign of weakness—that is why I rate the P/E ratio lower than the other information, since it does not tell you very much on its own. More important than the current P/E ratio is the Forward P/E ratio—stocks trade based on what the future holds, and more in line with future earnings than current ones. That is why an analyst upset (earnings being much higher or lower than predicted) can be a very negative or positive thing!
That’s it for now. I’ll post more later!
How to buy a stock
Since my last entry was on real estate, which is admittedly not everyone's foray, I've decided to alternate with a stock investing entry. Investing in stocks has a few added benefits over real estate. They are as follows:
1. Averaged over the past 100 years, including every recession from 1907 to the current bear market, the stock market has the longest on equity return of any traded security. In plain English? Investing in companies bigger than your own is a surefire way to make money in the long-run, more-so than currency trading, real estate, commodities, or anything else.
2. Your stocks are much more liquid than a real estate investment. While you can usually quite simply sell a stock and get fair market value for it at any given time during trading hours, getting your money out of real estate is a much more time consuming ordeal. You either need to contact a bank and sell them a secondary lien against the property or acquire a Home Equity Loan to tap into the value of your property. Either that your you need to arrange a buyer to buy your property. Either way is much more time consuming than simply clicking on "sell" or a call to your broker.
So that being said, there is much, much more to buying a stock than simply buying a stock. Sounds weird, right? It won't by the end of this entry.
Suppose you want to own 100 shares of company X. So what do you do. Do you just call your broker and say "I'd like to buy 100 shares of X."
The answer is a resounding HELL NO!
When you purchase a stock, it is utter HUBRIS to assume that you know when the best time to buy is. NOBODY in the world can predict a stock bottoming in price. So how do you solve this issue?
You do something called "scaling on." If you want to own 100 shares of Company X, you start by buying 25 shares of Company X. Here's why.
Suppose you buy 100 shares of Company X and the price of each share goes up 10 dollars. You just made 1,000 dollars! Good for you.
However, in the equally likely case that Company X's shares go down 10 dollars, you've just lost 1,000. In this case, you have no strategy. You just bought and hoped that the stock would go up. When it doesn't, you feel like quite the horse's ass (let me tell you I've done it before and I have felt like a horse's ass!). So let's examine the scenario if you scale on.
You own 25 shares of Company X. If the price goes up 10 dollars, you've made 250 dollars. You can sell them and pocket that money if you'd like.
Here's where the scaling on really benefits you though...
Suppose Company X's price per share goes down 10 dollars. Now, instead of just losing money, you BUY 25 more shares. If Company X was initially bought at 100, and you buy more at 90, averaged together the cost per share has now come down to 95. Now, if the stock goes back up 10 points-- that is, to the exact same price you bought the first 25 shares for-- you could sell for a profit.
Suppose the stock drops another 10 points, to 80. You buy 50 more shares. Now you've averaged your cost down to 87.5 per share. If the stock returns to the initial price you set your eye on it, you could sell it for $12.50 profit per share- and the price has never gone above what you initially would have bought it for!
Scaling in is so important that I talk about it even before the second most important rule: Diversification.
Note: I don't think you should buy 100 companies-- I think for an initial portfolio, 5 good solid companies are all you need. However, each of these companies NEEDS to be in a different sector. Why is this? Because 50% of the stock's move is affected by the SECTOR it's in and has nothing to do with the company. So if you bought Chevron and Exxon-Mobil instead of just buying one or the other, you'd be twice as prone to SECTOR RISK. You should instead spread your initial investments out among many different types of stocks.
...Oh, and that being said, never, ever invest in an airline stock. My first investment was in Continental Airlines and I lost a lot of money. Don't ask me why, perhaps it's the razor thin profit margins or the masses of competition, but airline stocks just plain suckity suck suck suck. My favorite companies are always ones that provide something that people NEED no matter what. They're not as sexy as tech stocks, but they perform the best. One of my favorite companies over the last five years is Potash. They are a fertilizer supplier. How boring is that? But they have international exposure during a mounting food crisis. You couldn't ask for much better of an investment of that.
I'm starting to realize this blog entry could go on for ages, so I will have to cut it short and continue some other time. I do want to touch on dividends-- they can be important, but Warren Buffet says that a company that does not know how to reinvest its earnings properly is the only company that issues dividends... I won't get into it too much, but it's for taxation reasons. Still, a dividend is a nice thing for a stock to have, and some of the really beaten down stocks have dividends in excess of 5 - 6% annually these days-- which is a return greatly in excess of the meager returns that Certificates of Deposit offer!
Review:
1. Stocks are the best on equity return of any investment. A well diversified and properly constructed portfolio will do well over the long run.
2. Never buy all at once, that's just hubris! Buy 1/4, 1/4, 1/2, of your position. Or if you want to be more conservative, 20%, 20%, 30%, 30%. The first one is easier to average your cost basis, and it's up to you to decide whether you want to add a second commission.
1. Averaged over the past 100 years, including every recession from 1907 to the current bear market, the stock market has the longest on equity return of any traded security. In plain English? Investing in companies bigger than your own is a surefire way to make money in the long-run, more-so than currency trading, real estate, commodities, or anything else.
2. Your stocks are much more liquid than a real estate investment. While you can usually quite simply sell a stock and get fair market value for it at any given time during trading hours, getting your money out of real estate is a much more time consuming ordeal. You either need to contact a bank and sell them a secondary lien against the property or acquire a Home Equity Loan to tap into the value of your property. Either that your you need to arrange a buyer to buy your property. Either way is much more time consuming than simply clicking on "sell" or a call to your broker.
So that being said, there is much, much more to buying a stock than simply buying a stock. Sounds weird, right? It won't by the end of this entry.
Suppose you want to own 100 shares of company X. So what do you do. Do you just call your broker and say "I'd like to buy 100 shares of X."
The answer is a resounding HELL NO!
When you purchase a stock, it is utter HUBRIS to assume that you know when the best time to buy is. NOBODY in the world can predict a stock bottoming in price. So how do you solve this issue?
You do something called "scaling on." If you want to own 100 shares of Company X, you start by buying 25 shares of Company X. Here's why.
Suppose you buy 100 shares of Company X and the price of each share goes up 10 dollars. You just made 1,000 dollars! Good for you.
However, in the equally likely case that Company X's shares go down 10 dollars, you've just lost 1,000. In this case, you have no strategy. You just bought and hoped that the stock would go up. When it doesn't, you feel like quite the horse's ass (let me tell you I've done it before and I have felt like a horse's ass!). So let's examine the scenario if you scale on.
You own 25 shares of Company X. If the price goes up 10 dollars, you've made 250 dollars. You can sell them and pocket that money if you'd like.
Here's where the scaling on really benefits you though...
Suppose Company X's price per share goes down 10 dollars. Now, instead of just losing money, you BUY 25 more shares. If Company X was initially bought at 100, and you buy more at 90, averaged together the cost per share has now come down to 95. Now, if the stock goes back up 10 points-- that is, to the exact same price you bought the first 25 shares for-- you could sell for a profit.
Suppose the stock drops another 10 points, to 80. You buy 50 more shares. Now you've averaged your cost down to 87.5 per share. If the stock returns to the initial price you set your eye on it, you could sell it for $12.50 profit per share- and the price has never gone above what you initially would have bought it for!
Scaling in is so important that I talk about it even before the second most important rule: Diversification.
Note: I don't think you should buy 100 companies-- I think for an initial portfolio, 5 good solid companies are all you need. However, each of these companies NEEDS to be in a different sector. Why is this? Because 50% of the stock's move is affected by the SECTOR it's in and has nothing to do with the company. So if you bought Chevron and Exxon-Mobil instead of just buying one or the other, you'd be twice as prone to SECTOR RISK. You should instead spread your initial investments out among many different types of stocks.
...Oh, and that being said, never, ever invest in an airline stock. My first investment was in Continental Airlines and I lost a lot of money. Don't ask me why, perhaps it's the razor thin profit margins or the masses of competition, but airline stocks just plain suckity suck suck suck. My favorite companies are always ones that provide something that people NEED no matter what. They're not as sexy as tech stocks, but they perform the best. One of my favorite companies over the last five years is Potash. They are a fertilizer supplier. How boring is that? But they have international exposure during a mounting food crisis. You couldn't ask for much better of an investment of that.
I'm starting to realize this blog entry could go on for ages, so I will have to cut it short and continue some other time. I do want to touch on dividends-- they can be important, but Warren Buffet says that a company that does not know how to reinvest its earnings properly is the only company that issues dividends... I won't get into it too much, but it's for taxation reasons. Still, a dividend is a nice thing for a stock to have, and some of the really beaten down stocks have dividends in excess of 5 - 6% annually these days-- which is a return greatly in excess of the meager returns that Certificates of Deposit offer!
Review:
1. Stocks are the best on equity return of any investment. A well diversified and properly constructed portfolio will do well over the long run.
2. Never buy all at once, that's just hubris! Buy 1/4, 1/4, 1/2, of your position. Or if you want to be more conservative, 20%, 20%, 30%, 30%. The first one is easier to average your cost basis, and it's up to you to decide whether you want to add a second commission.
Your Team
I've been debating back and forth whether to go with a residential real estate or stock entry as my first concrete entrance into the world of investing. I've decided since Real Estate is my passion, is more concrete and thus less likely to lose you your shirt, and is, most importantly, my area of expertise I will start there.
When examining your financial future, you need to think of it like you're building a house. A house will not stand without a firm foundation. This firm foundation is what you must build before you can become rich. People with bad habits try to build a house on a bad foundation, and find themselves in serious trouble.
That being said, the foundation of your success as a real estate investor is your employees.
Now, don't be afraid of the idea of having employees. Most of the people you employ will not ask a dime from you unless you're making money. Your initial team will consist of the following people:
1. Your BUYERS Agent.
2. Your Property Manager.
3. Your Mortgage Banker.
4. Your Accountant.
5. Your Lawyer.
Your Buyer's Agent is one of the most important members of your team, especially if you are unfamiliar or new to the property market you are entering. DO NOT GET A JOINT AGENCY, YOU WILL GET SHAFTED. If you look at the fine print on many joint agency papers, it will tell you that joint agents ONLY have obligation to SELLING the property. I don't know why this is legal, but it is, and you will get hurt if you use joint agency. Have an agent on YOUR side, that wants you to succeed, and is looking out for you. Furthermore, in most states, the agents take their fee from the sale of the property, so you don't even have to pay your agent a dime!
Your property manager will be your favorite person within a few months of owning real estate. Most people don't own real estate because they're afraid of the "toilet at midnight" syndrome. "Why would I want to rent out property, I'd be called at all hours to fix silly problems that tenants have." No, you won't, if you use a property manager. Your property manager, if they're good, will not take more than 10% monthly rent to take 99% of burdens off of you, which allows you to move on to acquiring more investments. If you move into new places, always have a new property manager in each area that is familiar with rental rates-- especially if you're not! You can save yourself some trouble by inviting your property manager along to new acquisitions. He/she will be able to tell you potential rent and how quickly they will be able to fill your units.
Your Mortgage Banker, if he's good, will be able to get you the financing you need. If you run into trouble getting proper financing at larger banks, try smaller, local banks-- they may be willing to work with you more if you're a member of the community. Having a good mortgage banker means that months down the road he'll call you to let you know rates have dropped and that you should refinance. Having a mortgage professional on your side will save you thousands in costs.
Your Accountant is necessary to manage your finances once you have a few properties under your belt. It's possible to do by yourself, but I wouldn't recommend it! The last thing you want is the IRS auditing you-- the banks that have invested their money in you will NOT like to see that at all. Do it right, hire a professional and pay a little extra to keep yourself from being crushed.
Your lawyer is necessary for two reasons: To establish your Company, which you should always invest through (For Liability issues) and to protect you in the case of tenant lawsuit. If you have a good property manager who takes care of the tenants and the property, that won't happen very often, but some tenants can be litigious and it never hurts to have proper legal council.
Sounds overwhelming? It is. That's why you need a team at your back. Not only will your team be looking out for your best interests because it is in THEIR best interests, but when you first start as an investor you will be wet behind the ears and their advice will prove invaluable! Remember, if you gather a team and don't like any member of it, YOU CAN FIRE THEM. That's the beauty of being Boss. ;)
Review for the day:
1. Your team is the foundation of your real estate investments. A good team makes the difference between succeeding without too many headaches and not.
2. Be as involved as possible and learn as much as possible from your team members. Pick up a little something on how mortgages work, learn how property management works, understand the value of property in your area. Be a jack-of-all-trades. Rich people do not specialize the way the middle-class do, but instead know a bit about everything, because they have to-- it will be your job to understand the workings of your business in it's entirety.
3. Don't be afraid of saying "No." This isn't really review, but I thought I'd throw it in anyways. Your tenants will always ask for new stuff, "No" should be a word you become familiar with. I'm not saying treat your tenants like crap, but if you give some people an inch they'll want a mile. Make sure to be diligent on your duties as landlord, but don't give away all your profits trying to please some people because it will never be enough.
When examining your financial future, you need to think of it like you're building a house. A house will not stand without a firm foundation. This firm foundation is what you must build before you can become rich. People with bad habits try to build a house on a bad foundation, and find themselves in serious trouble.
That being said, the foundation of your success as a real estate investor is your employees.
Now, don't be afraid of the idea of having employees. Most of the people you employ will not ask a dime from you unless you're making money. Your initial team will consist of the following people:
1. Your BUYERS Agent.
2. Your Property Manager.
3. Your Mortgage Banker.
4. Your Accountant.
5. Your Lawyer.
Your Buyer's Agent is one of the most important members of your team, especially if you are unfamiliar or new to the property market you are entering. DO NOT GET A JOINT AGENCY, YOU WILL GET SHAFTED. If you look at the fine print on many joint agency papers, it will tell you that joint agents ONLY have obligation to SELLING the property. I don't know why this is legal, but it is, and you will get hurt if you use joint agency. Have an agent on YOUR side, that wants you to succeed, and is looking out for you. Furthermore, in most states, the agents take their fee from the sale of the property, so you don't even have to pay your agent a dime!
Your property manager will be your favorite person within a few months of owning real estate. Most people don't own real estate because they're afraid of the "toilet at midnight" syndrome. "Why would I want to rent out property, I'd be called at all hours to fix silly problems that tenants have." No, you won't, if you use a property manager. Your property manager, if they're good, will not take more than 10% monthly rent to take 99% of burdens off of you, which allows you to move on to acquiring more investments. If you move into new places, always have a new property manager in each area that is familiar with rental rates-- especially if you're not! You can save yourself some trouble by inviting your property manager along to new acquisitions. He/she will be able to tell you potential rent and how quickly they will be able to fill your units.
Your Mortgage Banker, if he's good, will be able to get you the financing you need. If you run into trouble getting proper financing at larger banks, try smaller, local banks-- they may be willing to work with you more if you're a member of the community. Having a good mortgage banker means that months down the road he'll call you to let you know rates have dropped and that you should refinance. Having a mortgage professional on your side will save you thousands in costs.
Your Accountant is necessary to manage your finances once you have a few properties under your belt. It's possible to do by yourself, but I wouldn't recommend it! The last thing you want is the IRS auditing you-- the banks that have invested their money in you will NOT like to see that at all. Do it right, hire a professional and pay a little extra to keep yourself from being crushed.
Your lawyer is necessary for two reasons: To establish your Company, which you should always invest through (For Liability issues) and to protect you in the case of tenant lawsuit. If you have a good property manager who takes care of the tenants and the property, that won't happen very often, but some tenants can be litigious and it never hurts to have proper legal council.
Sounds overwhelming? It is. That's why you need a team at your back. Not only will your team be looking out for your best interests because it is in THEIR best interests, but when you first start as an investor you will be wet behind the ears and their advice will prove invaluable! Remember, if you gather a team and don't like any member of it, YOU CAN FIRE THEM. That's the beauty of being Boss. ;)
Review for the day:
1. Your team is the foundation of your real estate investments. A good team makes the difference between succeeding without too many headaches and not.
2. Be as involved as possible and learn as much as possible from your team members. Pick up a little something on how mortgages work, learn how property management works, understand the value of property in your area. Be a jack-of-all-trades. Rich people do not specialize the way the middle-class do, but instead know a bit about everything, because they have to-- it will be your job to understand the workings of your business in it's entirety.
3. Don't be afraid of saying "No." This isn't really review, but I thought I'd throw it in anyways. Your tenants will always ask for new stuff, "No" should be a word you become familiar with. I'm not saying treat your tenants like crap, but if you give some people an inch they'll want a mile. Make sure to be diligent on your duties as landlord, but don't give away all your profits trying to please some people because it will never be enough.
Don't be afraid of debt.
Okay, I thought for a bit what would be another good introductory lesson into the life of the rich and fabulous. I thought I might dive into the specifics of real estate investing, but it then occurred to me that there's something much simpler and fundamental to becoming rich. And that is:
Don't be afraid of debt.
Now, don't misunderstand me-- Not all debt is created equal. The credit card debt I mention in my last entry is what's known as BAD DEBT. Bad debt is the sort of debt that is not achieving you anything: Bad debt is debt towards that brand new TV you couldn't resist getting but couldn't really afford. Bad debt causes you heart ache.
But rich people have debt too. It's called good debt.
When buying a $1,000,000 piece of commercial property, you'd be hard pressed to find a single property developer or real estate investor that would want to pay that in full. That is why one sells a primary lien on their new property, which is also known as the primary mortgage. Your mortgage that you sell to a bank is leveraged to the piece of property- So, instead of putting $1,000,000 down, you put a percentage--say $200,000 down. Now, every month, you pay on your remaining balance of your $800,000 mortgage. You are now $800,000 in debt. Yikes!
So why is this good debt? Here's why:
Your commercial property is ripe and ready to go, and you sign a five year lease with your local Ford Dealership. They move in and pay you $10,000 a month to rent the space. Your mortgage payment is for around $5,000 a month. Because your income from your commercial tenant is earning above and beyond your payments on your debt, your debt is actually earning you money. This is called leverage.
Let's look at the return on the investment if you bought it outright Vs. you leveraging it with debt.
If you invested 1,000,000 dollars and earned 10,000 a month, your return would be 120,000 dollars per year on a 1,000,000 investment. Roughly a 12% return. Not terrible.
However, if you leverage your position, you're only investing 200,000 dollars. Now, because of your mortgage, your income is only about 5,000 a month, which is 60,000 a year. However, since your down payment is only 200,000, you're earning a 30% return on investment-- almost three times the value!
So if you learn anything from this entry, it's:
a) Not all debt is created equal
b) Debt can be used to purchase cash positive producing investments so long as your cash inflow is greater than your debt payment outflow.
c) Don't be afraid of a little debt, because no rich person is without it!
Don't be afraid of debt.
Now, don't misunderstand me-- Not all debt is created equal. The credit card debt I mention in my last entry is what's known as BAD DEBT. Bad debt is the sort of debt that is not achieving you anything: Bad debt is debt towards that brand new TV you couldn't resist getting but couldn't really afford. Bad debt causes you heart ache.
But rich people have debt too. It's called good debt.
When buying a $1,000,000 piece of commercial property, you'd be hard pressed to find a single property developer or real estate investor that would want to pay that in full. That is why one sells a primary lien on their new property, which is also known as the primary mortgage. Your mortgage that you sell to a bank is leveraged to the piece of property- So, instead of putting $1,000,000 down, you put a percentage--say $200,000 down. Now, every month, you pay on your remaining balance of your $800,000 mortgage. You are now $800,000 in debt. Yikes!
So why is this good debt? Here's why:
Your commercial property is ripe and ready to go, and you sign a five year lease with your local Ford Dealership. They move in and pay you $10,000 a month to rent the space. Your mortgage payment is for around $5,000 a month. Because your income from your commercial tenant is earning above and beyond your payments on your debt, your debt is actually earning you money. This is called leverage.
Let's look at the return on the investment if you bought it outright Vs. you leveraging it with debt.
If you invested 1,000,000 dollars and earned 10,000 a month, your return would be 120,000 dollars per year on a 1,000,000 investment. Roughly a 12% return. Not terrible.
However, if you leverage your position, you're only investing 200,000 dollars. Now, because of your mortgage, your income is only about 5,000 a month, which is 60,000 a year. However, since your down payment is only 200,000, you're earning a 30% return on investment-- almost three times the value!
So if you learn anything from this entry, it's:
a) Not all debt is created equal
b) Debt can be used to purchase cash positive producing investments so long as your cash inflow is greater than your debt payment outflow.
c) Don't be afraid of a little debt, because no rich person is without it!
Compound Interest
If you're reading this, it's because you're vaguely interested in how rich people become rich. As a person that is in the process of becoming rich,I have absolutely no problem divulging any secrets of how it's done to anyone that wants to know. I enjoy teaching, and furthermore, you learn a lot when you yourself teach.
The first thing I want to talk about is the most basic element of wealth building: Compound Interest. Compound Interest, as Einstein said, is the strongest force in the world. Why so many people end up in debt is because they get on the wrong side of Compound Interest. The Credit Card companies do not make it any easier: They design their bills to have only the minimum payment made so they can compound interest against you.
Let's look at compound interest in effect. Suppose you charge $1,000 to a credit card and never pay it off. For illustrative purposes, let's pretend the credit card company won't come after you but will instead simply charge you interest every month diligently. If the credit card has a 20% APR, after year one you will now owe $1,200-- $200 worth of interest has been recorded against you.
The next year, however, you will not owe $1,400-- you will owe $1,440, because your interest is calculated including the interest from the former month. Let's see how quickly this develops against you:
Year 1: $1,200
Year 2: $1,440
Year 5: $2,488
Year 10: $6,191
By Year 10, you owe over 6 times the original amount. By compounding the amount, you now have to pay $5,191 worth of interest-- or 519.1%. So that 20% rate? It's actually more like a 51.9% rate by year ten.
Compound interest can be dangerous, but it can also reward those who understand it.
Now, assume you have an investment that gets you a 20% return annually. This is not impossible--if you find a good rental property or small business, a return like that and above is certainly possible. If you compound that return over the course of, say, 40 years, a $1,000 investment would be worth roughly $1.5 million.
Thus, if you get anything from this entry, know this: Start early, avoid investments that do not provide you immediate, tangible cash flow, and always have compound interest in your favor.
The first thing I want to talk about is the most basic element of wealth building: Compound Interest. Compound Interest, as Einstein said, is the strongest force in the world. Why so many people end up in debt is because they get on the wrong side of Compound Interest. The Credit Card companies do not make it any easier: They design their bills to have only the minimum payment made so they can compound interest against you.
Let's look at compound interest in effect. Suppose you charge $1,000 to a credit card and never pay it off. For illustrative purposes, let's pretend the credit card company won't come after you but will instead simply charge you interest every month diligently. If the credit card has a 20% APR, after year one you will now owe $1,200-- $200 worth of interest has been recorded against you.
The next year, however, you will not owe $1,400-- you will owe $1,440, because your interest is calculated including the interest from the former month. Let's see how quickly this develops against you:
Year 1: $1,200
Year 2: $1,440
Year 5: $2,488
Year 10: $6,191
By Year 10, you owe over 6 times the original amount. By compounding the amount, you now have to pay $5,191 worth of interest-- or 519.1%. So that 20% rate? It's actually more like a 51.9% rate by year ten.
Compound interest can be dangerous, but it can also reward those who understand it.
Now, assume you have an investment that gets you a 20% return annually. This is not impossible--if you find a good rental property or small business, a return like that and above is certainly possible. If you compound that return over the course of, say, 40 years, a $1,000 investment would be worth roughly $1.5 million.
Thus, if you get anything from this entry, know this: Start early, avoid investments that do not provide you immediate, tangible cash flow, and always have compound interest in your favor.
