Am I Ready for Investing?

Over the last few months, over a dozen friends and relatives have asked me how to invest to get passive income. I've talked myself hoarse from sharing the few strategies that I use and the basics on how to execute on those strategies.

There are many investment opportunities and investment strategies out there. Not all of them are suitable for you. But if you have large savings sitting in a GIC or a Savings Account wondering if you can I make more than that, the answer is yes.

That being the case, the next question that follows is "how risky". The simple answer to that is "more". So before you delve into the details of investing, you should first examine your situation and yourself to see if you have what it takes to take on this added risk. Here are some questions to ask yourself:

• Do I have money to invest that I won't use for anything else?
  To make a passive income, you have to have money invested the whole time. Call this seed money. Seed money isn't liquid. This means that you cannot just take it out anytime you want. You can take out your income you make off the seed money but the seed money itself should remain invested. The larger your seed money, the larger your potential to reduce your risk.
  
• Am I temperamental?
  Warren Buffet, one of the world's most respected investors, once said "Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing." From experience, I can say that when the economy looks really bad or really good, it's easy to make brash decisions that will bite you in the end. The more you have stomach for this, the less risky you will be to yourself.
  

If you don't fit the bill on these exploratory questions, it's best to stand pat with the GICs and Savings Accounts.

Using Money to Make Money II

Finally, this is the conclusion from a previous blog on making money with money. Sorry about the wait.

After a series of mishaps with the lender, the lawyer and the broker, I finally got the mortgage arrangement I wanted. I extended my amortization by about 10 years and was able to pocket a cool sum while paying the same P&I each month.

On top of that, my home value went up and I was able to roll the additional equity as a line of credit.

Now I've some investment money at a pretty good rate of < 5%. The next thing is to find investment opportunities where I could comfortably beat 5% as a return on investment. I was toying with the idea of real estate for the longest time but eventually opted not to do real estate for 2 main reasons.

1. It didn't leave me much cash for a rainy day.
2. Based on my calculations, the rental ROI for a downtown property only allowed me to break even.

I have a simplistic way of calculating ROI for rentals:

100% * (Expected Monthly Rent * 11 / Price You Paid for the Property) - Expected Annual Expenses

Expected Monthly Rent is how much you can reasonably charge for your property in order to minimize your likelihood of vacancy. You multiply by 11 because chances are if you get a vacancy, it'll take you 1 month to fill it.

Price You Paid for the Property is exactly that.

Expected Annual Expenses should include things like repairs, maintenance fees, utilities, taxes and cost of borrowing.

I ended up investing half the sum I had in stocks and was able to break even within a couple of months.

Using Money to Make Money

As I'm planning to have a family soon, I've been contemplating for the past few months how I can work less and make more. It's not greed. I just want to be able to make free time so I can be with my children in their formative years. I've oft heard of how one should use money to make money but was never sure how to go about doing that - until recently.

So this is the beginning of a work-in-progress plan that my wife and I have on using our money to make money. I'll try to update on our progress as you may be able to benefit from our experience.

To provide context, this plan would work in Canada, and likely Australia, and perhaps other Commonwealth countries with similar taxation and real estate laws. We have about 15 years left on a mortgage on our home that has increased in value over the past few years.

The basic plan is to leverage the equity in our home for downpayment. Then extend the amortization on our mortgage to enable us to borrow more while keeping our regular payments the same. That combination will be used to buy an investment property which we intend to rent.

We are now at the first part of our plan. Securing financing. We approached a mortgage broker to secure financing under these assumptions:

• our regular mortgage payments (P&I) should remain the same
• only our amortization period is extended to the maximum allowable

What we need to find out is:

• how much of our equity can we use for downpayment on the investment property
• how much can we borrow maximum

With this information, we know the upper limit of what we can afford. Once we get financing approved, we can start hunting for an investment property. Stay tuned for what happens next.

Investing and Managing Wealth

Even for young people, it is important to start learning how to invest at an early age. There are many reasons for its importance. The trend of rising costs of living means that staying alive after your working days are through is going to be expensive - more expensive than today. Furthermore, the trend towards nuclear families means that the burden of your retirement will likely not be completely born by your children. Investing and wealth management is how you bridge the gap.

Sadly, this topic isn't something that everyone gets a chance to learn. Yet, it's something that everyone needs to know. When should you invest? As long as you have an income, you should be investing and managing your wealth. Do you have a part-time or full-time job? Do you have some extra money left from that interest free student loan? Have some allowance from your parents?

How do you do it? Everyone's got a slightly different situation, but I'll recommend a framework that you can use (assuming you live in Canada)

Long Term Investments
I'm assuming here that you're still in your teens or your early twenties. You have decades of your career ahead of you but you can start investing in your retirement. You can afford to have a higher risk tolerance than your comfort level when talking about long-term investments. Why? Because over the long term, almost all investment products has an upward trend. This investment doesn't have to be an RRSP. Unless you make more than $10K in taxable income, there's really no point to put this money into RRSPs. RRSPs are only good for reducing your tax burden at the cost of locking away your money in something not very accessible. There are many investment products for this: funds, stocks, bonds, etc. Do some research and find a comfortable product for you. Be aware of the service charges. Service charges can severely hamper your investments.

Short Term Investments
This is your rainy day savings - the portion of your savings that you cannot afford to lose. You should keep this in a guaranteed income investment like a savings account or a term deposit. Make sure this money is very liquid (i.e. you can draw from it anytime you're in trouble without penalties or losing interest).

Diversifying and Dollar Cost Averaging
For your long term investments, you should look to diversify your investments. This means investing into various different industries and/or markets. You should also take advantage of dollar cost averaging. This means that when you have a larger sum of money available, break it up into smaller amounts and invest it regularly over a period of time rather than one lump sum. These strategies reduce your risk for long term investments. Don't bother doing this for your short-term guaranteed income investments.

Proportions
How much of your income should you save? That depends on your budget. Please refer to my blog on budgeting to find out how much you can save.

How much should go into short term investments and how much should go into long term? While you're still young, you can put a larger portion of your savings into long term. Say, 90%. As you age and as your need for rainy day money grows, you should lower that percentage down.

Simple Budgeting for Youth in Debt

I've previously talked about things like how much you can borrow and what youth should do when they've borrowed too much. One of the step I mentioned before was to reduce your spending. To do that effectively, you need to plan your spending and follow through on your plan. This is called budgeting. There are several different budgeting methods described on the Internet but I will cover the one I have used to help some friends out of debt.

Step 1 - Calculate how much you make.
This is fairly simple. Find out your take home on each pay cheque (i.e. excluding the tax, CPP, or EI deductions). Multiply it by the number of times you get paid in a year. Don't forget to add your other sources of income, e.g. rental income. Also don't forget those odd income sources such as bonuses.

Step 2 - Calculate how much you spend annually.
Think about what you spend on. I normally organize my thoughts based on payment frequency. What are the things I pay annually? e.g. Car insurance. What are the things that I pay semi-annually? e.g. Property taxes. What are the things I pay bimonthly? e.g. Hydro. So and and so forth down to what I pay for weekly? e.g. Lunch, Coffee. Don't forget to add a miscellaneous expenses item.

Step 3 - Add your debt servicing into your annual spending.
If you have consolidated your debts already, you will know what amount you need to pay to service your debt on a monthly basis. Add this amount to your annual spending. If you haven't consolidated, go do that.

Step 4 - Balancing your budget.
Now you know how much you make in a year and how much you spend. Subtract your income from your expense. What's the difference? If the difference is positive, then the budget is done. If it's negative, then you have some work to do, so read on.

Divide your expenses into 2 categories: Must Have (Necessities) and Nice to Have (Luxuries). Your debt servicing is a Must Have, by the way. Then start taking away luxuries that you are willing to give up in order to service your debt. This is where your life style starts taking a hit. Keep chewing away at the luxuries until the difference between your income and expenses is positive. Then, you're done with the budget.

If you've given up all the luxuries and still come up in the red, you'll need to move on to step 5. Otherwise, skip to Step 6.

Step 5 - Calculate Your Assets
Take into stock all the major assets you have - everything that you can sell for some significant value that can be used to service your debt (real estate, vehicle, piano, etc.) . Sum this all up. Then try to rebalance your budget by selling off these major assets. Sell off more assets until the difference between your income + sold assets and expenses is positive.

Step 6 - Executing Your Budget
Once the difference is positive, you have budget - a plan on how to spend for the next year. Stick to your plan. Make sure you only spend on the things that are still in your expense budget. Make sure you sell the assets you said you were going to sell for at least the price you put in your budget. Make sure that you make at least as much as your income budget. Repeat this budgeting process every year until your debt is under control. Even if you've paid off your debt, you can easily convert that debt servicing amount into savings or investments. Those are topics for another day.

Now, if you've taken away all your luxuries and sold all your assets but the difference is still negative, you need to seek pardon for some or all of your debts. This is outside the scope of this blog but there are several debt/bankruptcy services available and you may even find some on the ads in the margin. You'll need to seek help from such professionals.

Mortgages & Loans

Buying a home is one of the most important purchases in life. It is a very expensive proposition, so you're likely to have to look into taking out a mortgage to pay for your home. Borrowing vast sums of money is very threatening so this blog will give some guidelines on just how much you can afford so you don't lose too much sleep over it.

Firstly, you'll need to have an income. Once you have that, here are some guidelines:

• The payments you make to pay off your debts in a year should not exceed 25% of your gross annual income. You can stretch this up to 31% but you'll have to sacrifice your standard of living.
• You should pay off your loan before you retire, so best to use an amortization period that ends before your retirement. You can stretch your amortization to keep your payments low, but you will need to continually push towards higher incomes so you can pay off your loan quicker. Don't stretch if you don't want the added stress.
  

The total debt (i.e. how much you can borrow) will be based on the above 2 factors so it is largely dependent on your age and when you plan to retire. From my own experience, if you plan to work for the next 25 years, you can borrow up to roughly 3x - 3.5x your gross annual income.

Hopefully, these guidelines will help you manage your debt in a way that'll leave you some breathing room to sustain a decent lifestyle.

Paying for School

These days, post secondary education is extortionately expensive. With easily accessible student loans, one may think that schooling is easy to pay for. But alas, students graduate only to face an insurmountable loan. Yikes! After graduation is usually when you need money the most. That's when you can explore the world and live out your independence. Unfortunately, a big loan is going to set back your plans by many years. So here are some practical things you can do while at school to avoid this situation down the road.

Minimize Borrowing

• Student loans are a valid payment option but minimize your use
• Do your best to keep your student loans under 1/2 of your projected gross annual income of your first job (yes, start thinking about how much you can realistically make in that first job out of school)

Co-Operative Education (or some kind of paid internship program)

• This is the single most valuable experience in my personal schooling
• It helps pay off school (and other luxuries)
• Provides work experience - prevents the proverbial catch-22 problem of experience/skills
• Helps develop confidence, job interview skills & resume writing skills
• Helps build professional networks

Work on Semester Breaks

• If you take a semester break, get a job

Scholarships

• Apply for scholarships if you think you might qualify
• You'll never know if you'll get one unless you try

Spending

• Students need to practice spending behaviours on a shoe-string budget
• Pack your lunches as much as possible
• Get that bus pass and whatever discounts available for students
• Live at home with your parents if you can

Buying Your First Vehicle

What's the difference between leasing vs. purchase financing? I hear this question asked a lot, especially for those getting their first new car from a dealership. So what is the difference... really?

Purchase Financing is taking out a loan for the purpose of buying a vehicle. You will be paying for the full price of the car plus interest. In this type of financing, the car is legally owned by you at the time of purchase (ownership doesn't mean much in a depreciating asset). At the end of the amortization period (i.e. when you pay off your loan), you can keep the car. The monthly payments are higher because you're borrowing more to pay the full price of the vehicle. Typically amortization periods (the length of time it takes to pay off the loan) is 7 years or less.

Lease Financing is an option usually only available for new cars where you pay for the use of a vehicle for a period of time (called the lease period). The amount paid is calculated by the depreciation on the car for that period of time plus interest (lease rate). Lease rates are lower and the monthly payments are lower. The typical lease period is 4 years or less. The car still belongs to the dealership for the whole time. At the end of the lease period, you have to return the car back to the dealership. You do have the option to buy the car at the end by paying what's left on the value of the car (i.e. initial purchase price - the depreciated amount). This is called the residual value.

Rule of thumb is if you're planning to change your vehicle often (every 2 - 4 years) and your vehicle is typically a luxury vehicle (over CAD$40k), leasing is likely cheaper for you. If you plan to drive your car into the ground, purchasing is better for you. Having said all that, if you really want the best deal on a vehicle, buy it used. Something within the 2 - 4 year-old range is my personal preference.

Youth in Debt by Free Credit Cards

So you just got your first credit card and now you finally can buy those gadgets and wizzbangs you always wanted. It's a great way to build credit history and the card's free too. Wow! Sounds like a great deal, right?

Well, sort of. I think there is one guideline to follow when using your credit cards. Make sure you can pay off the full balance at each billing cycle! Don't just pay the minimum. Never run a balance into the next billing cycle. If you don't have any income, don't use your credit card. Free credit cards charge crazy amounts of interest that adds up quickly.

If you're already in credit card trouble, then you need a plan to get that back in control. There are 3 ways to help reduce debt and none of them are easy. Best to stay out of trouble in the first place. Here are the steps:

• consolidate your debts - move all your debts to one account with lower interest - maybe a personal creditor (mom and dad?) or a line of credit
  
• increase income - get a job or get a raise
• reduce spending - budget your spending, slash your luxuries, take the bus, ride the bike and please cancel the credit cards.