The Wealth of Generations W H Y I N C R E A S I N G P E O P L E ’ S P E R S O N A L W E A LT H WILL INCREASE PEOPLE’S FREEDOM
BY INGEMAR ALEXANDER ANDERSON F I R S T P R E - E D I T I O N ( D R A F T 2 014 0 3 01 )
Published by Kitsap Printing, United States of America Cover Design by Ingemar Anderson First Edition LafundiaTM is a trademark of Lafudia, LLC, www.lafundia.com Copyright Š 2013 by Ingemar Alexander Anderson ISBN 978-0-9894551-0-7 All rights reserved.
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Ingemar Anderson was born in Stockholm and grew up in Germany in the State of Bavaria before he immigrated to the United States in his late thirties. He is an entrepreneur, investor, business analyst and manager. He has worked and lived in many cities all over the world - amongst them: Munich, Frankfurt, Paris, London, Tokyo, San Francisco, Los Angeles, Boston, Boise, Seattle and Monterrey. Mexico. Ingemar has a bachelor of science in informatics and a master of business administration in finance. His exposure to the European, Asian and American ways of life and business culture have shaped his view on financial management and the micro and macro economy.
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Dedication
This book is dedicated to my grand father Ingemar Per Aae who came from Sweden to the United States in 1934 to study and practice modern accounting as financial auditor in Chicago, Illinois. Ingemar died too young at the age of 34 in 1943 and left behind his dear wife M채rta and his three year old son. Even though I have never met my grand father and have only heard and read so little about him, he inspired me all my life, and he will always remain in my memories as my silent mentor. I thank my wife Barbara for her endless patience with me and the time she spent listening and responding to my ideas and thoughts. I thank my son Benjamin, whose free spirit gave me the motivation to write this book. [Picture taken by a professional photographer in Stockholm, Sweden in 1936]
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Table of Contents Dedication The Moral Grounds of Wealth Chapter 1: Self Assessment ................................................. Financial Freedom is relative Investor Levels Division of Labor Chapter 2: Asset Classes ..................................................... Chapter 3: The Investor ...................................................... Investment Styles What's your WILL Chapter 4: The Business Owner ........................................... Chapter 5: Wealth Management ........................................... Asset Quadrants The Rules of Sophisticated Investors Your Monthly Statements Social Networks for Investors Chapter 6: Asset Development ............................................. Life of an Asset Unproductive Assets Asset Purchase Bubbles and Schemes Dead Cows Liabilities and Assets Asset Income Exit Strategies Retirement Assets Chapter 7: Asset Ownership and Control ............................... Ratings and Scores My Home- My Asset? Chapter 8: Your Action Plan ................................................. Chapter 9: Epilogue (Novel-Style Outro)................................. v
ii vii 21 28 32 40 44 53 61 64 70 76 81 87 91 95 97 99 104 112 114 119 125 133 138 140 145 150 155 159 163
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The Moral Grounds of Wealth Which precedes the other: wealth or morals? Or are morals just in the way of getting wealthy? Can wealth exist without morals? What is actually wealth? These are questions this book is attempting to answer. I hope that I am able to show the reader how to build simple but lasting wealth in a world where fundamental changes are underway. I have personally seen under what poor conditions people live after they have been governed by communist regimes aimed to destroy people’s religions and families in the eastern states of Europe and in Communist China. When I visited parts of my family in Eastern Germany before and after the wall came down in 1989 I saw run down cities, grey and abandoned houses and broken windows. I remember when I visited my aunt Berta in 1984 in Jena, a small town in communist Eastern Germany. It was a typical multi-family house, and her bathrooms did not even have a water flushed toilette. I could smell the distinct stench of cheaply burned coal in every corner of the city. I have met people in Eastern Germany who have lived under a communist government for several decades, and these impressions have formed many of my believes in dysfunctional societies. Later in my life when I immigrated to the United States in the late nineties I saw a democracy, where people are meant to be free and are guided by their own strong moral values. They could trade and build wealth under this moral conduct. However, since then a lot has changed. I have witnessed that virtues have been undermined by commercial advertisements and political influence. Today, it seems that negative traits are being promoted overly. Have you watched scenes in TV commercials in which people envy their neighbors for having the latest products like a new car or another consumer item? Have you seen ads that promote greed, lust or excessive behavior? Vices seem to have become more acceptable in our lives even
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though we admit that too many of negative character traits are not good for us. How can we keep our vices under control? Religions are one way to learn and teach the basic morals. However, commonly accepted morals today have little to do with religion. Morals are the basic values for any wealthy society: they are known as the seven virtues. On the other side, there are the seven vices, which are known as the seven negative character traits. The Formula for Wealth For the sake of this book, lets stick to the following seven virtues: diligence, patience, kindness, humility, temperance, abstinence and gratitude. Everybody of us has the tendency to accept at least some of these virtues in one way or the other. But we are also often victims of our own greed, lust, excess, pride, envy, wrath and sloth. I believe it is not hard to argue that a person who can balance the seven virtues and the seven vices will more likely succeed in life than someone who is obsessed with one or more of the seven virtues and vices. I picture the virtues and vices pinned on a steering wheel of a big old ship. When the ship goes straight on the ocean waters it means the ship holds its course, and it will reach its destination. The upper part of the steering wheel is illustrated by the virtues, and the lower part is filled with all the bad habits, the vices. Of course, the ship has to be maneuvered, so the steering wheel has to be turned. At some point, some vices will appear above the sea-line, appear on the surface. And some virtues will disappear under the horizon. We live on earth, and sacrifices have to made, it is not a perfect world. We all are prone to some of the vices at some point or the other. So, I came up with the Wheel of Wealth. For me, it is a compass that shows me the way to my own integrity and, as I will describe later, ultimately to wealth. If I had known the Wheel of Wealth when I was younger, I would have done many things very differently. I would have had different friends, I would have seen their human weaknesses earlier, and I could have tried to guid them or I could have looked for other friends. I realize today that many of my family members and friends have been and still are obsessed with all kinds of vices, but also virtues. I have lost a very close person viii
FIGURE The Wealth of Generations.1 The Wheel of Wealth
Source: Artwork created by the author on a trip to Maui, Hawaii on December 2013.
years ago to the excessive overuse of alcohol and many other drugs. I lost another to his destructive political thoughts and activities related to obsessive national pride. I have lost two others to their obsessive dedication to music. I have lost a very close friend to his addiction to extreme sports, and I have lost a very good early friend to excessive greed for financial success. Luckily, I always had and still have a lot of other friends. But I have lost my obsessed friends due to the fact that all of them became blinded by their own obsessions and neglected reality and their friends for years. I lost some of them because they have been behind bars for quite some time as a result of their obsession, or I have lost them because their driver’s license has been taken away or their right to travel internationally has been limited so they could not visit me.
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All of these friends and family members are very poor today. Sure, some of them get by somehow. But many of them live from welfare and from others. Not only that they have very limited access to financial resources, their world is increasingly limited to their obsessions. Today, I hardly talk to any of them anymore, in many cases I got pulled into their negativity and their obsessions very quickly, so I have started to avoid them altogether. I realize that our human weaknesses and strengths are the ones that guide us through our lives. They are like the directions on a compass. All of us are prone to all of these behaviors. I see that some of us are more drawn to the weaknesses and some more to the human strengths. Furthermore, obsessions magnify certain human behaviors. Like a compass needle points to the North, people’s obsessions point them in a certain direction. Everybody of us has a personal North. It is the direction our destiny seems to push us towards. What's more, I believe, if the direction is towards the human weaknesses, that person will become poorer. If the direction is towards human strengths, he or she will become wealthier. It appears to me like a secret formula for wealth. I have seen people who are kind, diligent, patient, humble, temperate, give rather than take and exercise abstinence became generally wealthier than people who live in lust, greed, excess, pride, envy, wrath and sloth. I have seen with my own eyes over and over again how wealthy people have financial, human and social capital, whereas poor people are financial and social liabilities. Of course, some wealthy people might seem to be or are standoffish or even immoral. And we can find exceptions where completely immoral people become rich and famous. I have also seen people who were angel-like individuals but never accumulated any wealth. However, I believe that people who can control their virtues and vices will become wealthier than individuals who can’t. Today, our own society seems to make us more and more greedy, increase our lust for one or another product advertised, make us consume more than is good for us, make us overly pride for what we buy, own or are, make us long for our neighbors possessions, loosen our temper and make us right-out lazier. I will go that far to say: just watching too many commercials will make us poorer. Almost always, comx
mercials are made to promote products that were created by people who want to make money,. Commercials are generally not made to make the people who watch the commercials richer. Nothing wrong with that. Except, if you like to become wealthy, watching commercials will not help. So, what will help? When the code of interpersonal behavior, which is considered right or acceptable in a particular society is suppressed or even destroyed, that society will, sooner or later end up in poverty. There are many recent examples of countries that drowned in corruption while their citizens became dirt-poor. Recently, I watched a show titled “Is Greed Good?” on Fox News for Business. I was shocked by the arguments of the participants. Everybody seemed to assume that greed should or could be a part of regular business practice to make money instead of asking at what point greed will destroy a business. I believe greed is only in the way of getting wealthy; people should minimize greed, if they want to maximize their wealth. My conclusion is that people must learn and grow up with strong morals if they want to become wealthy. It is clear to me that people need a solid moral foundation to prosper. I believe when people’s morals are being suppressed they will become poor. Morals are the basis for wealth. Morals lay they ground for our education and all our actions. Without morals there is not even any true education. Actions without moral grounds lead to poverty and tyranny. When people lose their morals they will slide into poverty. In order to build wealth for generations, I believe we first need to teach our children morals, then they have a chance to becoming wealthy, and rich. It is like teaching people how to fish instead of giving them fish. Being Poor is a State of Mind As Robert Kiyosaki says: “broke is when you run out of money, poor is a state of mind”. One day I asked my seven years old son if a rich man should be considered poor when he loses all his money. Instantly, he responded: no, he will just do the same things he did when he got rich, and then he will have all his money back.
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His answer was not only remarkable because he replied so quickly, but also because his answer triggered an interesting thought in me that has kept me busy. What my son basically instinctively implied was that being rich is not about having money, he said being rich means to know how to make money. Later that day, I asked myself if a poor man would be considered rich when he suddenly owns millions of dollars. The answer must also be: no, because he will just do the same things he did when he got poor, and then he will have no money again. So, my conclusion was that becoming wealthy must be a matter of education and habits. Many generations have worked hard to become wealthy, but only a very few were able to do so. During my research on this subject, I discovered that there is a master plan behind so many people do not become wealthy: we are not being educated to becoming wealthy. In this book you will see why this has been so for so many generations. Each generation has a common goal: all try to create their own form of wealth. But almost everybody in each generation except a tiny number of elite individuals in all generations has failed miserably. Do you know anybody who can live from the returns of their financial assets? Which generation are you part of ? Over the last 150 years The Missionary Generation (1860-1882), The Lost Generation (1883-1900), The Greatest Generation (1901-1924), The Silent Generation (19251942), The Baby Boomers (1943-1960), Generation X (1961-1980) and The Millennials known as Generation Y and Internet Generation (1981-2000) have each had their challenges and hopes. I believe that due to the never-seen ease of access to knowledge and tools our current generations, the generation Z is finally able to break through the paradigm that keeps us from creating assets for generations. In this book I will try to explain how to build practical wealth for generations, for you and for your family. It will show you why you need to get out of your comfort zones in order to actually build wealth. You will be encouraged to rethink your entire past and future career and re-evaluate your financial habits. The book will show you through practical examples why it is so important to create financial products in your lifetime instead of only buying them. This book will tell you how exactly you can do that. I have gone through nearly all of the scenarios described xii
in this book, and I envision it as a complete guide to converting your life from an average credit burdened individual to a team-building, sophisticated, powerful investor who can create wealth for generations. From The Wealth of Nations to The Wealth of Generations On March 9, 1776, Adam Smith published his book The Wealth of Nations. In the 18th century, the idea of nations was forming rapidly. In Europe, people were rather loyal to their religions or to their leaders rather than to their nations before the dawn of the 18th century. The Wikipedia writes “With the emergence of a national public sphere and an integrated, country-wide economy in 18th century England, people began to identify with the country at large, rather than the smaller unit of their family, town or province. The early emergence of a popular patriotic nationalism took place in the mid-18th century and was actively promoted by the government and by the writers and intellectuals of the time”. These developments were predominant of course as well in the new world America. The 18th century american mastermind Adam Smith must have been a trendy fellow when he wrote his book The Wealth of Nations. He published it just four months before the United States Declaration of Independence was signed, which is known today as the day the birth of the American Nation. His concepts on the Division of Labor, Money, and Debt helped tremendously set the course of the development of our current economic system that has made many nations very rich. The basic idea of Division of Labor is that every individual specializes his or her work skills, learns a trade and earns money by selling these skills to an employer or to his or her own customers. This turned out to be an ultraeffective way for nations to become very wealthy. The most recent example is China. Many people have been added to the Chinese economic system as employees over the last twenty years, and as reported by many sources, in 2012 China became the second richest nation on earth. But two major developments happened at the same time when China as a nation grew richer: a tremendous number of people started their own businesses and became very wealthy as well, whereas an even greater number of people and families became what is now called in China “fang nu” (房奴): housing slaves. Based on a February 20th, 2013 Bloomberg report the number of housing slaves in China grew out of proportion. Many Chixiii
nese people will need a lifetime to pay off their mortgages, Bloomberg reports that some pay more than seventy percent of their salaries to service their mortgages. It seems, even in China, with a culture more than 5,000 years old with a long tradition of economic activities, has not learned or forgotten how to successfully transfer wealth from generation to generation. A Chinese saying is: "Fu bu guo san dai" (富不 三代), which literally means that wealth does not pass three generations. Apparently, it is an absolute rarity that the wealth of a family lasts for three generations. The first generation works extremely hard, so that the second generation reaps the benefits and may see the value of hard work. But the third generation has forgotten all about it. By the time the fourth generation arrives, the wealth is squandered. Is it possible to transfer and even grow wealth throughout many generations? There are many factors that prevent wealth from being transferred? For example, once you acquired wealth for you family, you will have to look into The Rule Against Perpetuities, which is part of the common law and limits how wealth can be transferred within generations. This book, The Wealth of Generations is an attempt to provide a source of information and inspiration to build wealth of generations. In contrast to Adam Smith’s book, this book describes how individuals, families and whole generations can build and maintain wealth through entrepreneurship and sophisticated investments. Small groups of people like families and larger groups like communities are the foundation for the wealth of all nations. But since the dawn of the modern economy, the wealth of nations has been the driving force in the economy. It is about time that individuals, their families, and whole generations form a similar manifesto of economic progress. Only a fraction of families became and remain wealthy over the past centuries, and all other families have to start building their financial foundation from scratch with each new generation. It is now time to give young generations a tool, so that they can build wealth for generations. Even Adam Smith hinted in his book at the limits of the division of labor and the wealth of nations. He wrote in his book that workers who are too specialized can develop 'mental mutilation', which could negatively impact a nation’s wealth. xiv
It is time to think about how we can make families and whole generations wealthy. Today, almost everyone relies almost entirely on one or more incomes per household. When the salary fails to come in most people start to struggle, begin to panic, and like drug addicts they run for the next available job to satisfy their creditors. It does not have to be that way. Our forefathers and -mothers worked hard to create the knowledge, wisdom, and tools that we can use today to live a more sophisticated life. I will show you how to use this knowledge and the tools in a way that frees you from financial dependencies, personal time limitations, and constant concerns about our job security and social status. Why do I write a book like this? After working for many years as business consultant, advising big companies on how to leverage emerging business technologies, I have learned a lot about how businesses work. I have also seen how many failed and why they failed. I saw employees crawling to their job sites every morning, not always trying to hide their personal, often financial, problems while producing rather mediocre results at work and personally. In the last few years before I started my own companies, I sometimes even found myself among them in the same state of mind. What changed my view of the financial world and my entire career was converting my hard earned retirement money account into a self-directed retirement account, which freed up financial assets that I had to manage. With my savings and some additional financial assets that my wife and I inherited, I was now in charge of several financial assets in several different types of asset classes. Over the years, I have made many investment mistakes, but I have had several successes, which provides us now with some amount of passive income. Now instead of worrying about how to find my next job, I worry about how to invest our assets to provide us with passive income. Currently, our passive income is only a fraction of what I earned as an employee. But due to my independence and our efforts to cut down our personal expenses by about 50%, my wife and I have now much more free time. We have to learn how to be smart investors, instead of learning to be smart employees. Luckily, I started small, years ago when I worked as an employee, preparing for my new job as sophisticated investor. xv
My task now is it to take that little seed of wealth and turn it into something bigger. Something that my family can pass on to future generations. In my book, I invite you to follow me on my journey. The scenes on the ride might not always be pretty, and they might not be easy to handle. We will talk about human strengths and weaknesses. Building Wealth without Greed and Fear I have experienced that greed and fear prevent me from being financially free. I remember several years ago when I invested a large sum of our family money in precious metal, I often woke up at night just to check on gold and silver prices only to learn that my fundamental assumptions for being in precious metals was absolutely right, and I became much more confident. This book will demonstrate how you can build kingdom of wealth without greed and fear by eliminating most financial risks. The book is not about money. It is also not about getting rich quickly. It is written for people who want to build sophisticated wealth over generations. Necessary Endings When you read this book you will realize, as I did along my journey, that it is most of the times more important for you to forget things versus learning new things. You will see that it is important for you and your family to put an end to bad habits. You will realize that you should focus on habits that increase your wealth. This book will help you identify your bad financial habits, and it will show you how you can put an end to some of your bad habits so that you can focus on habits you benefit from. Albert Einstein once said: “insanity is doing the same thing over and over again and expecting different results�. Quitting bad habits and parting from some bad assets in your portfolio will free you, so you have more time to try out different passions, things that really bring out your and your portfolio’s full potential. Much like a gardener cuts dead branches from trees and prunes the branches so that they can produce more fruit, you will learn how you can manage your financial assets so that dead assets will disappear from your portfolio and good assets become stronger and more stable. You will discover that many of your most valuable assets might not even be of financial nature, and you might notice that your current fixvi
nancial assets held in your bank and your retirement accounts might not even be the right assets for you if you want to reach your personal goals. We all own assets and have to manage them or we will lose them sooner or later. It may be personal skills, a learned trade, stocks, real estate, a career, or money in the bank, like a gardener manages the trees in the garden. We need to manage our assets or we will lose them sooner or later invaded by weeds and parasites who will take over. I am inviting you to read this book and go with me on an exciting mental journey to leave the financial la-la-land. Pride Do you believe you are a good person who deserves to live well and prosper in the future? What are you doing today to achieve that goal? What are you giving up for it? Whether the world is heading for a long economic emergency or towards a strong economic period of growth, you want to be prepared. Whether the world economy is running on extremely cheap crude oil or fueled by unaffordable expensive energy, you don’t want to be a financial burden. You want to be a strong and responsible member of your community, your country and our world without being overly pride of what you are. Diligence I wrote this book to share some of my most essential insights in finance that are as unique as they are controversial, but also simple and practical. The book skips complicated financial lingo to increase readability for a broader public. I have gained my insights in my career as business analyst, business manager, business owner, mentor, project manager and investor. I believe that the ongoing financial drama presented in the daily news turns people away from economic and unbiased financial thinking. People seem to rely more and more on the government and institutions to fix problems. Trapped in ever increasing time commitments to their employers and financial creditors, people seem to forget how to cook fresh food, parent their kids, maintain their marriages, not to mention manage their financial assets.
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Time Magazine reported in its August 2012 Moneyland issue about a study conducted by CareerBuilder.com that two in five households in the United States live paycheck to paycheck. If the breadwinners of these households lost their jobs tomorrow, most of their families would be living on the streets within only a few months. If they don’t find a job, they will likely depend on welfare and on people who were prepared, not only financially but also mentally. It is your choice to be among one group or the other. Patience You might ask yourself how do two out of five households find themselves in this financial situation in the first place? In my opinion it has to do with misplaced pride, financial education, and the things they buy. First and foremost, I believe that even though many people are convinced that they are investors, they really act only as consumers. Consumers buy products to use them themselves, while investors buy assets and let other people benefit from them while investors themselves make money. Almost all investments made by the average investor today are made by purchasing financial products that sophisticated investors have created. Most people never even learn how and why it is important to create financial products and manage their own assets, nor did they ever need to do so in an economy pumped up with too much credit. My observation is that the minority of people who do buy assets focus exclusively on capital gains. They are simply buying and selling assets, but do not develop them. They are traders who try to buy low and sell high. Professional traders got pretty good at trading. They are not buying assets for steady income, they bet that their assets will gain in value. Short-term traders are speculators who buy and sell assets in a very short period of time, make a profit and move on. Long-term traders primarily buy funds and call themselves investors, they feel good about their investment and hope the value will stay high or go higher. However, in my opinion traders are not even investors. Trading is a profession, they operate on one dimension: the asset value. They primarily focus on the value of their assets but not on income that can build real wealth.
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There is one other dimension that is crucial for every investor: steady income. I have very successful friends who won’t buy an asset if it does not produce any significant steady income from day one. If they have to put money down every month to keep the asset, they will not buy it. Their philosophy is: “if an asset does not produce income, I don’t buy it.” This book is a written for anyone who wants to become someone who creates financial products instead of just buying financial products. If you care about your family and you are willing to make drastic changes in your life, if you feel the urge to build a solid and very unconventional asset portfolio for generations to come, then this book is for you. You will learn how to manage your assets in two dimensions. It is like driving a car on the autobahn with no speed limit. You control two dimensions: direction and speed. You do not want to be too fast or you will end up in the ditch after the next curve. If you invest, you control two dimensions: income and value. Both are equally important in order to reach your target destination. If you mismanage one, you will end up either in the ditch or in the wrong place. Gratitude You definitely want to be a two-dimensional investor and appreciate and manage the income stream (portfolio income) and the capital gains at the same time, even if they are small. No asset can be a perfect investment unless you recognize and manage both. Warren Buffet sums it up to “Never lose!”. This does not mean someone else has to lose when you win. The best deals are always win-win deals. This book is written for people who want to learn more about two dimensional wealth management. The goal of this book is to provide an alternative and, in my opinion, a far more solid and future-oriented approach than common practices offered by most investment advisors, banks and wealth management firms. Humility Early in my life, I pursued a career in economical informatics, business analysis and project management as business consultant. For almost 20 years, I worked for fortune 500 companies and numerous start-ups in management and consultancy. I xix
have worked in Munich, Frankfurt, Stuttgart, Paris, London, Tokyo, Monterey, Mexico, Singapore and in many cities in the United Sates. But what does that all mean? Over the past five years or so, something happened to me. I came to realize that my career goals were counterproductive to what I wanted to achieve in my life. For almost twenty years, I have had great successes as business analyst, consultant and manager in many fields and industries. But with each promotion I only got more work, and my assignments got riskier and more time-consuming, whereas my salary only grew moderately. In 2012, the inevitable change has happened when my employer at that time and I came to a mutual agreement that involved a generous severance package. I could not wait to downshift and re-arrange my life. First, I looked at all my financial and personal assets in great details and decided to make sure they were all in order. I sold what did not produce any or enough income and I restructured or paid off debt that was attached to some of my assets. It was the biggest inventory of my entire life. I also felt a little bit like John Galt, a fictional character in the novel Atlas Shrugged. John Galt seemed to have disappeared one day for no obvious reason. Me too: I retracted from the typical business-as-usual life in order to take care of my own family matters including our financial future. I am writing this book to express my thoughts and experience, which I made while learning to speak the language of someone who does not get paid for the work they do but for the results they produce. Investors get paid for the results not for their work performed. I welcome you to learn with me to speak a - very simple - financial language of a small group of people who control a disproportionate amount of wealth and political power in the world today. I even urge you to learn that language and become more literate in financial matters not only for your own good, but also for our nation’s good and our children. Your financial independence and literacy will increase the chance that an economic crisis will keep your family, your neighborhood, and your city afloat. Email, internet and social networks, and readily available information makes it easier than ever to become a steward of your financial
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future. Start small, get financially educated, get out of your comfort zone and get out of the rate race! Are you ready to grab that steering wheel and press that pedal of your brand new environmentally, cool and financially super friendly car? Take a seat and read on!
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CHAPTER 1
Self Assessment When a behavior becomes a habit “There is a time when panic is the appropriate response.” EUGENE KLEINER - (12 May 1923 – 20 November 2003) one of the original founders of Kleiner Perkins, the Silicon Valley venture capital firm which later became Kleiner Perkins Caufield & Byers
On November 26, 1973 President Richard Nixon proposed a nationwide 50 mph (80 km/h) speed limit for passenger vehicles and a 55 mph (89 km/h) speed limit for trucks and buses. It was an emergency response to the 1973 oil crisis. The speed limit was imposed because of a crisis: the first world wide oil shock. Gas was limited and so was the speed for cars and trucks on the highway. Your financial sophistication is no different. If your financial sophistication is limited, your financial possibilities are limited, too. You live in a crisis-mode. But if you overcome your financial crises, your options will be unlimited. Today, in some countries there are no speed limits on highways between larger cities. You can go as fast as you wish, you’re only limited by your own judgement. This is how you must think as an investor: without limits. As long as they are legal and ethical, you shouldn’t feel limited in your investment ideas. You want to switch to the highest gear possible if you need to. Too many people don’t use higher gears in their financial activities. Instead, they are crawling along in a traffic jam sometimes even idling in neutral, stuck with thousands of other people all trying to follow the flow. But they are losing the
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game. Without shifting into second, or a higher gear, they will never pick up any speed. If you feel like you are one of these slow drivers, you will need to first invest in your financial education. You need to find out how good your financial knowledge and experience really is. This chapter will support you in defining a baseline for your financial knowledge. Sources for the average investors, who buy financial products (mostly paper assets) are available nowadays in abundance. Even the government runs web sites like www.mymoney.gov or www.investor.gov, which are designed to support the general public in their every-day financial education. And then there financial super coaches like Robert Kiyosaki, a very successful self-made business man, investor and teacher of financial education. He lays it all out for you, if you want to go a step further beyond the average investor. So, you have all you need to get ready for your new financial journey. However, we all come from different backgrounds, have different levels of education and different experiences. So, the starting point for every individual reader is unique. Also, the time we are living in, as well as current event, shape investment trends as well. During the late nineties when crude oil was relatively cheap it was mostly a decade of financial boom. In contrast, the first decade of the twenty first century was an economical challenging decade. Depending on what you expect during the coming decade, your investment ideas might vary. However, what this book will show you is that the basic financial rules apply during all economic periods and situations. Every person has a different background in life, and everybody carries a different baggage. Some might have had a difficult childhood growing up in poverty, some might have lived in abundance their whole life, some might a lack of financial education in some areas or some bad financial habits, or some might simply not be interested in the topic of increasing their wealth. It matters where a person is coming from when it comes to financial topics. This book is written with the goal in mind to make financial education more transparent and more fun for everybody, but also to raise the level of urgency on the personal priority list. 23
Now, let’s first find out how your personal life is organized. Are you rushing from one task to another? Are you employed and your job is taking too many hours so you see your children at best shortly before they go to bed? Are your vacations typically no longer than two weeks? Are you getting nowhere with your financial plan? You do not own a business and you do not own real estate? If you answered yes to at least one questions, you should think about improving your financial sophistication. Start finishing this chapter thoroughly to find out what you can do to improve your chances of becoming a more sophisticated investor. Start identifying your own financial and personal assets and start managing them. Taking these first steps might be very challenging for many people. Most people are addicted to their own habits. Becoming a sophisticated investor does not mean to give up the person your are. But it means to get in control of your own habits. Depending on what kind of person you are, you might be addicted to your own powerlessness and victimhood, or you might be a person who is addicted to your own sense of entitlement. Before you can gain control over your financial situation you need to find out what kind of person you are and get in control over your own habits. For example, if you are a person who collects all kinds of coupons to save money when you go shopping, you might focus too much on your expenses instead of becoming smarter about how to increase your passive income. The Average Investor I claim that the average investor today is really nothing else than a consumer. They buy products, which sophisticated investors have created. Many attributes describe the typical average investor: it is an employee who pays a mortgage or rent and almost all income comes from one or more salaries, whereas the majority of the income goes to daily expenses, and none of their income is passive income. Today, the vast majority of the western population can be categorized as average investors. The Sophisticated Investor First off, being a sophisticated investor has nothing to do with a job. It is a life style. The typical definition of a sophisticated investor is a person who is consid24
ered to have sufficient investing experience and knowledge to weigh the risks and merits of an investment opportunity. Today, many businesses and organizations expect a certain net worth and income before a person can be classified a sophisticated or accredited investor. Such an investor is eligible to buy into certain investment opportunities, such as pre-IPO securities, that are considered "nondisclosure" or "non-prospectus" issues. Typically, this type of investor must have either a net worth of $2.5 million or have earned more than $250,000 for the past two years to qualify. But these requirements can only be met as a result of a certain life style. More important is how sophisticated investors became sophisticated in the first place. They follow a simple but effective formula: P=V+D+I+M+S+O . Financial products P are the sum of the results of having a vision (V) to development (D), implement (I), the marketing (M) activities, sales (S) activities and the operation (O). Very generally said, sophisticated investors create financial products after they find out how they can create a product that people will buy. The entire right side of the above equation describes the work of the sophisticated investor. Just by successfully following this formula a person will become a sophisticated investor. The left side of the formula (P) is for the average investor, or also called consumer. The right side of the formula is for the sophisticated investor. There will always be an equilibrium between the left side and the right side. In other words, the more sophisticated investors exist, the more products will exist, and the more can be consumed. Of course, sophisticated investors act also always as consumers for certain products. When average investors say they invest, they buy financial products. In our daily conversations, both sides of the equation typically represent investment activities. However, buying in a financial product or selling a financial product are two completely different activities. The average investor follows only one activity and that is to buy a financial product P. On the other side, sophisticated investors create the infrastructure to create and sell such products. They create business blueprints. In this book you will learn more about the right side of the equation. You will read how to make financial products. You will not read about how to buy financial prod25
ucts. Although buying financial products is an important part of our economy, you need to know that financial products make typically only the people wealthy who created them. Information about studying and buying financial products is readily available everywhere like at your local bank, online and from many financial advisors. V+D+I+M+S+O activities of sophisticated investors are very similar to the activities of entrepreneurs. Both, the investor and the entrepreneur invent, develop, implement, market and sell products. The only difference is that the investor operates on a more abstract, passive level. The investor has a business focus, whereas the entrepreneur is typically focused on the product and the company itself. While the entrepreneur creates products and services directly and is also more involved in running the business, the investor has a more passive role in every activity. However, the investor executes far greater control over the entire business and can hire and fire the CEO of a company. Entrepreneurs are therefore also called active investors and investors are often called passive investors. An employee picks generally one profession. An employee is typically for example either a scientist or researcher, a developer or project manager, a marketing person or a sales person. An investor needs to master all professions: an investors will need to be a scientist, an inventor, a developer, a project manager and a sales person. Also, beside other professions an investor will need to be a fundraiser and a good accountant. Of course, investors always work with a team of people, and they typically possess high social capital, which allows them to interact intelligently with all specialists. When an investor starts to work on a new business idea, the investor’s involvement will be critical in all five areas: V, D, I, M, S, O. Now, what are financial products? Financial products are investment vehicles that are made by sophisticated investors. These are for example investment funds, government or other bonds, insurance policies, futures, options, swaps, cash deposits (CDs), simple products like our currency or complex products like collateralized debt obligations (CDOs). Basically, all intangible assets are financial products, which also include intellectual property and other rights. But if you take it further, a rental property that pro26
duces cash flow is also a financial product even though it is a tangible product. For example if an investor buys a run-down property, remodels it as a special needs home and rents it out to a company that runs senior homes. The investor created a financial product. The senior home company uses the rental to run their business to make money. If you have been able to establish a financial product in the market, you can be considered a sophisticated investor based on my book. The product will make you richer, while you can focus on your team that brings to life more financial products. Hence, it pays off to be a sophisticated investor in many ways. Sophisticated and accredited investors are the dream clients of most financial services firms, as they generate much higher fees than retail investors. J.P. Morgan Chase Bank gives some of their customers Chase Private Client (CPC) Accounts, who receive many perks around the bank’s services like free international money wiring, safe deposit boxes, etc. Typically, certain assumptions are made about sophisticated investors: that they can hold their investments indefinitely (the funds do not need to be liquidated for cash needs), and they can assume a total loss of investment principal without causing severe damage to their overall net worth. The table shows where the average, active and passive investor receive their income from. Earned income comes from a job, while passive income comes from financial assets that produce income for the investor. FIGURE 1.1 Earned vs. Passive Income INVESTOR
TYPE
ACTIVITIES
INCOME
TAXES / BENEFITS
average
employee
buys financial products
earned
high taxes / close to no benefits
active
business owner
creates and operates financial products
passive
little taxes / some benefits
passive
Accredited / sophisticated
creates and controls financial products
passive
lowest taxes / determines all terms
Author’s classification in average, active and passive investors.
27
If you are an average investor you will benefit the most from reading this book. If you are already an active or passive investor, this book will still be very valuable for you as convenient source of information about many aspects of assets and asset management. Where ever you are in your life now, the goal of this book is to make you and your family wealthy individuals with a solid financial education. This is illustrated in the following diagram with nine boxes below. I will explain this diagram, the investor levels and Wealth W in more detail later. If you now find yourself in one of the boxes with little wealth and a low or average financial education, I especially encourage you to read this book. It will help you steer towards financial independence and more freedom.
FIGURE 1.2 Your Path to financial Freedom
Created by the author in December 2012.
28
SECTION 1
Financial Freedom is relative! “Are you still managing your expenses instead of your income?� UNKNOWN
Being financially sophisticated is the fundamental requirement for being financially free. When someone rolls up their sleeves, starts a business and creates something of value, financial wealth and freedom will typically follow. But today, too many times financially sophisticated people seem to be mistrusted, assumed to be liars, cheaters, and often even immoral. I am sure you remember at least one of the latest financial scandals of people who seemed to have mishandled huge sums of public money, created pyramid schemes scandals or received unjustified high amounts of bonuses and salaries. In such an environment it seems to be hard to argue that there is an urgent need for more financially sophisticated people. However, this book unmistakably aims to bring our common financial sophistication back to basics. We will need to re-learn simple financial economics of income and value of a financial asset. We will need to start spending our money and time in a way, so that we lay the ground work for our children and grand children to live the dream that we all dreamed of: the dream of financial freedom. It is a journey for generations that our fathers and mothers have started. But now we are waking up from a nightmare of private and public financial disasters all around us. Our current financial habits have pushed already more than enough people into financial ruin through overwhelming debt burdens. We are worshipping the gross domestic product that is composed of private consumption plus gross investment plus government spending plus (exports − imports), without realizing that the consumer is really the one that contributes. Private consumption accounts for more than 2/3 of the entire GDP, and it is rising every year.
29
This book is written for the average person to help improve his or her financial situation. This book writes about income and value control but also about controlling our own emotions triggered by greed, lust, excess, pride, envy, wrath and sloth. In the short-term, this might lead to some sacrifices people will have to make. For example, I have tried to teach my son patience by not taking a candy that is promised to him now when he at the same time is promised to receive two candies in one hour from now. The upper class and the elite understand the concept of patience very well. They know how to wait in order to make money. The average person likes instant gratification, and the current overall economy likes that too. Instant gratification might support the GDP in the short-run, however in the long-run we will lower the people’s financial sophistication. Certain people might not like this book since overall consumption and economic growth might stagnate in the short-term when more people follow my advices. But more people will become financially free, and less people are willing to work for big corporations. Less employees are available, and it will be more expensive to hire the remaining people who are willing to work for big corporations. When people become financially more independent, companies have to pay more for their employees since the general workforce available to companies will become smaller. This can lead to unsatisfying corporate revenues. Big corporations like people who are depended on a paid job, they can exploit their employees. Many of my friends are small local employers. Some of them got into financial trouble after 9/11 and had to reduce their workforces. These employers shared with me their experience when they had to even tell their long-time employees that they will have to be laid off. Employees looked up to their employer to support them. It was a devastating situation for both. This book might be a hard pill to swallow. Many average investors who own stocks of mega corporations will not like the ideas in this book since their stocks might not gain any or even lose value over time. Many people have all their retirement funds invested in big stocks and bonds. These individuals will not like this book either. It seems to me that this book might be a hard sell. But I had to write this book because the truth about simple financial responsibility has to be said.
30
Individuals will have to change their habits to become financially independent. They have to make sacrifices in their lives, invest their time and money in something that they can represent ethically. As Dave Ramsey says in his book The Total Money Makeover: A Proven Plan for Financial Fitness “(Stop) buying with money you do not have things you don’t need to impress people you don’t like”. Remember, you do not only owe the money you borrow but you also owe our children your personal contribution to achieve a better future. I urge you to rethink the way how you make money. You can only contribute to a positive future when you are really free, financially, spiritual and with your time. To understand how limited your freedom is compared to some few look at a typical income distribution between the working class, the middle class and the now called elite: FIGURE 1.3 Income Distribution: Middle Class working for BMW, CEO of BMW and Owners of BMW.
€700,000,000 €525,000,000 €350,000,000 €175,000,000 €0 Middle Class working for BMW
BMW CEO
Company Owners
Source: 3/2012 report in “Einkommen und Einkommensunterschiede”, “Income and Income Discrepancies” by Helmut Creutz in www.humane-wirtschaft.de.
The average employee including management at BMW AG made 200,000 euros in 2011, Robert Reithofer, CEO of BWM made about 6 million euros in 2011, and the owner family of BMW received about 650 million euros as reported in 3/2012 in “Einkommen und Einkommensunterschiede”: “Income and Income Discrepancies” by Helmut Creutz in www.humane-wirtschaft.de. There is nothing wrong with the fact that the owners of a company make a lot of money. But there is something wrong with the picture of income distribution. In the graphic below you can hardly even see the income of an average worker 31
and manager of a company like BMW. Compared to the owner’s income you can even hardly see the income of the CEO, although some people might even criticize him for pocketing too much money. And, I would say it is not even unethical of the current owners, who inherited all the assets from Herbert Quandt, the original majority owner of BWM, to receive 650 million euros through dividends in 2011. It is rather unethical to let them do it when supporting them by providing ones own workforce and precious time without be willing to learn about financial sophistication oneself. This income example at BMW just shows how much more money one can make as active and passive investor and business owner versus employee. No matter how smart you are, no matter how much you work, as employee you might be able to support your family, but you will not be able to support your own future generations. You will very likely just be a small wheel in a big machinery, and a footnote in the book of your ancestors. It is your responsibility to make a difference. You can start working on your little asset portfolio today, no matter how much money you have now, whatever you believe in, and no matter how much money you inherited. Do not enslave yourself to the elite, but work with the elite and be the elite to create a better elite.
32
SECTION 2
Investor Levels “The three E’s possessed by the inside investor: - Education - Experience - Excessive Cash” ROBERT KIYOSAKI
Nobody wants to be put in a box. So, I apologize to the readers of this book for presenting the investor levels in this way. I created the investor table on the next page to provide you, the reader with a quick tool to find out about your personal current financial literacy. The table is designed to give you a first idea about your own financial habits and skills from the point of view of this book.. The table is based on Robert Kiyosaki’s book Cashflow Quadrant. Kiyosaki describes seven basic levels of investor skills and habits starting with level zero. Level zero is the lowest level where everybody starts in life. Some start as kids, learning from their parents, while others learn in their jobs and many also from their friends. Like any other skills and habits, the earlier in life you learn the better are the chances that you will get really good at it. Based on the Wikipedia Encyclopedia The Beatles were playing as young musicians in small clubs in Hamburg, Germany seven nights a week from 8:30-9:30, 10:00 until 11:00, 11:30-12:30, and finished the evening playing from 1:00 until 2:00 in the morning for more than 2 years. That adds up to 4 hours a day times 365 days times 2 years equals 2,920 hours on stage just during their time in Hamburg. You know what good musical performers they became. Imagine that you dedicate that same amount of intense practice to your financial skills. Looking at the skills in the Investor Level Table, you can see there are a lot of activities you can practice regularly. Please also note that these investor levels have nothing to do with how much money you have (net worth: assets liabilities) or make (your income). The levels just represent your state of mind and your habits that affect your financial decisions.
33
FIGURE 1.4 Typical Financial Habits of People on each Investor Level Habits
0
1
2
3
4
5
6
Spending
spend all
spend randomly
Save to spend
buy useless tools
control spending
stewards of money
excellent stewards
Income
Salary or food stamps only
Salary only
Salary only
Salary only
Salary + little high passive passive income, track income income
Assets
no fin. assets, no liabilities
no fin. assets, little debt
small assets, little debt
small assets, much debt
assets often < assets often > own many debt liabilities strategic assets
Expenses
expenses seem random
don’t track expenses
Lending
mostly bad or have savings no credit scores account
start tracking track expenses track income track expenses expenses extensively vs. expenses have homeequity loans
credit scores credit scores debt/equity ok, high debt great, hi. debt under control
sky high passive income
expenses negligible control debt issuers
Investment Style
make other people poor
shopping is hobby
savings only
hoping and praying
use advantage of time
not new to investing
make other people rich
Team
n/a
n/a
work alone
work alone
reach out to advisors etc.
work as a team
orchestrate other people
Involvement
none
none
observe trends
follow trend
analyze trend
create trends
create mega trends
Financial Products
n/a
n/a
buy financial products
buy financial products
buy financial put own deals products together
create fin. products
Exit Strategy
none
none
none
rarely have exit strategy
might have exit strategy
several exit strategies
History
long history of losing
history of losing
short history of losing
win randomly
Liquidity
none
some
CDs, save to consume
have CD’s, let funds readily money sit available
Security
rely only on rely mostly seek security seek challenge gov. programs on gov. progr. only money mkt account
diversified in paper assets
have exit strategy
win long history of long history of occasionally winning winning
rely on own control
many active accounts
excessive cash
control all their assets
control own + other’s assets
diversified in are in all asset are in all asset paper assets classes classes
Diversified
n/a
Awareness
not aware of own habits
not aware of aware of own own habits spending
Risk
unaware of any risks
everything is too risky
risk averse
risk taker
Stocks
no experience no experience
little experience
main focus
some common stocks
preferred stock
preferred stock only
Funds
no experience no experience
some skills
main focus
some
negligible
rather not
Bonds
no experience no experience
some skills
some skills
good skills
some
rather not
maybe
some
some
Commodities
n/a
investment aware
no experience no experience no experience no experience
system awareness
appear in public
work behind curtains
manages some not afraid to win every time risk lose, cautious
Real Estate
none
none
only home mortgage
home + condo property with several cash many cash w/ neg. return positive return cow properties cow properties
Businesses
work for money only
work for money only
work for money only
work for money only
own some bus. get income shares from own bus.
Max. ROI
none
less than 2% less than 3%
less than 5%
less than 10%
greater 10%
often > 100%
Fin. Education
no or primary school
HS
Mainstream Media
‘Suze Orman Show’
some higher fin. classes
special inv. seminars
private advisory team
Profession
Worker, unskilled
Worker, skilled
Worker, blue collar
Doctors, Artists, etc
Employees, white collar
Class
Work Class
Work Class
Work Class
Middle Class
Middle Class
Source: Author, Note: all categorizations are personal observations of the author.
34
own many businesses
CxO job, bus. any, so called owners Philanthropist Upper Class
Elite
Level 0 Individuals on level 0 donâ&#x20AC;&#x2122;t have any money to invest. However, every individual has personal assets like skills and attributes that make that person valuable. Unfortunately, people on level 0 do not take advantage of any of their assets and are stuck in their current financial situations. Individuals on level 0 pursue no activities that can be considered investing. Level 1 Activities on level one are things that you would learn and practice in an average family today. These are activities like paying bills on time, borrowing to buy a small house, buying consumer items, or going shopping. This level probably might be the most common in our society and is taught in primary school. Many people never move beyond this level in their lives. Although the Investor Levels are not meant to be chronological, in some ways they do represent the story of personal development for many people. Level 2 Level two activities are things that people typically learn the hard way during their first years in their jobs. They save money after their credit got ruined, build a savings account, save to buy rather than buying on credit, avoid credit card debt and they like security. Level 3 Individuals on level 3 start to learn investor skills and gain experience during their employment. For example, they start using tax benefits when starting a 401(k) plan, buy company stocks or stock options that are offered by their employers, or participate in so called flexible benefits programs of the companies they work for. Most level 3 investors are young employees or self-employed people like medical doctors, lawyers and real estate agents. Young employees working for a medium or large company have often the advantage of learning on their jobs to work in a 35
team and learn about investing from many different angles, whereas self-employed people tend to often stay in their field and become very specialized, hence miss the opportunity to become a great investor, a level 4 and 5 investors. Level 3 investors are still only buying financial products instead of creating financial products. They are still only using simple templates and readily available investment products. Level 4 Level 4 investors have developed their own long-term investment plan. They work occasionally with level 5 investors, and they start looking behind the curtains of financial products, and they start working on taking control of their own financial assets. Good examples of level 4 investors are white collar employees in either management or other leading positions. Over the years they have learned how to work in teams, how to create products and sell them. For me, it does not seem to be very relevant what profession they actually have. They could be accountants, marketing gurus, salesmen, scientists, programmers or designers. Important is that they have learned how to be a good team player and how to lead a team. Level 5 Level 5 investors have typically passed the crowed that is working for money. They are mostly still employees but they are not necessarily dependent on their salary. In 2003, Steve Jobs received an annual salary of one dollar, and many other CEOs have worked for that amount in the past. Some call these CEOs the â&#x20AC;&#x153;dollar-ayear-men.â&#x20AC;? A typical level 5 investor works as CEO of a company or as successful entrepreneur who either made millions by selling his or her company, or owns one or more companies. Level 5 investors can be seen as the 5% of the society, and some of them meet with level 6 investors occasionally. Unfortunately, the overwhelming majority of the people today will never reach level 5 in their lifetime. It takes decades to learn level five skills, gain the experience and build a foundation of knowledge and habits. Only two types of people 36
will master level 5: the ones who were educated and trained from their childhood, and those who are self-made business people and investment gurus who have the urge, passion, professionalism and patience to learn and apply good financial habits. But even these level five people are often not capable of transferring wealth to their kids and the following generations. Level 5 investors are very successful in business and investors with little understanding of wealth for generations. Level 6 Level 6 individuals are individuals who grew up in wealth for generations. They are typically out of reach to the average citizen, in most cases they are not even known to the general public. Level 6 people are the 1% of the society. They are considered the Elite. They do not typically appear in the media, they tend to make decisions behind closed doors. They and their forefathers have mastered the task of building wealth for generations. Those tasks include much more than financial education. In America, classic level 6 investors come from families like the Rockefeller's, the Rothschild’s in Europe and Asia and the Oppenheimer’s in Africa, to name a few. All these investors have in common that someone in their families founded ultrasuccessful businesses. In the last one hundred years or so, hundreds of ultrasuccessful companies were founded by many people, and the level 6 investor circle grew substantially. Today, the investor 6 level circle, or the circle of the elite, has several layers, and each has their own power and influence, but they all work together to achieve many goals, none of them we know about in detail. We should not ignore that today many of level 6 families might have direct or indirect access to federal agencies, which determine many aspects of our all personal lives. But it seems to me that most people in these circles live in enormous fear. They seem to dream of a New World that is completely detached from us, the average people. They might even be afraid of us. They don’t let us get too close to them, some of the elite might even believe they can play god using all their financial resources, influence and today’s technological capabilities. Their education, habits, experience and power are likely superior to ours, so one might understand that they don’t tend to hang out with us. Would you hang out with a bum? You might 37
hand him or her one dollar or two. That might be how level 6 investors think of us. Furthermore, since level 6 people are highly connected they can easily form an alliance, which can lead to a â&#x20AC;&#x2DC;666 formationâ&#x20AC;&#x2122;, which is known as The Number of the Beast, or the Devil. Movies like The Time Machine. 1984 or Hunger Games illustrate what can happen if the average people lose against the so much powerful level 6 investors. I believe, those people on investor level 6 and their families are in a deep crisis today. They have excluded themselves from the average people, so that they lose more and more contact to the real world. Natural resources like crude oil and water reached their peak output years ago, and they feel their empire is in danger. A good example is how the young generation of level 6 investors feel and think today. I recommend watching a documentary created by Jamie Johnson and Nick Kurzon. Jamie is a 27-year-old heir to the Johnson & Johnson pharmaceutical fortune. Jamie made a 73-minutes film, which you can find by searching for Nick and Jamie Kurzon on YouTube. FIGURE 1.5 The House of the Elite
Source: The Author
38
I see the current world as a giant house where every person in our society has its place. The people who live on top of the house are members of the oldest families who have built wealth over generations, and the members of these families today are The Elite. They have been financially independent for decades. The people on level 5 are wealthy assistants for the elite and everybody below are the dependent ones that will scream for help from the upper levels when things get difficult. FIGURE 1.6 The 7 Investor Levels in Short LEV EL
FIN. NAME
0
Nothing-tolose
Loser
Fight-or-Flight, The Hunted
Average worker or unemployed
1
Dreamer
Exploited
Reactive
Ambitious worker
2
Saver
Smarter Consumer
Restful Awareness
Financially smarter workers
3
Speculator
Want-to-be Investor
Intuitive
Doctors, Artists, Scientists
4
Longterm investor
Part-time Investor
Creative
Many employees in leadership and management positions
5
Sophisticat ed investor
Active and Passive Investors
Visionary
most CEOs, CFOs, etc., successful entrepreneurs like Robert Kiyosaki
Capitalist
Families with Wealth of Generation, The Elite
Sacred
Old Money like Rockefeller Family, Rothschild Family, and New Money like Bill Gates, Steve Jobs Family, Richard Branson, Warren Buffet
6
PROVOCATIVE SPIRITUAL NAME CHARACTER*
EXAMPLES
Source: The Author, *) Level Names Borrowed from â&#x20AC;&#x153;How to know Godâ&#x20AC;? by Deepak Chopra
Investor Level Quiz So, would you like to find out on which level you are? One fast way is to look at what you do for living. Is your profession one of the ones listed in previous figure or do you do something similar in your job? Your profession is a very good indicator for your investor level. However, if you want to find out more about your current financial situation and your financial habits, do the following exercise: look at the investor level table 39
some pages earlier, start with the first row and circle one habit that fits most your personal situation. Repeat this until you get to the last row. After you made a circled in all rows add up all investor levels you fall into, take the sum and divide it by 26. The result represents your current personal investor level.
Book Recommendation: Family Wealth - Keeping It in the Family: How Family Members and Their Advisers Preserve Human, Intellectual, and Financial Assets for Generations, by James E. Hughes Jr., https://www.familyoffice.com
40
SECTION 3
Division of Labor Adam Smith (June 5, 1723 – July 17, 1790)
“Let us conclude from these principles that nature creates some men for liberty and others for slavery; that it is useful and just that the slave should obey. The reader will perceive how exactly this passage is paralleled by the statements of middle-class economists, that incapacity, laziness, and thriftlessness will inevitably condemn a large portion of the population always to labor for a mere subsistence.” This is what Adam Smith wrote in the introduction of his book The Wealth of Nations. Well, this is a very cruel assessment of the situations of people who could be called employees today. Many employees might feel that way. In an earlier chapter I described how a small portion of the country today owns and earns so much more money than the typical employee, so that Adam Smith’s statement maybe not so far fetched. There will always be a large amount of people who will have to work too hard for too little money. However, constantly emerging technologies and possibilities to put energy sources like crude oil, wind, the sun, or hydro electric to work, leave more and more people unemployed or require them to learn different, mostly white collar skills. And this is the chance for many to also learn financial skills and become sophisticated investors. With the rise of the internet the time is coming for people to break free from Adam Smith’s terrible paradigm of labor. A very different Career Strategy Life itself is all about the right mix between specialization and generalization, standardization and individualism.It has been that way since the beginning of time. Beings with a high level of specialization were more effective than other creatures with less specialization. However, too many too specialized species went extinct when their environment changed too much, too fast.
41
So, being a highly specialized person might provide you with a lot of success, cash and a decent income you might lose your job in an instant if your skill is not required anymore. Many smart people become highly trained and specialized individuals, work in that trade for a number of years and save a lot of money during that period. But they must be prepared for the day when their specialization is no longer needed, or when they are ready to do something else. By then they need to have enough money to be able to live off for a while. Why not be a fisherman for a while? I have some friends who were fisherman for several years when they were younger. They were working on a ship far out to sea sometimes for three or four months in a row. When they came back onshore they would receive a paycheck that exceeded many other peopleâ&#x20AC;&#x2122;s annual salary. After being fishermen for several years they have earned enough money to be able to pay cash for several condominiums, fourplexes and other income producing assets, which then produces enough income for them to cover their monthly living expenses. Many of these friends are now successful business men, investors and advisors. Fortunately, we as humans are all highly flexible and intelligent beings that can change and adapt to different circumstances. Like the fishermen, some people can even use these human attributes to their benefit by taking advantage of a highly specialized skill to make enough money to then be able to pursue other things. Adam Smith already foresaw the essence of industrialism in his book â&#x20AC;&#x153;The Wealth of Nationsâ&#x20AC;? by determining that division of labor represents an increase in productivity. For Smith, specialization of labor was the dynamic engine of economic progress. And he must have been right. Most would agree that the worldwide economic development of the last two or three centuries is an unparalleled success story in the human history. However, in a further chapter of the same book Smith criticizes the division of labor by writing that specialization of labor leads to a 'mental mutilation' in workers. Today we know that there are clearly limits to labor specialization. In this book I even claim that the current employment system requires white-collar and blue42
collar workers to be too specialized for a too long period of time, in many cases an entire work life. A few would argue that this is the cause for all kinds of distortions in our society that result in extremely high divorce rates, social isolation, mental mutilation and decadence as well as certain extremist behaviors. It is the goal of this book to provide solutions to solve the problem of overspecialization. I believe the time is here for a more sophisticated view on employment, entrepreneurship and investorship. Do you still work for money? Can you imagine a world where people do not work for money but for experience only? My impression is that being employed is the hobby of the ‘rich’ and the curse of the ‘poor’. What if employment could be everyone’s hobby? For example, I know great musicians whose hobby is to play and sell music and they do so with more success than some other people who play professionally. In particular one friend of mine inherited a blacksmith business from his father that he had little interest in. However, instead of turning away from the business or selling it, he decided to work with his father for several years in the business. Later, he took over the business and today lets his employees manage it. Meanwhile, he pursued a career in music and now makes more money with his own record company than his father’s business ever did. Now, he owns two very successful companies. The point I am making is that if his father did not have a business, he would not have been able to become that successful musician. When he was younger he did not need to work, working was a hobby for him but he learned how to run a business. And making music was his passion, which, like his dad did with his company, turned his passion into a business. Would the world not be a much better place if we all had the chance to pursue our dreams like my friend? Can you see what would happen if people inherited income producing assets like small businesses or real estate from their parents instead of liabilities like homes or cars that are in most cases not even paid off ? What would happen if retirees lived from income, which comes from their income-producing asset instead from accumulated 401(k) money that will very likely be all used up when they die? What would happen if people asked them43
selves how much income per month they need to retire instead of how much money they need in the bank account? In a financially sophisticated world our kids would be able to work for experience and not for money. And what if we could even teach our kids how to create real income producing assets that generated real value every month? Not only could they live from these assets, but they would also be able to contribute their valuable work and knowledge to produce even more valuable assets. This book is written for everybody who is interested in breaking free from the traditional economic thinking that is driven by the division of labor principals. It is written for people who like to look behind the curtain of the current economic system to see a financial world that is not dependent on money, but instead creates money.
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CHAPTER 2
Asset Classes In a country well governed, poverty is something to be ashamed of. In a country badly governed, wealth is something to be ashamed of. Confucius Almost all financial education taught in school today is of a very technical nature. I remember very well my classes I took in my MBA program. Real financial sophistication in my view is much simpler than the financial science that schools, media and companies currently build around simple common financial sense, which is the only thing you need to be really successful. It starts with the question “does an asset make me richer today or not?”. In today’s world we study more the characteristics of financial products like the currencies, stocks, funds or bonds instead of learning how to create new financial products ourself. This book shows you what you need to know in order to create your own financial products. The most important term you need to know before you even start investing is: asset class. If you are not very familiar with the term asset class, this chapter will give an overview of the five major asset classes. You might have learned about asset classes in the past, and you might own and manage assets in different assets classes already. There are only five major asset classes, which are: securities, businesses, commodities, real estate and the money market. So, if you really like to diversify your portfolio, these are your choices. But there is one basic rule: before you invest in a certain asset class, make sure you know the asset class in and out. As a matter of fact, many great investors are kings of their asset classes. For example, people recognize Donald Trump is a big shot in real estate, Warren Buffet as king of stock investments, Matthew Simmons was
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FIGURE 2.1 Asset Classes Overview (in bold: real assets, others are paper assets) ASSET CLASS
EXAMPLES
TYPE
Money Market
Currencies, Cash, Bank Accounts, CDs
Soft Asset
Securities
Equities (Stocks), Bonds
Soft Asset
Businesses
Royalties, Patents, Businesses
Hard Asset
Commodities
Precious Metals, Crude Oil, Agriculture
Hard Asset
Real Estate
Residential, Commercial
Hard Asset
Source: AssetVault LLC
king of commodities, and Steve Jobs, a business entrepreneur who made many companies like Apple Inc. and Pixar very successful companies. Most people only own securities and assets in the money market. These asset classes are easier to understand and easy to trade. On the other hand, there are business and real estate asset classes that are more difficult to understand and very difficult to trade. Hence, not many people own businesses or real estate. However, businesses and real estate are the real income generating assets. In my observation there is an inverse relationship between asset income and number of people who invest in certain asset classes. The higher the return the less people invest in these assets. The reason is that asset classes with potential high income opportunities require much higher skill sets than asset classes that provide lower returns. Most advisors make the connection between high return and higher risk. What they generally do not mention is that the investor can eliminate almost all risk by increasing their knowledge about the asset. There are several seminars and classes you can visit for all five asset classes. By going to a seminar or class you can find out if you like these assets and if you have a passion for them. A good way to find groups for each asset class is to use social media like meetup.com. But please remember, visiting these seminars will only be the entry point for you. Before you invest in an expensive asset you need more skills and experience, which you can only gain from starting small. Buy a small condo for income, park that money for a while in some low risk, low return securities, leave some of your income in the money market to have cash at hand when you have
46
the opportunity to buy another real estate property or even a cash flow positive business.
Money Market The money market consists of mainly savings accounts, checking accounts, foreign currency accounts, cash deposits and of course cash. You donâ&#x20AC;&#x2122;t need much experience and knowledge when you get into the money market, hence this market is by far the most common asset class. Almost everyone has a checking account at a bank. However, important to understand is that assets in the money market are really only a medium of exchange. As Jeff Naber from Nabers Financials says about paper money: notes are just some weird little papers with dead presidents on them, and people actually would rather work for real stuff that you can exchange these little papers for. Currency is not the real economy. The things you exchange paper money for are the real economy, which is one of the most important realization any investor should have. Real assets are commodities, businesses, human resources and inventory that produces income. The currency is not the value, the item being exchanged for currency is the value. The entire money market can collapse, and the natural and human resources are still there. As an investor you want to invest in real assets. Money market assets are good to store wealth for a certain time until a lucrative hard asset has been found. Securities Securities include paper investments like stocks, bonds, ETFs, other funds and certificates. They all fall under the same umbrella of paper assets as holdings in the money market. They are exchanged for either other paper assets or natural and human resources. If the entire money market and the entire stock market were to collapse, the real assets would still be there and could still be traded. But investments in the money market and security markets would vanish since they are purely build on trust, on IOUs, on debt. So, assets in the money market and also in the security market are good assets to own temporarily as an effective storage of wealth 47
and an easy way to exchange value. Cash is king! But they will lose all their value if the currency or security exchange markets collapsed. Even if these markets just became uncertain, a lot of money could be lost. So, be careful when investing. If you are only investing in the money and security market, you might just own worthless IOUs instead of actual assets. And the items that make up your wealth are not diversified enough to provide you the security you might be looking for. Today, most retirement assets consist completely of investments in paper assets. In a later chapter I will write more about retirement planning strategies. Businesses On the other side, businesses represent a real value in the economy. If you are able to think outside of the employee box, you might consider becoming a business owner. A business owner is not a self employed person. Being a business owner includes much more than just providing services in return for money. Having started two successful business from scratch, I have seen what it means to be a business owner. Most important: you need a business blueprint, which explains how a business can be scaled to any size. The blueprint also needs to show how to solve real problems for your customers. You might be the only employee of your business for a certain time but the important thing is that you have a blueprint, a system that can generate income without you being involved later on, and that can be scaled to almost any size. That income can come from selling products or services, royalties from a book you wrote, or patents and trademarks you submitted. Real Estate Like businesses, real estate is also a real asset in the economy. When you buy a property, the first and foremost question you should ask yourself is if you plan for portfolio income or passive income from tenants. Will the rent income from the property be a source of recurring income or do you expect the value of the property to go up in value in a foreseeable time? Or do you intend to flip the property by remodeling it and selling it with a profit? Either way you should educate yourself about the fundamentals of real estate. Real estate is a very unique asset class, which has a lot of pitfalls. You have to con48
FIGURE 2.2 Types of Real Estate
REAL ESTATE TYPE Single Family Commercial Office Commercial Retail Multi-family Warehouse Industrial Farm Land, Forests Condos Source: AssetVault LLC
sider many factors if you want to make a good real estate deal. You need to do a detailed cash flow analysis and be able to determine the right leverage with bank loans, which I will explain in later in the book. Even good financing might not save you from a bad deal. You have to consider that not every bank will give you a loan for certain kind of properties. You have to get knowledgable about city planning and zoning changes in your county or city. Also, there are many opportunities to reduce your taxes through real estate. In my experience, you can make money in four areas in real estate: cash flow, appreciation, tax benefits, principal reductions. You will find more information about real estate investment in chapter Asset Development.
Before you decide to specialize in real estate, and before you purchase your first property you need to find out which type of real estate suits your investment style. Above real estate types are very different and require very different skills. For example, think about what kinds of tenants you want to focus on: longterm tenants with families, students or short-time renters, young or older individuals or smaller companies that need office space. Commodities Commodities are the fifth asset class I describe in this book. They are not paper assets like securities and money market assets, and they are also not like real estate and businesses since they do not generate any income. Commodities are in between paper assets and real assets. On one hand they do not represent a value based on a financial product like all paper assets. On the other hand they do not produce income like businesses and real estate. Commodities serve a different purpose: they primarily provide the investor with security. The value of a commodity will typically never go to zero, and a commodity can also, in some cases, provide a source of physical security for self consumption.
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When I talk about commodities for investing purposes I do mean actual physical goods. The most known commodity exchange markets in the USA are the NYMEX and COMEX where investors and traders can exchange energy, precious metals, industrial metals. There are other exchange markets like the Memphis Cotton Exchange or the Minneapolis Gran Exchange that specialize in agricultural products like wheat, barley, sugar, maize, cotton, cocoa, coffee, milk products, pork bellies, etc.). In addition, many commodity investors buy physical instances of a commodity like gold or silver and store it themselves. The advantage of owning the physical commodity can be better access to a commodity but it might not outweigh the disadvantage of higher storage expenses and less ability to trade the commodity. The Investment Cycle Level 5 and 6 investors play in all five asset classes. They might have their focus on one asset class. However, the advantage of using all asset classes is that the investor can benefit from characteristics of all asset classes. They are applying a two-bucket investment approach. It is a pretty simple concept. You create two virtual buckets FIGURE 2.3 Investing liquid assets
FIGURE 2.4 Receiving income from
in real assets
hard assets
Source: AssetVault LLC
Source: AssetVault LLC
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FIGURE 2.5 Income from Paper Assets vs. Real Assets ASSET CLASS
ASSET TYPE
Money Market Paper Asset
PORTFOLIO / PASSIVE
TYPICAL INCOME
Portfolio Income
capital gains, interest
Securities
Paper Asset
Portfolio Income
capital gains, dividends
Commodities
Real Asset
Portfolio Income
capital gains
Real Estate
Real Asset Passive Income
Rent Income
Businesses
Real Asset Passive Income Net Income from Business Operations
Source: AssetVault LLC
in your portfolio: the paper assets bucket and the hard asset bucket. Now, you take the paper asset bucket, which you have to fill up initially from your salary or any other income you might have, and pour it into the hard asset bucket. In other words, you buy real estate, start or buy businesses or commodities using your money in the bank, selling securities or bonds. Automatically, money will flow back from your income producing hard assets into the paper asset bucket, and you can pour the paper money again back into the hard asset bucket. The income from your hard assets, your real assets, will provide you with income in form of money market assets (currency, money), which you can re-invest again in real assets. Robert Kiyosaki sums this simple cycle up as: â&#x20AC;&#x153;I have a problem with too much money. I can't reinvest it fast enough, and because I reinvest it, more money comes in. Yes, the rich do get richer.â&#x20AC;? If you are serious about building a real nest egg for your future, your retirement or if you like to leave your children real assets, you will have to think like a level 5 and 6 investor and follow the 2-bucket investment approach as illustrated in above figure. A business is the most effective asset class in terms of income generation. It has the capability to generate that excessive amount of cash, which you need to invest in any other assets. Even Warren Buffet who initially made most of his money in the security market now is heavily invested in businesses like the BNSF Railway Company, and of course he owns and runs Berkshire Hathaway, which today in 2013 has over 400 billion dollars in assets and a net income of over 14 billion dollars. 51
Are art and collectibles assets? Art as an asset is much debated and some might say they are also very risky. Someone I know calls art just ‘broken things’ as the artist used fresh paint and a nice white canvas to make both unusable. But if you have a passion for collectibles, art can be for you and depending who owned the pieces of art in the past, it might cash out very well if needed. However, art and collectibles are of very speculative nature, and I am not recommending putting art into your asset portfolio until you have so much cash at hand that you can pay for a certain piece of art or a very rare collectable item with petty cash. Are natural goods an asset class? In difficult times, natural goods like food items, items for your hygiene, or even seeds and fresh vegetables from your own garden might become the biggest asset you own. Even though they are not financial assets, they can provide many benefits, even financial advantages in the future. When you plan your financial freedom you should not underestimate the importance of natural goods in case you lose all your financial assets. A stock and your own supply of natural goods can lower your personal expenses and also help others in times of need. However, this book will not get more into natural goods as assets beyond this paragraph. A word about Derivatives Warren Buffet says “Derivatives are financial weapons of mass destruction.” And a statistic published by GlobalResearch.ca reports that derivatives were worth more than twenty times the world GDP in 2012. The basic idea of derivatives is to increase the leverage for the derivative issuer who is a sophisticated investor. With every other financial asset than derivatives you buy a share or all of the actual asset. Like with a stock from a company you own a certain share of that company. However, derivatives are financial instruments in form of contracts (options, forward contracts, futures, etc.) that allow investors to speculate on the future price of, for example, commodities or shares without buying the underlying investment.
52
So, why are derivatives so dangerous? Derivatives are legal contracts that are made between adults. Why are derivatives WMDs as Warren Buffet says? Since derivatives tend to amplify the power of underlying financial products and commodities they can easily derail a certain type of asset class or certain economic sectors. Even though derivatives are not part of the real economy they can manipulate the economic system and destabilize it. This book does not cover derivatives in more details since derivatives tend to be investment vehicles for profesFIGURE 2.7 Derivatives Contract Types UNDERLYING
Equity
CONTRACT TYPES Exchange-traded futures
Exchange-traded options
OTC swap
OTC forward
OTC option
DJIA Index future Single-stock future
Option on DJIA Index future Singleshare option
Equity swap
Back-to-back Repurchase agreement
Stock option Warrant Turbo warrant
Option on Eurodollar future Option on Euribor future
Interest rate swap
Forward rate agreement
Interest rate cap and floor Swaption Basis swap Bond option
Repurchase agreement
Credit default option
Eurodollar future Interest rate Euribor future Credit
Bond future
Option on Bond future
Credit default / Total return swap
Foreign exchange
Currency future
Option on currency future
Currency swap
Commodity
WTI crude oil futures
Weather derivative
Commodity swap
Currency option Iron ore forward contract
Gold option
Source: http://en.wikipedia.org/wiki/Derivative_(finance)
FIGURE 2.6 Notional Amount and Gross Market Value of OTC Derivatives Outstanding
Source: http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf, page Book side 299, PDF page 328
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CHAPTER 3
The Investor “The heaviest penalty for declining to rule is to be ruled by someone inferior to yourself.” — PLATO, THE REPUBLIC
You might not see your self as an investor or you might even dislike thinking about investing at all. However, this might be a fatal mistake. All of us make daily decisions about what to buy, what we trade, what we learn and what we spend our time on. Everybody of us has financial obligations and some source of income. And everybody can decide on a daily basis how to manage each of these factors. Over the last few decades, too many of us seem to have forgotten to be and act like investors. Too many of us became super consumers, dreamers, borrowers, financial losers, pumped up with literally endless money from the central banks. In the twentieth century, the middle class grew to be the largest group in our society, which spurred economic growth through ever increasing consumption. That has been a good thing for us all. But the times have come where the middle class, the lucky ones, the ones that found their spot in our overall wealthy nation became more and more threatened by the instability of the exact same system that brought the middle class to where it is today: the current economic system. Many people in the middle class have either downshifted and now work fewer hours, or they were downsized and need to find new employment that requires them to work longer hours.
54
Investor Levels and Social Cultural Classes The ongoing downshifting and downsizing of individuals from the middle class resulted in a unique phenomenon: we are coming apart, as Charles Murray claims in his book Coming Apart. Charles explains that a moral decline combined with the rise of poverty within the middle class creates a more and more divided society. For me, part of the moral decline is also the decline of well rounded education, including financial education and sophistication. In the following diagram are nine boxes, which I call the LAHLAH boxes. The boxes are LL, LA, LH, AL, AA, AH, HL, HA and HH. L stands for low, A for average and H for high. Every single box represents a unique financial situation from low wealth to high wealth combined with the financial literacy from level 0 to level 6 of a person. For example, in the low wealth - low financial sophistication box LL are individuals who have no wealth and are not financially sophisticated. Important to note is that wealth here is defined as passive income over personal expenses: W = P / E. So, you can increase your wealth when you increase your passive income or when you decrease your personal expenses. What seem to have happened in our society today is that individuals cluster around certain investor levels and wealth levels as illustrated by the nine boxes. And all nine groups of people are increasingly separated by family values, faith, vocation and community. For that reason I call these groups also classes. Certain service companies like wireless communication service companies, hotel chains, banks or credit card companies seem to cater progressively to only some of these classes because each single class has very different needs. Have you ever noticed how a representative from for example American Express communicates with you over the phone versus someone from, letâ&#x20AC;&#x2122;s say Citibank? Have you ever noticed the difference in how you are treated as a private client in a bank versus an average bank customer? When individuals become financially more literate they move from their current investor level to a higher level, and at the same time they might become part of the adjacent group to their right. For example, it is a well known phenomenon that 55
FIGURE 3.1 LAHLAH Boxes
Created by the author in December 2012.
when a person in the working class gets a better education and improves his or her financial habits and skills, he or she will very likely get many new friends in the middle class and might even break with his or her past life. If you are an average investor, someone in the middle class, and if you like to improve your financial literacy, if you like to move from your current investor level 3 or 4 to investor level 5, you also need to change your habits, get a lot of investing experience, increase your financial skills and education, and you will need friends from the higher investor levels that can coach you. There are only very few people who are part of two classes on the same investor level. For example, on investor level 2 there are people from the working class and some few people from the middle class. They all have comparable financial habits, skills and education. However, from their upbringing, heritage or other reasons consider themselves either in the working class or in the middle class. The same is 56
FIGURE 3.2 The seven investor levels in short BOX
LEVE L
LL
0..1
Low wealth, low financial IQ
Beggar, the stranded, low wage worker, seasonal workers
AL
0..1
average wealth, low financial IQ
high school drop out, minimum wage employee
HL
0..1
high wealth, low financial IQ
clueless lottery winner, uneducated heirs
LA
2..4
low wealth, average financial IQ
blue and white collar workers
AA
2..4
average wealth, average financial IQ busy consumer, smart employee
HA
2..4
high wealth, average financial IQ
Movie stars, educated heirs
LH
5..6
low wealth, high financial IQ
convicted Bernhard Madoff, Ponzi, etc.
AH
5..6
average wealth, high financial IQ
talented employee, CEO, entrepreneur
HH
5..6
high wealth, high financial IQ
The 1%, the Elite, the Old and New Money, Bill Gates, Warren Buffet
XY
EXAMPLES
Created by the author in December 2012.
true for some few people on investor level 5. Some people from the middle class on level 5 have very good financial knowledge and skills, so they are sometimes able to join up with individuals from people in the elite. This book is written for people who are willing to go with me on that rough and cumbersome journey that takes us from one investor level to higher investor levels. It requires discipline, patience and time. But I want to point out that you wonâ&#x20AC;&#x2122;t need any additional money for that journey. The journey will instead lead you through wild life-style changes, mindset transformations and huge paradigm shifts. In my observations, all three groups, the working class, middle class and the elite avoid each other like the plague. They are completely incompatible, except some individuals at edges of the investor level bell curves. Today, the different groups have mostly nothing in common except their basic needs. For an individual it is becoming more difficult to move from one group to another. And, as described earlier, these classes seem to grow apart more and more.
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When you read this book you are most likely interested in becoming a level 5 investor. An individual on investor level 5 or 6 is an inside investor (not to be confused with an inside trader!). He or she works beyond the visible economic system. They have a network of many other level 5 and 6 friends. They have abundant social capital since they all work as a team to put mega-deals together. It is indeed a very exclusive crowd. Many of them appear on television here an there or you hear from them in the financial news. They donâ&#x20AC;&#x2122;t want to play with the average investors, which are still in the financial rat race. For example, in Germany, there is one percent that owns more financial assets than the 90% of the rest of the population who is the middle and working class, who are in the financial rat race, where their total passive income is lower than their total expenses. In short: investors on different investor levels donâ&#x20AC;&#x2122;t want to play with each other. Do you live in a bubble? So, it seems there are three completely separated groups or classes in our society that donâ&#x20AC;&#x2122;t even really talk to each other. If you read this book, you might be an average investor on level three or four. And if you like to talk to sophisticated, accredited investors you need to learn the language of level five and six investors. Have you ever met one? Would they talk to you? And why? Before you try to reach out to such people you will have to learn to speak their language, understand their motivations and how they operate. You will very likely not agree with many of their believes and actions, and you might even oppose their thinking altogether. Not every one is made for a world on investor level 5 and 6. However, I ask you to think about this from this point of view: if we, as the average people, let the 5% of level 5 people and the 1% of level 6 people do what they are doing without even interacting with the average people they will do what ever they want. Becoming a sophisticated level 5 investor, which means interacting and being able to communicate with the 5% and 1% on the same level, becomes not only an individual quest for freedom but an obligation for the common good. The mental states of individuals on investor levels 5 and 6 operate outside of the visible economic structure. What I mean by that is that they play by different rules: different tax laws apply to them, they have different purchasing and negotiation 58
power, different benefits at banks and other institutions. They even have very different life-styles and values than other people. Entitlement It is easy to understand that people who receive such greater benefits get used to these treatments, and the chances are high that they will lose contact to the average person. They then seem to live in a bubble. This explains that there are even stronger forces now that change the typical middle class towards a more dual society: the richer get richer and the poor get poorer. The sophisticated ones become more sophisticated and the less sophisticated ones become less sophisticated. In my opinion this trend will continue unless the average people take action to become more sophisticated as well in their financial education, in their lifestyle and their values like family, faith, community and in their choice of vocational development. How do you start? There are only two things you need in order to become financially more sophisticated, and that is: passion and opportunity. Pick a trade, a skill or an asset that you are passionate about, and then use a good opportunity to start a business. Make it happen for you and your family and your community. You can still live the American Dream these days, overcome the hurdles and go the path from the financially powerless to the average investor and to a sophisticated investor: to become an average investor you need financial education, and to become a sophisticated investor you need even more financial education and vast business and investment experience so you can buy or start successful businesses that provide you with that excessive cash, which you need to invest. Excessive cash sounds funny or too much to ask for. However, if you have a good business system, cash will pour in like from a water hose. You will use that cash from your business to invest in assets that the average investor has not access to. This is how sophisticated investors do it. Once you have excessive cash from your business, people will 59
find you faster than you might wish for, and they will offer you cool investment deals that you have never thought about. The easiest and most practical path to becoming a sophisticated investor is through becoming a business owner first, then use the excessive cash generated by your business to invest in other assets. For the longest time I did not understand this concept. Even after reading several books about investing I did not know how to start. Slowly, I discovered that becoming a sophisticated investor is a very long process, and that I had to change many things in my life first before I can even try to become a sophisticated investor. Obviously, I had a very good education. I had a bachelors degree and a master degree in finance. I knew all the theory but I was not street-smart in a financial sense. When I started my new career as investor, I felt like a kid who just graduated from school starting a new job even though I have worked as an employee for almost twenty years. But eventually, two things got me started: I founded my first company in 2008, and I studied the tax laws much more extensively. Since then I have started an investment company, a software and service company and a real estate company with great success. Looking back, I realized that I actually grew up in a state where many people are financially exceptionally sophisticated. The region is the economically most successful country in Europe: Germany. And it is the most successful state in Germany, where I grew up: Bavaria. Their secret is to promote small businesses. Here is a Bavarian Fairy Tale from ABC News February 2012. ABC news reported in its Foreign Correspondent section on February 14, 2012 (link): â&#x20AC;&#x153;Fact is Bavaria is the richest state in Germany and Germany is now the richest country in Europe. And while much of the rest of Europe is mired in the financial quicksand of a sovereign debt crisis, business in Bavaria is booming, exports are rising and unemployment is at a 20-year low.
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How come? Well, the Germans have got a word for it and only they know what it means. Mittelstand! It’s the very German secret to the success of modest family enterprises all the way to the global domination of the local auto-giants like Audi.” They call it Mittlestand. In other european countries and even in America, the word “Mittelstand” became a known term for its very strong small business entrepreneurship. The french even speak of “Le Mittelstand’” and recently announced to copy that idea to promote small businesses. Many say a strong Mittelstand is one reason why Germany has a very strong middle class, many successful companies and many of the wealthiest people in the world. But will all these initiatives with the gaol to build a strong Mittelstand be successful? The answer is no, if there are not enough people on investor level 5 and 6. If there are too few people who understand how to start and run a business and understand why it is so important to invest in good assets, then there will be no Mittelstand. Investing is like hunting Investing is a hunting game, not a shopping game. You need ammunition, which is represented by readily available cash and you need a whole bunch of experience to successfully catch a wild animal. Now you also know why it is important to keep money in cash (some call that saving money): when you see a deer you want to have your ammunition ready and shoot quickly. When you see a good asset you want to have your cash ready to buy quickly under the best terms possible. Paying cash will get you the best deal, and chances that you will create good income with that asset are much higher.
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SECTION 1
Investment Styles Investment Styles You can start buying assets no matter on which investor level you are, except of course level zero, since on level zero you spend all the money you make and will not have any money to invest. If you are on investor level 1 to 6, you are ready to invest your money. This might be the time when you want to refresh your memory about investment styles. Because investment styles vary from investor to investor, from investment to investment and will also change with different overall economic situations, you should familiarize yourself with the different ways to manage your assets. Your style might change after certain economic events, growth periods, recessions and especially during and after depressions. In below figure are eight basic characteristics of investment styles. FIGURE 3.3 Investment Styles CHARACTERISTIC
A
B
C
Time
Short Term
Mid Term
Long Term
Risk
Risk Averse
Risk Tolerant
Risk Seeker
Capitalization (Cap)
Small Cap
Mid Cap
Big Cap
Derivatives
Low
Medium
High
International Diversification
National
Regional
Global
Asset Class Diversification
Low
Medium
High
Investor Involvement
Low
High
Medium
Businesses
Value
Growth
Quality
Every investor has their preference for a particular investment style.
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Three Types of Investors Amongst the average investors there are three types. The saver focuses all activitors ties on saving money and sometimes TYPE PARAPHRASE buys assets at the lowest price possible. Saver Slow grower The speculator focuses on the biggest Speculator The shotgun investor bang for the buck with little or no knowlSpecialist The vertical investor edge about the assets. The specialist however only buys assets after a very deSource: tailed due diligence process, and keeps very well informed about the asset after asset acquisition. The specialist picks a certain asset class and becomes the absolute steward of that asset class. The specialist is on its way to becoming a sophisticated investor. FIGURE 3.4 Three Types of average Inves-
A Word about Market Manipulations It is no secret that the level 5 and 6 investors are able to manipulate certain markets for their benefits. For example, while a group of sophisticated investors meet FIGURE 3.5 Asset Types and typical Asset Management Activities ASSET TYPE
TYPICAL MANAGEMENT ACTIVITIES
Real Estate for Income
Condo Maintenance, Manage Repairs, Mange Tenants, Accounting
Stocks
Monitor Stock Price and company news
Funds
Research, Hope and Prey
Bonds
Watch Government activities and overall economic events
Commodities
Watch economic activities, growth and GDP
Real Estate Flipping
Find, Fund and Flip
Money Market
Park money and find investment opportunity in real estate, business and commodities.
Source: AssetVault LLC
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at an isolated location like a golf course they discover their passion for a certain asset, like stock or a commodity. At one point they happen to agree to invest in the same asset. Of course, it is very natural that they would also talk about when they plan to invest in it. Consequently, they might even buy on the same day or week. If their purchases are big enough within a relatively small market like the precious metals market, the effect might be that the price of the asset on that day will shoot up. There are all kinds of techniques how to manipulate the market, and when you enter â&#x20AC;&#x153;market manipulationâ&#x20AC;? in the Google News search you will be overwhelmed with examples of incidents and cases pursued by the SEC. Market manipulation is an ugly thing and nobody really wants to talk about it. Sometimes the investors might not even really be aware of how much they manipulate the market with their investment transaction. But it is a fact that every investor has to deal with. Smaller and bigger manipulations do happen more often than one would think. It is prohibited in most countries. and it can be done in any asset class. If you interested, there are numerous famous cases of market manipulation, which I encourage you to identify yourself and study since it helps you understand more about the markets. You, as an average investor should know about these possibilities of market manipulation. You should be cautious when you buy an asset and consider the impact on your assets. One rule to always remember is: the smaller the market for an asset is, the easier it is to manipulate the market price by buying or selling significant amounts of that asset.
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SECTION 2
What’s your WILL? Wealth consists not in having great possessions, but in having few wants. ― Epictetus
What’s your WILL? The word ‘will’ can refer to many things. In the world of law ‘will’ can be your last will, which I recommend everybody to arrange with a lawyer no matter how old you are. In the world of philosophy ‘will’ can stand for willpower as defined in Wikipedia as a property of the mind, and an attribute of acts intentionally performed. Will in psychology can also stand for the cognitive process by which an individual decides on and commits to a particular course of action. I would like to add a new meaning of the word will: the will in a financial sense. Will in a financial sense is the ability of a person and a family to build Wealth W as defined in this book, increase your financial independence I and possess a high leverage L of self financing when investing in new assets. Will in a financial sense plays very well with the legal, philosophical and psychological meanings of the word will. These other meanings are even necessary to increase your financial will. Now, let me explain the ingredients of the financial will. The input parameters for the financial WILL formula are very easy to determine: they are your personal total monthly expenses E, your total monthly salary S, and your total monthly passive income from the assets you own. Here is how you apply the formula: if your passive income is zero, then your wealth and financial independence are zero based on the WILL formulas. In this case your financial leverage becomes most important, if you desire to become wealthy. Try to increase your financial leverage as much as possible and use your dreams, visions and missions to increase wealth and independence. Here is how: W stands for Wealth Wealth is commonly defined as net worth, which is all your assets minus all your liabilities. Wikipedia defines wealth as the abundance of valuable resources or ma-
65
terial possessions. In broader terms wealth is known as the possession of anything of value. Well, let me ask you this question: what does all the wealth help a person who possesses huge wealth if he or she can only benefit from his or her wealth when he or she sells a portion of the valuable possessions? For a while that is great but one day that wealthy person will have sold all valuables. And what then? Adam Smith quotes in his book The Wealth of Nations Xenophon of Oikonomikos. He writes in the introduction on page 11 that wealth is a relative thing: "A man's wealth is only what benefits him. Suppose a man used his money to buy a mistress by whose influence his body, his soul, and his household would be all made worse, how could we then say that his money was of any advantage to him?. . . We may then exclude money also from being counted as wealth, if it is in the hands of one who does not know how to use it." That is why wealth must have another inherent component: income. Letâ&#x20AC;&#x2122;s say Tim, an average thirty five year old employee wins one million dollar in the lottery. He can put the money in a bank and receive interest, which is a form of income passive income. But that does not even cover the inflation rate. Tim is very cautions and he does not want to spend all his money immediately. Tim wants to benefit from his new wealth without spending too much of it. He will need to think of a way to benefit from that wealth without selling it all off. For that reason I created the Wealth Formula. I call it the real PE Ratio: Wealth =
PassiveIncome P = Expenes E
First, Tim put the full amount of 1 million dollars in his savings account. Tim plans to go and buy a nice home for half a million and use the rest of the one million to pay off his credit card debt and pay for his future personal expenses of about 3,000 dollars a month for about three years. But then he thinks, in three years, what will I do then? All his money will be spent and he will need to go to
66
FIGURE 3.6 Wealth and Financial Sophistication
Source: AssetVault LLC
work again. By plugging in the number of this scenario into the wealth formula, he sees his wealth is zero: W = P / E = 0$ / 3,000$ = 0. So, Tim thinks if he took half of his million and bought instead a cashflow positive business with some employees or a great fourplex that he rents out that gives him 4,000 dollars passive income every month to cover his expenses of 3,000 dollars, he could still buy the same nice home for himself in cash and have a great paycheck from his business or real estate to cover his expenses for a life time. Then his wealth is W = P / E = 4,000$ / 3,000$ = 1.33. His wealth is higher than 1
67
FIGURE 3.7 Whatâ&#x20AC;&#x2122;s Your WILL?
P = Passive Income, S = Salary, E = Personal Expenses Source: AssetVault LLC
and he would find him self in one of the upper boxes in the diagram, which represent the high wealth investors. This is why I define wealth as the ratio between passive income and personal expenses. Wealth has to do with the time you can live without a salary. I suggest you never confuse wealth with net worth. Net worth is all your assets minus all your liabilities. When looking only at your net worth you could be deceived. Net worth does not tell you anything about your independence in the longrun and how you create your income. Also, your should consider that wealthy people try to minimize their net worth to save taxes, which I will explain later in more detail. I stands for Independence Being financially independent is most important for every investor and, as a matter of fact, for everybody. Your most precious resource of your life is your own time, and that is what you are getting with financial independence. The formula for financial independence is as follows:
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Independence =
PassiveIncome P = Salar y + PassiveIncome S + P
Independence in this formula is a number that ranges from 0 to 1. You should always aim to reach an independence value of 1 (100%). If it is lower than 100%, that means you still have to work for someone else to cover your personal expenses. The time you spend working for someone else might be a lot of fun, and you might even learn from it. But when you are an investor or a business person, the greatest risk is being not independent. That is not only because you limit the time you can spend to complete your your own mission, working for someone elseâ&#x20AC;&#x2122;s business will also very likely distract from your own goals and will limit your creativity. It is a classic case of opportunity costs. Spending time and energy for your employer limits the opportunities that you have as an entrepreneur and investor. L stands for Leverage Leverage in this context refers to your ability to use your own funds to invest in assets. Do you remember Robert Kiyosakiâ&#x20AC;&#x2122;s quote? He wrote he has so much money coming in from his assets, he cannot reinvest the money fast enough. He has a very high internal investor leverage. He can fund his investments with his own money instead of bank loans or other external funding. I am not saying that Robert Kiyosaki uses only his own money to invest. He is a big proponent of taking on debt to leverage investments. But he also cautions investors when leveraging investments with external money. For more information on leverage please refer to chapter Asset Development, section Liabilities and Assets. If you can buy an asset without external leverage you have many advantages. Almost always, paying cash for an asset will give you a competitive advantage over other buyers and you might even get the asset cheaper. It also increases your cash flow per investment, and it almost eliminates the risk of default since you are not obligated to pay your creditors back. With the below formula you can calculate your personal ability to leverage using your own funds.
69
If you are still working as an employee to cover your personal expenses and have no passive income, you can use the following formula to calculate your investor leverage: Leverage =
Salar y S = Expenses E
If you have passive income, you can use this formula: Leverage =
Salar y + PassiveIncome S + P = Expenses E
What if your passive income P is negative? Believe it or not, many people buy assets, especially real estate as an investment property that costs them money every month. Early in my career as investor, I had been sold a nice little condo in an up and coming town. The only problem was that I had to pay money every month to keep it. My passive income was negative. With my good salary I was able to compensate for the negative passive income, so I could hold that asset. However, I needed to make my asset cash flow positive. That is where my journey started. I needed to get smarter about investing in more asset classes, and I started to get smarter about my cash flow and other asset classes.
70
CHAPTER 4
The Business Owner Out of all five asset classes, businesses have by far the most potential for providing the owners and all share holders with the highest returns. This is the reason I dedicate a whole chapter to the business owner. Starting a business is a huge challenge for everybody. I have talked to many people who shared with me their great ideas on how to make money, and only maybe a handful of these people have really been able to create very successful businesses. Today, I am well aware of the reason for this small number of successes: having a great business idea maybe a matter of days or weeks. Envisioning opportunities is easy. Turning that vision into reality however is the real challenge, and it will take months, if not years to convert an idea into a successful business. Being not able to implement a great business idea is why many entrepreneurs fail, not lacking of ideas. Some say nine out of ten start-ups fail within the first five years. My conclusion is: companies that can execute will succeed. Turning a vision into reality Turning a vision into reality requires the entrepreneur to play on all manuals. The key is that, before any product or service can be created, a machine needs to be built, which can make all products. When I started my first company I often found myself in a vicious cycle that became unmanageable. For example, I could not find a developer to work on the product because I could not pay a salary. I could not pay a salary because I did not have any funding (except my own internal funding). I did not have any funding because I did not have a completed business plan. I could not bring in other people to work with me on the plan because I did not 71
FIGURE 4.1 An example illustration for a business start-up machine
Source: The Author
have a profit-sharing contract set up with a lawyer to offer potential partners or employees. The list seemed to become longer and more complex every day. I started to track all activities in a project plan and tried to prioritize and sequentialize all activities. I found myself doing classic project management, and I realized that starting a cool business is really all about managing a huge project. I have heard the saying that having a great team that can execute is much more crucial to becoming a successful business owner than having a great business idea. A very well implemented bad business idea is most likely more successful than a badly implemented perfect business idea. For me, the bad news was the realization that I had to put much more energy into working through lengthy tasks in all these areas. The good news however was that
72
managing all these project-like tasks is rather mechanical than really difficult, and that meant that I can learn it. I learned how to deal with legal issues like copyrights, trademarks, company profitsharing contracts. I got knowledgable about ways to search for investors and developers, and I was able to create a team that will execute the first minimal viable product, a product that can be built with the existing resources in order to create the first revenue stream. In the end, I created a complete, well-oiled machine that will create all the products I would like to sell in a reasonable timeframe. I always try to build the machine in a way that allows me to scale the business, so I can for example add more products, include more sales channels or increase the quality of the products. The following table shows a sample list of management activities and deliverables in every area of a start-up machine. FIGURE 4.2 Components of the Start-up Machine MACHINE PART
TYPICAL MANAGEMENT ACTIVITIES
Legal
Create and manage patents, trademarks and copyrights
Marketing
Build and execute a marketing and business plan
Development
Generate business requirement documentation and technical specs, develop product, develop and implement company processes
Graphic Design
Create graphical design document and design products
Functional Design
Create functional design document
Sales
Create a sales plan, build sales channels and sign contracts with customers
Quality
Build quality plan and implement quality assurance (inspections, etc.)
Source: Author
Most entrepreneurs find them self trapped in a vicious cycle between finding the first customer, having adequate funding, and creating a product that can generate money. The only thing available at the beginning of most start-ups is a business idea or a vision. Until the start-up founders have not found a paying customer or created a first sellable product or have found someone who will fund the the new 73
company, the business engine cannot start-up. As ilCycle lustrated in the diagram it starts with an idea in the middle. There is no product, no funding and no customer yet. The founders will need to work initially with a lot of other people until a developer has been found who is willing to work on the first product or an investor who agrees to fund the companies projects or a first customer is Source: The Author found, who puts money on the table to receive the first product. Eventually, the customer-product-funding machine will start running, and money can be reinvested in more and better products, which will then create more customers. FIGURE 4.3 Simplified illustration of the Start-up Vicious
To start up that engine that draws attention to investors, creates products, customers and money it will take a lot of energy and time. The entrepreneur will have to literally run around and talk to potential customers, investors and to developers who can make the first product. Entrepreneurs will need to knock on their doors until finally one will work with them. Most businesses fail due to the lack of either customers, investors or the right product. There are typically only three possible scenarios how successful businesses start: a) At least one investor is willing to invest in the implementation of an idea. b) At least one customer is available who is willing to fund a first product. c) At least one sellable product is available to the business founders.
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If none of the above scenarios apply, the entrepreneur has almost no chance of building a successful business. So, before you start a new business it is crucial to first think about the chances of following at least one above scenario. Buying versus starting a new business As an entrepreneur you do not always need to start your own company. Many successful entrepreneurs have purchased an existing business that they have transformed over the years to become a totally different company. ★ In 1979, Trader Joe’s was bought by Theo Albrecht, of Aldi Nord. ★ In 1987, the original owners sold the Starbucks chain to former employee Howard Schultz. ★ In 1951, Robert Maxwell, who founded the Maxwell Publishing Group, in 1951 purchased Permagon Press Limited, a minor textbook publishing company. He quickly built Permagon into a major publishing house. If you are interested in more stories about the greatest entrepreneurs, you can find a nice compilation of many entrepreneurs at www.topbusinessentrepreneurs.com. When you buy a business you generally buy at least two important ingredients of a successful business: the customers and the products. Your purchasing contract should also clarify whether you buy any other assets like copyrights, trademarks, any securities or any other asset class like real estate or even commodities. You definitely want to buy the hard assets like the machinery necessary to build the products, and you want buy customers who have ordered at that business for years. With the customers and the products you can generate income from day one after your purchase, and you can increase operations, quality and customer base as you wish. Of course, the disadvantage of buying a business is that you have to deal with legacy infrastructure, which can hinder you to develop your own vision. If you do it right however, buying a business can give you the necessary cash for your own projects though, and that might be a very good reason to buy an existing business.
75
What companies can you start? What companies would you buy? Would you like to convert a Small Business to a Large Business? Look at your career experience and skills. You will discover that your background is the perfect mix to find customers for a product that you can develop and sell. Useful Links: http://www.mystartuplab.com
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CHAPTER 5
Wealth Management “Broke is a when you run out of money, poor is a state of mind.” ROBERT KIYOSAKI
I remember the times when people were sitting in their offices with huge news paper pages and reports opened on their desks so they could study the latest financial news. There was no internet or computer available. Today, most sophisticated investors are using the internet and software that can make their investment decisions and management of their assets so much easier based on real-time data. Gathering and pulling up data from the internet is great, but how exactly can financial asset management tools help? With a financial asset management tool an investor takes advantage of today’s technology, especially mobile applications, to control all or some of their financial assets. The most effective and most crucial method to stay in control of your assets is to monitor asset income and asset value on a constant basis. Even in today’s advanced world, this can still be a lot of work, especially if you own many different assets in different asset classes. There are many services available on the internet that allow you to look up most financial data for free. However, it is still utmost cumbersome to gather all the data on a regular basis. A tool that could do all the legwork for you by presenting a dynamic, flexible but very effective view of all of your financial assets will really help to stay up-to-date with all your assets and make better decisions. As an investor, I promised to my self that I will never again lose sight of the net income and the net asset value of all my financial assets. For that reason I have developed a method to create such a congregated view. Here is how it works using an example of Amazon Inc.: 77
The two figures show Amazon Inc.’s Net Income, Total Debt and Total Assets. Based on these three numbers, a single view is being displayed automatically for each of my assets. Every time such a view is generated the application will take a snapshot of these numbers and will store them in the asset history.
FIGURE 5.1 Amazon Revenue, Net Income
Source: Google.com
FIGURE 5.2 Asset Grid based on Google’s Data for Amazon’s Balance Sheet and Income Statement from 2008 to 2011
Source: AssetVault LLC
By plugging in the data from Amazon’s income statement and balance sheet as shown in the Asset Grid, you will see that Amazon has delivered financial results exclusively in the upper right cash cow quadrant. I will explain more about the quadrants and the meaning of them in the next section. Important now is to realize that, if you create the Asset Grid diagram for NYSE companies, the dots would appear for most companies in the cash cow quadrant.
The Asset Grid gives the investor a very quick view of the financial performance of a company. Another example of a company with very different financial results is illustrated below. In the four years shown, Cubic Energy, Inc. has produced only negative net income, and most of the time their assets were less than their liabilities. They appear to be the dead cows in your portfolio.
78
The net asset value varies extremely from industry to industry. So, a negative net asset or equity (assets are smaller than liabilities) might be considered acceptable in industries where big projects are common and extreme amounts of capital are needed. So, for a period of time, a negative net asset is considered to be O.K. for some companies. However, if the asset imbalance seems to remain negative, and if the investor is not a good industry insider the investor should refrain from buying into such companies. Now, you can analyze any company with this method and application. However, the most beneficial way to use this tool is by analyzing your own assets. The same rules that apply to a for-profit company should apply to your own assets. You want to grow them and you want to receive a good income with your assets, correct? If you track your own financial assets and apply such a method, this information will mean the world for you. Income and asset value are the two only numbers that will determine if your assets are giving you your financial freedom or not. So, lets look at the two axis a bit closer: the horizontal axis is the income axis and the vertical axis shows the asset value. Here is how the method calculates the values for both axis: IncomeNet = IncomeGross â&#x2C6;&#x2019; ExpensesAll AssetNet = AssetMarket â&#x2C6;&#x2019; FinancingTotal The gross income is the sum of all income that you receive from the asset in a certain time frame (e.g. a month). This could be the rent you collect from a condo or the dividends your receive from your stock investments. The total expenses are all expenses related to that asset including taxes. Depending on the asset class these expenses might be account fees, property maintenance costs, loan service payments, etc. The market value of your asset is the current money you could receive when you sell the asset. In case of a security like stocks or bonds you can easily look this value up on diverse online trading platforms, which reflect the current price on a public exchange system. In case of real estate or business assets it might be more 79
FIGURE 5.3 Asset Grid for Cubic Energy, Inc.
difficult to find an current value.
The total amount of loans related to an asset is the sum of all liabilities that you took on when you bought the asset. It might be one or more bank loans or it could also be an amount from internal financing. When Source: Google.com you or your company only used own money to buy an asset the internal financing is 100% and the leverage is 0%. If you buy an asset with a 10% downpayment using your own money, and you used a bank loan for the remaining 90% to buy an asset you used: â&#x20AC;˘ 10% internal financing â&#x20AC;˘ 90% external financing (leveraged with a bank loan) The asset is 90% leveraged. Important to note is also the total financing consists of internal and external financing: FinancingTotal = FinancingInternal + FinancingExternal Do you have to pay for your assets every month to keep them? I promised to my self that I never again wanted to be in a situation where I had to pay to keep my asset. In December 1998, I bought my first newly built condominium not only for twice the market price as it turned out after the construction was completed. I also signing up for a too high mortgage payment with a too high interest rate and a low principal payback rate. So, for ten long years I had to pay about 500 dollars from my hard earned salary every month to satisfy the bank that 80
loaned me the money for the condo. Finally, in 2011, I paid off the entire loan, and I now receive a small paycheck every month. But I was lucky I was able to pay my loan back early. Buying this condo was a a great lesson for me. Over these ten years I improved my financial literacy, I developed a method to track all my financial assets to make sure I am not buying into a dead cow investment again. I also wanted to find out how I can develop my assets, so they will all produce income in a foreseeable time. Most sophisticated investors are big fans of tools that make their investment decisions and management easier. So, I was encouraged to develop this method into a tool that can be most easily used by investors. The tool only exists as a simulation today, and a first release is planned to come out in the coming years. If you like to read more about the project visit lafundia.com.
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SECTION 1
Asset Quadrants â&#x20AC;&#x153;The individual investor should act consistently as an investor and not as a speculator. This means that he should be able to justify every purchase he makes and each price he pays by impersonal, objective reasoning that satisfies him that he is getting more than his moneyâ&#x20AC;&#x2122;s worth for his purchase.â&#x20AC;? Benjamin Graham
FIGURE 5.4 The Asset Grid
Imagine a grid with four quadrants. Everything you ever invest in will show up in one or more of these four quadrants. On the vertical axis is the asset value and on the horizontal axis is the income generated from that asset. Both can be either negative or positive.
A negative income means you pay every month for the asset. A negative net asset Source: AssetVault LLC value means you owe more on the asset than it is worth. In other words there is no equity in the asset, the amount you owe to the bank is higher than what the asset will sell for. In that case you cannot sell the asset without making a loss. Furthermore, if you pay more in debt services to the bank than the asset generates net income, the asset in the death zone. You have to pay to keep the asset and you cannot sell it without a loss. It is a financial dilemma. It is a disaster for every investor, and it happens more often than one might think. That is the reason the lower left quadrant is called dead cow quadrant. There is nothing you can do to bring the asset back to life, unless you lower the leverage by paying off a portion or the entire loan in a lump sum. 82
If the asset is in the right lower corner, which means you make money QUADRANT STRATEGY PICTOGRAM with that asset, even Young Cow Invest though the net asset value is negative, meaning that Cash Cow Monitor & Control you owe the bank more than the asset is worth, Old Cow Re-Structure you might want to hold Abandon or reDead Cow on to the asset, keep the develop money each month and, Source: AssetVault LLC with the control you have over your asset, increase the net asset value over time. Then you might even be able to sell the asset with a profit. FIGURE 5.5 Strategies
The net asset can also be explained with the debt to asset ratio, the D/E ratio. If that ratio is greater than one, the asset is worth less than the amount owed to lenders. A ratio smaller than one means the net asset value is greater than the debt associated with that asset. So, it has a positive net asset value. As illustrated in the below graph representing as an example the financial data from the electronic company Siemens, the debt to equity ratio varies over the time quite a bit.
FIGURE 5.6 Siemens: Debt to Equity Ratio
Source: http://ycharts.com/companies/SI/debt_equity_ratio
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FIGURE 5.7 The Young Cow
The young cow has not seen the world yet. It still needs much care, it is mostly inside the barn where it is protected and fed. A young cow is in an incubator and is waiting to be with the big cows to produce milk. Also, chicken are raised in an incubator, so they can lay eggs. More or less money had to be invested before young cows will become productive. Source: AssetVault LLC
FIGURE 5.8 The Cash Cow
The cash cow turned from a young cow into a cash cow. A cash cow does not fall from the sky. It has to be created. If you have good financing (preferable internal financing), you will be able to buy a cash cow and your asset will produce income from day one. If you leverage your asset, you might not receive income immediately and you will have to share your income with your lender. Source: AssetVault LLC
Now, in which quadrants would you like to be? In the upper right, right? You can do a quick test by looking at financial assets you own and make a dot for every asset based on the last statements you have. You will be surprised where you will find your dots. When I did my first asset diagrams I noticed two things immediately: there were some in the dead cow quadrant, and many of my other assets were actually not really producing much or no income. I did the same thing for some public companies like Siemens or Microsoft and I saw a big difference. Both companies operated almost always in the cash flow quadrant and some times in the old cow quadrant. That opened my eyes immediately and I started to work on repositioning all my assets. Historical Asset - Value Grid
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FIGURE 5.10 The Dead Cow
The dead cow is the end stage of every asset. For businesses, the end stage is bankruptcy or any other liquidation, for real estate it is mostly a negative cashflow combined with negative equity. For securities and money market accounts it is the devaluation of money combined with high fees and too little interest income. There is typically no way out, except if it is sold to another investor with better conditions or loan restructuring. Source: AssetVault LLC
FIGURE 5.9 The Old Cow
Typically, a cow turns old after a longer time of producing. Every asset needs constant maintenance and reinvestments. If these investments are too small or other market forces put too much pressure on an asset, your asset might sill produce net income but the asset will lose in value so it becomes an income producing underwater asset. Source: AssetVault LLC
It can be helpful to see income and asset value over time. Some assets move between all quadrants of the grid. One month they are cash cows and other months they are dead cows. One month you win and others you lose. A good example for such unstable assets are stocks. Most of the stocks can move pretty heavily on the value axis, and they can also provide huge changes in the income they bring as dividends. It might help considerably to use a tool that can create such a historical incomevalue grid. With AssetVault, a mobile application you can take advantage of realtime data and the very convenient possibilities of highly available information. The application pulls real-time information from several market places like NYSE,
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BullionVault or commodities markets and combines them with your personal asset portfolio. It creates a grid for each asset. In the asset grid you can visualize the two dimensions of your assets: income and value. If you enter the current asset value and the monthly income from that asset into a table and build a scattered graph from that table you will receive an asset grid. The X-axis shows the income and the Y-axis shows the current value of the asset minus the debt owed on the asset. Now, where you definitely don’t want to be is the left lower quadrant of the grid. It is the Dead Cow Quadrant. If you do not do your due diligence before you purchase an asset, chances are very high that you will end up in this corner pretty quickly. Even if the monthly numbers might vary and you are most of the times in any of the other quadrants, showing a red dot in the Dead Cow Corner is a screaming alarm sign for every asset. And if you have leveraged that dead asset with a bank loan you are trapped. You have to put out cash to sell it and if you don’t have that cash, your only option is to keep the asset and pay your monthly interest and principal. This is a typical underwater situation not only so many home owners (your home i not an asset) but whole investment companies are in nowadays. In addition, for many people the house is their only residence. So, not only that they have to pay the deficiency between their underwater house and the bank loan, the house is also their only residence so moving might not be an easy task. Later in the book I will write more about your house as an asset. A Strategy for every Quadrant Depending in which quadrant your asset is you will need a certain strategy. The good thing is that there is at least one strategy for all four quadrants. In below diagram is a short hint about such a strategy. After you purchase an asset you will either invest, win, start to lose control or you lost already. Your job is it to control the investment process in order to never hit the “You lost” quadrant.
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FIGURE 5.11 The Asset Value - Income Grid
Source: AssetVault LLC
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SECTION 2
Ten Rules of a Sophisticated Investor DIAGRAM 5.1 10 Asset Management Rules i.
Never buy an asset above market price
ii. If an asset does not produce net income, don't buy it unless it is a highly secure liquid asset like cash or gold. iii. Do not keep dead cows. Sell them or convert them into a cash cow, old cow or young cow. iv. Never over-leverage: keep dead cow risk low. v.
Create an asset statement every month showing income and current asset market value.
vi. Aim to keep all assets in the cash cow quadrant at all times. vii. Put your assets first. Always make sure they are in the right quadrant. viii. Don't be just a trader! Do not trade your assets for capital gain purposes only. ix. Sell assets that do not create enough income to keep risks for losses low. x.
If you buy a Young Cow, have a good plan to develop it into a cash cow. Take 100% control of that asset.
Source: AssetVault LLC
Although these ten rules apply to all five asset classes they are really important for the asset classes businesses and real estate.
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I. Never buy an asset above market price This first rule seems to be an obvious statement. However, how many investors end up paying too much for an asset? Do your intensive research before you buy, do your due diligence, and always try to understand the seller to get a better deal. Paying cash will always be an incentive for the seller to sell quicker. II. If an asset does not produce income, don’t buy it. Together with rule number I rule number II is a game changer. By following only these two rules you will minimize the risk of ending up as a loser. Of course, it is not an easy task to follow these two rules, and there will be setbacks. However, a good investor will develop skills that will allow him or her to master these two rules. There are some exceptions to rule number II however. If the asset is a highly secure and a liquid asset, which can be used to trade for other assets in the future, the present income shall be forgone and traded for future opportunities. Some people say “cash is king” and “gold never gets old”. So, instead of buying an income producing asset today, it might be smarter to keep the cash or buy a nonproducing asset in order to be able to buy an income producing asset at a later time. But that should be an exception rather than a rule. III.Do not keep Dead Cows Everybody who owned a Dead Cow asset like an underwater real estate property knows how dangerous a dead cow in your portfolio can be. That asset drains constantly money from you. The property is less worth than you owe to the bank . You might not even be able to sell the property without putting a lot of cash into it or foreclose. So, under any circumstances, never keep a dead cow. Sell it, let it go or pay it off so you get it out of your debt column. Rule number III is: never lose money! IV.Never over-leverage You heard it many times: buy a condo in a good location, put down a small downpayment and take a bank loan to finance the rest. Many people suggest a high lev89
erage like 80% loan and 20% downpayment. That will work out great for your monthly income stream, of course. Considering the debt payments and other costs your monthly income will be higher and all is good. However, you will take the full risk if the condo depreciates over time and your loan is higher than the condo is worth. My recommendation is to leverage as little as possible but as much as necessary. V.Monthly Asset Statement Create an asset statement every month showing income and current net asset value of all your assets. VI.Stay in the Cash Cow Quadrant Aim to keep all assets in the cash cow quadrant at all times. It seams logical and even easy to accomplish that. However, too many businesses run out of money every day, many real estate properties are in the red and a lot of money market accounts are just stumbling along drawing money out of peopleâ&#x20AC;&#x2122;s pockets too often. VII.Put your assets first If you lose sight of your assets, they will turn sour sooner or later. Assets need constant attention in regards to their financial performance. VIII.Don't be just a trader! Do not trade your assets for capital gain purposes only. Trading is a profession and has little to do with investing. Think about the 2-bucket investing approach of level 5 and 6 investors. They make mostly money with their ideas and creativity, which they understand to convert into businesses and real estate assets. IX.Sell assets that do not create enough income To keep risks for losses low it is important to have a good income buffer zone. If you are making less than 5% net income based on the asset value no matter how high the leverage when you bought the asset, you should try to restructure the asset or sell it. 90
X.Have an Asset Development Strategy If you buy a Young Cow, have a good plan to develop it into a cash cow. Take 100% control of that asset. If you buy an old cow, know how to convert it into a cash cow. And if you intend to buy a dead cow, donâ&#x20AC;&#x2122;t. Never buy an asset as a dead cow. For the seller, an asset might be a dead cow. But when you buy that asset from such a seller make sure you donâ&#x20AC;&#x2122;t turn it into a dead cow in your portfolio. This means you will have to buy it, so that the asset is worth more than you owe on it, ideally you buy it under the current market price and leverage as little as possible.
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SECTION 3
Your Monthly Statements Have you ever played a game called Cashflow 101 Game? It is a board game that Robert Kiyosaki invented. It is like Monopoly with a different layout and a more sophisticated content. In that game you will fill out and maintain an income statement and a balance sheet throughout the game with a team of preferably four people. The person who has more passive income than expenses first gets out of the rat race and wins part of the game. You should do the same thing in real life. Create your financial statement regularly, especially if you own a signifiFIGURE 5.12 Your Income Statement and Balance cant number of financial asSheet sets. If your assets earn more income than your personal expenses are, you are out of the rat race. Do you know what dollar amount you are away of being out of the rat race? Create your financial statement and find out! Every publicly traded company issues amongst other statements and documents an income statement and balance sheet. Income statements and balance sheets are the most important financial documents that show how well a company is doing. As investor you should not only be able to read in-
Source: AssetVault LLC
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come statements and balance sheets from other companies but you should also be able to create these two documents on a monthly basis for your own financial assets. The Asset Statement You can create your own financial statements by entering all your monthly incomes and expenses and all your assets and liabilities. Do the math, add up every column and then link all your expenses to the one of your liabilities and every income item to one ore more of you assets. Remember: if you are an employee, you FIGURE 5.13 Your monthly Asset Statement Asset Class
Monthly Income
Return *
Asset Appr./ Depreciation
Asset Change
Purchase Value
Current Value
Precious Metal
Commodities
$0.00
0.00%
$30,000.00
42.86%
$70,000.00
$100,000.00
AB Checking
Money Market
$0.00
0.00%
$0.00
0.00%
$377,000.00
$377,000.00
AB Bank Savings
Money Market
$80.00
3.20%
$0.00
0.00%
$30,000.00
$30,000.00
XY Bank Savings
Money Market
$0.00
0.00%
$0.00
0.00%
$11,000.00
$11,000.00
ABC LLC
Business
-$50.00
-60.00%
$1,000.00
0.00%
$1,000.00
$2,000.00
BI LLC
Business
$0.00
0.00%
$15,000.00
37.50%
$40,000.00
$55,000.00
Company AB
Business
$833.33
100.00%
$0.00
0.00%
$10,000.00
$10,000.00
City 1 Condo
Real Estate
$300.00
12.00%
-$2,000.00
-6.67%
$30,000.00
$28,000.00
City 2 Condo
Real Estate
$200.00
2.40%
-$50,000.00
-50.00%
$100,000.00
$50,000.00
Town 1 House
Real Estate
$1,250.00
6.82%
$30,000.00
13.64%
$220,000.00
$250,000.00
Town 2 House
Real Estate
$600.00
1.66%
$795.00
0.18%
$435,000.00
$435,795.00
Fonds
Equities
$575.00
22.26%
$0.00
0.00%
$31,000.00
$31,000.00
Bonds
Bonds
$300.00
1.44%
$0.00
0.00%
$250,000.00
$250,000.00
Equity
Equities
$400.00
1.92%
$0.00
0.00%
$250,000.00
$250,000.00
$24,795.00
1.34%
$1,855,000.00
$1,879,795.00
Total Total Annual Income
$4,488.33 $53,860.00
Source: AssetVault LLC
are an asset and you will need to enter your salary as income. However, who has the time to do all the number crunching every month? A company that I founded is doing all the legwork for you. Based on your bank accounts 93
FIGURE 5.14 My income statement and balance sheet that I drew on my whiteboard in 2003
Source: AssetVault LLC
it calculates your income and expenses and based on information on the web it calculates your total assets and liabilities. The application presents your complete portfolio in a very effective and friendly way - on demand. The asset statement is a combination of an income statement and a balance sheet. It shows all assets with its current value and how much money they produce. In above example, not all assets have positive equity, and some do not produce income. After being an employee for about 10 years, I created my own income statement and balance sheet the first day in 2003. I immediately noticed with great shock that almost all my money that I earned as an employee was GONE every money. I had an above average salary, but not only that I had high monthly expenses, I did not even have a plan where to put my hard earned money. I just spent everything I had. I was a level 0 investor at that time. I had nothing to invest.
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That was my first wake-up call. In the following years I tried to improve my situation but as life went on, my habits did not change significantly at first. In 2007, I created my first asset grid, like the one that I have explained earlier in the book. It showed me exactly which assets that I owned at that time were dead cows and which ones I should keep since they were cash cows. I started investing heavily in commodities, precious metals and real estate, and after some years I saw the end of the tunnel. I started a small investment company in 2008 with much success. I was almost able to cover all my expenses with passive income from my newly acquired and restructured assets. I suddenly had much more time, and I had many new friends. As I am writing this book, I am working on building a business in the software and financial industry. Today, I am receiving three types of income. That is portfolio income from capital gains, a part is passive income from many positive cash flow assets, and I receive some small earned income from sporadic work I do as independent contractor in the financial and IT business. Creating my financial statements for my own assets helped me get out of my previous financial odyssey that brought me nowhere. From my own experience, it takes about ten years to change the course of someones financial path. Becoming a sophisticated investor was a life-changing event for me, and it certainly has much more to do with other things than just finance. You as a person will change for the better. You will become more generous, you will be more relaxed, and you will be more confident since you will understand the world much better compared to the time when you were in a financial hole.
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SECTION 4
Social Networks for Investors If you want to become a sophisticated investor, you need to invest in your social capital. Individuals on higher investor levels always work as a team, they have friends on higher investor levels that can help them with financial, legal, technical, business related, tax or other subject specific questions. Sophisticated investors have a strong network of friends that mostly contribute to deals, business ideas and businesses. The average investor might have many friends but not many of them are likely interested in financial assets. If you like to improve your financial literacy and move up in the investor levels, you will need to build your network of people who are in the higher investor levels. Nowadays, it is much easier to find people in all areas. There are online and mobile systems like MeetUp.com, LinkedIn.com, even messaging services like Twitter.com, which provide you a wealth of opportunities to link up with likeminded people. For example, on MeetUp.com you will find many groups that meet regularly in your town. There, you will find groups that talk about every one of the five asset classes. If you are interested in real estate, type in real estate in the search field on MeetUp.com and enter the area you live in. You will find many different groups. Join them, go to a meeting and talk to people face-to-face. You will find out quickly if you click with these people or not. If you feel misplaced in a meeting, you might try another group or the subject you selected is maybe not for you. Try other groups and subject areas until you find an asset class that really excites you. Once you have found your group and asset class, meet regularly with your group, find out the people you can work with and collaborate with them. Show them what your are working on, how you are currently investing and ask questions.
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It might take some time. But you will be able to come up with cool business ideas, and if you do it right, you can soon collect income from your business to cover some or all of your personal expenses. At that point you are free to explore more, spend all of your time and energy into your assets and your journey as sophisticated investor can begin. A very important advice I would like to give anybody who wants to build and maintain a professional, but also a personal social network. The seven deadly sins are part of the age-old ethical morals, and their negative effect on a society are taught for over 2,000 years . The sins are pride, greed, lust, anger, gluttony, envy and sloth. If you want to make good friends, especially in business, be aware to avoid all of these sins. Don’t be overexcited about your product, don’t become too focused on the money you are making on a product, don’t get carried away by your business friends, avoid getting angry or showing your anger overly, always be personal - no mass emails unless necessary - and have role models but follow your own goals. In other words, just be a nice but firm guy, be someone other people like to hang out with. Some people say that ‘your network is your net worth’. So, build your social capital with caution and modesty. And always be of service to people. Believe it or not, being of service is the only real way to make money in the long-run. Create a business with great people, and create and provide things that people really find useful and joyful. Of course, make sure you make money in the process. What does it help if everybody loves what you are selling but they can’t buy it anymore after you are out of business?
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CHAPTER 6
Asset Development “As a sophisticated investor you don’t buy financial assets. You develop them. — UNKNOWN
As a sophisticated investor you don’t just buy financial assets. You develop them. This chapter will show you what the life-cycles of assets look like and it will explain what you can do to make sure your assets don’t die on you. Have you ever thought in great detail about how and why your assets change over time? A very effective way of following their life path is by looking at the AssetIncome Grid. The grid shows four quadrants: the young cow quadrant, the cash cow quadrant, the old cow quadrant and the dead cow quadrant. At any given time, your assets can be found in one of the four quadrants. Your assets might even move from one quadrant to another quite often, triggered by certain events. You might not always be able to control how they move, but you will be glad you know that they actually have moved, so you can take measures.
FIGURE 6.1 The Asset Grid
When you buy an asset you should know ahead of your purchase which path you want your asset to move. Assets are born, fed, produce income, are maintained
Source: AssetVault LLC
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and eventually they do die. Some investors will be able to give some assets a second life. But this will need a very high financial sophistication and often a good portion of cash. On the following pages, the below formulas will help you understand the graphs. Equit y = CurrentValue â&#x2C6;&#x2019; CurrentLoans LT V =
CurrentLoan CurrentValue
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SECTION 1
Life on Assets - Some Examples The Trader The most straight forward asset development is also the most common asset development strategy: the investment in a non-income generating asset with the goal to sell it with a profit for a higher price in the future as illustrated above without adding any or significant value to the asset itself.
FIGURE 6.2 The Trader
Source: AssetVault LLC
Under this category fall collectors, traders, dealers, merchants, salesmen and -women, vendors, purveyors, peddlers, hawkers, merchandisers, distributors, suppliers, shopkeepers, retailers, wholesalers.
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The Flipper
FIGURE 6.4 The Flipper
Then there are investors who buy an income generating asset, add value to it and sell it with a profit. Many call it the motto of the 3-Fâ&#x20AC;&#x2122;s: find, fund and flip. The goal of this investment is to find an undervalued income-generating asset, fund it with usually a higher leverage, and quickly resell it for profit after improving the asset. This process is illustrated in above diagram. Typical investments using flipping Source: AssetVault LLC are in real estate. Real estate flippers call this investment the three Fâ&#x20AC;&#x2122;s: find, fund and flip. Initial public offerings fall also sometimes into this category. Below graph shows an example of a typical real estate flipping investment. FIGURE 6.3 Typical Real Estate Flip
Source: zillow.com (8185 NE View Ridge Ln, Poulsbo, WA 98370) 101
The Loser
FIGURE 6.5 The Losing Investor
In case an investor makes the huge mistake of paying too much money for an asset, the asset is under water immediately after the purchase. Like deadstock in a store, it canâ&#x20AC;&#x2122;t be sold on the market unless the seller takes a huge financial loss. In case the asset is generating a negative return as illustrated in the above diagram the asset is a dead cow. The above diagram illustrates the sale of the asset as a Source: AssetVault LLC dead cow. In the housing market it is referred to a short-sale, where the bank might share or completely pay for the deficiency between the sales price and the amount owed.
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The Incubator
FIGURE 6.6 The Incubator Investor
An incubator investor puts money into an asset that is growing in value and brings the asset to operation to produce income, and then sells the asset after some time of harvesting the income. A century old example of such investors are cattle farmers who raise cattle, produce income from selling milk and after a typical life of a milk cow selling the old cow for slaughter place. Other typical incubators are investors Source: AssetVault LLC who start businesses with their initial capital and knowledge to sell the cash flow positive operative business with a often very huge profit margin. There are many business incubators all around the country that provide young businesses office space, networking opportunities, knowledge and other support during the start-up phase. Writing a book falls also under the incubator investor.
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The Blue Chip Investor
FIGURE 6.7 The Blue Chip Investor
Blue Chip investors are mostly successful businesses that run well for decades. The business founders started small, increased the value of the business quickly and became cash flow positive sooner or later after inception. A good management and good market climates helped the business to produce income over long periods. Tendencies that let the company fall behind, like technological changes or social deSource: AssetVault LLC velopments have been recognized early and acted on enough to keep the company a cash cow and avoid to turn into an old cow.
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The Wise Investor
FIGURE 6.8 The Wise Investor
The wise investor sells an asset after growing it, harvesting the profits and then loses the capability of maintaining, managing the asset. The asset becomes old. Before the asset stops producing income, the investor sells it.
I have seen too many times that the asset investor neglects many factors of investing, over-leveraging Source: the asset, and then eventually ending up with a negative cash flow. Often, the asset turns first into an old cow with a negative asset value, and then eventually the asset becomes a dead cow many times before the investor realizes it. At that point, the asset is over-leveraged and it costs the owner money every month. Selling the asset is impossible, unless the owner puts a lot of money down towards the deal. The asset becomes literally a liability.
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The Home Owner
FIGURE 6.9 The Home Owner
A frequent question I hear is the question if a home owner is an investor, or if buying a home is an investment. The short answer is: no. The long answer is: at best a very bad investor. I placed this asset grid for home owners in this section because it explains very well the financial situation of every home owner. The above graph represent the only possible Source: AssetVault LLC scenarios of home ownership. The final preferred outcome is that the home owner owns the entire home without any debt owed to the bank after the mortgage is paid off. However, as you can see, there will never be any scenario where the â&#x20AC;&#x2DC;assetâ&#x20AC;&#x2122; (the house) produces any net income. Quite the opposite, the owner pays every month a mortgage payment to the bank. And even after the house is paid off the owner will need to pay property taxes, utilities and maintenance. For that reason none of the dots will ever appear on the right side of the grid.
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The Naive Investor - A Dead Cow Investor
FIGURE 6.10 The Naive Investor
Not all investors have enough experience to execute an investment strategy successfully. It all starts with the asset purchase. If the asset is bought for a price above the market value or the buyer over-leverages, the investor will end up with a negative asset value. If the asset, on top of the negative value does not produce any net income because the financials of the deal (e.g. too much leverage) Source: AssetVault LLC were not evaluated carefully, the asset will end up in the lower left corner quadrant: the dead cow quadrant. The asset is under water. Keeping it will require constant payments by the investor, and the selling of the asset would result in a huge loss and potentially a required deficiency payment to the loan company. If an asset is worth less than the asset owner owes to a third party, it can become an old cow if it still produces income. After a re-evaluation of the asset, the asset is worth less than the total debt on the asset. The owner cannot sell the asset without losing money. But since the asset is still generating income the new owner can re-invest in the asset to increase its value. As a buyer, it makes a lot of sense to buy an asset as an old cow. The asset might be converted to a cash cow with the purchase if the buyer can refinance the debt with better conditions. Then there will be a positive cash flow that can be re-invested into the asset. However, the owner might not like to sell it, as long the asset produces income.
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The Negligent Investor
FIGURE 6.11 The Neglecting Investor
Some investors buy and develop an asset, make good money for a while, and then they lose interest in the asset, have more important things to do or they simply get too old to manage the asset. There are many examples for this scenario. Many business owners who get older lose their energy to run their business. Another example are children who inherit assets from their par- Source: AssetVault LLC ents but have not learned how to manage these assets - a typical case were wealth of generations are being lost. The critical moment of an asset is when the asset has already lost its value and the income that it generates decreases. Once the asset hits the vertical axis and moves into the lower left quadrant the asset is lost. It is lost to its creditors, who will only wait until the asset owner cannot pay the costs - like maintenance, fees and loan payments that are associated with the asset.
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Critique of the Asset Grid, Disclaimer Of course, the asset-income grid must be interpreted differently in different industries. Some industries like construction companies require high upfront investments and large leverage, and some do not require any debt to fund their projects and operations. Furthermore, not all asset classes can be analyzed the same way. For money market assets and securities the income axis is not of great significant. Assets in these asset classes are rather one dimensional - people buy these assets to speculate that their values go up. Businesses and real estate are two dimensional assets, meaning they vary in their net asset value (equity) and income they produce. But as a general rule, assets that can be found in the dead cow quadrant are dangerous for you as an investor and need immediate attention. And the asset grid can detect young cows, which should only temporarily draw money out of your pocket. You can use the asset grid as a general guidance but you should always perform your general due diligence before you buy an asset, and you should regularly analyze the financial performance of your assets with different tools and methods.
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SECTION 2
Unproductive Assets “How in the world can I track my client’s capital gains?” — Quote from an unknown Investment Broker —
Warren Buffet hates gold. It does do anything for you. This book too tells you over and over to look for income when you buy assets. Gold does not produce any income. All unproductive assets are not designed to produce income. So, why is it still worth owning some unproductive assets? What are unproductive assets? Examples for unproductive assets are commodities like precious metals, cash, money in a non-interest bearing checking or savings accounts, or any other asset that you exclusively buy for speculation on capital gains, security or as a bucket for your rather liquid assets to buy income producing assets. Unproductive assets only move up or down in value in the asset grid. If you believe in pure two-dimensional investments like Warren Buffet, you should still conFIGURE 6.12 Typical productive and unproductive assets sider holding some unproPRODUCTIVE ASSET UNPRODUCTIVE ASSET ductive assets. These kind Bonds Gold Coins or Bullion of assets do have their Rental Property Cash at home place in every investor’s cook book. Why? Savings Account Consumer goods Stocks with dividends
Stocks without dividend
Businesses
Checking Account
Cash Deposits (CDs) ...
...
Source: AssetVault LLC
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Unproductive assets are like ammunition for a hunter. A hunter without ammunition, let it be bullets for a gun or an arrow for a bow, would be on a
lost mission. Likewise, without liquid assets like cash or gold for internal financing, any investor will have a hard time to find a lucrative asset. Depending on your believe about how secure currencies are and how high you expect inflation to eat into your liquid assets, you can either increase your liquid assets with cash, gold or any other unproductive liquid asset. Letâ&#x20AC;&#x2122;s look at some assets: Unproductive assets are financial holdings that are not designed to create income. In contrary, productive assets are specifically designed and purchased to produce income. Important to note is also that even though a productive asset, which does not produce income at certain times or even creates a negative cash flow some times or always, that asset will still be considered a productive asset. It is called a not performing productive asset. Unproductive Assets and Taxes How are unproductive assets treated by the tax code? The IRS requires you to declare some of your unproductive assets on an annual basis using the form TD F 90-22.1. Also, assets that are sold in a year will need to be reported with a materialized gain or loss. Starting in 2014, many IRS rules will change how unproductive A productive asset, which does not produce income is called a non-performing productive asset.
assets are being treated by the tax code. As a trader and speculator you will need to be very informed about the current tax regulations for capital gains. The IRS calls it Cost Basis Reporting. Since trading exists it has always been very difficult to calculate the exact total capital gain from the sale of assets, especially when they are sold frequently and through many different institutions. Even today, cost basis reporting can often not be calculated correctly. Not being able to report your capital gains sufficiently can be a painful trap for you as an investor.
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I would like to close this section with a quote from Warren Buffet, the chairman of Berkshire Hathaway. He is not a friend of unproductive assets, and in an interview on CNBC in 2012 he said: “when we took over berkshire, berkshire was selling at $15 a share and gold was selling at $20 an ounce. And gold is now $1600 and berkshire is $120,000. but you take a broader example. if you buy an ounce of gold today and you hold it for 100 years, you can go to it every day and you could coo to it and fondle it and 100 years from now, you’ll have one ounce of gold and it won’t have done anything for you in between. You buy 100 acres of farm land, it will produce for you every year. You can buy more farmland, all kinds of things. And you still have 100 acres of farmland at the end of 100 years. You could buy the dow jones industrial average for 66 at the start of 1900. Gold was then $20. At the end, it was 11,400, but you would have gotten dividends for 100 years. So a decent productive asset will kill an unproductive asset.” Warren Buffet on May 7, 2012 in an interview on CNBC Earlier in 1998, he made the comment at a Harvard speech that: “[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.” With all the negative words about unproductive assets, they do have an important role for investors. They are a relatively safe place to put assets if no lucrative productive asset is in sight, they are the ammunition that can be used to purchase productive assets for pennies on the dollar. Earlier in the book I talked about the two-bucket-principle, that explains how to pour cash produced by productive assets into to bucket with unproductive assets as a storage of wealth, and then use this wealth to purchase more productive assets.
As a general rule: remember that unproductive asset are typically relatively liquid assets and a short-term storage of wealth. They can quickly be traded for productive assets. Productive assets are the real storage of wealth since they will provide the investor with cash for further investments and for all personal expenses.
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SECTION 3
Asset Purchase â&#x20AC;&#x153;The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell.â&#x20AC;? John Templeton
It matters when you buy an asset. The asset purchase or an acquisition is the most crucial step in investing. Several factors contribute to the success of the asset purchase: 1. Purchase time 2. Purchase price 3. Market price 4. Financing (internal or external) 5. Seller reputation and warranty The minute you buy your asset you know in what quadrant your asset will be. If you too much you are underwater, and if you also leveraged your asset too heavily, your debt service payments are too high, so that your returns will be negative. With an over-leveraged asset purchase you burdened your portfolio in the long run, and it will draw money out of your pocket. However, if you buy for example a distressed asset that the current owner needs to sell - since it is a dead cow for current owner - you might get a very good deal and you can buy the asset under market value. If you keep the loan amount you take out to buy the asset low, the chances are good that you will receive a good income from that asset. You might have heard the saying: donâ&#x20AC;&#x2122;t miss out on a crash! There is much truth to this. Most sophisticated investors buy shortly after a major market crash. Let it be the real estate market, the commodity market, the security market or the economy itself, which impacts many businesses.
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It might even pay off to look at the long economic cycle, which lasts based on Kondratieff about 55 years. Being aware of some major past cycles might give you a hint on when to buy or sell. Important to note is also which asset classes should be bought in which cycle. As indicated in above digram you should buy paper assets like securities and currency during the exFIGURE 6.13 Kondratieff Wave Cycle pansive cycle, and during the contractive cycle you should by tangible assets like businesses and real estate. So, as a sophisticated investor you have learned when and Source: http://arttrust.com.au/content/why-invest-art how you will buy which assets. The genFIGURE 6.14 Kondratieff Economic Cycle eral rule is to reinvest the money you receive from your tangible, income producing assets in other tangible, income producing assets. But considering the Kondratieff and other economic cycles, Source: http://arttrust.com.au/content/why-invest-art which very well can have different effects on different asset classes, you should always invest the money in your liquid paper assets into tangible, real assets. Merrill Lynch suggests using an â&#x20AC;&#x2DC;investment clockâ&#x20AC;&#x2122;, which shows investment vehicles depending on the four basic current economic cycles: boom, slowdown, recession and recovery. 114
SECTION 4
Bubbles and Schemes Asset bubbles happen frequently in every asset class. Asset bubbles happen when asset values are inflated - when the nominal, the market value, is out of proportion to the real value. There might be many reasons for asset bubbles to form. However, for an investor there are only two things of interest: 1. When is a bubble forming? 2. When will a bubble burst? Experienced investors have generally a good idea when bubbles start to grow. Often, they are even greatly involved with the creation of the bubble. So, ideally good investors pull out of the market before the bubble bursts and everybody starts to panic. Every investor will notice when a bubble has bursted. But not every investor takes advantage of the situations, instead many panic and sell everything they have. For sophisticated investors however, this is the time when they buy assets. Sophisticated investors have learned how to control their fear and greed, and they are ready when other panic. Asset bubbles occur frequently, sometimes intentionally created, sometimes just by a set of market forces, sometimes by a ship of fools heading in one direction, and in one direction only. The general rule is to invest in an asset either well before the bubble starts to form or right after the burst of the bubble. For example, everybody know now that it would have been wise to buy real estate after the housing market collapsed in 2008 and 2009. Some properties, especially in the state of California have dropped in value in half over the period of one year.
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Bubbles versus Trends It is very difficult to know and see the difference between bubbles and trends. The general rule is: if there is a reasonable explanation why a certain asset increases in value, then it is very likely not a bubble. The Gold Bubble Investors argue about if gold is in a bubble or if the gold price follows a trend. The explanations why gold has risen from about 300 dollars around the year 2000 to about 1,700 dollars in 2012 is manifold and controversial. But so far many investors in gold seemed to have a reasonable explanation why the gold price is trending higher, and they seem to be right, even with the latest huge drop in the gold price. Stages of a Bubble It would be interesting to find out how the stages of a typical bubble can be detected. The stages of bubbles can be summarized as follows: stealth stage, awareness stage, mania stage, blow-off stage and re-invest stage. I am an investor in gold since 2004, and I have observed much caution and stealth amongst people. There is definitely an awareness phase, and there was a blow-off period right after the crisis of 2008. However, after 2008 the price recovered quickly. So, there must have been a huge re-investment phase after the price drop of about 10% in 2008. In early 2013 the price was more than twice as high as in 2008. So, clearly the bubble did not burst. But, as for many bubbles, assets that become inflated are often in small markets and can easily manipulated. So, can a surge in demand easily increase the price, whereas a big sell off drop the price to very low levels. We will all witness how the gold price will move and if the bubble will burst one day. My prediction is that this will happen after a full recovery of the overall economy, and a the ongoing energy crisis has been solved, which might still be decades away. The South Sea Bubble
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Did you know that Sir Isaac Newton lost ÂŁ20,000 - the equivalent to about 300 million dollars in present day value, which was almost his entire fortune in South Sea Company shares, which were hyped by the government and other interest groups in the early sevSource: BullionVault.com enteen hundreds. He is know to have said, "I can calculate the movement of the stars, but not the madness of men". FIGURE 6.15 Gold Price over 20 Years
FIGURE 6.16 Phases of a Bubble
Source:
117
FIGURE 6.17 Main Stages in a Bubble and their Participants PHASE
MAIN PARTICIPANTS
Stealth
Passive Investors
Awareness
Sophisticated and Institutional Investors
Mania
Average Investor
Blow-Off
Average Investor
Re-Invest
Sophisticated and Institutional Investors
Source:
Legal and illegal Ponzi Schemes and other fraudulent investment operations Some bubbles are even created intentionally. This is true for some business models for certain investment vehicles (financial products). They have a flaw, which is generally not detected by the vast majority of investors. These financial products are advertised to average investors, but there is no real value and no real assets behind the these products, and there the bubbles grow with every dollar invested. One of such flawed investment vehicle is a now called Ponzi Scheme. Based on the U.S. Securities and Exchange Commission’s (SEC) website a Ponzi Scheme is: “... an investment fraud that involves the payment of purported [false] returns to existing investors from funds contributed by new investors.” It is a fraudulent investment operation that pays returns to its investors from their own money or the money paid by subsequent investors, rather than from profit earned by the individual or organization running the operation. Ponzi Schemes might be compared to the FIFO principle: first-in first-out. Legal Ponzi Schemes Legal Ponzi Schemes? It might not be very known, but there are in fact legal Ponzi schemes. In general, as per definition, if an investment vehicle does not create any added value, it very likely is a Ponzi scheme. Today, many claim that Social Secu118
rity as it exists in the United States today, is one of the biggest Ponzi Schemes of all times. Money from young people is deposited into a fund and paid to the older people who have paid into the system when they were younger. Obviously, money from income producing and economically efficient people is moved to the inefficient - a situation that I will explain later, does not support the wealth of generations. It can be argued that the stock market is also a giant Ponzi scheme if the current retirement system is vastly based on 401(k) and IRA plans, which contain almost only stocks and equity funds. Money is poured from young people into a system that will pay the ones that are dropping out of the market. Taxes are legal Ponzi Schemes. Pension plans are legal Ponzi Schemes. Looking at all these legal but inefficient economic systems, I can imagine many solutions that will improve the economy by applying other market rules. Reverse Social Security We could for example think about a, as I call it, Reverse Social Security System where the old contribute to the young. How? If people start becoming sophisticated investors early in their lives, they will have enough passive income (productive assets) when they retire, so they can support the young people while the young invest in their education, experience and financial assets.
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SECTION 5
Dead Cows “I swore I was going to exclusively collect assets and not liabilities for the rest of my life. I swore never to take gambles I couldn’t back up, or that I couldn’t afford to lose. And, I’ve stuck with that ever since.” – Tim Blixseth is an American real estate developer, record producer, songwriter and timber baron who is known for cofounding the Yellowstone Club in Montana
Yes, when you invest in assets, sooner or later you might end up owning a dead cow. I am talking about an asset that is worth less than you owe on it, and that costs you money each month to keep. An Example For example, you own a rental property in an up and coming town. It has always produced great rent income each month and each year. But after some years went by the local rental market went south, and while you were trying to find a new renter you discover that your monthly return on that property has turned negative. The search for a new tenant and the lower rent caused you to hit a big loss for the year, and due to the lower locked-in rent, the coming years will also be in the red. To make matters worse, the housing market in the town you bought the property also tanked considerably over the last years so what you owe the bank for that property is now more than what the property is worth. Now, you have a typical Dead Cow. What do you do with it? You sell it for under the price that you owe the bank? No, this would require you to put several ten thousands of dollars on the table to pay the deficiency. You keep the property in the hopes that the rent goes up and the housing market will increase, so you can sell it with a profit? Well,
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that is the way most property owners handle such a situation. But both options are extremely costly. Being Under Water Not only an overwhelming number of homeowners are underwater. The latest numbers from the research firm CoreLogic indicate that at the end of the fourth quarter of 2011, 11.1 million, or 22.8%, of all residential homes with a mortgage were underwater. But also many investment firms own assets that are underwater. For example, Behringer Harvard Holdings LLC, a real estate investment firm dropped a bombshell on its clients end of 2012 when it announced that one of its largest funds for wealthy, accredited investors is under water. In this case, the Strategic Opportunity Funds I and II, not only the fund it self lost a considerable amount in value. The investment company Behringer Harvard Holdings took several loans to put money back into the assets in hope the funds would rise in value. The assets’ “liabilities are greater than its assets,” said the chief executive of the funds. And in addition, huge loan payments need to be made to banks and other business entities. So, these funds are typical Dead Cows. Reference 1, Reference 2 I personally have been in this situation for almost a decade with a condo that I purchased in 1998. Luckily, I was able to keep the property by paying the monthly interest and a low principal for all these years, and at the same time saving enough money to pay off the entire loan amount to the bank. Now, I make a moderate profit with that rental every month. I converted my Dead Cow into a Cash Cow. However, it is still less worth than what I paid for. How did I get into this situation? My first asset was a Dead Cow After I graduated from college I worked for a couple of years in the software industry and I made my first money as an employee. Much of it I spent traveling, on some cool gadgets, and on other small stuff, which I can’t really remember what that was. Then in 1998, after about two years working, a friend of my coworker approached me and said: why don’t you invest in a nice condo in a up and coming town in East Germany and benefit from some government tax programs? Since I wanted 121
to get into real estate and into investments in general, I bought the property without much hesitation and with little to no due diligence. After the deal was done, and after a few years past by and some better research on my part, it turned out that I paid twice the amount than what the property was Source: http://www.stadtbild-deutschland.org/forum/index.php?page=Thread&postI actually worth, I paid D=38590 monthly about 500 dollars in loan services with a rent of only 300 dollars. Moreover, the value of the property never reached not even half of what I bought it for until this day. FIGURE 6.18 My Dead Cow Investment
Well, you might say I deserve nothing better since I did next to no due diligence before purchasing the condo. You are right. Also, I had no experience in real estate at all, so the risk to lose with this investment was pretty high from the beginning. So, it turned out my investment was a Dead Cow from the beginning. It was like a real dead cow, an asset that cost me money every month, and I owed more money to the bank than the property was worth. I had to pay interest and principal to the FIGURE 6.19 Exit Strategies for People who own Dead Cows #
SOLUTION
I
Keep the asset and make payments every month
II
Sell the asset and pay the deficiency to the bank
III
Pay off the entire loan or portions of it to become cash flow positive
IV
Abandon the asset, declare bankruptcy
Source: AssetVault LLC
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bank every month, and I only got about half of these costs from the renter. The only positive was that I always had a renter since it is perfectly located in a downtown area of a hip mid-size town. Now, thirteen years later I still own this condo and I actually made it work. However, in order to convert it from a Dead Cow I paid off the entire loan in one lump sum. It is now producing net income. But the money I spent in total for the condo is around hundred thousand dollars above the actual value of the property. So, somebody made some good money all these years but me. At least the monthly income is now positive and I can call this asset a Cash Cow, and it has been one of my best learning experience in investing. Recently, I even learned that I was not the only investor that bought condominiums in the same complex and went through this exact same investment nightmare. Many famous Germans like a well known german TV show master and a national league soccer player bought real estate from the same agency around the same time as I did. That show master even filed bankruptcy in 2011 as a consequence of her highly leveraged real estate investment.* So, how do you get rid of a Dead Cow? There are four basic exit strategies if you need to get rid of an asset that pulls money out of your pocket each month and is worth less than you owe for it. They are as follows: Any exit strategy from a Dead Cow asset is ugly, painful and hard to initiate. I have gone through all four of these scenarios my self, and I have seen many of my friends going though these steps as well. Option I - Keep the asset and make payments every month If you can afford option I, you should hold on to the asset only if you believe the asset will become a cash cow or an old cow in some foreseeable time. Otherwise, you should consider option II, III and IV.
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Option II - Sell the asset and pay the deficiency to the bank If you can easily sell the property on the market and pay the difference between the amount you owe to the bank and the money you receive from the sale, I recommend option II. Option III - Pay off the entire loan or portions of it to become cash flow positive However, if you believe your money is well invested in the property with a positive cash flow after the loan re-payment, you might consider option III. In case your money would just sit in a low interest baring bank account, you will have at least a small additional income in form of the rent. Also, as a sophisticated investor you know that lenders will negotiate a deal with you, even though they might not give you that impression first. Tell them you would like to pay off a portion of it, and if they donâ&#x20AC;&#x2122;t agree, have a letter that confirms that you made that offer. Many lenders will accept your terms after a while when they realize that they better take what you offer them, instead of losing the entire loan amount when you declare bankruptcy. Option IV - Abandon the asset, declare bankruptcy Option IV should only be your last resort. In that case you got into an intentional or unintentional situation in that you are absolutely not to pay the monthly loan re-payments. Then you will have to abandon the asset. It is called strategic default on the asset. For the bank this option is the most troublesome scenario, and you need to make sure your bankruptcy will not prevent you from recovering quickly. I personally have never gone through a bankruptcy process, but I know from friends it is emotionally the most difficult situation. Before you decide which of these four options work best for you, you should get detailed information for all for scenarios from your bank regarding pay-off terms, principal modifications, re-finance options. You should inform your self about the bankruptcy law though a lawyers and collect as much information about government regulations.
124
If you are interested in option II, you should contact real estate agents and negotiators that can handle short-sales and foreclosures. They can be very helpful when you go though that process.
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SECTION 6
Liabilities and Assets â&#x20AC;&#x153;An asset is an investment that puts money in your pocket, a liability is an investment that takes money out of your pocket. ROBERT KIYOSAKI
Using debt as a leverage for the purchase of an investment is like handling fire. You will need to learn how to handle a flame without burning the whole place. Debt is a financial tool. If you want to use it, you will need to learn how to handle it. Like a carpenter needs to learn how to use a saw, an investor needs to learn how to use debt. If you decide to invest in an asset but you cannot or you do not want to afford to pay the full purchase price for the asset in cash, you can choose to finance a portion or most of the asset by taking a loan from a lender. That might be a very smart idea if you can came up with a plan on how to still make money even though you will have to pay off the loan every month. Taking a loan to invest in an asset is called using financial leveraging. The combination of the two ingredients loan and cash is know as the deal structure. Depending on the structure the asset will produce income or not. If you over leverage, that means if the loan you take out to purchase the asset, is too big, you might end up squeezing the profit or ending up with a monthly loss - an amount that you have to pay every month to keep the asset, which is in this case an actual liability. Example for external financing (Leverage): Condo What income producing assets can you buy with $10,000? Here are some examples: you buy a 2-bedroom condo for $80,000 with $8,000 down and with a $72,000 bank loan with 8.3% annual percentage rate (APR). After the purchase you pay monthly $500 debt service and rent it out for $900 a month. You reserve 126
$100 for maintenance vacancy and property taxes. Your monthly income is $300. So, you have a monthly return of $300 out of a $8,000 investment. That is an annual return of $3,600 or almost 50% return on investment: ReturnOnMoneyInvested =
NetIncome 3,600 = = 0.45 = 45 MoneyInvested 8,000
Example for external financing (Leverage): Truck Letâ&#x20AC;&#x2122;s say you use your American Express Card buying a pick-up truck for your newly founded business. You use the truck to drive to your customers and provide your services and increasing thereby your revenue. At the same time you increase your monthly payments to the bank to pay interest and principal to pay off your credit card debt. If your increased revenue due to the truck is higher than your new expenses related to the new credit card debt, you have invested well, and you will benefit from your asset purchase with credit. Internal Financing versus External Financing In general, there are benefits for internal and external financing as follows: if you make a very low down payment when purchasing an asset, your external leverage is high and your internal leverage is very low. Vise versa, if you pay down a lot of money towards your asset purchase you only need to leverage the purchase with a small loan, your external leverage is low, and your internal leverage is high. Now, both, a high internal and a high external leverage have their benefits and drawbacks as illustrated as follows. The net income depends heavily on the amount you leverage. A higher leverage requires higher debt payments and will lower you net income. As a general rule the following statement can be made: If the return of investment (ROI) is higher than the interest rate (APR) that the bank offers you, a higher external leverage will increase your return on your invested money. Whereas, if the return of your new investment is lower than the offered Annual Percentage Rate (APR), you will decrease your return when increasing the leverage. 127
Leverage Indicator So, how can you quickly determine if you should take a loan to leverage your investment or not. I recommend using the formula for theLeverage Indictor Li: Li =
ReturnOnEquit y ROI = BankInterestRate APR
Lets look at a simplified example: you want to buy a condo for 80,000 dollars, which provides an annual net income from rent after debt payments, taxes and maintenance of 4,000 dollars. If you pay cash for the condo, your return on your money invested money (Return on Equity) is 5% (4,000 dollars / 80,000 dollars). If the bank offers you an annual interest rate APR of 6% to borrow money for that deal, then Li is 5% divided by 6%, which is 0.833, and that is smaller than one. If Li is smaller than one, then ROI is smaller than APR, and you should not get a loan to buy this condo (Scenario C). Whereas if the net income were 8,000 dollars, your rate of return on equity would be 10%, then Li is 10% divided by 6%, which is 1.67, and that is a value higher than one. You should take a loan to increase your leverage on this investment. The loan would increase your rate of return ROI when you increase the external leverage (Scenario A). The three following diagrams illustrate three different scenarios: A, B and C. In scenario A the return of your investment with no financing is higher than the
FIGURE 6.20 Internal vs. external financing RETURN WITHOUT LOAN VS. INTEREST RATE
Li
EXTERNAL LEVERAGE
RECOMMENDATION
A: ROI > APR
>1
You will make more money the more you leverage externally
Leverage as high as you can tolerate
No matter how much you leverage, your return will remain the same
Donâ&#x20AC;&#x2122;t leverage the investment.
Every external leverage will decrease your return
Donâ&#x20AC;&#x2122;t leverage the investment.
=1 B: ROI > APR
C: ROI < APR
<1
Source: AssetVault LLC
128
FIGURE 6.21 Case A: ROI > APR, Li > 1 Interest Rate < ROI without Loan
Return on invested money
100.00% 75.00% 50.00% 25.00% 0% -25.00% -50.00% -75.00% -100.00%
0%
25%
50%
75%
100%
Percentage Leveraged Source: AssetVault LLC
FIGURE 6.22 Case B: ROI = APR, Li = 1 Interest Rate = ROI without Loan
Return on invested money
100.00% 75.00% 50.00% 25.00% 0% -25.00% -50.00% -75.00% -100.00%
0%
25%
50%
75%
100%
Percentage Leveraged Source: AssetVault LLC
FIGURE 6.23 Case C: ROI < APR, Li < 1
same investment with any potential bank loan. Scenario B is a theoretical case, where the bank interest rate is exactly equal to the return he would make with no financing. No matter how high the external leverage would be the investor would always make the same return. And scenario C covers the case when the return with a 100%-downpayment is lower than the bank interest rate APR. In case C, taking a loan reduces the return of the investment when increasing external leverage. Only in case A a higher leverage will increase the return of the money invested. As a matter of fact, if you can fund an investment 100% with external money (100% leverage), you will make infinite returns. Here is why: you invest zero dollars, and any return you receive will be infinite since due to the formula for return: Return[%] = (Net Income / Money Invested) x 100.
Interest Rate > ROI without Loan
Any number divided by zero is infinite.
Return on invested money
100.00% 75.00%
What if I still want to buy but don’t have the money for it?
50.00% 25.00% 0% -25.00% -50.00% -75.00% -100.00%
0%
25%
50%
75%
Percentage Leveraged Source: AssetVault LLC
100%
Banks typically don’t tell you whether you should take a loan from an investment point of view or not. The bankers won’t tell you about he Leverage Indicator. A bank most always wants to sell 129
you a loan as long it works for the bank - and that does not mean necessarily that it will work for you. In most cases the bank is asking for collateral assets, which they can put a lien on when they give a loan. Most all home buyers take a bank loan to purchase a property. In that case the Leverage Indicator is zero since the home buyer generally doesnâ&#x20AC;&#x2122;t have any return on their investment. ROI = 0. But these home buyers still buy the properties because they want them. For an investor this makes absolutely no sense. As you can see in the figure for the Home Buyer, a 20% downpayment and a 80% bank loan provides them in a negative 25% ROI every year independently from the purchase price of the house (annual loan payments / (property purchase price - mortgage amount). Buying Stocks on Margin in 1929 But not only home buyers make these irrational investment decisions. Believe it or not, in the late 20â&#x20AC;&#x2122;s, taking a bank loan to buy stocks was the hippest thing to do. Average investors, inexperienced investors and even sophisticated investors started to buy common company stocks on the New York Stock FIGURE 6.24 Buying stocks on margin in 1929 Exchange market on the Margin as it was called back then. The problem with that was that people were speculating on the stock price, and hence on the rate of return they would make when the sold the stock. Nobody knew where the price of a stock was going. So, nobody knew the return on the investment (ROI). ROI was a huge variable number. The interest rate from the bank (APR) however was given Source: The Author
130
when they took the loan. The ROI was the big unknown. So, people didnâ&#x20AC;&#x2122;t really know if they bought into scenario A, B or C as illustrated in the grid diagrams before - it was a big gamble. And as you can see in scenario C, as soon as the return went below the interest rate the return on their investments could turn negative very quickly even before the stock price went below the price when they purchased the stock. As you might remember, it was the time of the Great Depression, and some argue that buying stocks on margin was one of the largest factors that caused this economic turmoil. These are the two most important lessons I have learned from my investments: My first condo made a 3.3% rate of return on the purchase price. My bank loan was however 6.2%. So, taking any loan was not a good idea in the first place. But it gets worse: since I was new to investing and the bank agent was a good salesman, I agreed to leverage the purchase with a 95% bank loan. As a result, I payed a large amount in interest and principal every month, which was higher than I collected in rent. Years later, I calculated that I needed to pay down at least 50% of the price of the condo only to break even, which I finally did after ten years of carrying this dead cow along in my portfolio. In the investment world, doing the simple math before the deal will determine success or failure of your investFIGURE 6.25 Home Buyer: ROI=0,, Li < 0 Home Buyer ments. It is the difference between 100.00% owning cash cows or dead cows. Return on invested money
75.00% 50.00% 25.00%
0% -25.00% -50.00% -75.00% -100.00%
0%
25%
50%
75%
100%
Percentage Leveraged Source: AssetVault LLC
131
The diagram illustrates my situation: based on the leverage indicator formula L, which was smaller than zero, I should have either negotiated the interest rate of 6.2% down to less than 3.3% or I should have paid more than 50% of the purchase price with cash.
The general rule of Leveraging: If the return from your asset (return on equity) is higher than the interest rate you will pay for a bank loan, you can get a bank loan to buy your asset. If the return from your asset is lower or equal than the interest rate that you will pay for a bank loan, you should NOT get a loan to buy your asset. Only leverage an investment with external money when: 1. the rate of investment return with a 100% downpayment is higher than the interest rate offered by the bank. 2. the rate of investment return is somewhat constant over time (like rent income from a condo or income from bonds) Getting a Loan to purchase your Home is Gambling! In no case it is financially favorable to take out a loan when your investment return is smaller than the interest rate you pay to the bank. If you intend to sell your house with a profit some years later, you might get a return due to a general housing market increase. The increase might then be higher than the bank rate you pay but it is a very risky proposition you are in since you are nowhere in control of the housing market.
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SECTION 7
Asset Income Generating or receiving income is most critical for everybody; this is not only to cover ones personal expenses but also to invest in new assets. Even if you are â&#x20AC;&#x2DC;justâ&#x20AC;&#x2122; an employee with a regular job, you receive a salary that can be invested in financial assets. When you work for an employer you are the financial asset that earns income every month. Receiving a salary is active income, but it does not mean that you are an active investor. If you own an income producing asset like a business that you operate your self, you can receive passive income as an active investor - if you receive a salary from you business, that is still not passive income. If you own assets that produce passive income with little or no involvement or your self, like rent income generating real estate or preferred stock or companies you own but are managed not by you, or if you are a venture capitalist lending money to businesses, you are a passive investor investing in passive income. Your income is then not your salary but dividends, shareholder profits, member drawings to name a few. Investors who do not receive their income as a salary are active and passive investors and are called sophisticated investors. It is very crucial to understand that there are different tax laws that apply depending how you receive your income. This is why not only the IRS, but also many investors consider the three types of income. Types of Income FIGURE 6.26 Tax Breaks TYPICAL TAX
TYPE OF INVESTOR
INCOME SOURCE
Earned Income
up to 50%
Employee, self-employed
Salary, wages, tips from a job
Portfolio Income
up to 20%
Active Investor
Income from paper assets / capital gains
Passive Income
as little as 0%
Passive Investor
Income on a regular basis
Source: AssetVault LLC
134
FIGURE 6.27 Three Types of Income
Source: AssetVault LLC
There are three types of income as illustrated here. All three types differ greatly in their tax codes. To find out more about the income your are interested in you can use the following tables and links to read the exact and up-to-date tax codes. Examples of Income from all three Income Types If you study the tax code, you will quickly find out that it is written for the sophisticated investor, as they will get the best tax breaks. Being a sophisticated investor means your investor sophistication is comparable of a level 5 or 6 investor. Becoming a level 5 or 6 investor is a lengthy process, which you can find more about in section Investor Levels earlier in the book. Although this book will prepare you for becoming a sophisticated investor, a considerable great effort from your side is required to think and act like a sophisticated or accredited investor. If you look at the examples in above table, you will get an impression of the type of assets sophisticated or passive investor buy. Intellectual Property IP. Business success is increasingly dependent on intellectual property. If you do not include IP into your investment and business strategy 135
FIGURE 6.28 Types of Income and its Tax Code. INCOME TYPE
T
Salaries
Topic 401
Interest Received
Topic 403
Dividends
Topic 404
Business Income
Topic 407
Capital Gains and Losses
Topic 409
Pensions and Annuities
Topic 410
Pensions – The General Rule and the Simplified Method
Topic 411
Lump–Sum Distributions
Topic 412
Rollovers from Retirement Plans
Topic 413
Rental Income and Expenses
Topic 414
Renting Residential and Vacation Property (formerly Renting Vacation Property and Renting to Relatives)
Topic 415
Farming and Fishing Income
Topic 416
Earnings for Clergy
Topic 417
Unemployment Compensation
Topic 418
Gambling Income and Losses
Topic 419
Bartering Income
Topic 420
Scholarship and Fellowship Grants
Topic 421
Social Security and Equivalent Railroad Retirement Benefits
Topic 423
401(k) Plans
Topic 424
Passive Activities – Losses and Credits
Topic 425
Stock Options
Topic 427
Traders in Securities (Information for Form 1040 Filers)
Topic 429
Exchange of Policyholder Interest for Stock
Topic 430
Canceled Debt – Is it Income or Not?
Topic 431
Source: http://www.irs.gov/taxtopics/tc400.html and http://taxes.about.com/od/income/Types_of_Income.htm
from the beginning, you may find out that your competitors will lock you out of lucrative business growth areas or you could end up violating IP laws, which could cost you more than you would expect. 136
What's a patent worth? How much is a trademark worth? Did you write a book? Did you register it as copyright at www.copyright.gov? I encourage you to take a look at the fast-growing disciplines in intellectual property. Even if you do not consider to invest or operate globally, you should consider global intellectual property laws by consulting with a lawyer that has specialized in IP. You should ask if trademarks, patents and copyrights transfer from the United States to other countries and you should learn the basics of global intellectual property. Many global IP rules will surprise you. You will find an abundant resource in the internet as for example http://www.wipo.int with a well written complete Intellectual Property Handbook. The government runs a web site www.uspto.gov and www.copyright.gov where investors can look up and register intellectual property in the United States. This way, if you have good idea and product you can register for a relatively low fee a name that will be associated with your product. When companies are assessed, trademarks are a important assets that will add to the companyâ&#x20AC;&#x2122;s value. As a matter of fact, companyâ&#x20AC;&#x2122;s patents are seen as one of the most valuable assets. Rental Income Income from real estate is one of the most popular investment method of sophisticated investors. Every sophisticated investor has or considers owning real estate for income generation. It is typically less complex than investments in businesses and, once acquired, maintenance and operation is comparably small. Business Income Income from businesses sophisticated investors own are financially the most promising assets. A business can generate income with almost no limits. Owning a business is like driving on a german autobahn with no speed limit. You can drive as fast as you can, only limited by your own judgement and common sense. My advice to a young person starting out in the world after graduating from school is to acquire as many income producing assets as necessary to cover at least all expenses for your family. Once you can cover all personal expenses with you passive income you are a financially free person, and you can pursue what ever 137
FIGURE 6.29 Intellectual Property INTELLECTUAL PROPERTY Patents Trademark ™, ℠, ® Copyright ©, ℗
Patents allow businesses to protect their intellectual property and profit from their ideas and inventions. A business needs to secures all of its trademarks to protect valuable company assets. Copyright laws protect original works of authorship. For business owners, understanding copyright rules and regulations is critical. You want to protect your own copyrights while making sure that you don't unwittingly engage in copyright infringement.
Source: http://www.gaebler.com/Intellectual-Property.htm
you desire. You can stay with you family and enjoy your seeing your kids growing up, being there for your family. Or you can work on creating even more monthly income from income producing assets! Wealth for you and your family will just grow and grow.
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SECTION 8
Exit Strategies Before you buy any asset you always will need to plan how to exit the investment after you bought and maintained your asset. In my experience, not having an exit strategy is the number one mistake investors make. You always need an exit strategy, even if your strategy is to hold the asset for ever. Then your exit strategy is not to sell the asset and collect income from it. The exit strategy is one of the first strategies when planning the asset development, even before you purchase the asset. Not having a strategy has left many investors with big losses. However, the most challenging part when buying, developing and exiting an asset is managing your emotions. Many investors get attached to their assets, and parting from them or restructuring them is not always as easy as one would think. Before your buy and as long as you own the asset you will need to have answers to the questions when and how you will sell or restructure your asset, which event might trigger to sell or restructure your asset, and always look out for other investors who you can sell your asset to? Even if you buy an asset purely for income generation, and you intend to keep the asset for as long as you can think, always try to be flexible, consider offers you receive for your asset or research the market for your asset. Being a sophisticated investor means that you constantly have control over your assets. And that means that you always have an answer to any question someone would ask you about your investment - especially when it means selling it. As follows are typical exit strategies that every investor should consider before putting money into any asset. Important is to pick the asset strategy and then elaborate your strategy after the purchase. This will increase your ability to plan ahead and it will lower your investment risks.
139
FIGURE 6.30 Investment Exit Strategies INVESTMENT STRATEGY
TRIGGER EVENT
DESCRIPTION AND EXAMPLES
TYPICAL TECHNIQUES AND SKILLS
Flipping
Asset improvement completed
Buy an asset, increase its value and sell the asset with a profit.
Subject matter expert knowledge about the asset
Buy and Invest
n/a
If you are still making money with your asset, but the value has dropped below your purchase price, consider investing additional money to increase the value and income.
n/a
Buy and Hold
Market price x amount above purchase price
This is a combination of portfolio and passive income investment.
n/a
Buy to Sell for Profit
Market price x amount above purchase price
This is a typical trading transaction. Almost all stock investments fall under this category.
Stop-loss
Strategic investment
Strategic goal achieved
Sometimes it makes sense to buy an asset to improve your market position.
mergers and acquisitions
Source: AssetVault LLC
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SECTION 9
Retirement Assets The question isn't at what age I want to retire, it's at what income.
Retirement: It's nice to get out of the rat race, but you have to learn to get along with less cheese. Gene Perret
VS.
George Foreman There are some who start their retirement long before they stop working.
The challenge of retirement is how to spend time without spending money.
Robert Half
Author Unknown
These above quotes illustrate very well what different views currently exist on retirement. Some people see retirement as a point in life where everything changes, and some see retirement as a decade long transition. The left two quotes above from comedy writer Gene Perret and a common saying represent in my observations the attitude of the majority of the population today who think retirement is a point in time where people stop working and draw from their savings until they die. The right two quotes from former boxer, entrepreneur and author George Foreman and founder of a job agency Robert Half paint a very different picture: retirement is a time when people have long passed the point where their passive income exceeds their personal expenses. In my opinion everybody can achieve financial independence in their twenties or thirties. Lately I was talking to a former co-worker. We were chatting about when my colleague plans to retire. He stated he would need another ten years to be able to retire. I asked him: why ten years? His answer was: because he planned to have a certain amount invested in paper assets before he retires, which he has not reached yet. So, I asked him how much he thought would be enough. Even though he did not give me a concrete number, his answer was pretty clear. His goal was to accumulate an undefined number of financial products, which he then will sell after he is retired. I told him that I think that is very risky. Let me explain further. 141
I had a similar experience when my wife talked to our client banker who managed part of our quite large money market account. She asked us what we want our withdrawal rate to be when we retire. What she meant was how much money we would like to withdraw each month from our retirement funds when we officially retire at around age sixty. Immediately, I was thinking: what a rip-off, what a simple and flawed approach to retirement planning. Of course, we never even considered working with our banker to invest for our retirement. And luckily we didnâ&#x20AC;&#x2122;t. In the 2008 market crash and we would have been thrown back years in terms of reaching our withdrawal planning. And yes, if we had most of our money in a paper asset account, we would have our money back today due to the recovering stock market. But I ask myself, what a risky way to invest. So, I am looking for alternatives. What my co-worker and our banker was talking about was a Portfolio Retirement Plan. Luckily, there are alternatives: Retirement Planning for Income Most peopleâ&#x20AC;&#x2122;s 401(k) and IRAs a retirement plans are based on accumulating paper assets. This is very risky, egocentric and unsustainable. Let me explain: paper assets are risky because they tend to lose actual purchasing power over time due to inflation, there is risk of potential currency devaluation driven by international economic forces; and they are egocentric because these retirement funds are designed to support only the retiree when he or she retires but not his or her children and their children; and finally, these plans are unsustainable because classic retirement plans are only designed to fund a personâ&#x20AC;&#x2122;s life for about 10-20 years after the beginning of retirement. The longer a person lives the higher are the chances of running out of money before the person passes away. So, why not consider a different retirement plan? A plan that involves increasing your financial literacy and learning how to manage your assets years before you retire. Why not retire right now, take some time to downshift your life (lower or rightsize your personal expenses) and increase your investor sophistication, so you can start living from your passive income? Many people convert their 401(k) retirement plans to self-directed tax free retirement accounts, which allow them to invest in all five asset classes: real estate, com142
FIGURE 6.31 Advantages of Planning for Income RETIREMENT PLANNING AS PORTFOLIO INVESTOR
RETIREMENT PLANNING AS INVESTOR FOR INCOME
Income after retirement
very low or no income. Income is mostly exclusively from funds withdrawing.
sustainable, medium to high income
Beneficiaries
mainly the retiree only
retiree , entire family and all future generations
Risk
very high risk. The entire risk of money market like inflation, currency fluctuations, recessions, depressions
very low risk. Income can only grow or shrink. Income will still come in after retiree passes away.
Timeline
until death of retiree
throughout generations
Source: AssetVault LLC
modities, businesses, securities and money market. This way they can start creating passive income that goes right back into their retirement account and they will build a sustaining nest egg for their retirement, which can be passed on to their children. I have converted my 401(k) account to a self-directed retirement account in early 2008, and my retirement fund receives today already a steady monthly income from renting out condos. That income goes right back into my retirement account. Of course, since it is a tax free account, which is designed to support me after my retirement starting at the age of 65, I cannot withdraw any money today without paying a huge financial penalty. There are many companies out there that can help you converting your retirement plan. I have worked with a company called CompleteIRA.com. They were very helpful and are supporting me even after the conversion with how to properly use my self-directed account. The following diagram illustrates two different paths the average and the sophisticated investors take on their way to retirement. The average person has a typical portfolio retirement account in form of a classic 401(k) plan and builds up a cushion of savings during his or her employment years, which he or she will draw from when he or she retires. A typical retirement planner will ask you the questions what you want your withdrawal-rate to be when you retire. You can challenge
143
FIGURE 6.32 Tow Ways for Retirement Planning
Source: AssetVault LLC
your retirement planner by saying you want the withdrawal-rate to be zero. You want your retirement income come from income producing assets. The sophisticated investor however, who is an investor for income, uses his or her savings and dedicates his or her time to purchase and create several income producing assets right when entering his or her career, which will supply plenty of passive income not only during their careers, but also after retirement including a sufficient cushion of cash (retirement funds). Caution Retirees: Mixing Personal Assets and Business Assets Have you experienced a situation or heard of people fighting over their heritage after a family member passed away. So many times people get really mad over the
144
question who gets what, and in most times there is no easy answer when it comes to dividing assets. People seem to fight most when the deceased person only owned one major personal asset, in most cases their own home. How could a single home be divided into parts for each heir? It has to be sold or other arrangements have to be made to compensate for the ones that were not put on the title of the house. From my own experience, I recommend to never mix personal and business assets. A personal assets is for example a home where you and your family live in. Nonpersonal assets or family assets are assets that produce income and are being managed separately from peopleâ&#x20AC;&#x2122;s daily lives. Creating wealth for generations means acquiring financial assets, not personal assets.Â
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CHAPTER 7
Asset Ownership and Control One day, my six year old son discovered a nice white teddybear that I used to play with when I was a kid. I owned that teddybear for my whole life and I remember when my grandmother gave it to me as a present when I turned six myself. My son fell in love with my little teddybear, and he asked me if he could keep it. I said he can play with it but I would like to keep it. My son was not amazed about my comment and he immediately said: “no, I want to have it forever”. In other words he wanted to own the teddybear. Playing with it for the day was not enough for him. He wanted to own him. When I told my son he could play with it as long as he wants to but it will always remain my bear, he protested. He just wanted to own the bear. So, I gave up, and I said “you can have it, it is yours”. But I told him, even though he will own the bear, I will tell him when he can play with it and when he can’t. To my surprise, he was immediately ok with that arrangement. He just wanted to own it. I realized that ownership must be something special. I noticed that even adults love to own things. So I looked into ownership and control a little further. Asset ownership and asset control are obviously two different things. In one extreme, you can own something but you would not have no control over it. In other cases you could have 100% control over an asset, but you would not own it. In other words, one person can possess an asset, and another person can actually own the same asset. The english language seems to be vague in its meaning. The german language has two different words which clearly distinguish between owner146
FIGURE 7.1 Asset Ownership Examples ASSET
IN-TANGIBLE
TANGIBLE
Personal
Checking Account, Cash
house, condo, car, furniture
Private (companies)
Issued stocks and bonds
real estate, inventory, its employees
municipal bonds
Playgrounds, Schools
Tax Payers, Mortgages (TARP), Loans
Inventories, property, plants, equipment
Public (local, municipal) Government (federal) Sources:
http://www.fms.treas.gov/fr/11frusg/11frusg.pdf (pg. 45) http://en.wikipedia.org/wiki/Ownership
ship as Eigentum and the possession as Besitz. The english dictionary seems to be more flexible in this regard. Examples are common stock holders. They have shares of stock of a company, but they donâ&#x20AC;&#x2122;t have any real control over the company who issued them. The question of who really owns an asset is not as trivial as someone might think. Another examples are home owners. A lender is the legal owner of a property (mortgaged as a collateral for payment of a loan) by a borrower, who is its legal possessor and retains only the right of redemption in it. A title to an asset is recognized as ownership by law. Did pay off the house you live in? Then, you should have a title or deed as it is called in real esate that shows that you are the legal owner of the house. If you still have a mortgage on your house, your bank has the original deed of the house, even though you are officially listed in the county property records as the owner. Do you know that you are a government asset? We as income tax payers pay ten times more to the government as income tax than all companies in America together. So, you are even a very valuable asset to the government. You are even an income generating asset, a productive asset. 147
FIGURE 7.2 Government Revenue
Source: http://www.fms.treas.gov/frsummary/frsummary2011.pdf
FIGURE 7.3 Government Assets
Source: http://www.fms.treas.gov/frsummary/frsummary2011.pdf
148
What about the company you work for? Are you an asset for your employer? You bet! What about your house? Whoâ&#x20AC;&#x2122;s asset is that? Your house is generating income, yes, but not for you - for the bank. The most basic explanation is: assets are things that we own. On the other hand there is debt. Debt stands against the assets and needs to be subtracted from the asset value. Debts are liabilities like mortgages, credit card balances, lines of credit, car loans or other loans and payment plans for purchased items. As an exercise, fill in the following table to get an idea what assets you own. You might be surprised to find out what great personal assets you actually own that are not burdened by any debt. And you might see how many things you assumed were assets but are in reality they are only debt burdened liabilities, which means you owe more or almost all of the assetâ&#x20AC;&#x2122;s worth to a lender.
149
FIGURE 7.4 List of Personal Assets PERSONAL ASSET
TYPE
Residences
Physical
Vehicles
Physical
Bank Accounts
Financial
Cash
Financial
Land
Physical
Real Estate
Physical
Retirement Accounts
Financial
Antiques
Physical
Collectibles
Physical
Precious Metal
Physical
Saving Bonds
Financial
Art
Physical
Jewelry
Physical
Securities
Financial
Personal Possessions
Both
Household Appliances
Physical
Electronics
Physical
Furniture
Physical
Clothing
Physical
Businesses
Physical
Commodities
Both
MARKET VALUE
Source: AssetVault LLC
150
DEBT OWED
NET VALUE
INCOME FROM ASSET
SECTION 1
Ratings and Scores Credit ratings are important measurements for every individual if they need money. Investor ratings are important for every individual to make money. Rating agencies like Standard & Poor rate companies and countries, credit bureaus rate consumers. The three important bureaus in the United States are Equifax, Experian and TransUnion. All three agencies use the most common three digit score ranging from 300 to 850, called FICO Score. FICO stands for Fair Isaac Corporation. It is a public 600 million dollar revenue company listed on the NYSE. The company FICO which created the industry standard credit scores used by almost all lenders. Fair Isaac Corporation has been in business since the mid 1950s. They started building and introducing the famous FICO score in the mid 1980s. Â The basic idea is that if someone applies for credit, a quick number, the credit score will determine if this individual will receive the credit and under what terms. Similar scores are used in other countries like Germany, where a publicly traded company named Schufa Holding AG provides credit information about individuals to contracted partner companies. Today, the credit score is also widely used for rental applications, cell phone contracts and even indirectly at car rental places. It is a very useful tool when doing business. Based on a study by charles SCHWAB taken in December 2012, 13% of the population have a credit score over 800; they are seen as financially flawless, 27% have a score between 750 and 799, which is considered excellent, 18% are between 700 and 749 and seen as good borrowers. 15% are in the mediocre range of 650 to 699. 12% have 600 to 650, which is seen as not good. 8% have a poor credit rating from 550 to 599. There are even 5% of the people with a 500 to 549 rating. About 8 million people, which is 2% of the population in the United States have a credit score lower than 499.
151
But what does the credit score number really tell anybody about their investor sophistication? Really not much or rather nothing. It could sometimes even give a quite deceiving picture of someone: a bad credit score might sometimes mean that the individual took some drastic measurements to cut him or her self clean of liabilities - dead cows - that he or she has been burdened with due to his own mistakes in the past or other peopleâ&#x20AC;&#x2122;s faults, and now has a lower credit score. Or sometimes people have not used any credit in the past or moved from another country and has not built a credit history yet. There are wealthy investors who will not qualify for loans due to a their credit history. I have a friend from Europe who recently came to America. He is fairly wealthy and never buys anything on credit. He immigrated years ago but he never really built a credit score in the Unites Sates. He would not even be able to get a cell phone contract with a wireless carrier if he did not pay for his own phone. Of course, he got a phone without a plan and otherwise does not need to proof to anybody how great his credit worthiness is because he does not need any credit at this time. If you have your spending habits under control, and if you donâ&#x20AC;&#x2122;t have the need for huge capital investments, you might consider trying to live and work with less or even without credit. If my wealthy friend however were to be rated with an investor score instead of a credit score, he would score much higher than most of all of the average investors. In fact, he is an accredited investor and plays in the league of level 5 and 6 investors. But what about all other investors on lower levels than 5 and 6? How are they rated? To give these investors, which are the great majority of this modern society, a way to tell them where they are in terms of investor sophistication. As follows I describe a way to rate investors with using a unique investor score. The Investor Score The following investor score rating can rate every investorâ&#x20AC;&#x2122;s ability to invest in and manage their assets. The components are payment history, amounts owed, length of credit, new credit and types of credit used. These measurements have been used from the FICO score and reversed from a liability viewpoint to an asset based view. 152
The same score ranging from 300 to 850 as for credit ratings is being used to increase readability. People with an investor score above 800 are investor level 6 investors, individuals with an investor score below 550 are on investor level 0, they donâ&#x20AC;&#x2122;t have anything to invest. The following formula will give you your financial independence. It is equal to passive income over the sum of your salary plus your passive income:
FIGURE 7.5 Example of an Investor Score 33%
14% 33%
10% 10%
35% Passive Income History 35% Income producing Assets owned 15% Length of passive income history 10% New passive Income 10% Types of Assets owned
Source: AssetVault LLC
Financial Independence = I = P / (S + P) If you are used to the numbering system of the credit score rating, you can use the following formula to calculate an investor score IS that uses the same range from 300 to 850: IS = 300 + (b x 350) + (I x 200) IS = Investor Score b = if you have at least one income producing asset, b-1, otherwise b=0 I = Independence (I = P / (S + P)) Lets say you receive monthly $4,000 from your salary and $2,000 monthly from passive income with two income producing assets. In this case your independence is: Independence I = $2,000 / ($4,000 + $2,000) = $2,000 / $6,000 = 0.33 IS = 300 + (1 x 350) + (0.33 x 200) = 716
153
FIGURE 7.6 Investor Ratings and Investor Levels INVESTOR SCORE
INVESTOR LEVEL
INVESTOR SOPHISTICATION
POPULATION
800 - 849
6
Mint
1%
750 - 799
5
Excellent
5%
700 - 749
4
Good
10%
650 - 699
3
Mediocre
20%
300 -649
1..2
Insufficient
74%
Source: AssetVault LLC
The investor score of 716 is considered good. You still need a paycheck from a salary to cover your personal expenses but you have income generating assets that you can grow to achieve the maximum score of 850. How can you use the investor score? The investor score is primarily for your own information. The score is a daily measurement that shows you if you are on the right track? Did you consider downshifting? There is no easy way to increase your wealth over-night. But if you are able to lower you expenses a little and maybe take a voluntary time-out from work or just a weekend off to re-focus, you could go a long way towards increasing your investor score. Which of the following gauges would you fit in? Are you the typical average investor, the elaborated investor, a sophisticated investor or a typical elite investor? On the following page you see some examples of different investors and their passive income over expenses gauges. The lower diagram shows typical investor mistakes and how they will decrease your investor score.
154
FIGURE 7.7 Typical Average Investor:
FIGURE 7.10 Elaborate Average Investor:
Source:
Source:
FIGURE 7.8 Sophisticated Investor:
FIGURE 7.11 Typical elite Investor: ex-
Source:
Source:
0% of personal expenses are covered by passive income.
more than 100% of all expenses are covered by passive income.
50% to 100% of personal expenses are covered by passive income.
penses are covered many times over by passive income.
FIGURE 7.9 Example for Damage Points: How mistakes affect your investor score INVESTOR MISTAKE
DOWN FROM 780 BY
Owning a Dead Cow for too long
25 to 45 points
Owning too many Over-leveraged Assets
25 to 45 points
Irregular asset income
90 to 110 points
Debt Settlement
105 to 125 points
Clamp Down of an asset
140 to 160 points
Strategic Default of an asset
140 to 160 points
Source: AssetVault LLC 155
SECTION 2
My Home - My Asset? How much do you pay each month to live in your house? If you pay to live in your house, your house is an expense item in your personal budget, not an asset. As Robert Kiyosaki in his book Rich Dad says: “If you stop working today, an asset puts money in your pocket and a liability takes money from your pocket. Too often people call liabilities assets. It’s important to know the difference between the two.” FIGURE 7.12 The Asset Grid
Robert is referring to the concept illustrated in the asset grid. In the grid you see the two axes income and value. We are all too focused on asset value and not on asset income. Your house you live in is either a Young Cow, or if it is “underwater”, your house is a Dead Cow. It will never ever be a Cash Cow or an Old Cow. Source: AssetVault LLC
We as a society got used to certain language that makes us feel good. Life is good is one of them. Homeownership is another. Officially, we might own the house we live in, but it is really only a form of rent we pay for a long time. A mortgaged house we live in is just another consumer toy that we have to pay for each month. It is very risky to hope or speculate on selling the house at a later time with a profit. But did you really buy your home to make money? Even if you rent parts of your house to tenants, your house is still not an asset. Even if you outright own your house without a mortgage, that house is still no asset since you have to pay taxes, maintenance and other costs. 156
So, when you buy a house, which you intend to live in, you typically will not generate any income. Instead it is an expense. Most people are focused on the value of the house. They look at one dimension of the asset grid: the asset value axis. They are traders. Traders are one-dimensional investors. They try to buy low and their goal is to sell high. Now, when you buy a home for you and your family you might not think that way. But your house is at best a one-dimensional asset. Remodeling What about upgrading your house with new energy saving appliances, new windows or a new heat pump? Remodeling your house can lower your personal expenses and might increase the value of the house. It could save you a lot of money, but it would not make you any money. Your house is still an expense. Who owns your home? Who really owns your house many home owners are finding out when their mortgage are underwater; that is, owing more to the bank than their homes are worth. The most underwater homes are in Arizona, California, Florida, Michigan, and Nevada. The president of the National Community Reinvestment Coalition expects between 15 and 16 million foreclosure filings in this country. Buy your home with the right downpayment! A home is a residential property, which you and your family intend to live in. It is not an investment. It is an expense item as your car or any other item you use. But when you buy your home you will have to apply some investor thinking to reduce some financial risks. If you intend to buy a home for example for 228,000 dollars, take a loan of 200,000 dollars and put down 28,000 dollars, you will pay at current low rates of 5% about 1,200 dollars a month for a 30-year mortgage plus other monthly costs like taxes and maintenance. Letâ&#x20AC;&#x2122;s assume that that property shows a rent estimate between 1,200 and 1,600 dollars (You can find out rent estimates on many popular websites like zillow.com).
157
FIGURE 7.13 Calculating the downpayment for your home
Source: AssetVault LLC
If you do the math, you can determine a range for your downpayment that allows your monthly costs to stay below the amount that the place would rent out for. Then you have the freedom to move somewhere else at any time, start renting the place out and receive a monthly income. Whereas if you financed in this example more than 200,000 dollars you might have to pay some money each month when you rent it out because the mortgage would be higher than what you will receive in rent. Every investor will need to plan for an exit strategy. And you as home buyer should do the same thing before buying your home. It is for the case when the unforeseeable happens: imagine the price of your home drops below the amount you owe the bank, and you need to move out of state due to a job change, or as many people you get divorced and need to sell the home. So, when you buy a home be sure you have an exit strategy. One way to do so is to get a loan with the right downpayment. That way you will not only have the home you want but also you have an insurance in case you need to move or sell. You have always the option to move somewhere else because you can either sell your home with a profit if the housing market went up, or you you will receive monthly income by renting it out if the house is underwater. You cannot lose 158
when buying a home with the right downpayment, and it is also a good compromise between being a home owner and an investor. You should never consider your home to ben an investment, but you still have to crunch some numbers to lower financial risks. Having the right downpayment will lower the risk of financial loss or default dramatically. It will very likely prevent you from going through a short-sale procedure or foreclosure, which would impact your credit score dramatically. When you purchase your home do your homework and calculate the right amount for your downpayment and stick to it. Even if banks offer you a lower downpayment or you would like to go for the bigger more expensive home, stick to your plan. A higher downpayment increases your payment upfront, and you might not even be able to buy the house you really want. But, believe me, the right downpayment will save you from huge trouble. Remember: The job of mortgage departments in banks is to sell loans. So, if you ask them if they can give you a loan for a home, they will will say â&#x20AC;&#x2DC;sureâ&#x20AC;&#x2122;, and they will try to make it work for them no matter how good or bad your credit score is. But be careful! Before you sign make sure it will work for you!
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CHAPTER 8
Your Action Plan The proper amount of the following three ingredients are required to build wealth for generations: your passive income, your financial literacy (sophistication) and the right size of your personal expenses. This section will tell you how to manage these three components. The transition from an average investor to a sophisticated investor will not happen over night. Only when someones wealth W is greater than 1, that person can be considered a sophisticated investor. Wealth W is passive income P over expenses E (W = P/E). In my experience it takes at least ten years to reach this goal if you start from zero, or as an average investor. In general, the younger a person is the faster someone will be able to become a sophisticated investor. It certainly is a life changing process, it means a lot of sacrifices and willpower at first but it also involves a lot of fun and excitement, and eventually one will look back and ask how he or she ever could have lived differently. The only goal on your path to a successful investor is to increase your wealth to be greater than 1. Written as a formula: W > 1 or P/E > 1. This means your passive income P will have to be higher than your personal expenses E at all times. To achieve this goal you will have to build your solid fundament of income producing assets like real estate and businesses but also the right mix of money market assets, securities and commodities. If your wealth is lower than one, you still need a salary to pay for your personal expenses like rent or mortgage. To increase your wealth you can lower your personal expenses or increase your passive income, or both. Working harder to increase your salary S will not improve your wealth. Quite the opposite: increasing your sal160
“There is a time when panic is the appropriate response.”
“Stay hungry, stay foolish! “ Steve Jobs
Eugene Kleiner - (12 May 1923 – 20 November 2003) one of the original founders of Kleiner Perkins, the Silicon Valley venture capital firm
ary S will only lower your independency I = P / (S + P) and will do nothing to your wealth W. However, increasing your passive income P will increase your independence. There are certainly huge changes going on in America. Today, 1% of the american people own more than 30% of all assets. In 2007, the average annual income of the 1% was 1.3 million dollars, and the income of the lowest 20% was 17,800$. 0.1% of the Americans make in average every one and a half days as much as 90% in an entire year. Before the crisis in 2008, 65% of the GDP gains reached the 0,1% richest of the country, thereafter 93%. And those who call them self middle class lose their savings and houses. What is happening? Does it maybe pay off to be a sophisticated investor. A resent article in a European daily newspaper recently wrote that less and less young people believe that hard work alone will pay off. It seams only logical that there needs to be more sophisticated investors to increase checks-and-balances between the average people and the elite. Would you agree? Not everybody has the capacity to become a sophisticated investor, but everybody who can ought to try. The bigger the gap between the elite and the average the greater the risk of the rise of tyranny and undemocratic behavior. Many people are frustrated with the financial industry, the available investment products and the never ending financial scandals popping up worldwide. The riches are getting richer and all the rest is getting poorer by the day. Have you asked your self where you can put your hard saved money without the ever increasing worry about the value of it and the fear of high fees, taxes and inflation? Do you feel your are only getting screwed by a big investor machinery, the elite, cheated of your savings, retirement funds and your ever decreasing buying power? As the average investor, it is now time to wake up, start to build your own 161
FIGURE 8.1 The Decision Tree to building your Wealth of Generations
Source: AssetVault The Author
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financial foundation. The times have changed since the dawn of the new century. Natural resources are becoming more scares, economic growth is increasingly in jeopardy and the form and availability of employment is changing. The Massachusetts Institute of Technology MIT published a very interesting ebook about how information technologies are affecting jobs, skills, wages, and the economy. If you hope the old boom times will come back soon, think twice. Many reputable economists, former CEOâ&#x20AC;&#x2122;s and politicians are screaming it already from the rooftops: the times of endless conventional economic growth, endless social welfare and cheap resources are over. A mega long-term Kondratieff Shift is under way. Everybody who wants to maintain a certain lifestyle will have to rely increasingly on their own creativity, sophistication and their own financial assets. This book provides all the knowledge and tools to start acting and thinking like a sophisticated investor on level five and six. Take action today, come up with a 10-year plan to become financially free, and follow the below steps: 1. Start increasing your and your familyâ&#x20AC;&#x2122;s financial literacy, learn how to consume less - decrease your personal expenses 2. Continuously improve your financial education in all asset classes 3. Invest only in income generating assets; use paper assets to pay for your expenses and to store income from your investments for short-term 4. Continuously increase your passive income 5. When your passive income is greater than your expenses, stop working as an employee 6. Maintain all your assets as your new job
I hope this book has given you some ideas for how to change your life to become a financially free person, and how you can build wealth for generations. I am working on Edition Two of this book, which I plan to publish end of 2014. Thank you for spending your valuable time to read this book.
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CHAPTER 9
A man with a mission to probe the New Economy - A True Novel It was a cold late summer morning in Sweden on a Monday September 23, 1935. A large ocean liner was anchored in the harbor of Gothenburg, a seaport in southwestern Sweden, on the Kattegat strait. The ship was scheduled to leave Sweden at noon on that day, heading to New York. Earlier that morning, a slim five foot, ten inch tall twenty-six year old fellow with dark hair and blue eyes named Ingemar Aae woke up precisely at five o’clock that morning to make last preparations for his journey to America. He had been invited by the American Scandinavian Foundation to study and work in Chicago, Illinois in the field of accounting as auditor and revisor. His immigration papers have already been issued on August 23, 1935, and now he was ready to start his journey. Ingemar was born in Linköping, Sweden on June 9, 1909. He studied at the then newly inaugurated College of Economics in Stockholm HHS, Härnösand from 1927 to 1930. He graduated with a business degree and started to work as primary assistant for Professor Oskar K. G. Sillén who was the national key figure who brought business auditing to life in Sweden and is known as “the true creator of the modern audit system.”
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On September 23, 1935, the day of Ingemar’s departure to America, the Great Depression had shown its aftermath effects around the world. Unemployment in America had been at a rate between fifteen and twenty percent for years and a series of government programs, called the New Deal had been initiated in 1933. They were utterly unsuccessful. The First New Deal had been enacted in 1933 and had failed to improve the economic situation. The Second New Deal was supposed to replace many programs of the First New Deal from 1934 to 1936 and had improved the economy considerably starting in 1937. In the midst of all this economic and social turmoil, Ingemar was determined to learn, work and to contribute to a better world by auditing businesses and verifying that companies would actually apply the new regulations. At around eight o’clock in the morning of his departure in Sweden on September 23, 1935, Ingemar had breakfast with his soon-to-be wife Marta Söderholtz. Ingemar’s parents Gustav and Karin Aae came at eight-thirty to wish him all the best for his trip. His mother handed him a brand new photo camera, and she told him to take many pictures to show them the places he went to in the new world, America. Accompanied by Marta and his parents, Ingemar arrived at the ship named S.S. GRIPSHOLM at eleven a.m. He enjoyed the exclusive interior design in the ship and the friendly perFIGURE 9.1 The Cruise Ship S.S. GRIPSHOLM in 1935 sonnel that helped him on deck to find his cabin. The trip was very relaxing and uneventful. After five days, the ship arrived at the Port of New York. Following the immigration procedures, Ingemar spent some time in
Source: Author
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New York City and visited the Niagara Falls and downtown Manhattan. On Sunday, October 6th, 1935 Ingemar arrived in Chicago by train. The American Scandinavian Foundation had rented a small room for Ingemar near the Field Building at 127 West Upper Wacker Drive, Chicago, Illinois. He arrived early Sunday morning at the Chicago Union Station after a long twenty hour train ride through mostly beautiful FIGURE 9.2 Ingemar Aae in Chicago, in September 1935 countryside areas along Lake Erie. After having lunch at a small diner in the near neighborhood, Ingemar checked out Chicagoâ&#x20AC;&#x2122;s busy downtown areas on foot. But he was already mentally preparing for his new assignment in the Field Building, where the
Source: Author
office of his employer Ernst & Young was located. The next morning, Monday October 7th, 1935, Ingemar was scheduled to meet the secretary of the office at 8:00 AM for an office introductory, and to meet the director of the auditing department who knew Alwin C. Ernst, the founder of Ernst & Young, personally. The director welcomed Ingemar and cut right through the chase quickly by claiming: the catastrophic destabilization of the unregulated banking and financial markets threatened or destroyed national economies worldwide. Rooseveltâ&#x20AC;&#x2122;s government took drastic measures to correct the problem, closing all banks and only allowing them to open once they had proved their solvency. The plan worked, stabilizing the U.S. economy. The creation of the Federal Deposit Insurance Corporation, or FDIC, was part of the First New Deal initiative. Ingemar used a short pause the director made and asked: I read about Roosevelt and the New Deal. I am here in the United States to learn about the New Deal and help where I can. So, what do you want me to do? 166
The director went on and said: Well, we need you to work with our teams to help companies create adequate financial reports, especially in regards to their employed staff. Roosevelt’s radical approaches to banking and unemployment caused opponents to label him a Socialist, but millions of unemployed Americans found work as a result of First New Deal programs. Some programs, such as the Civil Works Administration and the Public Works Administration, hired workers directly rather than waiting for employer incentives to take effect. The Civilian Conservation Corps hired the unemployed to clean and maintain national forests and parklands.*
FIGURE 9.3 The Field Building in Chicago, Illinois painted by Sehnten Wanjord
*) director's quote inserted from: www.wisegeek.com on page what-is-the-first-new-deal.htm
After taking a deep breath and starring at Ingemar for a short moment, Source: This original pencil drawing has been in the possession of our family since Ingemar Aae acquired it the director went on and said: Ingemar, from a local artist in the United States. I am glad you are here and I will show you your first assignment now. We need to make sure all companies implement and follow the new New Deal rules. That’s why you are here. I want you to learn about the new rules, go out to our clients and work with our team to audit the accounting books of our clients. These companies have already started projects to establish internal auditing departments that perform regular inspections in all departments.Will you be able to start tomorrow at our client’s site to join the team of auditors? Ingemar was glad to learn first-hand and he instantly replied: Ja visst!. He corrected him self instantly and said: of course, sir. Ingemar learned English in school for several years, and his grades in English were always good to great. He had no trouble at all to understand and speak fluently. However, once in a while a swedish
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saying slipped his month. But people back then were very used to the swedish language in Illinois. Illinois was full of swedish immigrants. The next morning, Ingemar arrived at the client site, a big factory several miles out of town. It was a metal manufacturing plant, which had barely survived the Great Depression. But now is was a vital part of the newly emerging automotive industry in Chicago and Detroit. Ingemar arrived by taxi in a Yellow Cab taxi. The reception area was cheaply maintained and Ingemar had difficulties opening the small entrance door which was about to fall off its hinges. The lady at the front desk was very nice but it was obvious that she was overwhelmed with work and she seemed to be overtired. The receptionist guided Ingemar to the auditing team that was located on the first floor in same part of the building. There were four external consultants and one project manager from the factory. The consultants already created a project plan that determined what has to be done to set up a new controlling department. They introduced Ingemar to the project and assigned him the task to set up a process for creating and auditing the balance sheets of the factory. The project manager from Ernst & Young explained to him: FIGURE 9.4 Svensk-amerikanska historiska sallskapet 1937, Svensk Metallverken
Source: Svensk-amerikanska historiska sallskapet 1937
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“Before the Wall Street Crash of 1929, there was little regulation of securities. Even firms whose securities were publicly traded published no regular reports or even worse rather misleading reports based on arbitrarily selected data. To avoid another Wall Street Crash the Securities Act of 1933 was enacted. It required the disclosure of the balance sheet, profit and loss statement, the names and compensations of corporate officers, about firms whose securities were traded. In 1934 the U.S. Securities and Exchange Commission was established to regulate the stock market and prevent corporate abuses relating to the sale of securities and corporate reporting. So, those reports had to be verified by independent auditors, and this is where you come in, Ingemar. Can you please work with the accounting team of this factory and create a first list of all assets and liabilities? We will transfer them a standard balance sheet when we are back in our Ernst & Young headquarters in Chicago.” Ingemar was excited to be part of such an important task. Ernst & Young spearheaded a new practice in finance, standard financial reporting for public and private companies. At that time, Ernst & Young’s activities were not limited to the auditing part, they actually helped companies around the world to establish procedures and departments that can create these new financial reports. Ingemar worked in this metal factory for six months, and when he finished his assignment in March 1936, he felt that he not only helped the factory tremendously, but also that he learned so much with the guidance of his colleagues at Ernst & Young. He felt comfortable talking about his experience and the things he learned as soon as he was back in Stockholm. On March 5, 2936, he arrived in Goteborg on the same ship that he came with. The next day when they met in the professor’s office in Stockholm, his mentor and boss Professor Oskar K. G. Sillén was already very excited to hear what Ingemar had to say about his trip to America. It did not take long until Ingemar was asked to speak at the University of Stockholm to talk about the new world of auditing. He talked about the necessity and importance of establishing internal processes within companies and how to accomplish it within a short time frame. Between 1937 and 1941, Ingemar worked in Professor Sillén’s office and held several speeches at various locations in Stockholm including many companies. He 169
FIGURE 9.5 Ingemar Aae explains the auditing practice in Sweden on January 27,1937
was advising manufacturing companies in starting their internal auditing departments to improve compliance with “modern accounting methods.” In March 1942, Ingemar was promoted to Professor Sillén’s personal assistant and started in his new position in downtown Stockholm. He wrote a letter to his sister who lived in Southern Sweden: March 26, 1942 My Dear Sister!
It took some time until I could find the shirt for father. But now I got it and that is why I am sending this card. Today, I got my Source: Svensk-amerikanska historiska sallskapet 1937 own office, and I love to work there. The rest of the family is doing pretty well. My boy has a little cold, but that has obviously no effect on his energy. The day before yesterday, dad and mom where here to take a bath. They told us about their plans to go on a trip to the countryside. They thought about Källvik but it seems hotels are all full. I will be dismissed from military service until March 1944, which is very pleasant. Otherwise, there are no more news. I hope you are doing well and that you will get to know nice people. All the best, Your brother Ingemar
When Ingemar wrote this letter to his sister he did not know about his tragic destiny. Four months after he wrote the letter to his sister he was diagnosed with leukemia during a routine doctor’s visit. The doctor said, his white blood cells were noticeable elevated. It was summer in Sweden. He was at the hight of his life, he had a happy family and a dream career.
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Due to Sweden’s high latitude, one thousand miles north of the US state Maine, the sun sets very late in summer. The days are long and beautiful. But Ingemar had no choice other than facing this disastrous sudden change of his and his family’s life. The entire summer and the following fall, Ingemar went from one hospital to the next only to find out that there was no cure to his developing sickness: he had blood cancer in its final stages. The days got shorter quickly, the leaves were falling soon in October, and the winter knocked on the door in early November. 1942, the winter in Stockholm turned out to be one of the coldest and darkest winters. But all these months, Ingemar did not lose faith although he got weaker very quickly. He was diagnosed with Acute Leukemia, which leaves a patient little time to realize what is happening. Early January 1943, within a couple of weeks Ingemar developed high fever, had night sweats, headaches, had easy bruising and bleeding, bone and joint pain, a swollen and painful belly from an enlarged spleen, and most of the times he felt very tired and weak. Ingemar lost thirty pounds by the end of December 1942. And by February 1943, Ingemar had to stop working for Professor Sillén. It was a Saturday morning on April 17, 1943. A late winter cold front had reached Stockholm during the night and covered Stockholm once again in a thick layer of snow and ice. Ingemar had been stationed in the Sabbatsbergs hospital down town Stockholm. This Saturday morning, Ingemar barely woke up, but even with a high dose of morphine Ingemar must have felt more pain in his joints than ever, and his cloths were soaking wet. He had not eaten for many days, and in the last couple of days Ingemar had been put on a morphine IV, which helped him with pain and general discomfort. Since the last weekend, Ingemar was barely conscious, and on Friday April 16, the doctor already notified his wife Marta that his organs were starting to 'shut down'. Marta’s sadness and desperateness overshadowed everything in her life. The only comfort she had was that Ingemar seemed very restful and at peace these last days. At 8:00 AM on that Saturday, April 17, 1943, the nurse came into Ingemar’s room and was about to check on the patient. Marta had stayed with Ingemar for the entire night, and at 8:00 AM she was still asleep after holding Ingemar’s hand until late in the morning. Immediately, the nurse noticed that Ingemar was awake but 171
seemed to drift away. While she was calling the doctor, Ingemar had stopped breathing while half asleep. At 9:14 AM, the doctor announced Ingemar dead. He died at the young age of 33. FIGURE 9.6 Ingemar Aae died on April 17, 1943 at the age of 34 in the Sabbatsbergs hospital.
Source: Author
A column in the Stockholm newspaper reported: on April 17, 1943, the certified auditor Ingemar died in the Sabbatsbergs sjukhus hospital at the age of only 33 years after several months of suffering from severe illness. He was the only son of lector Gustav Aae and his wife Karin Aae, maiden name Söderbaum. He left behind his young wife Marta, a three year old son and his three sisters Inga, Margit und Brita. On the second easter holiday Ingemar was buried in the Norra Crematorium in Stockholm. Beside his close relatives and friends a large number of representatives from companies Ingemar had worked with and Professor Sillen joined the service. Professor Sillen held a moving speech and said that Ingemar has demonstrated a high degree of talent for the profession as auditor already during his 172
college time, and he noted that Ingemar finished college with honor. Ingemar Aae leaves behind memories of a good son, lovely husband and father. Relatives and friends give all their sympathy and will keep him in their memories. Ingemar's sudden and early death has shattered the life of a young woman Marta, a young boy of the age of 3 and Ingemar’s parents Gustav and Karin Aae. Marta never recovered from the shock of her tragic husband’s death, and she became addicted to alcohol. Fortunately, the boy grew up somewhat normal, he finished college and married a young lady from Germany. The marriage resulted in three children, which I am the oldest. The true story of Ingemar Aae is the story of my grandfather. All events and places are based on family lore and actual records that my family had kept for two generations. Some dialogs are fiction but most reflect what really must have happened. While studying my grandfather’s life, I realized that the time between 1935 and 1943 is very relevant to what happens today. Although this book is not about auditing and not about the overall macro economy or government regulations, personal wealth has a lot to do with financial rules. Without learning about the rules of a certain investment you cannot build wealth. I realized that investing is learning the rules around investments. Of course, some rules and regulations today are necessary, and some regulations hinder and even destroy certain economies and the wealth of many. If you want to build wealth, you must understand regulations and rules, not only in your field of investment, but also in more general fields like tax regulations and company laws. This book lays out a very unique approach to building wealth. It is my way to continue my grandfather’s work that he was never able to complete.
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T H E W E A LT H O F G E N E R AT I O N S
For centuries, the wealth of many nations has risen dramatically, country by country, led by various governments and huge mega corporations that have turned into monstrous money machines. At the same time, only a tiny proportion of the people became really wealthy — the founders of these mega corporations, kings and sophisticated investors. But for most of us, it has been at best a comfortable ride. As a matter of fact, the vast majority of people and their families today cannot be considered wealthy. Quite the opposite, they are mostly burdened by mountains of debt. This book, The Wealth of Generations is written for us, the people! This book explains in layman’s terms why it is so important for us, the people to build wealth for generations and how everybody can do it. Today’s financial education is mostly based on how individuals make nations richer by giving in to the division of labor and over-specialization, being compartmentalized within an anonymous machinery, only to achieve mediocre financial successes for themselves. Today, investing seems to be limited to accumulating paper assets. This book explains how real
wealth must be generated to achieve the freedom for generations that we the people will have to claim ours. This book is book is a must-read for all people who love freedom. ISBN 978-0-9894551-0-7
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