Cashflow Blog

There’s been a lot of posts on leverage lately in the blogworld so I didn’t think it would hurt to have one more…

Also - I’m in no way advocating anyone use leverage for investments unless they are comfortable with the extra risks.

Leverage is an instrument that almost everyone uses when they buy their house. Although most people buy a house to live in, not as an investment, it’s an example of where people are using leverage and they might not even realize it.

If you ask people on the street about how they feel about borrowing to invest they might give you a lot of negative feedback. I suspect this is a holdover from times when margin accounts were the only way to borrow for investing. The problem with margin accounts is that if your investments drop in value enough then you have to come up with cash to pay the difference which is why certain investors were running out of windows in 1929.

My opinion is that leveraged investing can be a useful tool but definitely entails extra risk. However it occurs to me that sometimes the idea of leveraged investments can be a question of semantics.

Consider the following:
Person A gets a $200k mortgage on his house with a 25 year amortization. After five years, his mortgage is $185k and he also has $10k in cash that he has saved. This person decides to invest the $10k into a dividend stock, let’s say…BMO. So now he has a $185k in mortgage and $10k of stock.

Person B also gets a $200k mortgage on his house with a 25 year amortization. After five years, his mortgage is $175k but he has no extra cash to invest because he has been making extra mortgage payments. This person decides to borrow $10k from his secured line of credit and buys $10k of BMO as well and gets the tax rebate on the interest paid.

According to popular wisdom, person A is the epitomy of responsible investing using good old cash to buy his stock. Person B on the other hand has made a deal with the devil and plunged into leveraged investing.

So what’s the difference between the two? The only difference I can see is that Person B can write off his interest on his investments and Person A can’t. Obviously there are interest rate differences but I’m ignoring those since they shouldn’t be too significant.

Moral is - if you don’t make extra payments on debt and use cash to do investments then you would be better off to put that cash into the mortgage and then borrow it out again for those investments and get the tax rebate.

And yes, I realize that this logic was the genesis of the Smith Maneuvre but rest assured that I don’t recommend that particular strategy.

~ http://www.four-pillars.ca ~

A fine line between good and evil…

1. High Dividend Stocks

There are a lot of stocks that paying quarterly or yearly dividends. Over time, the power of compounding (with a little help from inflation) can substantially increase the value of your dividends. My mother bought the Indian subsidiary of Unilever (Ticker: UL) called Hindustan Lever about 20 years ago. She’s being reinvesting most of her dividends and today her annual dividends are larger than the value of the original stock purchase. American Capital Strategies (ticker: ACAS) has been growing its dividends approximately 10% every year. According to The Dividend Investor,

If we invested $100,000 in ACAS on December 31, 1997 we would have bought 6906 shares. Your first quarterly check would have been $1,726.50 in March 1998. If you kept reinvesting the dividends though instead of spending them, your quarterly dividend payment would have risen to $17,095 by December 2007. For a period of 10 years, the quarterly dividend has increased by 300 %. If you reinvested it though, your quarterly dividend income would have increased by 890%.

Yes, reinvesting the dividends in companies that have historically kept increasing their dividends is key. Even though you might get only 2.5% return today, eventually with the increase in stock price and rise in dividends, your annual return should be greater than 12%. This concept is very well explained in Prof. Jeremy Siegel’s excellent book, The Future for Investors, which I highly recommend.

2. Oil & Gas Royalties

While there is a lot of fraud and speculation in direct oil drilling programs, they can be very, very lucrative for investors. Charlie Munger invested about a $1,000 in such an oil drilling program in the 60s and he’s estimated that its paid out over $500,000 in royalty payments since then. Apparently it still pays out $2,000 a month. Of course, most people NEVER see these sort of returns, but for the average person, investing in Canadian Oil & Gas Royalty Funds (or Income Trusts) is the next best thing. I’ve invested quite a bit of money into both the direct oil wells and the Canadian Income Trusts (or Canroys) and the overall result has been pretty positive in both (which is in excess of 12%).

3. Royalties on Books and Patents

Royalties on Books and Intellectual Property Rights can be even more lucrative. However writing a best-selling book or creating a something thats worth patenting can extremely time consuming and expensive. For most authors and inventors, its a labor of love - something that they would pursue even if there was no monetary reward to it. But many ebook writers who sell get-rich-quick books about “making money online” are getting very wealthy. Most of these books are garbage and the only people getting rich are their authors and resellers. Not a very ethical way to make money.

4. Rental Income on Properties Bought at the Bottom of a Real Estate Cycle.

If you bought rental buy and hold property in California, Nevada, Arizona or Florida during 2005 and 2007, my heart goes out to you. A lot of smart people got suckered into buying at the top of the market and are paying for it. However, if you buy correctly, preferably at the bottom of a real estate cycle, real estate can provide excellent passive income and fantastic tax advantages as well. According to Charlie Munger at the 2008 Wesco Financial Annual Shareholder meeting, “most real estate investors don’t pay any income tax, except once every 20 years or so“. Bought correctly (that is based on value, not speculation), rental properties can provide a steady stream of cashflow that is somewhat inflation-indexed. I say somewhat, because in the short-term anything can happen, but over a long period of time, real estate is going to match the rate of inflation.

5. Investing In Timber

Similar to Canroys, there are companies that grow trees specifically for timber and pay pretty decent dividends. There are also direct tree-planting programs where you can invest a minimum of $5,000 and own a portion of a timber operation. The company does all the work for you and supposedly cuts you a check once a year after a specific time interval. The endowment funds of Harvard and Yale have apparently been investing in timber for several years now with great returns.

Read the original here:
5 Best Ways To Earn Passive Income

The rest is here:
Generation Rich Dad Invades Europe

Most of us think about our finances in terms of our top line — in other words, how much money we earn.  We pursue big incomes and then we spend those incomes on the right clothes, the right cars, the right home. Isn’t that what wealth is all about?

Not at all. What really matters in building net worth isn’t how much we make, but how much we keep. That’s the bottom line on a financial statement. It’s also the key to accumulating wealth.

Self-made millionaires know the importance of the bottom line.

Thomas Stanley and William Danko, a pair of business professors, spent years studying households that had net worths of more than $1 million. Their research, outlined in their landmark work, “The Millionaire Next Door”, contradicts nearly all the stereotypes surrounding wealth.

Most millionaires, it turns out, accumulate wealth by living below their means.  They avoid status objects such as big cars, huge homes and designer clothes.  They do their own yard work, drink beer instead of champagne, and stock up whenever laundry detergent goes on sale.  They put the emphasis on building up their bottom lines: the amount of money they have left over after taxes and living expenses.

You don’t have to be a genius to adopt the same lifestyle. 

Jay Zagorsky, an economist at Ohio State University, tracked down 7,000 American baby boomers who wrote a standard IQ test in 1980. He caught up to them in 2004 and asked them about their financial status.  Much as you might expect, the people who had higher IQs tended to earn more.

But — and this is a shocker — there was no correlation between higher IQs and higher net worth. Smart people may earn more, but they appear to be just as vulnerable as anyone else to spending as much as they make and neglecting their bottom lines.

One reason we get dazzled by a high income is that we forget the bite that taxes take.  If you’re a middle-class Canadian, you’re probably losing close to half of each additional dollar you make to income taxes, GST and PST.

Think about what that means: the latte that costs you $4 in after-tax dollars costs you $8 in pre-tax dollars. (Makes you think twice about that morning treat, doesn’t it?)  The dinner at a fancy restaurant that costs you $250 in after-tax dollars costs you $500 in pre-tax dollars. (Gee, and the chateaubriand wasn’t even that good)

Of course, the positive way to look at this is that if you pass up the latte and the dinner, you’re giving yourself the equivalent of a $508 raise in your pre-tax salary. That’s a good thought to keep in mind. After all, it’s how millionaires think.

Barbara Hawkins

Read more from the original source:
Don?t be too smart

In his third or fourth “Rich Dad Poor Dad” book, Robert Kiyosaki expresses the advantages of investing in real estate by describing another type of cash flow quadrant.

This cash flow quadrant describes the four ways to generate money through investing in real estate.

They are: depreciation, tax benefits, rental-income, and appreciation.

I like this model as it is simple to understand and remember.

Let’s define each one a little bit more clearly:

• Depreciation - This is, thanks to Alan Greenspan, the amount structure loses in value over time, assuming no improvements have been done to it. Residential real estate, for example, is considered to fully depreciate its value in 27 1/2 years. So, for the purpose of taxes, an investor may choose to take that depreciation as a deduction. If the structure is worth $200,000, it’s depreciation for the year is $7273.
• Tax benefits - Anyone who holds a mortgage for property knows that all that mortgage interest is tax deductible. Similarly, when acquiring additional properties, the mortgage interest from those properties are also deductible, as well as improvements made to that real estate.
• Rental income - When we put a tenant into a property, be it residential, commercial or industrial, we usually receive an amount of rent associated with that occupancy. Hopefully that rent will cover the mortgage payment with some money left over.
• Appreciation - We all know that although we take depreciation at tax time, the property itself is actually appreciating in value as cities and populations grow. Typically, unless a major economic or whether related disaster occurs, real estate only increases in value. That is why banks and other lending institutions are willing to lend most, if not all the money to purchase properties.

See more here:
Rich Dad?s Other Cash Flow Quadrants