I was having lunch with a friend of mine who I used to work with. His name is Harper. We went to Nando's and while there he started criticizing me for eating out all the time, saying that it is bad for my health. I told him that it is possible to buy food that is healthy, e.g. salads and sandwiches. He then claimed that I should not eat out because it is a waste of money.
When my friend tried to lecture me about how I should spend my money, it made me feel really wrong. I admit I used to do it in the past. I would tell people that they should not spend money on luxury items and that they should spend it instead on necessities so that they can save money. I even went so far as to criticize people for having children since I believed that children are expensive luxury goods. But since then I have learned that it is best to let people spend their own money on whatever they want to spend it on. Other people have different values and different goals in life, and unless you are walking in their shoes, you don't really understand and you are in no position to lecture.
I do admit I eat out whenever I am at work simply because I don't like to prepare food and I don't like to make my own food or have a family member make it for me (because it tastes bad). When you're busy dealing with the stress of work, the last thing you want is to have to deal with bad quality food that stinks up the office. In addition to eating out at work I also drink coffee. On some days I drink one cup and on other days I have two. All this eating out and coffee adds up to maybe $3000 to $4000 per year. It's a lot of money, I admit, but I kept records of how much I have spent for many years now and according to calculations that I did today I found that I only spend about 15 per cent of my gross income from work. Some people may be able to achieve better savings rates than that but this is what I am comfortable with. My friend Harper, on the other hand, had a girlfriend who he spends bucketloads of money on. I also remember him going on about a $1000 wristwatch he purchased. He wears fairly trendy clothing and even wears men's jewellery. Based on his history of spending on luxury goods, I am surprised he is lecturing me on the differences between needs and wants and how eating out and drinking coffee are expensive habits!
The lesson from this story is that in your interactions with people it is, in my opinion, a good idea to have a non-interventionist policy whereby you let other people decide for themselves what they want to do with their lives. This doesn't mean you should not help a friend in need, but there is a fine line between helping a friend and imposing your values on him.
28 November 2010
21 November 2010
Beyond Social Business and Microcredit
The Problem with Microcredit
Wikipedia defines microcredit as follows: "Microcredit is the extension of very small loans (microloans) to those in poverty designed to spur entrepreneurship. These individuals lack collateral, steady employment and a verifiable credit history and therefore cannot meet even the most minimal qualifications to gain access to traditional credit. Microcredit is a part of microfinance, which is the provision of a wider range of financial services to the very poor."
The problem with microcredit is that it is doubtful that it works. What microcredit does is allow poor people to get loans. Making poor people rich with microcredit is like trying to make a young university student rich by giving him a credit card. In theory the young university student, with his credit card, could buy computers and other equipment and then start up an IT business in a garage and then suddenly become a millionaire. This could happen. But it's unlikely. (Read From Uni Dropouts to Software Magnates.) Likewise, a poor entrepreneur could borrow money, start up a business, and become very successful, but it's unlikely.
How do young university students escape from poverty? They get jobs. Once a university student gets a job, he can pay off his credit card bills and start saving up for a house, car, marriage, children, or whatever.
Similarly, for a poor person to escape from poverty, he needs a job! We know this works because it has worked in China. The greatest escape from poverty in human history has already occured China, and it occured through massive employment of poor people in low-skilled manufacturing jobs. This is the answer to world poverty.
Social Business
Muhammad Yunus, who won the Nobel Prize for inspiring a global microfinance movement, seems to be growing skeptical about microcredit. According to Banker to the Poor Goes Beyond Microlending, Muhammad wants to encourage "social business" instead. Social businesses are businesses are designed for social purposes and not profit. They make money only to pay for operating costs.
I believe there are many problems with this idea. The main one being that if there is no profit then the incentives for starting a social business are non-existent. This means that there will not be many social businesses and hence there will be little employment. Because there is no profit to be made, a social business will not be as competitive compared to a for-profit business.
The Solution
Here is my solution. Currently we have the situation illustrated in the diagram below. A worker and a company come together. The worker gives labor to the company and the company gives a salary to the worker. Unemployment is created when the value of labor is less than the salary so that the company has no incentive to hire the worker.
My solution involves a philanthrophic investor stepping in and paying the worker's salary. This may sound like a major sacrifice if we look at wages in developed countries, but many of the world's population can live on about $1 per day, so it is not a big deal for a wealthy philanthropist to pay the salary of a worker. In fact, the philanthropist can set aside about $7300 worth of government bonds whose income will pay the worker's salary, assuming the government bond yields 5 per cent per annum.
The philanthropist will pay the worker's salary and in return the company will give the philanthropist shares in the company. If the worker is being paid $1 per day then the philanthropist can put aside $7300 worth of government bonds to fund this salary. The philanthropist can then demand $7300 worth of shares in the company.
The company should be happy with this because it gets free labor and companies want demand for their shares to be high. Labor for a company is a major obligation. Paying shareholders is optional. This means that the risks for a company is significantly reduced. It is more likely to want to hire more labor and this will reduce unemployment and aid in the reduction of poverty.
The worker is happy because he has a job that provides a stable income. The only damage that is being done is being done to the philanthropist who no longer has converted a stable income into an unstable income from dividends from shares. In other words, the philanthropist will be exposed to more risk.
However, the damage should be very little because wealthy people tend to want to increase risk on their investments anyway because more risk means more return. In the long run, history shows that the returns on the stock market are higher than the returns on safer assets like government bonds. Therefore, there is a reasonably good chance that the philanthropist will make even more money, and because his gains will be in the form of capital gains rather than income, he will get tax benefits as well.
This idea works because rich people are in more of a position to take risk than poor people. Rich people can take risk because they can afford to. If something goes wrong, they have a lot of money to bail them out. A poor person cannot take significant risks because he needs a steady income to buy essentials like food. The relationship between a poor worker and the philanthrophic investor in this scenario is similar to the relationship between an insurane company and a client. An insurance company has vast pools of money that can be paid out to clients to fund some expensive disaster (e.g. if you crash your car or if something is stolen from your house) but in return the client pays the insurance company a regular amount.
Wikipedia defines microcredit as follows: "Microcredit is the extension of very small loans (microloans) to those in poverty designed to spur entrepreneurship. These individuals lack collateral, steady employment and a verifiable credit history and therefore cannot meet even the most minimal qualifications to gain access to traditional credit. Microcredit is a part of microfinance, which is the provision of a wider range of financial services to the very poor."
The problem with microcredit is that it is doubtful that it works. What microcredit does is allow poor people to get loans. Making poor people rich with microcredit is like trying to make a young university student rich by giving him a credit card. In theory the young university student, with his credit card, could buy computers and other equipment and then start up an IT business in a garage and then suddenly become a millionaire. This could happen. But it's unlikely. (Read From Uni Dropouts to Software Magnates.) Likewise, a poor entrepreneur could borrow money, start up a business, and become very successful, but it's unlikely.
How do young university students escape from poverty? They get jobs. Once a university student gets a job, he can pay off his credit card bills and start saving up for a house, car, marriage, children, or whatever.
Similarly, for a poor person to escape from poverty, he needs a job! We know this works because it has worked in China. The greatest escape from poverty in human history has already occured China, and it occured through massive employment of poor people in low-skilled manufacturing jobs. This is the answer to world poverty.
Social Business
Muhammad Yunus, who won the Nobel Prize for inspiring a global microfinance movement, seems to be growing skeptical about microcredit. According to Banker to the Poor Goes Beyond Microlending, Muhammad wants to encourage "social business" instead. Social businesses are businesses are designed for social purposes and not profit. They make money only to pay for operating costs.
I believe there are many problems with this idea. The main one being that if there is no profit then the incentives for starting a social business are non-existent. This means that there will not be many social businesses and hence there will be little employment. Because there is no profit to be made, a social business will not be as competitive compared to a for-profit business.
The Solution
Here is my solution. Currently we have the situation illustrated in the diagram below. A worker and a company come together. The worker gives labor to the company and the company gives a salary to the worker. Unemployment is created when the value of labor is less than the salary so that the company has no incentive to hire the worker.
My solution involves a philanthrophic investor stepping in and paying the worker's salary. This may sound like a major sacrifice if we look at wages in developed countries, but many of the world's population can live on about $1 per day, so it is not a big deal for a wealthy philanthropist to pay the salary of a worker. In fact, the philanthropist can set aside about $7300 worth of government bonds whose income will pay the worker's salary, assuming the government bond yields 5 per cent per annum.
The philanthropist will pay the worker's salary and in return the company will give the philanthropist shares in the company. If the worker is being paid $1 per day then the philanthropist can put aside $7300 worth of government bonds to fund this salary. The philanthropist can then demand $7300 worth of shares in the company.
The company should be happy with this because it gets free labor and companies want demand for their shares to be high. Labor for a company is a major obligation. Paying shareholders is optional. This means that the risks for a company is significantly reduced. It is more likely to want to hire more labor and this will reduce unemployment and aid in the reduction of poverty.
The worker is happy because he has a job that provides a stable income. The only damage that is being done is being done to the philanthropist who no longer has converted a stable income into an unstable income from dividends from shares. In other words, the philanthropist will be exposed to more risk.
However, the damage should be very little because wealthy people tend to want to increase risk on their investments anyway because more risk means more return. In the long run, history shows that the returns on the stock market are higher than the returns on safer assets like government bonds. Therefore, there is a reasonably good chance that the philanthropist will make even more money, and because his gains will be in the form of capital gains rather than income, he will get tax benefits as well.
This idea works because rich people are in more of a position to take risk than poor people. Rich people can take risk because they can afford to. If something goes wrong, they have a lot of money to bail them out. A poor person cannot take significant risks because he needs a steady income to buy essentials like food. The relationship between a poor worker and the philanthrophic investor in this scenario is similar to the relationship between an insurane company and a client. An insurance company has vast pools of money that can be paid out to clients to fund some expensive disaster (e.g. if you crash your car or if something is stolen from your house) but in return the client pays the insurance company a regular amount.
Avoid the Joneses. Otherwise, Talk Sport.
What I find is that among people who are obviously my superiors (e.g. my bosses) status anxiety is not a problem because it is clear what the relationship is. When I talk to my boss it is clear that he or she has more power over me and that he or she tells me what to do, and I dutifully follow these orders. I also try to learn from these people.
If I am among people who are obviously my inferiors then likewise I find that those at the bottom tend to show admiration towards me. When you are among your inferiors, you have a choice of either being cruel and belittling to them or alternatively you can be compassionate and try to guide, help, and develop these people. As Thomas Carlyle said, "A great man shows his greatness by the way he treats little men."
However, it is the relationship among people of more or less equal status that is difficult. The uncertainty about who is superior to whom spurs competition. Your colleague at work who is at the same pay level as you wants to think he is better than you by talking up how important his work is. Your neighbor across the road will want to impress you with hus expensive car.
The Avoid-the-Joneses Strategy
I get along well with my superiors and my inferiors, but not my equals. The mainstream solution to this problem is to tell yourself that buying status symbols and showing off is childish and silly, and not to be worried about it. In other words, when Jones shows off his new Ferrari and trophy wife, just forget about it.
The problem with this solution is that it ignores how much status anxiety affects us all. It is human nature that we feel jealous when our equals seem to be getting ahead. This is because we are losing control and losing power. When we see the neighbor showing off his luxury car and trophy wife, it will create pain. We must accept it. There is no point denying your own biological urges and trying to wish them away. These instincts will exist and will continue to exist.
The solution then is not to try to deny the problem or to try to forget about it. The solution is to simply not be friends with your equals and try to limit the amount of interaction you have with them. In other words, avoid your equals.
This strategy of trying to associate with people who are clearly your superiors or your inferiors, in my opinion, leads to peace and harmony because everyone knows his role and position. But how do you avoid your equals if these people are the people you work with, your neighbours, relatives, and so forth? Even if you try your hardest to spend little time with your equals, there is a good chance you will still have to be polite with them, to talk to them, and so forth.
Talk about Sports
If you are with your equals, try to limit the amount of time you spend with them, and try to talk about topics that do not create status anxiety, e.g. do not talk about personal finance, work, or money. It is better to talk about trivial topics like the weather, sports, film, or television. Many people already do this instinctively, which is why discussions about sport are very popular and why discussions about topics like wages are taboo.
The Implications of Class Mobility
People move around quite a bit. Your boss may lose his superior status because of a multitude of reasons. He may get fired or he may get divorced and lose all his money. But if your boss suddenly becomes less fortunate than you, this should not create too much anxiety for you. The real danger is if your inferiors suddenly become your equals or if your inferiors become your superiors.
Your inferiors may become your superiors in a very short period of time as they may advance more quickly than you. It is important then to estimate how likely it is that a particular inferior person you are talking to will advance in status to the point where he is equal to you. If it is reasonably likely, then try not to talk too much about topics that elicit status anxiety. Try instead to talk about trivial topics. The more risk averse you are, the more you should talk about trivial topics.
Image: Neither Fanboy
Differences Between Gold and Real Estate
One of the benefits of investing in gold is that it protects against inflation. One cause of inflation is a rise in the money supply, which can be caused by money printing by the government. Money printing is very tempting for governments because it gives politicians more money to spend without actually increasing taxes. Even though printing money runs the risk of increasing prices, it's a more subtle way of raising revenue rather than directly taxing people. Printing money also devalues the currency, making exports more attractive.
Gold cannot be printed, so it is much more difficult for the supply of gold to increase. Gold can be mined from the ground, but obviously this is not as simple as printing money.
Some people suggest that real estate is a good investment that can keep up with inflation and has similar safe haven properties as gold. They argue that in times of hardship, you can grow food on your land. Furthermore, land cannot be printed. There is a finite supply.
It is true that you can grow food on land, but there being a finite supply is hardly helpful. The major problem with land is that governments have too much control over it. Physical gold is difficult to tax. It is almost pointless for government to tax gold because people tend to buy physical gold and trade among themselves, leaving no paper trail. Gold is portable and can be easily stored and hidden. Land, on the other hand, is not portable. It cannot be smuggled out of the country. You cannot hide it from the government. The result is massive taxation. The reason why banks are very happy to lend to home buyers is because they know that if they lend to you, they have you by the balls. You cannot run off to another country if you cannot pay your debt. The bank can easily sieze your land and sell it. Gold is different. If you borrow money from the bank to buy gold, you could easily run off to another country with the gold. Gold is freedom. Real estate is slavery.
If government were to slap a tax on gold, people would simply move it out of the country or just do informal transactions. If government were to slap a tax on land, people cannot do anything about it but to accept it. Just as government can print money, government can also print land. Not literally! For example, the government can control the amount of land released for residiential development by altering the urban growth boundary. If government wants to keep land prices higher to collect more land tax or land transfer duties, it can limit the supply of land. If government wants to help out property developers, it can increase the supply of land.
In an end-of-the-world scenario, when banks collapse and civilization as we know it is finished, land ownership will be worth nothing because the land you own is land you own thanks to a piece of paper enforced by the judiciary. If civilization breaks down, it is assumed that the judiciary has no power and hence your land is gone. Even though you may live on it, it's not really yours. Gold is different. Physical gold is held by you and hidden by you. Since you control it and since you own it by force or threat of force, then it is yours, regardless of what a Supreme Court judge says.
Gold cannot be printed, so it is much more difficult for the supply of gold to increase. Gold can be mined from the ground, but obviously this is not as simple as printing money.
Some people suggest that real estate is a good investment that can keep up with inflation and has similar safe haven properties as gold. They argue that in times of hardship, you can grow food on your land. Furthermore, land cannot be printed. There is a finite supply.
It is true that you can grow food on land, but there being a finite supply is hardly helpful. The major problem with land is that governments have too much control over it. Physical gold is difficult to tax. It is almost pointless for government to tax gold because people tend to buy physical gold and trade among themselves, leaving no paper trail. Gold is portable and can be easily stored and hidden. Land, on the other hand, is not portable. It cannot be smuggled out of the country. You cannot hide it from the government. The result is massive taxation. The reason why banks are very happy to lend to home buyers is because they know that if they lend to you, they have you by the balls. You cannot run off to another country if you cannot pay your debt. The bank can easily sieze your land and sell it. Gold is different. If you borrow money from the bank to buy gold, you could easily run off to another country with the gold. Gold is freedom. Real estate is slavery.
If government were to slap a tax on gold, people would simply move it out of the country or just do informal transactions. If government were to slap a tax on land, people cannot do anything about it but to accept it. Just as government can print money, government can also print land. Not literally! For example, the government can control the amount of land released for residiential development by altering the urban growth boundary. If government wants to keep land prices higher to collect more land tax or land transfer duties, it can limit the supply of land. If government wants to help out property developers, it can increase the supply of land.
In an end-of-the-world scenario, when banks collapse and civilization as we know it is finished, land ownership will be worth nothing because the land you own is land you own thanks to a piece of paper enforced by the judiciary. If civilization breaks down, it is assumed that the judiciary has no power and hence your land is gone. Even though you may live on it, it's not really yours. Gold is different. Physical gold is held by you and hidden by you. Since you control it and since you own it by force or threat of force, then it is yours, regardless of what a Supreme Court judge says.
14 November 2010
Aurora Property Buy-Write Income Trust
The Aurora Property Buy-Write Income Trust (ASX: AUP) is currently yielding about 10% per annum, which is very high. It achieves this by buying listed Australian real estate trusts and then selling call options on these securities to earn extra income. A portion of the income it earns from selling these securities are then used to buy put options for protection against price falls. This is a strategy that I am definitely unfamiliar with. Regardless of the strategy, the fund pays very attractive dividends. This is something I will strongly consider, even though this fund seems to have very high fees. It may be worth it consider the attractive dividends. It's worth a try.
Aurora Funds Management has a number of other investments, such as funds that employ a technique of dividend stripping on Australian equities, a fund that employs the buy-write strategy to global infrastructure, and a hedge fund called Van Eyk Alternatives Plus whose performance has been underwhelming, and a brief skim of this hedge fund's PDS reveals things like commissions for financial advisors. Most impressive of all, Aurora Funds Management has a fund (ASX: ABW) that pays 8.4 per cent and has been able to track the ASX200. It is able to track the ASX200 by using future contracts and other derivatives. An investment that tracks the ASX200 and pays dividends of 8.4 per cent is very impressive. Given that the ASX200 has average about 8 per cent over the long run and given that this fund's yield is 8 per cent, you are looking at potentially 16 per cent total return for this fund.
Below are Aurora funds listed on the ASX with their estimated yield (estimated by CommSec).
Like I said, I will consider these, but I do not like the high fees, and I'm not sure if I get any currency diversification. Aurora's funds, its investment strategy, and so forth have a Bernard Madoff feel to it, so some more reading would be necessary before I jump in. The great thing about these listed investments is that you can put a few thousand dollars in and if you are dissatisfied with the fund's performance (e.g. it pays low dividends) then you can simply stop putting more money in. If you feel like the performance is good you can put money in as you go. This control that I get from investing in listed securities is why I am pro-shares and anti-real estate. (When I talk about real estate I am talking about homes, not A-REITs.) If you buy a home, you are all in. The average house in Melbourne costs $500,000. If you decide to buy a house you borrow maybe $450,000 and then you are a slave to the bank for the rest of your life. You work like a slave to pay the mortgage and then when the banks raise interest rates you complain and complain. This is the typical behaviour of that breed of Australian known as the Aussie battler. As you can see I am passionately anti-debt, but that is not the main focus on this blog post, so I will hold my tongue. I have a tendency to drift to unrealted topics. The rant about the Aussie battler will have to wait until later.
Aurora Funds Management has a number of other investments, such as funds that employ a technique of dividend stripping on Australian equities, a fund that employs the buy-write strategy to global infrastructure, and a hedge fund called Van Eyk Alternatives Plus whose performance has been underwhelming, and a brief skim of this hedge fund's PDS reveals things like commissions for financial advisors. Most impressive of all, Aurora Funds Management has a fund (ASX: ABW) that pays 8.4 per cent and has been able to track the ASX200. It is able to track the ASX200 by using future contracts and other derivatives. An investment that tracks the ASX200 and pays dividends of 8.4 per cent is very impressive. Given that the ASX200 has average about 8 per cent over the long run and given that this fund's yield is 8 per cent, you are looking at potentially 16 per cent total return for this fund.
Below are Aurora funds listed on the ASX with their estimated yield (estimated by CommSec).
| ASX Ticker | Estimated Yield (%) |
| AOD | 6.2 |
| ABW | 8.4 |
| AUP | 10.0 |
| AIB | 8.4 |
| VBP | 4.6 |
Like I said, I will consider these, but I do not like the high fees, and I'm not sure if I get any currency diversification. Aurora's funds, its investment strategy, and so forth have a Bernard Madoff feel to it, so some more reading would be necessary before I jump in. The great thing about these listed investments is that you can put a few thousand dollars in and if you are dissatisfied with the fund's performance (e.g. it pays low dividends) then you can simply stop putting more money in. If you feel like the performance is good you can put money in as you go. This control that I get from investing in listed securities is why I am pro-shares and anti-real estate. (When I talk about real estate I am talking about homes, not A-REITs.) If you buy a home, you are all in. The average house in Melbourne costs $500,000. If you decide to buy a house you borrow maybe $450,000 and then you are a slave to the bank for the rest of your life. You work like a slave to pay the mortgage and then when the banks raise interest rates you complain and complain. This is the typical behaviour of that breed of Australian known as the Aussie battler. As you can see I am passionately anti-debt, but that is not the main focus on this blog post, so I will hold my tongue. I have a tendency to drift to unrealted topics. The rant about the Aussie battler will have to wait until later.
Spend Less vs Earn More
In this blog I speak a lot about investing and personal finance. Investing is not a precise science as there are so many market uncertainties. For example, it's hard to tell if the US dollar is going to keep going down or whether it will strenghten in the fiture. These uncertainties are what I love about investing.
I consider investing to be a hobby. I do it in my spare time and I find that it is a lot of fun. Someone once said to me, "Dude, why do you spend so much time studying investments. You should be spending time increasing your income instead." My friend, in my opinion, believed that work and investing is a trade-off. If you do more of one thing you must do less of another. I think this is wrong. My response to his comment is that I do spend time increasing my income. I do try to do the work I need to do at work to the best of my abilities. I don't study investing at work. Investing to me is leisure, so I do it at home after work or during the weekends. It does not interfere with work. If I weren't studying investments at home, I'd probably be doing some other leisure activity, e.g. watching reruns of Survivor or Shaytards.
Some people argue that saving money, investing and so forth is a waste of time because you should be focusing on improving your career, getting promotions, and so forth. Everyone has his own preferences but personally I find saving money and investing to be a lot of fun. The investing is certainly more fun than saving money, but saving money and investing as a whole is more fun and certainly more easy than working hard.
Working hard actually involves hard work! If you listen to all the career gurus, they will tell you that doing well in your career requires major analysis on office politics. You've got to do all sorts of difficult things like networking and watching what you say, making sure that give good impressions to others, and so forth. Some people are naturally good at this. I am not. You can call me old fashioned but I believe that you go ot work to simply do the work you're given. If you are given X then you do X to the best of your ability. There is no need to go beyond that. There is no need to stay back at the office just to show off to the boss. There is no need to set up coffee with every single person in your division to expand your network. There is no need to walk around the office and volunteer to do everything and find that with so much work to do you are overloaded and cannot cope. Like I said, for some increasing your income is easily, but for me it is difficult. Furthermore, because I work for the government, our pay structure does not include bonuses and other complex incentives structures that reward you for hard work--nor should it be because working in government is not really about hitting certain KPIs, as what is good for the organization is public welfare, not something measurable like profit or stock price appreciation.
Saving money and investing is simple. In fact, saving money is very simple because you don't do anything. If you want to advance in your career you usually have to do something, e.g. impress your boss. To save money you have to not do anything. The less you do, the more you save. If you spend your free time going to bars, pubs, casinos, movies, nightclubs, and so forth, then you will pay big. But if you don't do any of these things, you don't pay anything and you save money. Some people are what I call active savings in that they save money by aggressively trying to find hihg-value goods. These are the people who will not buy a coffee because $3 for a cup of coffee is not good value because you can make your own coffee for 50 cents. These are the people who are happy that they spent $5000 on their wedding because the average price for a wedding is $30,000. Active savers spend a lot but whenever they spend they save a lot of money. This is not me. I am a passive saver, which means that the way I end up saving money is simply by not buying things. The active saver will be happy if he spends $5000 on a wedding rather than $30,000. A passive saver will not get married and ends up paying nothing. I am not saying that I don't value marriage or leisure. I am just lazy, but this laziness has its benefits.
I consider investing to be a hobby. I do it in my spare time and I find that it is a lot of fun. Someone once said to me, "Dude, why do you spend so much time studying investments. You should be spending time increasing your income instead." My friend, in my opinion, believed that work and investing is a trade-off. If you do more of one thing you must do less of another. I think this is wrong. My response to his comment is that I do spend time increasing my income. I do try to do the work I need to do at work to the best of my abilities. I don't study investing at work. Investing to me is leisure, so I do it at home after work or during the weekends. It does not interfere with work. If I weren't studying investments at home, I'd probably be doing some other leisure activity, e.g. watching reruns of Survivor or Shaytards.
Some people argue that saving money, investing and so forth is a waste of time because you should be focusing on improving your career, getting promotions, and so forth. Everyone has his own preferences but personally I find saving money and investing to be a lot of fun. The investing is certainly more fun than saving money, but saving money and investing as a whole is more fun and certainly more easy than working hard.
Working hard actually involves hard work! If you listen to all the career gurus, they will tell you that doing well in your career requires major analysis on office politics. You've got to do all sorts of difficult things like networking and watching what you say, making sure that give good impressions to others, and so forth. Some people are naturally good at this. I am not. You can call me old fashioned but I believe that you go ot work to simply do the work you're given. If you are given X then you do X to the best of your ability. There is no need to go beyond that. There is no need to stay back at the office just to show off to the boss. There is no need to set up coffee with every single person in your division to expand your network. There is no need to walk around the office and volunteer to do everything and find that with so much work to do you are overloaded and cannot cope. Like I said, for some increasing your income is easily, but for me it is difficult. Furthermore, because I work for the government, our pay structure does not include bonuses and other complex incentives structures that reward you for hard work--nor should it be because working in government is not really about hitting certain KPIs, as what is good for the organization is public welfare, not something measurable like profit or stock price appreciation.
Saving money and investing is simple. In fact, saving money is very simple because you don't do anything. If you want to advance in your career you usually have to do something, e.g. impress your boss. To save money you have to not do anything. The less you do, the more you save. If you spend your free time going to bars, pubs, casinos, movies, nightclubs, and so forth, then you will pay big. But if you don't do any of these things, you don't pay anything and you save money. Some people are what I call active savings in that they save money by aggressively trying to find hihg-value goods. These are the people who will not buy a coffee because $3 for a cup of coffee is not good value because you can make your own coffee for 50 cents. These are the people who are happy that they spent $5000 on their wedding because the average price for a wedding is $30,000. Active savers spend a lot but whenever they spend they save a lot of money. This is not me. I am a passive saver, which means that the way I end up saving money is simply by not buying things. The active saver will be happy if he spends $5000 on a wedding rather than $30,000. A passive saver will not get married and ends up paying nothing. I am not saying that I don't value marriage or leisure. I am just lazy, but this laziness has its benefits.
Estimated Yield of iShares S&P Global 100
I am keen on producing high yields from my investments. Due to the strong Australian dollar, I have recently purchased on iShares S&P Global 100 ETFs (ASX: IOO). According to the iShares website, this ETF's distribution yield is estimated to be around 9.5 per cent, which seems very high. However, when I actually did the numbers myself using data on the ETF's actual distribution history, I noticed that the yield is more like 2 to 3 per cent. I am not saying iShares has misled anyone. On their site they clearly state that their figure is an estimate with various assumptions. Clearly iShares's assumptions were different to mine. I suspect that the main difference is that I took all the historical distributions from about three years back and then divided it by the current price. Perhaps iShares took the historical distributions and then divided it by a weighted average. Perhaps they also accounted for exchange rate fluctuations between the US dollar and the Australian dollar. It would make sense that this ETF would give low yields if you consider that currently the Australian dollar is strong and has been appreciating against the US dollar for a while now. If the Australian dollar were to suddenly pull back for whatever reason (e.g. American money printing actually turns out to be a valid plan that strengthens corporate America and and the US dollar with it) then I should expect yields on IOO to increase.
I am in a little bit of a dilemma because on one hand I want high yields but on the other hand I want to hedge against a collapse of the Australian dollar. I can hedge against a collapse of the Australian dollar if I buy US dollar denominated assets, but the problem is that as the US dollar weakens then my income from dividends gradually falls because the dividends are originally paid in US dollars and then is converted to Australian dollars. As the US dollar gets weaker, so too does the value of these dividends.
I am in a little bit of a dilemma because on one hand I want high yields but on the other hand I want to hedge against a collapse of the Australian dollar. I can hedge against a collapse of the Australian dollar if I buy US dollar denominated assets, but the problem is that as the US dollar weakens then my income from dividends gradually falls because the dividends are originally paid in US dollars and then is converted to Australian dollars. As the US dollar gets weaker, so too does the value of these dividends.
12 November 2010
Arguments Against Rick Ferri’s Take on Gold
The latest round of US money printing has pushed the price of gold above US$1400 per ounce. The attackers of gold have come out and criticized the metal, claiming it is a poor investment. Some blog gives Rick Ferri's Take on Gold, providing arguments against gold. After reading this article, I felt like I had to respond to the points made by Rick Ferri.
Argument 1: Gold ETFs will not protect you in the event of financial or economic catastrophe.
Response: Just because there is an economic catastrophe, it doesn't mean the banking system will collapse. It doesn't mean all ETFs will lose value. The GFC is an economic catastrophe, yet ETFs didn't all go to zero.
If you believe that there will be a total collapse of civilization such that banks will not functions, stock exchanges will be no more, airlines will not work, and so forth, then gold ETFs are not good. But this does not mean gold is not useful as an investment. In such an end-of-the-world situation, physical gold, which you can feel in your own hands, is preferable. Many people prefer physical gold rather than ETFs.
I am an ETF buyer. I agree that in an apocalyptic situation, I'll likely lose my money. If the banks collapse, I agree I will likely lose money. So what? That is a risk I understand and that is a risk I am willing to take. I happen to believe it is possible that there will be an economic catastophe that is extreme enough that it will cause enough fear and inflation (or even stagflation) to cause gold prices to skyrocket. All this can happen without all banks collapsing or the entire financial system completely being wiped out. Stagflation has occured during the '70s. It occured in the late '00s as well just right after the GFC when oil prices skyrocketed. Stocks will not protect you during stagflation. Gold usually does.
Argument 2: Investing in gold is like investing in bricks. Bricks produce no dividends. A brick will always remain a brick. One brick will not become two bricks.
Response: An investment does not have to produce dividends or cashflow to be good. Gold can go up in value as measured by particular paper currencies. Gold can also maintain purchasing power.
Here is what Rick says:
Argument 1: Gold ETFs will not protect you in the event of financial or economic catastrophe.
Response: Just because there is an economic catastrophe, it doesn't mean the banking system will collapse. It doesn't mean all ETFs will lose value. The GFC is an economic catastrophe, yet ETFs didn't all go to zero.
If you believe that there will be a total collapse of civilization such that banks will not functions, stock exchanges will be no more, airlines will not work, and so forth, then gold ETFs are not good. But this does not mean gold is not useful as an investment. In such an end-of-the-world situation, physical gold, which you can feel in your own hands, is preferable. Many people prefer physical gold rather than ETFs.
I am an ETF buyer. I agree that in an apocalyptic situation, I'll likely lose my money. If the banks collapse, I agree I will likely lose money. So what? That is a risk I understand and that is a risk I am willing to take. I happen to believe it is possible that there will be an economic catastophe that is extreme enough that it will cause enough fear and inflation (or even stagflation) to cause gold prices to skyrocket. All this can happen without all banks collapsing or the entire financial system completely being wiped out. Stagflation has occured during the '70s. It occured in the late '00s as well just right after the GFC when oil prices skyrocketed. Stocks will not protect you during stagflation. Gold usually does.
Argument 2: Investing in gold is like investing in bricks. Bricks produce no dividends. A brick will always remain a brick. One brick will not become two bricks.
Response: An investment does not have to produce dividends or cashflow to be good. Gold can go up in value as measured by particular paper currencies. Gold can also maintain purchasing power.
Here is what Rick says:
You can take a bunch of bricks and pile them in your backyard and look at them every day and say, ‘Go up in value, go up in value.’ But you can’t say, ‘What kind of dividends are my pile of bricks going to pay me this year?’ Because it’s zero. How much interest am I going to get from my pile of bricks? None. Is my pile of bricks going to become two piles of bricks over the next 10 years? No, it’s going to be one pile of bricks a year from now, 10 years from now, and a hundred years from now. You’re just hoping that someone comes along who thinks that pile of bricks is worth much more than you paid for it.Dividends and cashflow are great. If you put money into a bank savings account, you get cashflow from the interest. Many other investments don't do this. Stocks pay dividends, yes, but the dividend yield on stocks is usually less than the income yield from cash investments, but people invest in stocks because they want capital growth. Not everyone cares about dividends. Some people want capital growth. Gold does not pretend to do pay dividends to create cash inflows. That is not the point of investing in gold. Gold can, does, and has gone up in value. In fact, gold has gone up in value more than any other investment in the last three decades.
05 November 2010
Australian Economy Powers Ahead
There is a guy on YouTube named George. In a video above, he talks about the difficulties of living in the United States as it stills suffers from the aftermath of the GFC.
The US dollar continues to fall, the Fed continues to print money, and official unemployment flirts the 10 per cent mark (while actual unemployment that includes discouraged jobseekers may actually be 20 per cent).
President Obama is facing a backlash as his promise of hope and change have not materialized and American citizens see nothing but the same old stuff. Many of the problems that led to the GFC in America were the result of a house price bubble that slowly grew during the presidency of George W. Bush, and when the bubble burst, Obama inherited the mess.
But here in Australia, all is good! It is true that the GFC hit Australia, but the country has rebounded back. Unemployment is around 5 per cent rather than 10 per cent. The Australian dollar is now at parity with the US dollar, which is unprecedented. Since Australia is a major exporter of natural resources and minerals, a combination of demand from emerging markets like China as well, as strong investor demands for safe-haven assets like gold, have seen mining profits explode, which increase the value of the Australian dollar. Australian house prices are one of the most expensive in the world and continue to increase.
Some executive in America who commented on malinvestments immediately prior to GFC said the following: "You cannot stop dancing while the music is playing."
Here in Australia, it seems like everyone is dancing and everyone expects the music to continue to play forever.
I am worried about the possibility of something going wrong with the Australian economy, which is why I am hoping for the best but starting to prepare for the worst. About 30 per cent of my wealth is in cash, ready to buy dirt-cheap shares if there is a post-1990 Nikkei-225-style double dip, which may lead to a full-blown depression, resulting in a lost decade or two. The Fed chairman seems willing to prevent deflation at all costs, so maybe worries of deflation are unfounded. If you believe the Americans will simply flood their economy with cash to jump-start it, then it is best that investor get out of cash and go into anything else, shares, gold, silver, platinum--anything but cash. Even the cash of countries other than America can be dangerous as a currency war may see multiple countries printing money to devalue their currencies and benefit their exporters even though it is means higher prices for everything.
The bottom line is you should be careful. I recommend being mostly in shares but keep a significant amount of cash ready just in case there is a deflationary collapse. Furthermore, for Australians, I believe now is a good time to start selling Australian dollars and going into foreign currency. Today I just purchased some ETFs that invest in global multinational corporations (see the iShares Global 100 ETF). In my opinion, now is not the time to buy real estate. Interest rates are so high that you will find the value of your assets being dwarfed by the value of your debts. There is no guarantee--and it is highly unlikely--that the Australian residential real estate market can sustain the kinds of growth rates needed for you to just break even considering the immensely high mortgage rates currently offered by Australian banks (around 7.5 per cent).
02 November 2010
Banks Lifting Rates Over RBA Rate
Today the RBA lifted the official cash rate by 25 basis points from 4.5 per cent to 4.75 per cent.
The Commonwealth Bank immediately lifted its standard variable mortgage rate by 45 basis points, almost double the increase in the official cash rate.
Many mortgage holders are up in arms, claiming that the banks have no right to lift interest rates over and above that of Australia's central bank.
But I think otherwise.
The cash rate and the mortgage rates are two completely different interest rates. The cash rate is the rate at which banks lend to each other overnight. The variable mortgage rate is the rate at which home buyers borrow from the bank to buy homes. They are two completely different products. To say that these two rates must be perfectly correlated is like saying that the price of oil and the price of coal must be the same. They are different products hence they have different prices.
One key factor that influences the rate at which banks lend money is risk. The higher the risk of the borrower, the higher the interest rate the banks need to charge in order to compensate for the risk. For example, if the bank were lending to the government (i.e. purchasing government treasury bonds) there is very low risk that the government will default and hence bond rates are usually low at around 4 to 5 per cent per annum depending on the country as well as other factors. However, if the bank is lending to people who are starting their own business, there is a fair chance that a significant number of them will default. The bank must therefore increase interest rates so that the increase in interest repayments the bank gets compensates for the expected loss because of these defaults.
The same concept applies to mortgage loans. When banks lend to people to buy homes, this is a fairly safe loan compared to business loans and credit card loans, but there are still risks. Many things can go wrong--house prices could go down and borrowers may lose their jobs. It therefore makes sense for banks to keep interest rates high to protect themselves against borrowers who do not pay what is owed to the banks.
The only argument against the lifting of interest rates by banks is the argument that thre is not enough competition in the banking sector in Australia. This argument may have some merit as the Australian banking sector seems to be dominated by four major players. However, there are other banks out there. Many people do not like being slugged with fees on their transaction accounts, but by switching to ME Bank (Members Equity Bank) they can avoid fees. Many don't like the interest rates that the big four banks charge, but there are dozens of building societies, credit unions, and other small players who provide cheaper loans. But I have spoken to many people and suggested they switch bank. None of them do. Either they are too lazy or they say they like their bank.
The Commonwealth Bank immediately lifted its standard variable mortgage rate by 45 basis points, almost double the increase in the official cash rate.
Many mortgage holders are up in arms, claiming that the banks have no right to lift interest rates over and above that of Australia's central bank.
But I think otherwise.
The cash rate and the mortgage rates are two completely different interest rates. The cash rate is the rate at which banks lend to each other overnight. The variable mortgage rate is the rate at which home buyers borrow from the bank to buy homes. They are two completely different products. To say that these two rates must be perfectly correlated is like saying that the price of oil and the price of coal must be the same. They are different products hence they have different prices.
One key factor that influences the rate at which banks lend money is risk. The higher the risk of the borrower, the higher the interest rate the banks need to charge in order to compensate for the risk. For example, if the bank were lending to the government (i.e. purchasing government treasury bonds) there is very low risk that the government will default and hence bond rates are usually low at around 4 to 5 per cent per annum depending on the country as well as other factors. However, if the bank is lending to people who are starting their own business, there is a fair chance that a significant number of them will default. The bank must therefore increase interest rates so that the increase in interest repayments the bank gets compensates for the expected loss because of these defaults.
The same concept applies to mortgage loans. When banks lend to people to buy homes, this is a fairly safe loan compared to business loans and credit card loans, but there are still risks. Many things can go wrong--house prices could go down and borrowers may lose their jobs. It therefore makes sense for banks to keep interest rates high to protect themselves against borrowers who do not pay what is owed to the banks.
The only argument against the lifting of interest rates by banks is the argument that thre is not enough competition in the banking sector in Australia. This argument may have some merit as the Australian banking sector seems to be dominated by four major players. However, there are other banks out there. Many people do not like being slugged with fees on their transaction accounts, but by switching to ME Bank (Members Equity Bank) they can avoid fees. Many don't like the interest rates that the big four banks charge, but there are dozens of building societies, credit unions, and other small players who provide cheaper loans. But I have spoken to many people and suggested they switch bank. None of them do. Either they are too lazy or they say they like their bank.
No Difference Between Gambling and Investing
Due to personal reasons I will not engage in any betting during the Melbourne Cup as I believe horse racing is animal cruelty. In my opinion, racing a horse is similar to raping a horse. But that is not the main topic of this blog post.
I remember a long time ago I had a friendly argument with a friend over betting versus investing. I put to him the idea that betting and investing are the same thing. He disagreed and believed that betting is a losers game whereas investing is a winners game.
Most agree that conventional investing involves taking ownership of some company or some asset that will appreciate in value in the future thereby making you a profit.
But if you believe an asset will rise in value, is owning the asset the only way to take advantage of this? Why not bet? What is the difference? Usually betting does not involve taking ownership of the asset that will appreciate. For example, suppose I believe that UK house prices will go up in a month's time. My friend believes that if you think UK house prices will go up in a month's time then the way to win from this is to buy a house in the UK. Very simple. This is the conventional way of investing.
However, why not bet? Using IG Index's house price spread betting platform, you can wager that house prices will rise and make money from it. In fact, there are many arguments in favour of betting rather than investing in this case. By betting, you don't actually own the house and therefore you don't have to pay numerous taxes including stamp duty and land taxes. You avoid all sorts of other costs associated with buying houses such as real estate agent fees, lawyers fees, bank fees, and so forth. However, it is not costless to bet on house price increases. IG Index makes money through bid-ask spreads. But nevertheless, what's the difference? Both methods (investing and betting) involve costs. Both methods involve risk. Both methods involve you assessing the situation, taking a position, and making a bet.
There is no difference between gambling and investing.
But my friend believes otherwise. He says that gambling institutions never lose because if it were likely that house prices will rise then they will change the bid-ask spread so that they take a substantial amount of your winnings. But how is this any different to investing? If it were likely that UK house prices would go up, that would already be factored into prices. The high demand for houses would push up prices thereby increasing the costs of buying houses. This effectively increases the costs of betting that house prices will rise. Because house prices are higher, they are more likely to fall. Try this thought experiment. Imagine you have 100 people. Imagine every single one of those people believed house prices will go up. This means they all buy houses and house prices rise. Can house prices go up further? No, it cannot because there are no more buyers. Everyone who had faith in house prices rises has already purchases houses and there are no more buyers left in the market. There can only be selling, and selling reduces prices. Since there are no more buyers, prices cannot go up anymore.
Image: Waffler
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