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Should you borrow money to invest?
It is a very common thing to do in property investments. Almost everyone borrow to invest in properties. Why not? When the interest rate of the loan from the bank is lower than the rental yield you would get from your properties? Not only would you get the difference in yield and interest rate, chances are, you can even get the capital appreciation of the property as a reward. In fact, if you have RM 1,000,000, instead of buying one property, you might choose to instead, use the cash to pay for the down payment of 10 properties and borrow the rest from bank. If all goes well, you can enjoy the capital appreciation of not 1, but 10 houses, possibly 10X the return you would have get if you have invested all RM1,000,000 in cash in one property. This is a no-brainer.
At this point you may think you have made a very smart decision.
How about in stocks?
Should you borrow money to invest in stocks?
If you're still unaware of, you can..actually borrow to invest in stocks..using this facility called buy on margin. That means to say that if you have RM1000, you can buy a stock worth of RM2,000 (or more depending on your brokerage.) Now the question is should you buy on margin? Again, if you have a stock that promises you a dividend yield of 8% and the interest rate is just 6%, then you should be able to get a 2% free cash. Very clever move,right?
(If you're unfamiliar with buy on margin, it is actually like you use your stocks of RM1000 as collateral to borrow another RM1,000.)
It depends..(Please don't hate me,just pointing out my concern)
Have you ever thought of what would happen if all of a sudden, your dividend yield might not be able to pay for your interest rate?
At this point you might think, "It won't happen,the company is stable"
Really? What if it decides to keep the dividend to fund new projects?
Well..you might have some saving to pump in right? Okay then..but what if you get a margin call? When your stock plummet in price and the brokerage calls you to top up more cash.
(Please don't say it will not happen, we are human not God,we can't predict the future. What if there is a black swam(911 Incident)).
Do you have that kind of cash prepared? Else, your share will be sold at a low price which is bad for you. Meaning to say, you lose your holding power thus incurring more risk. (More risk means more likely to lose money)
Then again, some property investor will say,
This will not happen to me, property rarely drop in price. I will be safe. Or really?
Is your interest rates from the bank loan fixed? or does it fluctuates? What if your rental yield become less than your interest rates? Even if your interest rates is fixed, you could be affected by the market condition. If there is an increase in interest rates and many people default in the loan, the properties will be sold at huge discount thus lowering market price. Your property might be revalued lower due to this and you might get your home loan margin call. (Yes,it exists). Do you then have the cash to top up?
So the point is never use debt to fund your investment?
No. What I want to illustrate here is debt is a very powerful tool. But like a double edged sword,it could help you or harm you. The key here is to buy at the right time, right after a crisis,when things are so cheap,you wish you could buy them all. This is the time of minimal risk,so you can use debt. Second thing is, predictability, only use debt to fund investments that is very predictable and stable. (Example: Buying companies like Nestle instead of Apple or Blackberry)
Final words, if you really want to supercharge your investment return using debt,make sure you know what you are doing and have factored in the risks before you make a decision.
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Are you an independent investor?
In this context, it refers to investors that can think and make decisions independently based on facts,common sense and logic.
Let's run these tests.
Try answering the following questions and it should effectively diagnose if you are an independent investor, a hunch follower/speculator or a blind follower.
1)Why did you buy the stocks that you are holding now/or about to buy?
2)What is your target price or estimated intrinsic value of the share and how do you justify that number?
Are you able to answer both the questions with clarity and confidence? If yes, Congratulations, you are an independent investor.
However, if you even have the slightest hesitation,doubts or uncertainty on answering those two questions, chances are, you are not a fully independent investor.
If you're only able to answer the first question, you are probably a hunch follower or speculator.(There is nothing ethically,morally or legally wrong with being a speculator or hunch follower). Why? Usually, a hunch follower will buy a business thinking that the business is a good business or just because they heard news that might benefit the industry but the problem is, they might not know how to evaluate a company. No doubt having a good business model and good development in an industry will always benefit the underlying company, however, if you're not able to justify the target price(I hope you have one) or intrinsic value with actual numbers ,you're probably not going to get a very good return. For example, iPhone is a great product, no doubt the quality is good, but paying for an iPhone that's worth of RM2,300 with RM5,000 just isn't a very clever decision. Moreover, if you're buying based on good news, chances are, the positive impact has already been reflected in the share price. Worse still, if you can't justify the target price or intrinsic value based on your own analysis, probably you don't know what is the financial health of the company or whether the company is well positioned to benefit from the growth of the industry. Even if the company happen to be in a good position and is appreciating over time, you might not be able to achieve as good a result as those who know what is the right price to buy and sell because you might have overpaid for that counter.
Then comes the blind follower, if you are unable to answer both questions based on your own analysis, chances are, you bought it based on hot tips or friend's recommendations.( This my friend, I'm not qualified to comment on whether it is legally,morally or ethically correct).
Chasing hot tips is like playing with fire. Remember what mum always say? If you play with fire, you're gonna get burnt eventually. Many people like to chase hot tips, they buy a stock on the hope/promise that they share will appreciate greatly in value, while sometimes these may come true, other times, it is pure tragedy when they see the share price free falling way below their purchase price. What's worse? Fueled by their previous success,some of these people might have borrowed money to enhance their return only to end up with deep debts that might lead to bankruptcy. How about buying based on friend's recommendation? Well, it depends on how good an investor is your friend. But one thing is certain, those who buy based on friend's recommendation will at least experience some emotional stress. Why? This is because their emotion swings like a roller coaster with the share price. My mother is a very good example of this, whenever the security that she is holding experience a sudden rise or drop in price, I will get a call, whenever there is a news concerning a potential war in Russia, I will get another call. You see, not being able to understand why and what to buy will make you very insecure in your decision. You will keep asking people if you should buy or sell and start believing in "gurus" on what might happen to the share price in the next few days( next time someone predicts something, write it down and compare to what really happen, you will realize how foolish you are to have wasted your time reading their predictions).
The truth is, it takes experience and knowledge to become an independent investor. A successful investor must be able to avoid herd thinking, control their emotion and make decisions based on facts ,common sense and logic. Money is a very emotional thing to people, and that's why we have to train ourselves to detach emotion from the equation. Nobody like to see a loss in their portfolio, but fluctuation is the nature of the stock market, the earlier you accept this fact, the faster you can become a successful investor.
How to know if you have become an independent investor? Your portfolio shows gain over time and you can sleep soundly even after buying a large amount of shares.
If you are not an independent thinking investor yet, I urge you to start feeding your mind by reading more books and practicing on how to control your emotions.
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It has been shown through research that 80% of the businesses fail within the first 5 years. Out of the 20% who survived, another 80% of it would fail in the next five years. That is to say, only around 5% of the businesses that got started, survives. If the 80/20 rule is true, only 1% of the businesses will thrive.
What can we learn from these statistics? We can safely say that entrepreneurship is a harsh journey. It is often the most challenging venture but it provides no guarantee of success, no matter how much money and effort you put into it especially in this fast paced, exciting yet challenging time where the world is changing at a rate like never before. A company can go from nothing to billion dollars in net worth (Facebook) and from billion dollars in net worth to almost nothing (Blackberry) in just a few years. It is also because of this reason that I do not like to invest in industries that are very volatile (example : technology sector). No one can predict what will happen in the next 6 months, not to say 5 years. Even when you thought that you're enjoying the lion's share, some college kids could be working on a product in their basement that will make your business obsolete in no time.
So, what can you do to protect yourself from such phenomena? Invest in a great and sustainable business with solid track record. What is solid track record? To have a solid track record, a company need to be making increasing profits year after year for at least 5 years and preferably the business should be around for more than 10 years. Why invest in a company with solid track record? because if a business can survive for more than 10 years and is able to consistently generate high profit, it is already in the top 1% of all businesses. Why invest in the top 1% of the businesses? The logic here is simple. If 99% of the businesses fail within the first 10 years, why is this business still around? If you look at all the companies that has been around for a long time and has been pretty lucrative, you will find that these businesses possesses a special quality that separates them from the others,they all possesses a competitive advantage. These businesses may have secured a government license (PLUS highway, Genting) , provides product or service that is part of customer's habit (Nestle, Tobacco, etc) or just having carved a brand name for themselves (Padini, albeit a very weak competitive advantage). These are the businesses that is likely to continue to thrive,even in turbulent times because of these advantages over their competition. This is exactly why I'm interested in these businesses. However, knowing when to buy them is another story that I will leave for another day.
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How much do you need in order to retire?
To answer this question, we should ask ourselves, how much do we need to spend every month? What kind of lifestyle do you want to live?
Let's take for example, I'm a modest guy and am comfortable with RM5,000 per month.( Today's value). How much money on hand,do you think I need in order to retire?
Notice that unlike most speakers out there, I did not inquire about your age, you will see very shortly why the number of years you expect to live on does not affect how much you need in order to retire soundly,given that you are able to replicate the below situation into your portfolio. Besides,who can predict when they're gonna die? The following part of the article is very powerful, before you read on,I invite you to find a place where you will not be interrupted as you will discover how easy it is to retire. Sit tight and be prepared to be astonished as I open your investment eyes.
Let's move back to the above situation, a nice guy with not much commitment,he only needs to provide for his parents and himself and they will all be living a humble lifestyle with RM5,000/month. How much does he need to retire forever (at least until he kick the bucket)?Below is the magic number :
If you want to retire at a small town with RM5,000 pumped into your account for you to use monthly,You'll only need Rm1,000,000.00 . Why?
Theoritically, if you use RM5,000 per month, all your RM1,000,000 would have been used up in 16 years and 8 months.Say,you're 30 years old now,by 47,you'll be broke if you retire with only RM1,000,000.
So why did I say you can retire without worrying about how many years more you will live?
Let's introduce the dividend paying stocks!!
There are few kinds of stocks in the market,one of them is the dividend paying stock. These companies are usually established cash rich company with strong free cash flow. These stocks may not be able to generate amazingly high return but they are stable and most of the time will not be too badly affected by the economic dips. Most importantly, they generate dividends. When these companies have more cash than what they know what to do with,what do they do? They give them out, straight to the shareholder's pocket. How we usually measure these companies are through it's dividend yield.
Dividend yield(%) = (Dividend Per Share for the whole year / Price of Share at the time of purchase) * (100)
Let's bring out the first business I have ever invested in, Padini.
As of the time of writing, Padini is giving out a projected dividend of 10 cents per share (And growing based on record) . Divide 10 cents by the share price of 196 cents and you get a dividend yield of 5.1% and supposedly growing). 5.1% if considered okay. But I would always enter to support the price of Padini shares at 1.61 which yields a dividend yield of 6.2%.
Now,multiple this 6.2% to your 1 Million ringgit and you should obtain RM62,111.00. Make it easy,say RM60,000.00 per year, divide it by 12 months and you will arrive at the number I have shown you above, RM5,000 per month.
This means that you will enjoy a passive income of RM5,000 per month doing nothing. No bosses,no difficult customers,no stress.
Do you know what is the best part of this idea? Your RM1,000,000 is still there. That means after 10 years,if you choose to donate all your money to charity, you can still use the RM1,000,000 in your assets account. Given that the share price does not climb, which is not likely the case as the share price will increase as the company make positive progress. Just imagine if it is compounded at only 10% per year. Retiring at a small town with a PASSIVE INCOME of RM5,000/month just to find out that your humble pie of RM1,000,000 has turned into RM2,600,000.00 in just 10 years.
Not too bad~
Of course, generating RM1,000,000.00 to invest is easier said than done but with the right method and determination, It's only a matter of time.The only obstacle between you and your financial freedom is your unwillingness to learn and to take action. I challenge you to say you can't afford to retire after reading this article.
Astonished by what you have just read? Share this with your loved ones for this might be the greatest gift you could give them. The guide to financial freedom.
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"The Most Powerful Force in the Universe is the Power Of Compounding Interest" - Albert Einstein
What is compounding interest?
In order to illustrate the effect of compounding interest, let us do some exercise. First,get yourself a sheet of paper,as large as possible. What you do with this paper is to start folding one edge to the opposite edge and count how many times you can fold the paper until you cannot fold it anymore. Theoretically, you should only be able to fold it up to 7 times. Now,compare the thickness of this paper against the thickness of the paper when you first started out. What you have here is called the effect of compounding thickness.
What you have just done just now is to compound the thickness of the paper at 100% (or double) every time you fold it.
Mathematical Explanation using geometric progression:
t(2.00)^n = T
where t is the initial thickness
n is the number of times you fold the paper
T is the final thickness
2.00 is the number used for it is the constant compounding rate. (Keyword:Constant)
In case you want to know, taking the average thickness of A4 paper at 0.10mm, and the number of time of folding as 7. The final thickness of your paper is now 12.8 mm. Which is 128 times thicker than your original thickness.
Now,you will be wondering what has paper folding got to do with investment. In fact, it is the key to a successful investing journey. Just imagine if you could replicate the above situation into your investment portfolio. By using the same formula,with
t as your starting capital
n as the number of years
T as your results
you may change 2 to other number (1 + ROI/100) but to illustrate how wealthy you can be,we will use 2.00.
Now,let's perform some simple calculation,
Let's imagine if you are 20 years old, and you're only have a savings of 10,000 MYR that can be put aside to be invested. Compound it at 100% per year over 10 years. If you're with me just now, you should come to an amount of MYR10,240,000!!!. Turning 10,000 into 10 Million in reinvest-able cash/equity, not bad for a young adult, how many people ever have even 1 Million in cash/equity in their lifetime! However,let's all be realistic. A 100% gain for 1 year is not easy and in fact,you need a little bit of luck to achieve that. But to achieve that results consistently for 10 years, it doesn't sound achievable. But what you can achieve is 10-50% if you follow the correct method and do your due diligence. It might take a longer time but the rewards are sweet. If you want the fruits, you must first plant the seed and nurture the plant.