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Re: Newbie Lessons - Chapter one: Budgeting
Looking forward to the next installement.
Looking forward to the next installement.
Newbie Lessons - All your questions answered
- Thread starter Sir Osisofliver
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Newbie Lessons - Chapter Two - How to manage your Bank Manager (secrets from the
Not sure if you want a seperate stickied chapter Prawn - I think this might be better if it's all in one place.
This is gonna sound a little like bank bashing - and there is a reason for that. Simply put...when you go and see your bank manager does he have YOUR best interest at the front of his mind or THE BANKS' best interest? We know the answer to that one it's the Banks best interest - otherwise your bank manager is out of a job. Yet the bank manager as an employee of the bank will do his or her best to appear to be your best friend and trusted banking professional who saves you money.
So when your bank manager appears all friendly and uses sales techniques against you - just remember - he or she works for the bank - not for you.
Ok so what are the sorts of things that they do to ensure that they work in the banks best interests?
Bank Secret number 1.
Ok this is something that EVERY bank will do and by doing this will save you THOUSANDS. When you get a mortgage, they will ask how frequently you want to make payments. If you say monthly...
they'll say 'No Problems" and continue.
If you say Fortnightly.... they'll say "no problems" and continue.
If you decide to pay fortnightly (AND YOU SHOULD), when you get your mortgage documents, if you are paying attention and haven't gone glassy-eyed from reading all the legalese, you will see that they will amortise your fortnightly payments across the year so that you pay exactly the same as someone paying monthly. You pay exactly the same over the course of a year.
Now ask yourself why would they do that? Go ahead - ask your bank manager (and remember that he'll use sales techniques against you) you probably won't get the REAL answer.... Here it is.
There is 52 weeks a year, 26 fortnights a year...but only 12 months. So by choosing to pay fortnightly (AND NOT AMORTISING THE PAYMENTS) you are in effect making 13 months of payments in a year. You are making EXTRA payments (even though the difference to you is about the cost of a cup of coffee every fortnight).
By not amortising the fortnightly payments, over the course of a 30 year mortgage, you will make an additional 19 payments earlier than you would normally have done so, and save yourself...72 mortgage payments.
Wait 72??? How is that possible I hear you cry? Because when you start paying your mortgage - for the first decade or so when you make a payment, the largest portion of that payment is paying off the interest - not the principle. Extra payments reduce both the principle and interest portion of the loan - and hence you pay it off that much faster. Don't believe me? Go ahead ask your bank manager. I haven't found one yet who'll give me a straight answer - but they will all blush when they realize they have been caught out.
Bank Secret Number 2 - Banks and interest
DEBT VS LIABILITY
Ok this relates a bit towards Budgeting. Remember when I said that if you want something you plan for it in your budget? A LOT of people of course don't do that - they use Debt. Debt is VERY different to Liability. Let me explain.
Debt
Lets say you want to go away on holidays to Fiji and laze by the pool drinking Pina Colada's. You haven't budgeted for it but you really need that holiday and so you use debt to fund it. Debt is paid for from income that you have not yet earned. Remember to take plenty of pictures when you are on holiday - because you will be paying for it for a LONG time if you use debt.
Liability
Lets say you borrow money to buy an income producing asset. Lets say property. At ANY TIME if you choose you can sell that piece of property to remove the liability associated with it. This is very different to the holiday in Fiji. You cannot sell your memories and holiday pictures to clear your debt.
What has this got to do with the bank?
Banks prefer you to have debt rather than liability
What? Why would they do that? Because generally debt based products attract a higher rate of interest than liability based products. Your credit card has a high rate of interest in comparison to your home loan. (The bank will tell you that this is because risk assessment says that your credit card is a higher risk of default than your home loan). So why then when you borrow money from a bank do they structure it in such a way as to make it easy to get a credit card, and hard to alter the terms of your mortgage?
Two reasons. 1) With a higher rate of interest they get more money and 2) It limits their ability to lend
You might scratch your head on that last one so here it is in more detail.
Lets say you have a piece of property worth $1M and you want $100,000 to go invest it into the share market. You rock up to your bank manager and make the request and he says something along the lines of..."Hmmm investing it into the market? I'm not sure, let me see what I can do I'll have to ask head office." (This by the way if you can't recognise it is a sales technique). Inside the bank manager is jumping up and down, because for loaning $100,000, they now have as security a $1M asset. This security then lets the bank lend out about a further $812,000 to other lenders. You are most valuable to a bank when you have large assets and small liabilities, because they get to use your assets to make more money on top of the interest that you get charged. Neat eh?
Secret number three - When to borrow from the bank.
I'm probably preaching to the converted here on this forum but Timing is important. It's important as well when you decide to borrow (or more correctly to receive approval to borrow) because of the way ecomonic cycles work.
Right now (when the share market is crap, the economy facing recession, unemployment up etc etc) trying to borrow money is bloody hard. Yet when should we be buying quality assets? When the bulls are running or the bears savaging?
It is of course better to buy quality assets when the markets are rubbish - but as I said, it's bloody hard to borrow right now. So when should you seek pre-approval on an line of credit against your assets? Answer is when the market is BOOMING. You'll then have the capacity to invest at the bottom of the cycle that those who don't have your foresight do not.
Once again be very careful of your bank manager - They will be happy to lend you money at the top of the cycle, just make sure you are getting a facility that you don't pay interest on unless you draw the funds. You want the capacity to draw, not have the money sitting in the bank account earning less interest than you are paying.
OK - once again I'm going to stop there and seek comments, flames, and requests for more information.
Sir O
Not sure if you want a seperate stickied chapter Prawn - I think this might be better if it's all in one place.
Chapter 2 - How to manage your bank manager... secrets from the inside.
This is gonna sound a little like bank bashing - and there is a reason for that. Simply put...when you go and see your bank manager does he have YOUR best interest at the front of his mind or THE BANKS' best interest? We know the answer to that one it's the Banks best interest - otherwise your bank manager is out of a job. Yet the bank manager as an employee of the bank will do his or her best to appear to be your best friend and trusted banking professional who saves you money.
So when your bank manager appears all friendly and uses sales techniques against you - just remember - he or she works for the bank - not for you.
Ok so what are the sorts of things that they do to ensure that they work in the banks best interests?
Bank Secret number 1.
Ok this is something that EVERY bank will do and by doing this will save you THOUSANDS. When you get a mortgage, they will ask how frequently you want to make payments. If you say monthly...
they'll say 'No Problems" and continue.
If you say Fortnightly.... they'll say "no problems" and continue.
If you decide to pay fortnightly (AND YOU SHOULD), when you get your mortgage documents, if you are paying attention and haven't gone glassy-eyed from reading all the legalese, you will see that they will amortise your fortnightly payments across the year so that you pay exactly the same as someone paying monthly. You pay exactly the same over the course of a year.
Now ask yourself why would they do that? Go ahead - ask your bank manager (and remember that he'll use sales techniques against you) you probably won't get the REAL answer.... Here it is.
There is 52 weeks a year, 26 fortnights a year...but only 12 months. So by choosing to pay fortnightly (AND NOT AMORTISING THE PAYMENTS) you are in effect making 13 months of payments in a year. You are making EXTRA payments (even though the difference to you is about the cost of a cup of coffee every fortnight).
By not amortising the fortnightly payments, over the course of a 30 year mortgage, you will make an additional 19 payments earlier than you would normally have done so, and save yourself...72 mortgage payments.
Wait 72??? How is that possible I hear you cry? Because when you start paying your mortgage - for the first decade or so when you make a payment, the largest portion of that payment is paying off the interest - not the principle. Extra payments reduce both the principle and interest portion of the loan - and hence you pay it off that much faster. Don't believe me? Go ahead ask your bank manager. I haven't found one yet who'll give me a straight answer - but they will all blush when they realize they have been caught out.
Bank Secret Number 2 - Banks and interest
DEBT VS LIABILITY
Ok this relates a bit towards Budgeting. Remember when I said that if you want something you plan for it in your budget? A LOT of people of course don't do that - they use Debt. Debt is VERY different to Liability. Let me explain.
Debt
Lets say you want to go away on holidays to Fiji and laze by the pool drinking Pina Colada's. You haven't budgeted for it but you really need that holiday and so you use debt to fund it. Debt is paid for from income that you have not yet earned. Remember to take plenty of pictures when you are on holiday - because you will be paying for it for a LONG time if you use debt.
Liability
Lets say you borrow money to buy an income producing asset. Lets say property. At ANY TIME if you choose you can sell that piece of property to remove the liability associated with it. This is very different to the holiday in Fiji. You cannot sell your memories and holiday pictures to clear your debt.
What has this got to do with the bank?
Banks prefer you to have debt rather than liability
What? Why would they do that? Because generally debt based products attract a higher rate of interest than liability based products. Your credit card has a high rate of interest in comparison to your home loan. (The bank will tell you that this is because risk assessment says that your credit card is a higher risk of default than your home loan). So why then when you borrow money from a bank do they structure it in such a way as to make it easy to get a credit card, and hard to alter the terms of your mortgage?
Two reasons. 1) With a higher rate of interest they get more money and 2) It limits their ability to lend
You might scratch your head on that last one so here it is in more detail.
Lets say you have a piece of property worth $1M and you want $100,000 to go invest it into the share market. You rock up to your bank manager and make the request and he says something along the lines of..."Hmmm investing it into the market? I'm not sure, let me see what I can do I'll have to ask head office." (This by the way if you can't recognise it is a sales technique). Inside the bank manager is jumping up and down, because for loaning $100,000, they now have as security a $1M asset. This security then lets the bank lend out about a further $812,000 to other lenders. You are most valuable to a bank when you have large assets and small liabilities, because they get to use your assets to make more money on top of the interest that you get charged. Neat eh?
Secret number three - When to borrow from the bank.
I'm probably preaching to the converted here on this forum but Timing is important. It's important as well when you decide to borrow (or more correctly to receive approval to borrow) because of the way ecomonic cycles work.
Right now (when the share market is crap, the economy facing recession, unemployment up etc etc) trying to borrow money is bloody hard. Yet when should we be buying quality assets? When the bulls are running or the bears savaging?
It is of course better to buy quality assets when the markets are rubbish - but as I said, it's bloody hard to borrow right now. So when should you seek pre-approval on an line of credit against your assets? Answer is when the market is BOOMING. You'll then have the capacity to invest at the bottom of the cycle that those who don't have your foresight do not.
Once again be very careful of your bank manager - They will be happy to lend you money at the top of the cycle, just make sure you are getting a facility that you don't pay interest on unless you draw the funds. You want the capacity to draw, not have the money sitting in the bank account earning less interest than you are paying.
OK - once again I'm going to stop there and seek comments, flames, and requests for more information.
Sir O
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SM Junkie,
It depends on the bank what level of autonomy the bank manager has (if any). In many circumstances where the LVR (Loan to Valuation Ratio) is much higher..(eg $1M property with $800,000 loan) the bank will instruct the Manager (or mortgage broker, reseller etc) to put the numbers through the risk department of the bank. It's then the job of some paper pusher at head office to determine whether you get the loan.
Remember however what I said previously. Where there is a relatively low LVR your Bank Manager will use sales techniques to keep that figure as low as possible. Where you have a LOW LVR you are much more attractive as a client (and have greater leverage during a negotiation). However OTHER bank managers do not yet have your business (or the additional security that your asset will bring to the company). Hence they are much keener to get your business.
When negotiating a new loan from the bank (and remember you will do this when the market is booming to take advatage of the money being thrown around) ALWAYS do your research and don't feel bad about shopping around. If you are with ANZ and NAB give you a better rate, TELL ANZ (and they might better it to keep your business), and THEN TELL NAB (and they might counteroffer)...keep going till they start refusing to budge.
Generally my experience has been that by having correct timing between cycles you can go to your bank manager with a 30-40% LVR and achieve lending capacity of 75-80% during boom times. (You don't use all that capacity - but that is another topic for another day).
Sir O
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Great stuff Sir O, looking forward to the next lesson.
J
J
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OK All,
which do you want next..
Asset Classes and sundry info
or
Risk management techniques and equity optimisation?
First in best dressed
Sir O
which do you want next..
Asset Classes and sundry info
or
Risk management techniques and equity optimisation?
First in best dressed
Sir O
Risk Management Techniques and equity optimisation please
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Risk Management Techniques and Optimisation. (Part 1)
I'm going to try and keep this pretty simplistic - This IS a newbie thread after all.
Ok so Bank secret number 2 told you one of the ways in which banks make money from you. By using the security value of your assets and lending against those assets (and keeping a small reserve).
If you look at the example I gave you above where you go to the bank with $1M property for a $100,000 loan. They would then on-lend about $812,000 (even though the maximum capacity for them to on-lend is....$900,000). They reserve the remaining security.
For the bank this is a legislative requirement - They must retain a certain minimum percentage of unused security for safety reasons.
When you approach you own finance and risk management techniques - you should do the same (just not to the same level because the government won't bail you out if you stuff up).
Let’s say you have a significant asset with a low LVR (This could be your PPR or an investment property for example). Currently the bank loves you - they get to use your asset and make lots of money from you by using the currently unused security value of your asset.
You would be MUCH better off if instead of the bank using that security value - you yourself use it. But how do we use it effectively so as not to endanger the viability of the asset?
In the case of a PPR (principle place of residence) there are a couple of important things you need to consider.
1) Taxation - Interest payments on your PPR are not tax deductible. Any debt on your PPR is not good debt.
2) Serviceability - Your PPR doesn't have tenants (generally) that help you make the interest payments on the loan - so the bank will determine whether you can service the loan with your income.
For these reasons it's best to exclude the PPR from optimisation activities that involved large amounts of gearing. Your best use of the PPR is to use it to cross collaterize into an income producing, appreciating asset class. (usually residential property assets are the easiest to achieve this - There are a number of key characteristics that I look for but that's for another time). This will allow you to have a 100% LVR on a new investment property and use your available disposable income for other activities. (Just MAKE SURE that all of the new debt is held via the new Investment Property to ensure maximum tax write-offs). NOTE if you cross collaterize two assets the lending institution has the ability to veto the sale of either asset.
IMPORTANT - if you choose to do the above and the rental income of your investment property is not sufficient to cover the entirety of the loan (IE - negative gearing). YOU ARE RISKING YOUR HOUSE IF YOU ARE NOT CAREFUL.
Just like what the bank does when they have your asset - we should apply the same lessons here and calculate a reserve from our accessible loan. (Generally you want this at call as well so a Line of Credit facility is the best to use). A reserve is an UNUSED PORTION of your approved loan that can be used to prevent mishaps and unexpected events from compromising the viability of the asset. Depending upon what your risk tolerance is depends upon what size reserve is appropriate. I generally find that a 20% reserve is the maximum that I will use. The reserve should be in place until the asset becomes positively geared, then the reserve can be either drastically reduced, or used entirely for other purposes.
Want to really appreciate why the use of a reserve on your PPR is important? Go read the Storm Financial Thread. https://www.aussiestockforums.com/forums/showthread.php?t=13176. The major issue with Storm was using such a LARGE amount of gearing on the principle residence with inadequate protection in place.
In the case of an Investment Property asset – you can be much more aggressive with your gearing activities because the interest payments on loan funds are tax deductible for you. You still need to maintain a reserve for contingencies but it can be much smaller, and is designed to cover the shortfall whilst the property moves from negatively geared to positively geared. As a general guideline I’ve found it takes about 5 years for a quality property to move from negative to positive gearing.
OK Time for another secret:
If your PPR has non tax deductible interest and limitations towards optimisation and gearing; and investment properties do not have these limitations, which is the better first purchase?
A great many people seem to want to follow some kind of script that involves chaining themselves to a large asset with an inefficient gearing and taxation profile. The better first purchase is an investment property (or two) BEFORE you purchase a PPR. For a great many people this little secret comes too late – remember to tell your kids when they are old enough to appreciate it.
Part two IS coming guys – just got busy.
Sir O
I'm going to try and keep this pretty simplistic - This IS a newbie thread after all.
Ok so Bank secret number 2 told you one of the ways in which banks make money from you. By using the security value of your assets and lending against those assets (and keeping a small reserve).
If you look at the example I gave you above where you go to the bank with $1M property for a $100,000 loan. They would then on-lend about $812,000 (even though the maximum capacity for them to on-lend is....$900,000). They reserve the remaining security.
For the bank this is a legislative requirement - They must retain a certain minimum percentage of unused security for safety reasons.
When you approach you own finance and risk management techniques - you should do the same (just not to the same level because the government won't bail you out if you stuff up).
Let’s say you have a significant asset with a low LVR (This could be your PPR or an investment property for example). Currently the bank loves you - they get to use your asset and make lots of money from you by using the currently unused security value of your asset.
You would be MUCH better off if instead of the bank using that security value - you yourself use it. But how do we use it effectively so as not to endanger the viability of the asset?
In the case of a PPR (principle place of residence) there are a couple of important things you need to consider.
1) Taxation - Interest payments on your PPR are not tax deductible. Any debt on your PPR is not good debt.
2) Serviceability - Your PPR doesn't have tenants (generally) that help you make the interest payments on the loan - so the bank will determine whether you can service the loan with your income.
For these reasons it's best to exclude the PPR from optimisation activities that involved large amounts of gearing. Your best use of the PPR is to use it to cross collaterize into an income producing, appreciating asset class. (usually residential property assets are the easiest to achieve this - There are a number of key characteristics that I look for but that's for another time). This will allow you to have a 100% LVR on a new investment property and use your available disposable income for other activities. (Just MAKE SURE that all of the new debt is held via the new Investment Property to ensure maximum tax write-offs). NOTE if you cross collaterize two assets the lending institution has the ability to veto the sale of either asset.
IMPORTANT - if you choose to do the above and the rental income of your investment property is not sufficient to cover the entirety of the loan (IE - negative gearing). YOU ARE RISKING YOUR HOUSE IF YOU ARE NOT CAREFUL.
Just like what the bank does when they have your asset - we should apply the same lessons here and calculate a reserve from our accessible loan. (Generally you want this at call as well so a Line of Credit facility is the best to use). A reserve is an UNUSED PORTION of your approved loan that can be used to prevent mishaps and unexpected events from compromising the viability of the asset. Depending upon what your risk tolerance is depends upon what size reserve is appropriate. I generally find that a 20% reserve is the maximum that I will use. The reserve should be in place until the asset becomes positively geared, then the reserve can be either drastically reduced, or used entirely for other purposes.
Want to really appreciate why the use of a reserve on your PPR is important? Go read the Storm Financial Thread. https://www.aussiestockforums.com/forums/showthread.php?t=13176. The major issue with Storm was using such a LARGE amount of gearing on the principle residence with inadequate protection in place.
In the case of an Investment Property asset – you can be much more aggressive with your gearing activities because the interest payments on loan funds are tax deductible for you. You still need to maintain a reserve for contingencies but it can be much smaller, and is designed to cover the shortfall whilst the property moves from negatively geared to positively geared. As a general guideline I’ve found it takes about 5 years for a quality property to move from negative to positive gearing.
OK Time for another secret:
If your PPR has non tax deductible interest and limitations towards optimisation and gearing; and investment properties do not have these limitations, which is the better first purchase?
A great many people seem to want to follow some kind of script that involves chaining themselves to a large asset with an inefficient gearing and taxation profile. The better first purchase is an investment property (or two) BEFORE you purchase a PPR. For a great many people this little secret comes too late – remember to tell your kids when they are old enough to appreciate it.
Part two IS coming guys – just got busy.
Sir O
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Hi Guys and Gals,
Ok So the above post will be edited by Joe hopefully sometime today. My meetiing got pushed back so I spent some more time yesterday editing my post (but wasn't aware I was under a 20 minute deadline) and lost the additions I wanted made. The second (and possibly third) parts will be coming along a bit later.
Sir O
Ok So the above post will be edited by Joe hopefully sometime today. My meetiing got pushed back so I spent some more time yesterday editing my post (but wasn't aware I was under a 20 minute deadline) and lost the additions I wanted made. The second (and possibly third) parts will be coming along a bit later.
Sir O
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Part two - more risk management
OK Let’s leave property for now and move onto shares – and the sorts of risk management techniques to employ. You have a lump sum of cash to invest. It may be the result of diligently squirreling away funds from your income, it may be the result of optimising your equity in your Investment Properties (or worst case your PPR), or you may have inherited a bundle from your eccentric Aunt. Point is you’re about to hear a bunch of people tell you what they think you should do.
Professional traders will tell you that you can make money in any kind of market – bull or bear. (And they are right), but that level of skill requires education, practice and a great deal of time. For newbie investors – by all means educate yourself to be able to trade any market but don’t mess around with core investments if you don’t know what you are doing. If you don’t know what you should do – seek advice - but decide yourself.
Now is the time to really analyse who has your best interests at heart. The BEST person to control your money is YOU. You should NEVER cede control to someone else. You should also ALWAYS get a second opinion. There has been lots of discussion on these boards about the parasitic nature of advisers in the financial services industry. Take advice but don’t cede control.
Remember which is the best time to invest in the share market? When the bears are savaging - not the bulls running. When does the bottom happen? You’ll need to decide that for yourself, because your broker will ALWAYS be able to find something for you to buy.
OK So cast your minds back and it’s August 07. The market has just had one of the best 5 year periods it has EVER had, the share market is booming, Storm Financial directors just paid themselves a $24 million dollar dividend, for a lot of people life is good. NOW is the time to PROTECT or LIQUIDATE your existing share assets. (If you Liquidate be prepared to pay CGT and make the appropriate reserve for tax purposes). If you’ve read the bit I wrote about banking secrets you now KNOW that right now is when you go to your lending institution for approval on a line of credit facility to the maximum that you can achieve. Your existing Share portfolio is looking healthy and you are maintaining a 50% margin with your margin lender.
August 07 – December 07 – You should do the following:-
1) Pay off margin facility (Because interesting things are going to happen to interest rates in the next 12 months)
2) Either A) Sell the majority of your shares down and move the money into cash products OR B) Protect your portfolio using put options
I’d normally talk now about options in great detail – but I’ll leave that for another time –Basically you can use options like an insurance policy to preserve your value at the top of the market.
December 07 – June 08
Right now you should be looking at cash products and Bonds – (If we get a bit more advanced we can use gearing strategies to create tax deductible interest payments to offset the unfranked nature of cash payments)
June 08 – NOW
This is where we start examining the market and selecting (not necessarily purchasing) which stocks to buy (or choose an index when you think it is appropriate).
OK let’s say that you think the bottom of the market is upon us right now. (Or more appropriately that the probability of further falls in the market are small in comparison to the previous 12 months). If so you are probably holding either a wad of cash or a large amount of unused approved capacity. Normally I recommend that unless you are a professional trader, if you wish to trade a portion of your available equity, you do so with a relatively small percentage of your capacity and have the majority in a portfolio that requires minimal effort and is focussed towards the longer term timeframe of the next 5 to 10 years.
I always prefer direct equity and direct control – See next topic on Asset classes for the reasons behind my preference.
OK so you’ve made your decisions about what shares or indexes to purchase – what is an appropriate level of optimisation?
I don’t go above 50% gearing. What this means is if you bring $100,000.00 to a margin lender, you use $100,000.00 of their money to invest. Margin lenders generally allow you to use significantly more than that figure and will tell you the benefits of gearing to 75% - Don’t let them push you into using a higher level of gearing than you should.
BEFORE we gear however we need to project what the cash flows are going to be. Why do we do this? For the same reason we use a budget for our income and expenses (to know what we are safely capable of achieving). When you construct your ideal portfolio (BEFORE YOU BUY) work out what dividends have been paid in the last year, what level of franking credits were paid and then work out what interest payments will cost you. When you have this calculated you can then work out what your safety margin will be (I generally use 5-10%).
So if we use the above example, we will reserve $5,000 to $10,000 of unused cash or additional lending capacity and then gear the remainder.
If your timing is correct and your choice of stocks is careful – you will be able to positively gear the portfolio.
Important lessons
Leave it alone – If you have chosen your stocks well, and no major events happen that will impact the dividend streams or massively impact the share price, you won’t need to do any selling until the market is at the top again.
Review quarterly – Look at the cash flows, interest levels and capital appreciation levels. If your gearing ratio has fallen more than 10% buy additional securities to bring it back to 50%.
Next time Aug 07 appears, Rinse and Repeat.
Sir O
OK Let’s leave property for now and move onto shares – and the sorts of risk management techniques to employ. You have a lump sum of cash to invest. It may be the result of diligently squirreling away funds from your income, it may be the result of optimising your equity in your Investment Properties (or worst case your PPR), or you may have inherited a bundle from your eccentric Aunt. Point is you’re about to hear a bunch of people tell you what they think you should do.
Professional traders will tell you that you can make money in any kind of market – bull or bear. (And they are right), but that level of skill requires education, practice and a great deal of time. For newbie investors – by all means educate yourself to be able to trade any market but don’t mess around with core investments if you don’t know what you are doing. If you don’t know what you should do – seek advice - but decide yourself.
Now is the time to really analyse who has your best interests at heart. The BEST person to control your money is YOU. You should NEVER cede control to someone else. You should also ALWAYS get a second opinion. There has been lots of discussion on these boards about the parasitic nature of advisers in the financial services industry. Take advice but don’t cede control.
Remember which is the best time to invest in the share market? When the bears are savaging - not the bulls running. When does the bottom happen? You’ll need to decide that for yourself, because your broker will ALWAYS be able to find something for you to buy.
OK So cast your minds back and it’s August 07. The market has just had one of the best 5 year periods it has EVER had, the share market is booming, Storm Financial directors just paid themselves a $24 million dollar dividend, for a lot of people life is good. NOW is the time to PROTECT or LIQUIDATE your existing share assets. (If you Liquidate be prepared to pay CGT and make the appropriate reserve for tax purposes). If you’ve read the bit I wrote about banking secrets you now KNOW that right now is when you go to your lending institution for approval on a line of credit facility to the maximum that you can achieve. Your existing Share portfolio is looking healthy and you are maintaining a 50% margin with your margin lender.
August 07 – December 07 – You should do the following:-
1) Pay off margin facility (Because interesting things are going to happen to interest rates in the next 12 months)
2) Either A) Sell the majority of your shares down and move the money into cash products OR B) Protect your portfolio using put options
I’d normally talk now about options in great detail – but I’ll leave that for another time –Basically you can use options like an insurance policy to preserve your value at the top of the market.
December 07 – June 08
Right now you should be looking at cash products and Bonds – (If we get a bit more advanced we can use gearing strategies to create tax deductible interest payments to offset the unfranked nature of cash payments)
June 08 – NOW
This is where we start examining the market and selecting (not necessarily purchasing) which stocks to buy (or choose an index when you think it is appropriate).
OK let’s say that you think the bottom of the market is upon us right now. (Or more appropriately that the probability of further falls in the market are small in comparison to the previous 12 months). If so you are probably holding either a wad of cash or a large amount of unused approved capacity. Normally I recommend that unless you are a professional trader, if you wish to trade a portion of your available equity, you do so with a relatively small percentage of your capacity and have the majority in a portfolio that requires minimal effort and is focussed towards the longer term timeframe of the next 5 to 10 years.
I always prefer direct equity and direct control – See next topic on Asset classes for the reasons behind my preference.
OK so you’ve made your decisions about what shares or indexes to purchase – what is an appropriate level of optimisation?
I don’t go above 50% gearing. What this means is if you bring $100,000.00 to a margin lender, you use $100,000.00 of their money to invest. Margin lenders generally allow you to use significantly more than that figure and will tell you the benefits of gearing to 75% - Don’t let them push you into using a higher level of gearing than you should.
BEFORE we gear however we need to project what the cash flows are going to be. Why do we do this? For the same reason we use a budget for our income and expenses (to know what we are safely capable of achieving). When you construct your ideal portfolio (BEFORE YOU BUY) work out what dividends have been paid in the last year, what level of franking credits were paid and then work out what interest payments will cost you. When you have this calculated you can then work out what your safety margin will be (I generally use 5-10%).
So if we use the above example, we will reserve $5,000 to $10,000 of unused cash or additional lending capacity and then gear the remainder.
If your timing is correct and your choice of stocks is careful – you will be able to positively gear the portfolio.
Important lessons
Leave it alone – If you have chosen your stocks well, and no major events happen that will impact the dividend streams or massively impact the share price, you won’t need to do any selling until the market is at the top again.
Review quarterly – Look at the cash flows, interest levels and capital appreciation levels. If your gearing ratio has fallen more than 10% buy additional securities to bring it back to 50%.
Next time Aug 07 appears, Rinse and Repeat.
Sir O
Hi Sir O
I'd like to ask questions about mortgage offset accounts if you don't mind:
Let's say I bought a property 12 months ago for $500K. Downpayment was 20% which is $100K and I paid another $40K over the past 12 months as mortgage repayments.
I called my bank the other day to make an inquiry and was told that I have access to that $140K($100K+$40K) and i can use it anytime I want.
I'm a bit confused cos I thought most of my repayments are actually paying interests and that should be considered "profit" for the bank. How come I still have access to it?
On the other hand, I was told that the bank calculates my repayments according to the difference between my loan and my money in that offset account. So I guess if I start using that money, I will have to start making higher amounts of repayments?
Your help would be much appreciated.
I'd like to ask questions about mortgage offset accounts if you don't mind:
Let's say I bought a property 12 months ago for $500K. Downpayment was 20% which is $100K and I paid another $40K over the past 12 months as mortgage repayments.
I called my bank the other day to make an inquiry and was told that I have access to that $140K($100K+$40K) and i can use it anytime I want.
I'm a bit confused cos I thought most of my repayments are actually paying interests and that should be considered "profit" for the bank. How come I still have access to it?
On the other hand, I was told that the bank calculates my repayments according to the difference between my loan and my money in that offset account. So I guess if I start using that money, I will have to start making higher amounts of repayments?
Your help would be much appreciated.
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Thanks for these figures which I agree are very scary - but also are very important as they highlight the reality of peoples efforts!
This reality is that very few people become wealthy! And it is extremely simplistic to imagine that any 'formula' will secure financial independence. Although a focus on budgetting is worthy, in reality the majority of wealthy people got there either through a major amount of hard work, luck or risk or all three. Unfortunately we are all individuals, with different capabilities which we may achieve but are influenced throughout our lives despite our best efforts by luck, chance or fate.
My own experience is of a lot of hard work to achieve a high income level - but it is only after I devoted significant time to a financial education that I actually focussed and developed that income to move towards financial independence in 'retirement'. I am less than 10 years away from that (despite the current downturn) but enjoy my job so will probably work longer.
My path has suited me, I have had a great time, happy family, lots of travel and significant social and community involvement (including working in developing countries). I feel that I have been successful, especially considering my poor starting point.
I sometimes regret that I did not commence my 'financial education' earlier - but then I may have 'budgetted' and not have as good a time or been there for the kids when they were younger!
My 2 cents worth.
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Tasmart - define wealthy.
I am using the ABS definition - I'm not talking James Packer, gold toilet seats kinda wealthy. I think that a couple of simple rules would do wonders for those motivated enough to learn so that those stats do better. No formulaes involved - no one right way, just a few pieces of knowledge to guide people into financial security. I'm not pushing an agenda here, I don't want a 7% upfront fee and ongoing trail to leverage your principle place of residence and invest into highly geared index funds aka Emmanuel Cassimatis. Yes everyone is different, I'm merely sharing what works for me and I've seen work numerous times for others and consider that it is nothing special. No great amount of hard work, luck or risk was involved - merely a small amount of hard-won education.
Sir O
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Hi hissho,
The money is available for you to withdraw and use and your repayments wont change. BUT you are correct that the bank calculates the interest on the difference between your money and the loan. That is why it is a good idea to have a mortgage offset account so you can reduce your interest bill.
Your repayment amount and the amount of interest you are charged are separate. If your repayments are $3,000/mth they will always be that until the end of the loan unless you refinance. The interest charged is just added onto the loan balance.
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Hissho,
1) I can't provide you with specific advice - it's against the rules of this forum.
Ask yourself the following questions...
What type of lending facility do you have. Have you got a line of credit for example that has that level of flexibility? Standard P&I loans (even with offset accounts) generally don't allow that level of flexibility.
When you sought approval from the bank what was your approval limit based upon your income and serviceability? If you have a high income that could support a larger loan the bank may be keen for you to have a larger amount of debt.
Has the value of the property significantly increased in value in the last twelve months?
For what purpose have the bank approved this drawdown? Eg are you planning on investing this into another asset that the bank will have security over via cross commercialization.
More debt=higher repayments (what other way coud it work?)
As far as offset accounts go - I love 'em - but still pay your mortgage fortnightly.
Sir O
You still have access to it because the bank wants you to redraw it - because then they get more interest from you.
Your repayments pay down the original loan amount meaning that you pay less interest over the term of the loan. By redrawing the money the outstanding loan amount goes back up and you get charged more interest. That's why banks love it when you redraw on your loan.
Edit: Great thread Sir O, very educational.
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Sorry, my post did seem a bit critical - and was before I read some of your later posts. However I found the stats depressing (especially with the ABS definition of wealth) - because as you point out the information for people to do better is plentiful, but human nature, lack of appropriate financial education and the minefield of 'advisors' are the greater influence.
Also I have found a lot of the discussion in these forums amazingly ill-informed so it is good to read your approach which is more sensible.
Keep up the good work!
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Ok ready for the next lesson newbies?
Asset Classes and Sundry info. Part 1a
There are three main asset classes. We will deal with them each separately and in some detail, which I will break into three parts.
First Asset class - Shares
Yup on his forum no doubt this is everyone's favourite asset class. After all we all come here every day to look at what people are saying about stocks and to bounce ideas off of each other in ways that make sense. Spending quite a large portion of my adult working life as a Full Service (private client) broker I have to modestly say I know a bit about this asset class. I'll try not to go too deep and keep it simple for the newbies and if anyone wants to ask questions we can build from there. Those of you who know this stuff feel free to skim until you find something interesting...
A share (stock, security, unit - in many cases these phrases are interchangeable) refers in it's simplest sense to a portion of ownership in a company. Companies can be either listed (in which case they have to abide by certain rules called ASX Listing rules. http://www.asx.com.au/supervision/rules_guidance/listing_rules.htm) or unlisted - which means they are responsible to only their share and stake holders.
Who do companies list? The first function of the Australian Stock Exchange is to serve as a primary market. The raising of funds through IPO's (Initial Public Offerings) by means of an offer document (prospectus) which is required to detail the business proposition of the company attempting to float. This document will contain business projections, P&L statements, Balance sheets, key employees and board members, independent experts reports and other vital company information.
Be aware of course the principle of Caveat Emptor "Let the buyer beware" applies. The information is presented to you so you can decide whether it is worthwhile in making an investment. This if you didn't know is BIG business. Look at any prospectus and listed in the "use of funds section" will be a section called listing fees, or offer fees or expenses associated with offering and depending upon the size of the float, can be several million dollars. These expenses are made up of the following:-
1) Fees paid to the broking house selling the IPO - which will include fees paid to your stockbroker or financial planner, a chunky fee paid to the corporate department (who administer the IPO and are a central sell point), and any spotter or finders fee (if the deal was sourced outside of the corporate department). Now ask yourself this question...Does your broker have your best interests at heart if he is being paid to sell you something? Oh and the more he can sell to his clients the greater the size of his commission.
Don't get me wrong - in a bull market there tends to be several IPO's a year that everyone wants...and when everyone wants it the stock is likely to stag well. (Stag - open at a premium to it's issue price - BNB due to the popularity of it's IPO at the time opened at a 60% premium to it's issue price - and within a short period of time was over $15.00 - $300% above issue price). In that circumstance the broker would be thinking "which clients do I reward with a stock I KNOW is going to stag?" It is of course the client that takes every other sh!tty float offered. I've actually heard when sitting in the dealing room an adviser say.. "Look you take some of this float and dump it after a couple of months and I'll look after you with the next good one."
In ten years in the broking industry I can remember offhand about 15 stocks that I personally put money into on IPO (usually there was anywhere from 20 to 40 floats a year offered to clients) - but then I'm a cautious investor - not a rabid punter.
2) Fees paid to Accountants and Auditors
3) Fees paid to independent experts and assessors
If the listing is successful and all shares offered in the company are purchased, the stock will list on the exchange and be subject to market forces.
Ok I'm going to leave it there (it is Friday night after all and the scotch bottle is calling me) and pick this up later.
Have a nice weekend
Sir O
Asset Classes and Sundry info. Part 1a
There are three main asset classes. We will deal with them each separately and in some detail, which I will break into three parts.
First Asset class - Shares
Yup on his forum no doubt this is everyone's favourite asset class. After all we all come here every day to look at what people are saying about stocks and to bounce ideas off of each other in ways that make sense. Spending quite a large portion of my adult working life as a Full Service (private client) broker I have to modestly say I know a bit about this asset class. I'll try not to go too deep and keep it simple for the newbies and if anyone wants to ask questions we can build from there. Those of you who know this stuff feel free to skim until you find something interesting...
A share (stock, security, unit - in many cases these phrases are interchangeable) refers in it's simplest sense to a portion of ownership in a company. Companies can be either listed (in which case they have to abide by certain rules called ASX Listing rules. http://www.asx.com.au/supervision/rules_guidance/listing_rules.htm) or unlisted - which means they are responsible to only their share and stake holders.
Who do companies list? The first function of the Australian Stock Exchange is to serve as a primary market. The raising of funds through IPO's (Initial Public Offerings) by means of an offer document (prospectus) which is required to detail the business proposition of the company attempting to float. This document will contain business projections, P&L statements, Balance sheets, key employees and board members, independent experts reports and other vital company information.
Be aware of course the principle of Caveat Emptor "Let the buyer beware" applies. The information is presented to you so you can decide whether it is worthwhile in making an investment. This if you didn't know is BIG business. Look at any prospectus and listed in the "use of funds section" will be a section called listing fees, or offer fees or expenses associated with offering and depending upon the size of the float, can be several million dollars. These expenses are made up of the following:-
1) Fees paid to the broking house selling the IPO - which will include fees paid to your stockbroker or financial planner, a chunky fee paid to the corporate department (who administer the IPO and are a central sell point), and any spotter or finders fee (if the deal was sourced outside of the corporate department). Now ask yourself this question...Does your broker have your best interests at heart if he is being paid to sell you something? Oh and the more he can sell to his clients the greater the size of his commission.
Don't get me wrong - in a bull market there tends to be several IPO's a year that everyone wants...and when everyone wants it the stock is likely to stag well. (Stag - open at a premium to it's issue price - BNB due to the popularity of it's IPO at the time opened at a 60% premium to it's issue price - and within a short period of time was over $15.00 - $300% above issue price). In that circumstance the broker would be thinking "which clients do I reward with a stock I KNOW is going to stag?" It is of course the client that takes every other sh!tty float offered. I've actually heard when sitting in the dealing room an adviser say.. "Look you take some of this float and dump it after a couple of months and I'll look after you with the next good one."
In ten years in the broking industry I can remember offhand about 15 stocks that I personally put money into on IPO (usually there was anywhere from 20 to 40 floats a year offered to clients) - but then I'm a cautious investor - not a rabid punter.
2) Fees paid to Accountants and Auditors
3) Fees paid to independent experts and assessors
If the listing is successful and all shares offered in the company are purchased, the stock will list on the exchange and be subject to market forces.
Ok I'm going to leave it there (it is Friday night after all and the scotch bottle is calling me) and pick this up later.
Have a nice weekend
Sir O
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Sorry about the delay guys and girls - I haven't forgotten you - will try and continue with this sometime today (Got extra busy).
Sir O
Sir O
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Ok In the continuing saga of what I promise and what I actually do... I probably won't get to this for a week or so. (Sorry 'bout that - dealing with other advisers mistakes is starting to &^%$ me off). I have a large report I need to prepare for a client which will take most of my time over the next several days, but then when $20m says jump....
Just FYI.
Sir O
Just FYI.
Sir O
