VNR cuts dividend in half

newlogo7.9.10Vanguard Natural Resources, a stock I have written about many times, has cut their dividend from $0.21/unit to $0.1175/unit. That is an almost 50% cut. Good for me that I moved that money to discounted notes a few months ago.

Perhaps you’re wondering if I would continue recommending it? I would if it fits the need. For any critical analysis, you must understand the business. VNR is 85% natural gas. This has nothing to do with the oil market, which caused its price to tumble in the first place. In essence, a lot of people panicked and took a lot of the energy market down. In my opinion, VNR has been acquiring solid assets. They have a strong history of paying dividends.

To be honest, this appears like a great opportunity to collect some VNR stock at a discount. Again, if it suits your purpose. My purpose in owning VNR stock was to pay off an interest only HELOC. If my monthly payment on that debt was cut in half, it would no longer be the right tool for me.

My prediction (take it or leave it) is that VNR will eventually recover and slowly but surely be able to raise its dividend again. How quickly? I don’t know. But MLP stocks have a high payout ratio due to their corporate structure.

Thankfully I moved my money into a warrantied, discounted, first position note. It is paying off my HELOC at a higher rate than before and isn’t linked to tremors in the stock market.

I’m not a financial advisor. Don’t buy or sell anything simply based on my opinions. Do your own analysis and make your own decisions.

Building wealth isn’t free

habit-saving-moneyAll too common, I see people obsessing about fees at the wrong phases of building wealth. There are countless websites and forums where people discuss low cost index funds. The problem is, they haven’t calculated the Big fee that will hit them at retirement: taxes.

Standard IRAs and 401(K)s are designed to get you to sock away money tax free today, only to turn around and pay income level taxes at retirement. And to top it off, Uncle Sam demonstrates his hunger for that tax revenue by forcing you to start cannibalizing your savings at the age of 70 1/2. If you save up a big pile of money in something that pays a handy dividend, you can’t keep it forever. You will be forced to start taking minimum withdrawals.

To illustrate, I tracked down an online early withdrawal calculator. I plugged in $1,000,000 balance, and it told me that the age of 70 1/2, the minimum withdrawal amount was just shy of $36,500. To frame this in lingo that financial consultants use, we are all told to withdraw no more than 4% per year in retirement. 4% of that balance would be $40,000.

A subtle but little discussed point in all this is the “no more than” piece of that advice. The idea is that our retirement fund is expected to grow by more than 4%. Hence, ONLY withdrawing 4% should let our principle grow. But if we only have a 3% growth, we should ONLY withdraw 3% and hence NOT tap into the principle.

If we have a losing year, we shouldn’t draw anything at all. The hope is that our retirement funds would throw off dividends to fund ourselves. Anything else, and we are cutting into the principle and forever reducing future earnings and available cash. But these minimum withdrawals don’t grant us the ability to scale back to 3% or even skip a year of withdrawals. Instead, we are forced to cut into that principle so the government can get their piece of revenue.

It’s okay to pay taxes

TaxesIf there is any kind of lesson, it’s that taxes must be paid. The only question is when. People obsess over paying taxes today. They would rather push them off and score all the tax deductions possible. But that might not be the most efficient strategy nor the most stable one for your retirement.

The truth is, it’s better to pay the taxes now. That way, in retirement, there is no need to ship off a chunk of your retirement wealth to the government at who knows what tax rate. And if you use Roth IRAs instead of standard ones, there are no required minimum withdrawals! If there is any hint of what the IRS prefers, just checkout the fact that people making over $191,000/year can NOT contribute to a Roth IRA.

There is an old adage: would you rather pay taxes on a bag of seed or on the harvested crop? In true mathematics, if the rate at both times is identical, then you would pay the same taxes on either side. But that is rarely the case. And who knows what the tax rates will be 30 years from now?

Don’t forget about management fees

panic_buttonI’ve talked about fees many times. One really surprising article was about a couple that held dozens of mutual funds and never consolidated. They actually had a big chunk of cash. The effect was disastrous!

The couple in that linked article were paying a financial advisor 2.5% annually. Sounds small, except that they had saved up $1.3 million. Annual fees exceeded $32,000! Imagine paying $32,000 each and every year of your retirement.

The actual plan they were pursuing was to consolidates into half a dozen funds, and reduce annual costs to 1%. That is terrible! Cutting down to $13,000 in annual fees is terrible. The irony is that if they looked at the top ten stocks in each fund, they might find a lot of well recognized companies: Coca-Cola, Walmart, Apple, General Mills, Pepsi, Dr. Pepper-Snapple Group.

If they simply sold everything and bought $130,000 of each of the top 10 stocks, their annual fees would drop to nothing. There would be a one time cost of selling the funds and buying the positions, but after that, no management fees. And then they could drop the financial advisor! To top things off, they would probably rack up better dividends, dividend growth (like getting a raise in retirement), and also see asset appreciation.

Stocks aren’t the only way

Mortgage_Loan_Approved1Other options would include discounted notes. I’m in the middle of migrating my Roth IRA into a Self Direction Roth IRA. The plan is to buy warrantied, discounted notes. The noted fund I have joined sells 1st position notes at a discount. That means mortgages that were perhaps written for 5% would yield me something much higher, like 9-12%. They are also warrantied meaning that if the payee stops paying, I have the option to either foreclose and sell the property, or I can collect on the warranty and get back what I put in. Show me a stock or mutual fund that offers that.

As an example of discounted 1st position notes, imagine a note where the payee owes $100,000. Imagine it was written with a 5% interest rate. Monthly payments would be $536. The person holding the notes decides to sell it for whatever reason. Maybe they needed a quick source of capital. To move the note quickly, they are willing to accept $65,000. For $65,000, I can get that monthly stream of $536. Punch that into your calculator, and you’ll see that we are getting 9.9% yield on that investment.

To top it off, whenever the payee decides to pay it all off, I collect an extra $35,000 (remember, original balance owed was $100,000). If that happened five years out, the annualized ROI would be about 9%. Pretty good return on the money. And then I can take all this cash and buy more notes, boosting my monthly yield.

Thanks to having this inside a Self Directed Roth, there are no taxes involved. I have to pay a service fee to my note payment collectors of about $15/month. And the Self Directed Roth custodian needs a minimal fee as well. But nothing close $13,000 year! That is horrendous.

EIULs are designed to reduce costs in the future

EIULeffectThe last leg in my talk about good vs. bad management fees are EIULs. I frequently hear life insurance products criticized as being ridiculously expensive. The truth is they ARE very expensive….for the first ten years. After that, the costs drop dramatically.

Insurance companies design these products so that they collect their profits up front. That way, if you fall through on future payments, they don’t care so much. It also makes the products better guaranteed to last properly. A key ingredient, though, is to overfund as much as possible. By overfunding a policy, the cash value grows much faster. And the faster the cash value grows, the less total insurance must be bought. It’s a vicious cycle. If you slow down the growth of cash value, more of your premiums is used to fund the difference, i.e. the corridor between face value and cash value.

But when you overfund the policy, the total amount of insurance purchases through the life of the policy is greatly reduced and in the end, the annualized costs drop to somewhere like 0.5-1.5%. That’s pretty handy for getting a big chunk of cash in retirement that is completely tax free according to IRS tax code.

It’s not simple or easy to build wealth all by yourself. But delegating ALL decisions to a financial planner can be very costly when you reach retirement. The key is understanding the fundamentals of building wealth so you can hire the right experts to set up things most efficiently.

Are you saving big enough and smart enough?

rodin_thinkeI was recently approached (again) from a freelance writer, offering to write blog entries. I figured this would be similar. They would offer several articles, and I would find them filled with stuff and nonsense about 401K plans, which I have remarked countless times DON’T WORK. This time it was different. The articles given were even worse.

One of these articles pointed to a recent survey of Millennials and how were they doing regarding saving. All the status I could find were that Millennials were doing better by starting five years younger than Gen X, and auto-enrollment options for employer-based 401K plans has helped shift 401K participation from 81.4% to 84.6%

First of all, starting younger IS a good thing to do. When you talk about the power of compound interest and compound stuff-money-in-the-bank, every extra payment is good. In fact, if you pay off rental properties at an accelerated rate, it will make the interest rate almost irrelevant. What that links points out is that when you calculate the payment with a couple points of difference in the interest rate, you’re talking about a six month speed up of the payoff of that note. What speeds things up is making extra payments EVERY month, or EVERY year.

Hence, socking away extra cash from EVERY paycheck is the real ticket to success. Or at least, a key factor.

But something that really got my goat was how the article assumed that auto-enrollment was the reason that 401K participation had increased by 3.2%. First of all, no evidence was presented that this was the correlation at all. For such a small change in statistics, there could be a dozen factors. The slow recovery of the stock market (until a few weeks ago!) could make people more comfortable. Or watching the market rally here and there might make people start jumping in.

But the focus was on the entirely wrong points. The real question should be, “Hey Millennial, what rate of return are you getting with your savings?” and “How much cash flow do you predict you’ll have in retirement?”

When we ask these types of questions, our advisor should tell us, “You’ll make more in retirement then any year you ever worked.” Instead, the most common street advice is, “Don’t worry about taxes in retirement. You’ll be a smaller tax bracket.”

Uhh, why will I be in a smaller tax bracket? Is it because I’ll be making LESS then than I’m making now? After retirement might devalue my dollars perhaps 60%? And drive me to get ripped off by taking a reverse mortgage?

401K plans are betting on mutual funds. Mutual funds are doing horrendously. They always have. There is over 20 years of data showing that people that invest in mutual funds tend to get less than 4% a year in annualized growth. Ever since I pulled my money out of my 401K, and repurposed it with real estate and notes, my net worth has sky rocketed. My portfolio isn’t secured by shaky fishbowls of stocks that are supposed to mitigate the risk, but never do.

So I turned down this potential author, because this person didn’t seem to write in the same vein as any of my articles. No, my standards are quite high, and finding someone that shares this odd but evidence based quality of writing is hard.

Goodbye VNR, hello discounted notes

Mortgage_Loan_Approved1This may be a bit of shock to the readers of my blog, I have sold my entire stock position and used the cash to buy some discounted notes.

Say what?!?!

Anybody that has read my blog for awhile is aware that some of my most passionate articles have been about my big position in Vanguard Natural Resources (VNR). And it’s true. VNR has averaged a yield to 7.5%. In fact, in light of the recent sell off the market, their dividend yield is now looking like 14%+. Suffice it to say, VNR has been pretty good. To top things off, the HELOC I used to buy a majority of my position has been knocked down by 20% thanks to monthly distributions from my past position.

So why drop something so good? Because I have something better. First, a little background.

Discounted notes

What are discounted notes? A “note” is another word for a loan. And we’re talking about real estate loans, i.e. mortgages. When you secure a mortgage with the bank, they hold what is referred to as a note. When you buy a note from someone, you hand them a chunk of cash in exchange for receiving the monthly payments from whomever secured the loan. You also take over the lien on the property meaning that you have the power to foreclose and sell the property to get your money back in case something goes wrong.

To top things off, there are different positions regarding notes. When a foreclosure happens, the notes get collected in order. 1st position notes get first dibs on collecting on the sale until their obligation is satisfied, then 2nd position, etc. The name of the game is to get a first position, discounted note, secured by a piece of real estate, ideally where the value of the property exceeds what you paid for the note.

Time for a real world example in the realm of discounted notes. Imagine someone decided to buy a house for $125,000. They go to the bank and put down $25,000 cash and borrow $100,000 at 5% for 30 years. The monthly payment would be about $536/month to the borrower.

Now, for whatever reason, the bank that loaned out that cash needs some money fast. So, they decide to sell the note. Perhaps at the time, the balance is now down to $90,000 based on past payments. But to move the note quickly, they are willing to part with it in exchange for $65,000 of cash. That’s where you step in. If you have $65,000 burning a whole in your pocket, you can buy the note and start receiving $536/month backed by a total obligation of $90,000.

What are the numbers? Over twelve months, you would receive a little over $6400. And since it only cost you $65,000, the yield on that would be 9.9%. This is not only higher than the original loan’s rate of 5%, but is in fact higher than the 7.5% yield of VNR. Tiny hint: the note I bought is actually yielding 12%. Sweet!

In addition to collecting monthly payments, people are paying off loans all the time. Let’s fast forward and imagine that we managed to collect five years of payments. That would add up to $32,160. The principal balance would be down to about $79,000 (remember, you are the one collecting the interest). At that stage, the person, perhaps through inheritance, perhaps through devote saving, decides to pay off their note by sending you a check for that remaining balance. You have now collected a total of $111,160, virtually doubling your initial investment. Given the timeline of 5 years, that would be a 14.4% ROI. With your bigger pile of money, you can now go and buy some more notes. Rinse and repeat.

Tradeoffs

So what are the trade offs? There are always tradeoffs. When you buy a stock, you can get in and out in a second. You can buy a big position, and sixty seconds later, sell it all. I built up my stock position over a couple years and then cleared it out in no time flat. I sold VNR at a peak price of $30.85/unit. Today, VNR was dragging along at $17/unit thanks to the panic of the energy market. I nicely pocketed a nice 10% total gain on the money I had stuffed into my brokerage account. That wasn’t pure skill on my end. It was fortuitous. The time frame it has taken me to cash in and wait for a note has been seven months. I have been paying off my HELOC out of the 10% gain, and still come out ahead.

All in all, it’s pretty nice compared to this recent massive sell off that has fleeced many people’s mutual fund accounts.

Notes don’t work like stocks. Each note has to be investigated. Is it a first position note? Is it a performing note (meaning the borrower is currently paying and up-to-date)? What is the value of the property that is collateralizing the note?

This is an area where DIY can kill you. You need professional people that know this industry. It’s why I have been working with Jeff Brown for about a year and his efforts to find the best note investment company to work with. Jeff has decades of note buying experience, which means he knows the questions to ask when researching companies that deal with notes. In fact, he has fine-tuned what is known as the “Bawld Guy Fund” and how it operates to make it worth my time. For example, every note this company gets appears to have a life of about 20 minutes before someone snatches it up. Sound stressful? The Bawld Guy Fund lets top tier members get first dibs for two weeks. Then second tier members (me) get second dibs for two weeks. After that, any member can go for a note. That’s fair in my book.

The note I bought also includes a warranty, so if it stops performing, I can still collect and not lose my money. Did you even know about warranties? Didn’t think so.

At the end of the day, what we seek is yield. We want to grow our net worth with a solid yield. And as Dr. Dave has shown, we need double digit growth if we expect to enter retirement with someone of value. By slowly but surely moving my investment portfolio into real estate, EIULs, and discounted notes, my net worth is not based on flimsy mutual funds, but instead on tools that minimize losses during down years, and instead, are poised to do well in positive years.

Happy investing!

What is happening to the stock market?

graph_up2The stock market lately has gone CRAZY! So what’s happening? Well, I don’t have all the answers, but let’s look at some of what’s going on, and see what we can figure out.

At the beginning of this latest market crash, news reports came out about the price of oil dropping drastically. In case you didn’t know, oil is a key piece of the economy. Whose economy? Well, I know the most about the US economy, but oil is an international commodity, so it affects everybody. In essence, we all use oil to drive cars, fuel shipping trucks/planes/trains, and deliver most other goods of the economy. When oil prices fall, other parts of the economy rally. And when oil prices shoot up, other parts of the economy suffer.

So why is the whole market sliding down? One word: panic. Back in the 1970s, OPEC tried to control the oil market at an extreme level, and they actually contributed to a worldwide recession by pushing the oil market too hard. I’m not saying that is what’s happening, but when the price of oil moves a LOT, MANY investors panic.

All the oil stocks dropped off quite a bit. Strangely enough, stocks like VNR, which is 85% natural gas and has little to do with oil, has dropped 50% in the past 2-3 weeks. That is probably because many of the people that bought VNR are panicking that for some reason, VNR is next. In general ALL energy stocks will typically suffer a hit or a rally when stuff like this happens. A nice side effect for people like me that have a more long term aim at things is that I just reinvested a monthly dividend and picked up twice the usual shares.

But what about other things? VMW is a stock I pay attention to, because I still have a sliver of stock option. It has dropped to $77/share. It has nothing to do with the oil market. But many investors freak out and simply want to get their money out of the market when “shaky” situations like this occur.

This is known as systemic risk. Financial planners push mutual funds hard by selling the story of risk avoidance. They make it sound like during rough patches, mutual funds help you avoid such situations by spreading your risk across the whole market. The trick is, in these types of situations, emotions run high and people will pull their money out of everything. Hence, mutual funds will suffer losses just like other things. The trick is, when people cash out, they want their money. Mutual fund managers are forced to actually sell to dispense cash, and thus lock in losses. The time to get back to where you were takes too long and hence we all suffer.

The thing is, I have little money now invested in mutual funds. Instead, I have real estate, an EIUL, and other vehicles (one which I’ll post about soon!) My net worth has hardly dropped at all. And the yield on my investments is just as strong, meaning I’m not waiting for the market to recover nor am I waiting to “get back to where I started”. This saves me from having the proverbial “201K”.

I don’t have all the answers. I can’t tell you what the market is going to do next. But I can point out the risks that exist, and how mutual funds don’t provide the answers their salespeople claim. Everything comes with risk, and I have that nicely managed by having a super sized bank account filled with cash.

Happy investing!

habit-saving-money

Financial Math III: Diagramming Cash Flows

This post will wrap up my series on Financial Math. I’ve previously written about:

In this article, I want to go over a fundamental mechanism any investor should at least be aware of: Cash Flow Diagrams. If you look to the right, you’ll see a common example.

The first line, that goes upwards, represents a burst of positive money you receive. The following payments, or negative cash flows, are essentially used to payback the initial cash flow. Do you recognize what common financial structure it is where you get a big chunk of cash up front, and then make small payments over a certain time period? That’s right, a loan.

For another cash flow, check out this one. It is the opposite. It shows a big chunk of cash being put out, followed by several small cash flows coming back. Can you think of any examples that match this? Buying a rental property and receiving monthly rent checks. Buying a big chunk of stock and then receiving dividend payouts.

At the heart of any financial transaction, investment, or purchase, you can probably see one of these two diagrams. When you are trying to make a choice on whether to buy a big chunk of stock OR put the money into a rental property, its useful to sit down and chart all the cash flows. Then, you can compare the two. The ratio between the the periodic payments and the invested cash is known as the cap rate, and it’s important to understand the cap rate for each usage of your money. When one opportunity yields less than the other, we refer to it as opportunity cost.

When you are about to pick a certain investment vehicle, it’s good to also make a list of the risks involved. Real estate has certain risks. Stocks have another. And paying off your mortgage early may carry fewer risks, but also consider the loss of opportunity if you don’t build up any positive cash flows in the future. Are you painting yourself into a corner of being house rich/cash poor?

Ever see those commercials where you can “get your cash now?” They are all about taking over your tiny positive cash flows, and swapping them with a big one right now. Believe me, those people make money. They simply calculate your cap rate, plug in a profit factor on top, and essentially calculate a smaller amount of cash to hand you than if you had kept the cash flows for yourself.

Hopefully, this series will have alerted you to the benefit in understanding some financial basics. Happy investing!

Financial Math II: Averages and standard deviations

GDvsS&P5001996to2012This Part II of my series on financial math. Previously we talked about some simple math tricks that can help you think faster on your feet.

In this post, I want to talk about some key statistics that get thrown around and how to parse them. I’m sure many of you have read this famous quotation:

There are three kinds of lies: lies, damned lies, and statistics. –Benjamin Disraeli (according to Mark Twain)

Statistics are what happen when we try to look at a whole batch of data points and spot some sort of trend, correlation, or conclusion. The reason they have to be looked at with a discerning eye is because people will either knowingly (or unknowingly) perform some sort of statistical calculation and then TELL us what it means. What they tell us and what the numbers actually mean can be very different.

rodin_thinkeLet’s introduce an example. Whenever you take a collection of data, such as amount of income earned by every person, and average it together, you can produce a couple different outputs. One is known as the mean. This is when you add all income and divide by every person. In these situations, it is easy for a small group of either very high earners or very low earners to skew the metrics one way or the other.

But if you instead take the entire collection of people and split them into two groups, right down the middle, and look at the mid-point, this is called the median. The median and the mean might be very close together, or they could be far apart.

By itself, these two different statistical values hold no bias. They simply show a slightly different perspective on the spread of income. But people can pick and choose which particular data set to show when making a point. They might choose the data set that better trumps their point of view.

Continuing with our current example, when people calculate such values, the purpose at hand is usually to deduce, where do I fit in? And that is why using the mean, which can be heavily skewed based on outliers, tends to not be as good of a statistic as the median when it comes to predicting things like that.

Another factor we want to know is how spread out is the data from the mean. To do so, we commonly use the standard deviation. If we tried to average the difference of each person from the mean, we would actually reach zero. That’s because half of the data points are greater and half are less than the mean, by definition. So to come up with something of value, we instead square the difference, average that, and take the square root. (In science, this is known as the root-mean-square).

Much research has been done that shows that anything with one standard deviation of the mean has about a 68% chance of success. Two standard deviations = 95%. Three standard deviations = 99%+.

Because standard deviation is so easy to calculate, you should always ask for it whenever someone, such as a financial planner or whomever, attempts to woo you with averages. “The average performance of this fund is 18%.” “What’s the standard deviation?” If they scramble from answering that, it’s a sign that you should probably run.

You see, the bigger the gain, the bigger the risk, and the probably the bigger the standard deviation.

You can see an example in a blog post I wrote for Dr. Dave. In it, I compare the average performance of the S&P 500 compared to an EIUL. To do an analysis, I figured that most people will have about 25 years to get serious about saving in either plan in order to “catch up” if they are late to the game. So, what if I looked at EVERY 25-year window of the S&P 500 going back to 1950, calculated it’s actual performance, and averaged them together? On top of that, let’s find out what the standard deviation?

Turns out, we have a 68% chance of landing somewhere between 4.77% and 9.53% in total growth. If we don’t do so well, we might barely be grazing past inflation. Or we might be well ahead of it. For something in which we only have one shot, I don’t really care for those odds.

Compare that to an EIUL, for which we must trade in a certain amount of highs to avoid certain lows. Turns out in that scenario, we have a 68% chance of landing somewhere between 7.52% and 8.84%. The 8.84% is certainly lower than 9.53% of the S&P 500. But in exchange we are almost three points higher than the low point, meaning our odds are pretty good of beating inflation, a key factor for investing in EIULs.

Neither of these stats factor in costs or how much cash you can put away. Remember, you can always clobber returns rates by putting away more money. The key is that means and standard deviations are important statistics you need to understand if you plan to take an active role in investing.

man_finishing_line

Financial Math I: Rule of 72 and other fast math

When making financial decisions, it’s important to understand how financial math works. This is the first of a short series where I hope to cover some financial math basics.

Rule of 72

For starters, when we are faced with an opportunity, it’s good to be able to quickly assess if it’s worth spending more time investigating. We often call these “back of the envelope estimates”. Without a spreadsheet can we get a ballpark estimate of the value of something?

One of the most well known mathematical devices is the “Rule of 72″. The formula provides a way to see in what time frame and with what interest we can double our money.

Interest x Years = 72

For an example, imagine we had an account growing at 10% annual interest rate. Take the 10, multiply if by 7.2, and you get 72. This means that in 7.2 years (approximately), our money would double.

You can flip things around. If we wanted our money to double in 10 years, we would need at least a 7.2% interest rate.

If you wanted something to double in six years, you would need 12%. 3 years? 24%.

To generalize, any situation that involves the compound interest effect works here. It’s also important to recognize this is only an approximation, and the further you get away from the middle, the less accurate it is. Rule of 72 may say that 2% takes 36 years to double, but this is much less accurate than 7.2% and 10 years. (BTW, you can swap the two such that 7.2 years and 10%.)

This type of quick math can help you. If you hear some investor advertise that there is no risk in doubling your money in six years. In your head, you can quickly deduce he is suggesting 12% growth. Sorry, but that is 3x what people average when using mutual funds. In real estate, this is definitely doable, but it requires either a lot of cash to mitigate the risk, or it requires taking on debt. None of this is risk free.

Gains and Losses

I’m always hearing things like “The Dow is up 5%” or “The NASDAQ is down 10%”. People seem to think that growth and losses are arithmetic, i.e. pluses and minues. They aren’t. They are multiplicative.

If you had $1000, to grow it by 10% means you multiply by 1.1, another way of saying (1 + 10%) or (1 + .10). $1000 x 1.1 = $1100.

To reduce by 25% mean you multiply by 0.75, another way of saying (1 – 25%) or (1-.25). $1000 x 0.75 = $750.

Why is this important to understand? Because combining multiple gains and losses together involves multiplying all of the factors together, not adding them. When you have a 10% gain following by a 25% loss, what is the result? You might think 10% – 25% = -15%, but that isn’t right.

Instead, let’s take what we did earlier (1.1 and 0.75) and multiply them together. 1.1 x 0.75 = 0.825, or -17.5%. That loss (-17.5%) is actually greater than you would get if you just subtracted one from the other other (-15%).

It’s important to know that getting 10% each year for three years doesn’t add up to 30% gain. Instead, it’s 1.1 x 1.1 x 1.1 = 1.331 or 33.1%. This is power of compounding. But when we suffer losses, the effect is equally drastic. And people often don’t realize just how hard losses can be on overall performance.

Understanding this basic tenet of gains and losses is critical to building spreadsheets that evaluate things that are more complex. And the more you use this mechanism, the more you notice how people like to quote “Your investment will average x%!” You will be able to size something up and ask, “Hmm, if I multiple by 1.xx every year, do I really get what they just advertised?”

That’s enough for starters. Tune in for future posts about more financial math.

Time to pay real estate taxes

DSCN0002That time of the year has arrived. I must send in checks paying property taxes on my rental properties. Last year, I contacted my lender and requested them to stop escrowing money to pay for taxes and insurance. Instead, I would pay it myself. This way, there is no confusion and quandary over how much money to set aside in escrow on top of pure P+I payments (principal and interest).

This has simplified things for me, because I can see exactly how much is owed on each unit. I don’t have parts of my net work tied up in escrow accounts that might be stocking up too little or too much. Instead, I have an annual cost that has to be paid and is instantly reflected when I make the payment in my net worth tracking spreadsheet.

As I wrote four hefty checks, it is a bit challenging, since property taxes in Texas are a bit steeper than Tennessee. But knowing that my tenants are paying off the mortgages at record pace and I’m earning top rent, I feel good that I’m developing strong, cash flowing assets that will build strong retirement wealth down the road. And I’m constantly reminding myself that real estate is one of the strongest investments one can make in growing wealth.

Happy investing!

Why EIULs work and VULs don’t when building wealth

booksA friend of mine who occasionally pings me with financial questions asked recently about VULs. He appears to be getting prompted to investing in them. It would appear my past blogs about EIULs causes him to ask a financial advisor about them. In response, it would appear they have countered with suggesting VULs instead.

I wrote a detailed response to him, but thought why not share it here as well?

The problem with VULs

I don’t like VULs at all. To start things off, what are VULs? They are Variable Universal Life insurance contracts. An EIUL is an Equity Indexed Universal Life insurance contract.

VULs take the idea of universal life insurance (which would be the same idea as an EIUL) but instead of using indexed investment options for the cash value, they instead use mutual funds. My whole retooling of wealth building was to get away from mutual funds. Mutual funds have historically had high costs and lackluster performance.

As part of the question I received, my friend included quotes on the cost of insurance. It appears the agent was trying to point out how inexpensive things would be on the insurance side of things.

Hate to break it to you, but cost of insurance is something regulated by each state. Essentially to buy $1000 of pure life insurance costs the same despite the company you go to. Things like fees, profits, etc. are where different companies can vary things. Different companies manage cash value investments differently. The funds, options, indexes, etc. are different for every company. Different companies offer different degrees of customer service and different ratings when it comes time it either loan out money pay up on claims. Different companies can offer different ways to loan you cash from the cash value part of your policy. But the actual cost of insurance is the same.

So in essence, when evaluating a life insurance company, you should basically subtract out the insurance aspect of things instead look at how well such a company has done on the investment side of things.

For any universal life insurance policy, the agent has a fundamental option to either write up the policy where they either maximize or minimize the death benefit based on IRS regulations. Minimum face value causes maximum cash value growth, and that is what we want. Even if you have no children, no spouse, and no family, these contracts are great places to load up with cash that you can get your hands on when needed, over the long haul.

The financial coach/agent that I learned much of this from runs a blog at http://shaferfinancial.wordpress.com. He was actually a PhD in statistics and psychology before entering the financial/industry. He is driven by evidence and actually has an undergraduate degree in finance. Most financial planners are trained in sales. Dr. Dave’s views on wealth building tend to not follow traditional sales routes but instead focus on evidence of success. If you visit his site and search for VUL, you’ll find some detailed analysis of them and why they don’t work.

I talked to him two years ago and said, “Here’s the money I want to invest. What would that look like at retirement?” He put together a plan and we discussed it over the phone. We made some adjustments and over a five month period put it in action. It’s been doing good so far. One things that I solidly know is that my cash value will do nothing but grow. It won’t drop in value at the next market correction like a VUL would. Therefore when the recovery begins, I will have more cash value to grow from than mutual fund investors.

Do you have an illustration or a quote from an agent? Contact Dr. Dave and ask him to look it over. He has written thousands of them, and knows the lingo. He will surely be happy to point out the pros and cons.

Whatever you do, given the long term nature of this vehicle, take your time until you understand it completely.

FYI: I don’t receive a nickel of cash for writing this opinion on EIULs nor Dr. Dave.