Posts Tagged "money"

Leverage Part 1: What is Leverage?

Posted by Preet on Aug 1, 2007 | 0 comments

Leverage: Think of it as using “other people’s money” to make money more quickly. Probably another topic that is best explained with an example.

Greg has $1,000 a year to invest for 10 years. Assuming a rate of return of 10%, at the end of 10 years he will have $17,531.

BUT, we know from the post on the magic of compound growth that TIME has a large effect on growth.  The philosophy is that if you could instead take all that $10,000 over 10 years and just put it in now, you will have more money than by putting it in over 10 years.

Okay, let’s look at a simple use of leverage: Greg only has $1,000/year, so he can afford a loan payment of $83.33/month (That’s $1,000 per year). First we have to figure out how much of a loan he can get. Assuming a 6% interest rate, $83.33/month for 120 months (10 years) will allow him to borrow $7,530.89. So he isn’t starting with $10,000 since we have to compare apples to apples (in the form of how much cash flow he is willing to dedicate to his investment savings).

Okay, so now let’s calculate how much $7,530.89 will grow to if invested and assuming the same 10% rate of return… My trusty financial calculator tells me $19,533. So in this case he has roughly $2,000 MORE through the leverage than with the yearly savings (which yielded him $17,531).

Now before you go out and get a loan to invest, remember that a lot of people get burned on leverages – as they magnify RISK as well as return. In Part II of “Leverage” I’m going to look at a negative scenario.

You know, the topic of leveraging is a big one – I envision that I could easily write a 10 part series of posts on it, and probably will. It’s glamorous, but please make sure to consult with a professional before getting one! This post is in no way meant to be taken as advice to get an investment loan.

Having said that, if you own a house and have a mortgage – you already have a leveraged investment! :) You have borrowed money to buy an appreciating asset.

Use our strong dollar to save on online purchases…

Posted by Preet on Aug 1, 2007 | 0 comments

Our dollar has been hovering around $0.95 USD.  So to figure out how much you pay for something that is listed in US funds, just divide the US price by 0.95. Now you have how much you will pay in Canadian funds.

To take advantage of this you need to know that the price spread of an item (the difference between how much it costs in US funds and how much it costs in Canadian funds) is greater than the price spread between the loonie and the US dollar.  (The price spread between the loonie and the US dollar is 5 cents divided by 100 cents). <– THAT’s the philosophy, but what you really need to know is that when you divide the US priced item by the exchange rate, is the result less than what the items sells for in Canadian funds? Let’s take an example:

I posted that I recommend “The Richest Man in Babylon” as a great book to buy.  If you look on Amazon.COM, it is $6.99 USD.  If you look on Amazon.CA is it $9.99 CAD.

$6.99USD / 0.95(Exchange rate) = $7.36 CAD

So it is actually cheaper to buy it on Amazon.com since our loonie has made such a dramatic increase in value over such a short period of time. HOWEVER, you have to note that to qualify for free shipping on the US site, you need to spend $25 USD. To qualify for free shipping on the Canadian site you need to spend $39 CAD. In addition, the US site will not ship for free to Canada, so to really save money you need to find a friend with a US address and have it sent there and then arrange to get it across the border.  That’s a fair bit of trouble for a small savings, but for electronics…. :)

Can you Diversify too much?

Posted by Preet on Jul 31, 2007 | 0 comments

This is a tricky topic to talk about.  So please read the caveat at the bottom of this post!

The wealthiest people in the world have, on average, made their fortunes on ONE stock… and that is usually the stock of the company they themselves founded and ran in the form of a small business that just kept expanding.  But of course for every small business that becomes the next GOOGLE, there are countless more that fail and go under. This is the ultimate example of why you won’t get rich quickly by diversifying AND how you could lose everything quickly by NOT diversifying.

Understanding this debate is understanding the trade off that you want to make between risk and reward. You take on an astronomical amount of risk by buying only one company’s stock, but if that company is indeed the next GOOGLE well then it was worth it, wasn’t it? :)

Similarly, a lot of successful investors advocate buying only a handful of stocks (maybe 10-20) that they KNOW and BELIEVE in and expect will grow faster than the rest of the economies in which they are domiciled.  They understand it will be a rockier ride than holding every stock in the world, but expect to be rewarded over the long term for the increased amount of risk they expose themselves to.

By properly diversifying, you virtually guarantee you will never get rich overnight, but you also virtually guarantee you won’t lose your shirt either. Conversely, by under-diversifying you open up the possibility of making a lot money very fast… or losing it!

For new investors – you will want to diversify as much as possible, and across multiple levels of diversification as well – see “What is Diversification?”. (At least until you get your feet wet and experience a full market cycle.)

What is a "Line of Credit"?

Posted by Preet on Jul 30, 2007 | 0 comments

A Line of Credit is basically like a credit card in that you apply to have the ability to borrow money whenever you want and have a set limit that you are authorized to use (let’s use $10,000 as an example).  The Line of Credit remains open even when your balance is $0 – and you have no payments to make. If you were to use $5,000 then you would start to be charged interest.  You could pay back the $5,000 right away or you could pay it back over time, the only thing you have to make certain is that you pay the interest monthly. So if your line of credit had a 10% interest rate you would owe a minimum of ($5,000 x 10% / 12) = $41.67 per month. You could take until eternity to pay it off in full if you wanted to so long as you made the interest payments.

The interest rate on the line of credit is usually very good. It is usually at the prime rate (the interest rate offered to the bank’s best customers) if it is secured, or “prime plus 1″ or “prime plus 2″ if it is unsecured.  The “plus” amount varies depending on how credit-worthy the bank thinks you are.

Myth: "I don't want a raise! It will move me into a higher tax bracket and my take home pay will be less!"

Posted by Preet on Jul 30, 2007 | 6 comments

I’ve heard this many times, even from my beautiful mother! This is not true! Let’s bring up my SAMPLE tax table as a refresher:

$0-$10,000       = 0% Tax Rate

$10,000-$20,000 = 10% Tax Rate

$20,000-$50,000 = 20% Tax Rate

$50,000-$75,000 = 30% Tax Rate

$75,000+            = 50% Tax Rate

You will hear some people complain that they don’t want their next raise because it will move them into a higher tax bracket and reduce their takehome pay and they will have less money to spend. Okay, the Government does some interesting things but they’ve figured this one out a long time ago. Here’s how it works:  Let’s take someone earning $49,000. Their marginal tax rate is 20% in our example tax system. That DOES NOT MEAN they pay 20% x $49,000 in tax. They pay 0% on their first $10,000, 10% tax on the next $10,000, and 20% on the next $29,000. Let’s work that out:

(0% x $10,000) + (10% x $10,000) + (20% x $29,000) = $6,800 in tax

$49,000 Income – $6,800 tax = $42,200 TAKE HOME

So let’s say they get their raise to $50,001. The myth is that now instead of paying 20% on all their income, they pay 30% – which would reduce their take home pay by roughly $5,000! This could not be further from the truth! Let’s do the real math:

(0% x $10,000) + (10% x $10,000) + (20% x $30,000) + (30% x $1) = $7,000.30 in Tax

$50,0001 Income - $7,000.30 Tax = $43,000.70 TAKE HOME

Last time I checked, $43,000.70 is greater than $42,200! So feel free to ask for that next raise… :)

Thanks to everyone who has been submitting (and re-submitting) this post to your favourite social media websites like Reddit and Stumbleupon – much appreciated!

Your savings account choices could save you $100,000 over your working life!

Posted by Preet on Jul 25, 2007 | 0 comments

Let’s take a look at how a relatively simple decision can make such a huge impact.  Many traditional banks charge monthly account fees. My personal account with my previous bank charged $11/month and it paid 2% in interest.

Some “virtual banks” like ING and President’s Choice Financial have savings accounts that have no monthly fees. They typically pay a higher interest rate as well, for this example let’s call it 4%.

Let’s examine what the real cost is:

$11/month x 12 months = $132/year

But let’s take is a step further. Many banks offer a lower-fee or fee-free account to students or kids until they turn 18 – so let’s assume that we have this $11 monthly account fee from age 18 to age 65 (again, many banks have a reduced monthly fee for seniors).

Let us also assume that we are wise and decide to invest this saved money into an investment portfolio that averages 8% per year.

$132/year @ 8% rate of return x 47 years = $59,783 that could’ve been in my pocket!

So if you have a savings account at a bank that charges a monthly fee, you can see that even a few dollars a month makes a big difference.  If anyone would like to step up to the plate and provide their monthly account fee and age, I will calculate your “money lost” and post it here as well. (Warning: it’s depressing!)

Note: we haven’t looked at how much less interest you earned inside your savings account during that time! Since the average, free high-interest savings account pays roughly 2% more than a traditional bank, and assuming that the savings account holds an average balance of $5000, then you are foregoing an additional $100 year in interest paid to you.

I guess I’m feeling sadistic, so let’s look at the new final total:

($132/year (account fee) + $100/year (lost interest)) @ 8% x 47 years = $105,073.

So, about 15 minutes to setup your new account today could save you over $100,000. What are you waiting for?

Disclaimer!: Most people will not invest the savings because it is not an established habit – in which case your savings will be a *paltry* $10,904 over 47 years. That is the magic of compound interest – which I will cover in another post!

I hope this post helped you out! :)