Archive for September, 2006

I periodically read various blogs out there to see what’s on people’s minds.  I like reading comments and questions people post on a blog.  Lately, I’ve been reading a great deal of how debt (all kinds) is bad.

I’ve read articles on how credit card debt is bad….
I’ve read articles on how student loan debt is bad…..
I’ve read articles on how mortgage loan debt is bad….
I’ve read articles on how debt is a bad…bad…thing…

I generally refrain from advising people with “xyz solution” because there are simply too many variables to consider (age, marital status, health, financial goals & objectives, children, housing preferences, educational skills/level, etc) to offer any kind of specific advice but I will offer this piece of advice to everyone:

CHEAP MONEY IS A GOLDMINE OPPORTUNITY!

I wont’ give you specific advice and I’m not telling you to go get a mortgage, student loan and credit cards but I will tell you how I’ve taken advantage of cheap money.

I’ve written about credit card arbitrage earning me $1200 over an 8 month period.
I’ve written about using a 3.25% Interest Only ARM to pocket $14k over a 3 year period.
I’ve advised my wife to borrow as much student loans as possible her last year of school because the rates were so low (3%) and the interest can be written off on fed taxes!!

In all instances above, debt was never a “bad” thing.  I could even argue that all this “bad debt” helped improve my FICO score because it showed responsible repayment of all borrowed money.  Higher FICO score mean lower rates (see 3.25% loan rate above).

In my opinion, one of the key ingredients to building a wealthy portfolio is obtaining, using and leveraging (preferably someone else’s) cheap money.

Some people think Comedy Central is the best comedy channel on cable TV but I like to laugh it up watching CNBC.

Yesterday was the perfect example of how funny CNBC can be; the Dow was “rocketing” up to an all time high around noon near 10750. The computer graphics guys were busy flashing “Breaking News” in bold white text with a red background signifying that something important was happening. Every five minutes with every uptick of the Dow we got another “Breaking News” popup. By late afternoon, the Dow was slamming back down to 10680 but it was too late for the CNBC comedy team.

They had already booked the usual parade of clowns claiming the Dow was set to explode over the next few weeks and months. I call them clowns because CNBC “analysts” and “experts” are perennially claiming the Dow will break records sometime in the near future. It’s never a bad time to buy any stock; it’s always buy now buy today.

The rest of the shows on CNBC are perpetual repeats such as Larry Kudlow praising Bush for tax cuts, hand picking selective data and pointing out how awesome it is to have had those tax cuts and of course, any month now the Dow will break 12,000 (he’s been saying that for the past 5 years!).

Oddly enough, I could repost a copy of this exact post a year from now and it’ll likely be the exact same thing on CNBC. That’s kind of what makes it so funny.

As some of you know, I took out a 24k loan from my credit card at 0%.  The zero rate was only for 6 months so I took the money and placed it in a high yield CD earning 8%.  The gross profit on this transaction will be about about $1200.

The 0% rate runs out in December and I was planning on opening a new credit card account and transfer the balance to another 0% card but I recently received my credit card statement and lo and behold there more 0% checks to extend it another 6 months.

I’ll hold off on opening a new account and hold off using the checks until late October or early November but this “generosity” from the credit card bank got me thinking as to why they do it.

The common wisdom is that banks offer 0% as a teaser and simply wait for you to default so they can pop the rate to 25% or more but I’m not convinced this is the whole story.

Banks have sophisticated credit models to know how likely a person is to default on their credit.  With me, personally, I have been doing business with this particular bank for years and have NEVER been late nor will I ever be.  This partially explains why they have given me higher and higher credit limits.

My suspicion is that banks KNOW that a certain number of their customers are doing Arbitrage deals and THEY benefit more from it than we do.  How?

With the advent of “fractional reserve banking” bank can lend out 90-99% of the money in their accounts out as loans.

So let’s take a look at how my particular transaction would work:

Credit Card lends me $25,000 at 0% (they know I’ll pay them back so it’s relatively risk free)

I take $25,000 and deposit it at Emigrant earning 5.15% (I earn ~ $1300)

Emigrant takes $25,000 in as a deposit and can lend out $25,000 at say 10% interest (more credit card loans) and accumulates $25,000 in interest from those loans.

This turns into a win-win for banks.  On the one hand, they have the potential to earn 25%+ interest on a credit card loan of 25k if I default and on the other hand, they have the ability to lend out 10 times the amount it has on deposits courtesy of my deposit.

It seems to me that banks can truly optimize their returns and profit if they can find people like me that will arbitrage their own money back into their accounts.  We’ll see which one does it first.

I hope everyone enjoyed this weeks book review. I’ll try to do another one in six months time after I read some additional books that have been recommended by readers and other bloggers.

Getting back to Exchange Traded Funds Covered Call transaction, I ran a report to see where the “action” was heading into October 2006. As of Friday, I came up with the following opportunities:
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GDX and the 35 Strike (GDXJI symbol) is currently selling at $1.40 which (if bought late today or opening on Monday) at $34.85 and sold the 35 strike October options could return 4% return (sans commissions) on investment in less than 30 days! Do that 12 times a year and you’re looking at 48% return!

Gold, however, has been experiencing quite some volatility so it ultimately depends on where you think gold and gold mining companies will be heading in the future.

FXI (China 25 ETF) comes in returning 2.11% which isn’t too shabby but the price might leave you with some stick shock since FXI is trading at $80.70. This too has been volatile so be careful!

It’s amazing to think that it has almost been 10 years since I picked up my first “finance” book.   I tend to keep all my finance books and last night I glanced at the first one I had purchased; it was a book named The Truth About Money by Ric Edelman published in 1996.  Ric Edelman subsequently came out with a new book (after tax law changes) called The New Rules of Money a couple of years later.  I picked up that book too.  Note: There are now 2nd and 3rd edition of The Truth About Money.  This review is about the original published in 1996.

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I’m reviewing both of these books today from a historical perspective.  From 1995 through 1998, the stock market was booming.  It’s funny to read Ric talk about 20% returns being common for equities and U.S. Treasuring paying a “paltry” 6.5%!   Funny how today we WISH U.S. Treasuries were paying 6.5% and only dream of 20% average equity returns!

It’s also interesting to note how global events really can make a difference.  From $60-$80/barrel oil to 9/11 to Enron scandals, the markets have taken hits and yet they manage to hang on.

Both books contain Ric’s “Rules of Money” which often provide useful ideas, sometimes contrary to popular dogma (Ric doesn’t like index funds) and at other times fairly basic and common sense advice (spend less than you earn).

Ric Edelman also dislikes the Roth IRA (or at least he did when these books were written) for various tax implication reasons that may or may not apply to the average investor.

As a finance/investor novice in 1996, I thought Ric’s advise was gold but now I believe it to be more like silver -still valuable but there’s better out there.

I don’t recommend you go out and buy these books but its fun to re-read books that were written during an equities boom period and the assumptions and advice they give during these times. I glanced at Amazon’s reviews to see how people were ratings the book and people either love it or hate it.

Of course, Ric now has some new books one of which is called What to do now written after the dot com meltdown and 9/11 attacks.  I haven’t picked that up but the Amazon reviews have the ratings as “hated it” or “loved it.”  No doubt, Ric Edelman is a controversial financial advisor but I’m beyond the advice he doles out in his books at this point.

While not exactly a finance strategy or tactics book, Atlas Shrugged by Ayn Rand is a MUST read book for all investors. The book was written over 40 years ago but I continue to see parallels of her fictional world and our real world today.

Who is John Galt?

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Essentially, the book is fictional account of various entrepreneurial capitalist characters who find themselves being swallowed whole by a global socialist movement. In the text, the socialist movement begins in foreign countries with various announcements that various industries (mining, transportation, etc) have been nationalized by newly elected socialist governments. If this sounds familiar in our real world you might recall Bolivia recently nationalizing their gas industry, Mexico nationalizing the oil industry and Venezuela threatening to nationalize just about everything. In the book, the United States becomes the last bastion of free enterprise and capitalism in the world but it too slowly begins to slide towards the socialist doctrine with citizens demanding more and more social services often at the expense of business. Sound familiar?

I won’t give any more of the book away because there are interesting twists and turns but the first page of the book contains the infamous phrase, “Who is John Galt?” This question is at the core of the book and if you understand the answer then you’ll understand Ayn’s perspective of the world.

Side note: I understand this book is now under production by LionsGate. Rumors have it that Angelina Jolie will play the main character (Dagny).

After the dot com crash, many friends gave up on the market and resided to either move their money into cash or invest in highly conservative mutual funds. Not happy with either of those choices, despite losing some money in the crash of WorldCom, I decided to invest in a little investment education. I purchased various books only to be greatly disappointed.

I finally stumbled upon a book named Covered Calls & Naked Puts by Ronald Groenke. I was captivated by the nature of the investment strategy and a bold statement the author makes in the book,

“You make money SELLING stocks not holding them.”

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That sentence has stuck in my mind for the past two years and changed my whole philosophical outlook on investing. The book is essentially written as a story about an older couple that is running out of cash during their retirement years. Eager to find a new way to create cash flow, the main character, Jake, meets up with an old finance professor who has been phenomenally successful in investing. Jake asks the professor to teach him how to make money off of the stocks he owns the way the professor has been doing so successfully over the years.

The next few chapters are dedicated to “teaching” Jake how making money from stocks by using Covered Calls is a very conservative way to generate cash flow from existing investments.

The book is easy to read and can be done so in a long sitting. What I really like about this book is that you will learn something new the second and third time you read it.

I have taken what the professor “taught” Jake and expanded it to focus strictly on Exchange Traded Funds. It is primarily because of this book and the lack of information it contains out in the financial blog world that I decided to start this blog!

Needless to say, I HIGHLY recommend this book as an eye opener into the world of covered call transactions and the methods for creating cash flow from stocks you may already own.

A friend picked up Ray Lucia’s Buckets of Money at a seminar he gave a year or so ago and passed it on to me. I enjoyed reading the book but my first and immediate impression as I began to read it was that it was geared toward “older folks” who had already accumulated a sizeable nest egg and were closer to retirement (late 40’s and older).

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This book doesn’t offer advice on how to get your nest egg up to 300k nor does it have any “system” for stock picking or advice on trading nor does it tell you to “skip the latte” every morning; it is a strategy book on what to do with the nest egg you’ve already built up.

The strategy is fairly simple and straight forward. Ray advices the creation of three “buckets of money” to secure your financial future.

Bucket 1 contains money you need for on going expenses today
Bucket 2 contains money you will need in the immediate future once Bucket 1 runs out
Bucket 3 contains money you will need later in life (preferably retirement)

The strategy takes advantage of the time value of money and growth for Buckets 2 and 3.

I’ll break down an example of how I think the mechanics of this would work.

Say you need $2000/month to live on during your retirement years. In Bucket 1 you would put 24k into a money market account from which you will draw 2k for monthly expenses. You now know that this bucket will only last a year before it empties.

Meanwhile, in Bucket 2, you have 100k or so in a conservatively safe income producing investment. Whether high dividend yield fixed income securities of income funds and bonds, you keep the money safe but growing.

While Bucket 2 grows income, Bucket 3 is a little more aggressive and should yield higher returns and growth. Because the window for using Bucket 3 is far away, any “shocks” to the money bucket because of downturn in markets will be offset by the longer time horizon.

The mechanics are simple, as Bucket 1 empties; siphon another 24k from Bucket 2. This process repeats until Bucket 2 is empty at which point you draw funds from Bucket 3 and pour into Bucket 2 which then funds Bucket 1.

It is a simple effective way to manage your money. The only problem with this book is that is makes many assumptions such as:

  1. You have a large reserve of funds (300k +)
  2. You are an older individual close to retirement
  3. You will have fixed monthly expenditures

I’d love to see Ray Lucia come out with a book that focuses on the younger generation and longer time horizons but the book is a good read and I’d recommend it to everyone who would like to see effective long term financial planning theories and ideas from a veteran investor.

As my financial wealth has continued to grow, I’ve become increasingly concerned about keeping that wealth. Warren Buffets two rules of investing are

1. Don’t lose money
2. See Rule #1

I can across a well written and highly recommended book regarding asset protection called Asset Protection : Concepts and Strategies for Protecting Your Wealth written by Jay Adkisson and Christopher M. Riser.
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The book debunks many myths and provides some interesting examples at how creating complicated and extravagant “in your face” offshore trusts or other asset protection schemes can backfire and turn a simple civil case into a criminal case with jail time.

There are many practical things a person can do to limit their liability and properly and legally protect their assets. The author points out that the most obvious asset protections are generally the best and safest. Adkisson recommends a layered approach to asset protection and while I can’t cover every aspect of his strategy here, I think some of them distill down to the following:

While laws vary state to state, the right state can help protection many of your assets under existing laws:

States like Texas & Florida have generous homestead and property exemptions. If I’m not mistaken, Traditional IRA & Roth IRA (up to 1 million), 401k Plans (unlimited), Homestead (certain limits and restrictions) are exempt from lawsuits (except divorce) in Texas and Florida. State laws and exemptions offer the first layer of protection.

The second layer of protection is proper insurance. Often, an umbrella policy with one or two million coverage can be purchased for a few hundred dollars. Complicated offshore trusts and other schemes usually recommend cancellation of insurance coverage but his is a big no-no according to Adkisson.

The third layer of protection is one afforded to everyone: Bankruptcy. While usually a last resort, this does offer protection of some of your assets and can help unload heavy financial burdens placed on you.

The fourth layer of protection comes into play as subtle yet practical and innocent creation of Limited Liability Corporations and Trusts. The key in creating these is ensuring that their creation serves multiple legitimate purposes rather than just “to keep money away from US judges.” Legitimate uses include creation of family protection trusts, tax shelters, business protection amongst other things.

There are other facets in the book that make it an interesting read. There is a section dedicated to the whole “morality” of using any of these asset protection schemes and how they may be technically legal, they may be ethically and morally wrong.

I highly recommend this book anyone interested in protecting their wealth. Recent bankruptcy laws aren’t included in the book so be on the look out for an updated version and keep that in mind if ordering this book.

A few times out of the year, various financial advisors, radio and TV personalities, and such will host seminars at key cities to sell their wares or offer advice. I often attend seminars whenever I can to see what the current trends are and advice being doled out to the public.

A couple of years ago, I attended one of these shows with the intent of seeing a segment that began at noon. It was an all day affair and I arrived early morning, around 8:30 a.m, to watch the presenters. I don’t recall the exact name of the company or presenter but he was touting “Asset Protection Legal Kits” to attendees. The “kit” was essentially some legal forms to help individuals create LLC’s and other trusts to protect assets from lawsuits and the government. Part of the strategy was to create an LLC and wrap that inside some Family Limited Partnership and blend together with some offshore magic. The sales pitch was slick and I was tempted (for about 3 seconds) to buy the kit which was selling for about $4000.

At the end of the show, the announcer calls out that the first 50 or so customers would receive some free goodies and a discount to sweeten the deal. A wave of people ran to the back of the room to pickup their “kits” and free goodies.
I passed on the kit and as I waited for the next segment to start, I got a call on my cell that my kid was sick and I needed to pick up some medicine so I left the event. It was a two day event with the same show repeating on Sunday so the next day, I headed in a little later 10:30 ish to see the second segment that I missed the previous day. Lo and behold, the same “special” for the legal kit was happening but I noticed a funny thing…. the SAME people that ran to the back to take advantage of the “deal” on Saturday were the same people running to the back on Sunday!

I decided to do a little research on the internet to find out more about the whole asset protection concept and the “kit” and, as I suspected, it was nothing more than a gimmick. An expensive gimmick none the less!

After some more real asset protecion research I came across a really good book regarding asset protection. It was recommended by various experts and the legal/finance web community.

This week, I’ll be providing a brief review of some of the best financial books I’ve read and recommend. You won’t be seeing any “don’t buy Starbucks every morning” or “spend less than you earn” books here; these books will focus on things beyond Finance 101 – they are tactical and strategic finance books that will help you undestand some interesting elements about finance.