Dear (Investment) Diary

Dear Diary: What I write down is important!

In addition to things covered in recent blog postings relating to planning to improve your investment returns, there's also another thing you can do.

And that is to keep an investment diary - what you bought, when, and why (most important is why, since your statements will tell you the what and when). Write down a bit about what attracted you to that stock/ETF/investment, and what your "exit point" is. There's almost always an "exit point", even for the most conservative investments - perhaps it's when/if the yield falls below a certain level. If you're a more active trader and trade in small cap stocks, then you are probably looking for a certain pe ratio to be achieved ... write it down.

Review your writing occasionally. This will help you to stay the course where needed, or to remember where you thought was a good point to get out (before you got all those huge gains and got married to the stock!). It can help foster a better perspective.

In addition, it can help simply to write down when you are thinking of changing your portfolio, and getting your thoughts straight before doing anything drastic. This definitely helped me in the days and weeks following hurricane Katrina, when I initially felt the economic effects might be much worse than originally envisioned.

Finally, it can also help in your annual review of what you did right and can get even better at, and what you need to mitigate - you'll have a record that you can peruse with detachment on your thoughts and worries of the day.

One last thing we'll cover later before moving onto another topic is: "scrapbooking". More later ...

JW

The Confused Capitalist

Lift Your Investment Returns

In addition to the planning items I've recently discussed in the last two postings, there's also another way to raise your investment returns.

And that is done by analyzing what you have done with your portfolio over the past while, perhaps a year or so. Because if you stop to look and think about your various trades, you'll probably be able to glean some insights into your own investment personality.

For instance, you might find that you are drawn to the latest and greatest growth story, something that was discussed in the fascinating research paper, The Seven Sins of Fund Management as Sin Number Six, or you might be more subject to Sin Number Five. Whatever; the point is that if this particular investing flaw is causing you to have a lower than potentially possible return, then you need to do something about it. And that can only be possible by realizing you are doing it, looking at it, seeing it, and hopefully choosing a strategy in the future that allows you to minimize its effects.

On the other side of the coin, analyzing your pattern of trading and investing also allows you the opportunity to exploit your strengths to even greater advantage. You might find that you are doing one thing particularly well, that is adding some dollars to your investing each year. If you realize it, you might be able to figure out a way to take even greater advantage of it.

In an analysis of my own investing over the past year or so - done by looking at all my trades - I came to certain conclusions, some of which are as follows:

Right things:

• I accurately over-weighted my portfolio when I found a cheaply-priced (ie low pe) fast-earnings growing stock (but I could have done this even more, I see in hindsight);
• I accurately purchased additional position, when I saw a stock
  suffering from a temporary weaknesses.
  

On the other side of the field, some of my bad habits were:

• Bought too many micro-cap "story's", that lacked adequate net earnings and these returns impaired my overall return (and also increased my propensity to trade often);
• Bought some expensive (ie high pe) fast-earnings growing stocks, and that also impaired my returns.

The point here is that I've looked at both things I done right, and mistakes I've made in a considered way. In the future this should allow me to do, respectively, more of the first, and less of the second. Thus improving my overall investment returns. If you do the same, you'll see certain things you have done, or habits you have, that become more obvious to you. This allows you insight into your investing style and worries - thus providing you with the opportunity to raise your future investment returns by modifying your behavior.

A little more on this topic later ...

JW

The Confused Capitalist

Planning for Emotional Control

We all have emotions - which is great in our personal lives, but doesn't help that much in our investment lives.

In fact, many great investors have stated that being in control of one's own emotions allows one to tread where others fear to go, and to fear to tread the well-worn path. What this means is that the best returns are generally earned when no one is considering that sector/company or timing (due to a recession, for instance), while returns earned when everyone is on the bandwagon, are typically only fair, and often poor.

Fidelity reportedly did an analysis on their then flagship "Magellan" mutual fund, and found that the average investor in the fund typically did much worse than the fund itself. Why? Timing, they found - investors piled more money in after a period of strong returns, and tended to pull more out after a period of weak returns.

So we as investors want to avoid the same fate. One way to do so is through planning. Make a plan to start the year and follow it. Write down what could cause you to want to deviate from that plan. Then when you are tempted to change your investment strategy, go and review your plan to see if you'd already predicted that could happen. For instance, bearing in mind my own plan for the year (see prior post) and my own personality, I considered that these items could possibly derail my attempts to follow my strategy:

1. The volatility of my leveraged investments might worry me - so just ignore them and remember that volatility is the order of the day with this investment type;
2. Ensure that I have enough money to continue to invest in my small cap stocks - I really enjoy investing in this area, and if I completely exited it, I know I'd get "itchy feet" with my other investments;
3. Trust that the investments based on the "value screens" of others will produce worthwhile long-term results - just as they have in the past;
4. Avoid excessive diversification, bearing in mind that superior investment results usually come from a focused portfolio.

If you read between the lines, you can see that a number of my reminders have to do with the characteristic of impatience. If I can control that within myself, this will personally make me a better investor.

The point here is that we all have our weak points, and if we recognize them, write them down, they hold less power over us. Your weak point as an investor might be the same as mine, or it might be different. As Sun Tzu is reported to have said in The Art of War:

If you know neither the enemy nor yourself, you will lose every battle, if you know yourself or the enemy you may win some battles and lose some, but if you know both yourself and the enemy, you will win every battle.

At least improve your investment "battle" chances by knowing yourself.

JW

The Confused Capitalist

Prepare a Battle (Investing) Plan

As I'd mentioned in my last posting, preparing even a basic investing plan can help to improve your results. Of course, this involves some thought and preparation of what type of investor you are, your age and tolerance for risk, and what you consider acceptable results over time. All of these will have some impact on the type of investments you would like to own.

Generally, the younger you are and longer your investment horizon, the more risk you can be willing to accept. This means that if you're age 30 or below, you should generally be looking to be fully invested in the stock market at most times.

Conversely, if you're 60+, you're probably going to be looking at owning some more conservative investments, including high-yielding stocks, and perhaps some bonds of various profiles. Whatever ... the point is that you spend some time thinking about where you are in your investment life, what keeps you awake at night, and how you think you can best achieve your goals, all things considered.

For instance, my plan this year was a five-pronged strategy and included:

1. Significant exposure to a few select emerging markets through ETFs,
2. A number of leveraged stocks (similar to the types I've written about recently),
3. Continued exposure to the oil and gas theme,
4. An allowance to buy some stocks based on "value screens" produced by others and,
5. Plus an allowance to allow me to continue investing in my favorite area - small cap stocks.

The point here is that I stopped to compare to what I did last year, consider the year ahead and what I think might be favorable themes going forward. While I might tinker with a variable here or there, at the end of the year, I think my themes will have been intact, and I can measure my results on that.

I also took one more step that I recommend for others - I wrote down what could mentally and emotionally go wrong with the plan - and if I have "reason" to consider wholesale changes against my plan, then I can go and read what I've already written about danger areas - thus probably comforting me to "stay the course". While my plan won't fit most other people (we're all unique individuals), doing a plan like this will! Good luck with yours ...

JW

The Confused Capitalist

Have a plan - you'll do better than without one.

Well, our team of four players plus numerous local add-ons eked out a 5-5 draw last night. Although most of the players didn't know each other very well, we all seemed to playing within a unified plan. And that seemed to be, that no one left our zone without being in clear control of the puck. So despite playing against a vastly superior team, we played pretty even against them, and nearly had the game won.

This is similar to investing too - writing down even the basic rudimentary elements of a plan can help you to keep your sense of direction in the face of uncertain markets, and numerous "great ideas" (ie new stocks, which you simply "must buy", today!). Furthermore, analyzing your results against your plan periodically (every year or so), can help you improve on areas you did well, and shore up your weak areas. I'll be discussing this more in the future.

By the way - an unheralded near spiritual event occurred for me - I scored three goals! (If only one of them hadn't been on my own goalie!). Bye for now.

JW

The Confused Capitalist

Off to a hockey tournament - back on Monday!

Well, I'm off this weekend to play in an out-of town 40+ old-timers hockey tournament, and I therefore won't be updating my blog this weekend.


Send a good thought my way so that I may make my Chris Chelios-like moves on defence. We're nearly the same age, and I think I play the same high skilled and rugged style, but I couldn't quite make the Olympic team like "Chelly".

Anyway, here's a picture of me deking and making my way with skill and panache across the blue line ...


JW

The Confused Capitalist

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Who is The Confused Capitalist

Why do I call this site “The Confused Capitalist”?

First of all, because I thought it was a catchy title and one that’s relatively easy to remember. It’s certainly not because I’m confused about the massive positive roll that capitalism plays in the world today. I kind of think about it like my grandmother (who escaped the grips of communist Russia, back in the 1920s) once told me, “Capitalism is the worst system in the world, except for all the others”.

What she was saying was while capitalism has its’ flaws, it actually works better than all the other economic systems that have been devised to date. However, unbridled capitalism, without some consideration of social equality is, in my opinion, doomed to failure. We all need to consider others, to help “raise the median”, and the most primary way to do this is through payment of our taxes, so that we can help educate our youngsters and keep them out of trouble, aid our older folks, protect our citizens and, also, try to rehabilitate those fail us.

Unbridled capitalism, without some consideration of others through taxes, simply becomes selfish greed. And given the demonstrable benefits of living in a society based on cooperation, I imagine that a society based solely on selfish greed isn’t a place most of us would like to live. So perhaps we shouldn’t moan about paying our taxes quite so much, or so often.

Here’s what a famous Republican had to say about taxes:

“I like to pay taxes. With them I buy civilization.”

- Oliver Wendell Holmes, Jr.

Besides, let’s face it – most of us occupy an enviable position in the world – three-quarters of the worlds’ population would undoubtedly trade places with us in a heartbeat.

That’s my point of view – what’s yours?

JW

The Confused Capitalist

Things have never been better!

Isn’t it the greatest time ever to be a small investor!!? Decades ago, the game was rigged against the small investor, it seemed.

An investor wanting to plunge into the stock market was plagued by high trading costs, and limited portfolio diversification. The game was geared to the “big boys”, it seemed, with their ability to withstand the relatively high fixed portion of the trading costs, and their financial ability to be able to buy a wide enough slice of the stock market to avoid having one or two company’s nasty surprises nearly destroy a lifetime of savings.

Now however, we’ve got internet-based trading to lower your trading costs, a huge variety of regular mutual funds whose costs of ownership have been generally falling over the past few years, index funds, ETFs of growing varieties so you can slice and dice your portfolio any which way, enhanced index funds so you can take advantage of new ways to passively "beat the index", hedge funds - once the domain of the uber-wealthy - some with minimum investments of only $2,500, levered mutual funds - both bear and bull funds, fractional share purchase and sale at nominal cost, the free flow of information such as SEC filings available over the internet, great market newsletters and commentary, stock screens and finance sites to help to help you make better investment decisions. And of course, we have a plethora of blogs – like mine – to add a little spice and help you make some sense of it all.

In short, the list of significant market improvements for the small investor goes on and on.

I think it’s just the greatest time ever to be a small investor – don’t you?


JW

The Confused Capitalist

Augment your returns with levered stocks and investments

There's more than one way to enhance your long-term investment results than borrowing money from the bank to buy stocks as I've written favorably about recently. There's also some opportunity - at least here in Canada - to buy stocks or investments which THEMSELVES are levered on an underlying company or index.

They therefore magnify the potential gains (but also losses too) that can be had compared to the underlying stock or index. For instance, Scotia Managed Companies offer a number of "split share" companies that use another index or company to magnify the returns. Some of the ones they offer include one which uses the S&P500 Health Index as its basis, but it offers leverage at a 3.22 factor against the underlying index. Which wouldn't have been good for your portfolio over the past several years, as that index slid, and the sliding has been magnified by this leverage factor.

On the other hand, they also offered split shares on the TSX 60 benchmark - which would have been fabulous for your portfolio recently, given the 1.79 factor leverage on an index that's been on fire the past few years. They also offer narrow (company specific) or more broadly based split shares, such as ones that highlight the Canadian banks or banking sector, life insurance companies, utility companies, as well as other sectors. There's also the shares that lever on the trophy property and asset manager, Brookfield Asset Management company through BNN Investments at about 3x leverage.

One thing I like about many of the levered investments discussed here, is that they are on staid, conservative companies. In this way, I can get some of the returns offered by smaller companies, but without so many of the risks inherent in them.

Finally, there's even mutual funds offered by Horizon Beta Pro Funds that offer 2x upward OR downward leverage.

For more on the whole split share structure, go and read this article by the Money Sense people. For an investor with a long enough time horizon to ignore the inherent volatility in this type of investment, I say definitely take a look at these types of investments.

JW

PS If anyone knows of any levered US market investments please drop a comment here, or send me an email. I'll pass it on.

The Confused Capitalist

Fear is Your Friend: Embrace It!

The other day I entitled an article “Fear: an Investors Biggest Friend & Worst Enemy” and it occurred to me that I’d said why it was an enemy, but didn’t say why it was a friend. The reason is, if you learn to use your fear – which generally occurs after an extended market decline – as a contra-indicator.

In other words, you recognize the fear, but also recognize that a market decline generally represents an excellent opportunity to increase your long-term rate of return. I’d read that an analysis determined that if you added 10% to your stock portfolio after every 20% market decline (an opportunity that admittedly doesn’t happen very often), that you would increase your overall rate of return by 2% annually.

While 2% doesn’t sound like a lot, it has large implications over a long investment horizon. For instance, if you think your return rate is likely to mirror the long-term average of the stock market (large stocks: 10% or so), then increasing your return by 2% annually means this over a 25 year period:

Instead of a $100,000 portfolio being worth under $1.1 million in 25 years, it is instead worth over $1.7 million. What a huge difference when using fear to your advantage.

So this is how to turn fear to your advantage – by using the Warren Buffett saying … “We seek to be greedy when others are fearful, and fearful when others are greedy.”

Fear – your best friend.


JW

The Confused Capitalist

Magic Formula Investing

Some people may have noticed the "Magic Formula" investing link on the right-hand side of my blog and wondered what that was all about. Well, the so-called "Magic Formula" is Joel Greenblatt's attempt to show two very basic key elements for outperforming the market.

Joel Greenblatt ran Gotham Capital for many years, producing a phenomenal 40% annual return. He has also written two books, the latest of which is the companion explanation to the "Magic Formula" investing site (although you don't have to read the book to benefit from the site). In short, he's a man with very serious credentials and practical experience. The stocks his "Magic Formula" picks ares ones that, in the aggregate, are able to outperform the market because they display two key attributes, which are:

• They have demonstrated that they have earned a very high return on their capital, and
• They are cheaply priced (by the inverse of the pe ratio, called the earnings dividend [this is quite different from a dividend yield]).

Back-testing by Professor Greenblatt (yes, he also teaches now, out of Columbia University) has shown a 30% annualized rate of return over the past few decades using the "Magic Formula."

I think that any value investor would recognize the aforementioned attributes as clearly offering potential for great investment returns, and Mr. Greenblatt's research confirms it. The link takes you to a screen that automatically generates the best of these prospects, depending upon certain parameters you enter. I highly recommend this site as a place either to invest on what I might call the Magic Formula "Index", or to use these as leads to uncover potentially lucrative stock prospects.

One more word about Mr. Greenblatt - he has invested his own money to "raise the median" in the New York public school system - a man after my own heart. Read the very fascinating story and the tremendous results he has achieved with the relatively small investment of $1,000 per student per year. We salute Mr. Greenblatt's attempts to "raise the median", both socially and economically!

Magic Formula - check it out ...

JW

The Confused Capitalist

Levered Stocks - Aye, Volatility Ahead Captain!

There's also a different type of leverage than simply going out and borrowing money to invest in the market, like I've written (favorably) about recently. There's also the ability to buy a number of stocks and mutual funds whose returns are geared to, or levered on, a particular underlying stock, or index.

However, since they are "geared", that means they'll experience more rapid increases and decreases as that particular stock/index burps and belches over time. Which can be darned uncomfortable to watch during a market "correction", since the changes are magnified. However, on the other side of the coin, when the market is moving these stocks or indexes upward, it adds a wonderful upward profile onto your portfolio. But if you don't sleep well in "stormy seas", then this type of investment isn't for you.

However, if you can live comfortably with the underlying volatility and are reasonably confident that you aren't entering the market at a high valuation point, and have a long enough investment horizon, then these levered or geared investments can get you a better return - get you to where your going sooner. Later, we'll look at a few of these levered investments ...

JW

The Confused Capitalist

Fear: An Investors Biggest Friend & Worst Enemy

Although I've laid out a very conservative and creditable plan for using leverage (see the Leverage Series, just completed) to help an older couple with poor retirement prospects significantly improve their future, many people will see the same plan and completely pass it by.

Why? The reason is usually fear. However, many people won't admit to that; they'll talk about the market at a peak (although they might know very little about the market), or use some other justification to avoid changing their situation. Many great investors have said that managing one's own emotions is the largest hurdle to becoming a successful long-term investor.

In this way, you can avoid selling when "the market" has declined in value (and in fact look to BUY at that time), and not panic and sell your own investments (or "rebalance" from a position of emotional weaknesses) during a market downturn. Managing your own emotions also allows you to avoid chasing a hot market or sector, as many people did (like I did, too!) during the NASDAQ rocket ride in 1999 - only to be shortly followed by the crash thereafter.

Being emotionally balanced and remaining committed to the long-term, despite the markets burps and belches, is the best way to have the success in the long run.

JW

The Confused Capitalist

Financial Leverage: $3.06 Opportunity missed?

So, we have a relatively diversified portfolio for our pre-retirement couple, that should spin off a very nice cash-flow in just a few years.

Now, the thought has been brought up that maybe some people don't like certain sectors or companies (tobacco is a frequent mention in this regard), and they'd prefer not to have them in this leveraged dividend portfolio. Certainly, with some of the yields available today, there's the opportunity to have the portfolio with somewhat of a different profile. For instance, some folks (including me), like the valuations in the banking sector and think it offers above-average potential for long-term gain in comparison to some of the selected companies.

For those people, you might lean away from one sector or company you didn't like, and lean a bit more towards those you did - bearing in mind that you're intending to create long-term value with positive cash-flow as soon as practical (bearing in mind the safety consideration of the portfolio). The thing here is that everybody's ice-cream can be flavored a little bit differently, depending upon their age and individual investment goals and profile.

The other important thing is NOT to sit on your hands forever - right now, mortgages have a fairly attractive interest rate to use for the leverage, and many stocks currently offer pretty decent dividend yields in relation to their stock price. I don't think this situation is going to last forever - I think some of these stocks are going to increase in value (thus lowering the dividend yield), and it's almost certain that the cost of the leverage (mortgages) is going to increase.

It's much harder for those with modest incomes with little ability to service negative cash-flow to make these number work if the average dividend yield drops to 3.5% and mortgage rates increase to 7.5%.

Sometimes opportunity must be seized quickly ... it seems to be one of those times.

JW

The Confused Capitalist

Financial Leverage: $3.05 Diversification

An important safety component in any portfolio is based upon diversification. That means NOT buying companies that are all in just one sector or industry. This protects a portfolio against a dramatic cyclical decline based on one industry or sector weakening over time. Against that, hopefully other companies or sectors held within our portfolio will be experiencing an asendancy in their fortunes.

In short, diversifying sufficiently protects our portfolio, provides possible enhancement of returns, and best of all - allows us to sleep well at night.

Let's consider this portfolio. While it lacks some components of diversification (such as smaller companies, foreign companies, and emerging market companies) the large companies are well-suited to having the probability of providing a steady stream of dividend income to us - a very important consideration. So we are mainly looking to see that we haven't inadvertently selected companies in just one market sector. So let's look at them:

1. ATT - Telecom
2. Altria - Tobacco / Food
3. Bristol Meyers Squib - Pharmacueticals
4. Conagra - Foods
5. Progress Energy - Utilities
6. Reynolds American - Tobacco
7. Sara Lee - Foods
8. Southern - Utilities
9. UST - Tobacco
10. Verizon - Telecom
11. Bank of America - Bank/Financial
12. Citigroup - Bank/Financial

Although we can see some concentration, particularly in tobacco, most of these companies are in areas where there has traditionally been good dividend yields available, especially tobacco, banks, utilities, and telecoms. In general, given our insistence of a high dividend yield and the safety of large companies, this portfolio has fairly good diversification.

The point is here, that it's currently possible to construct a conservative portfolio that's initially close to cash-flow positive, after borrowing all the money to buy that portfolio. I'll talk about some other possibilities later ...

JW

The Confused Capitalist

Financial Leverage: $3.04 - value of stocks & cash flow

So our 50 year old couple are anticipated to have a positive cash-flow after a few years, reaching over $91,000 annually, by age 80. In addition to this rather nice supplement to their living income, the value of the stocks they purchased should also be increasing.

Over the past 10 years or so, the average total annual return on the 12 stocks we picked for them increased by about 10% annually. However, about half of that was being received in annual dividends, meaning that the value (or cost) of the stocks was inflating by about 5% per year.

While this might seem small, remember that we wanted them to have an adequate cash-flow for living expenses, and some nice extras in their retirement years, rather than having to scrimp and worry.

Using the 5% projected annual increase in value then, the expected value of this initial $200,000 stock portfolio is:

1. In 10 years: $325,000
2. In 20 years: $530,000
3. In 30 years: $864,000

and our positive annual cash-flow is projected as:

1. In 10 years: $5,957
2. In 20 years: $28,728
   
3. In 30 years: $91,376 (loan payment has expired)
   

So not only do the dividends pay well, but the increasing base value of the portfolio means that they are offered some protection against inflation for their income component, plus they may have the opportunity to pass this on through their estate to loved ones, or favorite causes.

And again, this was all because they took a fairly modest risk at this time, using some leverage to buy a high yielding stock portfolio. We'll later examine this portfolio to see if it meets some basic criteria for diversification.

JW

The Confused Capitalist

Financial Leverage: $3.03 - situation overview

Financial leverage continued ...

Our couple: 50 years old, limited savings, poor retirement prospects, so did equity take-out of $200,000 from their house, additional loan payments of $1,199 monthly, intend to invest in dividend paying "Widow and Orphans" stocks, which are projected to have a small negative cash-flow for a few years, but are expected to become cash-flow positive in the sixth year and by their 70th birthday, is anticipated to be providing around $28,728 annually in positive cash flow.

We found them 12 large NYSE-listed companies. Not only does it seem likely that the dividend will cover the mortgage payment in a few years and continue to increase thereafter, there's also the prospect that at some point the mortgage will be fully paid off. In addition, we've got to consider that it's quite likely that the value of these stock holdings will be increased in the future.

We'll take a look at what those values are likely to be ...

JW
The Confused Capitalist

Financial Leverage: $3.02 - the actual portfolio

Financial leverage continued ...

So we have our 50 year old couple, limited savings, poor retirement prospects, so did equity take-out of $200,000 from their house, additional loan payments of $1,199 monthly, intend to invest in dividend paying "Widow and Orphans" stocks, which are projected to have a small negative cash-flow for a few years, but are expected to become cash-flow positive in the sixth year and by their 70th birthday, is anticipated to be providing around $28,728 annually in positive cash flow. Here are the 12 NYSE-listed companies that were selected from the newspaper and met a few other criteria and, as you can see, there are some large companies included such as Citigroup and ATT, amongst others .... (scroll way down, I'm having some trouble formatting this puppy!)

Company	Symbol	Yield	Annual Yield Growth
ATT	T	4.70%	6.70%
ALTRIA	MO	4.40%	9.50%
BRISTOL MEYERS SQUIB	BMY	4.90%	0.00%
CONAGRA	CAG	5.20%	4.60%
PROGRESS ENERGY	PGN	5.40%	2.70%
REYNOLDS AMERICAN	RAI	4.80%	6.20%
SARA LEE	SLE	4.40%	7.60%
SOUTHERN	SO	4.40%	2.50%
UST	UST	5.70%	4.60%
VERIZON	VZ	4.70%	1.00%
BANK OF AMERICA	BAC	4.50%	13.60%
CITIGROUP	C	4.20%	34.40%
AVERAGE		4.80%	7.80%

You can also see that they produce an average dividend yield of 4.8%, and that dividend has, on average, been growing by 7.8% annually. Later, we'll consider other aspects of these 12 stocks as a stand-alone portfolio.

JW

The Confused Capitalist

Leverage Edition: $3.01 - Do what you CAN afford

Financial leverage continued ....

50 year old couple, limited savings, poor retirement prospects, so did equity take-out of $200,000 from their house, additional loan payments of $1,199 monthly, intend to invest in dividend paying "Widow and Orphans" stocks, which have a small negative cash-flow for a few years, but is expected to become cash-flow positive in the sixth year and by their 70th birthday, is anticipated to be providing around $28,728 annually in positive cash flow.

Of course, your home might not be worth the same as those folks, or maybe you couldn't afford that amount of initial negative cash flow (averaging about $2,000 annually for the first five years [without considering the tax benefit of the deductibility of the mortgage interest]) - so you might be able to only afford a $50,000 equity take-out. In that instance, everything would simply be divided by four, but otherwise the example would remain the same.

On the other hand, you also might be starting out younger, and that allows much more time for everything to build up by retirement age.

Later we'll look at the specific companies I used in this current example.

JW

Leverage Edition: $2.01 - Escape Financial Jail

Financial Leverage Continued ...

50 year old couple, limited savings, poor retirement prospects, so did equity take-out of $200,000 from their house, additional loan payments of $1,199 monthly, intend to invest in dividend paying Widow and Orphans stocks.

So, carrying on, I was able to quickly go through the local paper, and find a number of large company names I recognized (Widow and Orphans Stocks), and looked for yields in the 4-6% range. Lower than that, it wouldn't provide enough immediate cash-flow to help pay the mortgage, and higher than that can indicate a smaller company, or a large one in trouble. And we want a reasonable amount of safety, so we're staying in that general range.

I was quickly able to find 15 stocks (just from an abbreviated list) that met those criteria, then I went over to Morningstar to look at the recent dividend payment history. I was looking to eliminate stocks which decreased their dividend payment compared to five years ago, and also whose total annual return (dividend payment plus change in the stock price) wasn't greater than 2%.

This left me with twelve big name stocks, who have an average market capitalization in excess of $50 Billion, with only one of those names below $10 Billion market capitalization. They produce an average current dividend yield of 4.8%. Not only that but, on average, those dividends had been increasing by 7.8% annually over the past few years.

So this offers the very distinct possibility that the dividend payments in the future will more than cover the increased mortgage payment of $1,199 monthly.

In fact, if we divide the $200,000 evenly in stock purchases among those 12 companies, we should recieve $9,600 annually in dividend payments for the first year, compared to our annual mortgage payment of $14,388 (12 x $1,199). So the first year, we'll have to cut our expenses and dig into our pockets to fund the difference of $4,788, or $400 monthly. However, there's also the matter of the tax write-off for the interest on the mortgage (about $12,000 is interest in the first year), which should help narrow that $400 monthly shortfall (talk to your accountant about the exact amount).

Since the recent history is that these companies increase their dividends on average by 7.8% annually, we can reasonably expect that we'll get a higher payment in the future. Using the 7.8% increase per year, by the third year we'd be getting $11,148 annually, and by year five, our dividends of $13,968 almost cover the mortgage payment. If these companies continue increasing their dividends just like they have in the recent past, then by year six we be getting a positive annual cash flow of about $672.

Fifteen years from when we took the loan out, at retirement age of 65, the positive cash flow (after the mortgage payment has been fully paid from the dividend) would be about $15,228 annually. This cash flow continues rising so that five years later, it should now be around $28,728 annually in positive cash flow. At the time we hit 80, the loan is then fully paid off, and our annual dividends are $91,368. SWEEEET!!

And all because you decided to fund a small shortfall for a few brief years - and managed both your risk and leverage wisely.

More later ...

JW

Leverage Edition: $1.01 - The Basic Plan

A little title humor there, folks!

Continuing on - 50 year old couple, bleak retirement prospects, but nice home, mostly paid for.

Well, WAS mostly paid for - now we approach the bank. Your current home value is $400,000, against which you've got a $100,000 existing mortgage - the bank agrees to a 30 year refinance of $300,000, at 6%, which would increase your current payments by $1,199 per month, which we can find out by using this Mortgage Calculator. Yiiiiiikes!

But let's see how we can make that extra $200,000 go to work for us, by the power of leverage. We are going to use that money to buy some Widow and Orphan Stocks that pays high dividends.

By going through my local newspaper, with its condensed stock listings of large companies listed on the NYSE, I can pull up a number of large company names that I recognize, where the dividend yield is above 4%.

If I can find enough of these companies, and ones that have generally increased their dividend payment over time, then I can - after a spell - get the mortgage to pay for itself. After a bit more time, I can start to get a positive cash flow, because the dividend payments become more than the loan payment, and after a while, I'll own a whole lot of stock that has increased in value, and is now loan free and spinning off even more in dividends.

More later ...

JW

The Power of Leverage: Find a Class 1 Lever

Financial Leverage can be truly awesome when used correctly in the proper balance between growth and safety. Too much of one is likely to impede current cash flow (growth costs money), while too much of the other (safety) won't produce an adequate financial return for the risk taken.

Let's say that you're a 50 year old couple, who is realizing with some alarm that you haven't put away enough for retirement. You've got a nice home, but that's about it. You're starting to think that things will be very bleak once you hit 65. Your pension will be minimal and your savings aren't currently much. It certainly doesn't look like you'll be able to go south for the winter, and you fear having to sell your home to finance current living expenses as you age. Not pretty.

But with a little bit of the right financial leverage, and just a bit of scrimping for five years, you can let leverage take care of those nasty retirement fears. Using current some current examples, we'll see how it's very possible to have a positive cash flow of almost $1,300 per month at age 65, and if you live to 80 - $7,614 per month (wow, what a bonanza!).

Next time

JW

Financial Leverage

Leverage: Fear and Enjoy!

Leverage: in the investment world, that's the ability to buy something with part equity (ie your cash), plus some portion financed. The portion or ratio financed is the leverage.

I recently read that seven out of ten millionaires achieved that status primarily through real estate. And the reason they were able to do so, was through the wise use of bank-provided (or equivalent) financing. Real estate is often loaned upon on a 3:1 basis of debt to equity. Very few other investments can be financed to this high a ratio.

However, leverage is also to be feared, since it can magnify investment losses. So if you choose to re-finance your home to invest it in the stock market, you have to be careful - careful both that your investment is conservative enough that your principal is protected over the longer term, but also careful that it's likely to grow in value (thus paying for the leverage).

Finally, you also have to have enough earning power - either through your own job OR through the investment itself, that you can afford the increased loan payments.

Leverage - a fabulous wealth creator - or a potential bankruptcy helper!

I'll be discussing leverage - and some different types of leverage - more in the future.

JW

Risk

A four letter word: Risk.

Risk is not volatility (beta) and it's not a lot of things that the academics ponder. In my mind there's two kinds of financial risk: the risk of permanent loss of capital, and the risk of returns insufficient to meet future expenses.

They are very different, and usually arise from two different places. Permanent loss of capital usually arises from chasing too high a return under too uncertain circumstances.

Insufficient return risk usually arises from a belief that complete safety of capital exists, and that capital can be completely guarded. This mindset usually results in achieving far too low a return, given the circumstances.

JW
The Confused Capitalist

My Viking Heritage

My Viking Heritage. My Mom says this looks a lot like me. Thanks Mom!

Opening Volley

Hi! I'm Jay Walker. I intend to write here mainly about improving performance in the stock market, with occasional musings on other subjects, which tangentially affect market performance.

I'm the author of The Brink's Truck Burst Open on Wall Street! A Holistic Approach to Finding the Easy Money in Common Stocks. which shows how a novice to average investor can outperform the market.

I hope you'll find this blog interesting, and profitable.

JW