Real Estate Property Investment Myth

I have heard a lot of my friends who believe by investing in real estate property make will them super rich.

Here’s their claims:
1. Properties prices will go up forever.
2. It gives them passive income.
3. In future they can sell it for higher prices and upgrade to a bigger house.

Let’s analyse how true those claims are.

1. Properties Prices Will Go Up Forever.

We have witness one of the greatest depression caused by the housing bubble in 2008 across countries in US and Europe. It happened in countries in south East Asia during the 1997-1998 Asia financial crises, during those times, people who bought those houses at the inflated prices, until today they are either in a loss position(negative equity) or manage to break even after the prices are slowly picking up. Prices might continue to go up, the question is how long will it take? 10 years? 20 years? Is it worth it?

2. It Gives Them Passive Income.
This is true if you have a second or more properties where it can fetch you good rental income.  And those rentals can be used to fund the housing loan, or give you additional money to spend. The reality is, if you need a bank loan to get a second property, you need to have good credit background. Or Else, you will have to find cash to fund your purchase. Also, you need to spend effort to manage your tenant and hope that they keep the house in good order. Else you need to spend extra money just for the maintenance when they move out.

3. Sell It For Higher Prices And Upgrade To A Bigger House.
If your plan is to sell the house at a higher price so you can use the profit to fund your purchase for a bigger house, you end up working for the bank because you will need to loan extra cash to pay for the bigger house!

Take the simple example below:

Small House = $200,000

Big House = $300,000

10 Years later, assume that prices gone up 50% for both houses.

Small House = $300,000

Big House = $450,000

$450,000 – $300,000 = $150,000 more needed to pay for the bigger house!

You will only make profit if you are downgrading to smaller house, and invest the profit to pay for your second property, and then use the rental income to pay for the mortgages. The question is, are you willing to downgrade?

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How To Invest Your Money?

How To Invest Your Money?

So we now know it is even more dangerous to save your money than investing it. Now let’s look at what are the potential returns you can get by investing in stocks of good companies.

Let’s look at the table below for comparison by having some assumptions:

  1. Buying the stocks for 20 years without selling it even during all the recessions.
  2. Exclude collecting dividends from the companies.

For simplicity, I am using the share prices of three of the biggest companies in the word:

  28th February 1992 (20 years ago) 27th February 2012 Average Annual Return % Total Return (%)
McDonald $10.12 $100.36 49.5% 991%
Exxon Mobil $14.28 $87.23 30.5% 610%
Wal-Mart $13.50 $58.46 21.6% 433%

As you can see, the average annual return is way ahead of inflation and saving interest rate! Who says money does not grow?

Can You Further Increase The Return?

Of course you can! If you pick up the right skills to get in and out of the stocks (good companies of course) during all the ups and downs of the stock market, you can magnify your return.

The trick is to leverage on the power of compounding return. The formula of compounding return is by continuous investing the total return with the profit year after year. Here’s how it works:

Let’s set our target at getting minimum 20% return every year with a $10 initial investment by utilizing the effect of compounding return, and see what happens after 20 years.

Year Investment Total Return
1 10 10 + (10 x 20 / 100) = 12
2 12 12 + (12 x 20 / 100) = 14.40
3 14.40 14.40 + (14.40 x 20 / 100) = 17.28
4 17.28 17.28 + (17.28 x 20 / 100) = 20.74
5 20.74 20.74 + (20.74 x 20 / 100) = 24.88
6 24.88 24.88 + (24.88x 20 / 100) = 29.86
7 29.86 29.86 + (29.86 x 20 / 100) = 35.83
8 35.83 35.83 + (35.83 x 20 / 100) = 43.00
9 43.00 43.00 + (43.00 x 20 / 100) = 51.60
10 51.60 51.60 + (51.60 x 20 / 100) = 61.92
11 61.92 61.92 + (61.92 x 20 / 100) = 74.30
12 74.30 74.30 + (74.30 x 20 / 100) = 89.16
13 89.16 89.16 + (89.16 x 20 / 100) = 106.99
14 106.99 106.99+ (106.99 x 20 / 100) = 128.39
15 128.39 128.39 + (128.39 x 20 / 100) = 154.07
16 154.07 154.07 + (154.07 x 20 / 100) = 184.88
17 184.88 184.88 + (184.88 x 20 / 100) = 221.86
18 221.86 221.86 + (221.86 x 20 / 100) = 266.23
19 266.23 266.23 + (266.23 x 20 / 100) = 319.48
20 319.48  

Average Annualized Return –> ($319.48 / $10 x 100 / 20 years) = 159.74%

Shock? That’s the amazing power of compounding effect.

What Are The Risks?

Yes there are risks, the maximum risk you will get is to lose all your money if you:

  • Invest your money with a lousy company.
  • Sell away your stocks during irrational market panic, remember, market will always go up eventually. Look at the historical performance of stock index if you do not believe me.

How Do I Achieve The Maximum Return?

The key learning here is to buy at the price when good companies are undervalue, sell at the price when the companies are overvalue.

There is no free lunch in this world. To invest successfully, continue to educate yourself to be financially literate. The learning process never stops.

Why Is It Important To Invest Your Money Than Saving it?

Why Is It Important To Invest Your Money Than Saving it?

For simple reason, it is important because you need to learn how to grow your money by beating inflation!

What Is inflation?

Simply put, inflation refers to the increase of prices of everything that you buy over a period of time. For example, 40 years ago your grandparents pay $2 dollar for a pair of movie tickets. Guess how much it costs you now? $8 dollars? That’s 400% increase!

What Causes Inflation?

There are many mays to explain what causes inflation. In economist view, it is caused by increasing of money supply due to changes of monetary policy in that particular country.

However, it can also be illustrated with the theory of supply and demand effect. Think about it, populations are increasing while natural resources are decreasing constantly. There are more people than ever before are buying food to eat and clothes to wear; and food and natural resources are getting lesser and lesser. With more demand to consume and less supply to produce, prices go up, and lead us to inflation.

What Will Inflation Do To You If You Don’t Invest Your Money?

Let’s assume the below scenario:

Annual Inflation rate = 3.5%

Saving Interest Rate = 0.5 %

Prices of a Television: $1000

Amount of Money to Save: $1000

By using compounding formula, and after rounding off the figures, in three years’ time:

Cost Of Television After Three Years:

Year 1=> $1000 + ($1000*3.5/100) = $1035

Year 2=> $1035 + ($1035*3.5/100) = $1071

Year 3=> $1071 + ($1071*3.5/100) = $1108

Amount Of Saving After Three Years:

Year 1=> $1000 + ($1000*0.5/100) = $ 1005

Year 2=> $1005 + ($1005*0.5/100) = $1010

Year 3=> $1010 + ($1010*0.5/100) = $1015

The loss in dollar value => $1108 – $1015 = $93.

The loss in percentage => $93/$1000 * 100 = 9.3%

So here’s the reality, the money you are saving which is good enough to buy you a television now, in 3 years’ time, you will need to find extra money just to top up the difference!

Now I am not saying you should just go ahead and buy a television now and hope to sell it in future so you don’t lose the $93 dollar. Because if you buy a television now and in three years’ time it will probably worth $500 dollar. The idea here is to describe how money itself will lose its value overtime if you just put it into saving with ultra-low interest.

How Does A Public Listed Company Gain Access To the Cash From the Stock Market?

When I started to learn about investing, there is one question I have in my mind. How did companies withdraw the cash when investors/traders are buying and selling the stocks? Why is it that when someone buying the stocks, then sell the stocks to someone, and since the cash is constantly flowing between the investors, just how do companies withdraw the money to use it?

What a funny question I have in my mind. Well, I think my logical cells were sleeping. It’s all logical thinking. Here’s how:

For example and simplicity, let’s imagine there is a company name by ABC Company, 2 investors – John and Zack

When ABC Company listed its stock on the stock market, John bought the stocks with $10,000 cash. Now ABC is funded with $10,000. 3 Months later, the stock that John bought is now worth $20,000 as the company is making good profit and business is expanding.

John then decided to sell the stock at $20,000 and make good profit out it. Zack comes in and is willing to buy the stock from John at $20,000 as he believes the stock will worth $30,000 in future. So now Zack bought the stocks with $20,000 cash! So now you see, the ABC Company did not have to withdraw any money to return to John as Zack is the one comes out with the money! In fact, after this transaction, ABC Company is now funded with another $10,000! Plus, John is now richer by another $10,000!

Well, the above example looks all good if ABC Company is a good company.

What if ABC Company Is A Lousy Company And The Share Price Of The Stock Drop?

Let’s do this again, if the stock that John bought is now losing its value as the company is doing badly. Now John is panicking and he wants to get out of his position and he is offering $10,000. Unfortunately, no one wants to buy it because everyone knows the company is in a bad shape and the stock is probably worth half price. John has no choice but to offer the sale of the stock at $5,000.

Then Zack feel this deal looks attractive because he believes the company will do very well in the future and the stock could worth a lot more by then. So now Zack bought the stock from John at $5,000 with his own cash! Same thing, ABC Company did not have to return any money to John, because the $5,000 is being funded by Zack. The sad story is that John is poorer by $5,000.

By the way if you notice in both scenarios, ABC Company is a sure winner. Why? In the first scenario, it gets additional $10,000. In the second scenario, it simply gets to keep the $5,000. Sweet….

How Do You Buy & Sell Stocks?

Stocks are traded on stock exchange by stock brokers and traders. Some of the famous ones are:

  • NYSE Euronext (United States)
  • NASDAQ OMX (United States)
  • Tokyo Stock Exchange (Japan)
  • London Stock Exchange (United Kingdom)
  • Hong Kong Stock Exchange (China)
  • Shanghai Stock Exchange (China)

In this era, stocks are traded electronically online. So for people like us, we need to have an online brokerage account with a brokerage firm to help us buy and sell stock in the stock exchange. Some of the big names are:

  • OptionsXpress
  • TD Ameritrade
  • Thinkorswim
  • ETrade
  • Charles Schwab

What to Look Out for When Choosing a brokerage firm?

Credit Rating
It would be better to check the credit rating of the brokerage firm to ensure that it is less likely to go bankrupt should something unexpectedly happen. Best if the brokerage firm is a public company, so you can easily find out the credit rating from some of the rating companies such as Moody’s, Standard & Poor’s & Fitch Ratings.

Platform Capability
In order to fight your war in the stock market, you need all the below ammunitions.

  • Charting – Use it for you to see the historic price trend and analysis. The MUST have type of charts will be Line Chart, Bar Chart, Candlestick Chart & Volume Bar Chart. For advanced trader/investor, you will need additional technical indicator functions such as Simple Moving Averages, MACD, Relative Strength and etc.
  • Speed – Prices on Stock market move very fast, your brokerage platform must have real time update to the price change of the stocks.
  • User Friendliness – Needless to say, it must easy to use so that you know what to click with your mouse. Most of the advanced brokerage provides a Virtual Trading Platform. It will allow you to train yourself how do buy and sell in a testing platform. So get yourself familiar with the platform before you start any trading and investing.

Efficiency of Transferring Fund – Check how fast and easy it is for you to withdraw and credit your money with your brokerage firm. You don’t want to be cash strapped when you need to withdraw fund.

Credibility – Check the brokerage firm creditability, my favourite site is to do a search on Wikipedia and do some reading on the firm. Or you can do a search on any search engine and enter search such as “Abc Firm Review”.

Brokerages Fees & Charges – Find out and compare the fees and charges among the brokerages. For stock trading, it should not be more than $10 for each trade. Each trade means buy or sell, for example, if you buy a stock today and sell the stock tomorrow, that is consider 2 trade.

Support – Find out the level of support provided by the brokerage. Best if they provide 24-hour telephone support.

Market Access – Some brokerage might not have access to the stock market that you wish to trade. Best to verify this.

Insurance – Check if the brokerage protect your funds with insurance, so you don’t lose all your money should someday if it went bankrupt.

Value Added Services – Check if the brokerage provide any value added services, such as seminars, platform training, dedicated support and etc.

 

What Is Stock Market?

Well since this is my first post, I’ll start by going back to the basic.

Recently a lot of my friends have started putting their hard earned cash into the stock market, buying up shares of companies. What surprised me is that most of them are just doing it because they “THINK” by putting money into the stock market and money will just keep growing and making profit out of it, without even understanding the fundamental. The irony is that they do not even understand why does a stock market exist in the first place!

What Is Stock Market?

Simply put, stock markets are places where companies are trying to sell their partial ownership to the public investor in the form of shares. Think of it as a supermarket, instead of seeing stall owners selling stuff such as food or vegetables, shares of the companies are being sold for cash to the investors (customers).

Why Do Companies Want To Sell Their Ownership In The Form Of Shares?

The main reason is that a company is selling a portion of the ownership to the public investors in exchange for cash. By gaining access to those cash, the company will be able to expand their business by doing things such as hiring more people, buying new machines and more materials to build more products. As a result, the company will make more money by selling more of those products or providing more services.

However, another underlying reason is also to let the original owners of the companies to get extremely rich by selling part of their ownership. Think about it, all the owners, who have invested so much money into setting up the business, would definitely want to make all those money back as soon as possible. By making their company going public, they can manage the company, and at the same time getting back all their invested capital. Plus, if the company is running a very very very good business, investors are willing to pay and buy the shares at any price. So, the owner, instead of getting back all their invested capital at 100 percent, they might even get it back at 500 percent or more!

Why Would Public Investor Want To Invest In the Company? 

Shares are sold at certain price, rightfully if the company is making good profit and growing consistently. The value of the company will grow, so as the share price of the company. If the share price rises significantly, the investor can make solid profit by reselling the shares to other investors. Also, some companies will also return cash to the investors in the form of dividend periodically, generating passive income for the investors.

However, if the company business is doing badly for whatever reason, share price will drop as there is a potential chance that the company might even go bankrupt! If it does happen, it is possible for investors to lose all the money they have invested.

How Would Investors Judge Whether The Company Is Doing Good Or Bad?

Public Companies are required to publish financial reports quarterly to the public. They will also hosted public general meeting where shareholders are able to attend to get to know more about the companies. Anytime, Investors can also send in questions and request for information.