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Thursday, 21 November 2013

Some international consumer debt data points - part 3a in Corrosive Debt series

In this week's British press, one article about spiralling consumer debt in the UK, another about similar happenings in Russia.

Personal debt in the UK now stands at £1.4 trillion (with a T).  That's about $2 trillion.  A report by the Centre of Social Justice (CSJ), called 'Maxed Out:  Serious Personal Debt in Britain', reports the following:

  • The average household debt stands at £54k, almost twice of what it was a decade ago
  • Households owed the equivalent of 94% of the UK's economic output last year (!!)
  • Thankfully (my words, not CSJ's), a vast majority of this debt is in the form of mortgages (see Part 3 of my Corrosive Debt series - this should be consider "good" debt)
  • However, is it really "good" debt?  Unlike many other countries, British mortgages are typically based on floating interest rates.  The UK government is concerned that when record low rates (currently 0.5%) start to rise, many of these 'good' mortgages will become unaffordable.
  • According to CSJ, nearly 4 million families do not have enough savings to cover their rent or mortgage for even one month.  
  • Looking at non-mortgage consumer debt, the amount outstanding is £158 billion (so an average of £3k per citizen).  This will mostly be 'bad debt'.  Credit card debt represents about £58 billion (£1k per citizen) - a lot of the remainder are 'pay day' loans (loans to help folks reach their monthly payday) and similar.  As a comparison, The US average household has $14k of credit card debt.  So Britain, with 26 million households, is slightly better off than their US counterparts with a little over $3k in credit card debt.
  • Unlike the US, where people have been paying down debt in this low interest rate environment, people in Britain don't seem to be taking advantage of the same opportunity.  
The full CSJ report can be found here.   

Switching gears to Russia, yesterday's Financial Times reported various Russian central bank warnings regarding 'high household indebtedness'.  Some snippets:
  • The central bank head states 'there are already visible elements of overheating'.  She notes 'exceptionally high level" of households' debt and is concerned on its impact on financial stability.
  • Russia's largest bank is now warning of a consumer credit bubble in 2014.

You may be asking yourself what is the relevance of these stories to the New Investor?  Well, as I have stated emphatically before, you cannot prudently start a long term investment program if you are mired in bad debt.  If you are one of those with high personal debts, make a plan to start paying yourself first NOW and use this 'new-found' money to get out of debt asap.  Because interest rates WILL go up.  It is a mathematically certainty.  

And when interest rates do rise, if you have crushing, floating rate debt, not only won't you be a successful investor, you'll be fighting for financial survival.  See the difference?

Wednesday, 6 November 2013

The corrosiveness of debt – part 3 (when to use debt & when not to)

It’s like we’ve all been in a collective deep slumber…lasting many years. 

We, as a society, have enabled, through our inaction, a new addiction to form.  Whereas some take an ostrich approach and willfully ignore the new dependence, others are lured into the attractiveness of the offering…like druggies to crack or heroin.  Still others are just plain ignorant and yet many more believe the polished & targeted marketing crammed down their throats.  To what do I refer?  Debt.  Insidious, destructive debt.

I’ve intimated it in my prior corrosiveness of debt posts but now I’ll be more explicit - debt is an effective way for others to enslave you.  Please pause, take a deep-breath and re-read that last sentence again (and again).  Because unless & until you fully understand what instruments are being actively used against you - to control you - what hope do you have? 

We’re all very familiar with the mortgage-led housing crisis of recent years.  Most of the problems stemmed from dishonest brokers & bankers coupled with foolish borrowers and stupid investors (among others).  But as I describe below, real estate is one of those assets where, ironically, it makes sense to use debt.  Just use common sense, know that you can pay the mortgage each & every month, and take the time to understand the particulars of your mortgage offer. 

But more broadly speaking, using debt to live beyond one’s means is insanity.  As Albert Einstein so famously said, insanity is doing the same thing over and over again and expecting different results.  If you feel that you never have any money to invest, yet you’re making ends meet by using debt, don’t expect this to change.  Ever.  You have been brainwashed to believe you need that new product or service and are willing to mortgage your future to get it.  In short, you have lost your capacity to think, and to act, in your own best interest.  Now how does that make you feel?

Pigeons unite!  (or not...)
We have a family joke that whenever one of us is manipulated by a third-party or perhaps acts without thinking, we’re acting like a pigeon.  In fact, to make the joke even funnier, we refer to the guilty party as a pigeon detective.  With rich irony, of course.  Can you imagine a pigeon using logic to analyze available facts to determine best course of action?  No, I thought not.  And that’s precisely the point I’m trying to make:  no one aspires to be a pigeon (at least I hope not!).  Societal pressures may try to dumb us down to spur us into making that spontaneous purchase; but we must fight back by remaining vigilantly open-minded, always seek the truth, and being prepared to defend ourselves against nefarious actors.  The same characteristics apply to the astute young and/or novice investor.

Real vs. not so real…
Fact:  debt can be a useful tool, enabling both individuals & companies to purchase things that they otherwise could not purchase.  But let’s be crystal clear here - purchasing anything other than real assets with debt is a sure-fired way to find oneself firmly on the path to financial destruction.  My goal at newinvestortoolkit is to help young and novice investors get on the road to financial freedom, not financial ruin.  Consequently, to achieve this goal, I need to share with you pitfalls to avoid; some of which I have experienced personally over the last 20 years.  That is why I’m focusing so much attention in my initial NITK blog posts to the corrosiveness of debt theme.

Real assets - when debt makes sense
So when does debt make sense?  Real estate.

Given global population growth projections, the demand for quality housing will always be greater in the future than it is today.  There are, our course, obvious exceptions to my gigantic generalization (both by country & by region & by city).  Where my generalization is completely accurate, guaranteed 110%, is in cities like London and New York.  Simple supply & demand, my dear Watson.  A lot of people want to live and/or invest there (demand) and there simply isn’t enough new properties being built (supply) to match the demand.  Other cities may offer similar ‘slam-dunk’ return potential but probably not as assured.  Austin, Texas, for example?  Not a given but probably still a good bet.  What about Detroit?  Speculative, at best.  You can make a killing…but also may loss your entire investment.  As you’ve no-doubt heard many times prior, choose investment property locations prudently. 

But based on empirical evidence, one can assume that over the long-term, house prices (including apartments/flats) will increase over time, usually in excess of inflation.  That, coupled with the relatively low cost of the mortgage (because the loan is secured against the property), makes real estate a solid long-term investment.  And in this specific circumstance, debt provides good value to you, enabling you to buy a real, appreciating asset with much, much less costly debt than the average credit card charges (two main reasons for this: (1) credit card debt is unsecured, unlike a mortgage, and (2) almost anyone can get a credit card these days with no need for ‘equity’.  Yes, mortgages were given to individuals with no equity and the standards for approval were lax, running up to 2008…and we saw where that got us.  I assume the mortgage industry will continue to adjust its eligibility criteria back to historic norms).

Another great example of the usefulness of debt, at least as it pertains to the corporate sector, is in acquiring cash-producing companies.  The benefits are multiple:  (i) you get a tax break for use of debt; (ii) debt increases equity returns of the corporate, albeit by increasing financial risk to its shareholders, (iii) you can use the acquired company to pay a portion or all (and more) of the debt borrowed for the acquisition.  Suffice to say in this post that corporate debt, when used properly, is an excellent tool for management to create shareholder value.

Soft assets – when to avoid debt like the plague
So if we understand what real assets are, how to describe all non-real assets?  Generally speaking, non-real assets (also called ‘soft’ assets) are those that lose value over time - e.g., flat-screen TVs, PCs, iSomething, clothing, food, vacations, etc.  The strict rule to follow is that soft assets should never be purchased using debt.  Ever.  Let me repeat:  for your own financial well-being, do not ever buy a soft asset with debt.  (There may be one exception – automobiles.  Whereas I believe cars are soft assets - we’ve all heard new cars lose 25% of their value once driven off the lot - if you need one to get to work and don’t have the money to buy one outright, then I think it rationale & necessary to use debt to acquire one.  But use the ‘pay yourself first’ technique found in the prior blog post to pay off the car loan as quickly as you can). 

Many people use credit cards to fund more than useful “float”.   Remember my credit card experience when I was a young man living in New York (described it in my credit card post)?  Suffice to say here that such a purchase is a bad trade for you.  Why?  You end of paying 10-14+% interest charge on the money used to purchase an asset that becomes worth less and less over time (in the case of technology, a product value’s “half life” can even be measured in months, not years!).  I’ve known folks who still carry credit card balances for items they no longer even own.  You must avoid this at all costs.  Defer that urge for instant gratification.  Avoid that spontaneous desire to consume, consume, consume!

Sad fact:  we’ve been programmed to consume (beyond our means)
The rather unpleasant reality is that we’ve been programmed to always buy the latest gadget or to upgrade or even to have multiple devices that essentially do the same thing.  And since, perhaps, the 1990s, a lot of us in the West have been living beyond our means….and funding the gap with cheap debt. 

I’ve heard our society’s materialistic-centric model described – perhaps exceedingly harshly & cynically (but sometimes that’s needed to wake us up from our slumber) – as follows:  The average citizen’s utility to the powers that be is to produce, to consume and then to die.  Money has, in many ways, become the end game in itself, not a tool by which to just play the game.  

The fact is, you need to be smarter than others with respect to debt.  And you need to start being smarter NOW.  Make your own rules for how you use debt…and how not to use it.  Two summarizing tips:
  • Never use debt of any kind to purchase ‘soft’ assets
  • Use credit cards judiciously: (i) aim to never carry a credit card balance into the next billing cycle and (ii) only use credit card debt as ‘float’ (see my blog on credit cards if you don’t understand this point).
To summarize, use of debt to purchase hard assets can be an excellent use and you can do very well indeed on your ‘equity’ portion of the transactionBut don’t use debt (in particular, high-cost credit cards) for buying soft assets.

Next debt bubble, coming up…
Which brings me to what many consider to be the latest debt bubble (at least in the US) and one of the main reasons why I stated in the opening paragraph that we’ve all been asleep at the wheel.  It’s been a growing problem since I went to college (way back in 1985 to 1990…yes, I was on the 5 year plan:)) and only recently has it entered into our public discourse.  Namely, the growing problem of student loans.

Student loans are crippling our young generation (i.e., the young investor, thus my personal interest), financially, psychologically and morally.  I’ll tackle this in my next blog post.

Friday, 18 October 2013

Finding your investment money

I interrupt my ‘mini-series’ on the corrosiveness of debt to answer a question that I get asked quite often - how to I find the money to invest?  You know, this stuff.....

With the overall economy in the dumpster, salaries growing less than inflation over the long-term, and especially for high-school & college kids who may work part-time but the pay is barely enough to fund the all-important beer money, how can I possibly find the money to invest? 

Easy – you just need to pay yourself first.  And you can implement it in about 10 minutes.  Interested?  Well then read on.

This particular technique took me well into my 30s before I mastered.  (Tragic, I know.  But remember, my concept of the NITK is to share everything I’ve learned over the past 20 years in an attempt to help the younger generations).  And it is so simple – and I believe fool-proof – that you can put it into practice when you first starting earning income, whether from a paper route, a waitress job, a temp position but, most definitively, your first post-school job.

So how does one go about paying themselves first?  You do just that – you pay yourself before you pay bills, buy late night snacks, purchase that morning latte…even buy food and, yes, tragically, before you buy beer.  You see, if you don’t see the money, you won’t (and can’t) be tempted to spend the money.  In short, paying yourself first means you transfer a portion of your income (in whatever form it’s in) to another bank account – a newly-established bank account that you do not live on and that you, most definitely, don’t have a debt card or check book to draw funds from.

As I write on the NITK website, first you need to pay off your credit cards (see recent blog entry), then you need to pay yourself first…and you know what?  It doesn’t really matter how much you pay yourself.  What really, really (REALLY) matters is that you start as young as you can.  And you take this ‘new-found’ money and invest it in the greatest wealth creating vehicles of all time.

One key point I’d like to make…and that is that this really isn’t very difficult….if you’re young.  However, it does get increasingly difficult as you age.  And I’m not referring to the discipline of paying yourself first but rather the ability to build serious long-term wealth by utilizing one of the most powerful forces in nature….time.  And add to time some knowledge & discipline and you are, truly, 100% able to forget about your financial future.  You can, instead, focus on the important things in life – family, friends, hobbies, and anything else that floats your boat.

How to implement?  How much to start with?  Where to put the money?  Well, I’m not going to spoon feed you on this blog.  You need to check out to find out the details.

Love Mondays?

For the Brazilians / Portuguese speakers out there, I found a wonderful site that gives internal insight into companies...information that you can use before you join as an employee.  

Why & how is this relevant to the NITK?  Well, left unsaid is that one needs an income in order to allocation some capital towards investing.  An active income is everyone's starting point.

The site describes itself as follows:
Considering a career change? Often you don't really know what it's like to work at a company until you start working there. And then if you don't like it, it's already too late! Love Mondays gives you access to free company reviews - all posted anonymously by employees of those companies. They say what they like, what they don't like about the company, how happy they are with the culture, management, salary, work life balance and much more. This way, you can make a well informed decision on what's the best place for your next career move. 

The link is 


Sunday, 13 October 2013

The corrosiveness of debt - part 2 (credit cards)

In part 2 of my look at the corrosiveness of debt, I am going to deep dive into credit card debt. In part 3 I'll discuss what constitutes "good debt" from "bad debt" and I'll finish this mini-series on the corrosiveness of debt with a look into our new bubble in the US economy – student debt.  So, in effect, you can expect a mini-series on debt before we turn to investing.

But why so much attention on debt, you may ask?  Because I strongly believe that debt is the key impediment, thrown up by our societal influences and/or our economic systems, to successful investing…

The dangers of credit card debt
First, two stories about my personal experience with credit cards in college as well as in my first post-college job. 

Back in 1989, I went on Spring break to the Bahamas with my Clemson University fraternity brothers.  I won’t get into the debauchery normal with Spring breaks – this is an investing blog after all – but rather, make the point that I had recently received a newly-minted American Express Optima card…that I was going to fully test drive!  (Let’s conveniently ignore the fact that AMEX would give a college student with no income a credit card with a $10,000 spending limit…)

A fraternity brother of mine & I agreed that we would buy stuff together (mostly Kalik, a local Bahamas beer) and at the end of our Spring break, he would pay 50% of the bill (my potential mistake number 1 – I took all of the repayment risk to the credit card company.  Fortunately, Scott was an honest person and did pay half of the bill).  My point in this little story is that by day 3 or 4, after charging far too much, incremental purchases on the Optima card (we actually started yelling OPTIMA in local establishments when we were about to make a new purchase) increasingly became ‘funny money’.  In other words, the balance was growing so quickly, I began thinking, what’s another $100?  From a percentage basis, it wasn’t sooooo much.  I had lost touch with the value of the underlying (and quickly growing) debt.  Fortunately, we did pay off the bill in its entirely when we returned to Clemson. 

Fast forward to my first job experience in New York City.  In 1990, the cost of living in NYC wasn’t cheap (I’m pretty sure that it’s still as bad, perhaps even worse).  I had a good paying job with Goldman Sachs but I still found myself running short every month (being a young, single bachelor in Manhattan requires a certain lifestyle!).  And so, every year (for the 3 years I lived in NYC) I would gradually build up my credit card balance (my actual mistake number 2 – in fact, a personal Full Monty mistake (Full Monty is a British expression meaning all out, complete) – I ran up a balance that I did not pay off each month). 

At the end of the year, I would have this monstrously-large credit card balance….that I would then have to use my annual bonus to repay in full.  Yes I was lucky to have this bonus available that I could use to repay my debt but I clearly remember to this day, nearly 20 years later, the horrible sinking feeling I would have using my ‘new’ money to repay debts for things that I had long lost forgotten I’d purchased.  Yet I would repeat this stupid mistake for two more years.

My lesson learned from these two stories - credit cards should only be used for short-term liquidity ‘float’ – i.e., you can borrow money at no-cost as long as you repay the balance every month, every time.  Because so many people fail this basic test every month, credit card companies make fantastic investments (think AMEX, Mastercard, Visa).  Why?  Because they are so profitable…due to those folks who have never learned the most basic of basic lessons – (i) credit card debt is NOT ‘funny money’ and (ii) don’t live beyond your means month to month.  I made both of these mistakes and learned the hard way.  Don’t do the same.

The cost of credit card debt – some numbers
As I write on, The credit card industry is a gimongously profitable business.  According to various sources (including a 2010 Federal Reserve Bank of Boston study - search for it, and others, this information is all out there), there are over 600 million credit cards held by US consumers.  Average credit card debt per household is in excess of $14,000.  This amount, no doubt, fluctuates over time.  I would venture to guess that average balances go up during the good times, when people consume more, and down in the dire times when people are concerned about the economy, their job stability, etc.  However, one could easily take the opposite position and believe credit card balances increase during bad economic times because people need the credit in order to pay bills and make ends meet.  Whether the former hypothesis is correct or the latter is doesn't matter - what matters is you should never, ever carry a balance on your credit card.  Why?  Simple mathematics.

The average APR on credit cards is over 14%.  Many cards charge far in excess of this amount.  This is extremely expensive money when one considers the cost of money to banks is currently close to 0%.  They charge this spread because they can.  No other explanation.  But rather than rail against these credit card companies your take-away here should be two-fold:
  • If the cost of this money is so expensive, I should prioritize paying off my balance....and keeping the balance at 0 every month (i.e., pay it off every month)
  • If they charge so much they are most likely very profitable.  Therefore, perhaps I should investigate investing in Mastercard, Visa and/or American Express?  This is an important mind-set change that I encourage you to develop over time.  One person's cost is likely to be another's profitable venture.

But back to my point - the cost of borrowing money from your credit card company is greater than the average returns from the stock market over the last 30-40 years.  Warren Buffett, perhaps the greatest investor in our lifetime has achieved 19.7% average annual returns in Berkshire Hathaway, his main investment vehicle, from 1965 to 2012.  The average annual return from the S&P 500 index (which includes the 500 largest publically-traded stocks in the US), including their dividends, was 9.4% over this time period.  Your takeaways?

  • If the cost of credit card debt is higher than the average stock market returns, then this is a bad trade.
  • Unless, of course, you're Warren Buffett - then you can capture a 4-6% spread by borrowing expensive credit card debt and investing this in the stock market!  Woo-hoo - road to riches, right?!  Well, no, as neither you nor I are anywhere close to Uncle Warren in investing prowess.

So, a final message to those currently carrying credit card debt – pay it off as soon as possible.  Use the ‘paying yourself first’ methodology that I cover on for credit card repayment.  Because, until you get control of this extremely corrosive debt, you will never ever become a successful long-term investor.  Unless you’re as good as Warren Buffett.  But you’re not.  And I'm not either, but I learned the hard way.  Don't do the same.  Pay down your that credit card balance to zero as soon as you can.  For your own good.

Next up – a look at what makes "good debt" and "bad debt" in part 3 and completing the debt series in part 4, student loans.  And why it impacts you and what you should do about it…

Until next time, read more about investing on

Monday, 7 October 2013

The corrosiveness of debt (and how we got into our current global predicament)

Debt can be a useful tool.  But it can also be corrosive.  So corrosive, in fact, that it can destroy hope, prosperity and, ultimately, even lives.

Debt is defined on Wikipedia as an obligation owed by one party (the debtor) to a second party (the creditor); usually this refers to assets granted by the creditor to the debtor.  In order words, someone lends you money (among other things) and you are expected to pay back this money, with interest included.

Debt comes in many forms, some ‘acceptable’, others less so.   A mortgage, secured by a property and a person(s) is a commonly accepted form of debt that has enables millions to ‘own’ a home (note – you truly only own the home when the mortgage is repaid…).  The traditional mortgage is relatively low cost (secured against the underlying property) and is, most times, a reasonable exchange between debtor and creditor. 

In the world of corporate finance, bank loans and bonds are secured against corporate assets and/or cash flows and, in the case of project finance, secured against a project’s cash flows and the equity capital of a sponsor.  These forms of debt are useful in a capitalistic society as they enable companies to leverage their activities with more capital than they would otherwise have at their disposal – and they do so by promising a portion of future value in some way, shape or form to repay the debt in the future.  But it’s a fair trade.

Prior to the year 2008 (perhaps even by 2006-07, when signs of over-indebtedness began to appear), debt was generally a useful - and non-manipulated - tool for capitalists to fund growth.  Yes its use increases financial risk of a company but, used prudently, it can be an effective lever to growth.  Even in the junk bond era in the late 1980s, when companies of dubious standing were able to raise a lot of debt in the high-yield bond markets, most of the resulting losses that occurred were suffered by sophisticated investors.  They knew the risks they were taking when they bought the junk bonds and if they lost money, well, that’s how a functioning capitalistic system should work.

Whereas the corporate sector maintained some semblance of reason leading up to the current debt crisis, unscrupulous mortgage brokers, borrowers, commercial & investment banks, federal agencies all worked in concert to effectively & completely “screw the pooch” at the retail level (excuse the American idiomatic phrase as I realize I have many non-American readers – it means that these actors have has made it difficult for the rest of us). 

This has, in turn, caused this New Recession that we still find ourselves in, 5 years later, after the start of the debt crisis.  I wouldn’t call our current predicament a depression….yet.  We seemed to have dodged this particular bullet with extremely loose monetary policy (think a lot of very low cost credit from institutions like the US Federal Reserve and the European Central Bank).  The level of societal debt has increased, dramatically, since 2008, as hundreds of billions of dollars in bad loans were covered by governments around the world (and, ultimately, tax paying citizens like you and I).  Look around you – do you think we’re in a better situation now that we were pre 2008?  I think not.

As many others have written about, this housing crisis was caused by a dishonest alliance of people who couldn’t afford loans; brokers who only wanted that upfront transaction fee; lenders who didn’t do the required due diligence because they didn’t intend to keep the loans on their balance sheet; the investment banks on Wall Street who took said loans, packaged them into CDOs (i.e., collateralized debt obligations – a fancy way to say a lot of loans jammed into an investment portfolio), and… stuffed them to stupid investors.  I should say there were also various enablers involved – think credit agencies like Moody’s, S&P, etc – who rubber stamped these CDOs, indicating they were solid investments.  In fact, most were a giant piles of sh!t…And we, as a global society, are still paying the price. 

So, this was (is?) clearly bad debt.  The original borrower had no capability to repay it (possibly even no intention of repaying it), brokers collected their fee and moved on, not caring about the loan’s performance, the lending banks also didn’t care as it sold this ‘asset’ into CDOs, the investment banks collected their fee as they found, with the credit agencies help, the sucker at the end of the line who thought they were buying a quality, yielding investment.  A dishonest alliance.

However, this only tells half the story of our current debt predicament.  As mentioned earlier, various governments around the world helped bail out the banks to restore solvency – leaving you and I to ultimately pay for others’ bad judgment & dishonesty.  And we’ll still be paying this bill for a generation (or more).  But what is this only half of the story?  Ironically, the damage of debt continues afoot in two other areas where debt, on the one hand, should be used a tool of flexibility, and on the other to benefit society at a macro-level.  Rather, corrosion has set in and may derail the United States (note – each of the two have much less impact in other parts of the world; so there is that).  I’ll address these forms of debt in my next blog entry.

One final point to make today:  you may ask yourself, why is, a website that aims to help young and novice investors get on the road to financial independence via simple & proven investment strategies, discussing problems with debt?  Simple.  If you have too much debt – of any kind – you must eliminate it before you can turn to investing.  If you don’t, you are merely taking capital from one pocket & shifting it to the other – BUT, you are taking all of the investment risk while “between pockets”.  What I mean by this is that you would be taking 100% of the risk that you can earn more from your investments than the cost of your debt.  And you probably cannot do this long term.  Warren Buffet can – and he has.  But you’re not Buffet.  Check out Finding the $ on to see what I mean.