What do I do when my financial situation is strained? Do I limit my budget?

In today’s post I will try to answer the question above and flesh out the reasons why I don’t think it’s a good idea. Personally I never limit my budget.

One day you may find yourself in financial trouble. That’s just part of life. It can be that you have fallen ill and have expensive medical bills or that you have just lost your job. These are all circumstances that normally force you to look into your personal finances and take a hard look. In the end you may come to the conclusion that you don’t really need all those restaurant dinners or coffees at Starbucks.

To cut back on low-hanging fruit like that does not do you any harm – it may even be a positive for your economy – but I still seldom do. Why is that? It’s because I have made a budget that allows me to lead a certain lifestyle. That lifestyle is then non-negotiable which means that I simply don’t compromise on the things that I’m doing. For instance, I love biking in the nearby hills and even if I had been unemployed I would still enjoy doing that. Now you can say that going on a bike is not the most expensive of things, but even so it still costs a fair amount each month. So what do I do?

The answer to question may seem to obvious. When my resources are not enough for the month’s expenses I simply increase my income. That is what I suggest that you do too. An extra income will allow you to maintain your lifestyle so you don’t have to cut back on the things that you enjoy the most.

Conclusion:

Today we have been talking about personal finance and what to do when there are unexpected expenses. Do I limit my budget? No. I try to increase the money coming in.

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How can I start learning the basics of investment? What are the books that I should read?

The first thing that you need to consider when you want to learn the basics of investment is that almost every investor is a saver down below.  You will never be rich by spending your money on lattes at Starbucks. The only way to become rich is to begin to save regularly at an early age – the earlier, the better. In this article we will therefore lay out the basics of investment and give you a few tips on books to read to begin with.

If you have trouble with spending money spontaneously and want to learn the basics of investment here’s a little tip that you can use:

If you are going out shopping, decide in advance what you want to buy and estimate the approximate cost of the things you want to buy. Then bring that money along plus a little extra, but don’t bring your credit card. Leaving your credit card at home will prevent you from shopping many unnecessary things.

When that is all out of the way, let’s get into some of the specifics.

Sure, you can be rich by speculating, but chances are that you won’t. Successful speculation involves buying and selling securities at the exact right time and that is very difficult to do consistently. Therefore, what I suggest is to look into companies with a steady cash flow and a good dividend yield. The cheaper you can get them, the better it is.

How do you determine the price of a security?

How cheap a security is, is determined by the price to earnings-ratio. If, for instance, you have a company that cost 100 $ while at the same time earning 10 $ then the P/E-ratio is 10.

If you want to buy apples on your local market, you know that the cheaper it is, the better. Somehow that quality does not apply when people are buying securities. Instead the more a stock falls, the more people tend to sell it instead of taking advantage of the opportunity. The facts are indisputable, the cheaper you buy a security, the more value you get. Similarly, when prices have gone up it means that you receive less value for your purchase.

Therefore, always look at the predictability of the cash flow. Are the company’s earnings something that you can count on or do they fluctuate? Is the dividend yield increasing over time? If it is it is generally a sign that the company does have enough cash to pay out to shareholders. Otherwise you can go in and look at the company’s free cash flow – which is defined as the operational cash flow minus CAPEX-spending – and see if they generate enough. The free cash flow is the money that is readily available to the company to pay out dividends. Otherwise they have to borrow money, which disturbs their debt structure.

What books should I read?

• The Intelligent Investor by Benjamin Graham. This is considered by many – myself included – to be the bible of value investing. It gives a blueprint, not only for finding good stocks to invest in but also for keeping your head cool when the market is in turmoil. A true classic.

• The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor by Howard Marks. This book is full of praise for defensive investing which may prove to be the soundest piece of advice that you can get.
  

• The Little Book That Beats The Market by Joel Greenblatt – This book lays out a formula for how you want to approach the market and how to play it in your favor. Of course it is easier to invest if you are feeling the wind is in your back.

Conclusion:

This is a short top three list of our own favorite financial books in order to learn the basics of investment. Don’t just read them, but also try to learn the wisdom that they are teaching. That way you are almost guaranteed to become wealthy one day.

 

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I’m 28 and just came into some money (8 figures). About 70% is invested in stocks and the rest is cash. I don’t want all the money tied up in stocks. Should I buy apartments or land and build my own apartments?

First of all congratulations. You have achieved something most of us just dream of and cannot achieve in a lifetime. Because both stocks or real estate are assets with fluctuating values your money is not guaranteed but needs to be invested. And wisely so.

Now is the time to do some serious soul searching. What is your long term goal with your money? Do you want to preserve its value long-term or make a decent return? It may sound as a trivial question, but it actually holds a little bit more substance than first anticipated.

At first it may be a good idea to read some books on what you want to do with your money. Even if blogs like this may give you a short description, we cannot do your due diligence. You have to do that yourself.

If you come up with an answer where you want to preserve the value of your capital you should invest in tangible assets, like precious metals, farmland or fine art.

The reason for this is the current regime of central banks where quantitative easing is slowly diluting the value of money. One of the facets of precious metals is its “moneyness” and the reason people buy it is that it preserves buying power over the long haul.

The fundamental reason the gold price got higher in the period between 2008 and 2011 was the negative real interest rates. The negative real interest rates is defined as the differential between the nominal interest rate and the inflation rate. In other words, it is the interest rate that businesses and people are experiencing at any given time. During the three years between 2008 and 2011 the real interest rate was negative which drove prices higher.

The trouble with gold is that its value fluctuates wildly and that when its price in dollars goes up, it soon blows out of proportion. For instance, in 2011 when gold had its last peak at over 1900 $, it had gone up from 1100 $ a year earlier. The hype around it made it very expensive very fast. Similarly, it fell from 1900 $ to 1150 $ over two years. These wild gyrations are attributed to the size of the gold market. If you compare it to the size of the bond market, it is minuscule.

In this sense farmland is a better investment since it also is a tangible asset that preserves its value. Over the past few years farmland has increased in value of an average 8 per cent a year.

My own preference when it comes to investments in tangible fixed assets is fine art. For instance, if you had invested 100$ in a work of art by the French artist François Boucher in 2001, it would be worth 197 $ by now. Similar gains can be seen with other artists.

Compound interest

It is however important to stress that this strategy of preservation only makes sense if you believe that “money” as we know will be diluted and eventually die at some point in the future. It does not make sense to preserve value like this if you believe that the central banks are doing the right thing .

The difference between between buying something tangible and investing in a return-yielding stock or bond is called “compound interest.” This does not take place if you invest in tangible assets. What “compound interest” means is that if you have an interest rate of 10 per cent and you reinvest those 10 per cent each year, you will be building on your capital much faster than if you did not reinvest the surplus. The longer your investment period is, the higher the return.

In real terms this means reinvesting your dividend each month or each quarter or whatever the dividend period is. If you just stick to reinvesting your dividends in a disciplined manner your money will soon grow much bigger than any doubling or tripling of prices that you occasionally see in the stock market.

Value investing

If you do not believe central bank policy being a problem then you want to shun precious metals and fine art and invest in good cash generating stocks instead. I would take a look at small-cap stocks in your own country with good cash flows, dividends and interesting business ideas.

The idea may sound like a dangerous approach, but is less so once you know the companies that you invest in a little better.

It does not really matter where in the cycle we are – what matters is how these stocks are valued at any particular time. Try to go for stocks with a positive free cash flow (the free cash flow is calculated by taking the operational cash flow and subtracting the CAPEX spending which is found under investing activities in the cash flow statement.) The free cash flow is the amount of money that the company has available for paying out dividends. If the company is not generating a free cash flow it has to borrow the money.

Another thing to look for is a low price to earnings ratio and a high dividend yield. Ideally, for a good investment, the P/E should be around 7, but a higher number may be acceptable. It depends on the business. When it comes to the dividend, of course the higher the better.

The next thing is of course to reinvest your dividends in the same stocks and see your capital grow, slowly. The key will always be to be patient. In the short-term there is no guarantee of financial gains at all and anything might happen, but if you have chosen good value eventually the market will reward you.

Conclusion:

In today’s post we have been looking at a (presumably) young man or woman who has inherited a fortune. Allegedly his or hers fortune is an 8-figure dollar inheritance which apparently is invested in stocks and bonds. The person then asks how he/she should invest his/her money.

We have divided our answer in two. One which is based on tangible fixed assets if you don’t believe in the current central bank policy and another if you do.

Our suggestion would therefore be based on your current thinking. Remember that it is not a question of prudence – we are always prudent.

If you believe in the current central bank policy we would invest 10 per cent of our portfolio into tangible fixed assets and the rest in small-cap stocks. That way you are hedging against a really bad outcome whilst at the same time earning a more than decent return on your money.

If on the other hand you don’t believe in the central banks you can increase those 10 per cent into tangible fixed assets to 25 or even 40 per cent.

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