How Much Passive Income Do You Need?

Most people I speak to, when they want to measure someone’s wealth, measure wealth by referring to how many houses they have. For example, “John owns 14 houses. He is rich.” However, someone may own 14 houses, but each house may only be worth $200k, which gives total assets of $2.8 million. However, what if he also had $2.7 million worth of debt? His net worth would be $100k whereas someone who owns one house worth $1 million that is fully paid off would be 10 times wealthier even though he owns 14 times fewer houses. This example clearly demonstrates how misleading a count of houses is. A more sensible approach is to calculate net worth.

However, net worth can be misleading as well. For example, suppose you inherited a house from your parents that was worth $500k and you live in this house. Suppose suddenly this house went up in value to $1 million. Are you better off? Your net worth has increased by $500k, but because the extra wealth is within the house, you cannot unlock it unless you sell the house. If you sell the house, you’d still need a place to live, so you’d buy another place. The problem is that if you buy another place, that home will have risen in value as well, so the net effect is that you have paid taxes, real estate agent fees, conveyancing fees, etc but there is no difference in your living standards. You are worse off. If you downsize and buy a cheaper place, you’d be able to unlock your extra wealth, but then your living standards drop (e.g. extra commute time).

This point highlights that net worth, although better than a count of houses, has its flaws. An alternative metric, in my opinion, is passive income. Passive income (e.g. from dividend income but also from rent, interest, etc) is income you receive by not working. Passive income should subtract any debt as debt is negative passive income. Debt is the opposite of passive income because you must work to pay off debt. This applies if you hold debt as a liability. If you hold debt as an asset (e.g. you own bonds) then this is passive income. The bonds generate interest for you that you can live off without any work.

Passive income is more useful because it directly measures your standard of living. If your net worth goes up by $500k, that may have zero impact on your standard of living. However, if your passive income goes up by e.g. $1000 per month, that is actual cash in your hands. It directly impacts how much you spend and directly impacts your standard of living.

So how much passive income is enough? It all depends on the person. Everyone is different. It also depends on the city you live in. Some cities are expensive while others are cheap.

However, using Melbourne, Australia for this example, in my opinion, to cover the basic necessities of life, passive income of about A$2000 per month (US$1500 per month) at a minimum is needed, in my opinion.

Currently I work, and I do like my job at the moment, but loving my job is a recent experience. For a long time I have hated my job mainly because I have had bad managers. Something I have learned is that things change all the time at work, so you need to have an exit plan at all times. Too many people get a job, expect they will always love the job and always make good money, so they go into debt to get a mortage, have children, inflate their lifestyle, etc and then suddenly they find they hate their job, but by then they are trapped. I made this realization early on in my career because, when I started working, I went through a restructure in the organisation. I learned quickly how risky it was to have debt and obligations, and I realised the value of structuring your life so that you have the ability to walk away from anything, not just your job but from any person or any organisation. There is great power in being able to disappear at the drop of a hat, and this is achieved with passive income coupled with minimum or no obligation (including financial obligation i.e. debt).

Don’t let yourself get attached to anything you are not willing to walk out on in 30 seconds flat if you feel the heat around the corner.

~ Neil McCauley

Even if there were a restructure at work or a tyrannical manager took over and started legally abusing staff, with passive income of $2000 per month, it is easy to stop work and live an urban hermit lifestyle e.g. renting a one-bedroom unit on the outskirts of the city (e.g. this place in Frankston), living off Aussielent, and surfing the internet all day. The only costs are rent ($1000 per month), Aussielent ($320 per month), wifi ($50 per month), electricity ($100 per month), and water ($100 per month), which comes to a total of $1570 per month. I round that up to $2k per month just to give a little buffer. Nevertheless, this is quite a spartan minimalist lifestyle. Doubling it makes $4k per month passive income, which I feel is enough to really enjoy a comfortable and luxurious lifestyle e.g. travelling, living in the city, eating out, etc. Nevertheless, $2000 to $4000 per month in passive income is a good range to aim for.

Why You Don’t Need Debt

I do have debt, but it’s a small amount. For example, I have credit cards, but I always pay it off before there is interest. I also have a margin loan, but I have this so I can buy easily when the opportunity presents itself, and I try to pay off any debt quickly.

Many people talk about how debt is a tool for making money, and theoretically this can be true. For example, if you borrow at 4% from the bank and invest in something an asset, e.g. an investment property that makes 8% then you make a profit. However, if you borrow money from the bank to invest, you need to ask yourself why the bank didn’t invest in that investment itself. The answer is that it is risky.

Banks have a certain level of risk they are willing to take. The property could have gone up 8% but there is no guarantee that it will. If there were a guarantee that the property would go up 8% then the bank would simply invest in it rather than let you borrow money to invest in it. By letting someone else borrow money to invest in the house, the bank effectively transfers risk. If the bank vets the borrower to make sure they e.g. have high enough income, etc and if there were clauses in the contract enabling the bank to seize assets in the event of default, then that 4% the bank makes is almost risk free.

But don’t you need to take on more risk to make more return?

Risk appetite is a very personal topic because everyone has different risk appetite. Generally speaking, it is recommended that young people take on more risk because they have greater ability (and time) to recover should something go wrong. This is the main principle behind the “age in bonds” rule, which states that you own your age in risk-free investments, i.e. government bonds. For example, if you are 25 you should own 25% of your wealth in government bonds.

However, if you’re a 25-year-old who has higher risk appetite, the “age in bonds” rule can be modified to e.g. (age – 25)% in bonds. This slightly more complex rule states that the 25-year-old would have zero in government bonds, which would increases to 1% when he or she is 26 and so forth.

A 25-year-old who has no government bonds and puts all his or her wealth into, say, the stock market, has a high risk appetite, but more risk can be taken if he borrows to invest.

You don’t need to borrow to take on more risk

However, even if someone does no borrow, he can still take on more risk. This can be achieved by investing in internally leveraged ETFs (e.g. GEAR and GGUS) as well as investing in more risky investments, such as emerging markets (e.g. VGE), small caps (e.g. ISO), tech stocks (e.g. TECH and ROBO), and cryptocurrency (e.g. bitcoin, ether, or litecoin).

Right now bitcoin and cryptocurrencies in general are making headlines because of spectacular growth. Had you purchased $10k worth of bitcoin in 2013, you’d be a millionaire today. However, everyone knows that bitcoin and cryptocurrencies in general are risky, and when you hear stories about people borrowing money from their homes and putting it all into cryptocurrencies, most people think this is stupid. It is not that it is stupid but rather than their risk appetite is very high.

However, the example of leveraging into cryptocurrencies shows that you don’t need to borrow in order to gain access to high risk and potentially higher returns. If you simply invest in a riskier asset class, e.g. cryptocurrencies, you already increase risk and the potential for higher returns.

Debt is slavery – the psychological benefits of having no debt

I would argue that there is no need to borrow to increase risk and return because you can simply reallocate your money to risker assets (unless you believe that leveraging into bitcoin is not enough risk).

The benefits of having no debt goes far beyond the lower risk you’re exposed to. Debt is slavery. Happiness is an elusive goal. It is almost impossible for you to know what will make you happy in the future. You may think a particular job, relationship, car, holiday, or house will make you happy, but once you actually have it, you may not be happy. Trying to predict what will make you happy is hard, which is why the best way we humans can be happy to experiment and try out different things. In order to be able to try or experiment with different things that will make us happy, we must have the freedom to do so, and you don’t have that freedom if you’re forced to work in order to pay debt.

Even though freedom does not guarantee happiness, freedom is the best assurance we have of being happy.

Freedom comes from reducing your obligations. Obligations are mostly financial obligations (debt) but can be non-financial as well.

Ultimately it depends on your risk appetite

As I mentioned earlier, everyone has a different risk appetite. I have a fairly high risk appetite myself, but there are limits. For example, I’m happy to put 5% of my net worth into cryptocurrencies. I invest in certain sector ETFs because I estimate that they will outperform in the future (e.g. I am bullish on the tech sector).

Market fluctuations can result in the value of my ETFs and shares to go down by tens of thousands of dollars and I would sleep fine at night. However, there have been many times in my life when I have gotten carried away with buying too using my margin loan account and regretting it. You know you’re taken on too much risk when you worry about it.

Results don’t matter

The outcomes from investing are probabalistic, not deterministic, so results don’t matter. This is a common investing fallacy. Some guy would claim that he is worth $100 million due to borrowing money to generate wealth and that this is proof that you must use debt in order to become rich. However, this is misleading.

The outcomes from investing are probabalistic, not deterministic.

A person may borrow money to invest and be very successful, but another person may replicate the process, borrow to invest, and lose everything. What happens for one person may not necessarily happen for another person. For example, in 2013, there were many people who stripped money from their homes using home equity lines of credit and invested all that money into bitcoin. Just about everyone called these people stupid, but now they are multimillionaires. Does this mean you should borrow to invest in bitcoin right now? No. Just because bitcoin went up from 2013 to 2017 it doesn’t mean the same thing will happen e.g. from 2018 to 2020. Investing is not deterministic. Luck plays a major role.

Do you need debt?

Suppose you put 100% of your investments into risky areas such as cryptocurrencies, frontier market ETFs, mining stocks, etc. If you feel that this is not enough risk, borrowing to invest may be the answer, but I believe that most people do not want to take on this level of risk.

Where debt may be appropriate is if you having little savings and need to borrow money to invest in something that you are fairly certain is greater than the cost of borrowing, e.g. borrowing money for education and training can in most circumstances be a good idea. Even though borrowing money will cost you in interest, you boost your job prospects and your income. If you have savings (or if your parents have savings) then it is better to use those savings to educate or train yourself, but if you don’t have this, you need to go into debt as a necessary evil.

unsplash-logoAlice Pasqual

The End of Slavery – Why I Live Off Dividends

One of the reasons why I don’t like being around people most of the time is because they tend to say things that trigger me. Maybe I am too sensitive. Most of the time people just say whatever is on their mind, and they quick jump from one superficial idea to another. Most of the time human interaction is just an attempt to say something for the sake of saying something, so perhaps I take things too seriously.

I live with my mother, and a few days ago, someone at work commented that I should not live with my mother because she will become a burden on me as she grows older. The reason why this comment triggered me is because there are many assumptions made, and it simply isn’t true. I didn’t get much of a chance to explain myself before the topic of conversation moved on, but days after this colleague made this trivial comment, I am still thinking about it, and my colleague may have forgotten all about it.

If I moved out from my mother’s house, she could still be a burden on me because technology connects us all, so even if I lived far away from my mother, she can still call or message me if she wants something from me.

However, suppose my mother and I lived in different cities. It would be more difficult for me to get to her, so she won’t be as much of a burden on me. Regardless, currently I don’t consider myself to be too close to my mother even though I live with her. I work quite often, and she also works as well, so we often do not see each other. My mother and father divorced a few years ago, so my mother learned from experience how important it is to be independent and to never trust or be dependent on anyone. Even on weekends I may be out somewhere, and she would be as well, so we rarely see each other. The only time we regularly see each other is at night when I get home from work and she cooks me dinner, and this is a tradition that seems to just happen all the time. She has always cooked dinner for me, and I never objected to it, so it keeps happening. In fact, my mother cooked dinner from my whole family, but over time everyone moved out. After the divorce, my father moved out, then my brothers moved out, and now she only cooks for me.

Even though my mother is in the habit of cooking dinner for me, this doesn’t happen all the time. For example, last night I had dinner with a colleague at work, so I came back at around nine at night, had a shower, and went to bed. This tradition of my mother cooking dinner for me seems to be the only habit that keeps us together. My grandmother on my father’s side used to wake up early and cook breakfast for me. I didn’t like it because there were days when I wanted to go to work earlier, so I just wanted to make my own breakfast or skip breakfast and just drink coffee, but my grandmother wanted to make breakfast for me. After the divorce that ripped through the family, my grandmother left the house to live with my father, and now I rarely see her. Most relationships are based on dependence and habit. When you are a child and you’re dependent on your parents, you are forced to interact with them, and they become familiar to you, so you bond to them. The same applies with work. You provide skills to your employers, and employers give you a salary, so you are mutually dependent, and over time there are colleagues at work you see all the time, and familiarity breeds trust and bonding. But as people become more independent, that dependency goes away, and as a result, bonds break.

Going back to the topic of my mother and her habit of cooking dinner for me, there are many in my family who jokingly talk about how I need my mother to cook for me (or I need a woman to cook for me), but I think many people say this because many people are traditional, and they believe in the traditional family. They want to believe that the woman’s role is to cook. This includes many traditional women. However, in my opinion, modern technology has made cooking irrelevant. You can easily eat out at restaurants, but even if you consider that to be expensive, it is not difficult to cook simple meals for yourself using e.g. a blender or microwave. For example, it is not hard to microwave or boil beans or to throw fruits and greens into a blender. To clean up, there is the dishwasher. There are many traditionalists out there (mostly women, based on my observation) who want to go back to the days of old when they stayed at home and engaged in low-skilled cooking and cleaning duties, and I think the allure of this is that woman don’t need to go out into the workplace to make money, and this is what drives anti-feminism among women. These women are simply selfish. I would consider myself to be a feminist man, and I encourage all women to get out into the world, work, invest, and become financially independent. They should resist the temptation to glamorize slavery.

My mother does not always cook dinner for me. There are times when I eat out, e.g. when I had a girlfriend a few years ago I spent a lot of time having dinner with her. If I wanted a cheap dinner, rather than eating out, I can bring meal replacement powders (e.g. Aussielent, Soylent, Huel, or Joylent) to work, and after work I can simply mix the powder with water and drink it as dinner. For added nutrition, I can come home and prepare a green smoothie using the blender. Because these foods are simple to make, I am not dependent on my mother for anything.

In the future, I intend to rent a one-bedroom apartment in or near the city because I am quite tired of commuting to and from work. I love to just be able to walk to work. Once I grow my dividends, my dividend income should cover the cost of renting an apartment in the city. As my dividends grow even more, I may be able to work part-time and use the spare time to work in a coworking space doing projects that I enjoy. With the proliferation of cryptocurrencies and blockchain technology, I suspect that a lot of business in the future will be done online and on the blockchain. It is a new frontier. Basically my plan is to transition gradually from living in the suburbs with my mother to living in the city and being self-reliant. I will also transition away from the traditional 9 to 5 job into more flexible work that gives me more control over what I do and with whom I work, and all this will be funded by dividend income. I recently performed a quick back-of-the-envelope calculation and found that I am investing about $70,000 per year, which is a lot. A considerable amount of this (about one-third of it) is going into my superannuation fund, which means I will not have access to it until I am very old) but about two-thirds of it is going into dividend-paying stocks or ETFs, so I expect my dividend income to gradually increase, which will improve my standard of living. I want to use my dividends to fund a more autonomous life with more freedom. I want to be free from my family and from my employer.

I expect freedom to come gradually. Most people have a date when they simply retire. There is a clear date, a line in time when they are no longer slaves but are free. I will have no such date. I believe that slavery is a continuum. On one end you have total freedom, i.e. no debt, good health, and living off enormous amounts of passive income. Then on the other end you have total slavery, e.g. shackled and in prison. Then there are degrees of slavery, and most people have quite a considerable degree of slavery imposed on them by their jobs, their family, their children, their mortgage and car loans, etc. For me, there is no retirement, just a gradual move from slavery to freedom.

As my dividend income increases, I will eat out more for dinner (or drink Aussielent) rather than go home and get my mother to cook. As my dividend income grows even more, I will sleep at home less. Rather than commute back home, I may hire places to sleep at night using Airbnb or I will rent apartments in the city for longer periods of time. The same applies for work. My intention is to reduce my hours so that I work part-time, or I may be more flexible, e.g. I may work at coworking spaces or at cafes. I may even ask my manager if I can work at overseas coworking spaces. This is good for me because I get away from the office, but it is also good for my employer because my desk is not being used, so there are cost savings. If technology is good enough, working remoting should not make me any less productive. This will be my main digital nomad plan, which is to do what I currently do at work but to gradually do it remotely as my dividend income and skills increase. As dividend income and skills increase, I have more bargaining power, and technology will improve over time, which should make remote work be easier. There is also a broader push by feminists for more flexible working arrangement because women want to spend more time looking after their family, so this could possibly benefit me.

Basically with higher dividends, I have more power so that I can shape my life the way I want my life to be. This has been the intention since the beginning. Living off dividends is my guiding philosophy in life because it gives me the freedom and power to do what I want. The basic idea is that you increase dividend income so that you get paid without needing to work, and at the same time you reduce all obligations, e.g. debt, marriage, and children. You minimize responsibility, obligation, and duty. By not putting any future obligation on yourself, you are free to do what you want. You are free to experiment with what makes you happy, and dividend income will allow you to experiment.

At the end of the day, my belief is that freedom depends on the direction of flow of obligation. When you hold stocks, ETFs, government bonds, etc, then there is an obligation for others to pay you money. There is a legal obligation for companies to pay you dividends. There is a legal obligation for the government to pay you interest because you are a bondholder. The flow of obligation is from others towards you. However, if you have debt, then the flow of obligation is reversed. For example, if you have credit card debt or a mortgage, you owe money to the bank. If you have obligations to family, friends, spouse, or children, that also imposes either a legal or social obligation from you to others.

The flow of obligation from you to others makes you a slave. The flow of obligation from others to you makes others your slave and increases your freedom. Freedom or autonomy is dependent on the flow of obligation. Manage the flow of obligation and you manage your freedom, and freedom is happiness.

You Save 100% of Your Salary? What if You Die Before You Retire?

I probably shouldn’t do this, but I told someone recently that I save 100% of my salary and live off dividends. One of the argument he used against this is that, if you save up a considerable amount of money, you deprive yourself while you save and there is a chance that before you retire, you may die, which means you never had the opportunity to enjoy spending the money that you saved.

This made me think about why I continue to live a minimalist lifestyle and live off dividends.

If you die with lots of money saved up, you could have enjoyed that money. However, for many people, freedom is so important that it’s not the spending of money that makes them happy but the holding of money. This applies to me as well. I love to hoard money not because of what I can buy with it but because of the freedom and autonomy it gives me.

If I had, say, $1 million then according to the 4% rule I can spend $40k per year forever. I never need to work ever again so long as I’m satisfied with a $40k per year lifestyle. There is no need to suck up to some boss, and I can do jobs on my own terms and live according to your own rules. I continue to work, but I do the work that I love. That is freedom, and I care about that more than some shiny Ferrari.

You enjoy your work when you’re not dependent on it

In my opinion, you enjoy working when you don’t care if you’re fired. If something at work bothers you, you simply ask your manager if you can be transferred elsewhere. If for some reason you are fired, just shrug and walk to a job agency or find a new job yourself. Because you live off your investments, it doesn’t matter if you’re unemployed. You don’t work to feed yourself because other people feed you.

However, if you’ve never saved up any money, if rather than living off dividends you have massive debt and spending obligations, you are then dependent on your job, and dependency is slavery.

Slavery has not been abolished. It has evolved.

Property vs Margin Loan vs Internally Geared Funds

I have mentioned in a previous post that I don’t like to buy a house. Instead, from experience, I find that it’s best to invest in ETFs. The reason is because ETFs give you flexibility to invest in what you want. If you buy a house as an investment, you are leveraging into one house, and although the general property market may behave one way it’s very hard to know how your house will perform individually. For example, the house price indexes from the Australian Bureau of Statistics averages out results for a number of different houses. If, say, you have a house in Sydney and Sydney house prices went up 5% this does not mean your house specifically went up 5% but that houses in general in Sydney went up 5%.

Furthermore, if you buy a house to live in, you have nothing but debt (unless you buy a house outright without a mortgage, but this is rare). You have a mortgage that you must pay monthly and any benefit from the investment is in the form of capital gains, which you cannot access until you sell the house. You cannot see capital gains, and you cannot access capital gains. Capital gains are invisible and, if there is suddenly a recession, all your capital gain that may have taken you decades to accumulate may disappear in a matter of weeks or months.

Capital gains do not provide the same sort of comfort that cold hard cash income provides. If you have a house, this problem can easily be fixed if you turn your house into an investment property and rent it out, but even if you had an investment property, the performance of an investment property just doesn’t compare to ETFs, in my opinion. Unless you really know how to pick good property, residential property in general has low yields, and after you pay property management fees, taxes, house repair and maintenance, etc, you don’t end up with much, especially not when compared to ETFs that have been engineered to seek out and pay high dividends.

Property is not a good investment. From my experience with residential property, once you buy a property, suddenly everyone wants money from you and everyone sends in their bills. Once you buy property, you need to pay bank fees, mortgage interest, lawyer fees (for conveyancing), real estate agent commissions, taxes (stamp duty and land tax), and property manager fees. Once something goes wrong in your house (e.g. the shower breaks) you need to get a repairman in to fix it, and he send you a bill as well.

Investing in high-dividend paying ETFs is completely different. You use an online broker (e.g. CommSec) to buy ETFs listed on a stock exchange, and then you sit back and watch money flow into your bank account. That’s it.

What about leverage?

One of the benefits of property is leverage. Because you borrow money from the bank, you have more assets exposed to the market, which means potentially higher gains. However, leverage works both ways. If the asset price does not go up enough to compensate you for the interest expense, you will lose money, and when you are leveraged, you will lose a lot of money.

That being said, leverage is a legitimate strategy if you want to accept higher risk to get higher returns. You are effectively moving up the efficient frontier.

Leverage is easy to achieve using ETFs. There are two options: (1) invest in leveraged ETF (e.g. the Betashares Gear Australian Equity Fund (ASX: GEAR)) or (2) apply for a margin loan to borrow money from the bank to buy stocks or ETFs.

Based on the modelling I have done, all these options (property, margin loan, and leveraged ETFs) have somewhat similar returns, so it doesn’t matter which you do so long as you feel comfortable with the risk you are taking. However, that being said, I think that out of these three choices, property is the worst because once you sign up to borrow money from the bank, you have a monthly mortgage that you must pay. You basically have a noose around your neck. If you don’t pay it, the bank will sell your house, and you will incur substantial transaction costs. When you have a margin loan, many people will try to scare you about the dreaded so-called “margin call” but this I think is overblown. The bank will only step in to induce a margin call when your debt levels are high relative to the value of your assets (they look at your loan-to-value ratio or LVR). They do this because, if you have a high LVR, the risk you are taking is too high, and the bank will get worried that the size of your debt will be too high relative to the size of your assets, which means you may owe the bank money that you may not pay. As part of their risk management, banks will monitor your LVR and intervene to lower your LVR if you raise it too much. This applies not only with stocks but also with property.

Banks will intervene to lower your LVR if you have not been paying your mortgage. If you miss a mortgage payment or two, the bank may allow it because your LVR will not be too high, but if it goes on for too long and your debt levels start to rise too much, the bank will intervene to sell your property. Therefore, regardless of whether you have a property or a margin loan, the bank will still intervene if the LVR is too high. So long as you keep watch of your LVR and make sure it is not too high, you will be fine.

When managing your LVR, the problem with property is that you have zero control over your portfolio. Once you buy your house, there’s littel you can do to affect the volatility of the asset. You have zero control. However, if you own a portfolio of shares or ETFs, you can control how much volatility there is in the portfolio by buying specific listed assets. Managing volatility is important to managing your LVR because volatility affects the value of the portfolio, which of course impacts the denominator in the LVR. If you use a margin loan to leverage, say, into the Chinese stock market (e.g. the iShares China Large-Cap ETF (ASX: IZZ)) then the risk you face (and therefore the probability of a margin call) will be much higher than if, say, you invest in stable assets such as global infrastructure (e.g. via the AMP Capital Global Infrastructure Securities Fund (ASX: GLIN)).

There is a much easier way of leveraging that involves zero risk of a margin call, and this is by investing in internally geared funds. With internally geared funds, you don’t borrow. Rather, you take your money and invest it in the fund. The fund manager collects your money (as well as money from other investors) and uses this to borrow money from the bank in order to invest in stocks. Because debt is handled by the fund manager (rather than you yourself), you don’t owe anyone anything ever. Betashares currently offer two listed internally geared ETFs: GEAR, which leverages into Australian stocks; and GGUS, which leverages into US stocks.

According to the Betashares website, the fund is “‘internally geared’, meaning all gearing obligations are met by the Fund, such that there are no possibilities of margin calls for investors.”

Gearing via an internally geared ETF, in my opinion, is the optimal strategy unless you want to borrow money yourself so you can claim the interest expense as a tax deduction. However, that being said, if you borrow money yourself, because you are only one man (or woman), you will typically pay between 4 to 6 per cent at current rates, but if you invest in a leveraged ETF, the fund manager is responsible for borrowing, and the fund manager has access to low institutional interest rates (supposedly around 3%) thanks to its buying power. You are therefore able to gain even greater leverage with internally leveraged ETFs.

Conclusion 

I used to be very much against gearing because I strongly believe that debt is slavery, but now I accept that gearing can be a legitimate strategy so long as you have robust downside protection. I believe that no matter what you do (when investing and in life in general), it’s good to take risk because more risk provides greater return, but risk must be managed. It is okay to take risk so long as you have a safety net or a fallback plan if everything goes wrong.

My Thoughts on “The Big Short”

Yesterday I was watching a movie called The Big Short and it’s an awesome movie about the GFC. The movie makes me wonder about whether we are in for another financial crash. Stock and property markets went down about 50% in America and most countries around the world, but since then central bank injections of cash seem to have restored everything.

This movie blames the property crash on subprime loans, but at the end of the day subprime lending popped the entire American housing bubble. The bubble was there in the first place, and the bubble was in property, not just subprime property but also prime property, which is why property prices in the US fell across the board.

This movie also really exposed how corrupt and fraudulent the financial system is. The biggest injustice of all, in my opinion, is that investment banks created these toxic assets (CDOs, etc) and then when they were worthless they simply did a deal with the government to unload it onto the government in return for printed money (or bailout money). This pretty much means the banks can do whatever they want knowing that if things go wrong they can simply get the government to bail them out. If you or I started a cafe and the business failed, the government will not bail us out. However, this does not apply to bankers, the holders of capital. Capitalism, therefore, does not apply to capitalists. Bankers can create bubbles, create bad assets, and then sell these assets, and if everything goes wrong they can just tell the government to take it off their hands. There should be no bailout, and those who held CDOs should have been left to learn the errors of their ways. By bailing them out, you only reward bad behavior.

Looking at it this way, the banking industry is simply an arm of the government. Banks are simply government business enterprises.

The original view was that if the government prints money to buy these toxic assets off bankers, this would cause inflation, but these toxic assets are usually highly leveraged, and more debt actually increases the amount of the money in circulation, which is inflationary. As debt prices go down (e.g. there is a debt bubble that pops) then this means the expectation is that loans will not get paid, and the amount of money in circulation goes down, which is deflationary. The government printing money simply restores the money supply back to original levels. 

How to invest

My investing strategy is pretty simple. I’ve been focusing mainly on dividends and looking at funds that provide low volatility. The perfect ETF on the ASX, in my opinion, is Betashares’s HVST, which has a double-digit yield and pays monthly. It also uses derivatives to lower volatility by selling futures when volatility is high. If the market crashes, I’m sure this fund will go down, but it won’t go down that much, and while everything is rosy, this fund will produce great dividends, which is awesome.

If there is a GFC 2, I expect to take a hit. My net worth will go down, but I have been loading my portfolio up with funds that are designed to be low volatility (such as HVST) as well as other defensive investments like gold mining ETFs (ASX: GDX) as well as bond funds, and so if my net worth goes down, it won’t go down much, and when the market bottoms, I will definitely be plowing as much money as possible into leveraged ETFs expecting the government to print money to restore the economy. While the market is likely in bubble territory now, it’s also a good idea to keep debt levels low because a major risk when there is a market crash is that a margin call will be triggered. Keeping debt low reduces the risk of this happening. Furthermore, as the market bottoms, if your debt levels are low, you have more ability to take on more debt to invest when the market bottoms, which means you can leverage into leveraged ETFs and achieve “double leverage” to magnify your returns once central bankers start firing up the printing presses.

Bottom line is that at this stage you should load up your portfolio with defensive assets, e.g. cash, bonds, gold, as well as “smart beta” low-volatility ETFs, but don’t go all into these defensive assets because it’s almost impossible to determine when a bubble will pop. As they say, a market can stay irrational longer than you can stay solvent, so often when a bubble is formed, it’s often best to simply ride the bubble and make money, but always have a plan to protect yourself if the bubble bursts. There must be a plan B.

 

Commitment Phobe by Choice

It makes my blood boil when I read Generation who refuse to grow up: No mortgage. No marriage. No children at the Guardian, mainly because it reminds me of the many people over the years who have suggested to me that now that I have turned thirty (or when I was in my late twenties) that I must be a responsible adult and buy a house, get married, and have children.

There is so much negativity about commitment phobia on men that you’d think there was a concerted advertising campaign being funded by the real estate, wedding planning, and children’s lifestyle industries in order to encourage us to spend more.

Buying a house, getting married, and having children are very personal matters, so I don’t want to criticize others if they decide to walk down these paths, but what I hate is the assumption almost everyone has that by a certain age I must do this or that. People give you all sorts of rules that are clearly just made up: you must date a girl for this long before you are officially in a “relationship,” then you must be in a relationship for x years before you buy her a ring. You must then save up y years worth of salary to buy the ring, and then you must marry her, and then you must buy a house, etc, etc. And if you don’t follow this formula like a slave, many people have the balls to tell you that you are not “man enough.” They tell you to “man up” and start taking responsibility.

Seriously? If I were a conformist beta male who followed what other people say I should do and get married, buy a house, then that makes me a true man? And if I defied society and did what I wanted to do instead, that would make me less of a man?

The term “commitment phobe” is used a lot. There is even an article on Psychology Today titled Understanding and Dealing with Commitment-phobia that talks about reluctance to commit as if it were a mental disease. I absolutely hate it when people talk about reluctance to commit in relationships as if it were scientifically proven to be some mental impairment when if fact it is not a scientific or medical defect.