Sunday, April 29, 2012

Do something simple and profitable; do it over and over again!

That is something Ed Davis, a Calgary Entrepreneur told me in a presentation many years ago. “To get rich, you do something simple and profitable and then you do it over and over again” That is not exciting in the view of many retail investors who think they get rich by discovering the next Google, Facebook or the next Microsoft (for us old computer nerds).
But really, what did Microsoft do?  It made a piece of software (Windows) and sold it over and over and over again!  What does Google do? It helps you find something on the internet and you have to look at a Google ad over and over again!  How does that differ from Coca-Cola who puts some syrup in water and sells it throughout the world, over and over again?
As a geologist, I do the same thing. I learned how to evaluate oil and gas pools. The more I do it the better I get at it and…  I do it over and over again in return for a nice paycheque. You may say, “But that is boring and not risky!  It is risk and reward that makes the money!” My answer: Wrong, you are dead wrong!
In the book “The Millionaire Next Door”, the typical millionaire next door is a very boring guy or gal who is a small business owner for many years, or a teacher, or an engineer. They live in modest but good houses, are married and never divorced. They live below their means and they often reside in small to middle sized towns, like Omaha (Nebraska) – get it?.
Yes there are people that get rich investing in fast growing, revolutionary companies – their founders (one in a million) and the stock promoters they get rich! Wall Street legend Peter Lynch and long before him, the father of value investing: Benjamin Graham already told us that investing in stocks is like owning a business. Owning a business is boring because the good ones do something simple like selling toothpaste or razorblades and they do it over and over again. They are profitable year in and out, they reinvest a bit of their earnings to update their manufacturing facilities or to expand; the rest is paid out to investors as ever increasing dividends and stock buybacks.  Really, in the old country we used to say (in Dutch): “Better one bird in the hand than 10 in the air” (the original text is available free of charge plus a $10 shipping fee J). In fact, just like collecting dividend, this expression is so valuable it can be found back throughout the world including in common wealth country where it is distorted into “A bird in the hand is worth two in the bush”.
That reminds me! Did you know that Santa Claus is copied from the Dutch Sinterklaas?  O yeah! And… even worse, the concept of original Canadian main stay goods such as Tim Horton’s donuts is copied from the Dutch ‘olie bol’ or appel beignet (http://www.dvcuisine.com/images/stories/vicky-gabereaux-recipes.pdf). Never mind that ‘beignet’ is a French word. J
Where were we?  O yes: “Boring”. What can be more boring than David Chilton’s “pay yourself first”, i.e. put the first 5 to 10% of your paycheque in a savings account before spending the rest!  Wow, now that is boring! We could spend that money on booze or a hockey game or on a nice exciting trip to Las Vegas for some action!  Saving? Yuck!
Yes saving… and while we are at it, add your annual Christmas bonus and your tax refund and family allowance to that. In a short time, this becomes such a habit that you don’t even notice it in your daily life.  So how much are we talking about?  Well if you take someone with an annual income of $60,000 and a 5% Christmas bonus the savings are around $3750 from the pay cheque and another $3000 bonus. Total savings are $6750 per year. Put $5000 in a tax free savings account (TSFA) at a discount broker and the remainder in an ING savings account. Invest the TSFA money in a dividend paying ETF e.g. Claymore’s Canadian Dividend Fund or in a MIC (mortgage investment corporation). And… forget about it until next year. Do this over and over again!
A number of months ago Gordon Pape recommended a MIC that trades on the Toronto Stock Exchange  It has done well for me to date. The MIC is Firm Capital Mortgage Investment Corporation (symbol FC-T) and it pays currently a monthly interest distribution at an annual rate of 7%. An example of a dividend paying ETF, also a recommendation of Gordon Pape if I remember right: iShares (formerly Claymore) S&P/TSX Cdn Div Fund (symbol: CDZ-T).  CDZ has a dividend yield of 3.2%. Here is a link to its data: http://ca.ishares.com/product_info/fund/overview/CDZ.htm?fundSearch=true&qt=CDZ
I mention these two investments because they create a lot of cash flow. Every month you get a bit of bird. If you invest equally in FC and CDZ, your monthly tax free income is 5.1% not to mention appreciation.  So a year later you'd have $5000 + appreciation plus $255 in distributions + $1703 (incl interest on ING) plus another $6750 saved. He… you accumulated at least: $13708 plus appreciation. How much appreciation? Who knows, 5 to 10% could be a reasonable assumption.. so add another $500 for a total of $14208.
Now, supposed you rented an apartment for $1000 per month. Then after year 2 you could use $14208 as down payment for a $142,028  CMCH insured first-time-home-owner apartment. So let’s play this out a bit further. At the start of year 3 you buy your apartment with 10% down and condo fees of $250 plus (assuming a 35 year amortized mortgage at 3% plus $800 property taxes) that would be: $835 per  month. Oops, you’re paying $175 per month less in rent – savings!. If your place appreciates 3% per year, you made at the end of year 3:  $4200/14208 = 30% profit plus… yes there is a plus because you paid that year down your mortgage by $2,223 and you saved another $6750 (not counting salary increases).  Oops: after three years your net worth is: $22731.  All tax free!
If you can do that in three years, wouldn’t it be boring to keep this up for the next 40 years?
Before I forget! If you are working for a large corporation, chances are that there is an employee savings plan where you can contribute typically up to 10% of your gross income. So each month, they deduct 10% of your gross income from your paycheque, i.e. $6000 per year…. And your employer gives you a dollar and sometimes even a dollar and half contribution for each dollar that you saved!  Yes, Yes! That means, you save $6000 per year and your employer adds another $6000 to $9000 from their pocket! You’re total annual savings are... between the $12,000 and $15,000. Now don’t tell me that ‘boring’ is not exiting!
It is all so simple and the only thing you have to do is: doing this profitable thing over and over  again!

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