Thursday, August 9, 2012

Blueprint for getting rich – part I

All the ingredients for getting rich have been presented on this blog over the last number of years. So now we’ll try to make this into a plan – a “Blueprint to get rich”:
1.       State ‘Your Belize’ (i.e. your vision of the future)
You want to retire 25 years from now at the age of 22 - J 
That means you want to have a net worth of at least $1.5 million 25 years from now so that you can live and work independently of an employer. (In plain English you want to be able to say to your employer “scr/// you!” without losing your meals and house - J - I am having so much fun).
2.      To do so you, as a household, will have to save around $10,000 per year. You do that by living below your means. Saving will initially be difficult but over time with increased pay cheques that will get easier. Maybe, at a later age, you we will be able to save $15,000 per year and speed up reaching your ‘financial adulthood’ also known as retirement
3.       First you save a down payment for your first home using your TFSA (Tax Free Savings Account)
4.       You buy your home
5.       You put your annual $10,000 savings from now on in ETFs which are tax protected in your TSFA
6.       You will work for an employer who provides you with an attractive company savings plan.

7.       That’s all folks. See you in 25 years.
Really, this should get you pretty close to $1.5 million in 25 years. You want details?  OK, you get details.
The secret of getting rich is RETURN ON INVESTMENT (ROI) also defined in ‘Godfriedese’ as the speed at which your net worth increases. But speed is not all, just ask the speed bumps. You need cash flow to get through the bad times. It is really about COI (cash on investment) and ROI.
The best source of funds for a down payment is your job and some generous parents. Really, a down payment is doing more for your future lifestyle than a vacation in Mexico or the Caribbean. How much do you need?  Not a lot, you can probably scrape it together in under two years!  So, we’re starting with a cheap place – hopefully even cheaper than cheap.  So buy an older townhouse or 2 bedroom apartment. In Calgary you can get that from around $200,000 which means that you can buy with as little as 5% down or $10,000. But then you have to pay mortgage insurance to protect the bank. And if the house value falls just a little bit, your mortgage is ‘under water’, i.e. you owe more than the place is worth. It is safer to aim for 20% down because then you don’t have to pay mortgage insurance. That would be 40,000 down.
$40,000 down would be ideal and if you can get help from parents, I highly recommend it. For most people however, would be best to go with 10% down or $20,000. Even with not a penny in your bank account now, when saving $10,000 per year starting today then you would have this together in 2 years.  Why is owning your own place so important?  Well let’s do the math – yes if you want to get rich you need to do some basic math. No Calculus mind you, but plain high school math is a must. Remember the APOD (A Viable Investment) ? Well, we’re doing here something similar.
If you currently rent a normal apartment in Calgary you pay typically $1200 to $1300 in rent plus another $150 or so for utilities. Would you be able to pay that rent to yourself instead? So be your own landlord and run the APOD as shown below:
Click to magnify

Now deduct your ‘operating expenses’ (Oh lordy, lordy I hope my tenants don’t read this blog J):
Click to magnify
  Hmmm, after expenses you have still $10,340 in net operating profits that you use to pay your mortgage. In Calgary, you can get a 25 year mortgage for around 3% interest or for monthly payments of… $851.84 with your $20,000 down payment. Historically your Calgary apartment will appreciate around 4 to 6% per year. In the APOD I am using an even more modest rate of 3% - just a smidgen above the inflation rate. $851 per month is nearly $10,340 per year. Thus rather than pay rent to some anonymous landlord you pay the rent to yourself. Use this ' rent'  to pay for operating and financing costs. In effect your cost of living hasn’t changed from when you were a renter and you can keep on saving your regular $10,000 per year! Which from now on you will invest in ETFs stored in a TFSA. We’ll talk more about that later.
So, how much do you make on your first real estate investment? Well here is the rest of the APOD:
Click to magnify
 First of all, your mortgage payment goes to two items: interest and principal pay down! Your total annual mortgage payment is $10,222.10 of that goes $5299.65 towards interest (in coming years the interest goes down), the mortgage pay down reduces your debt by $4922.45 in the first year!  This money is of course yours! The mortgage is nothing more than a forced savings plan and so each year you save an extra $5 grant on top of your normal $10,000. So consider, just like with a rental property, the $5 grant as profit. Now add to this profit the annual appreciation which is 3% of $200,000 or another $6000. Your total profit in the first year is $11,040.35 on your investment (down payment) of $20,000 or a return on your investment of 53%!!! You won’t get that in the stock market!
But remember you’re using leverage and your ability of making your mortgage payments is the biggest risk factor. If the apartment appreciates nicely at 3% per year (which it likely won’t do – it is more up and down) then after 5 years, your property is probably worth $232,000 and you own the $32,000 appreciation plus you paid down your mortgage by that time by another $27,000. Now how is that for wealth accumulation? Oh, and do not forget the 5 years of $10,000 annual savings or $50,000 you socked away in the TFSA.  After 25 years your mortgage is paid off and your apartment is now 100% owned by you and worth around $405,000.00
They say the first $100K is the toughest, well you just saw how it’s done. 

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