I have updated my budget through to the end of the year to take into account:
(i) the recent sale and purchase of properties (including different rental levels and mortgage payments)
(ii) changes to spending to reflect additional costs associated with my children (which I fear will be the beginnings of a trend)
(iii) changes to my income projections for the rest of the year
(iv) a short holiday at Christmas for the family in Asia instead of further away (at lower cost).
Even after putting aside money for tax I will still have a cash surplus at the end of the year and the surplus will be slightly larger than the previous budget. The question is: what should I do with it?
Monday, July 30, 2007
Sunday, July 29, 2007
Predictions of economic doom usually wrong
Last week's sell off in the markets resulted in long faces among some investors and talk of a either a "crash", a "correction"or an "opportunity to buy the dips"among the media.
My take: the sell off is nothing to get excited about and not something that justifies much in the way of comment. Last week's sell off is nothing more than normal market volatility and evidence that capital markets are working in the usual manner.
A more interesting question is whether we are seeing the beginnings of either an economic slow down or a genuine tightening in the credit markets. Problems with sub-prime lending and the US housing market notwithstanding, I see no evidence of either at this point. That said, I am generally inclined to ignore predictions of economic doom given that the majority of such predictions are simply wrong. Here are some examples:
1. 1987 share market crash: while it lead to a deep recession in some economies (Australia, New Zealand) there was no world wide recession and most markets recovered fairly quickly. The endless comparisons to the 1929 crash and resulting depression were all well off the mark;
2. 1997 Asian crisis: it caused a lot of economic misery in Asia ( Thailand, Indonesia, Hong Kong etc) but the rest of the world was largely unaffected;
3. Y2K: this was a complete non-event (unless you were one of those who had the misfortune to spend the new millennium sitting in a crisis management office);
4. 2000 tech wreck: largely an isolated event that was bad news for investors in the tech heavy NASDAQ index and people who worked for a small number of companies that failed for one reason or another (bad business models, accounting fraud) but a non-event for the rest of the world;
5. 2002/3: SARS/Avian flu: the world wide pandemic never emerged. Only Hong Kong was effected to any noticable extent. Within a year of the SARS epidemic, Hong Kong's economy, share market and property market had all recovered strongly.
There are plenty of other examples I can point to. Certainly there will be economic ups and downs. Some will be global events while others will be much more localised. My point is that the only doom sayers who usually manage to predict such events correctly are those who predict doom and gloom on a regular basis (and who history has shown to be usually wrong).
The most irritating thing about all these events is that I have a poor record of taking advanatge of the investment opportunities that they create.
My take: the sell off is nothing to get excited about and not something that justifies much in the way of comment. Last week's sell off is nothing more than normal market volatility and evidence that capital markets are working in the usual manner.
A more interesting question is whether we are seeing the beginnings of either an economic slow down or a genuine tightening in the credit markets. Problems with sub-prime lending and the US housing market notwithstanding, I see no evidence of either at this point. That said, I am generally inclined to ignore predictions of economic doom given that the majority of such predictions are simply wrong. Here are some examples:
1. 1987 share market crash: while it lead to a deep recession in some economies (Australia, New Zealand) there was no world wide recession and most markets recovered fairly quickly. The endless comparisons to the 1929 crash and resulting depression were all well off the mark;
2. 1997 Asian crisis: it caused a lot of economic misery in Asia ( Thailand, Indonesia, Hong Kong etc) but the rest of the world was largely unaffected;
3. Y2K: this was a complete non-event (unless you were one of those who had the misfortune to spend the new millennium sitting in a crisis management office);
4. 2000 tech wreck: largely an isolated event that was bad news for investors in the tech heavy NASDAQ index and people who worked for a small number of companies that failed for one reason or another (bad business models, accounting fraud) but a non-event for the rest of the world;
5. 2002/3: SARS/Avian flu: the world wide pandemic never emerged. Only Hong Kong was effected to any noticable extent. Within a year of the SARS epidemic, Hong Kong's economy, share market and property market had all recovered strongly.
There are plenty of other examples I can point to. Certainly there will be economic ups and downs. Some will be global events while others will be much more localised. My point is that the only doom sayers who usually manage to predict such events correctly are those who predict doom and gloom on a regular basis (and who history has shown to be usually wrong).
The most irritating thing about all these events is that I have a poor record of taking advanatge of the investment opportunities that they create.
Saturday, July 28, 2007
Bank Manager Quits
I had developed a very good relationship with a manager at the bank which provides most of our property finance in Hong Kong. He made loan applications about as easy as I could reasonably expect (short of doing no financials loans). Everything was done by phone or e-mail and he came to see me when the time came to sign the documents. I never had to get off my butt and visit the bank. If I pointed out that another bank was offering a better deal he would match it. Best of all, he would get the bank approval required for each tenancy in a matter of days without ever having to amend the terms of a lease (other banks could take weeks and would insist on pointless or impossible amendments). Things had reached the point were he was taking me out to lunch.
Anyway, he has quit to join another bank (unfortunately one with which I have had less satisfactory dealings) so I will need to build up a relationship with his successor.
Anyway, he has quit to join another bank (unfortunately one with which I have had less satisfactory dealings) so I will need to build up a relationship with his successor.
Friday, July 20, 2007
My accountant would not approve
Keeping a form of personal net worth balance sheet is a useful financial planning tool. I've been doing it in one form or another for many years. Keeping a balance sheet requires some decisions as to what is included and what is excluded.
A true statement of (financial) net worth would include every asset ranging from our home to my oldest pair of socks. Each asset would be listed and valued at current realisable value. Every obligation including accruals for future expenses would be set out on the other side of the balance sheet. The difference between the two numbers would be my net worth at a given point in time.
While that approach may meet the approval of purists and accountants, it suffers from three flaws:
1. it is hopelessly impractical. I have better things to do with my time than to count the sets of underwear in the laundry hamper;
2. placing a value on many of the non-financial assets is nothing more than a guessing game;
3. many of the non-financial assets have no relevance to the purpose for which the balance sheet is drawn up. Knowing how many t-shirts I have will not affect my retirement planning.
Accordingly, it is sensible to confine the balance sheet to those items which are relevant to the purpose of financial planning. This is actually quite easy. There are no items (included or excluded) which I have any ambivalent thoughts about.
In the asset side of the balance sheet I include all our investments: shares, properties (including our home), managed funds, bullion, cash and foreign exchange. On the liabilities side I include all our borrowings and accruals for tax (there is no PAYE in Hong Kong), and an estimate of expenses incurred but not paid (e.g. credit card and utility bills). Everything else is ignored.
The items that are not included are items intended to be consumed (e.g. furniture, clothes), paintings (probably worth something but not much), my wife's jewellery (ditto) and my modest collection of claret (at least some of which will be drunk). If we had a car (completely unnecessary in Hong Kong), it would be treated as an item to be consumed and excluded.
Every item in the balance sheet needs to have a number assigned to it. Liabilities are all hard numbers (even the accruals are fairly accurate). Assets such as shares, managed funds, bank deposits and foreign exchange can be valued simply by checking the latest prices on line. The only asset which has any uncertainty attached to it is real estate. Assessment of current market prices is something of a guess. (A real estate agent looking to win a listing will give you a very different number from a bank officer looking for a worst case forced sale valuation.) I take an approach which makes life simple and errs on the side of under valuing the assets. All real estate is included at cost. Cost means the purchase price + stamp duty + agency + initial fit out + other transaction costs. I make no attempt to reflect current values in the balance sheet (although current values of the portfolio are well above cost.
My accountant would not approve but it makes my life easier and ensures that I do not fall into the trap of thinking that I am better off than I actually am.
A true statement of (financial) net worth would include every asset ranging from our home to my oldest pair of socks. Each asset would be listed and valued at current realisable value. Every obligation including accruals for future expenses would be set out on the other side of the balance sheet. The difference between the two numbers would be my net worth at a given point in time.
While that approach may meet the approval of purists and accountants, it suffers from three flaws:
1. it is hopelessly impractical. I have better things to do with my time than to count the sets of underwear in the laundry hamper;
2. placing a value on many of the non-financial assets is nothing more than a guessing game;
3. many of the non-financial assets have no relevance to the purpose for which the balance sheet is drawn up. Knowing how many t-shirts I have will not affect my retirement planning.
Accordingly, it is sensible to confine the balance sheet to those items which are relevant to the purpose of financial planning. This is actually quite easy. There are no items (included or excluded) which I have any ambivalent thoughts about.
In the asset side of the balance sheet I include all our investments: shares, properties (including our home), managed funds, bullion, cash and foreign exchange. On the liabilities side I include all our borrowings and accruals for tax (there is no PAYE in Hong Kong), and an estimate of expenses incurred but not paid (e.g. credit card and utility bills). Everything else is ignored.
The items that are not included are items intended to be consumed (e.g. furniture, clothes), paintings (probably worth something but not much), my wife's jewellery (ditto) and my modest collection of claret (at least some of which will be drunk). If we had a car (completely unnecessary in Hong Kong), it would be treated as an item to be consumed and excluded.
Every item in the balance sheet needs to have a number assigned to it. Liabilities are all hard numbers (even the accruals are fairly accurate). Assets such as shares, managed funds, bank deposits and foreign exchange can be valued simply by checking the latest prices on line. The only asset which has any uncertainty attached to it is real estate. Assessment of current market prices is something of a guess. (A real estate agent looking to win a listing will give you a very different number from a bank officer looking for a worst case forced sale valuation.) I take an approach which makes life simple and errs on the side of under valuing the assets. All real estate is included at cost. Cost means the purchase price + stamp duty + agency + initial fit out + other transaction costs. I make no attempt to reflect current values in the balance sheet (although current values of the portfolio are well above cost.
My accountant would not approve but it makes my life easier and ensures that I do not fall into the trap of thinking that I am better off than I actually am.
Thursday, July 19, 2007
Your home's value and your net worth
Mighty Bargain Hunter recently published this post on why he does not consider it appropriate to include the value of his home in his net worth calculation. As the comment I submitted appears to have been lost in the internet or caught in a spam filter (the story of my life), I set out my comments here. [Edit: it looks like the delay in publishing was due to a spam filter. My comments now appear on Mighty Bargain Hunter's blog.]
There have been many articles written about whether a person's home is an asset or a liability and whether it is relevant to retirement planning. My take on these questions is set out in these three posts: Part 1 , Part 2 and Part 3 .
Mighty Bargain Hunter makes the very valid point that an over inflated sense of financial net worth can be dangerous - especially to people who lack even a modest degree of financial self discipline and, on occasion, even to those who are reasonably savvy. Some of the horror stories of people who borrowed against their home equity to finance consumption spending illustrate the point very well. While I am of the view that home equity is part of net worth, if excluding it from your personal balance sheet motivates you to save more or to spend less, then excluding it is the right thing to do.
However, I must respectfully but strongly disagree with some of other reasons given for not including home equity in a net worth statement:
1."I didn’t earn a dime of that increase. "
This is not true. Mighty Bargain Hunter earned every penny of the increase when he risked his deposit (if any), his credit rating and his future cash flow in taking out the mortgage loan and making the purchase.
2. "The increase in my net worth is a gift from easy money policy and wild real estate speculation."
So what? I really struggle to see why this is relevant to the question of whether or not to include home equity in a net worth calculation. While easy money policies and speculation did contribute to increases in real estate values, studies have shown other factors to be more significant: land supply, planning restrictions and demographic shifts among them. More to the point, the same easy money policies and speculation have also contributed to increases in equity prices. If home equity is excluded on this basis then logically equity price gains should also be excluded. Another problem is that if this logic was applied consistently then any increase in value of an investment property should also be excluded? My take is that the cause of an asset increasing or decreasing is irrelevant to issue of whether or not to include that asset in a net worth calculation.
Another way of looking at the issue is to ask whether you would take negative equity into account if the value of your home declined due to tighter credit conditions (rising interest rates) and panic selling? Failing to do so would consistent with the view that increases in the value of home equity should not be included in a net worth calculation. However, that approach would create the same problem that Mighty Bargain Hunter is addressing - it would over inflate the net worth picture.
My own take is that I include both the asset (our home) and the liability (our mortgage) in my net worth calculation. I do this for two reasons:
1. I like to see the complete picture;
2. home equity is important to my retirement plan and it is important to keep track of it as part of the planning process.
If I felt that excluding the value of my home equity from the calculation would improve my financial management, then I would consider taking a different approach.
There have been many articles written about whether a person's home is an asset or a liability and whether it is relevant to retirement planning. My take on these questions is set out in these three posts: Part 1 , Part 2 and Part 3 .
Mighty Bargain Hunter makes the very valid point that an over inflated sense of financial net worth can be dangerous - especially to people who lack even a modest degree of financial self discipline and, on occasion, even to those who are reasonably savvy. Some of the horror stories of people who borrowed against their home equity to finance consumption spending illustrate the point very well. While I am of the view that home equity is part of net worth, if excluding it from your personal balance sheet motivates you to save more or to spend less, then excluding it is the right thing to do.
However, I must respectfully but strongly disagree with some of other reasons given for not including home equity in a net worth statement:
1."I didn’t earn a dime of that increase. "
This is not true. Mighty Bargain Hunter earned every penny of the increase when he risked his deposit (if any), his credit rating and his future cash flow in taking out the mortgage loan and making the purchase.
2. "The increase in my net worth is a gift from easy money policy and wild real estate speculation."
So what? I really struggle to see why this is relevant to the question of whether or not to include home equity in a net worth calculation. While easy money policies and speculation did contribute to increases in real estate values, studies have shown other factors to be more significant: land supply, planning restrictions and demographic shifts among them. More to the point, the same easy money policies and speculation have also contributed to increases in equity prices. If home equity is excluded on this basis then logically equity price gains should also be excluded. Another problem is that if this logic was applied consistently then any increase in value of an investment property should also be excluded? My take is that the cause of an asset increasing or decreasing is irrelevant to issue of whether or not to include that asset in a net worth calculation.
Another way of looking at the issue is to ask whether you would take negative equity into account if the value of your home declined due to tighter credit conditions (rising interest rates) and panic selling? Failing to do so would consistent with the view that increases in the value of home equity should not be included in a net worth calculation. However, that approach would create the same problem that Mighty Bargain Hunter is addressing - it would over inflate the net worth picture.
My own take is that I include both the asset (our home) and the liability (our mortgage) in my net worth calculation. I do this for two reasons:
1. I like to see the complete picture;
2. home equity is important to my retirement plan and it is important to keep track of it as part of the planning process.
If I felt that excluding the value of my home equity from the calculation would improve my financial management, then I would consider taking a different approach.
Tuesday, July 17, 2007
Mandatory Provident Fund Fees Slammed
The South China Morning Post included an article describing the effect of fees and costs on the payout which retirees can expect from their investment in their mandatory provident fund (MPF). (For those not living in Hong Kong MPF is our mandatory retirement savings scheme.) The article was derived from a report from the Consumer Council.
The report essentially said that based on returns of about 5% per annum, fees of up to 3% per annum would effectively consume about half of the total return over a lifetime of saving.
This is not rocket science. It is not news. The absurdly high fees (even by the standards of the Hong Kong funds industry) go a long way towards explaining why so few people make more than the statutory minimum investment into their MPF plan ( I do not know of anyone). In fairness to the service providers, some of those fees are justified by the additional regulatory burden imposed by the regulations. How much? I do not know, but not much.
The MPF scheme is a poor one. In fact it is an awful scheme. In its defence, it has only three things going for it:
1. it is compulsory: while the merits of compulsion are debatable, as a tax payer I do not want to face rising tax bills in my old age to pay retirement benefits to those who did not save while working;
2. only a limited range of substantial institutions can offer schemes and assets must be held through an approved custodian: there is very little risk of scheme assets being lost as a result a manager or custodian failing;
3. it is a defined contribution scheme: much better in the longer term than defined benefit schemes.
The reasons why the MPF scheme is so awful are:
4. no choice: employees must use the scheme provider selected by their employer;
5. day to day fees and costs are outrageously high. Low cost index funds are unheard of;
6. the cost of switching service providers can cripple already poor returns. If you switch jobs and have to switch your service provider you will be screwed.
In effect, savers are assured of achieving returns well below market and even below what they would expect the average actively managed fund to achieve.
The MPF scheme should be scrapped and replaced with a more flexible mandatory scheme. Savers should have the option of setting up and managing their own scheme and given a much better range of investment options. Default options can be used for those who do not wish to (or fail to) take control of their own retirement savings.
The report essentially said that based on returns of about 5% per annum, fees of up to 3% per annum would effectively consume about half of the total return over a lifetime of saving.
This is not rocket science. It is not news. The absurdly high fees (even by the standards of the Hong Kong funds industry) go a long way towards explaining why so few people make more than the statutory minimum investment into their MPF plan ( I do not know of anyone). In fairness to the service providers, some of those fees are justified by the additional regulatory burden imposed by the regulations. How much? I do not know, but not much.
The MPF scheme is a poor one. In fact it is an awful scheme. In its defence, it has only three things going for it:
1. it is compulsory: while the merits of compulsion are debatable, as a tax payer I do not want to face rising tax bills in my old age to pay retirement benefits to those who did not save while working;
2. only a limited range of substantial institutions can offer schemes and assets must be held through an approved custodian: there is very little risk of scheme assets being lost as a result a manager or custodian failing;
3. it is a defined contribution scheme: much better in the longer term than defined benefit schemes.
The reasons why the MPF scheme is so awful are:
4. no choice: employees must use the scheme provider selected by their employer;
5. day to day fees and costs are outrageously high. Low cost index funds are unheard of;
6. the cost of switching service providers can cripple already poor returns. If you switch jobs and have to switch your service provider you will be screwed.
In effect, savers are assured of achieving returns well below market and even below what they would expect the average actively managed fund to achieve.
The MPF scheme should be scrapped and replaced with a more flexible mandatory scheme. Savers should have the option of setting up and managing their own scheme and given a much better range of investment options. Default options can be used for those who do not wish to (or fail to) take control of their own retirement savings.
Friday, July 06, 2007
New Property Purchase (3) - Completion
Out with the old and in with the new. The sale of one small property completed at the end of June and the purchase of a larger property completed yesterday with no problems.
The refurbishment work will start tomorrow and should be completed in about 8-9 weeks. Until the new property is rented out I will have to meet all the mortgage payments and other outgoings from my own pocket in part (the other part will come from the cash back from the lending bank and from surplus cash flows on other properties). Between the short term negative cash flow generated by this property and the need to start putting money aside for my January tax payment, the amount of cash available for new investments this year will be quite low.
The refurbishment work will start tomorrow and should be completed in about 8-9 weeks. Until the new property is rented out I will have to meet all the mortgage payments and other outgoings from my own pocket in part (the other part will come from the cash back from the lending bank and from surplus cash flows on other properties). Between the short term negative cash flow generated by this property and the need to start putting money aside for my January tax payment, the amount of cash available for new investments this year will be quite low.
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