There’s been great discussions generated since my previous post on alternative income source. As such, I have decided to spend more time on topic.
One key question when considering alternative income source is how do you know if a 'good idea' is 'great idea'. My approach is to assess them as an investment or a business. That is, a 'great idea' will provide you with high & recurring revenue, low & stable running cost, and the least amount of capital outlay.
Let me illustrate these factors using the following examples of potential alternative income source:
1. Tutoring in University
2. Setting up a cafe
3. Buying an investment residential property
4. Buying a listed share with your own money
In my view, providing a service is a great source of alternative income. For example, tutoring in University will provide you with good revenue since income is typically based on pay by the hour / lesson (although there may be concerns over whether it is recurring), low running cost (e.g. transport, parking, and stationery) with your time being the main ‘cost’, and minimal capital expenditure (since your education was a ‘capital expenditure’ spent in the past).
Compare this to setting up a cafe, which requires initial capital to renovate, and buy various appliances & furniture. Recurring cost incurred to pay rents & labour costs, while revenue is generated by coffee and food sold in the cafe. Don’t get me wrong, I think a cafe is a good business if it is setup at the right place. However, comparing it to the previous example of tutoring, you have to invest alot more before you start seeing returns.
Now let’s have a look at buying an investment residential property. Most people think that it is a great form of investment. You earn rentals which is use to fund the mortgage, and you earn significant capital gains if the property value appreciates. What’s more, you can claim tax deductions from mortgage interest, depreciation on renovations and etc.
My view is that investing in residential property is alot more complicated than that. There are many ‘operational issues’ such as: Do you have tenants who are staying long term? Are they good tenants or do they damage your property resulting in cost incurred for repairs? Are you paying significant amount agent fees and are the agents doing a good job at looking after your property? If rentals does not cover all costs, how much more funding do you need every month? If tenants move and your property is left vacant for a long period of time, how long can you fund the investment mortgage with your own mortgage? And finally, the notion that property prices will continue to appreciate significantly does not hold.
Just because it’s a brick and mortar investment does not make it a good investment. In my view, the key factor to buying a property investment depends on the amount of debt you need to borrow (i.e. debt vs equity mix), and the foresight you have on identifying a good suburb and the right property.
Lastly, let’s have a quick look at buying listed shares with your own money. Cost incurred is low (i.e. brokerage fees). Financing via your own money means that there are no additional funding cost. You would need a decent amount of capital (but not as much as an investment property). The gains will be derived from a combination dividends and appreciation in share price. However, the main issue with buying shares is that the risk associated to losing your capital is significantly higher compared to investment property.
To re-emphasize my point, there’s plenty of ways to make money and find an alternative income source, but you should differentiate a good idea vs. a great idea. And a great idea is one that gives you the most profit (income minus cost) with the least capital required. In finance, this measure is also known as return on equity.
Tuesday, August 17, 2010
Thursday, August 12, 2010
Cost Cutting vs Efficiency
Over the Global Financial Crisis, you would recall times when CFOs of many companies announced their strategy on cost cutting.
As individuals, we do a similar exercise a.k.a ‘tightening our wallet.’ For example, thinking about whether what we are buying is a “need” or a “want”; reducing the number of fine dining or holidays (what we perceived as luxury items).
I believe that every individual has different priorities, needs and wants. So I am not here to suggest which expenditure you need to ‘cut.’ Instead, I am suggesting that we should think about whether there are ways to ensure the we get the ‘bang for our buck’, and I don’t mean buying cheap but ‘useless’ things.
Let’s have a look at one of the well known retailers in Australia, JB Hi-Fi Limited (JBH). One of the key performance measures JBH communicates to the market is “cost of doing business.” In other words, JBH is consistently looking at different ways to do business more efficiently and corresponding reducing cost. That is something we should consider.
In my own life, I notice that people pay a lot of money for ‘convenience.’ For example, paying a tax agent, a gardener, a house cleaner, and even people to iron your shirts. What we are really saying is “I will pay someone else to do the jobs that I don’t want to do.” What’s more, sometimes we even ‘justify’ these spending by thinking about tax deductions and thereby the cost is ‘supposedly cheaper’.
Although each individual’s circumstances are different, I would like to challenge you to re-think about some of these recurring costs and whether you are willing to do it yourself. In other words, “Don't be lazy.”
I have started to remind myself not to be lazy, and I did find it useful. Rather than thinking about how long and hard your day has been, and why you need to rest on your favourite couch to watch your favourite DVD, just get up and finish the chores.
That said, there's a difference between paying for convenience and paying for efficiency.
Feel free to post your comments and share with me your strategies to improve ‘your cost of doing business’.
As individuals, we do a similar exercise a.k.a ‘tightening our wallet.’ For example, thinking about whether what we are buying is a “need” or a “want”; reducing the number of fine dining or holidays (what we perceived as luxury items).
I believe that every individual has different priorities, needs and wants. So I am not here to suggest which expenditure you need to ‘cut.’ Instead, I am suggesting that we should think about whether there are ways to ensure the we get the ‘bang for our buck’, and I don’t mean buying cheap but ‘useless’ things.
Let’s have a look at one of the well known retailers in Australia, JB Hi-Fi Limited (JBH). One of the key performance measures JBH communicates to the market is “cost of doing business.” In other words, JBH is consistently looking at different ways to do business more efficiently and corresponding reducing cost. That is something we should consider.
In my own life, I notice that people pay a lot of money for ‘convenience.’ For example, paying a tax agent, a gardener, a house cleaner, and even people to iron your shirts. What we are really saying is “I will pay someone else to do the jobs that I don’t want to do.” What’s more, sometimes we even ‘justify’ these spending by thinking about tax deductions and thereby the cost is ‘supposedly cheaper’.
Although each individual’s circumstances are different, I would like to challenge you to re-think about some of these recurring costs and whether you are willing to do it yourself. In other words, “Don't be lazy.”
I have started to remind myself not to be lazy, and I did find it useful. Rather than thinking about how long and hard your day has been, and why you need to rest on your favourite couch to watch your favourite DVD, just get up and finish the chores.
That said, there's a difference between paying for convenience and paying for efficiency.
Feel free to post your comments and share with me your strategies to improve ‘your cost of doing business’.
Thursday, August 5, 2010
Where do I put my money?
Have a look at a company’s cash flow statement (you don’t have to be an accountant to do that), you will notice that there are three categories: Operating, Investing and Financing. A closer look at Investing activities will give you an idea of where a business is putting their money. This could be buying a new building, machinery, marketable securities and even another business.
For a company, investing activities consist of broadly (i) replacing ‘old’ assets; and (ii) buying new assets for growth. As an individual, we too ‘invest’ in ourselves. This includes further education, professional qualifications, specialised skill set to ultimately get us to the next promotion or new job.
But when a company buys another company, the thought process behind whether it is a good decision or not is not so easy. We faced similar challenges when you or your friends come across various investment strategies that you are apprehensive about it as to whether it's a good idea.
Regardless of whether you are an individual or a company, each investment has its own risk and return. One approach when considering whether an investment is a ‘good’ investment is to ask yourself these questions:
(i) How much can I earn (return)?
(ii) What’s the maximum amount I will lose (risk)?
(iii) How much do I need to start (initial capital outlay)?
(iv) When should I get my money back (investment horizon)?
This approach is a good start when thinking about any investment strategy. The next section of this post will focus on providing different perspectives of these concepts which may be contrary to what we know.
In finance, modern portfolio theory suggests that risk and return goes hand in hand. That is, the more risk you take, the more return you should expect. This is based on the fundamental assumption that market is efficient. Let us think consider these theories as an individual investor.
Risk vs Return
Let’s start by examining the notion of more risk = more return.
I will start by comparing three types of investments: (1) a term deposits which earns 6% p.a. ; (2) an investment property which (simplistically) also earns 6% p.a. ; and (3) a share that has a dividend yield of 6% p.a. These investments earn (yield) the same return, but do you think it bears the same risk? You may think I am not being ‘fair’ with my comparison, as that there’s always a chance property prices or share prices appreciates. But what if it doesn’t?
Now, let’s consider another example. A listed company whose share prices was rising for the past 12 months but has recently fallen significantly in the last 3 months. If modern portfolio theory suggests that because the share price has been volatile (i.e. riskier), the expected return should be high. Would you buy the shares without considering what is actually happening within the business?
I was once told that we (humans) are very good at self justification. We can justify the share price is cheap when it is $40, and we can still justify the share price will rebound when it is $0.01.
Share price is a function of demand and supply. It’s the price people are willing to buy and sell equity securities. People in the share market are typically driven by two emotions: Greed and Fear.
Putting that together, does more risk really = more return?
Market Hypothesis in Share Market
Focusing more on share market and apply modern portfolio theory that the market is efficient. The share market has to be a ‘super-sized computer’ (because I buy my shares online) that is the smartest and most complex machine that updates all share prices using the latest information from all parts of the world. A believer of this theory would conclude that the price you buy and sell any shares is always the “right” price and there’s no chance you will get a bargain.
If you read the business sections of newspaper or news from the radio, it always reports on whether share prices has risen or fallen and there’s always a reason why. “Share prices has fallen because there’s uncertainty over Europe.... Share price has risen because there's confirmation over Europe has hit its worse.” Does this information really impact how Woolies does its business and therefore its share price?
If the share market is truly efficient, would it keep changing its mind about what it thinks is the ‘right’ price?
As explained before, shares price is a function of demand and supply. Market is made up of people. My view is that financial institutions (I loosely term ‘banks’) are the ones that make most money out of any market. As a middleman, they earn money every time you buy and sell; they make money through price fluctuations (speculations); and they even sell information (stock analysis report) on when to buy and sell. Hence, the efficient market hypothesis is a theory the finance community wants you to believe.
When share prices fall because banks want to take profit, everyone will follow and start selling their shares, thinking that the market is efficient and there’s something the banks know that individual investors don’t. But in actual fact, there are no new information of the underlying business. Similarly, when share falls low enough then the banks begin buying, others follow, thinking that there must be some new information. Such herd mentality results in one thing: the banks will always be first to maximise their earnings.
If you and I lost money in the share market, we may think that we are not getting up-to-date information to keep up with the banks and therefore pay them more money to subscribe to their share reports.
I am not here to deter you from investing in shares. However, I am suggesting that you need a structured and disciplined method if you are considering putting money in the share market. Otherwise, you will lose your initial capital very quickly.
For a company, investing activities consist of broadly (i) replacing ‘old’ assets; and (ii) buying new assets for growth. As an individual, we too ‘invest’ in ourselves. This includes further education, professional qualifications, specialised skill set to ultimately get us to the next promotion or new job.
But when a company buys another company, the thought process behind whether it is a good decision or not is not so easy. We faced similar challenges when you or your friends come across various investment strategies that you are apprehensive about it as to whether it's a good idea.
Regardless of whether you are an individual or a company, each investment has its own risk and return. One approach when considering whether an investment is a ‘good’ investment is to ask yourself these questions:
(i) How much can I earn (return)?
(ii) What’s the maximum amount I will lose (risk)?
(iii) How much do I need to start (initial capital outlay)?
(iv) When should I get my money back (investment horizon)?
This approach is a good start when thinking about any investment strategy. The next section of this post will focus on providing different perspectives of these concepts which may be contrary to what we know.
In finance, modern portfolio theory suggests that risk and return goes hand in hand. That is, the more risk you take, the more return you should expect. This is based on the fundamental assumption that market is efficient. Let us think consider these theories as an individual investor.
Risk vs Return
Let’s start by examining the notion of more risk = more return.
I will start by comparing three types of investments: (1) a term deposits which earns 6% p.a. ; (2) an investment property which (simplistically) also earns 6% p.a. ; and (3) a share that has a dividend yield of 6% p.a. These investments earn (yield) the same return, but do you think it bears the same risk? You may think I am not being ‘fair’ with my comparison, as that there’s always a chance property prices or share prices appreciates. But what if it doesn’t?
Now, let’s consider another example. A listed company whose share prices was rising for the past 12 months but has recently fallen significantly in the last 3 months. If modern portfolio theory suggests that because the share price has been volatile (i.e. riskier), the expected return should be high. Would you buy the shares without considering what is actually happening within the business?
I was once told that we (humans) are very good at self justification. We can justify the share price is cheap when it is $40, and we can still justify the share price will rebound when it is $0.01.
Share price is a function of demand and supply. It’s the price people are willing to buy and sell equity securities. People in the share market are typically driven by two emotions: Greed and Fear.
Putting that together, does more risk really = more return?
Market Hypothesis in Share Market
Focusing more on share market and apply modern portfolio theory that the market is efficient. The share market has to be a ‘super-sized computer’ (because I buy my shares online) that is the smartest and most complex machine that updates all share prices using the latest information from all parts of the world. A believer of this theory would conclude that the price you buy and sell any shares is always the “right” price and there’s no chance you will get a bargain.
If you read the business sections of newspaper or news from the radio, it always reports on whether share prices has risen or fallen and there’s always a reason why. “Share prices has fallen because there’s uncertainty over Europe.... Share price has risen because there's confirmation over Europe has hit its worse.” Does this information really impact how Woolies does its business and therefore its share price?
If the share market is truly efficient, would it keep changing its mind about what it thinks is the ‘right’ price?
As explained before, shares price is a function of demand and supply. Market is made up of people. My view is that financial institutions (I loosely term ‘banks’) are the ones that make most money out of any market. As a middleman, they earn money every time you buy and sell; they make money through price fluctuations (speculations); and they even sell information (stock analysis report) on when to buy and sell. Hence, the efficient market hypothesis is a theory the finance community wants you to believe.
When share prices fall because banks want to take profit, everyone will follow and start selling their shares, thinking that the market is efficient and there’s something the banks know that individual investors don’t. But in actual fact, there are no new information of the underlying business. Similarly, when share falls low enough then the banks begin buying, others follow, thinking that there must be some new information. Such herd mentality results in one thing: the banks will always be first to maximise their earnings.
If you and I lost money in the share market, we may think that we are not getting up-to-date information to keep up with the banks and therefore pay them more money to subscribe to their share reports.
I am not here to deter you from investing in shares. However, I am suggesting that you need a structured and disciplined method if you are considering putting money in the share market. Otherwise, you will lose your initial capital very quickly.
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