The power of compounding

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I tend to keep away from actual numbers on this blog, mostly as they are not my strong suite and that I want to the readers to do their own homework.
So lets see how that goes when we will cover the subject of compounding.

Introduction

Compounding is the idea that when you receive interest on your investment and reinvest it you will start to receive interest on that interest as well. And next year, you will add another round of interest and so on. After some years, the snowball starts to build itself faster and faster.
This is the reason why you should reinvest your returns, be it interest rate or dividend payouts. The numbers go crazy after a few years.

One time investment: Savings account vs. reinvesting

A very simplified scenario. Say you invest 100000. And each year, you will receive 6%. The following table shows the growth with and without reinvestment, i.e. compounding for the first 25 years. I.e. plain is your savings account with 0% interest.

year	savings account	reinvested
1	100000	100000
2	100000	106000
3	100000	112360
4	100000	119101
5	100000	126247
6	100000	133822
7	100000	141851
8	100000	150363
9	100000	159384
10	100000	168947
11	100000	179084
12	100000	189829
13	100000	201219
14	100000	213292
15	100000	226090
16	100000	239655
17	100000	254035
18	100000	269277
19	100000	285433
20	100000	302559
21	100000	320713
22	100000	339956
23	100000	360353
24	100000	381974
25	100000	404893

The difference is a whooping 304893. Just by locking in your money and reinvesting each year the original investment has grown 4 times!
OK, the example is a little biased against the savings account. So lets look at a more realistic calculation.

Continuous investment: savings vs reinvestment strategy

In a more realistic scenario you would continue to invest new money each year, say 30000 per year the numbers would be the following:

year	savings account + additional savings	reinvested + additional investment
1	100000	100000
2	130000	136000
3	160000	174160
4	190000	214610
5	220000	257486
6	250000	302935
7	280000	351111
8	310000	402178
9	340000	456309
10	370000	513687
11	400000	574509
12	430000	638979
13	460000	707318
14	490000	779757
15	520000	856542
16	550000	937935
17	580000	1024211
18	610000	1115664
19	640000	1212603
20	670000	1315360
21	700000	1424281
22	730000	1539738
23	760000	1662122
24	790000	1791850
25	820000	1929361

The difference now would be 1109361. That's a lot of money.

Living on the yearly returns

If you, like me, plan to live on the returns from your investment, given the above numbers the following would be paid out per year if you stop reinvesting.

years	savings account	savings account  + additional investment	reinvested	reinvested  + additional investment
10	0	30000 for 10 years	10137	30821
15	0	30000 for 15 years	13565	51393
20	0	30000 for 20 years	18154	78922
25	0	30000 for 25 years	24294	115762
30	0	30000 for 30 years	32510	165062

Savings accounts: you would need to do withdrawals to get any money as most accounts have 0% interest rates.
After 10 years, the reinvesting plus additional investing will generate an extra investment unit of 30000 per year by itself. And after 25 years, it adds the initial investment each year!
And going from 25 to 30 years adds another ~50000 per year.

Conclusion

I know my plan. Continuously invest and reinvest all dividends! Event if the 6% per year rate is just fake and in reality it would be different depending on a number of variables, taxes, costs, market fluctuations etc. But the effect of interest on interest on interest over and over again is just something that must be leveraged in any long term investment plan.

Hope this helped a little bit in showing how this effect works :)

Disclaimer. I am in no way an expert on capital management or investing. On this blog I only wish to share my findings, ideas and comments on current events and fields that interest me. I hope that my thoughts can entertain you. I expect that everyone reading take their time and do their own research before acting on anything read on this blog. Investing is not for everyone. E&OE.

Financial institutes and how they create money (Investment Banks)

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Let's continue the journey through different financial institutes and figure out how they make money.
Be sure to check out the other posts in this series:

Banks

Investment banks

Insurance companies

This time we focus on investment banks.
These are not the banks that you come into contact with as a consumer. . Other than advisory services, investment banks do their own trading in the market and earn money that way.

Advisory

Investment banks are advisers primarily focus on corporations and help them with mergers and acquisitions. Generating large sums of money to the bank as the transactions are huge and they cut into it on a percentage

Sales

The sales divisions of investment banks are occupied with creating and selling product with the help of underwriting.
By performing an underwriting, the bank assesses the risks and figures out a price-tag on the product. When bringing a company to the market (initial public offering) they also raise money from investors.

How do they make money here?

They act as middle men. They buy up all the stock of the new company prior to introducing it to the market. Then, when the new share goes public they profit on the price difference. I.e. what they bought the stock for prior to going public and the price that they go public with. This can be a very large sum.

There are a number of products other than new companies that are created by the investment banks. Basically, if you come up with an investment, an investment bank will calculate the risks and give you a price tag for that investment. For an fantastic movie on the subject, you have to see The Big Short.

Conclusions

Well, the same as for banking in general. Investment banks take calculated risks for profiting. Sometimes on the greater good, other times on the greater stupidity. 

Is it wise to invest in investment banks? Same as for banks. Maybe, you have to do your own research and find out if you can live with the pros and cons of profiting off an investment bank.

Sources

https://en.wikipedia.org/wiki/Investment_banking
http://www.investopedia.com/terms/i/investmentbank.asp
http://www.imdb.com/title/tt1596363/


Disclaimer. I am in no way an expert on capital management or investing. On this blog I only wish to share my findings, ideas and comments on current events and fields that interest me. I hope that my thoughts can entertain you. I expect that everyone reading take their time and do their own research before acting on anything read on this blog. Investing is not for everyone. E&OE.

How to read an Annual Report part 1: Management

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The one key indicator of how well your business is performing is The Annual Report.

Before putting your hard earned money into a business, make sure that you read up on the annual reports for the at least the last 5 years, preferably the last decade. This may sound like a lot of work, but you want to get a picture of the business before handing over your cash. In the end, it is better to discard one too many companies than invest in a rotten one.

This is part of my series on The Annual Report. Please read the other posts for other perspectives on the matter:

How to read an Annual Report part 1: Management
How to read an Annual Report part 2: Dividend

Management perspective

Let's start with the part that usually comes in the beginning of most reports. This is the part where the chairman of the board and CEO (chief executive officer) make tell you their view of the business. They should go over major events of the past year and tell their plans for the future.
By reading up on the past decade of reports, you should get a pretty good view of how trustworthy the top management is in what they tell their shareholders.

Is there passion?

Do you want the management team to passionate about the company, or only their own careers? Passionate people take the extra step and put in the time that is needed to get things going.

Do they include not only the positive side of the story but also the negative? 

All years are not success stories, that's the way of life. If it is a trend that every year is only described in positive terms in the report then maybe there is something left out.

In my mind this should be a deal breaker if the chairman and CEO leave things out in the communication to the shareholders, then maybe you should go find another business to invest in.

Are they focusing on the share price or on the value generating streams in their business?

If the main goal for the top management is the market price of the company, maybe it does not suite your long term investment plans. In other words, if you try to ignore the whims of Mr Market, shouldn't the businesses that you invest in do the same?

Management Turnaround

Is there a continued red line in the management? Does the CEO change every year?
You should be able to trust the management in your investment and trust is hard to build up.
Is the top management invested in the business (this may not be clear in a report, check the Insider Trading lists of your market to find out more)
Of course you cannot expect that a CEO stays a decade in the same company, there are numerous legitimate reasons to change the CEO and even the Chairman but in the long run, it should not require detective work to figure out the red line in the management structure.

Fulfillment of goals

Goals that are set one year, are they followed up and in the end fulfilled?

Here's the reason you should read back on annual reports over a longer period of time. You get the backstory. If the management is new, look up what other companies they have worked on and if they got things done there.

Conclusions

In the end the question to ask is:
Do you trust these people to operate your business on a daily basis.


Disclaimer. I am in no way an expert on capital management or investing. On this blog I only wish to share my findings, ideas and comments on current events and fields that interest me. I hope that my thoughts can entertain you. I expect that everyone reading take their time and do their own research before acting on anything read on this blog. Investing is not for everyone. E&OE.

My Current Plan, 2016 October

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As I've hinted in previous posts, I don't follow the diversified investing strategy or invest in index funds myself. I still think that that is the best risk averse way to invest, perfect for your retirement plan or when you are saving for your kids and most of all when you do not want to put any real time into it.

That being said... I have too much time..

So, after reading a lot on the subject. Going through Graham, Buffet and numerous books that I don't remember the names of, that could be the subject of another post I devised my own strategy.
So lets go through the overall ideas that influenced me to form my own plan.

There is no one way to wealth, everyone do it in their own way

Some preach diversification, others are into value investing and then again others only want dividend payers. Buy only companies that are cheaper than the money they have in the bank, or buy into big well proven companies that are stable. Buy and hold or Buy and sell?

So there is no single path to riches.

There is no such thing as market timing.

At least not in the long run and I am in it for the long run.
This seems to be the least common denominator that everyone agrees on. Everyone meaning the authors and investors that have a horizon of a decade or five.
Graham didn't have to time the market as he basically bought the whole basket and then micromanaged that portfolio to see when things were ripe for harvest. Others buy at a nice price (not always the best) and hold the investment for a long period and see it grown.

What I look for

Management

Do I trust the management to drive the company forward into a money maker for me?

Dividend payout

I.e. a cash flow that can be re-invested. And when time comes, a cash flow that can substitute a full time job or 2. Best deal if it has a long term increased dividend strategy.

I can figure out how they make money

This is key. I don't want buy into a company if it is in a field that I don't know about. If it is unclear how the money gets created, then it is a no.

A Great Company

I don't want to go through the endless waves of small unknown companies that may become the next [insert any skyrocketing company here from your local financial news]. I want a boring old money maker with a well recognized brand that is out there and has 'always' been. Think Coca-cola.

Does not ask shareholders for a cash-in from time to time

Another no way. Steady long term business that is able to finance itself and pay a dividend.

Not my employer

I like my employer, I like working for them. But, a big but if.. If they go out of business and I loose my job, I don't want to loose my investment at the same time. Or the other way around. Just think about it. You see your investment go into ruins and the next day you get fired. Not an ideal situation. I don't buy my employer.

Is  better than the ones I already have?
If the proposed return of investment isn't better then from worst company I already own, then I might just as well buy more of the ones I know of.

When to I plan to sell

Never :)

But honestly, no.. I do not have an exit plan. I do have an emergency plan for when the

Management turns sour

As time goes by, the management team of a company change their members or the bigger shareholders want a change and it may turn out to be in a direction that I am not comfortable with. When trust is lost, that's when I might sell. Emergency plan, not an exit.

Until that happens, the market may do whatever it likes. If I trust my companies, then I'll hold on to them. Preferably for me would be if the market thinks the worst, as it just gives me an opportunity to buy more shares at a cheaper price.

So. That was a summary of the strategy that I follow. Currently holding 2 companies and buying more of them every month. Until something better comes up, I'll stick to those two.

Hope this gives some ideas to other people starting out in building their own future :)

Disclaimer. I am in no way an expert on capital management or investing. On this blog I only wish to share my findings, ideas and comments on current events and fields that interest me. I hope that my thoughts can entertain you. I expect that everyone reading take their time and do their own research before acting on anything read on this blog. Investing is not for everyone. E&OE.

Tips on finding extra income sources

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So far I have assumed that we have a fixed income from a day job to work with. When you start to get more interested and involved in investing you will soon notice that the investment potential of an ordinary paycheck is not that huge. How could we find additional streams of income that we can add to our investment?
Lets look at some options.

Reinvest your returns

This should be a no-brainer, during the build phase of your money machine you should reinvest everything. For funds, many of them do this automatically and you don't have to think about it. If you are investing in common stock of businesses then there is a chance that there is a dividend payout from time to time. You should add this sum to your next investment.
Over time, this approach together with your normal savings/investments should start to yield larger and larger return.

Start a business on the side.

If you have the know-how, why not monetize on it on your spare time? Register a small business and start doing extra jobs. Could be anything from photography and web-design to household chores.
If things go well, this could turn out to become your main business in the future. And until then, put all returns into your investment portfolio.

Garage sales

Sell off some stuff that you do not need anymore.
Advertise in a local newspaper and remember to figure out a pricing system that you want to follow on the big day.

• Make sure that you have a permit if it is required in your area.
• Bundle items. Lower valued items together with medium valued can boost the sell factor
• If you have more valuable items, try researching a little to figure out the price-tag that you can put on them. But expect that people will haggle about the price no matter what.
• Get extra change so that you don't stand there empty handed when someone hands you a large bill.
• Put on price labels that are easy to read.
• Use prices that match the change you have available at the start.
• Make sure there is enough parking place outside of your house. If you have advertised, there can be a real rush and its not fun to see potential customers go somewhere else. If 5-10 cars cant park then try finding an other location. 
• In the last 30 minutes, lower prices to get rid of the last things. You've already decided that you don't want it anymore, then turn it to a profit even if it is less than what you asked for in the beginning. 

In the end, if you feel that you have got the hang of the haggling business, you could try starting a side business. Buying items from other peoples garage sales and then selling at your own. Its quite a lot of work but a fun way to meet people.

Write

If you have knowledge of a subject, why not write about it?
For information on how to publish your own book, go to Writersdigest.com they have a large in-depth guide on the subject.

If you instead want to write smaller articles that maybe not suite as a book, try out blogging.
With the correct ad-placement you can turn it to a revenue stream as well. Key notes on blogging is to have a continuous publishing schedule to keep people coming back for more. This is something that I am not that good at. I tend to write a lot of articles and then have huge gaps until I get into writing mode again.
If you have your own hosting, try out wordpress. Their free service does not allow advertising (as they put their own ads into your blog). If you do not have your own hosting, then blogger is the way to go.
Also, make sure that you use high quality images that convey the subjects. Best are of course photos and images that you create on your own, but using one or two images from various free stock image sites can upgrade the quality feeling that you get at a glance.

Another way to monetize on articles is to sell them to magazines, try contacting a magazine that writes in the field that you want to write in. Put together a portfolio (could be your blog) and send them a question if you could write for them.


Good luck :)

Step 3: Index funds

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This is step 3 of my private economy, saving and investing series. Be sure to read the other posts as well:

Step 1: Stabilize your economy
Step 2: Expectations and mindset
Step 3: Index funds

An index fund. The simplest way to invest in a diversified way.
Lets start at the basics and look at Funds in general.

What is a Fund

An investment fund is a way to put together a sum of money from a number of investors and then investing that sum into some kind of financial resource, it could be common stock, bonds or more advanced instruments or a combination of all.
Funds usually specialize in certain specific areas. For example geographical funds could be focusing on for example:

• Japan
• Asia
• Eastern Europe
• Asia excluding Japan
• and so on

Other funds specialize in different sectors. For example

• Industrial
• New technology

The standard funds are usually managed by a business that takes out a fee for the trouble. The trouble being to decide what resources to invest in, when to invest and when to sell those holdings.

Many funds are rated based on their performance, many are measured against how well they manage to beat the market. Meaning, how good was the manager in picking stocks and timing the market during the previous week/month/year.

But there is a catch, nothing about their past performance can predict a funds future performance. Meaning that even if a fund did all the correct moves during last year, there is no way to predict if it will continue to do so.

In recent years, there have been many scandals where these money managers basically hug the market index that they are measured against and still collect huge fees.

So what to do? Managed funds have huge potential but at the same time there is a downside.

The good:

• Diversified investment
• Professionally managed

The bad

• High fees that eat into your profits
• By nature, fund managers want to beat the market and to do so they need to buy and sell the resources that they invest in. There is a risk that the fund will be worse than the average index.
• There have been incidents where fund managers mimic the fund that their performance is compared to. And still take out high fees. Just make sure you understand the philosophy of the fund.

The index fund

So, why trust in a person/business to select what to invest in when you can buy into a fund that is automatically managed to mimic one of the market indices. As the fund is automatically managed, these funds usually have much lower fees.

The good:

• Diversified investment
• Automatically managed / Passively managed
• Lower fees
• Not much trading in the underlying resources. Only when a company is moved out of the index and new ones are introduced.

The bad

• Booooooring. You just add money to the pile for a long period of time. Not a 
• Easily automated, as it is just adding more money each month.
• Other investors can foresee when a large index fund is going to sell or buy and thus do an index arbitrage. This affects the whole underlying index and thus, when comparing the funds performance to the index it is not seen. But it is something that exists, but should imho not really affect your investment.

My conclusion

When I started out investing I was a bit unsure what strategy to take so I followed the following:

if you invested in a very low cost index fund – where you don’t put the money in at one time, but average in over 10 years –you’ll do better than 90% of people who start investing at the same time
-Warren Buffet

Ok, I haven't invested for 10 years so I have no way to prove the above statement, but when looking at historic data of indices it seems like this is the way to go.

Disclaimer. I am in no way an expert on capital management or investing. On this blog I only wish to share my findings, ideas and comments on current events and fields that interest me. I hope that my thoughts can entertain you. I expect that everyone reading take their time and do their own research before acting on anything read on this blog. Investing is not for everyone. E&OE.