Best Investments For Young People

Since I am a young guy, age 30, I am often asked what the best investments are for young people who obviously have a strong desire to make as much money as they can.  It is always a tough question to answer because like my fellow young professionals, I have the immense desire to make as much money as I can as quickly as I can so that I can enjoy a good retirement and even a few toys today. Unfortunately, the answer isn’t always as simple as “invest in this stock and you will make 10,000%!” 

I started to research investments back when I was 14 years of age and one of the first big lessons I learned was the power of compound interest.  With compound interest, and with the proper long term outlook of retirement, a little bit of money doing well will lead to a lot of money down the road.  Here is an example: If you are 25 years of age and you make $40,000 per year, if you are able to save just $4000 of your income every year until age 65, assuming a 10% return (which is how much the S&P 500 has returned on average), then at age 65, you will be sitting with a nest egg of $1,950,000!  Again, that assumes that as you get raises and promotions, you ONLY invest $4,000 per year.  If you merely increase your savings by 4% per year, then by age 65, you will be sitting on $3,000,000! It’s crazy to think that off of a starting salary of $40,000 per year, you could have several million dollars, isn’t it? Well, that’s the power of compound interest.  (See the chart and table below to see how fast the money grows at the end)

Age	Balance	36	$94,091	48	$389,388	60	$1,316,158
25	$4,400	37	$107,900	49	$432,727	61	$1,452,174
26	$9,240	38	$123,090	50	$480,400	62	$1,601,791
27	$14,564	39	$139,799	51	$532,840	63	$1,766,370
28	$20,420	40	$158,179	52	$590,524	64	$1,947,407
29	$26,862	41	$178,397	53	$653,976
30	$33,949	42	$200,636	54	$723,774
31	$41,744	43	$225,100	55	$800,551
32	$50,318	44	$252,010	56	$885,006
33	$59,750	45	$281,611	57	$977,907
34	$70,125	46	$314,172	58	$1,080,097
35	$81,537	47	$349,989	59	$1,192,507

As you can see in the graph above, even at age 50, only 15 years from retirement and 25 years after you started investing, you are still at around $500,000 and in the next 15 years, you make up another $1,500,000! The key is to be patient.  I don’t want you starting to invest and in 25 years say “That Paul Gabrail was wrong! I only have $500,000 and I have only 15 years left to retirement! What gives!?!?” What gives is compound interest…it will catch up as you can see in the chart and graph above.  Patience is key.

So that’s all great and dandy, but the real question on your mind is, “What are good investments for young people like me?”  And that answer is a not very sexy but highly efficient answer: Buy good long term diversified Exchange Traded Funds (ETFs) or mutual funds with low expense ratios.  What are expense ratios you ask?  Good question. It’s something to pay attention to. It’s basically how much the fund or ETF will charge just to be managed and run.  Mutual fund companies tend to have higher expenses because they have research staffers that are looking for the best companies, or at least trying to. Unfortunately, most expense ratios can eat up 10-12% of your total return in a given year and over the long haul, that’s a big difference! Now, I am not opposed to expense ratios of course.  If the fund company can prove that they beat the market consistently by at least as big a margin as the expenses, then of course it would be worth paying that.  Unfortunately, most mutual funds do NOT beat the stock market on a yearly basis so why pay more to earn less?

Getting back to the point, though, is that the bottom line is you shouldn’t be trying to hit home runs.  Your goal should be to hit some solid singles and doubles and with a few diversified mutual funds and ETFs invested in several hundred companies, you won’t have to worry about any individual company taking a dive and potentially ruining a large chunk of your retirement. 

Is it sexy? Of course not, but what’s sexier than not having to worry about money during the last 25-35 years of your life?  That is the main goal in any long term retirement planning.

I personally own over 800 rental units and several businesses generating several revenue streams and I still save the same way I state above.  I am able to save over the 10% mark, but I have four ETFs that I purchase on a monthly basis with the money I automatically have taken out of my checking account.  I also have a retirement account that is invested in several mutual funds and bond funds to provide good stable long term growth that is better protected against massive drops in the market.  Is it sexy?  Nope! But I keep my eye on the prize: Retirement.

So, what ETFs do I buy? Well, there are four main ones that I buy: SPY, SDY, VB, and MDY.

SPY is the S&P 500 ETF that tracks the stocks and returns of the S&P 500. This ETF has a low expense ratio of around 0.17% which is about 80% LOWER than the comparable mutual funds.  Why should I pay such a large fee on mutual funds when all they are doing is mimicking a broad based index like the S&P 500?  In addition to appreciation, this fund generates around 2% in dividends each year which I reinvest back into SPY.

SDY is an ETF that purchases stock in the top 50 dividend paying stocks that have a history of consistently increasing their dividend payouts in the S&P 500.  If you look at history, dividend paying companies tend to outperform non-dividend paying stocks by 2.5% or so.  Over a 40 year period, that could mean over a doubling of your money! That’s nothing to sneeze at or ignore, so I choose to go with historical records.  This ETF yields around 3.5% for the dividend which, again, I use to reinvest for my retirement.

VB is a great ETF that invests in smaller companies. Small companies have a lot of growth potential and with such a long term outlook in my retirement, I can afford to take a bit of risk, as can you, in smaller companies making big moves and jumping. 

MDY is the ETF I use for my mid-size company exposure. These are companies that aren’t as big as the S&P 500 companies, but are also bigger than small companies that may be a bit riskier. In any given year, large, mid-sized, and small companies can really perform well. During down markets, large cap stocks tend to do well since they are considered more secure, which is true. 

The good news is that no matter how much money you are starting with, whether it’s $3,000 or $30,000, there are several online brokerage companies that make it easy for you to start an account and only charge $8-$10 per trade.  This makes it affordable for ANYONE who wants to start investing for their retirement.  You can try www.Schwab.com or www.TDAmeritrade.com to get started.

Unfortunately, this kind of investing didn’t come from some cheat sheet book.  Why?  Because books that preach boring investing tend to not do well. But the boring investing is what you will need in order to better secure your financial future.  I am recommending to buy ETFs and Mutual funds…books are ALWAYS written about buying stocks, not about mutual funds or ETFs. 

Anyone can chase returns and promise the moon and the stars, but being patient and disciplined is the surest way to financial security.

For more articles and thoughts like this, follow me on Twitter @capmanifesto and subscribe to my RSS feed. Also, feel free to contact me with any questions or comments.   

President Obama - Not the best at financial planning

http://money.cnn.com/2012/05/15/news/economy/obama-assets/index.htm?iid=HP_LN

In the article I just linked to, it shows President and First Lady have amassed a nice little fortune in the last few years.  Most of the money has come from royalties from his two books “Audacity of Hope” and “Dreams From My Father.” 

If you read closely, it shows that the vast majority of the First Family’s wealth is held in “treasury notes and bills” which is obviously a very safe form of investing.  With the President and First Lady being so young, it may not be the best route, and I don’t know if he is required to invest this way, but other politicians have invested with blind trusts, which are trusts that they give to someone to invest and have no say over so that there can never be a conflict.  Either way, this point is not my point of concern:

If you read on, it also shows that the family has a mortgage on a house in Illinois ranging in the $500K to $1MM range and an interest rate of 5.625%.  Finance 101 states that you only borrow money if you expect to be able to earn a return higher than the rate you are paying. 

Clearly, Treasury Notes and Bills are currently paying in the 0.09% to 2.93% range depending on if it is a 3 month bill up to a 30 year note.  Now, I don’t know when the President bought these notes but even if he bought them a few years ago and his yields have dropped this month, that would mean his investment has done quite well.  If he is paying 5.625% on his mortgage, he should sell those treasuries and pay off that mortgage.  Why spend 5.625% when you are only making 2.93%? 

Now, my comments are not 100% fair because I don’t know if they are in treasuries for a short period of time while he waits for other investments to come, but if this is a long hold, he needs to sell some treasuries and pay off his mortgage.  That would yield him a nice return on his money.

The moral of the story is that clearly President Obama is an intelligent man, but academic, legal, and political intelligence doesn’t always lead to financial intelligence and vice versa.  This is clearly NOT the smart financial move, but in the end, he can do with his money what he chooses.  I am sure he will do fine financially after he leaves office, whenever that may be.  In case you didn’t hear, President Clinton made $100MM in the 10 years after leaving office and President George W Bush made $15MM last year in speeches alone. 

If You Buy into the Facebook IPO, you are NOT very smart

I know this title may be a bit confrontational, but let’s call a spade a spade.  This Facebook IPO has nothing to be desired.  To get right to it, usually when an IPO has some upside potential, the argument would be made that there is a premium to be paid.  I won’t even get into the argument, right now, on why I think that is a flawed logic, but what I will say is that this statement is all the more reason why Facebook would be a bad investment based on the current numbers.

Last year, Facebook had $1.1Billion in profit and as of today, the IPO is looking for an $85Billion to $95Billion valuation.  That is a price to earnings ratio (P/E Ratio) of 77 to 86.  Right now, the stock market is trading at around the historical average of about a 15 P/E.  This makes Facebook 5 times more expensive when it comes to buying profit than the stock market in general, which is obviously a much more stable investment than one specific company.

Now, the argument back would be “well, yeah, but they have a lot of future earnings growth.”  True. Until last year, they hadn’t made money and are now in the advertising space, which Google has proven to be very profitable.  Facebook’s advertising setup is pretty easy to use and less expensive than Google, but then again, Facebook is for more of the building brands as opposed to the person who is ready to buy, which is what Google is going after.

Either way, let’s compare it to other tech companies that have more stable cash flows. Unfortunately, I am not splitting the atom or making any new statements that are not already out there by saying this, but Google is a conglomerate with a wide array of companies under its umbrella and billions in the bank and an established and dominating advertising business.  In 2011, Google made $9.7Billion and has a current market capitalization of $196Billion.  So they are a bit more than double the valuation Facebook is trying to get BUT they have almost 9 times more in earnings.  Hmmmm.

I would make the argument that if you MUST be invested in the internet based advertising/social media/search engine stuff, Google is the way to go. It’s much more stable. It knows how it to make money and it has almost $53Billion in current assets like cash and other cash equivalents.  That seems pretty solid to me.

For those of you who are reading this blog for the real estate, buying Facebook right now would be similar to buying a vacant lot for $500K because the house that would go on there would be worth $500K.  Wait until the house is built then pay $500K for it…please.

I could always be wrong.  I am wrong frequently, but unless Facebook has figured out some new way to make money that we haven’t been told of, it will be a while before they can justify the $95Billion valuation.  Will it happen?  Probably. It does have 900 million users and more time is spent on Facebook.com than any other website.  The potential is there, but do me a favor…wait until they prove it because you aren’t getting the discount now for taking that risk.

Secular Bear still has time on the clock

When it comes to timing markets, no one can do it.  Granted, I say “no one” realizing that maybe somewhere in the world of 7 billion people there are a few people out there who can time markets. And I only say that because it’s a numbers game, but either way, the bottom-line is, timing markets will probably be a losing bet.  The best one can do, in my opinion, is to see what is going on in the financial world and make determinations from it.

I am in Chicago right now meeting with a bank I do a lot of work with.  Great guys.  Smart guys.  We talk about investing and finance every time we meet and it’s a good time.

One of them, yesterday, told me this little anecdote: They have STORMS of clients calling in and asking how they can get shares for the new Facebook IPO.  And those clients aren’t even the young and stupid ones! They are the 60+ year olds.

This market isn’t done yet.  The lessons of 10 years ago haven’t been learned.  These investors are dying to get shares of a company that earned $1.1Billion last year in profit and is being valued at $100Billion.  That’s obscene by any stretch of the imagination. 

Facebook going public in this market is proof that the lessons haven’t been learned and even further proof is the desire of older successful people wanting some of those shares.

It may sound inconsequential, but when the masses haven’t given up, there is still room for lessons to be learned.  Unfortunately, those lessons will be financial ones. 

If You Build It, Tenants Will Come

When I first started buying real estate 8 years ago, my thought process was to buy an OK property for a fair price and rent it out as is, but make it presentable.  We had, at one point, 98% occupancy and 98-99% collected rents with waiting lists, so things were good. I didn’t think things would get better. I had always heard that some people put more money into their properties to increase rents.  My rationale was that people wanted low cost good options.  Now, in hindsight, I was right, but I was leaving a lot of money on the table.

We currently own and manage 300+ units in Shaker Square, a historic area of Cleveland. It is very close to the Cleveland Clinic, Case Western Reserve University, John Carroll University, University Hospitals, and a lot of places that demand higher-end renters.  Our units hadn’t been touched/rehabbed in almost 50 years, and I thought that was fine.  So did our renters. 

But two years ago, we tried something new.  We rehabbed a unit.  We spent, at that time, $8,000 to rehab one unit and you know what we found?  We got a better renter who was willing to pay us more than $100 more per month for that unit! So, for you number dorks out there, we easily increased the value of our unit by over $12,000 and it only cost me $8,000.  Our upgrades included granite countertops, new cabinets, tile in the kitchen, and a new bathroom.  Since then, we have increased our rehab to cost about $11K on average but now we are getting over $125 per month in rent and getting a better renter and less maintenance issues. 

Here is the prime example.  We use an online tenant background check system.  They have a “rentability score” of 0-100.  Anything in the 75-85 range is an acceptance but maybe with a condition of an extra deposit and anything above 85 is a full automatic acceptance.

Two years ago, we were happy to get in the 80+ range and we were ecstatic with 90+ scores.

As of yesterday, we had 19 rented apartments with approved applications.  Of those 19, 17 were perfect 100 scores and the other 2 were scores of 93 and 94.

So as you can see, we not only get a much better quality tenant, which saves me money in collections and evictions, but we also got a much higher rent.

Every market is different and you should know the market you are in, but putting money into a property can pay off big! Don’t be afraid to try it out.