Haugen employed factors, such as dramatic changes in production, interest rates, or inflation to predict stock returns. He divided the eras of finance into three--old, modern, and new finance. He designated the theme of new finance as inefficient markets and its paradigms as "inductive ad hoc factor models" (p. 3). In addition to Haugen's use of factors, other writers applied factors for predictions of risk (Chen, Roll & Ross) and behavior (Kahneman & Tversky). Three disciplines contribute to the understanding of factor models, statistics, econometrics, and psychology.
After discrediting the other methods, Haugen detailed the expected-return factor model and the five classes that it encompasses--risk, liquidity (measures of cheapness), profitability, and technical elements. Because many factors constitute each class, I will not list them all here. One example, however, is the liquidity factors--market capitalization, market price per share, trading volume/market capitalization, and trading volume trend. The author admitted that this list did not exhaust the universe of factors, such as insider trading.
To calculate expected return with factor information, the author instructed the investor to execute the following steps: "you multiply the stock's factor exposure by the projected payoff to the factor. This gives you the component of total expected return coming from the particular factor" (p. 50). This is the formula:
factor exposure X projected factor payoff = factor component of exposure return
"After doing this for each factor, you add up all the components to get the total relative expected return for the stock" (p. 50). This calculation does not incorporate trading costs. Regarding payoffs, the author states "The cheaper the stock, the better the outlook for future returns . . . then other things--including price -- being equal, the outlook for future return improves with more profitable companies in the portfolio" (p. 47).
In the chapter, "Super stocks and stupid stocks", the author graphs the factors to demonstrate the application of his theory. First, the author charts returns on a scale of deciles of 1 to 10, based on risk. He drew six graphs, decile risk characteristics, size and liquidity characteristics, technical history, current profitability, profitability trends, and price level. Decile stocks constitute the stupid stocks and decile 10, the super stock. These stocks exist within a range between true abnormal profit and priced abnormal profit. Furthermore, the author attests that "stocks ranking low in book-to-price ratio are likely to be relatively profitable" (p. 94). Comparing value and growth stocks, the author wrote "while growth stocks have been priced as though they will be able to sustain their relative profitability, this assumption has not been validated by actual corporate performance even during the period over which they enjoyed superior performance in terms of their market price" (p. 95). The author ends by explaining the strengths of the factors, cheapness and the profitability of the company, to increase expected return.
Haugen, R. A. (2002). The inefficient stock market: What pays off and why, 2d ed. Upper Saddle River, NJ: Prentice Hall.
Cheapness Factors:
Earnings to Price Ratio
Earnings to Price Trend (five year monthly time trends throughout)
Book to Price Ratio
Book to Price Trend
Dividend to Price Ratio
Dividend to Price Trend
Cash Flow to Price Ratio
Cash flow to price trend
Sales to Price Ratio
Sales to Price Trend
Monday, March 1, 2010
Monday, January 11, 2010
Financial Intelligence for Entrepreneurs: What you really need to know about the numbers
To manage successfully a portfolio, an investor should think like an entrepreneur. This book details the fundamentals of finance in a simple, yet comprehensive overview and cites current examples to elucidate principles. Because understanding finance entails a basic knowledge of accounting and typical accounting statements, the book covers the income, balance sheet, and cash flow statements. The balance sheet discloses fundamental questions about a company--its solvancy, the degree of liquidity, and the annual growth or decline of equity.
For a deeper interpretation of the numbers, the authors present the formulas for profitability, leverage, liquidity, and efficiency. A discussion of finance would not be complete without explaining return on investment (ROI). The authors weigh the strengths and weaknesses of the three methods for calculating ROI, the payback method, the present value method (NPV), and the internal rate of return method. They demonstrate the value of engaging in all three calculations in financial analysis, but view NPV as the most accurate measure of ROI. The authors argue the importance of managing balance sheet levers--days sales outstanding (DSO) and inventory. Finally, the authors address cash conversion, the speed with which a company collects its cash.
The authors end the book by stressing the importance of having a financially literate company, educated workers who understand how their work habits and actions impact the company's bottom line, a message equally applicable to a family and its members.
Berman, K. & Knight, J. (2008). Financial Intelligence for Entrepreneurs: What you really need to know about the numbers. Boston, MA: Harvard Business Press.
http://www.financialintelligencebook.com/
For a deeper interpretation of the numbers, the authors present the formulas for profitability, leverage, liquidity, and efficiency. A discussion of finance would not be complete without explaining return on investment (ROI). The authors weigh the strengths and weaknesses of the three methods for calculating ROI, the payback method, the present value method (NPV), and the internal rate of return method. They demonstrate the value of engaging in all three calculations in financial analysis, but view NPV as the most accurate measure of ROI. The authors argue the importance of managing balance sheet levers--days sales outstanding (DSO) and inventory. Finally, the authors address cash conversion, the speed with which a company collects its cash.
The authors end the book by stressing the importance of having a financially literate company, educated workers who understand how their work habits and actions impact the company's bottom line, a message equally applicable to a family and its members.
Berman, K. & Knight, J. (2008). Financial Intelligence for Entrepreneurs: What you really need to know about the numbers. Boston, MA: Harvard Business Press.
http://www.financialintelligencebook.com/
Friday, November 27, 2009
John M. Morris and Virginia B. Morris: The Wall Street Journal Guide to Understanding Money and Investing (1999)
This book lives up to its intention as an introduction to the basics of money and investing. It begins with the history of the monetary system in the United States and elsewhere, explains stocks, stock exchanges, the market and its cycles, bonds, mutual funds, and futures and options.
Full of charts, tables, and graphics, it provides illustrations and examples of concepts and financial processes, such as what happens during a purchase of stock on the New York Stock Exchange. Additionally, it shows correlations--the cause and effect relationship between weak and strong dollars on international stock purchases.
The book offered investment strategies, using options. As the authors stated:
"You can use options conservatively to increase your income or to limit your risk.
The most popular income-producing strategy is selling covered calls. You write call options on a share-for-share basis against stocks you own. If someone exercises the calls, you meet your obligation to sell by handing over your stocks. The goals of covered calls are to provide some protection if the stock price falls, establish a selling price above the current market price or increase your income in a sideways market, when prices move up and down within a very small range.
Writing cash-secured puts is another income-oriented approach. You sell a put for each 100 shares of stock an investor is willing to buy at a special price. Then, as security, you invest an equivalent amount in U.S. Treasury bills or a money market account. If the put is exercised, you liquidate that investment and use the cash to buy the stock"(pp. 144-145).
I plan to read more recent editions of this book, to make a comparison of the information they contain. Stay tuned!
Morris, K. M. & V. B. Morris. (1999). The Wall Street Journal Guide to Understanding Money and Investing. New York: Lightbulb Press, Inc. and Dow Jones & Co., Inc.
Full of charts, tables, and graphics, it provides illustrations and examples of concepts and financial processes, such as what happens during a purchase of stock on the New York Stock Exchange. Additionally, it shows correlations--the cause and effect relationship between weak and strong dollars on international stock purchases.
The book offered investment strategies, using options. As the authors stated:
"You can use options conservatively to increase your income or to limit your risk.
The most popular income-producing strategy is selling covered calls. You write call options on a share-for-share basis against stocks you own. If someone exercises the calls, you meet your obligation to sell by handing over your stocks. The goals of covered calls are to provide some protection if the stock price falls, establish a selling price above the current market price or increase your income in a sideways market, when prices move up and down within a very small range.
Writing cash-secured puts is another income-oriented approach. You sell a put for each 100 shares of stock an investor is willing to buy at a special price. Then, as security, you invest an equivalent amount in U.S. Treasury bills or a money market account. If the put is exercised, you liquidate that investment and use the cash to buy the stock"(pp. 144-145).
I plan to read more recent editions of this book, to make a comparison of the information they contain. Stay tuned!
Morris, K. M. & V. B. Morris. (1999). The Wall Street Journal Guide to Understanding Money and Investing. New York: Lightbulb Press, Inc. and Dow Jones & Co., Inc.
Tuesday, November 3, 2009
Time-Driven Activity-Based Costing
Kaplan, R. S. & Anderson, S. R. (2007). Time-driven Activity-Based Costing : A simpler and more Powerful Path to Higher Profits. Boston, MA: Harvard Business School Press.
Robert Kaplan, best known for his work on the Balanced Scorecard, and Steven R. Anderson wrote this book to demonstrate how enterprise resource planning (ERP) systems enable companies to assess at the transaction level the time consumed in steps of processes. Specifically, time-driven activity-based costing measured the "cost and profitability of producing and delivering their products and services, and managing their customer relationships" (p. xi).
The Balanced Scorecard, equally as necessary for companies to evaluate their progress, reveals how companies create value for employees, shareholders, customers, and investors.
If a company realized a low total-cost strategy, activity-based costing enables managers to accurately measure the costs of significant processes. If a company has not gaged the profitability of their customers, activity-based costing provides insight into that information. According to the authors, customer profitability influences other customer metrics, "such as satisfaction, retention, and growth, to signal that customer relationships are desirable only if these relationships generate increased profits" (p. xii).
Traditional standard cost system employed three cost factors--labor, materials, and overhead. With increased automation, the authors argued that allocations of costs under this system became distorted. Activity-based costing corrected these distortions "by tracing these indirect and support costs first to the activities performed by the organization's shared resources, and then assigning the activity costs down to orders, products, and customers on the basis of the quantity of each organizational activity consumed" (p. 5).
Anderson improved on the activity-based costing model with the 'time-driven activity-based costing' (TDABC). Finding the data gathering to support the conventional model "time-consuming . . . costly . . . subjective . . . . difficult to validate . . . local . . . not easily updated . . . theoretically incorrect when it ignored the potential for unused capacity" (p. 7), TDABC modified the conventional system "by eliminating the need to interview and survey employees for allocating resource costs to activities before driving them down to cost objects (orders, products, and customers).
Time-driven activity based costing involves a two step process. The first, "the TDABC model calculates the cost of supplying resource capacity . . . personnel, supervision, occupancy, equipment and technology" (p. 8). "It divides this total cost by the capacity--the time available from the employees actually performing the work--of the department to obtain the capacity cost rate" (p. 8). The second step, "TDABC uses the capacity cost rate to drive departmental resource costs to cost objects by estimating the demand for resource capacity . . . that each cost object requires"(p. 8).
PRACTICAL APPLICATION
Capacity cost rate = Cost of capacity supplied
----------------------------------------------
Practical capacity of resources supplied
Capacity cost rate = $567,000
------------------------------------------------
630,000 minutes = $0.90 per minute
TDABC estimates of customer related activities:
Process customer orders : 8 minutes
Handle customer inquiries: 44 minutes
Perform credit check: 50 minutes
TDABC COST DRIVERS
-------------------------------------------------------------------------
Activity Unit time (minutes) Rates (at $0.90/minute)
----------------------------------------------------------------------------------------
Process customer order 8 $ 7.20
Handle customer inquiry 44 $39.60
Perform credit check 50 $45.00
Used capacity
Unused capacity (8.2)
As a tool for future decision making, the TDABC allows managers to develop trends of data over time. Modifications to the tool occur from new activities, for example, changes in time due to more complicated or custom processes, changes in cost rates, due to automation or increased efficiencies, such as the implementation of quality programs. Therefore, the system adapts to changes in circumstances.
To estimate processing time, the first principal of TDABC, enterprise resource planning systems aid companies in accumulating data, such as cubic meters, kilograms, gigabytes, and bauds. Global positioning systems and radio frequency identification devices facilitate accumulating data. Having detailed and complete business process diagrams simplifies calculating time estimates. The author argued that the granularity at the transaction level provided greater accuracy for users of TDABC. Recommending steps for implementation, the authors suggested the following: "begin with the most costly processes . . . define the scope of the process . . . determine the key drivers of time . . . use readily available driver variables . . . start simple . . . engage operational personnel to help build and validate the model" (p. 36).
The second principal, aggregating the cost of capacity supplied, consolidates all department costs--"the compensation of frontline employees and their supervisors; occupancy, technology, and other equipment costs; and the costs of corporate staff functions that support the work performed" (p. 41). How companies determine these costs vary depending on the nature of the business and the degree of specificity desired. For example, equipment costs can apply historical, replacement costs, or the "opportunity cost of the investment in the equipment"(p. 43). The second part of this equation, practical capacity, "can be estimated somewhat arbitrarily or studied analytically. The arbitrary approach assumes that practical capacity is a specified percentage, say, 80 or 85 percent, of theoretical capacity" (p. 52). Similarly, equipment might register 15 to 20 percent downtime. Enterprise resource planning systems might record actual repair time, startups, downtime, vacation and sick time for equipment and employees. Although actual costs from accounting systems supply readily available numbers, some firms elect to use budgeted, normalized costs.
The remainder of the book covered the implementation of TDABC and some case studies, of organizations as diverse as an historical black university (HBU), for-profit companies, and not-for profit organizations. The authors address the transformation of customers from unprofitable to profitable with the TDABC system. They end the book by responding to frequently asked questions.
Robert Kaplan, best known for his work on the Balanced Scorecard, and Steven R. Anderson wrote this book to demonstrate how enterprise resource planning (ERP) systems enable companies to assess at the transaction level the time consumed in steps of processes. Specifically, time-driven activity-based costing measured the "cost and profitability of producing and delivering their products and services, and managing their customer relationships" (p. xi).
The Balanced Scorecard, equally as necessary for companies to evaluate their progress, reveals how companies create value for employees, shareholders, customers, and investors.
If a company realized a low total-cost strategy, activity-based costing enables managers to accurately measure the costs of significant processes. If a company has not gaged the profitability of their customers, activity-based costing provides insight into that information. According to the authors, customer profitability influences other customer metrics, "such as satisfaction, retention, and growth, to signal that customer relationships are desirable only if these relationships generate increased profits" (p. xii).
Traditional standard cost system employed three cost factors--labor, materials, and overhead. With increased automation, the authors argued that allocations of costs under this system became distorted. Activity-based costing corrected these distortions "by tracing these indirect and support costs first to the activities performed by the organization's shared resources, and then assigning the activity costs down to orders, products, and customers on the basis of the quantity of each organizational activity consumed" (p. 5).
Anderson improved on the activity-based costing model with the 'time-driven activity-based costing' (TDABC). Finding the data gathering to support the conventional model "time-consuming . . . costly . . . subjective . . . . difficult to validate . . . local . . . not easily updated . . . theoretically incorrect when it ignored the potential for unused capacity" (p. 7), TDABC modified the conventional system "by eliminating the need to interview and survey employees for allocating resource costs to activities before driving them down to cost objects (orders, products, and customers).
Time-driven activity based costing involves a two step process. The first, "the TDABC model calculates the cost of supplying resource capacity . . . personnel, supervision, occupancy, equipment and technology" (p. 8). "It divides this total cost by the capacity--the time available from the employees actually performing the work--of the department to obtain the capacity cost rate" (p. 8). The second step, "TDABC uses the capacity cost rate to drive departmental resource costs to cost objects by estimating the demand for resource capacity . . . that each cost object requires"(p. 8).
PRACTICAL APPLICATION
Capacity cost rate = Cost of capacity supplied
----------------------------------------------
Practical capacity of resources supplied
Capacity cost rate = $567,000
------------------------------------------------
630,000 minutes = $0.90 per minute
TDABC estimates of customer related activities:
Process customer orders : 8 minutes
Handle customer inquiries: 44 minutes
Perform credit check: 50 minutes
TDABC COST DRIVERS
-------------------------------------------------------------------------
Activity Unit time (minutes) Rates (at $0.90/minute)
----------------------------------------------------------------------------------------
Process customer order 8 $ 7.20
Handle customer inquiry 44 $39.60
Perform credit check 50 $45.00
Used capacity
Unused capacity (8.2)
As a tool for future decision making, the TDABC allows managers to develop trends of data over time. Modifications to the tool occur from new activities, for example, changes in time due to more complicated or custom processes, changes in cost rates, due to automation or increased efficiencies, such as the implementation of quality programs. Therefore, the system adapts to changes in circumstances.
To estimate processing time, the first principal of TDABC, enterprise resource planning systems aid companies in accumulating data, such as cubic meters, kilograms, gigabytes, and bauds. Global positioning systems and radio frequency identification devices facilitate accumulating data. Having detailed and complete business process diagrams simplifies calculating time estimates. The author argued that the granularity at the transaction level provided greater accuracy for users of TDABC. Recommending steps for implementation, the authors suggested the following: "begin with the most costly processes . . . define the scope of the process . . . determine the key drivers of time . . . use readily available driver variables . . . start simple . . . engage operational personnel to help build and validate the model" (p. 36).
The second principal, aggregating the cost of capacity supplied, consolidates all department costs--"the compensation of frontline employees and their supervisors; occupancy, technology, and other equipment costs; and the costs of corporate staff functions that support the work performed" (p. 41). How companies determine these costs vary depending on the nature of the business and the degree of specificity desired. For example, equipment costs can apply historical, replacement costs, or the "opportunity cost of the investment in the equipment"(p. 43). The second part of this equation, practical capacity, "can be estimated somewhat arbitrarily or studied analytically. The arbitrary approach assumes that practical capacity is a specified percentage, say, 80 or 85 percent, of theoretical capacity" (p. 52). Similarly, equipment might register 15 to 20 percent downtime. Enterprise resource planning systems might record actual repair time, startups, downtime, vacation and sick time for equipment and employees. Although actual costs from accounting systems supply readily available numbers, some firms elect to use budgeted, normalized costs.
The remainder of the book covered the implementation of TDABC and some case studies, of organizations as diverse as an historical black university (HBU), for-profit companies, and not-for profit organizations. The authors address the transformation of customers from unprofitable to profitable with the TDABC system. They end the book by responding to frequently asked questions.
Monday, October 26, 2009
Carlson, R. C.(2005). The new rules of retirement: Strategies for a secure future. New York: John Wiley & Sons.
In creating a retirement plan, the author recommends that each individual starts with "an estimate of monthly or annual spending in the first year in retirement. After that the length of retirement must be estimated. Then the spending estimate should be adjusted for inflation over the length of retirement. Finally, an estimated investment return is used to estimate how much money should be accumulated at the start of retirement" (p. 27).
The author suggested certain steps to ensure a more accurate forecast: "count on inflation . . . key issue is which inflation rate to use . . . don't underestimate longevity . . . don't overlook all possible income sources . . . make more than one estimate . . . check the numbers regularly" (p. 39).
Although the book covers other topics, such as social security, trusts, and IRAs, I will reserve them for future postings.
Monday, October 5, 2009
Kiyosaki: Rich Dad's Prophecy 2002
In typical Kiyosaki fashion, he prognosticated an impending financial collapse and wrote this book to explain how investor's can avoid the disaster. In the Introduction, he claimed that the book had six basic messages: "to remind all of us to be vigilant . . . about the flaw of ERISA . . . to see the world today with a true financial perspective . . . to ask yourself if you're truly ready for the future . . . to offer some ideas on what you can do to prepare for the biggest stock market crash in history . . . to let you know that you may have up to the year 2010 to become prepared . . . to let you know that you will probably be better off financially, if you actively prepare" (pp. 6-7).
ERISA, according to the author, caused employees with 401(k), 403(b), and other plans to plot their own financial future and rely on the vagaries of the stock market, fluctuating from business cycles. ERISA resulted in the change from DB plans, defined benefit, to DC, defined contribution, plans. The first, defined benefit plans, specified the amount an employee would receive from the length of employment and the term of service. Although not related to a company and regulated by the government, social security conforms to the definition of a defined benefit plan. In contrast, the DC plan returns to employees the amount of contributions, if any, that they have made to the plan. Companies can switch from DB to DC plans, forcing retirees to adjust to the transition. Many workers have not made contributions to their DC plans and, therefore, face a lifetime of employment.
The second lesson, that of the flaws of ERISA, applied to the requirements of the law. It mandates that participants begin making withdrawals to their accounts at the age of seventy, a mass divestiture of funds, which will depress the stock market. Another flaw concerns the source of education of investors--the financial community itself. Kiyosaki concluded that "financial education today is really a sales pitch" (p. 63). The final flaw entails the tax penalties that retirees will incur from early withdrawals from a 401(k). "Portfolio income is primarily from capital gains, which is typically the type of income you will earn from investments. The maximum capital gains rate for investments held for one year is 20 percent. The rate decreases to 18 percent for investments held for five or more years . . . If you hold your investments outside of a 401(k), the tax rate on gains would be 18 percent-20 percent. If, however, you hold these same investments inside a 401(k), . . that withdrawn income is ordinary income, taxed at the highest rate. That means a 401(k) plan doubles your tax rate from the capital gains rate (18-20 percent) to the ordinary tax rate (38 percent).
The author predicted that when retirees start to divest their assets, according to the plan, they will panic and transfer their wealth into cash, with a subsequent decline in the stock market. As an antidote to the impending crisis, Kiyosaki offered his prescription for the future.
He used the Noah's ark analogy in describing a plan of "taking control of the ark" (p. 145). The plan contained three elements, cash flow, leverage, and control. To understand how how his cash flowed, Kiyosaki completed a financial statement every month. He suggested that before a person invests or starts a business, he or she develop and review their financial statement. He recommended that every person, who seeks control of their ark, (1) compile and analyze his or her financial statement, "find a bookkeeper or accountant . . . make an appointment with an accountant or bookkeeper to review your financial statements to make sure you have completed them properly . . . analyze where you are today and what changes you need to make in your investing habits" (p. 153).
Kiyosaki based his system on accounting, which began with four quadrants of E (employee), B (big business), S (self-employed or small business owner), and I (investor). These designations divided the four ways people make money. To educate individuals in each of the quadrants, Kiyosaki illustrated the two fundamental statements of accounting, the income statement and the balance sheet. Contrary to most accounting principles, Kiyosaki defined financial terms as follows: "Assets cash flow money into the income column . . . Liabilities cash flow money into and out of the expense column" (p. 176). He offered this lesson, "the relationship of cash flow between an income statement and a balance sheet that tells if something is an asset or a liability" (p. 176). Therefore, what a person perceives as an asset can become a liability.
Similar to the distinction between assets and liabilities, Kiyosaki distinguished good debt from bad and good interest from bad. Good debt created wealth; bad debt purchased a car. Good interest generates tax-free income; bad interest penalizes the individual with taxable interest.
Businesses start small and grow large. Kiyosaki invests in PREPs (private real estate partnerships, a private partnership that is formed to buy a large real estate investment, such as a storage warehouse) and in triple net lease real estate ("triple net means that in addition to their lease payment, the tenant pays for the maintenance of the building, the insurance, the taxes, and structural repairs"). Kiyosaki warned that these investments necessitate large down payments and do not provide a commission for brokers, who seldom recommend them.
Kiyosaki urged readers, who sincerely want to control their ark to do the following:
"Challenge yourself to find a minimum of five hours a week to devote to building your ark . . .
"Visit a real estate broker to inquire about investment properties. Spend dinner one night a week discussing new business ideas. Attend franchise shows in your area. Attend local seminars on real estate, building businesses, or investing in the stock market. Decide which asset class you want to start with: business, real estate, or investing in stocks and/or options" (p. 226).
Vigilance means constant attentiveness. An attentive person remains true to his or her word; he or she will "keep an open mind and . . . ears tuned for change . . . learn to read financial statements . . . use technology . . . watch for bigness . . . watch for changes in the laws . . . watch for inflation . . . pay close attention to government's handling of its social programs (pp. 224-226).
To build the ark, perform the following tasks:
Grow your own company
Name your business
Begin to seek funding sources
Search for outside advisers
Select your business entity and form it
Obtain any necessary licenses and permits
Set up a relationship with you banker
Protect proprietary information
Write a business plan
Select your location
Form your service procedures
Plan ahead for bookkeeping, accounting, and office systems
Decide on pricing strategies
Determine employee needs
Prepare your marketing plan
Seek insurance coverage
Address legal issues
Fine-tune your cash flow budget
Set up your office
Hire employees
Announce your business
Buy a company
Buy a franchise
Join network marketing
Entry cost is low and there are training programs to help you succeed. The companies are typically based on direct sales with home-business opportunities
Invest in Small Real Estate Properties
Kiyosaki suggests that investors strategize to become rich, according to his definition of rich, protect themselves from extreme market gyrations and crashes, and diversity. For adequate leadership, he instructed investors to have a team of advisers, to meet with them regularly, to ask questions and make decisions, to learn from mistakes. As to areas for meaningful self-advancements, Kiyosaki advised investors to "Invest some time finding the long- and short-term reasons why you want to learn something . . . Invest sometime in learning the technical knowledge required to achieve your goals . . . invest some time learning via real-life trial and error" (pp. 263-264). "Stock options investing . . . sales and sales training . . . real estate investing . . . building a business . . . raising capital" (p. 265).
ERISA, according to the author, caused employees with 401(k), 403(b), and other plans to plot their own financial future and rely on the vagaries of the stock market, fluctuating from business cycles. ERISA resulted in the change from DB plans, defined benefit, to DC, defined contribution, plans. The first, defined benefit plans, specified the amount an employee would receive from the length of employment and the term of service. Although not related to a company and regulated by the government, social security conforms to the definition of a defined benefit plan. In contrast, the DC plan returns to employees the amount of contributions, if any, that they have made to the plan. Companies can switch from DB to DC plans, forcing retirees to adjust to the transition. Many workers have not made contributions to their DC plans and, therefore, face a lifetime of employment.
The second lesson, that of the flaws of ERISA, applied to the requirements of the law. It mandates that participants begin making withdrawals to their accounts at the age of seventy, a mass divestiture of funds, which will depress the stock market. Another flaw concerns the source of education of investors--the financial community itself. Kiyosaki concluded that "financial education today is really a sales pitch" (p. 63). The final flaw entails the tax penalties that retirees will incur from early withdrawals from a 401(k). "Portfolio income is primarily from capital gains, which is typically the type of income you will earn from investments. The maximum capital gains rate for investments held for one year is 20 percent. The rate decreases to 18 percent for investments held for five or more years . . . If you hold your investments outside of a 401(k), the tax rate on gains would be 18 percent-20 percent. If, however, you hold these same investments inside a 401(k), . . that withdrawn income is ordinary income, taxed at the highest rate. That means a 401(k) plan doubles your tax rate from the capital gains rate (18-20 percent) to the ordinary tax rate (38 percent).
The author predicted that when retirees start to divest their assets, according to the plan, they will panic and transfer their wealth into cash, with a subsequent decline in the stock market. As an antidote to the impending crisis, Kiyosaki offered his prescription for the future.
He used the Noah's ark analogy in describing a plan of "taking control of the ark" (p. 145). The plan contained three elements, cash flow, leverage, and control. To understand how how his cash flowed, Kiyosaki completed a financial statement every month. He suggested that before a person invests or starts a business, he or she develop and review their financial statement. He recommended that every person, who seeks control of their ark, (1) compile and analyze his or her financial statement, "find a bookkeeper or accountant . . . make an appointment with an accountant or bookkeeper to review your financial statements to make sure you have completed them properly . . . analyze where you are today and what changes you need to make in your investing habits" (p. 153).
Kiyosaki based his system on accounting, which began with four quadrants of E (employee), B (big business), S (self-employed or small business owner), and I (investor). These designations divided the four ways people make money. To educate individuals in each of the quadrants, Kiyosaki illustrated the two fundamental statements of accounting, the income statement and the balance sheet. Contrary to most accounting principles, Kiyosaki defined financial terms as follows: "Assets cash flow money into the income column . . . Liabilities cash flow money into and out of the expense column" (p. 176). He offered this lesson, "the relationship of cash flow between an income statement and a balance sheet that tells if something is an asset or a liability" (p. 176). Therefore, what a person perceives as an asset can become a liability.
Similar to the distinction between assets and liabilities, Kiyosaki distinguished good debt from bad and good interest from bad. Good debt created wealth; bad debt purchased a car. Good interest generates tax-free income; bad interest penalizes the individual with taxable interest.
Businesses start small and grow large. Kiyosaki invests in PREPs (private real estate partnerships, a private partnership that is formed to buy a large real estate investment, such as a storage warehouse) and in triple net lease real estate ("triple net means that in addition to their lease payment, the tenant pays for the maintenance of the building, the insurance, the taxes, and structural repairs"). Kiyosaki warned that these investments necessitate large down payments and do not provide a commission for brokers, who seldom recommend them.
Kiyosaki urged readers, who sincerely want to control their ark to do the following:
"Challenge yourself to find a minimum of five hours a week to devote to building your ark . . .
"Visit a real estate broker to inquire about investment properties. Spend dinner one night a week discussing new business ideas. Attend franchise shows in your area. Attend local seminars on real estate, building businesses, or investing in the stock market. Decide which asset class you want to start with: business, real estate, or investing in stocks and/or options" (p. 226).
Vigilance means constant attentiveness. An attentive person remains true to his or her word; he or she will "keep an open mind and . . . ears tuned for change . . . learn to read financial statements . . . use technology . . . watch for bigness . . . watch for changes in the laws . . . watch for inflation . . . pay close attention to government's handling of its social programs (pp. 224-226).
To build the ark, perform the following tasks:
Grow your own company
Name your business
Begin to seek funding sources
Search for outside advisers
Select your business entity and form it
Obtain any necessary licenses and permits
Set up a relationship with you banker
Protect proprietary information
Write a business plan
Select your location
Form your service procedures
Plan ahead for bookkeeping, accounting, and office systems
Decide on pricing strategies
Determine employee needs
Prepare your marketing plan
Seek insurance coverage
Address legal issues
Fine-tune your cash flow budget
Set up your office
Hire employees
Announce your business
Buy a company
Buy a franchise
Join network marketing
Entry cost is low and there are training programs to help you succeed. The companies are typically based on direct sales with home-business opportunities
Invest in Small Real Estate Properties
Kiyosaki suggests that investors strategize to become rich, according to his definition of rich, protect themselves from extreme market gyrations and crashes, and diversity. For adequate leadership, he instructed investors to have a team of advisers, to meet with them regularly, to ask questions and make decisions, to learn from mistakes. As to areas for meaningful self-advancements, Kiyosaki advised investors to "Invest some time finding the long- and short-term reasons why you want to learn something . . . Invest sometime in learning the technical knowledge required to achieve your goals . . . invest some time learning via real-life trial and error" (pp. 263-264). "Stock options investing . . . sales and sales training . . . real estate investing . . . building a business . . . raising capital" (p. 265).
Monday, June 1, 2009
Ken Fisher: The Ten Roads to Riches
Ken Fisher wrote a lively 'how to' book on getting rich. Unlike most books, which present only one formula, Ken offers ten: "manage other people's money, marry rich, be a sidekick, be an athlete or entertainer, become a CEO, invest in real estate, enter the legal field, start a business, invent income, and save and invest wisely" (p. xiii). No matter which route you choose, note the list of books on page 120 on selling yourself, a fundamental skill for any path.
If you find yourself in a leadership position, Fisher urged readers to lead from the front, acting in ways that followers can emulate--working the hours that they work, flying the class that they fly (coach or business), and working as a team. If you occupy the middle class with a average job and salary, Fisher recommends that you save and invest in stock, in up times and down. With compound interest and stock growth, you will increase wealth.
Recommended reading
How to win friends and influence people, Dale Carnegie
You'll see it when you believe it. Wayne Dyer
The psychology of selling, Brian Tracy
The difference maker, John Maxwell
Confidence, by Roseabeth Kanter
See you at the Top, Zig Ziglar
Spin Selling, Neil Rackham
Fisher, K. (2009). The ten roads to riches: The ways the wealthy got there (And how you can too!). Hoboken, NJ: John Wiley & Sons.
If you find yourself in a leadership position, Fisher urged readers to lead from the front, acting in ways that followers can emulate--working the hours that they work, flying the class that they fly (coach or business), and working as a team. If you occupy the middle class with a average job and salary, Fisher recommends that you save and invest in stock, in up times and down. With compound interest and stock growth, you will increase wealth.
Recommended reading
How to win friends and influence people, Dale Carnegie
You'll see it when you believe it. Wayne Dyer
The psychology of selling, Brian Tracy
The difference maker, John Maxwell
Confidence, by Roseabeth Kanter
See you at the Top, Zig Ziglar
Spin Selling, Neil Rackham
Fisher, K. (2009). The ten roads to riches: The ways the wealthy got there (And how you can too!). Hoboken, NJ: John Wiley & Sons.
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