A fortnight or six ago, I told you kids about the passive income source which are junk bonds. Skip the next paragraph if you’re already well aware of said asset class. If not, prepare to get your face educated RIGHT OFF.
Junk bonds are debt instruments issued by companies that are down on their luck. Individually, they’re pretty risky, but can also lead to some pretty exciting profits when you get the trade right. They’re much safer as a group, so I usually suggest y’all buy a junk bond ETF or a closed end fund.
I own the Dreyfus High Yield Strategies Fund (NYSE:DHF) because it uses leverage to really goose the yield from its portfolio of junk debt. It currently pays a dividend of 9.6%.
One thing I didn’t focus on when talking about junk bonds before was the ideal time to buy. If you’re buying the asset class as an income play, you shouldn’t really care about underlying price movements. As long as you’re happy with the yield, just let the price flap around like the Simpsons watching Japanese cartoons.
That was short-sighted. It always matters what you pay for an asset. Getting yield is nice. Getting a sweet capital gain along with an outsized yield is even nicer. It’s like an extra scoop of ice cream. Nobody says no.
It turns out there’s a really easy way to predict the return of junk bonds going forward. Seriously, it’s uncanny.
Junk bond return indicator
Here’s how it works. Junk bonds will always trade at a premium yield versus other bonds, because they’re riskier. Duh, right?
You’d also think this premium would remain relatively steady over time, with junk bond yields rising and falling with interest rates. This happens a lot of the time, but there are also issues that only impact the junk bond market individually.
One example today is the energy sector. A lot of energy bonds have entered junk status because oil remains under $50 per barrel. If the price of oil falls, the entire junk bond sector can get hit.
Junk bonds also will rise or fall depending on the general economic outlook. Even though the asset class tends to perform pretty well as a group, when the economy suffers, investors run away, convinced every junk bond is going to go to zero.
Like with any investment, the key to buying junk bonds successfully is to get in when they trade at a huge premium to safer bonds and get out when the gap narrows.
The St. Louis branch of the Federal Reserve keeps track of the spread. Let’s take a look at the last 10 years worth of numbers.
We’re obviously not going to see 2009 numbers anytime soon, but let’s focus on late-2011 and early-2016. Both times, the spread between safe bonds and junk debt peaked at about 9%. It was a good time to get in.
Looking at a long-term chart of NYSE:JNK, the largest junk bond ETF, confirms it.
If you would have bought in October, 2011, and sold in 2014, you’d be looking at a capital gain of at least 10%. Plus the nice yield. The capital gain had you bought in early 2016 would have been similar.
You’ll notice that while today probably isn’t a good time to buy junk bonds, the spread in 2007 was even lower. You can see what happened next. It works as a contrarian indicator as well.
Yes, it really is that simple
Sometimes, investing can be easy.
To ensure capital gains when buying junk bonds, buy when the spread approaches 10%. It worked in 2011 and 2016, and even would have worked out well in 2008, assuming you didn’t panic and sell when the spread went over 20%.
With the spread being so low today, I’d recommend against buying. Getting a decent yield is nice. Getting a decent yield with upside is better. Remember, capital gains matter too.
Hey hey hey! It’s time for my quarterly update on how fast we’re paying off our mortgage despite making fun of the guy who paid off his loan in a similar amount of time.
The difference between the two scenarios is simple. I could liquidate investments and have enough to pay off my mortgage by the end of the week. This would probably make my debt-adverse wife very happy. But I don’t do so because I’m convinced those investments will grow faster than the interest rate of the loan.
In other words, if I can grow my investments by 10% a year (which is my stated goal), it would be silly for me to take that money and put it towards a mortgage that costs me 2.7% annually. Besides, we’re making plenty good progress without doing so, as you’ll see.
As a reminder, we’ve set a goal to be mortgage free by January 1st, 2019, roughly 30 months after purchasing our house. We paid $195,000 for the place (whoo! small town real estate prices) and originally financed $190,000 of the loan from a very generous
sugar mama family member who was looking for a GIC alternative.
Here’s what we’ve accomplished so far:
- September 15th — Owed $151,324.51, meaning we paid back $40,000
- December 15th — Owed $129,457.09, meaning we paid back an additional $22,000
I promised this quarter could be even better because I expected a tax refund, and I felt good about my prospects in the new year. Can I deliver, or did I set myself up for failure?
The current balance
Can I get a drumroll please?
Aww, come on Italics Man. It’ll be fun.
You can’t hear them.
I know. But I want them to be excited. It’s all about marketing.
You are such a buzz kill.
Okay, that’s enough time killing for one blog. Today’s balance is…
$107,233.71, for a total payoff of $23,000 in the quarter.
BOOM KIDS THAT’S HOW YOU DO IT.
It was a pretty mundane quarter, all things considered. I did plan to put a little extra tax refund cash on the loan, but I haven’t actually filed said taxes. The rest came from existing cash flow, either from both of our jobs or from the people who owe me money.
Let’s throw up some graphs because at least one of you likes pictures:
The blue lines are the pace we’d have to maintain to pay the loan off in the original 30 month timeline. As you can see we are well ahead of our goal. I only have to pay off $7,000 in the next quarter to keep the pace going, and I intend to do better than that.
The next quarter should be pretty similar to this quarter. The only significant money I’m expecting is a tax refund, but regular cash flow should be enough to continue making a significant dent in the debt.
We’ve paid off 43.5% of our mortgage in just eight months, which is a pretty significant accomplishment. I will take it. It also puts us easily on pace to get this bad boy paid off by the end of 2018.
Simple math says we’ll need to chuck $5,100 per month at the loan to get it paid off in time for New Year’s, 2019. At this point, it’s looking good to happen, but that’s a lot of money.
People ask me all the time how I’m managing to pay off the loan so quickly. While we do live a relatively frugal lifestyle, success is all about the top line. We have a healthy household income that goes a long way because of where we live. I’m also heavily invested in things that spin off all sorts of cash flow, money I’m directing back to my mortgage.
There’s also the possibility of one (or more) of my private mortgage customers repaying me early. I’d likely throw that cash right down on the ol’ mortgage.
And that’s about it. Questions? Comments? Terrible jokes? The comment section is all yours, chumps and/or chumpettes.
Everyone, meet my new friend Jerry. He’s a true millionaire next door.
Jerry is a long-time Financial Uproar lurker who I recently met on a trip to Calgary. Like me, he’s accomplished a lot without actually going to university. Jerry started out working as a grunt on construction sites before being offered a job as a plumber’s apprentice. Four years later he had his journeyman status and was making a good wage.
He worked for the same company for a decade before the old owner decided to retire. Unable to find a buyer, he simply shut down the company. Seizing the opportunity, Jerry immediately hired three of his most useful co-workers and started his own plumbing company, knowing he already had a bunch of potential customers. That was in 1998, which was pretty much the best time to start a plumbing company in Calgary.
Nearly 20 years later, Jerry’s plumbing outfit has a half dozen employees and regularly earns Jerry between $100,000 and $150,000 a year. He has a net worth of $2.5 million despite his wife not working for the last 25 years and two kids who “eat too damn much.”
Jerry truly is a millionaire next door, so naturally I had questions. Lots of questions. Fortunately, Jerry was comfortable answering, as long as I didn’t reveal anything too sensitive.
Here are some of Jerry’s best financial tips.
Buy a house
OH SNAP WE’RE GETTING ALL CONTROVERSIAL IN HERE ALREADY.
Jerry is a huge fan of owning your own home. Even in today’s overpriced real estate market.
“I understand it’s cheaper to rent today, especially in my neck of the woods” he says, “but when I sign up for a mortgage I know the cost of ownership is going to stay relatively close to the same. Just be smart when buying and you can handle a rate hike.”
Besides, Jerry loves his home for another reason. It gave him an asset to borrow against when he started his plumbing business. He reckons his $50,000 in startup capital is worth at least $250,000 today.
Conservatively value your net worth
Jerry has an interesting way of calculating his net worth. He excludes his house and his business, even though they’re worth about $750,000 combined. Why?
His business is an easy one. He says he basically “bought himself a job” by starting his own company, although he admittedly doesn’t work very hard. He’s the flex employee. If there’s too much work for his existing team, then he goes and helps. He says he’ll be grateful if the business sells for anything when he decides to hang up his wrenches.
As for his house, Jerry figures he needs a place to live anyway. He’ll book the value on his net worth once his high school-aged kids move out for good and he sells. The plan is to downsize to a condo or townhouse partly so “my kids don’t decide to move back in.”
Speaking of Jerry’s kids, he has no interest in them making their own way through school. Both have $50,000 waiting for them upon graduation from high school, but with one caveat. They must go to university (or trade school) in Calgary to get it.
The reasoning is simple. “We have world-class schools right here. It makes no sense to leave the city to ‘find yourself’ or other such bullshit. Find yourself on your own dime.”
Jerry also plans to give each of his kids an additional $50,000 when they buy their first home.
I asked Jerry about this parental welfare, and his explanation was simple. He agreed it could lead to a troublesome case where his kids become useless, but he would much rather help them out at the beginning of their career when they could use the money. “It makes no sense to hoard all of my money to my kids when they’re 50 and already well-established.”
Jerry’s portfolio is almost exclusively invested in dividend-paying stocks.
Jerry’s first experience investing wasn’t a good one. I’ll let him tell you the story.
I was 19 or 20 years old with a buddy with a brother who worked for some obscure mining company. I ran into the brother one night at the bar and he told me there was so much gold in this company’s mine they were practically tripping over it. So I immediately threw most of my meager life savings into the stock, which naturally started falling. After losing 80% in a few months I couldn’t take it and cashed out.
Jerry started investing in mutual funds, but decided he’d rather invest himself. He stuck to blue-chip stocks that paid a dividend. He owns between 40 and 50 stocks today, mostly in Canada. Most of his net worth is in stocks. Top holdings include National Bank, Fairfax Financial, Extendicare (partly on my recommendation), and Telus.
Gerry’s goal was always to create an income stream in retirement. He was especially delighted to know the tax bill on these dividends will be virtually nothing.
But Nelson… these tips aren’t that exciting
Perhaps the biggest thing I took away from my conversation with Jerry is there’s no magic bullet needed to become a millionaire next door. He just plugged away at life, made smart decisions, and patiently waited for his net worth to head higher.
As much fun as it is to ask guys like Jerry their secrets, ultimately we already know a lot of them. There’s no secret sauce to becoming a millionaire next door. We all already know the steps. It’s all about execution and staying motivated.
I’ve received so much good financial advice I barely know where to begin. I’m much more sure of the worst financial advice I ever received, however.
The year was 2008, and I was a struggling Realtor/mortgage broker. When I got into the business, I decided I was going to wear both hats as a value proposition to my customers. I’d use mortgage marketing to get them in the door, pre-qualify them, and then go show them houses in their price range.
It was a fine theory that didn’t quite work out, for a couple of reasons.
First, I was a really terrible marketer. To be successful at something like that, you need to spend thousands of dollars per month in marketing to bring in a steady stream of interested folks. I was barely spending $100 a month on a crummy little ad in the newspaper, which generated about four phone calls a year.
Second, people would only phone me when they had exhausted their options with their bank. Sometimes I’d be able to help them (usually by taking the mortgage myself), but most of the time these people had no money and a terrible credit score. I was just wasting my time even talking to them.
Related: living life with a terrible credit score is easier than you think
I was having a little more success actually selling houses, but not a whole lot. I went from working at a grocery store to selling real estate, and the first year I made about 75% of what I made at the store. That wasn’t really what I had in mind, but it wasn’t a bad result. It takes time to get established in the business.
This wasn’t fast enough for my broker, however, which lead to all sorts of innovative motivational techniques.
The worst financial advice ever
One night he took me out for dinner to try and teach me how to drum up more business.
He suggested a number of ideas to get my name out there, including walking around to every business in the downtown core to introduce myself and hand out candy canes, since it was close to Christman. He also recommended I spend an hour each day walking around and ringing doorbells in nice neighborhoods.
I would have none of this. The last thing I wanted was to, and I quote “act like a used car salesman.” I viewed a lot of that kind of stuff as despicable. Talking to randoms all day long was (and still is) my own personal version of hell.
Looking back on it, it’s easy to see why I was a terrible salesperson. I like talking to you guys through a screen. I would hate doing it on a person-to-person basis all day, every day. When I type, I can proofread and change stuff I don’t like. It’s hard to take back misspoken words.
In his haste to help me — and to help himself, since he got a portion of my commissions — my broker suggested the worst financial advice I’ve ever gotten. He said my problem was I had low expenses, and therefore had no motivation. If I created a bunch of new expenses, I’d have no choice but to hustle to meet my obligations.
His main suggestion? Replace my perfectly reasonable used car with a brand new, bigger vehicle, that came with a substantial car payment. Yes, this was said with a straight face.
It’s been a decade since I received that advice, and it still makes my head hurt. It is, by far, the worst financial advice I’ve ever received.
Minimize expenses, don’t create them
Us here at Financial Uproar (me and 46 pet rats) are big fans of maximizing our incomes. It’s the whole reason why I advocate investing in everything from trailer parks to blogs.
But in order to have capital to invest in these things, you have to create a huge savings rate. Earning more is a big part of that equation, but it also helps to minimize expenses. Do both and you’re laughing.
That’s exactly what I intended back in 2008. I took steps to spend as little as possible so I could focus on investing the biggest percentage of my income as possible. The only problem was the income didn’t come. Primarily because I was terrible at my job.
The solution to this wasn’t to add more expenses. Are you kidding me? The solution was something I figured out a couple of years later, when I became a potato chip salesman. I needed to find something I was good at.
I can think of very few personal finance problems that can be solved with increasing expenses.
What is the worst financial advice you’ve ever received? Comment away, yo.
The big story in the Canadian personal finance blog-o-net this week was definitely Sean Cooper’s tire fire of an AMA (ask me anything) over on Reddit. Cooper was clearly looking for some free publicity for his upcoming book — which I reviewed and didn’t really care for — but it didn’t really go as planned after several people questioned him on the validity of his mortgage free in three years story.
The issues basically come down to one thing. Cooper stated he made around $100k a year for each of the three years it took to pay off his mortgage. But once you factor in things like taxes, groceries, house expenses, and a big renovation, it becomes obvious he only had $60,000 or $70,000 a year to throw at a $255,000 debt. The math doesn’t add up.
Sean’s explanation for the discrepancy is… well, nobody really knows. He’s pretty vague with his answers, essentially saying “guys, the numbers add up. Trust me. And no, I’m not going to disclose what I made.” People are saying that’s a pretty weak argument from a person who’s in the credibility business, which is a pretty valid take. It’s all about trust.
And then this comment showed up, which really started to grind my gears:
Pardon my french here, but there’s way too much of this kind of bullshit going on in the financial blogging sphere, and I’m tired of it. Criticizing Sean using throwaway accounts or in private messages and behind closed doors is a cowardly thing to do. If somebody thinks the guy is lying or is giving dangerous advice, own up to it.
We criticize payday loans and credit card debt and mutual funds and a million other terrible financial products on our blogs every damn day, yet when somebody presents a message we disagree with, nothing happens but whispers behind the scenes. Electrons fly back and forth with people saying to their friends “Oh. My. God. Did you just see what Nelson wrote?” Meanwhile, my comment section is more dead than Jimmy Carter.
Wait. He’s not dead? Are we sure there isn’t a Weekend at Bernie’s situation going on there?
The point is this. If somebody thinks Sean’s message will ultimately make people poorer, take a stand and say so. They have a responsibility to do so, in a way. And if a blogger is typing something out to a friend they wouldn’t say publicly, then maybe it’s time to hit the delete key. It takes courage to criticize somebody on a public platform. It doesn’t take much to talk shit behind somebody’s back.
Links I liked
1. Let’s start things off with an interesting article from Institutional Investor, highlighting the changes made by Quebec’s giant pension manager Caisse de depot under former BCE head Michael Sabia. Changes included getting out of index funds and taking a far more concentrated approach, despite managing more than $150 billion in assets.
2. This inside look at the Microsoft IPO back in 1986 is a great read for the creepy cover picture of Bill Gates alone. He looks like he’s about to slip something into your drink.
3. Mr. Dividend Growth Investor points out some myths surrounding index investing, which are very valid. Ultimately, investing comes down to consistency. Switching up your methodology because one part of your portfolio is struggling is a bad idea. If there’s one thing we can say about Dividend Growth Investor, it’s that he’s consistent.
4. Andrew Hallam continues to be one of my favorite finance writers. Here’s a piece he recently did for Asset Builder that looks at how Captain Kirk’s mindset can help your retirement.
5. TD Bank’s aggressive sales practices made the news this week, as profiled in this CBC article. One teller said “customers are prey to me. I will do anything I can to make my [sales] goals. I thought this was much ado about nothing, but TD shares slumped 5.5% on Friday because of this report. Investors think there might be another Wells Fargo situation here.
6. The funniest story of the week comes from Business Insider, who profiled a 31-year-old who paid off $220,000 in student loans in three years. Inspiring, right? There’s just one problem. She had all sorts of help from her family, including her mom giving her a job, a free condo, and a free place to live once our hero decided to rent out the condo for more income. Sacrifice is hard, yo.
7. Speaking of which, Paul over at Asset-Based Life has our previous linkee beat. He paid off $65,000 worth of student loan debt in two minutes. No, that’s totally not clickbait. Really.
8. Bitcoin crashed some 20% on Friday because the SEC rejected the much-anticipated Bitcoin ETF sponsored by the Winklevoss twins. Yes, it’s the same twins that supposedly invented Facebook because they had the idea first. I appreciate anything that knocks Bitcoin down a peg. What a dumb asset class.
9. I’m a big fan of Boomer and Echo’s so-called “four minute” portfolio, which gets its title from the amount of annual work Robb puts into it. ETF investing is supposed to be simple, and you can’t get much simpler than Robb’s two ETF approach.
10. Half Banked points out that if you really want to accelerate savings, making more money is far more important than frugality. It’s an important, timeless message that I will pound into everyone’s head until goo comes out their ears.
11. The execution is the hardest part, or so says Studenomics. Nobody wants to hear about the nitty gritty of starting a business or making more money. Remember that when you’re struggling to get ahead.
12. And finally, here’s a profile of a mutual fund that only invests in stocks trading under $35 a share. A bit of an odd rule, but hey, I’m interested enough to give it a link.
Stuff Nelson wrote
1. I wrote about suddenly cheap Under Armor, taking a look at whether the stock is worth checking out for value investors.
2. I recently spent some time talking to “Jerry”, a millionaire next door type who amassed a $2.5 million net worth just after his 50th birthday. Jerry is an interesting guy with a lot to say. I’ll have some more Jerry wisdom next week for y’all.
3. I also spent some time discussing whether the TSX Composite is in a giant bubble. It’s no worse than Toronto housing, anyway.
Tweet of the week
This didn’t even come from me. Way to phone it in, Nelson.
Have a good week, everyone.