Debt recycling case study

 Debt recycling:

Debt recycling is generally one of the strategy for the people who wants to build wealth from debt effectively.    

When planned and executed properly debt recycling can work in favour but it's definitely not risk free thus it will not sure everyone.  Let's understand this in detail with a case study.

Case Study:

Tom is an illusionary person for this case study purpose with Annual income of $100, 000.  Depending upon the country he is leaving he will have to pay tax on that income to the government.  For this case study purposes let's say the tax rate is 35%.

He bought a home with loan (mortgage) of $400, 000 5 years ago.   He has been paying around $2000 monthly repayments at an interest rate of 4% over 30 years.  He was also making significant lump sums payments during this period to reduce the overall debt and after the end of the 5-year period his remaining loan principal = $250, 000. 

Tom has relativity stable job and mostly he manages his expenses pretty well and he decided to invest in shares with the view of achieving financial freedom in life. 

As like most countries, Tom lives in a country which encourages investments with the incentives.  

One of which is: Tax deductible interest that is paid towards acquiring investments assets.   That means if Tom borrows $10,000 from a bank to invest in shares any interest that he is going to pay on this $10,000 is tax deductible.  

Tom has below options with money that he will have after paying all the bills (and lifestyle expenses) at the end of the month.

1. He could make additional payments into the mortgage

2. He could buy shares with that money to achieve his goal

3.  And here comes the third option .. Debt recycling .. 

First 2 options are fairly straight forward and in fact even the third one as a concept and theory is not that complex.  so, what is that? 

Debt recycling 

He pays additional savings into the mortgage and borrows money from the bank to invest. 

Ohh well, how is that helpful? Here is how .. 

Tom has essentially reduced his nondeductible debt by paying down his mortgage and borrowed money has deductible debt to invest. Numbers ..

So, the whole concept in a picture, 

Over the period, he could repeat this process to significantly built his asset column and also reinvest the profits (after tax) back into assets.  

So why not everyone is doing it?

1.    The assets that acquired with the borrowed money has to produce significant returns/profits to offset the interest that he is going to pay on the borrowed money. 

2. Generally, money borrowed for investments comes with higher interest rate and it is often require good serviceability.

3. Interest rates are not often fixed. if you choose variable interest rate, it could go up and thus the need for investments to produce more profits.

 Thank you so much for reading all the way through!!. Again, this blog post is to explain my understanding of debt recycling and I am not an accountant and financial advisor. :).

 

 

The secrets of investing

The secrets of investing:

    This is one of the common question most people ask. Are there any secrets in investing ?  what are the mantras that successful investors must know, well in this article I will share my experiences and thoughts. 

Respect the money:

     Without compromising your lifestyle you could save money, you will have to choose your spending wisely. Buying luxuries such as expensive cars, jewelry, costly clothes on credit cards or loan eventually is going to create problems financially later.  Instead use that money to generate assets such as shares, real estate so you could buy those luxuries with your money down the line.

Once you have enough money to invest,  it is time to find the right investment so that money can work for you.  Opportunity is everything. 

Don't invest money alone:

         More often than not, most people invest their money because they have seen someone investing and they do not want to fall behind. Just alone buying a property or shares in a company is not investing. It is gambling !!. You could loose or win and as with any gambling the odds of loosing is more.   

    "Invest time and money.  More time and less money"

Sam,  John both earn $3,000 a month from 9-5 job, saves approximately $500 a month after  expenses. 

Sam left all his savings in the same bank account without any research and with the assumption that it is small savings anyway.  On the hand, John spent an hour in finding a bank with high interest rates and at the end of it, he found a bank that is offering 1% higher interest rate and he opened an account in that bank and started using for his savings. At the end of the six months, 

Sam with his current bank interest rate 4% 

Investment amount = 6*500 = $3000

Interest earned = $35

John with his current savings bank interest rate 5% 

Investment amount = 6*500 = $3000

Interest earned = $43.87

So, John has paid himself $13.87 for his 1 hour research over period of 6 months.  This may not be big amount but guess what it's real money and it is only over 6 months period with a savings of $500 a month. This will have compound affects on his wealth over a time period. 

Another example with capital risk which is where research is more important to minimize the odds in investing.

Sam,  John both earn $3,000 a month from 9-5 job, saves approximately $500 a month after  expenses. 

Sam started investing his savings into share market at the end of the each month, he invested in companies that are doing well in the current market conditions. He did not take into account market cycles and company fundamentals. 

John also wanted to invest in share market at the end of each month but he could not find the right companies to invest in every month so only he ended up investing 3 times $500 each for the 6 months period. At the end of 6 months, 

Sam, out of his 6 investments 

4 companies contributed to profits of 10% of each = $200

2 companies contributed to loss of 10% of each = -$100 

So, Sam's total profits  = $100

John, out of his 3 investments 

3 companies contributed to profits of 10% of each = $150, and he has potentially earned interest on the remaining money on his higher savings interest rate account.

So, John's total profits  = $150+

Your research and time has double benefits they will not only help you make profits but at times helps you limit losses.   

Here is another article that I wrote about Investing : Investing Strategies

Investing in shares - Strategies, Terms, Research

Investing in shares :

It is an absolute necessity for each and every individual to understand how money works.   Money inflows into your pocket and Money outflows from your packet.  If you have not worked out how much money that you could spare per say at the end of every month to invest , that is a first step to start.

Where is the money?

Have you have worked out much money that you can spare and, out of which how much you can invest in shares ?  After that, below is the quick checklist to consider. 

• Its risky :  Unlike other investment options out there, share markets investment is risky. You could loose your money if you invest in a wrong company or at a wrong time or even for a wrong reason. So, consider the worst case of loosing all that money and work out your financial situation based on that.
•  Its volatile :  Markets are volatile, you may not be able to cash out the money when you need it as pulling out the money at wrong time may come with  capital losses. So, commitment is required. 
• Brokerage charges :  Every time you buy  or sell a stock you will pay fee to the broker, so if you want to buy stocks for short term gains , leave enough margins to yourself.
• Taxes and regulations : Depending on the place you live in and the place of companies that you buy stocks from , you will be subjected certain regulations and capital gain/loss taxes.  So,  get an idea. 
• Managed funds: It takes lot of time for you to find the right company and understanding the fundamentals, past history and predicting future of the it over short, medium and long term. If you have do not have enough time for that, you could use the professionals to invest the money for you to start with. You invest in managed funds and they invest in the companies for you.  Win, Win.  

What is your strategy:

Steady income vs capital growth:

You could make money in two ways as an investor from share market. 

Some companies pay monthly or quarterly portions of their profits to the share holders.  Yes, I mean Dividends !!!.

Some companies will reinvest the profits back into the business to generate more profits through increasing their market capitalization i.e increasing their product, service offerings or even expanding the existing offerings to more customers.  This increases the company value and thereby the share price. so you can eventually sell the shares at a higher price than you bought.   

Generally, if you are in your 20's or 30's, then consider capital growth stocks over dividends.  After all, you need money at later stages of your life, so reinvesting the money that you would have otherwise been paid  in dividends back into the market make sense.  

That said, there are companies out there which can pay you dividends and as well as grow over the period.  Growth and dividend stocks for the mixture of both worlds.  

Short term vs long term:

When investing in share market , you must ask yourself how many days that you are willing to hold that investment.  

From the day traders: who buy and sell on the same day,  there are share holders holding the stocks for decades.  

Consider investing for the long term, that gives you peace of mind and you do not have monitor the share market every second.   However, re-balancing the portfolio is required at times to limit the losses but otherwise you buy and forget about it and let the market do the magic over a period. 

Here is another article where I wrote about investment: Investment Secrets