Return on Investment Guidelines (Chicago Condos, Chicago Condos for Sale, Townhomes in Chicago, Chicago New Construction, Chicago Property, Cook County Real Estate, Chicago Townhouses, Chicago Condominiums, Chicago Real Estate Market, Chicago Real Estate)
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Return On Investment Guidelines
By William Cate
July 2004
[http://home.earthlink.net/~beowulfinvestments/]
[http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]
Investment reward should be a function of speculation risk. The investor's goal should be to have a reward that is a multiple of his risk.
Breakeven ROI For Startup Companies
If an angel investor is considering financing a local startup company, he needs a sevenfold Return on Investment (ROI) to breakeven. The simple reason is the U.S. Small Business Administration will tell anyone that only 15% of startup local companies succeed.
Thus, 7 X 15 = 105%, just over the breakeven point for his original investment. In my way of looking at investment, those are dreadful odds.
If a venture capitalist is considering financing a high tech startup company, he needs one hundredfold Return on Investment to breakeven. Only one High Tech startup company in one hundred makes money. Those odds are far worse.
Yet in the past five years, hundreds of billions of investment dollars have been washed away investing in such companies. And it's not only been the funds of the Venture Capitalists, but the additional billions of the small capital investors who then bought into the media and stock hype of these useless, non-productive companies when they went public.
Breakeven ROI for Investors Playing the OTCBB Market
Over 98% of OTCBB companies fail within five years. If you are a small capital investor and invest in one of these public companies, you need to eventually sell your shares for forty nine times what you paid for them to breakeven.
If you are a conservative investor and realize that inflation must eventually destroy the U.S. Dollar and thus you invest in Junior Resource Companies (mining, natural gas, minerals) trading in the US or Canada, you need to eventually sell your shares for two thousand times what you paid for them to breakeven. Here's why.
A Winning/Losing Investment
The success rate of mining exploration companies is about one in every two thousand. Among the best performing mining exploration stocks of the 1990s was Bre-X. Adjusted for splits, it climbed to US$240/share. Had you paid less than ten cents a share for this stock, it would have been a breakeven or potentially profitable investment.
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However, no matter what you paid, an investment in Bre-X proved to be a losing investment, because the company was a clever stock swindle. The conclusion is that anyone who invested in Bre-X shares for more than ten cents was making a losing bet.
Do As They Do
As a wise old British Investment Advisor, Harry Hone, observed to me in 1980: If the US Dollar and British Pound are about to become worthless, why are all the hard currency gurus so anxious to take paper currency for their invaluable gold?
His point was simple. Do what people do, not what they say. And, I've learned over the years that fads and promotions are never good investments. They can be good speculations IF you enjoy speculating and can afford the losses. There will be many of them.
Inflation and Taxes Are Factors
Annual inflation reduces your buying power. In recent years, the U.S. Government reports a 3% annual inflation rate. The business community doubles it, so that it better reflects the actual rise in living costs. Many investments are taxed, so you must adjust the inflation rate by the tax rate to find the breakeven point of any investment.
To breakeven on a US$100 taxable investment, you must earn US$10 in interest. State and Federal income taxes reduce your profit to US$6 for the year. The US$106 will buy the same amount of goods and services, as did the US$100 a year earlier. That will be an actual breakeven, not a profitable investment.
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Many limited-risk cash investments do not meet the breakeven test. U.S. Passbook Bank Account interest rates are a prime example of an annual losing investment strategy against inflation and taxes.
Cash is a Position and a Good Measure of Risk/Reward
What you can earn with limited risk cash investments is a good guide to what ROI you should expect from high-risk investments. Here are a few current examples of limited risk cash positions.
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1. Cash invested in a 401k Retirement Plan. It's in mutual funds operated by a major U.S. Insurance Company. The ROI is subject to deferred taxes. Current annual ROI is 22%
2. U.S. Dollar accounts in European Banks are paying between 11% and 15%. All these banks survived the 1929 Crash and, later, the 10,000+ bank failures of 1932.
3. Short selling OTCBB stocks has paid about a 32% tax free ROI for the past decade. With a 98+% failure rate of OTCBB companies, there is less than a 2% risk of failure in such short sales. And there are ways to mitigate that risk to well under 2% risk. The potential reward is 100% and usually takes less than three years to achieve. However, you do need a significant cash reserve position to begin this investment game.
4. California Real Estate has shown a consistent 20% annual appreciation for the past several years. When you put 20% down on a property, your annual ROI is 100%.
The GVIC ROI
The Global Village Investment Club (GVIC) risk is less than that of OTCBB short selling. If you assume the GVIC member's profit is taken in 5.5 years, the ROI is 100%/year.
Risk/Reward
You can usually determine the risk of any investment by knowing the failure rate of firms in that industry. Conservative investments like municipal bonds have low annual failure rates. Speculative Investments, like commodities and futures trading, have high failure rates. Once you know the risk, you must adjust the reward by inflation and taxes to find the breakeven point for the investment.
Many conservative investments are bad investments. Most high-risk investments are bad investments. If more investors viewed ROI as a favorable Risk/Reward ratio, there would be fewer wealthy people dying broke. And, there would be far fewer middle income people making terrible "bets" on the stock markets.
To contact the author: Visit the Beowulf Investments website: [http://home.earthlink.net/~beowulfinvestments/] Or, visit the Global Village Investment Club Website:
[http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]
About the Author
He has been the Managing Director of Beowulf Investments [http://home.earthlink.net/~beowulfinvestments/] since 1981 and is the Executive Director of the Global Village Investment Club [http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]
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If there's one thing American investors love, it's an over-inflated market. Which is why they keep buying houses and new ones keep coming onto the market. According to the latest data, housing starts rose an annualized 3.4% in September, matching a 17-year high. Whoo-ha! Go, baby go.
I wonder if the people buying these houses, for ever-rising prices, are the same people who couldn't get enough Amazon.com stock at $100 or Lucent shares for $75? Having been burned in the stock market, I guess they decided to re-invest what was left in their homes. Are we in a housing bubble? I don't know, but I suspect that we are, at least in some areas of the country.
Don't misunderstand me, now. I own a home, and I think home ownership is one of the great freedoms we enjoy in this country. I get nervous about the people who are pulling all the equity out of their homes with new mortgages. I suspect that most of these people are spending the equity, not investing it. What they're left with is a larger mortgage, and a bunch of worthless Chinese made goods.
The current low-interest rate environment is a once-in-a-lifetime chance to lock in a cheap 30-year mortgage on your home. If you refinance the balance of your current mortgage, you've won. If you refinance, and max out on your equity, you're probably hurting yourself. You might say that by refinancing the equity in your home, you're just cashing in on your home's rise in value. Well, not exactly.
What you're really doing is collateralizing the portion of the house that you own to get a cash loan, with the intention of paying back the loan at a later date. You've really transferred ownership of the equity in your house to your lender, not cashed it out. If you want to cash out your equity, you have to sell your house, plain and simple.
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For those who are buying new homes, the low interest environment is a double-edged sword. On the one hand, you can get a tremendous rate on a 30-year mortgage, the likes of which you see once in a lifetime. On the other hand, because we live in a world where the monthly payment is all that matters, lower interest rate mean higher home prices. The monthly payment stays the same, but now you've got a much higher mortgage balance, which could turn around to bite you in the future.
Very well. The later lines will be like a feather to the cap. Your further interest in this ballyhoo would be an added vantage for you.
The dangers of refinancing the equity out of your home are readily apparent, but why shouldn't you buy a home in the current environment?
I'm not saying you shouldn't. What I'm saying is you have to be careful. Most real estate professionals understand that the monthly payment matters, not the price of the house, when selling a house. Therefore, the lower interest rates fall, the more money can be charged for a house. If you're a home buyer, with a set amount of money for a downpayment, the price of the house will determine how much equity you start with. And, it determines whether you get a conventional mortgage, with 20% down, or some other form with less downpayment. That equity percentage will determine whether you'll be paying for the great rip-off known as Private Mortgage Insurance (PMI). Trust me, it's just another monthly payout that goes down a giant rat-hole. There's no value in PMI, and you don't want to pay it.
For the sake of argument, let's assume that you won't be paying any PMI. Now, let's compare two neighbors, with identical houses, who have the same monthly payments on thirty year mortgages. The first neighbor has a $100,000 mortgage at 10% interest, the second has a $146,000 mortgage at 6%. You may think this is extreme, but I can tell you that this is what has happened in my neighborhood over the last 5-7 years. The type of house I'm living in retailed for under $100,000 in 1999, and retails now in the $130,000's.
Back to our example. Both of our neighbors are paying about $875 per month on their mortgage. Now let�s suppose that both of them decide to pay extra on their mortgages, upping their payments to $1,100 per month. Both neighbors are reducing their principal balances by $225 more per month, and here�s where the first neighbor has the advantage. The balance on the $100,000 mortgage goes down much quicker than the $146,000 mortgage, such that while the first neighbor is paying more in interest every month than the second neighbor, by sometime in the seventh year, neighbor one is actually paying less in total interest. Neighbor one will pay his house off in a little over 14 years, while neighbor two will take about 18 years to pay off.
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In this example, we don�t even take into account the possibility that neighbor one could refinance the balance on his mortgage when interest rates decline. This would lower his required payment, and allow him to pay off his house even faster. In the meantime, the �market value� of his house has risen to about what neighbor two paid ($146,000). When neighbor one decides to sell his house, he�ll walk away with a lot more cash.
Obviously, this is a simplified example, but one that has been occurring over and over again in the last few years. I know that it�s expensive right now to buy a house, no matter where you go. What do you do in this situation? I recommend looking for, and buying, a home that needs some work. You should look for houses that are selling at about 80% of the average market value in a neighborhood. These houses will generally need only cosmetic work, and maybe a few minor repairs, but you�ll save on the price of the house and have extra equity right off the bat. Stay away from houses that need plumbing or electrical work, unless you know someone that will fix it for free. Those fixes cost big bucks, and will eat up much of the savings on the price of the house.
Buy the house, make the cosmetic changes, then have it re-appraised. You�ll be surprised at how much the �value� of the house has gone up. (I put value in quotes because the only real way to judge the value of a house is to sell it. An appraisal is simply an estimate of value.) This will also help you get rid of the PMI, if you didn�t have the 20% downpayment, because once the balance of your mortgage falls below 80% of your appraised value, you can petition to get rid of the PMI. Houses can be investments, and like any investment it takes a work to find good value. But it can be done.
About the Author
Chris Mallon is the editor and publisher of the Undervalued Weekly, a free personal finance and investment newsletter, published every Saturday.
To sign up for the Undervalued Weekly, send e-mail to underval@hot-response.com, or sign-up through the website at www.dynamicinvestors.net/index8.html.
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