#39 Adopt an Entrepreneur/Investor mindset

Having worked in the oil patch for a decade, I know quite a few wealthy people.  My father asked me the other day how most of my wealthy friends made most of their money.  My response was that the overwhelming majority of the wealthy people that I know, became wealthy by either starting a business or by taking a financial interest in a company by buying or owning company shares.  I struggled to name anyone I know who is wealthy who got that way from being an employee.  I believe this is a important learning and it reminds me of a few books I read by Robert Kiyosaki.

I first tried reading Rich Dad, Poor Dad by Robert Kiyosaki in 2002.  Tim, a co-worker of mine, had leant the book to me after reading it himself.  He was excited about what he had learned and suggested I should read it to learn how to become wealthy.  I got about halfway through the book and thought "Where is this recipe to building wealth that Tim talked about?".  The book doesn't specifically lay out what kind of investments to go into, it just went on talking about owning real estate and building businesses.  "Hell, I don't need this, I have a good job making good money... I don't have the time to do shit like buy rental properties.  This books sucks!"  I didn't finish the book.

The next time someone recommended I get into Kiyosaki's stuff was in 2007. By then Kim and I were well into into aggressively saving and investing our money so I was looking to maximize our investment dollars.  Another co-worker, another Tim oddly enough, was listening to self-help books and podcasts on his MP3 player and he recommended I try out Kiyosaki's book "Rich Dad's Cashflow Quadrant".  I listened to it. Then listened to it again.  This time I 'got' what Kiyosaki was saying.  The Rich Dad series is really about mindset and how you look at, and earn, money.  There is no recipe.  You create the recipe.  The focus of the book is in how somebody earns money, with emphasis on financial risk and reward.  In Cashflow Quadrant, there are 4 main earner mindsets.  They are summed up as:

Employee - You earn an income by working for someone else. You have no financial interest or risk in the success of the business.  If you stop working the money stops coming in.

Self Employed - You earn an income by working for yourself.  You take on the financial risk of your business but you also do ALL the work.  If you stop working, the money stops coming in.

Entrepreneur (Business Owner) - You earn an income by building and (possibly) operating a business.  You take on the financial risk of the business but you do some work and pay other people to do work to make the business a success.  At some point, your business may run on its own.

Investor - You earn income by investing your money in other people's business or in publicly traded businesses, such as those listed on the stock market.  You take on the financial risk of the business, but have no active role in running it.

Cashflow Quadrant from Kiyosaki.

Many people fit in to multiple earner mindsets or quadrants as Kiyosaki calls them.  The biggest learning I got out of Kiyosaki's Cashflow Quadrant book was that in order to become Financially Independent, you need to move towards the Entrepreneur/Investor side of the spectrum.  Being an employee or being self employed earns you a paycheque but often gives you nothing more once you stop working.  It is when you get your money working FOR YOU in the form of a business or investments that you are able to step back from working.  By moving to the E/I side of earning income, you begin to detach yourself from being dependent on other people to look after you, whether that be an employer or the government.

We were naturally moving towards that mindset on our own in the early 00's but after reading Kiyosaki's Cashflow Quadrant book, we ratcheted it up and were ready during the 08-09 financial meltdown to take advantage of investment opportunities and use leverage to buy quality stocks in the same way real estate investors/landlords buy rental properties.  We went directly to the Investor quadrant early while still in the Employee Quadrant, investing in dividend income and growth stocks.  By using our employee income to build our Investor income, we have gradually moved from one side of the quadrant plot to the other.  At present, about half our income comes from the Employee quadrant, and half come from the Investor quadrant.  At some point our investor income will be all we need to meet our monthly liabilities.  At that point we will be financially free.

By taking on an Entrepreneur/Investor mindset I believe a person takes on more risk, but acquires more freedom.  They are more in control of their life and less dependent on others.  It takes more discipline and motivation to take that path, but I believe it has been very worthwhile for us. While I do not suggest everyone go out and start a business, stocks are available to everyone once you have some savings to put to use.

Rule #15 Don't try to "Beat the Market"

Do you know the only thing that gives me pleasure? 

It's to see my dividends coming in. -John D. Rockerfeller

Have you ever heard anyone talk about beating the stock market?  Its what hotshot investors talk about at cocktail parties.  What they mean is that if the stock market has an annual return of 10% in one year, they have had a better return than that 10%.  Very impressive indeed!  They will try to achieve this by building and adjusting a stock portfolio, mutual fund portfolio, or with index funds.  Beating the market is all well and good if the market goes up, but what if the market goes down? If the market has a loss of 5% the next year and the investor only lost 3%, then they have also beaten the market because they have done better than the market has done that year.... but people don't tend to brag about losing money "Yeah! I only lost 3% this year!".  The market (and by market I mean Dow Jones Index, S&P 500 index, or TSX index etc...) has historically returned 8-12% returns annually but those numbers are smoothed out over decades of data, so you certainly couldn't count on a 10% return every single year... as has been the case the last decade.  One thing about measuring returns in the market this way is you only realize these returns when you sell the investment... and that brings on the issue of timing, and few people have mastered that.

I don't really care if I beat the market or not.  Beating the market is not my objective.  I am not in competition with the market, My objective is to build a portfolio that will eventually result in me being financially independent.  Who cares if you beat the market if the market has lousy or negative returns?  If the market loses 25% in a year, I feel no pride in only losing 20% that year.  And if the market were to make 25% in one year, its ridiculous for me to worry that I only returned 22% instead.  I feel this "beat the market" mentality is a waste and makes people take their eyes off the prize, or chase capital returns instead of stable cashflow.  People shop around for stocks or sectors hoping to get a winning year or to follow advisors or mutual funds because they have a few good yearly returns.  That just seems dumb to me.  I prefer a system that provides stable and somewhat more predictable results.

We have our own metrics.  We don't compete with the market, and we sure as hell dont try to beat it.  Our goal is to grow our cash-flow on existing assets by 8% a year... We get this by reinvesting the 3-5%-ish dividends that we get in cash-flow and then plan on a 4+% increase in dividends annually.  We generally don't pay much attention to stock prices once we own the stock because they tend to fluctuate due to world and political events rather than be based on actual company financial metrics.  Tracking growth of cashflow is pretty easy to understand and we don't have to follow the stock prices or compare with how the market is doing.  In fact, since we are reinvesting dividends to buy more stocks for cash-flow, we don't mind when the market takes a dive because it means we can pick up good stocks with even higher yields than before.

Every year for the last 10 years, our cashflow from existing assets has increased.  Every year! And Every year it has gone up above the rate of inflation.  The lowest growth rate was about 5% in 2009 and the highest has been about 15%.  Thats a pretty good record if you ask me.  This year is turning out to be a good one, we expect about a 10% increase in total this year if we keep going the way we're going.  Three quarters of our dividend producing stocks have increased their dividends this year and the rest probably will within the next 3-6 months, and we just keep rolling those dividends back into the portfolio buying more cash-flow-producing stocks, furthering the compounding.  This increase also does not include any new monies that we put to work in this strategy.  Include the new monies, and our conservative leveraging strategy and we're increasing our cashflow above our 8% per year target relatively easily.  Do I care how this all compares to what the stock market performance is doing these days?  No, I don't.

Rule #12 Use Leverage for MORE positive cash-flow!

Under the right conditions, we are very comfortable using leverage to buy stocks.  Big amounts too.  A lot of people will warn against doing this.  I don't advocate that you necessarily do it, unless you understand the risks and are comfortable knowing what the possible outcomes are, and of course if the investment makes sense in the first place.  If the investment value craters, you are still obligated to pay your debt, so do your due diligence and make sure your really understand what you're getting into before borrowing to invest.    An example of a trade gone wrong would be Research in Motion.  If you borrowed to buy RIM a few years ago you would have lost your shirt on that trade by now as the stock is down 95% off its 2008 high, yet you would still be required to pay back everything you borrowed with literally nothing to show for it. Yes, it really can be that bad.  I would not have invested in RIM because they pay no dividend.

If you are starting to use leverage I would suggest you start in very small amounts until you become comfortable with it.   With all of that said I still don't consider it quite as risky as most will tell you it is, IF you pick stable conservative investments and NOT put all you eggs in one basket.  I have also observed that most people have been conditioned to believe that leverage on investments is risky, yet borrowing (leveraging) to buy a home is not.  I view leverage on a house to be just as risky as using leverage on stocks, perhaps even more risky.  This has to do with my view of a home being a liability.  It pays you nothing, and if it drops in value you are still on the hook to pay for it.  Buying something that is overpriced or built on shaky ground, whether its a house or a stock, can lead to a loss, and leverage can amplify those losses if you sell at the bottom.

I will tell you how I use leverage to increase our cash-flow and pay for itself, while minimizing the risk of the loan over time.  I do not try and hit home-runs with large capital gains, I try and hit base-hits.  Lots and lots of base hits, by creating a cash-flow positive situation while borrowing money to juice it up.  To be clear, what I am talking about is borrowing money, most likely from a bank, to purchase income producing assets.  I prefer Canadian stocks that pay dividends, but you can use a similar strategy to buy an income producing property such as a house or multi-family building, or any other investment with an income stream.  Usually its difficult to find investments with a high enough yield to use the strategy I use, but do your research and you may find some opportunities out there.   Note that I have no experience in rental properties, so I will give an example from a stock that I watch.

There are four basic criteria I use when using leverage.

1. I typically leverage for 50-60% of the position... that is to say that I only borrow when I am willing to put up 40% of the money myself
2. The dividend/distribution must be stable, preferably growing, and never have been cut.  
3. The cost of borrowing must be relatively stable or be going down in the next 1-2 years.
4. The leveraged investment portion must have a positive and growing cash-flow that covers the cost of borrowing today. If it doesn't make sense today to make the investment, I don't rush it.

So here's an example of a leveraged position I might take.  I will use an example for a corporation I follow call Leisureworld Senior Care (LW on the TSX).  They own Retirement Luxury condos and Full-Service Retirement Homes.  Full disclosure: They are on my watchlist, but I do not own any LW and I am NOT suggesting you buy any...  I am just using them as an example.  Lets go down my criteria

#1 I am willing to put up $4000 to purchase some LW stock, I will also borrow $6000 from the bank to make a total investment amount of $10000.  

#2 The retirement home industry is a stable one and will likely grow in the future as Boomers move into retirement lifestyle living centres, I would expect the dividend to be stable and likely grow at or near the rate of inflation.  At present, the dividend yield is 7% 

#3 At present, I dont see interest rates rising much, if at all, within the next 1-2 years due to the slow growth situation right now with the economy... rates are at all time low.  Now may be a good time to use leverage.  RBC currently has a Home Equitly Line of Credit that is set at prime +0.5.  With Prime at 3%, thats an interest only loan for 3.5%.  Thats pretty low.  You could also lock in a rate of some sort through other lending products at the banks, but I typically use a HELOC as you tend to get the best rates, although they are almost always variable and may fluctuate abruptly.

#4 I would get paid a dividend of 7% annually, and use that cash-flow to pay the loan interest of 3.5%, leaving a spread of 3.5% in positive cashflow. This means on the $6000 that I would borrow, I am making $210 annually.  Congratulations, the leveraged portion of this investment is is cash-flow positive!  The Dividend would have to be cut buy 50% or the loan interest rate double before it becomes neutral to cash-flow negative.  Sounds safe in the near term.  

Now that I've established this as a candidate, how might this look with respect to cash-flow?  In most cases I use the cashflow from the total position (both borrowed portion and my own portion's cashflow to pay down the loan).  As the cash-flow pays down the loan, no additional monies need to be injected into the position.  We treat the whole position as a closed system until it pays off the loan.  You can essentially start saving new monies for your next investment as this one pays itself off.  Here's a  spreadsheet showing what happens whey you use the money to pay down the loan assuming no change in dividend or interest rate.  

After 10 years, the loan is paid off and you have $10000 of LW stock.  This spreadsheet DOES NOT consider the likelihood that LW will increase the dividend, or that the annual interest rate will rise into the future.  Both considerations are quite likely... you can test different scenarios in your own spreadsheets.  This spread just shows that if left alone the dividends will pay off the loan in about 10 years and then you will have about $700 a year in free cash-flow from your initial personal contribution of about $4000.  Thats a 17% yield on the money you put up.  Not bad. Not bad at all.

This strategy works well on stocks that are in conservtive sectors with healthy stable cash-flow and if you don't go hog wild with leverage all at once.  I would never use this strategy on a company that doesn't have a healthy balance sheet, a sustainable dividend or if its in a volatile sector like high tech.. its just too risky.  With that said, I believe using leverage conservatively and under the right conditions can be very profitable.