Too much financial news is a bad thing! It makes it hard to spot good ideas

Although I had heard of it through friends, today was the first time I ever tuned into Bloomberg TV which has a range of interesting videos for people interested in finance and politics (their sports coverage is terrible).

However the more I thought about it the more I realised that I was filling my head with those pieces of information that add very little in terms of useful knowledge that I can then go and invest upon.  To be sure I was getting a lot of good information the markets and how they are trading and things which are impacting them but then I started to think about how I could use this information and realised that it was essentially useless.

The advent of the 24 hour business news cycle is not necessarily a positive for investors, especially those investors like myself who prefer to take a longer run view of issues, trends and investments.  It adds a lot of useless information so that you need to dig further and harder to find the gems that make it all worthwhile. 

So the question for all investors becomes how do you balance the need to understand the market and know what you need to know with time constraints and potential information overload?

I find the following serves me well and can recommend it as a strategy for investors looking for a way to manage their information flows

1. Use a daily financial newspaper (such as the AFR or WSJ) to get your market information and general news about what is happening
• There may be less information than what is available through aggregating sources on the internet but this is a good thing - newspapers typically only print the headline stuff and this is what you want to know
• You may miss some points but in the big scheme of things this isnt a big deal
2. Avoid watching 24 business news TV
• It honestly adds nothing new and will often focus you on the short term when you should be focusing on the long term
3. Use the internet / online sources when you want to research a specific idea
• The wealth of information on the internet is perfect for when you want to research an idea that you have
• This is the time you use things like Bloomberg TV - their search function lets you find information on any specific topic
• You want to be able to narrow your search topic as much as you can before you start to research though
4. Remember that any 'great investment idea' on TV or media or other public domain is probably already fully valued into the share price
• Investing takes time and effort - you are not going to get great investment ideas from things that are published in the public domain
• I use ideas in the public domain to find out how investors, who I respect, think about certain investments - I never actually follow those investments myself
• Note that goes for sites like this one as well.  I will never post about an idea until I have already put my position on (after I put my position on I'll talk about it all day long)

Using the above strategy

What is TERP and how do you calculate it?

In previous posts on equity raisings I have said that you can make significant profits from equity raisings if you manage to invest at a significant discount to TERP.  In this post I will define what TERP is and how you can calculate it yourself.

What is TERP?

TERP is the Theoretical Ex-Rights Price of a share after an equity raising.  It is the price the share should trade at, all else remaining constant, after a company has completed an equity raising - it accounts for the number of new shares received as well as the increased cash in the business.

Why is TERP an important number?

You should always calculate TERP because it will tell you what sort of deal you are getting with an equity raising (or conversely how much you are losing by not participating in the equity raising).  The bigger the discount to TERP the more you lose by staying out of an equity raising or the more you have to gain if you participate above your original entitlement.

How do you calculate TERP?

The TERP calculation is pretty simple.  Instead of memorising a formula though - I find the easiest way to make sure you are doing the right thing is to remember all those things that are impacting the value of the company.  What you need to calculate TERP therefore is

• The pre-equity raising share price
• The pre-equity raising shares outstanding
• The price the new shares are being issued at
• The new shares to be issued

Thinking about TERP conceptually what you are doing is:

1. Taking the original market capitalisation of the company
2. Adding on the cash received during the equity offering to give you your new market capitalisation
3. Then divide by your new shares outstanding
4. This will give you your Theoretical Ex Rights Price

The above converted into a formula is:

[(Pre-Equity Raising Price x Pre Raising Shares) + (Rights price x New Shares issued)] / [Pre-Raising Shares + New Shares issued]

A simplified version of this is:

(Pre-equity raising market cap + Cash raised) / Total shares outstanding after equity raise

Things to remember about TERP

There are several things that you should remember about TERP including

• It is a theoretical value ONLY
• You can almost guarantee that the shares will not trade at this price however it is the best proxy you have for what the shares will trade at post an equity offering which is why people use it
• TERP is a point in time estimate.  The market will move while the equity offering is underway and there is the very real possibility that the shares will trade well below TERP.
• While a deal can look good on a TERP basis it may not be in real life
• This once again is due to the theoretical nature of TERP - I can't emphasise enough that you need to keep this point in mind
• Shares often trade above TERP post an equity raising
• Often shares are depressed prior to an equity raising because the market knows or suspects that the company will need to raise equity
• Once this has happened and the risk is removed the shares trade back at a 'normal' value and the post equity raise shares trade above TERP

You May Also be Interested In:
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Rights issues: Reading the fine print can make you thousands
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Share purchase plans - when things don't go to plan

FKP's Terrible Corporate Governance Screws Retail Shareholders

This post will cover FKP Property Group's equity raising and their blatant disregard for retail shareholders in relation to their oversubscription facility in their recent equity raising.

As background you may remember that last week I participated in FKP's property raising and it had an oversubscription facility which allowed shareholders to apply for up to $100,000 in over allocations.  At the time I had said that this was a great deal however which came with the significant risk of scale back.  I had experienced a scale back before in QBE's SPP and so I was very wary of this risk.

What FKP announced on Friday was that there was a 76% takeup of the retail entitlement offer however those that applied for overallocations were being limited to 50% of their entitlement offer.

Isn't this one of the risks of oversubscription facilities - why do you have such a problem with it?

It is true that scale backs and caps are a risk associated with equity raisings however if you continue to read the press release you will see the following statement:

The resulting shortfall after the allocation of Additional New Securities is approximately 35 million New Stapled Securities which will be issued to (or as directed by) the Underwriter, Goldman Sachs Australia Pty Ltd, under the terms of the Underwriting Agreement

If you follow the math you will see why I am so outraged at what FKP has done.  Earlier in the release it had the following statement

FKP recieved valid applications....for approx. 165 million New Stapled Securities in respect of their pro rata entitlements, representing a take up rate of approximately 76%

You can see how much of the oversubscription was allocated to shareholders and how much was allocated to the underwriter in the following way

1. Gross up the number of shares available to be take up: 165m / 76% = 217m shares
2. Work out the shares available for the oversubscription facility: 217m - 165m = 52m shares
3. Work out how much retail shareholders got = (52m - 35m) / 52m = 32.8%
4. Work out how much the underwriter got = 35m / 52m = 67.2%

The reason that this was such a great deal was the steep discount to TERP that these shares were issued at.  The people that got allocated the shares were always going to make a big profit off the shares.  I would have no problem if the shares were way overallocated and I missed out.  I have a massive with the fact that Goldman Sachs made the money even though they already being paid a fee for the undwriting.

It means that retail shareholders could have been allocated up to 150% of their entitlement instead of just 50%.  Benefits like this should flow to shareholders and not to investment banks.

The fault lies with the FKP Board and management

The FKP board and management are to blame for this debacle because one of several things has happened, none of which are acceptable in my view

1. Goldman Sachs was promised a minimum share of the equity raise provided the share price was above the raising price after all oversubscription allocations had been recieved 
• This would provide Goldman Sachs with a free option in the shares.  If the share price is above they can make a quick profit.  If it is below then the retail shareholders who subscribed to the oversubscription get allocated the shares
2. A certain percentage of the equity raising was promised to sub-underwriters who are typically instituional shareholders
• Sub underwriters are typically instituional shareholders in the company that is doing the raising
• While this way the value still flows to shareholders the company is making a distinction about which class of shareholder gets the benefit
• As usual it is the retail shareholder who has no voice and suffers

What should FKP have done?

There are a lot of options that FKP could have undertaken to make this acceptable including:

1. Not allocated any shares to the underwriter
• The benefit that is therefore meant to flow to retail shareholders does flow to them
2. If the provision of a certain proportion of shares (or cap on overallocation) did exist it should have been disclosed to shareholders
• If I as a retail shareholder was never going to get more than 50% overallocation, I would not have submitted more money than I needed to. 
• However the company got the benefit of this money for a month so if this is the way in which it was done I think this is particularly deceitful
3. Not treated classes of shareholders differently
• I can guarantee you that institutional shareholders and the institutional component of the equity raising would never have been treated in this way.
• Institutional shareholders have a voice with companies whereas retail shareholders do not

What can be done?

Unfortunately not a lot can be done at this point.  However as a retail shareholder you can voice your displeasure by:

• Writing to management and the board and asking them for an explanation
• Voting against board members at the AGM
• Keeping track of all board members and voting against them for all future boards they may wish to sit on

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Age discrimination amongst older workers

I confess that I have not often turned my mind to the concerns of older people both in terms of retirement considerations as well as workforce considerations.  As a person just starting out on their career (although a few years in investment banking has made me feel like an old man already) these issues seem a long way off for me. 

This post may not be as well researched as some of my other posts where I am trying to share knowledge that I have or have gained recently.  It will really be my thoughts on the issue of discrimination against older people, especially in terms of recruitment and hiring.

The problem was recently brought to my attention when an older extended family member was laid off and has been unable to find employment because he is too old and too experienced. This is almost the exact opposite problem that most young people have.  Young people have the issue of not being able to get a job because they are not experienced and not being able to gain experience because they cannot get a job.

With older people the problem is much bigger.  There are certain perceptions that exist in the community about older people including

• They are set in their ways and are unable to learn anything new - "you cant teach an old dog new tricks"
• You do not know how long they will work for you - "they are getting close to retirement anyway"

Employers are really missing out on a very valuable part of the workforce

We constantly see on television that because the unemployment rate is so low (~5%) in Australia employers are finding it hard to find people to do the necessary jobs and as a result wages are going through the roof. 

In this sort of an environment you would think that the ability to gain an employee who was both significantly experienced and potentially motivated to stay with your company for some time would be a valuable commodity.  However for some reason employers do not think of it this way.  They forget that:

• These members of the workforce have forgotten more than you could ever hope to teach a young employee
• They typically do not feel the need to 'prove themselves' and (in my experience) they play politics a lot less in the workforce
• They are part of the older generations mentality when it comes to employers. 
• A lot has been said about my generation (Gen Y) in that they have no loyalty to the companies they work for.  This is completely true.  I view myself as working for my own benefit and I am more than happy to move if someone else is offering me more or if I feel it would be better for me. 
• Unlike me older generations have real commitment and loyalty to their employers.  Why employers forget an important thing like this is beyond me

If I was a business owner I would think that 'overqualified' employees would be much better for your organisation than underqualified

One problem older people face is that when they have climbed the corporate ladder for their entire lives and then lose their jobs, finding a job to pay the bills is actually much harder because people will not employ an ex manager type person for an ordinary job because of the perception that they are using that job as a stepping stone to better employment.

I would have thought thought that, even if this was true

What is QE3 and why did the share market react so strongly to it?

If you follow the share market at all you will have noticed that there was a major spike towards the end of last week as the US Federal Reserve announced that it would undertake QE3.  This post is a quick background for all those who were wondering why the market spiked so much last week and what the impact of QE3 will be going forward.

QE3 actually stands for a form of unconventional monetary policy known as quantitative easing.  The quantitative easing announced on Thursday last week was the third time the Federal Reserve had announced this policy would be implemented (and hence the 3)

What is Quantitative Easing?

As mentioned above quantitative easing is a form of monetary policy.  Normally when an economy is slowing or inflation is well below central bank target levels, the central bank (or Federal Reserve in this case) will step into the market and reduce interest rates to help stimulate demand in the economy. 

The problem that the US Federal Reserve had was that it had already reduced interest rates to effectively zero which means that they could do nothing further on this front to help stimulate demand in the economy.  Given interest rates can be changed on very short notice the Fed had even tried to extend the period which they were committed to these low interest rates (currently they say they will keep them low out to 2015).  This still did not have the desired result and so interest rates are effectively useless now.

The US Fed then turned to quantitative easing.  The basic idea of quantitative easing is to print money and use that money to buy back US Treasuries and mortgage backed securities to provide liquidity in the market.  The basic hope is that with the excess of capital now in the market that investments will be made in 'real world' assets or on consumption and so stimulate growth and fix the economy.

Why does it involve buying US Treasuries and mortgage backed securities?

Using the money to purchase US Treasuries and mortgage backed securities is a function of the current financial crisis

• There has been a general 'flight to safety' where money has flowed to those assets deemed most safe in the markets.  If you have a look at the yield on US Treasuries it is clear that this is where a lot of the money has been flowing.  The Fed's aim was to move some of this money out of US Treasuries by buying these bonds back and hopefully people will allocate their funds elsewhere in the market
• The market for mortgage backed securities is still very weak and people do not want to be buying these assets.  By providing liquidity for these markets it is hoped that funding will return to these markets so and effective borrowing costs for homeowners will come down

Why did the share market react so strongly?

There are several reasons the share market reacted so strongly:

• It is a pure demand / supply outcome.  If you have billions of dollars flowing into the market which have been created out of thin air then this increases demand for the same supply of stocks thus increasing the general level in the market
• It provides confidence  in the market.  There are some who believe that this is the first step on the road to recovery.  That the inflow of funds will help right the state of the US economy and that things will return to normal.  I am less confident about this.  Given this is the third time that the US Fed is introducing quantitative easing it suggests that the strategy is not all it is cracked up to be.  There is a downside as well - market participants start to expect this level of involvement from the government and when and if it stops the market will return to 'normal levels'

The outcome from QE3 is far from certain.  Over the last week we have seen the dust settle after the furor created by the announcement and general market sentiment and share prices start to pull back.  Perhaps it will be this round of quantitative easing that works or perhaps the Fed has done nothing more than create inflation through the printing of money.

Rights issues: Reading the fine print can make you thousands

Regular readers would have noticed in my August 2012 expenditure tracker post that I was transferring a significant amount of money out of my home loan offset account into my share investment account.  I didn't give many details at the time but said that it was an investment which I hoped would result in quite a substantial short term gain.

This post will outline that investment and how you can make significant amounts of money out of equity raising's through over-subscriptions.  Often the ability to do this is only written in the fine print so you need to make sure you read over all of the fine print carefully whenever these opportunities arise.

Note that like all investments and opportunities that this carries potential risks.  I have outlined the major risks to this strategy below.

Oversubscriptions in equity raisings: the potential is there for large gains

When a company undertakes a significant equity raising they occasionally offers investors the opportunity to oversubscribe beyond their pro rata share for any untaken equity in the company.  I have posted about oversubscription facilities before on my post on how to make money out of share purchase plans.

However the reason that you can make much money out of a equity raising compared to a share purchase plan is because of the amount of oversubscription you can typically apply for.  In share purchase plans the oversubscription is normally limited to $15,000 while equity raisings are typically up to $100,000 oversubscription.

However the right to oversubscribe is often not very clear and only in the fine print.  The investment that I had which was doing an equity raising was the FKP Property Group's 6 for 7 non renounceable rights issue. The right to apply for an over subscription was pretty hard to find (and you would probably miss it if you were not specifically looking for it).

How do you make money through oversubscriptions?

Like in the case of share purchase plans you make money because the shares are being issued at a discount to the Theoretical Ex Rights Price (TERP).  This is the price that the shares should trade at post the equity raising.  The bigger the discount the more money you make from subscribing to the oversubscription shares.

In the case of the FKP raising above the TERP was approximately $0.29 (which is around what the shares were trading at post the announcement of the equity raising) and the equity raising price was $0.20.  If you subscribed for the full $100,000 over subscription and the price stayed constant you would make the following profit

• Number of oversubscribed shares = $100,000 / $0.20 = 500,000 shares
• Profit per share = $0.29 (current price) - $0.20 (price paid per share) = $0.09
• Immediate profit = $45,000 (45% in just under a month)

As you can see from the above example the potential profits from oversubscription facilities are HUGE however there are several potential risks which you need to consider

What are the risks in participating in the oversubscription?

There are several major risks that you need to consider when participating in the oversubscription.  These include:

• Being scaled back significantly on your oversubscription or not getting any oversubscription shares at all
• This is exactly what happened to me the last time I applied for an oversubscription- I posted about it here
• In this case you effectively lose money because your $100,000 has been tied up for a month and you are losing the interest you can potentially be earning on it.  If you have borrowed to undertake this strategy your potential loss is even worse (I would never borrow for this strategy)
• The share price trades below the price you paid for the rights
• This happens quite commonly as well
• There is a lag between when you apply for the shares and when they are allocated to you and you can sell them.  During this time the share price can fall below what you paid for the rights
• In the above example you lose $5,000 for every cent the share price is below the issue price
• The profit you make may not be as high as you expect
• The TERP is a theoretical price only.  The share price can fall to a level where you are not making as much as you would expect to make
• The close date for the FKP shares was last Friday and the share price has come off several cents so my potential profits are already lower than I was expecting

The above risks are risks that are inherent in all equity raisings.   They are also the risks you face if you decide to sell your shares as soon as they are allocated to you. If you decide to hold them for longer you also face risks that the company goes bankrupt or that the market tanks or a range of other factors.  This is not a risk free strategy so make sure you understand the risks before you get into it.

What are other things you should consider with rights issues?

There are several things you should consider when you are participating in the rights issue including

• What is the close date?
• Often the close date is much closer than you expect.  In the case of the FKP rights issue - the retail rights were only open for 2 weeks instead of the usual month.  Anyone who did not realise this would have missed on their basic allocation as well as the potential for oversubscription
• How do I participate?
• Different brokers work differently - if you hold the shares in your own name the chances are that you have to transfer funds to the company or the registry yourself
• Interactive Brokers has a corporate actions function which you need to navigate - I have posted on this before.  Also note that the Interactive Brokers deadline was before the actual deadline
• How much should I put into this?
• I put most of my free cash into the FKP offer.  This was significantly less than the $100,000 I could have put in but given the risks I did not want to borrow to invest in this opportunity
• Is my bank account able to transfer the required level of funds?
• My bank would only allow me to transfer $10,000 a day to my Interactive Brokers account.  If I wanted to participate up to the full $100,000 this would have taken a significant amount of time

Rights issues give you the opportunity to make thousands of dollars from oversubscriptions but they come with risks and you need to weigh up your own situation and risk profile before investing.  If you have any questions about them I am happy to answer them below so post a comment and I will reply as soon as possible.

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Property manager changes: A natural part of the industry

If you have a real estate investment there is a fair chance that you manage your property through a property management company (normally through a real estate agency).  I have posted before on the decision to use a property manager versus self management, how you should choose a manager, the expectations you should set and how much you should pay.

You will eventually get to a point where all things are running smoothly and you really do not have a great deal to do at all.  This is the perfect place to be as your investment is running according to plan and not taking too much of your personal time. 

Invariably though, whether it be after 6 months, or 2 years, you will get a letter in the mail telling you that your property manager has changed.  This post will deal with the question of why and whether this is a big deal.

Why do property managers change so often

The first few times it happened I was honestly surprised how quickly my property manager was changing.  In the first 3 years of owning my property I had 3 different property managers.  1 got promoted to running the full property management team at the estate agency I was contracted with and the second took maternity leave.

I looked into it and it turns out that I was not alone.  Turnover is very high in the property management industry for several reasons including

• Property managers are often overworked. The fees associated with each property are relatively low, so to pay a decent wage and still provide profit for the company each property manager typically gets a lot of files to deal with
• Unreasonable tenants / owners.  The property manager is often the one caught in the crossfire between tenants and landlords.  This requires a certain type of personality and the pay is often not enough to compensate for being the punching bag for both sides
• The job is often seen as an 'interim' one: I read on a forum once that property management jobs are seen as a good way to 'get your feet wet' in the real estate market.  Your wage is not dependent on the number of sales you make but you learn to deal with people in the property market

The real answer is probably a combination of the above factors and others as well.  However the fact is that if you rent out your property through an agency then you are going to have some turnover in your property manager over the years.

Should I worry if my property manager changes?

The change of a property manager is particularly disconcerting if you have had a good relationship with your old manager and were happy with the way things were going.  In a word you should not worry if your property manager changes. 

However you should be especially vigilant for mistakes in the first few months of a new property manager.  If the company you are with has good systems in place then you probably will not have an issue but it is probably a good thing to keep a close eye on things just in case.  This is one of the benefits of going with a large established firm with a good reputation over someone that is operating on their own or starting a new firm.  The probability that a small firm gets a good replacement for you is lower than a large firm. 

If the new property manager is not up to scratch then there are several things you should do:

1. First talk to the new property manager and make sure that your expectations are understood.  They are probably getting used to a hundred different landlords and it could be that they just briefly dropped the ball - give them a chance to get up to scratch
2. If this doesn't work then speak to the management of the firm: They will either get that manager in line or allocate you to a new one who does know what they are doing
3. If this doesn't work then move to a new manager:  In your property management contract you should not have a break fee or notice period - the property management firm will always try and include these in the contract - make sure you take it out.  Before you give notice to your old management company make sure you have a new manager all lined up!

Do I need to wear expensive clothes to work?

Recently I did a post on how to get tailored suits at knock down prices and effectively get a free trip to Asia.  I thought I would follow that up with a post on a topic that many people seem to ask: Do I need to wear expensive clothes to work?

At the very start of this post I should point out that I am not a fashionista, nor am I particularly interested in fashion per se.  However having worked a professional context for several years now I have come to realise that the clothes you wear do make a difference and people do notice what you are wearing even if it is only subconsciously.

This post will obviously focus on those environments where professional attire is required.  This advice does not apply across all industries.  For example a friend of mine who is a well respected web developer was telling me that clients of theirs do not expect to see them dressed up.  There perception of what makes a good web developer and the clothes that fulfil that perception are very different to that of an accountant, lawyer, investment banking or other professionals.

Perception is everything

As I indicated above - perception is everything.  People in certain industries are expected to look certain ways.  Think about it from the point of view of a client - if you are going to a lawyer - do you want them to look successful, moderately dressed or down at heels.  Even though they may all have the same skill level and competency what would you think of them.

When you are relatively junior and working your way up the hierarchy in the organisation this perception becomes even more important.  You want more senior staff to take you under their wing - being well dressed is.

At a very minimum you need to be adequately dressed.  For men this means that your suit needs to be in good condition (i.e. get rid of any suit that begins to get that shine that suggests it's been to the dry cleaners one too many times) and your shirts need fit well. 

Do people really notice when you wear expensive clothes versus less expensive clothes

In a word yes.  It actually amazes me how much people actually notice.  Some of the things I understand while others just baffle me

• Tailored Suits vs off the rack: Trust me you notice when a suit is tailored.  You can actually see the difference.  Also cheap suits you can spot a mile away - this shouldn't be a surprise to anyone.  You do not need to spend a lot of money getting a tailored suit.  I have done a post before on how you can get decent priced ones in Asia.
• Have a small collection of good ties versus a large collection of ordinary ones:  The extent to which people notice quality ties actually baffles me.  I used to have a large collection of ~$50 ties which I really liked.  I once received a $250 tie as a gift which I thought looked nice but not noticeably different but the comments I received (even in the workplace) was noticeable
• Cheap versus mid range versus expensive shoes: Sorry females but I'm only going to be talking about shoes from the male perspective - I don't really understand the rules for females.  But guys you should NOT be buying cheap chunky shoes.  I one black and one brown mid range pairs ($100 - $150 a pair) every 2 years and keep them in good condition with regular polishing and repair when necessary.
• French cuffs versus button cuffs: This depends on the country and environment you work in.  In Europe and Australia french cuffs with a nice set of silver cuff links are not over the top.  I've heard that in the US it is seen as over the top and should be avoided if you are junior
• Shirt cuts:  Having lived all of my life in Australia I was used to everyone wearing the standard European shirt cut and was amazed when I went to America and saw shirts that were very loose.  I think that no matter where you work that you should go for a European cut (if you can fit into it) - they look better and normally cost the same amount.

Subtle is under-rated

Perhaps I should have put this earlier, but even if you are buying expensive clothes you do not need to go over the top.  What you are trying for is to wear clothes that suggest that you are professional and in the top tier of your profession without screaming that you spend a lot of money. 

When you are starting out do not do all of the above - it will cost too much money at once

While you eventually want to get a wardrobe which has all of the above characteristics (and more) you do not need to get there straight away (especially if you are just coming out of college or university).  You can build up your collection slowly.  A great way to start is by doing the following

• You only need 2 suits when you start: One navy and one charcoal - off the rack is fine but make sure you get it altered to fit you (avoid black - it's too limiting)
• You only need 1 pair of shoes: Black (this goes with both the navy and charcoal suits)
• You need 6 shirts: And ALL of them should go with both your suits (i.e. whites and blue bases with red or blue on them will go with almost any suit).  All European cut.
• 1 tie if you don't need a tie for every day use or 3 ties if you do:  Most work places do not require you to wear a tie to work every day (only when meeting clients).  If this is the case you only need one good tie - make it a navy with red on it. This will go with all of your suits and shirts.  If you have to wear a tie every day get one navy base, one red base and one light blue.  These can mix and match with all of your shirts and suits.

I'll probably do another post on where you can pick out your first work wardrobe for good prices.  If you have any suggestions in the meantime please post them below.

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What is mortgage protection insurance?

If you ever take out a home loan banks will normally try and sell you mortgage protection insurance.  This post will cover what mortgage protection insurance is and whether you should have it.

Note that this is different from the mortgage insurance that banks make you take out if you have higher than their cut off LVR ratio (in Australia this is above 80%).

What is mortgage protection insurance

This is probably one of the easiest types of insurance to understand.  Quite simply it is an insurance product which pays your mortgage only in the event that

• You are totally and permanently disabled
• You are temporarily disabled and unable to work
• You lose your job (involuntary redundancy)

Note that this will not cover your medical expenses, nor will it provide an income for you to live on.  The money gets paid straight to the bank to cover your mortgage.

Should I get mortgage protection insurance?

As with all types of insurance it really comes down to your risk profile.  Most people take out this type of insurance to cover them in the event that they lose their job - that way they will still be able to keep their house and continue making payments. 

You need to weigh up your own situation when making a decision.  Things to consider include

1. What sort of other insurance cover do you have? 
• If you have TPD insurance and income protection insurance this should cover you if you are disabled (even for a short period of time)
• What you are essentially buying therefore is insurance in the event that you lose your job
2. How skilled are you and how easy would it be for you to get another job
• If your job is in high demand and it would be easy for you to get another job is it really worth paying an insurance premium for a product that you are barely able to use? 
• Only you will be able to answer the above question but for me the answer was no.
3. What sort of buffer do you have in your mortgage
• Some people only make the minimum mortgage repayments each month and so have no buffer at all
• I tend to keep a significant amount in my mortgage offset account which means that even if I did lose my job I have enough money in there to cover the mortgage repayments for 2 years without paying a cent
• Note that my buffer was not always this big - I just kept adding to it every month.  Really as long as I have a 6 month buffer I'm pretty comfortable.

I think that this is an 'extra' cover that only people who are particularly vulnerable or risk averse should have.  I think there are enough ways to mitigate the risks to make this insurance an excess but again if this insurance allows you to sleep better at night then you should probably go for it.

What are the things I should look out for when taking out mortgage protection insurance?

As with all insurance policies there are several things that you should look out for in the contract.  Read the contract and make sure that you understand exactly what you are buying:

1. Exclusion periods
• This relates to both how quickly you can claim after taking out the policy AND how quickly the policy starts to pay out. 
• The second point is actually the more important one because if there is a one to two month lag between claiming and payout then you need enough of a buffer to cover you during this period
2. Exclusions around claiming
• You need to understand what you can and cannot claim for
• If you are fired for reason will your insurance still cover you? 
3. Maximums (both on cover and time)
• The insurance cover is generally very high (~$10m) but may be lower so make sure you check this
• Also you need to see how long the insurance will continue to pay your mortgage

Overall

As mentioned above I think that people need to ask the question "do I really need mortgage protection insurance?".  I personally think that it is probably one step too far - I think having income protection insurance as well as TPD insurance are more than enough however given the size of the market it appears that others feel differently.

Do you have mortgage protection insurance?  Do you find it good value for money and have you ever claimed?  Please comment below.

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Starting a business: Don't bite off more than you can chew

Regular readers of this blog will know that for the last few months I have been trying to set up an online business.  My original timetable has been blown completely out of the water as I came up against several challenges including

• Not having certain skills and not realising soon enough that I would need to get them in
• Over-estimating how much time I had to commit to the project

I have previous done a post on not having the skills and getting them in (see the link above) and this post will be on the second point which relates to committing to a project and then not having the capability and time to follow it through.

I imagine that most people who read this blog are either working in a professional context or are full time students who are interested in finance.  Either way, the chances are that you are at work or college a significant portion of the day, another portion of the day you dedicate to family and friends and the last part (if you have gone down the same path as me) you reserve for starting a business.

It is important early on in the process to evaluate how much time you can commit to the business.  In my case I thought I had done this.  I didn't not realise one crucial mistake I made:

I made the decision to start the business and evaluated how much time this would take when I was not busy

It is an easy mistake to make.  This is typically when our creative juices are flowing.  We evaluate the time we can allocate to the business based on the time we have when we are making the decision to start a business.

As an college or university student will tell you - it is easy to start a business in your spare time...EXCEPT around exams when you are so busy with study and passing subjects that you have been cramming for that you barely have time to think about your business. 

The same is true for working professionals as well.  There are always times of the year where you are busier than others.  Personally I found that the busy time in my current job is during report season (when companies report their results and I need to update my models and attend a crazy amount of meetings).  In fact it gets so busy that you may have noticed that I am down to one post a day on this blog (from two a day).

When you evaluate how much time you can spend on your new business, think about how much time it will require and whether you will be able to sustain this during the busy periods of your life.

The business I have planned can probably survive me not being present 2-3 months in a year but it also means that I should have extended the start up time for my business by this 2-3 months!  I am still going to pursue the idea and see how it pans out but I am now more realistic about timing and what I can and cannot do.

Have you started a business and had the same problems that I am currently having?  How did you manage it? 

Understand your rights and obligations as a landlord

After you have purchased your property and have rented it to suitable tenants you need to make sure that you understand your rights and obligations as a landlord.  This is one of the core things that you probably will not know intuitively and so need to go out and seek the information.

There are several general things that you need to be aware of when it comes to landlords rights and obligations including

1. Rights and obligations vary across jurisdictions
• Make sure you understand your rights and obligations in each jurisdiction. 
• Understanding your position in your jurisdiction is not helpful if you invest in a property in another state or country
2. Not knowing the law is no excuse for not conforming with the law
• Another common way of saying this is 'ignorance of the law is no defence to a breach of law'. 
• If you do not know a rule exists and inadvertently do something you can still be liable for penalties even if you did not mean to breach the rules
3. Things always go wrong eventually
• There are some things that you can control for but others that you have absolutely no control over
• Things will always go wrong so make sure you understand what your rights and obligations are in each situation

What are the types of rules and regulations you need to understand

To list all of the rules and regulations would be a bit pointless as not all rules and regulations exist in each jurisdiction and more importantly I would not want to miss important ones that you may need.  The list below, therefore is an indication only of things you need to understand when renting an investment property

• Tenancy agreements - what they must contain and what they govern
• Rent in advance, deposits, charges, bonds
• Paying rent
• Water expenses
• Obligations on the tenant on the way in which the property must be kept
• Inspections and rights of entry
• Sub letting the property
• Rent increases
• Rights around end of tenancy and when either party can end the lease and on what notice
• Evictions
• Rights and obligations and avenues for appeal relating to tenancies

Where can I get the relevant information

Most jurisdictions have large tracts of legislation that cover these issues and as time goes by you should probably spend some time getting to know this area of law (after all you have hundreds of thousands of dollars invested - you probably understand your day job much better and have less money invested there!)

However, if you have read legislation at all in the past you know that it is often written in a way that is hard to read and often seems relatively ambiguous. 

The best source of information is typically on consumer affairs type websites and are typically written for tenants.

• This isn't a problem though as a tenants right is your obligation and their obligation is your right so you are reading it in reverse
• This is the best place to start as it is often written very very simply and will give you a feel for what you need to do in any given situation
• I suggest googling "landlord's rights and obligations for [xxxxx state]" and seeing what comes up
• You should get something like this site which covers the law for Victoria in Australia and gives a breakdown of everything you could possibly want to know

Laws change so make sure you keep on top of the information

Laws are changing all the time.  Make sure you keep on top of any changes to the renting laws in your state or jurisdiction so that you are not caught unawares when something goes wrong.

This area seems like a lot to learn when you are first starting out but it isn't that bad actually.  It is very rare for something to go wrong in the first couple of months so that gives you a fair amount of time to learn your basic rights and obligations.  As time goes on you can get into the nitty gritty so that you are aware of everything you need to know.

You May Also Be Interested In:
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What should you do AFTER you have bought and leased your investment property
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Investing in real estate: Essential record keeping
Investing in real estate: What insurance should you have?

The Australian Energy Regulator's insurance dilemma with respect to SP Ausnet

In the last week we have seen a fair amount of controversy raised in Australia (and Victoria in particular) over the Australian Energy Regulator's (AER) proposal that SP Ausnet be able to recover funds that they have to pay out (above their insurance cover) to the Black Saturday bushfire victims through higher charges no the Victorian electricity network.

This is the way SP Ausnet (an ASX listed company 51% owned by Singapore Power) described the proposal by the AER:

This further draft decision deals with the insurance pass-through event, which had not been finally determined. Under the draft decision, there may be circumstances in which liability which exceeds insurance may be recovered by SP AusNet as regulated revenue. The AER’s consultation on this draft decision closes on 12 September 2012.

I admit when I read this I could not believe it - on first read it seemed like a private operator was getting immunity for harm that they cause and the burden would need to be borne by rate payers.  The media's response was particularly ferocious.  This article by Michael West of Fairfax Media is just one of a host of articles ridiculing the proposal.

The Victorian government has announced that they will also be opposing this proposal and will lodge a statement with the AER.  However I think this was only in response to community misunderstanding and the flames whipped up by the media.

However I do not think that the issue is as simple as the media makes it out to be

In fact I think that the media does not understand what this proposal is truly saying.  This is pretty ironic because they have, probably without knowing it, been beating the drum on both sides of this debate.

If you go back through the articles written by Michael West of Fairfax Media (the same author as above) you will find this article which expresses outrage at the high price that consumers have to pay for electricity because of the gold plating (over spending) on the networks which consumers then have to reimburse.  To be fair to the author - this was an excellent article which raised very valid considerations.  He does not seem to link this to the article that he wrote opposing the AER's decision though.

Victorian transmission networks have not been gold plated unlike other states and there has been limited overspend compared with states such as New South Wales and Queensland.  This is largely a function of the privatised nature of the Victorian distribution network.  When you 'over-spend' or 'gold plate' a network it means that you spending to get that last (expensive) 1% of network reliability.  To get this last 1% it is very expensive and as outlined in the article above, probably not worth it.

However this 1% also adds to things like safety of the network.  When you spend these excessive amounts of money the probability of an event like Black Saturday happening also decreases.  Regulators, governments and in the end consumers need to work out what is the appropriate balance and what risk (there is always risk) is acceptable.

To mitigate the consequences of this risk the regulator requires (and provides an allowance for) insurance to cover these events

In the regulatory determinations (you need to read a fair few to get the hang on them) the AER allows operators a certain amount to take out insurance to cover the risk of an event happening.  This is because, in an efficient system you can never have 100% reliability.

What the regulator is proposing in this case, which the media does not seem to grasp is that, if the operator (in this case SP Ausnet) has spent this insurance money efficiently and appropriately and this is still not enough (i.e. implicitly the regulator did not give them enough in the first place) then they should be reimbursed

This actually makes a lot of sense in the regulatory context.

Corporate actions on Interactive Brokers

As I have mentioned several times in the past, I use Interactive Brokers to trade shares as it offers some of the cheapest trading cost going around especially if you want to trade in various international markets.  In addition you really can't get cheaper trading costs for Australian shares through any other broker.

The one major downside (which I have highlighted before) was that it did not offer access to dividend reinvestment plans.  When a company I had invested in through Interactive Brokers announced an equity raising at a significant discount to both the current price and TERP (theoretical ex rights price) I was worried that I would not be able to participate for several reasons including:

1. Interactive Brokers did not offer access to DRP's so would they offer access to corporate actions such as these?
2. The bigger issue was that when equity raising's are done in Australia, US investors are generally excluded from participating
• This is because these equity raising's are not SEC compliant as they do not need to be
• Even though I am not a US citizen, when you invest through Interactive Brokers, the shares are held by Interactive Brokers (not you) and as they are a US entity I thought this would be a real issue

If it turned out that I could not participate in the equity offering I would have lost a lot of money.

However it turned out my worries were unfounded

Interactive Brokers does allow you to participate in corporate actions such as these and they must have an Australian registered entity holding your shares because there were no restrictions at all on the participation in this raising.  It also allowed you to participate in any oversubscription facility.

Note however that the process for taking up your rights under the equity offering are different to other brokers

With other brokers you use your shareholder number to take up any offerings.  This is either done through the share registry (e.g. ComputerShare or Link Market Services) or through the company's website.

Because Interactive Brokers hold the shares in your name you need to do it through their website.  Below are a brief set of instructions on how to access corporate actions on Interactive Brokers website

Step by Step guide to undertaking corporate actions on Interactive Brokers

1. Log into account management



2. Go to the messages or corporate actions
If you have not viewed it before you can view it as a new message however as I have viewed mine before I have to click the corporate actions tab and link indicated below:



3. Select your corporate action

Investopedia - A great reference tool...but don't trust it completely

Investopedia is one of the greatest investing resources on the internet - it is one of the most comprehensive, easy to use investment websites.  It's strength does not come from it's financial articles and analysis (there are plenty of sites that have better material) however it is one of the best resources for looking up terminology and formulas availabel on the internet - it is one giant dictionary for finance.

If you use the search tool for almost any financial term it will come up with an explanation and if relevant a formula as well as a brief description of the inputs (note that if you dont understand the inputs then you can look these up too).

The problem with the site though is that there are occasionally errors and if you don't spot them you can make pretty big mistakes

For example Investopedia defines return on invested capital (ROIC) as



However this defintion doesnt really make sense.  The return on invested capital is either used to describe ther return on the assets (ROA) or return on capital invested (i.e. ROE).  The definition they have above moulds the two together to give a non sensical answer.

That is Investopedia's definition of ROIC uses a geared numerator and an ungeared denominator.  Why is this a problem you may ask?  Well consider the following scenario. 

• You have a company which has a certain ROIC (calculated in the above way). 
• The company issues more equity to pay down debt (i.e. the way in which the assets are funded changes but the total amount of funding doesnt change. 
• Your demoninator stays the same (as the invested capital doesnt change - just the composition) but the Net profit actually increases because there is a lower finance charge. 
• Assuming the dividend rate is lower than the interest rate (which it normally is) you get an increase in ROIC based on how the business is funded not how the assets are performing

This is a pretty fundamental (and rookie) error on Investopedia's behalf.  The problem is not only limited to individuals using this site

If you automatically assume that Investopedia is right and do not sense check what they are telling you then you may make embarrasing mistakes

This was certainly the case for Toll Holdings, one of the largest listed companies in Australia with billions of dollars in revenue and a market capitalisation of ~A$3.3 billion (US$3.4 bililon).  Someone in their investor relations department did not think about the definition of ROIC too closely (and I think probably just got the definition off Investopedia) and put the following slide in their presentation.



If you look at their definition of ROIC - it is exactly the same definition as that used by Investopedia.  In case you're thinking that this is actually the right answer and it is just a funny metric - Brambles

Expenditure Tracker - August 2012

Item	Aug 2012	Target (new)	Over/(Under)	Target (old)	Over/(Under)
Share Investments	+$21,125	+$3,100	+$18,025	+$3,300	+$17,825
Offset Acct.	-$18,675	+$1,300	-$19,975	+$1,600	-$20,275
Personal expenditure	+$3,231	+$2,000	+$1,231	+$1,500	+$1,731

This is the third month of my reset expectations with respect to my savings goals.  In the near term I will continue to show both my old and new targets and how I am performing against each of these.  In August 2012 my expenditure tracking summary looks very strange (and will continue to do so for the next few months).  This is because I am transferring most of the money in my home loan offset account to take advantage of a very attractive share investment opportunity (which I mentioned in my August 2012 net worth tracker post)

Compared to July 2012, I controlled my personal expenditure relatively well but I was still impacted by several a large one off expense related to my car registration.  Excluding this I was still over my target expenditure level but by significantly less (~$700).  My credit card bill for July was very low (which had to be paid in August).  My expenditure in August was higher so this will flow through to the September result.

I did not actually invest month in the stock market over August, however the big increase you can see above was because I transferred funds to my interactive brokers account to take advantage of a corporate action which I believe will give a very good return in the short run.  I am going to be transferring $30,000 more to this account over the next few days to take advantage of this offer so September 2012's result is likely to be even more pronounced.  As a result of this my home loan offset account is likely to decrease even further (I am actually running this account down as low as I can).

In my July 2012 expenditure tracker I mentioned that I would be doing some profit taking in August 2012.  I did do a little though not as much as I had expected.  Also this cash remained within my trading account which I treat as cash in the stock market (even though technically it is not).

The table below outlines my performance on a cumulative basis

August 2012 Net Worth - $255,000 (+2%)

	Value	% Change
Assets	$609,000	+0.7%
Liabilities	$354,000	0.1%
Net worth	$255,000	+2%

While the absolute performance of August 2012 was not bad, it was very disappointing because until about the 25th of August, the share market returns were so good that the result was significantly better than what actually turned out to be the case.  In fact it was the first month since the onset of the GFC that my share portfolio was in significantly positive territory.

Even with the pull back in the share market over the last few days of the month I still had a relatively good month.  This is even though I had several large expenses fall due during the month including:

• My investment property insurance bill for the year (I posted about the large increases I faced)
• My car registration was due
• Several utilities bills associated with my investment property

For those who have been reading my net worth updates from previous months they know that certain things tend to move my result pretty consistently from month to month.  These include

• My personal expenditure: This month was a lot better than expected which surprised me to be honest - it was not nearly as high as I would have expected. 
• My credit card debt increased marginally (but not to the levels seen earlier in the year when I never thought I would get it down to my target level)
• Continued contribution to my employee shareholder plan is a forced investment in the share market from month to month and this supports the absolute level of my net worth increases
• In August the first round of my employee share plan contributions vested and I got a nice gain from this (~25%)
• In a previous post I mentioned that I would be selling this straight away.  The high currency though has tempted me to stay in it a little bit longer so I have not sold yet but am still showing the gain in my share account.
   
• My home loan offset account actually decreased significantly at the end of the month.  A great investment opportunity came up (I will post about it soon) and I am allocating almost all my free cash to it.  It may turn out not to work out but the downside is limited and there is a great upside to it. 
• Most of my liquid cash is in my home loan offset account so this decreased significantly over the month. 

If you have a look at the chart below you can see the relative shifts in my investment profile over the month (note that this excludes my superannuation investments and that the property contribution is on a net basis).  The major shift as mentioned above was in the allocation away from my home loan offset account (treated as a fixed interest security) into my share account.



In my July 2012 net worth post I was hoping for a $5,000 increase in my net worth.  I actually ended up getting a $4,000 increase and would have been well above the $5,000 if the share market had not ended the month so badly.

In September 2012, if all goes to plan it should be a pretty good month for several reasons including:

• The investment opportunity I mentioned above should see a gain almost immediately during the month (although I will not be able to realise this for a few months - i.e. I am locked in for a period of time)
• I should get around to doing my taxes in September which should result in a nice cash return
• I have no major expenditure committments forecast for the month (although as I have seen before a lot of the big expenses tend to come out of the blue)