Month: November 2015

Analyze Yourself As A Company. Do You Have A Wide Moat? (2)

By Alfaris88 (Own work) [CC BY-SA 4.0 (http://creativecommons.org/licenses/by-sa/4.0)], via Wikimedia Commons

All Time Sleeping Average: (Target) 7h30m / day (Actual) 7h33m / day (154 night average)

3 Day Sleeping Average: (Target) 7+h / day (Actual) 6h30m / day (5h14m, 7h33m, 6h43m)

I wrote about the different aspects that one should consider in evaluating the financial health and value proposition of themselves in the previous article, but focused on the concepts rather than the specifics. This post attempts to delve deeper into the specifics.

I talked about how having minimal to no debt and a shit-ton of cash allows to patiently wait for the right opportunity to make the most optimum decision over the long term. So how much debt should you be able to take, and how much money should you target to always have?

Today I’d like to talk about the specifics of debt.

How much debt you should be able to take is dependent on a few factors, and the theoretical maximum from each factor combined together will give you a good idea:

  1. What is the purpose of your debt?
  2. How do you intend to invest with your debt?
  3. What is the interest rate of your debt?
  4. What is the monthly repayment amount of your debt? What’s your ability to repay?
  5. By when does the debt need to be fully repaid?

1. What is the purpose of your debt? I strongly believe in the difference between good debt and bad debt. If the debt you take on is not going to directly influence your financial well-being, then you shouldn’t take it on at all.

2. How do you intend to invest with your debt?If you are going to be a very concentrated investor, you should not use leverage.” If you’re going to run a diversified portfolio, what kind of investments will you make? A reference point is Warren Buffett’s leverage rate of 1.5x for Berkshire Hathaway. Warren Buffett’s alpha is generated by investing in low beta and high quality stocks at cheap valuations with low cost debt.

Putting aside the cost of your debt, if Warren Buffett’s leverage rate is 1.5x because he invests in low beta and high quality stocks at cheap valuations and we assume he is the golden standard of safe leveraged investing, then you should scale back your leverage rate based on that reference point depending on how much lower in quality (eg. Net Net Stocks) or how much higher in valuations you’re willing to go for (eg. Relative Valuation of Magic Formula vs. Market which could still be overvalued in absolute terms).

3. What is the interest rate of your debt? Another aspect of Warren Buffett’s leverage rate is that his debt is mostly from the float provided by Berkshire Hathaway’s insurance operations which consistently underwrite profitably. In other words, Warren Buffett is paid to borrow whether or not he ends up using the debt for investing. Similar to the previous exercise, you should scale back your leverage rate based on that reference point.

Another thing to note is, whatever you intend to do with the debt must produce financial returns that far exceed the interest rate of your debt, with the excess margins dependent on the volatility of your investment strategy (the higher the volatility the higher the excess margin you should demand). Volatility is risk when you are forced to sell, and if you can’t service the debt fully from your income streams or your NNWC, then most likely the repayment must happen from liquidating the investments you made.

4. What is the monthly repayment amount of your debt? What’s your ability to repay? A good reference point from Financial Samurai is to allocate 10x interest rate percentage of savings to service debt (eg. if 1% then allocate 10% savings). That in itself should allow you have a ballpark figure of how much debt you can take on.

Another aspect is your ability to repay. Let’s say you do allocate 10x interest rate percentage of savings to service debt, but it still wouldn’t make sense if your monthly salary was irregular or your job nature was volatile. This is when you have to also consider the other aspects of repaying debt, namely any additional sources of income you have and also your NNWC (Net Net Working Capital).

Let’s just say your monthly salary was irregular and your job nature was volatile, so you use a 50% discounted figure to estimate your ability to service your debt. Then you realize you own a bunch of dividend aristocrat stocks and use a 80% discounted figure to estimate the monthly dividend contributions from such stocks.

Combined together, you shouldn’t exceed the 10x interest rate percentage rule, but just to err on the side of caution, you also make sure your NNWC (100% value for cash, 75% value for receivables & bonds, 50% value for equity investments) should last you for as long as you need to find your next job just in case the monthly salary get completely eliminated and only your dividend aristocrat stocks’ monthly dividend contributions remain.

5. By when does the debt need to be fully repaid? There is a trade-off between how low the interest rate of debt goes and how long you can take to fully repay the debt. All things equal, if interest rates are the same, you should always delay paying the debt.

As mentioned earlier, volatility is risk when you are forced to sell, and since if you’ve done your homework and know that your investment strategy works on the long run, then you minimize the risk of having to liquidate investments during a down year for the investment strategy by extending the period to let the strategy work before you liquidate investments to repay the debt.

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Analyze Yourself As A Company. Do You Have A Wide Moat? (1)

By Alfaris88 (Own work) [CC BY-SA 4.0 (http://creativecommons.org/licenses/by-sa/4.0)], via Wikimedia Commons

All Time Sleeping Average: (Target) 7h30m / day (Actual) 7h33m / day (152 night average)

3 Day Sleeping Average: (Target) 7+h / day (Actual) 7h10m / day (8h23m, 7h54m, 5h14m)

A close friend of mine got laid off recently. He was the top performer in his batch, but the company was dumb enough to lay him off because he ended up in the wrong department for his rotation when the restructuring happened.

It makes me cautious. Even if you are killing it at work, the probability of you getting laid off / fired is always there, even if it is minimal. And you should always prepare for such black swan events.

I think the first thing that needs to be considered for preparing for black swan events is financial health. Just like a company, the only way you can go bankrupt is if you have not only debt, enough debt that costs you more than you can earn, but also seeing your cash reserves being dried up.

So the two ways to prevent bankruptcy from happening is to have minimal to no debt, and to have enough cash reserves for unexpected turn of events. If you have minimal to no debt and a shit-ton of cash, that gives you bargaining power to wait until you can make the decisions that make sense the most in the long term. And that makes your personal moat wide.

Then you have to consider your sources of income.

If your main source of income is your job, you have to ask yourself what you can offer in the market and how much people are willing to pay for it. The bigger the competition, the less you can expect to get paid, and the more risky your job becomes.

And you also have to think about your value proposition strategy in general. If you follow the 4Ps of Marketing (Price, Place, Promotion and Product), you have to consider if your salary (Price) is competitive enough versus competition (the higher the salary, the higher the chance of being laid off if you can’t justify it); you have to consider if your geographical mobility (Place) is competitive enough versus competition (you might just get that promotion for being willing to relocate when others aren’t); you need to evaluate if your network, your social presence (eg. LinkedIn) and your job hunting skills (cover letter, resume, interview, aptitude tests, assessment centers) are good enough to get you noticed and hired (Promotion); and last but not least, you need to understand where your skill sets compared versus the competition in your grade, and whether an upgrade in skill sets or a mix-over of multiple skill sets can allow you to offer better value for money output than the competition (Product).

So in general, the wider the gap between how much you cost (salary) and how much value you bring to your company (profit), the safer your job becomes. And if you can consistently keep that gap wide or wider, then that makes your moat wider too by building a reputation that helps you become attractive and employable beyond your company.

Which leads to another dimension, which is the need to diversify.

Anyone who has read enough annual reports will understand that many companies that rely most if not all of their revenue from one account is extremely easy to go belly flop when things don’t go their way. Look at Apple’s suppliers, who are forced to accept razor thin margins if Apple left them because they’d go bankrupt before they could configure all their manufacturing capabilities to accept non-Apple orders. That gives too much bargaining power to just that one account.

Same goes for most wage earners. If your skill sets are company / industry exclusive, your bargaining power diminishes when you can’t find another company that can appreciate your skill sets and there are others who can do what you can do.

And that’s why it’s important to diversify your sources of income as early as possible. It doesn’t have to end up making you quit your job (if you like/love your job, why not keep working?), but it just gives you more bargaining power in the overall scheme of things. Being less reliant on very few sources of income and having your multiple sources of income be very reliable also makes your moat wider.

So the question that I think many people need to ask is, “If you were a company, do you have a wide moat?” If the answer is no, then the respondent should think hard on doing everything to widen the moat before another black swan event comes knocking on your door.

Actual Sleep vs Time Spent Sleeping

By Andr.V.S. (Own work) [CC BY-SA 4.0 (http://creativecommons.org/licenses/by-sa/4.0)], via Wikimedia Commons

All Time Sleeping Average: (Target) 7h30m / day (Actual) 7h34m / day (149 night average)

3 Day Sleeping Average: (Target) 7+h / day (Actual) 8h17m / day (6h11m, 12h25m, 6h15m)

One interesting thing about Fitbit is it only records the actual sleep it feels you’ve had rather than the total time spent in bed.

Which to a certain extent means, I may have to reconsider my sleeping targets.

Of the current 22 sleeps I’ve logged on Fitbit, my current sleeping efficiency is 92%.

The implications are twofold:

  • I’m not getting enough sleep. If my All Time Sleeping Average is 7h34m, the implied actual sleep is 6h58m, which is close to the minimum 7 hours Fitbit recommends but too close for comfort for various reasons [1].
  • I should set a target of 8 hours of actual sleep. To provide a margin of safety whilst not causing marginal returns due to pursuing lots of sleep, I should target the mid-point between 7 – 9 hours of sleep that Fitbit recommends. That implies that I need 8h42m of sleep based on a 92% sleep efficiency.

Which, if I’m going to wake up at 5:30 am tomorrow, should mean that I need to go to sleep now. I’m already 7 minutes behind schedule.

[Footnotes]

[1] My sleeping efficiency is 92% as of the past 22 sleeps, but that was before I regularly did cardiovascular exercise. There’s a probable chance I may have had worst sleeping efficiency before, which drags my actual sleep time even more. There may also be other unaccounted for reasons, such as short sleeps I never logged, or sleeps being longer because I forgot to turn off SleepCycle after being awake.

I Want To Learn To Actually Speak Different Languages

Gage Skidmore [CC BY-SA 3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons

All Time Sleeping Average: (Target) 7h30m / day (Actual) 7h34m / day (147 night average)

3 Day Sleeping Average: (Target) 7+h / day (Actual) 8h47m / day (7h45m, 6h11m, 12h25m)

I was watching a video called Bilingual Celebrities 2012, and I stumbled upon the fact that Tom Hiddleston spoke French, Italian, Spanish and Greek. And my mind was blown.

Sure a lot of Europeans speak multiple languages, but it just made me think… I’d really like to converse with different people in different languages.

If authentic relationships are that important to me, I think being able to speak in someone’s native language helps bridge the gap of understanding much better than when speaking to someone’s second or third language. That’s how I felt in a business trip 2 weeks ago interacting with colleagues from different countries.

So what’s the first language I want to tackle beyond Cantonese, English and Mandarin? I think German’s the natural choice. I work for a Liechtenstein based company, and since I’d like to work in the global headquarters one day, I’ve heard German would come in handy since many meetings are conducted in German.

Also the fact I want to learn Dutch one day (my favourite football club is PSV Eindhoven, and my favourite national football team is Netherlands)… well let’s say German and Dutch have many similarities, so it would help me make the transition one day.

If I were to learn another language in the future, it would probably be the most popular ones, so judging by what I already know (Chinese and English) the next logical choice would be Spanish, followed by Hindi.

But I shouldn’t get too ahead of myself. Let me start with German first.