Confession – I am dipping my toe in the 0% balance transfer game

Well, I’ve done it. Something I said I would never do. Something I said was a complete waste of time. I’ve argued that it wrecks your credit score, and diverts your precious attention from investing, all for a few measly thousand bucks a year.

I’ve borrowed $22,000 on a credit card. And it wasn’t even a 0% card! And I plan on borrowing more!

The situation is as such: A little over a year ago, my wife and I assessed our lives and what was happening within our marriage. I was working 60-70 hours a week, often not even seeing my young daughter at all during the day – I’d leave early in the morning, and arrive home with her already asleep. My wife was working a job that was stressing her out too. She once quipped to me that she felt “like a single mom.” That was a real eye-opener – sort of a mix between a slap across the face, and a reality check.

We made changes. I accepted a job for less money that’s one mile from our house, and my wife went part time, which eliminated the most stressful duties of her job. We took a big financial hit, but it has actually increased our quality of life.

It has not increased the quantity of our portfolio, though. My investing goals have not changed (20% rise in net worth every year for the next 15 years), but it did slow us down a bit.

Then, my wife was pregnant with our second child, and it was time to ditch my old car. Time for a minivan. Back in February 2007, we purchased a used 2006 Honda Odyssey. I used our Home Equity Line of Credit to make the purchase. After trade in, it cost us $16,000. After borrowing on the HELOC, the balance was back up to $45,000. This balance consisted of the minivan purchase, a few home repairs we had made, and the down payment on our lakehouse (I still plan on posting about our October 2005 lakehouse purchase, and where it fits into our retirement plans).

The HELOC’s interest rate is Prime minus .01, or 8.24% at this time. As I am able to deduct this interest on our taxes, the after tax interest rate is 5.93%. That means right now, I’m coughing up over $300 a month in interest.

Not that this matters to the discussion, but I am completely comfortable with the portion of the HELOC debt related to the lakehouse. Trust me, this was a good investment, and is a blast to boot. I am less comfortable with the minivan purchase, even though the van rocks and really is a great way to get the family around.

Couple all of this with my desire to continue investing (it’s been going so well this year, why stop now?), and the fact that we’re not going applying for any large loans any time soon (no more apartment building purchases, one is enough – therefore, less of a need for a top-notch credit score), and it was clear to me – I have to get this debt shielded from interest.

Bingo – throw it on a bunch of 0% credit cards. The typical credit card arbitrager (is that a word?) is taking the cash pulled from their credit cards and investing it in a high-yield savings account. The highest online rate I’ve seen is 6%. By eliminating this monthly interest charge, I am in effect earning about 6%. Better yet, I can use that savings to pay down on the principal.

To fully shield us from interest, I need to get the full $45,000 onto credit cards. My first transaction involved a card we already held – a Bank of America Visa card. It’s one my wife held but never used. They sent us a letter stating that the credit limit had been raised to $18,000, and that a balance transfer or a cash advance could be done at 0.99% APR until November 2007. This included a max fee of $90.

I called and tried to get them to waive the $90 fee. They could not do that for me, but they did extend the offer until March of 2008, while raising the interest rate one one-hundredth of a point to 1.00% APR. They also raised the credit limit to $22,000. It had just been raised to $18,000 – why not raise it to $22,000?!?!?!?

So this was not the perfect deal, but there were some things to like about it. First off, I did not have to do a balance transfer, i.e., I did not have to already have credit card debt. Since I bank at Bank of America, they were able to wire the money right into my checking account. Second, the 1% interest rate is going to cost me about $18/month in interest – it’s not zero, but it’s not too shabby. Third, the $90 fee was more than I wanted to pay, but I calculated that by shielding this $22,000 from the high interest rate I was paying, I will have saved approximately $1,000 by the time March rolls around.

And besides that, I don’t plan on stopping. I am going to apply for a Citi card next, as I believe they will also send me a check (or wire me). Hopefully I can get the remaining $23,000 onto 0% cards, and then just keep hacking away at the principal, while also investing in our Roth IRAs.

And if it ever does come time to pay the piper, I have my HELOC checkbook. I write a check to the credit card companies, and we’re out of credit card debt.

Even my wife, who is a cautious cat, eagerly endorsed the idea. The HELOC debt bothers her. It bothers me, but to a much lesser extent. I have our net worth steadily on the increase, and this debt is manageable, so I’m not freaking out about it. But she wants to increase the pace with which we get it paid off, while I want to continue to invest while still paying the debt down. Not an argument, per se. She trusts me, and we’re doing well. But it surprised me how quickly she saw the wisdom in this credit card arbitrage plan of mine.

I’ll keep everyone posted as to how it goes, but I’m excited to get out from under this debt, and this plan should accelerate that. I welcome any comments or advice you might have.

Investing success (or not) for 6/27/07

The Dow was up 90 points today, and my portfolio blew the doors off with a gain of $1,200.

I love when a gain in the Dow corresponds to a much larger-than-expected gain in my portfolio. It normally does not happen this way. I usually see a commensurable gain in my portfolio when compared to the rise in the Dow, but an oversized drop in my portfolio when compared with a modest drop in the Dow. I don't know why that is - it could have something to do with the small cap stocks I own, which introduce a higher volatility to my portfolio. I could also just be imagining this phenomenon.

Investing successes today:
First off, I had some big gainers today, and I'll highlight them below. But today was unusual in the sheer number of stocks that were up. I had 45 advancers today, next to 10 decliners. That makes for a good portfolio day! I had 18 stocks that were up at least 2% today. Some details:

Inventiv Health (VTIV) - up 7.1%.

Nuance Communications (NUAN) - up 5.7%

Dawson Geophysical (DWSN) - up 4.4%

OYO Geospace (OYOG) - up 4.2%

Volcom (VLCM) - up 4%


Investing failures today:
Peerless Systems (PRLS) - down 5.4%. Big whoop, I own $300 bucks of this - it's the runt of the litter.

A few other decliners, nothing of great significance. It was a great day!


Also, I will soon bring news of a financial transaction that I recently consummated - something I said I would never do! Stay tuned.

Robert Kiyosaki - complete moron

Hello all! I am back from my self-imposed baby exile.... and I'm remarkably well-rested. Baby is sleeping well at night, save for the feeding every three hours. Today is my first day back at work (ughh), and judging by my inboxes (both paper and email), I may be in for a rough week!

Thanks for your patience while I was absent. I will be posting at a much more regular clip in the next few weeks.

I ran across this article on Yahoo Finance by our favorite author Robert Kiyosaki. I have opined in the past on how much of an idiot this guy is (see here). I am not even suggesting you read the attached article. If you really want to be entertained, just read the 150+ comments. It's a laugh riot - Yahoo Finance has readers that are practically trained to trash this guy whenever he posts an article.

It's true - this guy is a sub-par author and finance expert.

Just grab a beer and read through all of the comments - good times!

Daughter #2 has arrived

Here's a pic! Our C-section went as planned, and at 10:10am this morning, we were blessed with another beautiful daughter. Everyone is doing well. Talk to everyone soon!

Q

We're havin' a baby!

Q is going to be MIA for a few days, as we're having a baby tomorrow. My wife is scheduled for a C-section at 9:30am. Our almost 3-year old daughter is excited, and so are we. My wife is super-excited to return to her normal playing weight! We think we're ready to go.

I'll see everyone next week - take care, and thanks for visiting my blog.


Q

Silly question - would you buy a year's supply of gasoline at these prices?

There is a gas station directly across the street from my place of work. Many of our employees do alot of driving, so the price of gasoline is a constant topic of conversation, and worry.

However, according to an analyst quoted in this Yahoo Finance article, gas prices have likely peaked for the summer. If we have a bad hurricane season, or if we go to war with Iran, prices could be adversely affected.

And across the street, regular unleaded is now at $2.77/gallon, down from $3.04/gallon a few weeks ago. Our Honda Odyssey (gas hog) cost $49 to fill up recently, so these lower prices are a welcome sight.

That got me thinking - if I had massive underground storage tanks under my house, ones that the neighborhood association either wouldn't know about or would somehow approve of, AND if coming up with the money was not an issue, would I buy a year's worth of gasoline at $2.77/gallon?

For some strange reason, I'm thinking I would. We had a light hurricane season last year, so we're probably due (I am not a meteorologist, nor did I stay at a Holiday Inn Express last night). Also, I am thinking that our war in Iraq is not going to get any better -- the Middle East seems farther and farther away from peace, and the Palestinians are attacking each other and about to start a civil war. Frankly, $2.77/gallon looks great to me right now.

How much is regular unleaded where you live, and if you had the chance to stock up on gas at today's prices, would you?

Use other people’s money - Recap of discussion

I was very glad to see a keen interest in my recent topic of discussion – “Buy a company with debt or with cash?” I hinted that there may be a personal finance lesson to be learned, and I will speak to that below.

The company-buying scenario proffered in my previous post is one that I lived through (of course I changed the names to protect the innocent). I joined a company several years ago that had been purchased by some venture capitalists, and by an individual for whom I had worked previously. I joined as the deal was being consummated, and dealt with a lot of buyer/seller issues. It was awkward at times, as I was clearly pro-buyer (that’s who hired me), but I still had to deal with the sellers at times. The motto “It’s just business” sometimes didn’t seem to fit. Things got nasty – I sometimes wonder why rich people squabble over very small sums of money. Perhaps that’s how they got where they are?

The interesting part of the whole transaction was where the money was coming from.

First off, the two previous owners were forced, through negotiation, to give the new company a 5-year, interest-only loan. This was a very successful business, so they could be reasonably assured that their money was safe. Plus, they were each pulling in a massive interest check each month. It provided more than enough spending money for their months in Florida. : ) Even more interesting was that the buyers made it an interest-only loan. I had previously worked for another company that had an interest-only loan on their building, and quite obviously, they weren’t building much equity in the place, besides a bit of appreciation. When it comes to a transaction like a mortgage on our house, we are told by every expert that an interest-only loan is just unhealthy (and I agree). I know they are used in San Francisco and other red-hot markets, because otherwise young people can’t buy a house. Nevertheless, I feel pain for people that use such loans. And yet, an interest-only loan was used to partially finance this purchase.

Secondly, and much more interestingly, the venture capitalists were handling the money of some extremely wealthy folks about town. These were the “blue bloods” of my hometown – people with net worth’s of $50-600 million. Big, big-time cash. This transaction was rather small for guys like this. This VC firm was put together and funded to buy small to medium-sized companies, with the intent of holding them for awhile. They felt this size of business was not normally targeted by private equity, and they wanted to profit from it. I agree with them – these folks are going to make a lot of money at this.

But then I thought to myself, “Why even bother borrowing here?” I mean, really, what’s the point? One guy in the group had a $600 million net worth. Their combined net worth easily exceeded $1 billion. Why are the VC’s over at the bank borrowing $10-20 million? Why are they negotiating tooth-and-nail with the former owners over a small, interest-only loan? Why don’t they just put up the cash, own it outright, and take in the profits? It’s streamlined, it’s simple, and you’re beholden to no one.

The answer was two-fold: Return on Invested Capital, and taxes. I will speak more extensively on ROIC, but these guys paid a helluva lot of attention to taxes. I don’t have as extensive an understanding of taxes as they and their tax accountants do (as a CPA, I worked in the audit department of my old CPA firm), but I can tell you that they structured this thing to be as tax-efficient as possible. My two scenarios were entirely based on pre-tax calculations, for discussion purposes.

The real reason you borrow in this case is to achieve the highest Return on Invested Capital you can. There is a way to annually make money, and own a business, using less of your capital. You go to the bank and you borrow. By borrowing, you are able to control an asset, and profit from it, using the least amount of up-front cash as possible. As the poor simpletons we are (sorry, it’s hard to match wits with $600 million!!!), we do the exact same thing when we buy a house. Most of us use a mortgage because that’s all we can afford to do. But as I’ve pointed out here, if you absolutely have to have a house, a mortgage could end up being the most profitable way to do it. It allows you to retain more of your cash now, which can be used to invest in stocks and/or rental real estate.

Plonkee nailed it right on the head – when you borrow (option 2), you get a year 1 Return on Invested Capital of 37.8%, before taxes. Option 1 yields a year 1 ROIC of 17%, and is less tax efficient. These ultra-wealthy folks look at this, and the choice is simple – borrow. Use other people’s money to achieve a superior return. For folks like this, emotions do not factor in – they run the numbers, they trust their advisors, and they gun for maximum return.

Full disclosure: company cash flow suffers a bit in option 2, as you’re making a large loan payment ON TIME each month. This business was a cash cow – we had a few struggles, but they were mostly timing issues - nothing we couldn’t handle.

There is another aspect of option 2 that I find very interesting. Each year, as you pay off the 7-year term loan, you own more and more of the company. In year one, you generate a before-tax profit of $3.78 million, but you also build $2.57 million in equity. If you combine those two numbers, you earn a first year return of 64%! I think you have to figure that in. You put in $10 million, and after one year, you now have $16.35 million. It wallops the return of option 1.

My apartment building is much the same way. I put approximately $60,000 down on a $300,000 building, and besides repairs and maintenance (which can admittedly be a bit costly every once in awhile), that’s the last bit of capital I will put in the building. The business itself makes the payments (rents from the tenants). So I put $60,000 in, and in 30 years I will own a building that will probably be worth $400,000. Not to mention the excess cash it generates each month and the big depreciation tax write-off.

When choosing option 2, where you’re investing $10,000,000 instead of $36,000,000, some people wondered if you could earn an equal or greater return with the rest of that unspent $26,000,000. I do not live the lives these people live, but I would have to guess yes. Personally, I would not be concerned with this. My approach would be to invest the right amount of money, in the right places, for the right returns, and at the right time.

That’s the lesson I take from this experience - invest the right amount of money, in the right places, for the right returns, and at the right time. One might argue that middle class folks cannot afford to make financial decisions in the same manner that rich people do. I argue that you cannot afford NOT to emulate them.

Right now I have a 5.5% 30-year mortgage. Due to some previous prepayments, I’m probably ten years along on the amortization schedule. We itemize on our taxes, so I am able to take the mortgage interest deduction, and we are in the 28% tax bracket. That means that any prepayments I make on my mortgage would generate an after-tax return of 3.96%. I CAN BEAT THAT! Let’s be clear - when I have that damn mortgage paid off, it will feel better than watching Paris Hilton return to jail – this will be an emotional day! However, if I run the numbers and keep my emotions out of it, I realize that my excess month-to-month cash can be put to work a lot harder than prepaying on my mortgage. So we stopped prepaying years ago.

Why are people averse to debt? Simply put, debt equals risk. And risk = increased blood pressure. It is better, or it feels better, to owe no one anything. I look forward to the day when all mortgages are paid off – I will probably be a wealthy guy by then, and with no monthly mortgage payment, I will have a myriad of life’s options in front of me. But I cannot be in a rush to pay off a mortgage that in effect produces a 3.96% return for me. There is a better way.

As we invest our cash in the smartest ways I can dream up, I am giving myself the very best chance to be sitting on a big brokerage account 10-15 years from now. And 20 years from now, when the mortgage is finally paid off? Who knows how much we’ll have by then?!?!?

Thanks to everyone that commented in the previous post. It’s great to have you all here as readers. Cheers!