Why inflation shouldn't matter to you

How does inflation affect you 

Don't worry about the inflation figure! It doesn't matter.

You're probably thinking I've gone mad, but read on before you judge me harshly.

Let us define the inflation figure as simply as possible. In the UK the Office for National Statistics (ONS) has put together an average basket of 100 items sold in the UK economy. For example, it includes the average price to fill up a car with a tank of petrol. It also includes the average price of a bottle of wine and so on and so forth. This basket of goods is supposed to representative of what the average consumer spends their money on in the year. The ONS then measures how the prices of those goods vary from one period to the next (a period could be a month or a quarter). The average of this variation across the whole basket of goods is the inflation figure. Currently it stands at 2.8%.

Why you shouldn't worry about the headline inflation figure

The inflation figure should only matter to you if that is the exact basket of good that you buy. Clearly the vast majority of people do not. It may be that the particular brand of beans (let us call it brand B) that you buy has not increased in price during that month. So the knowledge that brand A beans has gone up in price should be meaningless to you.

Furthermore, the inflation figure ignores the substitution effect of prices. It is not the case that if the inflation figure stands at 2.8% that our buying power has decreased by that much. Consumers have the power to increase their spending power by substituting to cheaper goods.

We have now dispelled the myth that inflation eats away your spending power, but what about the idea that it eats away at your savings?

Inflation, destroyer of the savings of the nation?

Part of the reason that people worry about inflation is that it destroys the real value of your savings over time. This is why many savers are conscious that the rate of return needs to beat inflation. This is particularly poignant in this current period of historically low interest rates. There has been much talk about how the Bank of England and the Government are punishing savers for the overspending habits of the borrowers, as low rates, coupled with inflation means that savers lose money in real terms.

Contrary to popular opinion, I don't have a big issue with inflation being slightly above savings rates. It all depends what your plans are for your savings. For example, if you're saving to put a deposit on a house then the increasing price of baked beans is irrelevant. The only prices that should concern you are house prices. The very least that you require is that your savings grow in line with house prices.

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Shares: the reasons that I bought

Buying Shares - the explanations for doing so...

I recently read an article on an investing website that said that you should state your reasoning for investing in the various companies in your portfolio. So here goes:

My first share investment buys

Barclays, RBS, and Lloyds - I invested these banks in the summer of 2010. At that time the prices of the various shares were cheap relative to the book value on the balance sheet. The balance sheets particularly for Barclays tended to suggest that the price should have been double what it was.

In the case of RBS and Lloyds my reasons for investing was fairly simple. Currently the biggest shareholder in these companies is the Government. It would be political suicide for the Government to sell these companies at a loss. Since I bought them at a price well below what the Government bought them, I figured that these are some of the safest stocks in the world, as the Government would not let them fail - ironically encouraging the 'too big to fail' view of UK banks.

Furthermore, it was rumoured that in 2013 RBS and Lloyds will start paying a dividend. In the mean time I expect the small dividend of Barclays Plc to begin to increase. All three Banks are therefore longterm growth prospects. RBS and Lloyds - I intend to sell half the shares once they've doubled in value. Barclays is a long term divided provider - after repeatedly good results I'm hoping to see a growth in the dividend per share over the next few years.

Investing in mining shares

Centamin, Avocet Mining and Lonmin - these three miners are reflective of a large position in the mining sector. All three have a commonality in that I invested once there had been some sort of disaster in their particular industry, causing a large dip in share prices. Lonmin had problems with strikes in South Africa - that I believed must come to an end. Centamin, a gold miner located in Egypt had problems with supplies. I reasoned that supply issues tend to be short lived and the large price fall did not justify the true value of the company considering the strong balance sheet of the company.

Investing in blue chips and AIM

Debenhams - this is the second largest clothing retailer in the UK. The purchase was within an ISA stocks and shares trading account, thus protecting the dividend income (and capital gains) from taxation. On purchase the company paid a generous 3.5% dividend yield. The company is showing a good transition to the Internet whilst retaining its market share in bricks and mortar.

Morrisons - as well as paying a generous dividend, paid into my stocks and shares ISA account, Morrisons has done the most investing in terms of utilising their store space out of all of the big four supermarkets. I see this investment in 'store experience' eventually paying off in terms of share price growth.

BT - this telecoms company is a solid dividend paying stock. BT is currently on an expansion programme, building their wireless and cable networks. BT are also looking to buy up rights to various sports tv and seem to be edging their way into that market. Whilst the company grows, I'm happy to enjoy a small dividend yield in the meantime.

Hornby - I originally made my investment into Hornby after they had a poor period of selling over the London Olympics. I looked at the company's balance sheet and, whilst a relatively small company it had a long and strong track record or producing cash to pay to shareholders. I don't expect anything special from this share - rather it is an attempt to reduce the volatility in my portfolio.

Do you like what you've read? Tell your friends by sharing it with one of the buttons below. Please post this to Facebook or Tweet it to help your friends and family. Feel free to send me an email (mrmoneybanks<at>multimillionaireroad<dot>com), find me on twitter @millionairer0ad or comment. Whether good or bad, I want to hear from you all.

Property portfolio strategy

Building a property empire

None of us will have failed to realise that the current economic climate caused by the financial crisis of 2007 have meant some radical changes. We have seen a big change in politics, austerity measures, the euro zone crisis and a squeeze on capital.

Gone are the days of unlimited borrowing. It used to be the case that many consumers could qualify for mortgages up to 120% of the value of the property. Unsurprisingly, this madness has come to an end!

Making money from property - the old way

I talked to a few businessmen who operated property portfolios in those days of madness. It seemed to me that the way to make money from property was as follows:
1. Build a deposit for your first property
2. Move in to your first property using an interest only mortgage extended for as long as possible.
3. When you have built up equity in this property (which used to be the assumption) then release this equity by remortgaging
4. Use the newly released equity to put down a deposit on your first investment property
5. Get an interest only buy-to-let mortgage extended for as long as possible
6. Go back to step 3 to release more property and follow steps 4 and 5 for your second investment property
7. Continue following step 6 to grow your property empire as you gain more and more equity

This property portfolio building model was thought to work for several reasons:
1) it was assumed that property prices would go up over the long term
2) as the mortgage term came to a close you could always remortgage the property or sell it
3) tenants were easy to come by to and so the interest would be serviced

The problem with the old property portfolio model

I am no longer comfortable with this model. I want to build a portfolio of assets, not highly levereged debt! The problem with the old method is that if there is a sudden drop in house prices you are stuck with a lot of assets in negative equity. Furthermore, should the mortgage be up, crystallising losses becomes a reality.

The new property empire building method: the safe way

My new investment method attempts to circumvent the possibility or at least reduces the probability of being stuck in negative equity. Although, more painful on short term cash flow my method aims to pay off mortgages as quickly as possible.

The new method works as follows:
1. Rent/ live at home whilst building up a deposit
2. Once you have a deposit that provides you with one of the best possible mortgage rates go and find a property to buy to live in
3. Only borrow as much money as you can realistically afford to pay off between 5 to 10 years
4. Enjoy the property until the mortgage is paid off in full, whilst building up a new deposit in the meantime
5. Move into your new property using the same ideas as in section 2. Rent out the first property, looking for long term tenants ideally a family paying a 5%-7% yield. The extra income should help you to pay off your new property that you are living in, relatively quickly 5-10 years.
6. Follow sections 4 and 5 again.
7. Repeat sections 2 to 5
8. Now you have one property that you live in and 3 investment properties. You are ready for retirement!

The problems with building a property portfolio

One of the main concerns an investor may have with this technique is that it is inefficient. You don't receive any benefits from leveraging or from tax. But who said building a fortune was going to be easy or quick!? At least this method is safe. Thoughts?

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Investing with only one piece of information

Investor ratios

I would never advise making an investment with only one piece of information. I would strongly advise careful analysis, with an aim to gain a strong insight into a business and how it works. However, I thought that it may be an interesting thought exercise to try to see what would happen if we limited ourselves to one piece of information.

Dividend cover ratio

If I could invest with only one piece of company information to look at, I would look at the dividend cover ratio. Literally, this measures the company's ability to pay dividends out of the cash generated.
It is the division of the company's earnings per share divided by it's dividend per share. Put more simply, it states how much money the company pays out compared to how much it generates.

The reasoning for preferring dividend cover ratio

Why do would you invest in a company? Primarily for a return in the form of a capital gain and for dividends. The dividend cover ratio tells you several pieces of vital information. It tells you that the company pays a dividend. Furthermore, it tells you how sustainable those payments and whether those payments are likely to continue into the future.

Ideally we would want a dividend cover ratio of 2. This suggests that for every two pounds of net profit generated by the Company, it pays out one pound in dividends. This is ideal as it provides a level of comfort to suggest that the Company will be able to continue paying those dividends into the future. Furthermore you would also want to see a sustained or increasing dividend cover over the last few years.

A point of note with dividend ratio

I would emphasise here that noone should ever make an investment decision based solely on one metric. There are many other pieces of information that an investor would want before making a decision. For example you would want to know that the Company has growing revenues, assets and liabilities.

However, whilst I would never invest based on this one metric it is an interesting thought experiment. Additionally, the dividend cover ratio is a good place to start when trying to identify companies with which to invest. The dividend cover ratio provides a very good means by which to produce a shortlist of investments.

Do you like what you've read? Tell your friends by sharing it with one of the buttons below. Please post this to Facebook or Tweet it to help your friends and family. Feel free to send me an email (mrmoneybanks<at>multimillionaireroad<dot>com), find me on twitter @millionairer0ad or comment. Whether good or bad, I want to hear from you all.


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