Michael Jackson's Finances Were THE Thriller

Since the death of Michael Jackson last week, I have been interested in the many articles that describe the tangled web that was his financial life. The more I read, the more I realize that the age old financial principles apply to everyone, rich or poor.

Michael Jackson was one of the most prolific earners in the history of entertainment. He sold 61 million albums in the U.S. and had a decade-long attraction open at Walt Disney theme parks. The New York Times reports that he earned about $700 million as a performer and songwriter from the 1980’s on.

As if that is not a lot of money already, his most valuable asset was Beatles' music -- in 1985 he paid $47.5 million for ATV Music, which owned the copyright to 259 songs written by John Lennon and Paul McCartney. According to some estimates, he brought in an additional $300 million in record royalty fees from that deal.

Earning however, is only half of the equation. As Notorious B.I.G. declared, “Mo money, mo problems.”

In 1988, he paid $14.6 million for Neverland Ranch, a 2,500-acre property in Santa Barbara, CA. This “ranch” was complete with a theme park, a steam railway, lakes, a cinema and a zoo with giraffes, lions and tigers. At its peak, it was valued at over $100 million and he had as many as 150 employees running it, costing millions of dollars each year to maintain it.

A couple of years ago he nearly defaulted on the $24.5 million dollar loan tied to Neverland. Thomas Barrack, chairman and CEO of Los Angeles-based real estate investment firm Colony Capital LLC, agreed to bail out Jackson and set up a joint venture with him to take ownership of Neverland, yielding a $23 million loan.

“Michael never thought his personal finances were out of control,” said Alvin Malnik, a former advisor to Michael Jackson and godfather of Prince Michael II, the youngest of his three children. “He never kept track of what he was spending. He would indiscriminately charter jets. He would buy paintings for $1.5 million. You couldn’t do that every other week and expect your books to balance.”

As his income peaked out, his spending did not, forcing him to borrow money to finance his spending habits. In 2001, he used his half of the ATV Music assets as collateral to secure $200 million in loans from Bank of America.

The problem was that his appetite for spending exceeded his cash inflows -- to the tune of $20 million to $30 million each year. Right up to his death, he continued to lead a relatively lavish lifestyle, renting a property for a reported $100,000 a month in Los Angeles.

Whether you make hundreds of millions or tens of thousands, the lessons remain the same:

1. Know how much you earn
2. Know how much you spend
3. Spend less than you earn
4. Don’t borrow money to finance your lifestyle

Are You Paying or Collecting?

My brother had a very interesting observation the other day. We were having a conversation about building wealth and he said that one of the best gages is to understand your "Interest Collected vs. Interest Paid ratio" (ICIP Ratio...I just made that up). The more I thought about it the more I completely agree that it is one of the best ways of knowing how financially healthy you really are.

Let's compare two different people:

Mr. DooDad is a good earner, 125k year, but really enjoys his toys. As a matter of fact, he has yet to see a toy he does not like. Because of this "DooDad" addiction, his ICIP ratio looks like this:

House $1500/mo interest

Car 1 $250/mo interest

Car 2 $175/mo interest

Boat $475/mo interest

Credit Card $225/mo interest

Interest Paid $2625/mo interest

401k $125/mo

Money Market $12/mo

Interest Collected $137/mo

Mr. Doodad collects a measly $137 a month in interest and pays $2625 a month interest. So his ICIP ratio is 1:19.

Mrs. Wisdom is also a good earner, 100k year, but she has used her cash to buy assets that she can collect interest on. She has been wiser with her money, buying her cars in cash and never using a credit card. Her ICIP ratio looks like this:

House $1000/mo interest

Rental House1 $750/mo interest

Rental House2 $1100/mo interest

Interest Paid $2850/mo interest

Rental House1 $1400/mo interest

Rental House2 $1750/mo interest

401k $1500/mo interest

Roth IRA $750/mo interest

Indexed Fund $2500/mo interest

Money Market $150/mo interest

Interest Collected $8050/mo interest

Mrs. Wisdom collects a whopping $8050 a month in interest and only pays out $2850 a month so her ICIP ratio is 3:1. Over time, as her renters pay off her rental house mortgages, her ratio will climb to 8:1.

Spend 10 minutes and figure out your ICIP ratio. Are you closer to a Mr. Doodad or a Mrs. Wisdom? How long will it take you to retire by following Mr. Doodad's plan? The rhetorical question's answer is probably forever!

Can I Get Triple Insurance Coverage Please?

Fear of loss looms much larger than thought of gain.

In a study by Professor Daniel Putler, a former researcher for the Department of Agriculture, he made a very interesting discovery in an expansive study of all egg purchases in southern California. Economic theory says that price fluctuations should be received with equal intensity whether prices go up or down. What he discovered was something very different. When prices were reduced, consumers bought a little more than normal. When prices were increased, consumers completely overreacted and cut back their egg purchases by two and half times! You can probably validate that if you are the grocery shopper in your home. If prices go up, you decide to cut that product out when at all possible.

We experience pain associated with loss much more intensely than we do with the glee of experiencing a gain.

Taking these findings and relating it to things financial may provide a new lens in which to observe your behavior and how companies use this against you.

Take renting a car. At the last minute before signing the rental contract, they ask if you would like "loss damage waiver" insurance. The threatening phase conjures up all kinds of fear that most people pay for the expensive and redundant coverage.

If you haven't taken the time, do a little research and you will most likely discover that both your current auto policy and credit card will cover any "loss damage" issues that would arise. The offered policy is a easy way to generate huge revenue by playing on humans "loss" aversion.

There is a helpful article titled "Do you really need rental car insurance?" on USA Today.

Pay attention to how sly marketers are using this irrational fear against you to get you to quickly and consistently part with your hard earned cash.

Get Compound Interest on Your Side

There is a reason that Albert Einstein declared, “The most powerful force in the universe is compound interest”.

Compound Interest can be your fiercest enemy or your most powerful ally.

Compound interest is the concept of adding accumulated interest back to the principal, so that interest is earned on interest from that moment on. The act of declaring interest to be principal is called compounding (i.e., interest is compounded). A loan, for example, may have its interest compounded every month: in this case, a loan with $100 principal and 1% interest per month would have a balance of $101 at the end of the first month.

Here are some examples of the power of compounding:

Credit Card Balance of $15,000 at 29% interest

-          $4350 a year in interest

-          If you never made a payment, would climb to $683,812 in 15 yrs

Latte for $3.50 for five days a week

-          If saved money instead and invested at 6%

-          In 10 years you would have $12,000

-          In 15 years you would have $21,189

Car payment of $300 month from age 22-52

-          If paid for car in cash and saved and invested money instead at 6%

-          In 30 years you would have $284,609

401k at work investing 10% of your $50,000 annual salary

-          If invested with a 6% return

-          Over a career of 30 years you would have $395,290

Keep your first house as a rental property

-          original purchase price of $200,000

-          4% home price (national average since 1942)

-          In 30 years the value would be $648,679

-          …and the mortgage would be paid off now

Rental Income on your first house

-          $1200 when you first rent it out at age 30

-          Assuming a 3% annual increase in rental rates

-          At age 60, rents would now be $2912

-          …and the mortgage would be paid off now

Compound interest is a double edged sword. Great to have on your side and miserable to have working against you.

Where can you swing the momentum of compound interest on your side to create a better future for yourself and your family?

They Are Not Your Friend

The Wall Street Journal reported today that Bank of America is raising interest rates on 4 million US Credit Card customers who are carrying a balance. This means that even if you have always paid your account on time, you can expect your rate to go up if you don’t pay off the balance at the end of each month. WSJ reports:

“Starting with June account statements, any credit-card customer who carries a balance and has an interest rate below 10% will see his or her rate jump into double-digit territory.”

“The bank's move follows similar rate increases that other banks, including Citigroup Inc., JP Morgan Chase & Co., and American Express Co. have implemented in recent months. The banks, facing rising delinquencies, blame the economic turmoil. Many have been tightening the screws on people with less-than-perfect credit, but now they're pinching a broader range of customers who have good credit records, but carry a balance.”

The underlying lesson is that credit card companies are not your friends, even though they lay down the red carpet on your first date. They appear so generous and helpful and always seem to ride in on the white horse at the perfect time. Whether it is at the department store when you have way too much stuff in your arms and they generously offer you a 10% discount for becoming their friend or when a 0% balance transfer arrives in the mail serendipitously to convert your Citi card at 29.99% to a lower rate.

Having spent much of my own life racking up credit card debt, I have a new vantage point now that I have made a commitment to pay for everything in cash. Hindsight is 20/20. If I couldn’t afford to pay cash on the spot, how could I afford to pay for whatever I was buying with 29% tacked on top? The math does not work, but I guess it is because I never stopped to do the math. I was having too much fun shopping.

I once heard a catchy little phrase that helped me to see what I was actually doing,

Buying things I do not need

With money I do not have

To impress people I do not know

Tomorrow I will share a strategy to get out of debt as quickly as possible, because as we have seen, the furnace is only going to get hotter with major credit card companies turning up the heat.

Interesting Way to Save Money...

A Couple of More Ways to Save Money:

1. Bake your own bread by hand

2. Knit your clothing

3. Wash your clothes using a washboard to save electricity

4. Don't wash your car to save water and soap

5. Shave every third day to save cost of razors

6. Use washable diapers if have young children

7. Drink powdered milk

8. Hang your clothes to dry

9. Eat with your hands

10. Cancel cell phone and only use a landline

Lessons From the Men's Urinal

I recently ran across an experiment conducted in the men’s room at Schiphol Airport in Amsterdam. Authorities had etched the image of a black housefly into each urinal. As women can attest to and most men would sheepishly admit, men don’t pay much attention to where they aim, which can create a mess. However, if they have a target, something to aim for, their attention and therefore accuracy are dramatically increased. According to the man who came up with the idea, it works wonders. “It improves the aim,” says Aad Kieboom. “If a man sees a fly, he aims at it.” Kieboom, an economist, directs Schiphol’s building expansion. His staff conducted the fly-in-urinal trials and found that etchings reduce spillage by 80 percent.

The results are shocking when we have something to aim at. Prior to the target, the men didn’t even pay attention. With a target, attention increased and results improved by 80 percent. Doesn’t this same lesson apply in all areas of our life?

What if in our careers, we had an income target? Not the one the boss sets for you, but one that matches your prerogative and ambition? Wouldn’t your attention increase? You would have a better filter in which to run your actions through, quickly realizing that much of what we do in a day will not increase income. This income target, etched in your mind would surely increase your aim, focus and results.

What if in our finances, we had a short-term, mid-term and long-term target to aim at? Wouldn’t you pay more attention to what you were spending your money on? If there was a way to keep those targets in mind every time you went to make a purchase, don’t you think you would increase your results by 80 percent? 8 out of every 10 times you would be able to make a more grounded decision on need versus want.

What are you aiming for?

“Most people aim for nothing and hit it with amazing accuracy.” – Joe Niego

How Does That Math Work?

I spent some time with a very bright money manager yesterday and he shared something that I had never noticed or more importantly understood.

For simplification purposes, I will show you 4 years of stock market returns. We will start with $100,000 in our account and then I will specify a certain stock market return for that year and then the next years balance will be a result of that previous years return. Let me show you:

Year 1

Starting Balance $100,000

Stock Market Return -50%

Year 2

Starting Balance $50,000

Stock Market Return +100%

Year 3

Starting Balance $100,000

Stock Market Return -50%

Year 4

Starting Balance $50,000

Stock Market Return +100%

Year 5

Starting Balance $100,000

In this example, we had 2 years that had a 100% return and 2 years that had a -50% return. If we were to calculate the average rate of return for those four years you would get an average 25% rate of return. In reality, you finished with the same amount you started with, $100,000, no where near a 25% rate of return.

The numbers that are thrown around in your mutual fund and 401k prospectus are designed to help you, but do not tell the whole story. More time must be spent really understanding your numbers because your ability to retire depends on it.

Take your investment accounts statements out and figure out how much you started with, how much you added, and how much you have now. Do the math, you’ll be shocked at the results. (If you don’t know how to figure it out, go find someone who does, or spend 20 minutes on google. It will be time well spent)

How much should you be saving annually?

Have you ever wondered how much money you should be investing to insure you have enough at retirement? I have been in a course for three years now called the Aji Network and they talk a lot about this. A paper they released is very helpful for your calculations to how much capital (money invested) is needed to produce $100,000 a year in today’s dollars.

First let me give you some assumptions that were made in arriving at this point:

3% Inflation – the historical average (avg. increase in the costs of goods and services)

8% Return on Investments – historical average if passive investing (putting money in market and leaving it)

4% Annual Withdrawals from Principle – this is given as the maximum rate of withdrawal as to decrease the likelihood that you will run out of money before you die (this is determined based upon the Monte Carlo calculations that take into account stock market volatility)

 Here are the figures:

 Age - 30                    

Years to Work until 62 - 32                    

$100k income at retirement - $257,508    

Capital-at-Work needed to be on track today - $264,326        

Capital-at-Work needed at 62 - $6,437,707 

Minimum Annual Payments if started today - $47,966

If interested in looking closer, check it out the chart on their website.

If you think you can live on less than $100,000 after taxes you can cut the above numbers in half. Either way, it creates the need for some action and certainly a strategy and most likely a strategy different than the one you have. Now is the time to build the strategy and to do that you must begin to build relationships with those further down the road than you are.

How will you get it back?

The total net worth of Americans was $51.5 trillion as of 12/31/08, down 18% in the last year, reaching its lowest level since 9/30/05 (source: Federal Reserve). 

Those numbers seem low considering the Case Shiller home price index has dropped 16.7% in the last 12 months and the S & P is down 40.97% over the last year.

Whether it is 18% or more, new action must come from it. Some will live more frugally. Some will delay retirement indefinitely. Some will realize the job they are in simply will not provide them the income they will need to live the life they want and will go out and start new businesses. Some will begin investing in new ways.

What is your plan? How much net worth have you lost? How will you make it up? How much money do you need at retirement to live the life you desire? How about to maintain the current lifestyle you have?

Now is the time to build the strategy. Now is the time to take action. What has worked in the past will not work in the future. Time has elapsed and market dynamics have changed. A new philosophy for wealth accumulation must be built sooner than later.

To Me Boxing is Like Ballet

“To me boxing is like a ballet, except there is no music, no choreography and the dancers hit each other.” Jack Handy, Deep Thoughts from SNL

Like the eloquent Jack Handy, I have learned to appreciate brutal spectacles like our current economy. It is like a good economy, except many are losing their jobs, people are hoarding their money and no one is happy.

At the same time, we need to be grateful for the actions it forces upon us. Americans are saving their money like we have not seen in years and years as the personal savings rate climbed to 3.2% in Q4 of ‘08, up from 1.3% in Q3 of ‘o8.

Home prices are dropping and making homes more affordable. As a real estate investor, even 12 months ago, it was impossible to buy a rental property and get it to cash flow with 20% down. There is a very generic rule of thumb for investing in real estate called the “1% Rule”.

In simple terms the gross monthly rent of a property should be at least 1% of the purchase price. A friend of mine is buying a duplex at around $300,000 and so the rents should be around $3000 a month, which they now are and wouldn’t have been without this market correction.

I love boxing, more than ballet if you can imagine a guy saying that…and I am learning to love corrections too!

Do What the Billionaire Does

In December Billionaire Phil Ruffin Sr. bought MGM’s Treasure Island Casino in Las Vegas for $775 million, reported the Wall Street Journal.

“I knew to build a 3,000 room hotel today would cost $3 billion,” Mr. Ruffin told the Wall Street Journal. “I think it is a good value.”

Lesson 1 – Know Your Numbers

Mr. Ruffin, who made his first fortune leasing gas stations and convenience stores, was one of only a handful of potential buyers who had the cash on hand to complete a purchase.

Lesson 2 – Cash is King…”No man's credit is as good as his money.”  ~E.W. Howe

Mr. Ruffin is buying back into Vegas after having sold his previous venture at the height of the city’s real-estate boom.

His Las Vegas record has so far been a lesson in restraint, and impeccable timing. In 1998 he bought his first Las Vegas casino, the New Frontier – a low rent property mired in a six-year union strike – for $165 million. Less than a decade later, he sold it for $1.24 billion at the height of a Las Vegas land-buying frenzy.

Lesson 3 – Buy When No One is Buying and Sell When No One is Selling

Years earlier, while other Las Vegas operators took on billions in easy debt to outdo one another with ever-more extravagant gambling palaces, Mr. Ruffin cancelled his own $2.7 billion plan to tear down the New Frontier and build a new resort in its place. “It wasn’t a difficult decision because the numbers didn’t work,” he said in a phone interview. “I’m pretty good at math.”

Lesson 4 – If the Numbers Don’t Work, Don’t Do It

When asked about the recent email promotion Treasure Island recently sent out for $49-a-night rooms he laughed and said, “We know it is going to be soft for a couple of years. That’s OK. We won’t have any debt, so we’ll be OK. That’s what gets everyone in trouble, they pile on that debt.”

Lesson 5 – Debt Closes the Doors of Opportunity

4.50% Interest Rates…Hold Your Horses

A report leaked last week that the Federal Reserve was considering lowering the 30 year fixed rate to 4.50%, over a percent lower than the current market, in an effort to stimulate home buying.

The Wall Street Journal reported the following:

- “The plan, which is in the development stage, would temporarily use the clout of mortgage giants Fannie Mae and Freddie Mac to encourage banks to lend at rates as low as 4.5%.”

- “The plan remains in discussion and may not be made final before the Bush administration’s term ends in January.”

- “The lower interest rates would be available only to borrowers who are buying a home, not those refinancing a mortgage.”

- “Borrowers would have to qualify for a mortgage guaranteed by Fannie, Freddie or the Federal Housing Administration. Those guarantees apply to loans where borrowers can document their income and afford their monthly payments, steering the government away from backing loans considered risky.”

How would this happen…and would it work?

Fixed mortgage rates are tied to Mortgage Backed Securities (MBS) which are similar to stocks except that they are tied to mortgages as the security whereas a company is the security for a stock. Both stocks and MBS are priced based on supply and demand. The more investors want a stock the higher the price goes and vice versa. MBS function the same way.

Because the  price is determined by supply and demand, the Fed would have to artificially drive the rates down to 4.50%. In plain terms, they would pay to get them down. The only source of cash I know about would come through borrowing or printing the money needed to pay the difference between the current market rates and the new target rate.

When the government borrows and/or prints money, it is inflationary. Inflation simply means that the dollar you have now will not go as far in the future because it is worth less. By artificially driving down rates they will be stoking the inflation fire.

The reason this is bad for interest rates lies in the mechanics behind how rates work. As mentioned before, rates come from an investment vehicle called MBS. Investors who choose to put their money in MBS instead of stocks do it because they are looking for a safe, fixed return. If the return they want is say 4.50% and inflation strikes, the return of 4.50% is actually worth less than that. In other words, if your 4.50% investment paid you $1000 month and the inflation rate goes up, due to the government borrowing or printing money (which it will), then your $1000 will only buy you $900 worth of goods and services. Now the investor needs a 5% return to buy the equivalent to $1000 worth of goods and services. This is a vicious cycle and will work against the very mechanism used to artificially drive down rates.

In summary, can the government artificially drive down rates? Yes.

If they do, will it last long? I do not see how it could based on the mechanics of the market I have described above.

If they do it, who will benefit? Because it will take money to drive the rates down the Feds would need to identify some parameters on what loans they would offer this on. It will certainly only be purchase loans as mentioned in the WSJ and I speculate that it will be for a specific target market, maybe a certain loan amount range and quality of buyer. They do not have the money to open it up to all loans of any size or type and any and all borrowers.

If it happens, great. If it does not, rates are fantastic now and more importantly, the big money is made on a purchase through negotiating the right price, not a little lower interest rate. What makes buying now so appealing is the phenomenal deals you can get. If 4.50% comes and everyone jumps in, don't you think sellers will hold more firm on their prices with buyers swarming everywhere?