A Base for Taking Risks

On my blog I talk a lot about investing in the stock markets and assuming risk in exchange for positive returns over time. In this world, things can feel advanced and overwhelming very quickly. Particularly for newer readers.

While it is fun to explore the deep dives of investment strategies and better ways to invest, sometimes we forget about the basics. A base for investing—being in a position where we can take risks.

I often get emails from newer investors who will ask questions about the various investing styles I explore. (And some that I don't.) Is Dual Momentum a good choice for them? Should they stick with static index investing instead? Is adding leverage to a portfolio too aggressive for them?

While I enjoy the interaction, it is always difficult to answer these emails. I'm not a professional financial advisor and don't hold myself out to be one. I'm a regular guy who is interested in the markets, is moderately well read when it comes to investing, have experienced some decent success, and am continuously learning myself.

But more importantly, everyone's personal situation is different. A retiree who needs stability and tax-friendly income requires a different portfolio from my own. Someone who is starting out but has a shaky job and a lot of debt is also in a much different category of responsible risk taking.

Speaking from personal experience, my ability to invest carefully with appropriate risk and the right mental mindset was advanced when my personal financial situation stabilized. It is very tough to invest properly when cash is low, money is tight, and debt is high.

When I had little money and a big mortgage, I was tempted to go for home runs, treating investing little different from a lottery ticket. The problem is these big wins rarely happen. In the worst cases the more likely large losses can scare a person away from the markets forever.

Very few people get rich with 5x, 10x, or 100x baggers on risky forms of investing (penny stocks, cryptocurrencies, options, etc.). Even fewer stay rich.

Sticky wealth is wealth amassed carefully and methodically over a long time with a lot of hard work.

A Firm Foundation

Like everything else in life, investing begins with a firm foundation. Before taking on risk and putting money into the markets, have everything else in your financial world tightened up.

Pay off debt. Debt is a major financial risk factor today. Way too many people carry enormous debt loads that bog them down. Deep down, most regret the choices that led them into debt. I cannot emphasize enough how important it is to buckle up and do everything in your power to pay off debts. Take a second job, work overtime, live with mom and dad or in a low-cost roommate situation, spend nothing, sacrifice, do whatever it takes.

Never invest if you are carrying credit card debt or have personal loan or an unsecured line of credit balance. Paying these debts off aggressively can provide you with a guaranteed after tax return of 7 to 25 percent. It can also save you a huge amount of stress.

That said, a modest mortgage is okay to carry while investing. Your interest rates are likely to be low and the payments should not be overwhelming.

Cut expenses. Having low living expenses can provide substantial peace of mind. It is also likely to simplify your life. While a million websites will moan about spending on lattes and avocado, the best places to save money are the big expenses.

Downsizing your house, going down to one (or none) fuel efficient vehicle, getting rid of pricey toys like motorbikes or ATVs, selling the vacation cabin or time-share, and taking modest vacations are perfect ways to live better and save money. Way too many people have no money but think it is normal to live like millionaires. It's not.

Earn a decent income. It doesn't need to be a huge six figure take. In Canada I peg the healthy number at C$70,000 gross per year. In the U.S. this could be closer to $50,000. That's only a bit above average for a full-time skilled worker. In some areas of the country it will need to be higher, in others the number can be lower.

Many younger people follow the herds into Toronto, Vancouver, San Francisco, LA, NYC, or Seattle. For most a much better bet is a city like Edmonton, Winnipeg, Montreal, Dallas, Atlanta, Charlotte, or Phoenix. Or the hundreds of very livable smaller cities with low cost-of-living. You would be amazed how location can drastically improve your odds of building wealth and financial independence.

Save money. This is a big one and is the culmination of the prior three points. You should be in a situation where your monthly income consistently exceeds your monthly expenses. Nothing is worse for your portfolio than being in a situation where you put in a dollar and pull out 50 cents two weeks later.

This includes investing for financial independence but pulling money out to "invest" in a kitchen upgrade or "invest" in more reliable car. Investing is for the long-term. It should be kept completely separate from saving for a larger purchase, even if that purchase adds a bit of value to your home.

Build a cash cushion. I like to maintain a decent cash balance in our chequing account. Depending on the time of month, when income comes in and expenses go out, our chequing account will bounce from around $3,000 to $7,000. This provides a nice cushion to cover any spending needs without worrying about overdraft or credit card balances.

We use credit cards for most daily spending to defer the bill for up to a month and a half. Free short-term loans, free purchase protection, and free travel rewards are awesome! But I make sure I can pay it off in full every month.

I'm not a big fan of maintaining large emergency funds because odds are you will never need to use them if you manage your finances properly. Instead, get a personal line of credit set up at your bank. Don't use it unless you are in a financial emergency. Save and invest the rest of your money so it is working for you, not the bank.

Risk and Investing

When most people think about risk and investing, they focus on how risky their investments are. They might even dwell on the risk of losing money when investing—a virtual guarantee at some point in everyone's investing journey.

I prefer to look at the entire picture of risk. This includes investing but it adds in your personal situation (which in many ways is more important). A commissioned real estate salesperson is in a much riskier situation than a power lineman at the utility company. Even if the sales lady drives a BMW and wears nice clothes (or maybe because of that).

A shaky relationship with one very spendy partner is much riskier than a stable partnership of two frugal individuals. A family with a large house and a large mortgage is much more fragile than a family that rents a smaller house or rowhouse.

These ideas extend to a multitude of other factors: high debt compared with no debt, dual versus single income families, old versus young, kids or no kids, level of flexibility in pursuing the best work opportunities, renting or owning, biking and the occasional Uber versus multiple vehicles. The list goes on.

A young, dual income, no debt, apartment renting, no child, biking couple has the capability of taking on high leverage in their portfolio while still being lower risk overall. Flip the situation and invest in GICs and you are still setting yourself up for a major financial wipeout.

Set yourself up for success in your personal situation. Then let the markets do the rest of the work.

Comments & Questions

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Developments in Cryptocurrency

As many speculators keeping an eye on the space know, cryptocurrencies as a whole got absolutely hammered in 2018. This event was quite predictable given the mania that occurred in 2017 and early 2018. Everyone who asked me about cryptos at that time got a firm answer, "Stay away!"

Electronic tokens trading at valuations of billions of dollars when no-one even knows what to do with them is crazy! Sure, sending money around the world quickly and at a low cost is fantastic, but anyone with an ounce of honesty knew they weren't buying cryptos for that.

What Happened in 2018?

A lot of people who jumped into the space to buy Bitcoin and other "alt-coins" in 2017 have learned a hard lesson in speculation. Many have lost 80 to 90 percent of their money last year. Others got ripped off by exchange hacks, poor security, and scammers or lost access to their wallets.

However, 2018 was actually a great year in the blockchain world as far as the technology goes. This past year we are seeing better development of smart contracts, higher transaction capacity within the various protocols, increased efficiency, and some interesting end-user emerging projects.

For example, artists may soon be able to load their creative work on blockchain platforms and receive micropayments for each "listen" or "view" directly from their consumer. Code can be embedded into the work to prevent loss of revenue from things like torrent uploads.

Websites and blogs could attach micropayments to articles so readers can show appreciation for the work done by the authors. While many would shy away from a $10 monthly subscription (a general minimum amount required to make a credit card transaction viable), paying something like 1/10th of a penny to read an article might be acceptable.

There are also some very interesting advancements using blockchain contracts for betting. One project, Augur, is establishing an open-source market for bets. While not yet fully active, the idea is that users will be able to freely design bets of all kinds and settle in cryptocurrencies in a peer-to-peer format.

Beyond gambling on horseracing or election wins, Augur could theoretically host bets that work like options contracts or futures contracts in financial markets. It would completely bypass the exchanges, drastically reduce fees, and eliminate third-party risks as we saw with MF Global and some of the FOREX brokers.

One of the most exciting changes is the continued development of transaction processing and verification. As you might know with Bitcoin, the proof-of-work ("mining") model is very energy intensive. It also limits the number of transactions the system can handle to less than 10 per second.

Cardano, TRON, IOTA, and a few other projects are basing their verification and transaction handling process on proof-of-stake protocols. They claim this will allow great decentralization, be highly secure, and the blockchain will be able to handle hundreds of transactions per second with a roadmap to increase this to thousands of transactions per second.

The second largest blockchain platform, Ethereum, is said to be moving to a proof-of-stake protocol as well in the coming year so they can increase their transaction capacity and reduce the energy intensive "mining" process.

These developments are showing a use case for blockchain and cryptocurrencies that can be understood by the broader public. The blockchain is becoming more user friendly and it's only a matter of time before average Internet users will be able to use the blockchain for a wide variety of tasks.

It could be compared in many ways to the Internet: developing from a technical network used by universities and defense contractors to today's user friendly tools like Google, WordPress, and Interactive Brokers.

I suspect we might be at the beginning stages of a very exciting time in the blockchain world. If even a fraction of the blockchain ideas proceed, it will be a major disrupter to today's giant "middlemen" corporations: banks, exchanges, lawyers, payment processing companies, data management companies, and so on.

Speculating in Blockchain/Cryptocurrencies

From a technical trading perspective, a number of cryptocurrencies are beginning to look much more attractive. I'm particularly interested in the cryptos which are making large strides in technology—often called the 3rd generation blockchain.

Ethereum

Source: Yahoo Finance

While technically still a second generation blockchain project, Ethereum started the idea of smart contracts and has an active developer community working on moving the blockchain into the third generation to compete with Cardano and TRON.

After bumping up against the 10-week simple moving average for most of 2018, Ethereum solidly crossed over and has been climbing upwards for the past three weeks. The crypto also hit long-term oversold conditions in December 2018.

Cardano

Source: Yahoo Finance

Cardano is solidly a third generation blockchain with ample academic research behind it. The developers are working hard perfecting proof-of-stake models and are making significant progress in other areas of the protocol as well.

This is a newer blockchain that is still in early stages of development. However, it is also one of the most interesting projects in the entire space. If even a portion of their objectives are achieved, Cardano could be a blockchain platform that is a true game changer.

Cardano features a similar technical picture as Ethereum. The last several weeks have seen a turnaround that could be very promising for speculators.

TRON

Source: Yahoo Finance

TRON was formerly a token issued under the Ethereum blockchain. A migration to an independent third generation blockchain took place in June 2018. TRON has focused their efforts on the entertainment industry.

TRON is a Chinese-based blockchain group with many developers who formerly worked at companies like Tencent, Baidu, and Alibaba. The team seems highly centered around the CEO Justin Sun. TRON does state it is a fully decentralized blockchain which is a not-for-profit.

Summary

While still highly speculative and risky for any individual investor, cryptocurrencies seem to have finally shaken off the mania of the past several years. Interesting things are happening in this space.

Using simple trend indicators, some of the better cryptocurrencies are making a shift from a long, solid downtrend to a potentially promising uptrend. This could be a good time to take a closer look at some of these currencies and add a tiny amount to your portfolio.

I think it's still fair to say that many of these blockchain projects will fail and their associated currencies will be worthless. Proper risk management is absolutely crucial in this space as it is in all investing applications.

Some of the most interesting blockchain projects in my view are Cardano, TRON, and Ethereum. As these projects continue to develop their capacity and end-user tools, their adoption could become much more widespread. That can only mean one thing for their associated currency valuations.

Comments & Questions

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