Self-taught Investor who-s planning a second career after working in the finance sector for 14 years in many countries accross the world. On a mission to share with hard working professionals in Central Europe tips and tricks to make their financial lives better.
I recently bought a house, a brand
new house and moved my family of three in there. Given that the house was new,
we had the option of selecting our own lighting fixtures and appliances all
throughout the house. Being a responsible individual, I was focused on protecting
the environment while saving money at the same time. Therefore, I purchased
items that were energy efficient (energy classes A, A+, A++, A+++). This helped
a great deal with the electric bill. Now after some months of living in the new
house I can safely say that I am happy with the way I am managing my energy
usage.
Based on the current running
consumption for the entire house I can say that my monthly cost so far with
energy for a 4 bedroom/4 bathroom 170 square meters house with 3 people living
in it at 47.8 EUR per month. Pretty sweet I would say. That’s based on an
actual cost of 0.14 EUR per kilowatt-hour (kwh) and a current running rate of
275 kwh per month. The house has everything already installed. Given that the
testing was done in wintertime, AC’s were not used much during the testing time.
Prior to this home I stayed in a house of about 190 sqm in which was built
circa 2008 (with all the appliances from that time). The house was fairly
smartly built, so still efficient but not as efficient as my 2018 house). The
monthly bill was about 65 EUR. Prior to that house, I stayed in another home
built in around 2008 for about the same 210 sqm. Now this house was not
efficient, the house would run my electricity in the region of 85 EUR per
month.
So, returning to my house: I
wanted to understand exactly how my electricity bill for 275 kwh per month gets
broken down in a modern house with all the appliances. For that I bought a
power socket able to measure each appliance’s consumption. To buy one is not
very expensive, you can get a good one for as low as 15 EUR.
Here is how it looks:
With this, I was able to pinpoint
exactly how much each consumer comes up to. Althugh these numbers relate to my
house and the appliance that I have in my house, it would give you a really
good gauge for what it means for any modern house of similar size.
So, let’s break it down for each source of energy consumption without further ado:
Interestingly, the top consumers are: combo
washer/dryer and refrigerator. This is not unexpected for a family of three.
Also, you can see what you can eliminate.
Here is also a breakdown per each household main function, as follows:
Obviously a house in winter time
(when compared with winter time) will incur higher costs with heating (in my
case the natural gas bill is higher). On the flipside, the costs relating to
cooling the house (AC units) are effectively zero. Expect a larger electricity
bill in summertime (for the usage of AC) offsetting the lower natural gas
costs. Depending on your climate, it is obvious that is going to cost you less
in winter (if you live in a warmer climate) or less in summertime (if you live
in a cooler place).
Further, I have currently two cars
with conventional gas engine. I anticipate in the next three years one of the
cars will be replaced by a BEV (battery electric vehicle). In light of this, is
it worth putting solar panels on my house, is the cost justifiable? That will
be the subject of a coming article. Stay tuned.
The Central and Eastern European person has a lot to take care of
when it comes to his/her finances. The reality remains that life will
grow more difficult as we age. Facing decreasing fertility rates, the
state pension system will struggle to provide individuals with a good
lifestyle when retirement or old age come around.
That’s why it is your obligation
to take care of yourself.
We will consider Poland as a good
example for Central and Eastern Europe (CEE). According to Credit Suisse Wealth
X 2018 Report, each Polish adult citizen has, on average a wealth of 31,794 USD. So that is what we may
consider an average wealth for CEE individuals. Keep in mind that this includes
financial wealth (such as cash, bank deposits, shares, bonds etc.) but also
non-financial wealth (mainly real estate).
This average is skewed higher by
wealthy individuals who own millions and naturally distort the average. If we
take the mean wealth per adult (which means that if the population is 30 million and we sort
everyone based on wealth we take exactly the 15th million adult) the
amount is 10,572 USD. Pretty
sobering numbers I would say.
This amount of wealth is not sufficient by any means to ensure a
decent retiring. Even if we take a very modest 1,000 EUR per person to
retire the average wealth will ensure the average person will have
enough money for 2 years and a bit. What’s even worse, the mean wealth
is only enough for several months of retirement (not even one year) at
1,000 EUR per month. If you consider costs will increase (and people
will live longer – which implies healthcare costs will grow
exponentially), it means that the average person is not prepared at all
for a good financial future.
But you are here because you much
better than the average. So what does it mean for the above the average CEE
person, to have a secure financial future?
Pension (private pension)
The above average individual
knows that his pension is important. If he has private pension available to
him, he will invest diligently as much as he can to ensure his future. Of
course a person working a front-desk in a bank cannot invest as much as the CEO
of a multinational company. So, you will see the above average saving broken
down into three categories (low end, medium end and high end). You will want to
be aim to be as high as you income will allow it.
Since pension funds are typically
conservative, we will consider an average return of about 4% per year (4 %
increase to the invested amounts each year). When you consider that the typical
rate of inflation is about 2.5% per year, 4% is not high, but still it allows
you to take advantage of the power of compounding returns (we will discuss the
astounding power of compounding in a different post).
So there you have it folks:
By simply investing 1,000 EUR per
year (83 EUR per month only), at the end of working age one gets a cool 83,800
EUR. If you up that to 5,000 EUR per year, you would be sitting pretty at
419,000 EUR. Not bad, but I say we can do much better.
So let’s move further to…
Personal Savings and Investments (After Tax)
This is where your responsibility
gets bigger. It means that this are your hard earned money that you have in
hand. So instead of blowing this on a nice BMW you will decide to invest this
for your future.
Because you have the flexibility to be more aggressive with your
investments, you will likely earn a higher rate of return. If you have a
strong focus on stocks, and average return of 8% per year is realistic.
Here you may want to employ a
good financial advisor to work with or at minimum certain online tools to help
you make good decisions and sound planning.
So let’s see where we stand here.
We have used the same amounts as for pensions on the low end, but increased as
we get more ambitious (1,000 EUR per year at the low end, 3,000 EUR at medium
end, and 10,000 EUR at high end).
Here are the numbers:
Already we are getting somewhere.
So, if I take 10,000 EUR every year and invest it, I would become an EURO
multi-millionaire. Nice! Keeping in mind that an average car, if bought from
brand new costs about 10,000 EUR per year if you include depreciation, fuel,
maintenance, insurance, finance etc. So
why not ditch that brand new car you buy every 5 years and that’s the easiest,
painless way to become a multi-millionaire. The hard cold numbers show you:
this is possible.
Wonderful, we are getting
somewhere right now. But wait, the above average individual does not neglect
non-financial assets, such as real-estate.
Investing in tangible assets (real estate)
Central and Eastern Europe has a
long history with people wanting to own their own house, possibly buying a
second or third property to provide rent.
Typically, real estate does not
offer as much return as investing in financial instruments, such as stocks
(more here).
But let’s see what the numbers say. We have used the same amounts as
for after tax financial investments, to make it more simple (1,000 EUR
per year at the low end, 3,000 EUR at medium end, and 10,000 EUR at high
end).
Note how 8% return versus 3%
return per year means the difference between having 2.5 million vs having 1.5
million at the age of 65 if you invest 10,000 EUR per year! Quite a difference.
So there you have it folks! Three
ways to look at building wealth. But they are not excluding each other, in fact
they complement each other. So, let’s look at the big picture.
Big picture
Growing wealth works better if
you stay invested in multiple classes of assets. The smart European knows that
building multiple streams of income is the key to achieving financial
independence.
Here are the cold numbers. This will put together private pension
with after tax investing and having a bit of real estate investing as
well:
As you can see, even somebody
putting only 1,000 EUR per year (83 EUR per month) in each stream can achieve,
very conservatively, 282KEUR when retiring. Someone who can spear 10,000 EUR
per year (833 EUR per month) in each asset class can get to 4.4 Million EUR! $4.4
Million EUR for our region is rich, is what most people would say. 282
Thousands EUR, 1.35 Million EUR or 4.4 Million EUR sounds a hell of a lot
better than 31 Thousand or 10 Thousand. It is possible.
Recommendations for building
wealth:
Stay disciplined. Use a mentor, if you need to
somebody to keep you in check.
Use financial investing tools (online) and/or
work with an advisor.
Do not blow your resources on depreciating goods
(expensive cars are the perfect example)
Use the power of the X-Factor: compounding interest!
Note: This is an article inspired by my fellow Financial Independence writer, Financial Samurai.
There are many discussions going around about real estate investments. This is true in Central Europe just as it is true anywhere in the world. But perhaps in Central Europe this is discussed extensively, because people tend to have the vast majority of their wealth invested in real estate. This is mainly because there is a certain reluctance from people in general to invest their hard earned money in shares or funds or similar assets for fear of losing the money (this had to do with recent history in the area which has not been necessarily the most favourable in terms of shares and funds, but we’ll discuss this in another article).
Let’s tackle this topic, then shall we? Investment in real estate… its main benefit is the fact that, in many people’s view, well… it’s real. It is called real estate for a reason. It is tangible, people can see it; once you bought it it’s extremely difficult for someone to defraud you of it, it will not go bankrupt like a business could; so when you put it this way, what’s not to like about it?
Well, the reality is that real estate as an investment has significant drawbacks when compared with other types of investments. First and foremost, it needs to be said that real estate has historically underperformed other types of investment by quite margin.
See below graph detailing the yield of various investments since 1975 comparing the US House Prices with the S&P 500. Needless to add which one performed better, the graph does not need and additional comments:
Well, this may surprise you. But let’s deconstruct this: it will make sense to you in a minute. The main reason of this underperformance is the fact that real estate has no “engine” to produce returns. Investing in shares of a company (or a fund which owns a piece of multitude of companies) means that you have a portion of a business. That business is set up with a clear reason: generate profit. Most business thereby have profit, which they either reinvest for the future or they return it to the shareholders in terms of dividends. Of course, this is a simplified explanation, but for this purpose it suffice to say that this relentless search for profit provides the company with an engine that allows it to grow. Owning a piece of a growing business means that the piece (the shares) are increasing in value, based on the profits raked in by the business. For the risk taken by the enterprise, it is typically rewarded with profit rates significantly higher than the market interest rates.
On the contrary, a piece of real estate is an asset that can be considered in two ways. It satisfies a social need (provides a roof over the head of certain people). If the people living in the property are also the owners, there is no investment return in the traditional way of defining this term. Of course, the value placed on the item is dependant of how much a group of people (through the mechanisms of market) are willing to pay for it in the case of an eventual transaction.
Secondly, If the property is rented, it indeed produces a return for the owner. But because it does not produce any added value, but merely satisfying the need for housing, its value will only increase as a result of market increase, not because of a compounding engine which a business would have (as we established above). Sure, if you invest in the property to make it more desirable (property improvements) this could yield a return, but this return on investment typically is quite limited.
Now, I am not saying that the property market should be completely ignored. It can make you a lot of money, depending on the timing of your investment, location, market conditions, and perhaps a bit of luck also. But understand that, ON AVERAGE, property investment is less successful than buying stocks.
I will show you one way in which the real estate property can bifurcate in the future and how one can make money by leveraging the ongoing trends.
A very simple way of categorizing real estate investments is by splitting them between investing in land and/or investing in buildings. Let’s take each one of them:
Buildings, they depreciate. While in Central Europe this concept is fairly uncommon, in USA for instance, buildings are depreciated and taken as a cost during a period of 30 years. With the assumption that on average after 30 years, the building is being torn down. In Central Europe, if you pay for a building 500,000 Euros, and you get a rent of 1,500 Euros per month, you might think you’ve done a pretty good deal and you’ve insured yourself a good return for an indefinite period of time. But the 1,500 per month is 18K Euros per year. That means 540K in 30 years. However, when you consider that the 18K years you would collect 20 years from now means actually less today, the present value of the rent for 30 years is less than 540K. A lot less. It would be in fact in the region of 400K assuming even a low rate of inflation. So, the mighty investment of 500K Euro which seemed such a great deal with a perpetuity of 1,500 Euros per month is in fact an instant loss of 100K, judging by American standards. Of course, rental rates can increase thus making this calculation more favourable, but the point is the same: returns of real estate need to be considered by taking into consideration all aspects. We have not even discussed taxes, utilities, closing costs, empty periods of time etc.
Land, pretty much everywhere in the developed world does not depreciate. It just stays as it is, because of course, land can be reused once the owner desires to change its destination. You just need to demolish whatever you have built on top of it and then repurpose.
Now, it is a clear trend in the future that the robots will take over many mundane repetitive tasks in the economic activity in the entire world. They are better, more efficient, they follow the script exactly as instructed, they keep the same standard every time, they do not strike, they are not late, they do not go through emotional stress and so on.
Already, in today’s world there are entrepreneurs and venture capitalists in Silicon Valley who are building companies with complete infrastructures to allow buildings to be built from a blueprint by independent machines. Basically this means that entire construction sites will be managed with much less human intervention. Instead of 10 bricklayers, one machine will do every bricklaying needed. No call in sick, no bad day at home, same standard every time. As these algorithms improve, the cost of building a building will get down massively. The standard and quality will be, at the same time, increasingly better.
Will the buildings perhaps no longer be unique? Perhaps, but most people will not be concerned by this aspect. They will be happy to pay less and live more comfortably.
What will this do for current buildings? Well, as you can imagine the prices for old, depreciated, no longer great to live in units will plummet. Also, buildings built at a low standard (as many Communist buildings are in Central Europe) such as tiny apartments crammed one next to the other, will lose their desirability very quickly. That means price will go down rapidly.
On the contrary, land will not be subjected to this risk. On the contrary, green clean land will be more desirable, as people will seek to expand. The avent of the mobility revolution, where people will travel quickly and cheaply thanks to electric self-driven vehicles will mean that the distances between people will become less relevant. Urban sprawl will increase.
You can judge for yourself how this will impact the cheap land that is surrounding big urban locations.
In another article, soon to come, we’ll deal with how you can combine the perceived stability of real estate investments with the flexibility of owning stocks.
