Art Investment and Finances

							Financial Intelligence – Personal
   Finances & Investing 101


             Bob Y. Chan

          Outline fore talk #3
           October 16, 2003
      Synopsis of last talk
Follow your “money trail”
 Is investing an art or a science?
Markets can and do move up or down,
crazily!
       Outline for Talk #3
Whom do you work for?
On borrowing money
On Taxes
How smart are you vs. the market?
Recap: Balancing the check book
 The money game is a cashflow game
 Want to manage your cash flow so you have
 “seeds” for investing
 Key is to track down what are your
 expenses
Balancing the check book (cont.)
 Consolidate all income and expense items
 into 1 or 2 “principle cash flow points”
   Checking account
   Major savings account
 Keep investment monies in a separate
 account
   Allow you to look at income / expenses and
   also investment performance
Balancing the check book (cont.)
 Actual money in and out of the account (s)
 is your monthly cash flow
 Evaluate investment performance of the
 other account
 Spend 15-30 minutes each month to work
 out your “money game score”
Balancing the check book (cont.)
 The mortgage problem
   Mortgage is a liability, not an asset
   Your monthly payment (principal plus interest)
   is actual expense
   Your asset is the property, and rise and fall in
   the value will come out when you sell the
   property
         Borrowing money
Balancing your check book does not mean
you do not borrow
In fact, learn to borrow is an important
lesson in the money game
What you get from borrowing
  Money to spend
  Financial restraint over loan period
  Credit history
   Borrowing money (cont.)
The home mortgage
  Major problem is whether you buy the property
    Either a consumption or an investment decision
  Mortgage is the “by-product” of the buy
  decision
  Mortgage is a secured loan
    Lowest interest rate you can get
    Tax benefits
  Do not buy the house to get the cheaper loan!
Have a schedule to pay off debts
At some point of time, you need a “bridge”
to finance your expense
Once take on a debt, work out the size and
time frame to repay debt
The regular debt payment is an expense
item within the debt-repaying time frame
     Who do you work for?
Work for yourself, not for money
Most people work for
  The boss
  The bank
  The government
Do you future income flows too much to the
bank and the government?
Some facts and views on taxes
Tax is a “necessary evil” in modern society
Tax is a means of redistributing income
Many forms of taxes, some “hidden”
In reality, the middle income / poor pay a
larger chunk of taxes
Your actual income is after-tax
There are ways to minimize taxes
 A brief picture of U.S. taxes
Most comprehensive and complicated tax
system
Only “invented” in 20th century
Direct and indirect taxes
Like all other countries, the middle income
and poor pay more taxes
  U.S. taxes – for individuals
Federal tax
State and local taxes
Property tax
Sales tax
Taxes associated with investment
 U.S. taxes – for corporations
Ordinary income (Profits) tax
Capital gains tax
Dividend tax
Payroll tax
Chinese taxes - a very very brief
           summary
“second most” complicated tax system
Based on input, throughput and output
Most notably, value added tax (VAT)
          Hong Kong tax
The most simple tax system
Corporations based on output
However, SAR government has serious
financial problem!
Temptation to introduce and / or increase
tax
  Tax evasion and avoidance
Tax evasion is to “hide” the truth to escape
tax
  Illegal
  Don’t do it!
Tax avoidance is to follow the tax code to
minimize tax payment
  Legal
 Tax exemption vs. deduction
Individual as a “tax subject”
“salary man” vs. “business unit”
Some professions allows choice of type
Exemption vs. deduction (cont.)
“salary man” – exemption
  Marital status and family members dependence
  Tax based on taxable income
“business unit”
  Deduct expenses from income
  Tax based on after-deduction income
Exemption vs. deduction (cont.)
General rule is that “business related
expenses” can be deducted
However, tax code also allows for provision
of “welfare” to directors and key executives
       Allowable expenses
Housing
  “fair housing expenses” limits to 10% of
  income
  Might arrange housing allowance so taxable
  income is lower
Traveling
  Tax code allows for trip expense for individuals
  Allowable expenses (cont.)
mortgage interest (up to a limit)
Education expenses
Structure your taxable income
Important note: Hong Kong has no tax on:
  Interest income
  Capital gains
  Dividend payment
in some cases, may structure income so:
  Taxable income is minimized
  Build up asset base
  Realize investment income in the future
Structure your income – an example
 Trading business
   Structure into corporate and individual level
   Part of income pay to individual
   Take on a loan and pay interest to offset income
   Use the loan to buy income generating assets
   (e.g., blue chip stock)
   Dispose asset some time in future to realize
   capital gain
Estate tax and how to get around it
You can’t escape “death and taxes”
Build up a trust
  Purpose
  Trustee
  Manager
  Beneficiaries
With proper arrangement, trusts don’t “die”
and so need not pay estate tax
Should you be your own boss?
No simple answer -- only you know
Key is how much risk can you take
Most people work for their bosses,
especially well educated people
  Stable income with smaller risk
Most rich people own their businesses
  Most business fail
  There could be wide fluctuations in between
How smart are you vs. the market
  Many smart people in financial markets, all
  hungry to try to “make a kill”
  There are also a lot of “fools” out there
  It only takes a few smart guys with the
  capital to reap most / all the profit

Question: can I beat the market?
   How smart are you (cont.)
Question: can you find a way to consistently
make “large” profits?
The salesman says “YES!”
Many studies show that it is very difficult
Probably most convincing study is that even
professional money managers do not earn
more than the “naïve” investor
   How smart are you (cont.)
Key issue is called “market efficiency”
If the market is very smart, all information
is already reflected in the prices!
Only the unpredictable shows up in price
movements
If some pattern shows up, someone will
jump in and quickly grab the profit
   How smart are you (cont.)
The way to “beat the market” is to be faster
than most people
People see things in different time horizons
Prices might reflect a “consensus” that can
change
If you move ahead of the crowd, maybe you
would do well
   How smart are you (cont.)
Alternately, you can make more by taking
more risk!
Suppose in the long run, real estate goes up
10% per year
If you buy in cash and hold, you get 10% a
year
If you can borrow 70% at 10% a year, you
get a much higher return!