Manage Money and Income Sucessfully

Exchange traded funds (ETFs) are CEFs that own a set group of stocks, often those in an index such as the S&P 500 or the Dow Jones utilities. Most ETFs are also convertible into the underlying shares such that they always trade at or near NAV. The main issue with ETFs is that they only own the overpriced, overowned stocks in the index. When the last buyer is in for overpriced stocks, returns are mediocre at best and volatility increases.

However, ETFs, unlike index funds, are traded all day long. Overconfident investors will trade them, running up commissions and spreads. Internet companies now offer, for a fee, selected groups of individual stocks. These preset stock portfolios are tailored to attract a wide range of investor whims and are designed to give the investor the illusion of control.

With a mutual fund you are taxed on gains you did not incur and can lose value because other investors panic and sell. Internet portfolios allow you to control your gains and do not subject you to the whims of fund managers and fund management companies. Unfortunately, as a group, most of these portfolios will have the same swings as the market. These portfolios are full of the same overowned, overbought stocks that fill mutual funds. When the last buyer is in, return will be mediocre and volatility high. A mutual fund panic will cause your portfolio to drop just as it would if you owned a mutual fund. Powerlessness can lead to anxiety, numbness, depression, and freefloating fears as with any stock product.

Okay, I get it. Money is fun to spend, right? Would you be surprised if I told you that I agree and love to spend money? I do.

Ultimately, my beef with debt is that it forces you to send your money to someone else for something you bought in the past. I’d much rather get to spend it on things I truly want now or will need in the future (like a retirement or a college education for my kids). You have to shift your mind-set from “I don’t want to miss out on fun today” to “I want to have even more fun tomorrow.” It’s one of those “is the glass half empty or half full” type of moments.

By scrambling to pay off your debts now, that means interest does not accumulate as fast. That in turn means your debt gets paid off even quicker. This of course means the money you waste on debt each month will now be freed up for you to spend on whatever you like!

Let’s look at someone with $25,000 in combined short-term debts (a payday loan, a few credit cards, and some medical bills), with an average interest rate of 20%. Take a look at their total interest costs based on some different fixed monthly payments. What a difference $250 makes as you raise your payment from $500 per month to $750. It cuts your repayment period by more than half and saves $18,000 in interest! For what you saved in interest by paying off your debt as quickly as possible, you could go out and pay cash for a new car. If that doesn’t make the case for an opportunity cost of using your money for other things besides paying down debt, I don’t know what does!

Control is exercised by monitoring the company’s performance against agreed targets. Control over the transaction enables momentum to be maintained to complete it both during the restructuring discussions and subsequently within a given time frame. It also gives the participating banks the ability to react to events quickly, and thereby address problems before they are too late. Control plays an important part within the bank as well, so that the transaction team works efficiently and effectively.

Communication

Communication should be present at all levels: within the workout team in a bank so that all members of the team know the exact position and status of the restructuring; within the loan workout unit of a bank so that a consistent approach is adopted by the institution in all its workouts; within the bank to enable knowledge transfer from the workout department to, in particular, the bank’s credit function; with other creditors and the company during the restructuring so that all parties are kept informed of each other’s positions, where appropriate; and communication should be maintained with the company after the restructuring is in place to ensure effective monitoring and control.

A restructuring solution that is based on erroneous or unreliable information is unlikely to succeed. Every attempt should be made to establish the exact financial position of the company, as well as the credibility of any financial projections. Often this is very difficult and takes considerable time, partly because the lack of reliable information usually contributes to the company’s problems in the first place. Banks must invest all the time that is necessary to obtain reliable information at the outset of the restructuring. It is usually necessary to verify any information produced by the company independently to achieve this. Also, the sharing of information amongst stakeholders promotes trust in the loan workout process.

Anticipation and planning

An experienced banker can anticipate problems and take corrective action before it becomes necessary. To be able to do so, the banker must have sufficient dedicated time and resources to consider all possible options and approach loan workouts in a methodical way. The planning process should also incorporate contingency plans to be implemented in the event of unexpected outcomes. Planning also enables a bank’s resources to be deployed efficiently.

The case for continuous innovation is powerful. The key idea is that a company in time calibrates the slope of its technological Scurve in financial terms.3 It gains that knowledge through an analysis of the costs of its R&D programs, counting both successes and failures. At the same time, it learns the impact of improved performance on sales growth and margins. The combination tells it how fast it can move up the S-curve for a given level of technology spending.

Faster growth and higher margins translate directly into value. A higher, sustainable growth of free cash flow significantly boosts discounted cash flow (DCF) valuations. And higher margins improve return on invested capital. The combination of high returns and high growth rates can produce sensational gains in economic value.

Of course, an R&D investment reduces free cash flow in the short term, as in the Boeing case, so it is necessary to factor in R&D productivity to determine whether the long-term growth creates more value than the short-term penalty extracts. Several metrics have been proposed for measuring R&D productivity. In The Valuation of Technology, I proposed using a growth-related measure: the ratio of annual new product sales to the portion of the R&D budget dedicated to innovative new products.

Other companies have developed algorithms for calculating return on investment (ROI) on R&D investment. In the long term, however, R&D productivity cannot be expected to remain constant. As one mines out the more attractive opportunities at the foot of the S-curve and as its slope flattens, it makes sense to reduce R&D and to eliminate programs that no longer add value.