Category Archives: Personal Finance

Bitcoin Overview

Bitcoin has become very popular. But sometimes you also hear negative things about Bitcoin. Is is really secure? Why is the price of Bitcoin going up and down? Here is an overview of Bitcoin.

Bitcoin is a relatively new phenomenon. It was created in 2008 by Satoshi Nakamoto, which is believed to be a pseudonym. It is the first widespread distributed digital currency.

Explaining how Bitcoin works is not easy, an understanding of cryptography, software engineering, economics and some other areas is required if one wants to dig deeper into how Bitcoin works. A couple of terms that are good to know are the following:

Wallet: Software which is used to store bitcoins, can be online or offline. Note that bitcoins can also be stored in paper wallets
Bitcoin Exchanges: Market place where users sell and buy bitcoins.
Mining: Bitcoins are created by solving mathematical puzzles, this is called mining.
Cryptocurrency: A form of currency based on mathematics alone.

First of all, Bitcoin is based on open source. Everyone can download the source code and have a look at it. This has the advantage that it allows users to check that the code does not contain any backdoors or security vulnerabilities. That said, this requires not just programming skills but also advanced skills in cryptography.

Currencies are typically controlled by a central authority, Bitcoin on the other hand is a distributed currency. It lives in a peer-to-peer network, there is no central control of Bitcoin. Being an electronic currency means also that there are no coins or banknotes. Not that far ago, a digital currency would have been very odd. Nowadays, it is not that strange. But Bitcoin has a number of strange features compared to normal currencies such as the US dollar or the euro.

Despite being a digital product, there will be a finite supply of Bitcoins. This may sound odd, since it is very easy to make perfect copies of digital products, both quickly and cheaply. But the Bitcoin generation algorithm has limited the supply to a maximum of 21,000,000 bitcoins. In order to prevent people creating their own bitcoins, several sophisticated technical features have been used in the Bitcoin algorithm.

The heart of Bitcoin is a distributed database, this means that each participant in the network keeps a copy of it. Traditional financial systems have one central database, which means that the users are trusting the operator of the database with their money. In order to get a distributed database to work, a number of problems had to be overcome. The solution is very elegant, in essence all financial information flowing through the Bitcoin network is public. The only exception are the identities behind the transactions.

One thing to be aware is that while Bitcoin may be anonymous, it is possible to follow the flow of transactions. If you paid someone, you can find out what he or she spent the money on.

The Bitcoin distributed database is known as the blockchain. This is due to the fact that transactions are grouped in blocks, which are recorded in the database in a chain of blocks. By itself this is not a very efficient way of storing database records. But thanks to the chain, transactions are linked so that they create a history of all transactions which can not be altered. The links between the blocks are based on cryptographic algorithms which can not be forged unless an attacker has enormous computational resources.

The identities of the owners of bitcoins is not used in the Bitcoin system. Bitcoin addresses are used to identify funds. The software which helps a bitcoin owner to manage his funds is called a wallet. The wallet is protected by a cryptographic key, if the owner loses or forgets the key, the funds in the wallet are lost. Or more exactly, the funds are still there but without the key there is no possibility of using the funds.

Is Bitcoin really money? This is hotly debated, there is no clear answer. Most economists agree that Bitcoin is a medium of exchange, one of the main three characteristics of money. Additionally, money is supposed to be a store of value. Here Bitcoin gets a little bit in trouble. Yes, Bitcoin is a store of value but with a very high volatility, which makes it less useful as a store of value. The high volatility also makes Bitcoin a poor unit of account which is the third characteristics of money. Few goods or services have their price quoted in bitcoins.

All in all, understanding how Bitcoin works requires a fair bit of skills in several areas. But you can use Bitcoins without knowing the details how it works. Bitcoin is reasonably safe but you must know how to keep your funds secure. One of the main problems with Bitcoin is the high volatility. Bitcoin was for a long time worth about $10, then it increased quickly to more than $100 and then skyrocketed to more than $1,000. But after that the value of Bitcoin has kept on dropping, at the moment is a bit above $200.

Quite clearly, Bitcoin is a risky investment. The currency itself may be safe but its high volatility makes it possible to lose a lot of money quickly. It is also worth remembering that Bitcoin works outside government regulations. This has some advantages but also makes it more risky. It is worth remembering that governments may crack down on Bitcoin, many governments are fond of keeping their currency under strict control and don’t like competition.

Street Smart Financial Basics

It is not easy to make money but often it can be even harder to keep the money you have.

The old saying is still true, if it sounds too good to be true, it probably is. It is always good to remember the old saying when dealing with people you don’t know. It is good to be optimistic but being naive can be very bad for your financial well being.

Plenty of scams are being promoted, that by itself is nothing new. The scams change from time to time but the promotion methods are often the same. Technology has opened new ways for promoters to find potential victims, email, social media and SMS are just some of the new ways.

Often you are invited to a free seminar which is supposed to be full of useful information. But it turns out to be sales presentation, although generally disguised to be an educational seminar. It is generally prudent to be wary of free seminars, unless it is being arranged by a non-profit organization. Companies do arrange free sales promotions but they make it clear that they will be promoting their services or products, not trying to disguise the event as an educational seminar.

Seminars to avoid are those which talk a lot about how cool it is to be financially free, show a lot of pictures of luxury items and is presented by someone who claims to be very successful. Typically, the presenter has a rags to riches story to tell. He was in big problems but when he stumbled on the solution and become successful. Now everyone can do what he has done. All you need to do, is to sign up for a training, offered at a special price but only today. Most common offers are about trading, property and Internet business but almost everything under the sun has been promoted this way.

Here are some of the typical warning signals to watch out for. High pressure sales, you have to sign up (and pay) today in order to get the special deal. Promises about getting rich quick, no experience required and no risk. Sometimes secret solutions or magic software are mentioned, without getting into any details. In essence, the message could more or less be summarized with the statement, just give me your money and I will make you rich.

Before signing or paying for anything, make sure that you understand exactly what is being offered. Especially solutions that are supposed to lower your tax are often presented in a way which is impossible to understand. But you get plenty of promises, the scheme is said to be approved by the taxation authorities, has been vetted by top accountants, no risk despite that the complexity of the scheme and much more promises which all sound very good, at least until you start to look deeper. Make sure that you get all the information and ask an independent tax account for advice. Very often, an experienced tax account will tell you that it is a scam, or call it a high risk scheme, which pops up every now and then, with huge losses for the victims. It seems to work fine in the beginning but once the taxman starts to investigate the scheme, things fall quickly apart.

Trading training and software are being promoted a lot worldwide. Obviously, it you want to try trading, you should make sure that you learn as much as possible before you start trading with large amounts of money. It is well known that there is no secret way of consistently making money or software which will automatically pick winning trades most of the time. Watch out for promoters who claim to have such solutions. How much would software which consistently pick winners be worth? It would of course be worth millions. Why would anyone sell it for two thousands or less?

The number of free property seminars skyrockets when property prices start to increase. Typically, these seminars either offer expensive weekend training or off-the-plan apartments. Or possible both but that has become illegal in several countries. Before paying big money for training, ask yourself if you have any guarantees that you will get more information than what you can get by buying two or three books about property investments. Unfortunately, it has often turned out that expensive 2-3 day property investment training includes less information than can be found in a book for a fraction of the price.

Be very careful with promotions of off-the-plan properties. If you want to be a successful property investor, less than ten percent of all properties are what we could call investor grade. Good off-the-plan project are typically sold out on the first day. Poor off-the-plan project are typically sold with rental guarantees. Unfortunately, this is added to the price paid by the buyer. Worse is that many off-the-plan projects are high-density buildings which are flooding many markets, creating an oversupply which often takes years to get rid of. But the promoters make a lot of money on each property they managed to sell. Unfortunately, the buyers often lose money.

Always be careful when you seem to get free advice from a promoter. It is seldom unbiased information, it may not be information, rather pure sales talk. In most cases, the promoter makes a commission if you buy so some of them may be tempted to stretch the truth. It is prudent to work out who pays the promoter. If he or she is getting paid on a commission basis, you should always get independent advice before paying or signing anything.

It can also be worth thinking about why someone who is supposed to be very successful or have excellent investments opportunities is looking for new clients. Surely the old clients would be coming back as well as tell their friends and relatives about such golden opportunities. Why would there be a need to try to find new clients? Why would such people send unsolicited emails and SMS messages to new people? Could the truth be so simple as that there are no happy old customers?

Two Common Scams That Must Be Avoided

No one likes to get fooled but sometimes it can alao become very painful financially. Two of the most common scams can unfortunately turn out to be very expensive. First, be very careful when someone offers you tax effective investments or in any way suggest you play around with your tax. Second, be very careful if you attend property seminars, buying an off-the-plan property can turn out to be much more expensive than initially thought.

Poor investments or scams are annoying and can be expensive. But at least your losses are generally limited to your initial investment. Unfortunately, there are two big exceptions to this rule. Getting into various schemes that are supposed to lower your tax can backfire badly. The same goes for off-the-plan properties, often bought with a relatively small initial deposit. But if you read the contract carefully, you will find out that you promised to buy the property at the given price. You risk much more than just your initial deposit.

No one likes paying tax and tax laws are complicated. In most countries, tax laws include plenty of various exceptions and tax effective investments which can be used to lower your tax. Unfortunately, scammers have realized that they have good chances of making easy money by setting up a scheme that lowers tax. Especially in the English speaking world, the tax system is very friendly towards such tax schemes, at least the first few years. All the time, people get persuaded to join a scheme that artificially lowers their tax. Things work out fine, until the taxman takes a closer look at the scheme.

The really bad thing about these tax schemes is that they often turn out to be very expensive for the victims. First, they have invested into something that turns out to be worthless. In other words, they have thrown away their money. It does not look like a loss, the artificial tax scheme meant that the money which went into the useless investment would have been paid as tax. But once the taxman has had a look at the scheme, things typically turn nasty. The scheme is not accepted as tax effective and the investors are required to pay the outstanding tax, possible with fines and interest as well.

Since it can take years before the tax authorities take a look at a specific scheme, victims could have invested in a scheme for years. Needless to say, this often is a financial disaster for the victims. It is of course possible to challenge the decision, but that just generally makes it more expensive and prolongs the pain. Never ever get into any tax arrangements without consulting an independent tax adviser. Amazingly, some people accept advice from a salesman who makes a commission from everyone who signs up. Probably very few realize how expensive it can turn out to be.

Property seminars are not as common as they used to be but off-the-plan promotions are far from dead. In theory, off-plan is a good idea. You are getting a property in 18 months or so at today’s price. Unfortunately, virtually all off-the-plan properties are overpriced. Be especially careful at property seminars, often poor investments are disguised as bargains at such venues.

What the seller seldom tells the customers is that by signing the contract, the customer promises to buy the property at the given price. In other words, the customer may lose much more than the deposit paid at the signing of the contract. Needless to say, if the developer has found suckers who have promised to pay more than the market price for a property, he or she is unlikely to let them off the hook.

You must be very careful when signing any contracts. Never believe what a salesman, who after all will make a commission if you buy, tells you. What they tend to forget to tell you is that you have already bought the property, at the given price. But things can be even worse, often you only get two weeks to arrange the final payment once the project goes live. If you fail to secure a loan within the given time frame, you could lose your deposit. This tends to only happen if the current market price is higher than what you have promised to pay. Something that happens very seldom but you should be aware of the possibility of you losing your deposit. If the current market price is less than what you are paying, the developer generally has some understanding if you need some extra days to get your finances sorted. But the developer is unlikely to let you walk away if you have realized that the off-plan price was far too high. He or she will insist on you buying the property at the inflated price.

How to protect yourself against inflation

Inflation can be seen as a stealth tax. It erodes the value of your savings but it does not affect everyone to the same extent, for debtors inflation can be good. The official inflation in most countries is low at the moment but some economists worry that the inflation will soon start to increase. But can you protect yourself against inflation?

The short answer is it is very difficult to protect yourself against inflation. Several studies have shown that inflation tends to erode the value of most assets. There is also a practical reason why it is difficult to protect yourself against inflation, you don’t know what the inflation will be in the future. If you know for sure that inflation will increase drastically in the future, you could make a fortune by buying real estate in good locations and borrowing as much as possible at fixed rate. But such a strategy is would backfire badly if the economy would slow down. Deflation could kill you financially.

No one knows what will happen in the future but obviously some scenarios are more likely than others. We can simplify things and look at four possible outcomes. First we have the risk of depression with deflation. This is what governments and central banks are trying to avoid, almost at all costs. Deflation is certainly possible, but not very likely. Next we have the preferred outcome for many, a sound economy with a little bit of inflation, about 2 to 4 percent. Unfortunately, at the moment this looks very much like wishful thinking. Higher inflation looks more likely, say between 6 and 10 percent. The last case, hyperinflation or very high inflation, is something governments want to avoid but if they would have to choose between deflation and hyperinflation, the latter would be preferred. Hyperinflation would cause a lot of pain but it would at least wipe out government debt.

Gold has been the classic protection against inflation but things have become more complicated. Inflation does not seem to have much influence on the gold price nowadays, instead speculation seems to drive the gold price. Still, in times of high inflation gold is likely to provide some protection. One big drawback with gold is that it does not pay any dividend. And in turbulent times, cash flow is very important.

Bonds have generally been classified as a losing investment when inflation is high. Actually, this is only partially true. Government bonds that are linked to inflation, called TIPS (Treasury Inflation Protected Securities) in the US, provide good protection against high inflation. Unfortunately, most governments understate the true rate of inflation, making these bonds less good against inflation. One interesting thing about index-linked bonds is that the Bank of England pension fund has invested 95% of its assets in index-linked bonds. This is very odd given that the BoE’s official view is that the inflation will stay low, less than 2%. With such a low inflation, index-linked bonds are not a very good investment. Does the BoE expect much higher inflation in the future?

Shares have beaten the inflation over time. But that does not automatically make shares a good hedge against inflation. Historically, shares have performed best in moderate inflation. High inflation has created trouble for shares, maybe because interest go up or maybe because not all companies can protect themselves from inflation, in essence, they can’t pass on the increased costs to their customers. But we are taking about average returns, obviously some shares will perform better than others during times of high inflation. The standard recommendation is to invest in blue-chips which pay high dividends.

Real estate has become very popular and a lot of people think that property will protect them against inflation. This is to some extent true. Obviously, the term real estate covers a lot of different types of property. But as protection against inflation, residential real estate in good locations typically provide the safest protection. Unfortunately, such properties are seldom cheap. The advantage of residential property is not only that inflation is likely to increase their value but also that rents will increase, improving your cash flow.

Trying to draw to many conclusions from the past can be dangerous, especially this time. Central banks will most likely try to keep interest rates down, even if inflation increases which may benefit shares. QE is also something that has never been tried before on this scale.

How to Invest in Bonds

Bonds have been the classic investment for people who don’t like taking risks. But even if investing in bonds is relatively safe, it is possible to lose money also on bonds. Here is a primer on how to invest in bonds.

Bonds are IOU (I owe You) issued by companies and governments. In other words, a bond is simply an acknowledgement that the issuer owes the holder of the bond money. The terms of the loan varies but typically interest, also known as the coupon, is paid regularly. Most bonds can also be sold on secondary markets. So called zero-coupon bonds don’t pay any interest, their value is derived from price paid by the bond issuer at maturity.

As a rule of thumb, the value of bonds has an inverse relationship to interest rates. If interest rates go up, bond values fall and vice versa. Bonds with fixed interest and zero interest will be more attractive when interest rates fall which means buyers are prepared to pay more for them.

Let’s look at an example with a zero-coupon bond, that is no interest, which matures in twelve months. If the price paid at maturity is $105 and the bond costs $100, a buyer would get 5% interest, ignoring transaction costs. The formula for the interest is (105-100)/100 which equals 5%. If interest rates would go up and new bonds were issued with interest greater than 5% a year, investors would prefer to buy them so the price of the bond has to go down in order to attract buyers. On the other hand, if interest rates would go down, the bond value would go up instead.

The same principle is true for bonds with fixed interest. Bonds with floating interest typically have their interest rate linked to a reference rate, such as LIBOR. Such bonds have less interest rate risk but are often issued by companies with low credit rating. Note that floating rate bonds are poor investments if interest rates go down, since the interest payments will be adjusted downwards. Increasing interest rates are on the other hand good for floating rate bonds. But if you want to speculate, high-yield bonds are generally considered a better bet than floating rate bonds.

High-yield bonds are also known as junk bonds. They are issued by companies lacking investment grade credit rating, this means that there is a risk of default. Since the risk of default is significantly higher than if the bond had been issued by an investment grade company or a government, investors expect a higher yield. The performance of high-yield bonds resembles more the performance of the stock markets than traditional bond markets. Therefore, high-yield bonds are seen as an alternative for investors who want better returns than traditional bonds offer but think that the stock market is too risky.

It is possible to buy bonds directly from the government but most investors use a broker, buy bond ETFs or bond funds. Note that brokers sometimes say that they trade bonds commission free but in reality they will add their commission on top of the price you pay for the bond. They just don’t call it commission. If you are only investing in low risk bonds such as government and high-grade bonds, using a broker is fine. But if you buy risky bonds, you probably don’t have enough money to build a bond portfolio with low risk. In that case, ETFs or mutual funds are a better choice.

Quantitative easing has made government bonds unattractive as investment so investors who used to buy government bonds need to look for new investment strategies. Of course, if you want to speculate in an end to quantitative easing government bonds could be a winner. But beware that government bonds are no longer safe investments. Governments are unlikely to go bankrupt but the return on their bonds could turn out to be dismal in the future.

The choice between ETFs and mutual funds is hotly debated. Both have advantages and disadvantages, but we certainly prefer to avoid bond funds with high administration costs. As a rule of thumb, bond ETFs have less overhead than bond funds. Some bond fund managers have been very successful but unfortunately they are the exceptions. If you want someone else to manage your investments and don’t mind paying extra for it, bond funds are the best solution. But if you have any aspirations of becoming a successful investor, ETFs are certainly worth looking into.

Given the risk that inflation will pick up we think that most investment portfolios should include very little bonds. Low-yielding government bonds certainly don’t look like a good investment at the moment. Things may very well change in the future but before we invest in bonds we would like to see an end to quantitative easing.

How To Manage Your Money

Good money management is a must if you want to become wealthy. Some people earn a lot but they are still just one or two pay checks away from going bankrupt. On the other hand, you have people who don’t earn much but despite that they are on their way to financial freedom. The difference is good money management. Here are a few tips about how to manage your money.

If you already have your finances under control, you may wonder why money management is important. Unfortunately, far from everyone have their finances under control. Some people simply run out of money long before the next pay check is due. Others have no problems paying their expenses but no money is invested. If they lose their job, they are in big trouble.

Few people like budgets but if you don’t know where your money is going, you can’t managing your money. A budget is relatively easy to create but sticking to it is much tougher. Few people possess the necessary discipline to follow a strict budget. Generally it is best to just include the large items in the budget and make sure that all your expenses are accounted for.

One of the main priorities of a budget is to make sure that you have some money to invest. The old rule about paying yourself first is very important. But before you can start investing, you should pay off any credit card debts. There are good debt and bad debt. Interest on credit card debt is generally very high. It is extremely unlikely that you can find investments with higher rate of return than the interest on credit card debt.

On the whole, it is important to avoid bad debts. In this content bad debt means debt on things you don’t absolutely need and can’t afford. Borrowing money to buy items that go up in prices is generally a good idea. Borrowing money to buy things that go down in value is seldom good for your financial well-being.

Assuming that you don’t have any credit card debt, you should make sure that you have an emergency fund. This can be used to pay unexpected expenses, rather than using your credit cards. But the main reason is that if your income dries up, for example if you lose your job, you will be able to pay your bills for a while. How large the emergency fund should be depends on your monthly expenses and how large your need for security is. For some people, being able to survive for six months is more than enough, others want to be sure that they have money for at least 12 months.

Once you a reasonable safety buffer, you can start investing some of money. The golden role is, always pay yourself first. It simply means that you invest part of your income before you start spending it. Often ten per cent of your net income is recommended. A lot of people set up an automatic monthly transfer to a mutual fund or similar. Most people who pay themselves first have not noticed that they are surviving on less money. Obviously, the more you put aside, the better. But it is very important that you get started, even if the amounts are small in the beginning. By getting into the habit of paying yourself first, you are on the right track. This is extremely important, far too many people simply keep on spending all their money. They say that once their income goes up they will start investing part of it. But virtually in all cases, when their income grows, they quickly find new ways of spending the extra money.

In order to be able to have money to invest, you may have to cut down on some expenses. This is not fun but if you keep on spending all the money you earn, you will never get ahead. Be creative, changing to a healthier life style can often both save money and improve your health. Some people may find this a boring solution but if it improves both your finances and health, it is worth trying.

One very important expense to get right is insurances. You need to be covered against huge setbacks. Even against things that are very unlikely to happen. If you are not insured, your saving could be wiped out.

Another important thing to remember is that often the best investment you can make is to invest in yourself. If you want to become wealthy, you need to be street smart. There are a lot of scams and poor investments that are being heavily marketed by promoters. If you want to increase your wealth, you must know the difference between a good and a poor opportunity.