Sunday, May 29, 2011

Summary: This post compares stock investing to mortgage.

This week I've been reading Saarion Sijoituskirja and considering investing into stock market.

First some background. I can't buy a house now for two reasons. Firstly, I expect to be laid off during the next year into a tight job market filled with 1500 Symbian programmers from Nokia and a comparable amount from subcontractors. This may mean a move to another city or country, creating a "push factor" away from Tampere. Secondly, there is a "pull factor" as my two siblings have recently moved to Helsinki.

My first lesson in investing

In September 2008, HEX index had collapsed 35%. I was going to an offshore assignment. I decided to buy stocks when they are cheap and moved a small apartment nest egg to a stock fund. The next week Lehman Brothers crashed, wiping away 40% of my nest egg.

I concluded that stocks are too volatile way to invest a nest egg, no matter how great average ROI they offer in 20-year timeframe.

In the hindsight, I made the right move for the right reasons, and the nest egg has recovered most of the melted value. Only timing was wrong: I should have spaced the purchases in 6 month intervals instead of trying to guess when the downturn is at the bottom.

Comparing stocks and mortgage

The biggest revealation I've learned from the book is emphasis on dividends. In the long run, the value of the stock is the time-discounted sum of dividends (price is something completely different). Companies pay on average around 5% of their share price in dividends. Dividend perspective also catches growth companies; they typically pay increasing dividends each year. This changes the picture in the following ways:
  • You don't have to sell the stocks to use them to pay mortgage. Instead, you can use dividends for mortgage payments. Typically you want to buy a house during downturn and sell stocks during boom. Dividends can bridge the time gap.

  • Temporary nest egg wipeout is not catastrophical. Debt-free companies continue paying dividends. Others resume after recession. Prices recover. In fact, selling stocks is strictly optional for a long-term buy-and-hold investor who is in for dividends and mortgage-length (20-30 years) timeframe. Of course, it is great for your wealth if you can sell high and buy cheap, outsmarting seasoned professionals, but don't count on it.

  • Both houses and stocks "pay dividends" and "increase in value". In house, the 'dividends' come from lower living costs. Value increases typically in pace with inflation, at good locations faster. Statistically stocks produce a little more in the long run; then again, in the long run we are all dead.

Additional factors attracting me to stock gambling are:
  • They have cute little numbers you can play with. Simple back-of-the-envelope calculations are a second nature to me. I do them almost instinctively. For example I "annualize" all costs by estimating, say, how many times a month I eat out and what is the cost per meal and how large % of monthly income goes to eating out.
  • It is a game of skill and luck. It is possible to raise your net worth faster than the statistical stock market average. For example for J it gives good profit per hours spent researching. Then again, J can invest in companies he has visited in his water engineering projects. I don't visit customer companies. It is unclear if there is any game of skill for me. The only way to find out is to try.
  • It is more leniently taxed than salary income. For dividends, 70% of dividend income is capital income for which you pay capital gains tax. The final tax is 20% of dividend's value. This is less than half my marginal tax rate on salary (if I would get 100e more salary, the tax man would take over 40e). Now you may say that there is double taxation on dividend income: the company paid taxes and you pay taxes. However, there are also side costs for employing people. As a rule of thumb, salary + side costs = 1.6 * salary. The 26% corporate tax is smaller than side cost percentage.
  • It makes you a better writer and person. Both J and Mangan invest, and their investment posts are consistently high quality: betting money on being right makes you consider your opinions. Investors have personal interest to know what happens in the world as it impacts their lives.

Money is a huge taboo, for example not a single person has ever told me his monthly salary. Outside immediate family, only two persons have ever admitted owning stocks. I am aware that writing about money is not necessarily wise in Finland, will be careful about not disclosing anything, and will stop as soon as I start to notice strange remarks in face-to-face discussions.

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