What is a Collectable?

Unfortunately, the word "collectable" has become way too common in our society.

Everything from decorative plates to special edition DVDs to motorcycles slap that word on them in a desperate attempt to justify a premium price on a crappy, mass-merchandised depreciating liability!

I mentioned collectables as a type of asset that you should look to buy (please see: "Saving is boring, buy assets instead!"). But it's very important to actually define what a collectable is.

There is one, and only one factor that determines if something is a collectable and here it is:

SCARCITY

That's it, nothing more. If there are a million versions of your collectable item, guess what? It's not a collectable and will not be worth anything.

In our modern, post-industrial society it's almost impossible to find items that are truly scarce. In fact, the only time we come across any scarcity - it's usually manufactured that way. Think about iphones, or the Nintendo Wii, or Tickle Me Elmo. The manufacture of all these items are deliberately held back to create a false scarcity (it also generates publicity which is good for driving future sales).

Most items that are scarce are items that haven't been in production for years. Over the course of time, as things wear out, they are relegated to the scrap heap. The few working models that are still in existence (and in good condition) become steadily more valuable with the passage of time. Examples include classic cars, vintage clothing or antique furniture.

You are never going to find anything collectable in Parade Magazine, or on QVC or at Wal Mart - NO MATTER WHAT THEY SAY! Don't waste your money.

You also have to be very careful about bubbles forming in fake collectables. Probably the most famous example of this is Beanie Babies. In the late 90s the market for these little, plush stuffed animals went crazy. Prices were bid up to unbelievable levels relative to their actual value. Parents stupidly bought tons of these mass manufactured items as part of their kid's college fund.

True story, we actually had two little yellow Beanie Baby ducks that my wife found out were quite "rare". We contacted several collectors in our local market in 1998 (this was before ebay really took off) and were able to sell them for - I swear - $750 each! We then used that money to buy a new refrigerator for a house we just bought. I'm glad we didn't hold onto those things because today I doubt we could get $20 for them.

Then, predictably, the bottom fell out of the market and the Beanie Babies went back to their true value, which was almost nothing. In fact, this past October, we were at the local elementary school for a Halloween fair. One of the carnival games was a fishing game where you could win a random prize. I guess some parent got tired of holding hundreds of worthless Beanie Babies in their house because they were giving away tons of them as a random prize (not even a premium prize for winning one of the skill games) - it only cost 2 tickets and my daughter ended up with a little white seal.

Comic books were another similar kind of bubble that burst in the mid 90s. I had been a comic book collector since I was in grade school. Interest in comics had been growing for years, but it seems like it hit a manic stage when they killed Superman in 1992. Then the "special editions" and "collectable" issues multiplied like locusts and people snatched them up just as fast as they could. It was crazy, there were foil embossed covers, multiple covers of the same comic, little trinkets sealed in a bag with the comic (and don't you dare open that plastic bag or it will be worthless!). Prices on comics, both new and used, skyrocketed. Finally, the whole thing collapsed under it's own weight and all these really expensive comics became nearly worthless BECAUSE THERE WERE TOO MANY OF THEM. I've got boxes of comics at home. Some of them do have some value, but most aren't worth anything. I've been thinking about saving a few of my favorites, selling off the rest for as much as I can get and go out and buy one or two truly collectable comics from the golden or silver age (that's the 1930s to 1960s).

If you decide to dabble in collectables, it is probably the highest risk asset you can own. True collectables have a very limited market, there's only a small pool of buyers and sellers, and so that makes them very illiquid. On top of that, you have to maintain the item and worry about it becoming damaged or stolen.

Still, if you're in the right place at the right time, you can make a killing dealing in collectables.

Turning A Liability Into An Asset

You've heard me ranting about how a car is not an asset, and that is still true.

However, you can still turn something like this from a liability into an asset. In December, I was flitting around on Ebay Motors and I found an auction on a 2004 Toyota Prius that was going to end in 30 minutes with no reserve.

I did a quick Carfax report on the car and it came back clean. I also confirmed that the title was clean (not salvage). I placed a bid and won the car for $15,400. My intention from the beginning was to resell this car for a profit.

I had to ship it from California and re-register the title into my name, that cost about $1,000. There was also about $250 - $300 in misc. costs (insurance, gas, advertising, etc.). So overall my total costs for the car was about $16,650.

I knew that I could sell this car for a proft and make some money. I put an ad in the local paper and placed some flyers around town and I eventually sold it for $18,200 just this past week! That's a profit of $1,550, or a 10% return in only 6 weeks.

So I made a nice little profit in a relatively short period of time. Remember, an asset is anything that has the potential to increase in value. Buy low, sell high, get wealthy!

Stress Test

Please note, I am not giving investment advice. This is only based on my personal experience. Investing in anything is a risky venture and you can lose money, please do your own due diligence before investing in anything.

Holy crap! After eeking out modest gains in 2007 (the Dow up 6%, the S&P 500 up 4.5%, Nasdaq up 9%), the market has completely cratered in 2008.

Just this past week the Dow dropped 500 (the Dow is now off 14.5% from it's all time hit hit in October). The Nasdaq shed more than 4% of its value (the Nasdaq is now 18.2% off it's 52 week high, dangerously close to being labeled a Bear Market).

All of the 2007 market gains were wiped out in the first 5 trading days of 2008. Right now all the indexes are within 1% of breaking through their 52 week lows. In my opinion, all the momentum on the market is down. I'm also convinced that despite all the bad news that's come out over the past 6 months, we are just getting started.

So - How are your investments doing? Chances are you just got your year end statement and it looked pretty good. However, how is it doing now?

The first thing you need to do is compare how your overall portfolio is doing versus the market. Just look at the total value of your accounts and compare that to what the value of the account was on your last statement. Quick and easy. If your portfolio is down more than the market is down, you need to do a deeper analysis.

The deeper analysis comes by checking each of your individual investments (stocks, mutual funds, etc.) and see how they have done since the beginning of the year. This is going to allow you to see the weakest portions of your portfolio. For instance, if you have more than 20% of your money in technology, chances are your overall portfolio is underperforming the market. You need to reduce the weakest positions fast! Don't wait and hope it will come back. We are in a declining market and your losses are only going to be magnified going forward.

I encourage you to go online ASAP and check your investments and see how they have done since your December 31st statement was printed.

In this kind of market, you want something that will hold it's value, or even go up, when the market sucks like this.

Ever since the first market shock that occured last February, I've been adjusting my holdings and getting into investments that do well in a bear market.

The huge declines we've seen the market since the New Year started have barely affected my portfolio. My qualified portfolio (which is more aggressive) has only declined about 1% in 2008. My after tax portfolio has actually gone up abut 3% since the new year started.

So, how did I accomplish this? Well first of all, I stayed far away from real estate, technology and financial stocks - I was pretty sure that all of these sectors were toxic waste. The sectors that I favored were energy and industrial materials stocks (both are plays on commodities - which did really well last year). However, I only had about 20% of my money in stocks, 10% in domestic and 10% in foreign stocks. I also put some money into gold and silver (again with commodities). I was in investments that would benefit from a weaker dollar like foreign currencies and foreign sovereign bond funds. Finally, I decided to hedge 10% of my portfolio in BEARX, a bear market fund. Bear market funds go up when the market goes down. Let me tell you, when the market is going down like this, a bear market fund is your best friend and it helps offset other losses in your portfolio.

I have passed the stress test with flying colors with this portfolio. However, things are always in flux and I'm always considering changes depending on what's happening. Energy is a tough call right now, there is a real possiblity this commodity could crash if market sentiment says a recession is at hand. Likewise, I've been thinking about increasing my BEARX exposure to 20% of my portfolio.

Look at where the economy is going and invest accordingly.

The $20 Ipod

If you want to get wealthy, and I mean really wealthy, here's the secret.

1. Find an item (this can be anything).
2. Convince people to pay you more for it than you paid for it.
3. Repeat until you are rich!

What does this have to do with Ipods? There is no one better than Steve Jobs at following this rule.

Did you know that it only costs Apple $20 to produce an Ipod? That's right, 20 bucks. Then, through one of the slickest marketing campaigns I've ever seen, they've been able to convince us - the consumers - to shell out $250 - $400 for one. That's a 1200% profit margin, MINIMUM!

Oh, it gets even better. The Ipod battery is only designed to last about 18 months and it's not easily replaced. So that means after a year and a half, you have to buy another one! Rinse and repeat and Mr. Jobs makes BILLIONS!

Freaking genius!

How about Starbucks? Somehow, they managed to convince people to spend $4 on a $1 cup of coffee - AND PEOPLE DID IT! How much do you think it costs them (in product) to make a cup of coffee? I'm guessing about a quarter including the cost of the paper cup. It's no wonder there's a Starbucks on every corner, that business model is INSANELY profitable!

It's easy to see this almost anywhere you go. Think about when you go to a restaurant and pay $7 for a burger and fries. You're not getting $7 worth of food. In fact, for $7 you can go to the grocery store and buy a pound of hamburger, some buns and a bag of fries - enough for 4 meals at least. Restaurants are a notoriously difficult business, though. Looking at that markup, I can see why. It's better if you go with something with a better margins.

Remember Dennis Kozlowski from GE and his $6,000 shower curtain (http://money.cnn.com/2002/09/23/pf/saving/q_tyco/)? Chances are that shower curtain didn't take much than a few dollars to produce. But someone had the hubris to convince Mr. and Mrs. Kozlowski that it was worth paying a 10,000% markup. Kudos to you, shower curtain salesman!

You can buy a spool of 100 blank CDs or DVDs for $30. Yet a new movie on DVD costs $20, a new CD costs about $15 - look at that markup!

When I was a mobile DJ, I maybe spent $15,000 - $20,000 on my equipment (and probably the same amount on music) over the 12 or so years I was in business. I turned that investment into $300,000 plus in gross revenues during that time. That's a huge markup for a relatively modest investment!

Here's another example. My wife is a fitness instructor and she presents at fitness conventions. I was pulling my hair out because she wasn't making any money on these outings (fitness conventions pay diddily). My solution, we decided to produce videos of the classes she teaches at these conventions. This way, instructors can buy the video of the class they just took. Our cost to produce these videos? A few hours and about $0.50 a DVD. We then sell these videos for about $10 each. It provides a nice profit source, even if we only sell a few videos.

So, go out there and find your $20 Ipod (whatever it is) mark it up and make some money!

Shuttle Launch

If you follow the principles that I have laid out so far you will make financial progress. I will review them here (please see my previous posts)

1. Limit your debt (see "Debt Slave")
2. Use a home based/small business to shield your income from taxes. (see "Wage Slave")
3. Limit the amount of money you spend on depreciating crap. (see "The Worst "Investment" You'll Ever Make")
4. Buy Assets (see "Don't Save Money, Buy Assets")
5. Make sure your net worth is going up each year and your debt is going down each year. (see "The Matrix")

If you follow this year in and year out you will see financial progress. However, this is not a quick process. You will not achieve financial independence in a year or two.

I equate the progress you will make as similar to a shuttle launch. If you know physics, you know that it takes more energy to lift that shuttle 1 foot off the ground than any subsequent foot of elevation after that. As the shuttle ascends into orbit, it picks up speed and momentum. After a while these forces overtake the actual thrust and push the shuttle into orbit. Orbit is a self sustaining process that requires no thrust as the shuttle falls around the earth.

Stage 1: When you start this process, it will take lots of energy and focus on your part just to stay on track. Keeping with this same analogy, the thrust from the shuttle is your income. You use your income to purchase assets and pay down debt. When your shuttle is on the ground (or even in an underground silo if you have a negative net worth), you need to push that shuttle in the air and it is a slow process. You can spend many years in stage 1 depending on where you are now.

Stage 2: As you stay on this process for a few years, you will notice momentum start to impact your returns. The effects of compound interest and asset appreciation will start to have a bigger and bigger impact on your portfolio. In this stage you will find that more than 50% of the gains in your net worth are as a result of asset appreciation instead of asset purchases and debt paydown.

Stage 3: In stage three of your ascent into orbit, the total value of your assets will exceed the total value of your debt. I reached this point in early 2006 and even though most of my assets were in retirement accounts (so I couldn't really access them to pay off the debt without paying big penalties to the government), it was an incredibly satisfying day for me. At this point, you should be earning more each month in income (interest and dividends) and appreciation from your assets than you are paying in interest on your debt.

Stage 4: At this point your shuttle is entering orbit (financial independence). Big characteristics of this stage are paying off all your debt and earning more from your assets than you earn in your day job. Other than stage 1, this will be the stage you stay in the longest (hopefully the rest of your life). You will no longer need to use debt to purchase items because there are sufficient assets to pay outright cash for things. Please keep in mind that you will continue to accellerate when you are in this stage.

Orbit: You'll know you're in orbit when your assets generate enough income to provide you with a comfortable lifestyle and you no longer need to work to live. Instead, a person in orbit will live to work and live in financial freedom!

Unfortunately, everyone's orbit is different. Likewise, it's not always a straight shot (market downturns or large purchases can set you back). But as long as the overall trend is going up, success will be yours!

FJ Quote of the Day

"Debt is the prolific mother of folly and of crime."- Benjamin, Earl of Beaconsfield Disraeli (1804–1881)

A great article from "The Simple Dollar"

Everything you ever really needed to know about personal finance on the back of 5 business cards.

http://www.thesimpledollar.com/2007/11/29/everything-you-ever-really-needed-to-know-about-personal-finance-on-the-back-of-five-business-cards/

The Matrix

So, how do you know if you're on the right track? You're working hard year in and year out and don't seem to be getting anywhere. I've developed a very simple matrix to help you know if things are going in the right direction.

There are two simple questions you need to ask yourself at the end of each year:
1. Has your total debt gone down?
2. Has your net worth gone up? Net worth is your total assets less your total debt. Please see my previous post about what an asset is.

Here's what the matrix looks like:












This is going to give you a real easy, quick check of how things are going financially.

The top left box is the sweet spot and indicates real financial progress. If your net worth went up and your debt went down you are doing great!

The top right box is more of a caution area. Your net worth went up, which indicates your investments did well, but your total debt increased as well. This could indicate a large purchase that you financed with debt, like a car. If your debt is increasing every year, you need to reassess your lifestyle because if your investments enter a bear market, you will quickly move into the big red box right below.

The bottom left box is also a caution area. If you're in this box, that means you've done a good job paying down your debts over the past year. Unfortunately, it appears that you are in a bear market because your assets are also going down in value. In this case you need to review your investments and make some changes there, but there's not much else you can do.

The bottom right box is the worst spot you can be in if you ever hope to achieve financial success. In this case you are in the worst of all worlds - your net worth is decreasing and your total debt is increasing. Ironically, you could be in this space even if your investments are increasing in value, but your debt is increasing even faster. If you are in this box you need to seriously reassess your entire lifestyle and make some changes quick because everything is going in the wrong direction if you ever want to achieve financial success.

Now, from personal experience I can tell you it is almost impossible to stay in the green box year in and year out. S*#t happens. You need to buy a new car or there's a bear market. However, as long as you're making progress on one of those two fronts and try to hit the green box every few years you'll be on the right track.

Because I'm an obsessive/compulsive I've been tracking this every year since we purchased our house back in 1998. Here's what it looked like for me:

1998: Net Worth Up; Debt Up (I purchased a home and a car)
1999: Net Worth Up; Debt Down (Score!)
2000: Net Worth Up; Debt Up (we started a new business for my wife)
2001: Net Worth Up; Debt Down (Trip #2 to the green box)
2002: Net Worth Up; Debt Down (3 our of 5 years in the green box)
2003: Net Worth Up; Debt Down (On a roll for 3 years in a row!)
2004: Net Worth Down; Debt Up (Danger zone, we bought a new car. Luckily the net worth only went down by about $200 when compared to the previous year)
2005: Net Worth Up; Debt Down
2006: Net Worth Up; Debt Eliminated! (We sold our house and paid off all our debt)
2007: Net Worth Up; Debt still at zero.

So 7 out of 10 years in the green zone, not bad. Please keep in mind that there were years my assets went down in value (like the 2000 - 2002 bear market), but I was saving money and paying down my debts so both those items helped my net worth. 2004 was also a tough year as our business income was down, we couldn't save as much and we purchased a new car. This caused our net worth to decrease even though our assets were increasing in value that year.

So, the New Year has just started and you can start to assess where you are. Use this matrix to make sure you are on the right path!

Don't save money, buy assets!

Please note, I am not giving investment advice. This is only based on my personal experience. Investing in anything is a risky venture and you can lose money, please do your own due diligence before investing in anything.

Saving money sucks. Why save for a rainy day when that money is burning a hole in my pocket right now! Americans have become very good and not doing things they don’t enjoy, like saving. Our national savings rate has been negative since 2005 and it doesn’t appear to be showing any signs of improving.

So, instead of going out and spending your hard earned money on a bunch of depreciating crap that isn’t going to be worth diddily in 5 years (please see my previous post on the worst “investment” you can ever make)…why not use your money to buy assets?

Now, it’s important to understand what an asset is so you know one when you see one. Here are two questions you have to ask before determining whether or not something is an asset.

1. Does this item produce a steady income?
2. Does this item have the potential to increase in value over time?

If you can answer yes to either of these questions, you are looking at an asset.

Please note that buying assets is risky, but isn’t that the case with just about everything you do? It’s so funny to see people so worried about their small IRA account losing 10% in value (so they keep it in a money market) yet they go out and buy a brand new car every 3 years.

So, is a car an asset? Some might say that you need a car in order to get to your job, so a car is an asset based on question number 1. Unfortunately, this is not true. If you run your own business, a car is a liability. It is an expense which subtracts from your income. A car also does not increase in value over time (except in the case of collectables, I will talk about that in a minute).

Stocks and bonds are certainly the most common examples of assets. They both can earn income (stocks pay dividends and bonds pay interest) and they both have the potential to increase in value over time (bonds tend to appreciate when interest rates are falling, stocks tend to appreciate when economic conditions are improving).

Here are some other examples of assets:

Commodities
Foreign Currencies
Collectables
Precious Metals (gold and silver)
Bank accounts
Real Estate
Your Own Small Business

Here are things that you may think are assets but they are not
Automobiles, motorcycles, RVs, ATVs, etc.
Anything technology
Clothes and Shoes
Furniture
Jewelry (other than the metal weight)
Home décor

Keep in mind with all assets there are different degrees of risk and liquidity. Likewise, not all assets are good buys at the same time. Real estate has been a great investment in the past. I wouldn't go near real estate right now (for reasons I will post later).

However, if you take part of your income and devote it to buying assets, long term you will be in better shape that those fools who spend all their money on all those depreciating trinkets that make them think they're rich.