How to Defang the Debt Monster and Reap a 43% Annual Return

Have you encountered the debt monster?

At first, he hardly bothers you. In fact, he’s small and even helps you out of a tight spot now and then. But before you know it, he’s huge. Impossible to ignore. And, quite frankly, dangerous. You find yourself in a state of constant worry that his appetite will become the end of you.

Here’s a strategy to tackle him and build your wealth.

Debt monster
Photo by Ramy Alaa

Have you encountered the debt monster?

At first, he hardly bothers you. In fact, he even helps you out of a tight spot now and then.

But as time goes by, he grows. His teeth sharpen and claws become fearsome.

No longer just a mosquito-like annoyance. He begins to get in your way, obstructing you from your goals.

Then, before you know it, he’s huge. Impossible to ignore. And, quite frankly, dangerous. You find yourself in a state of constant worry that his appetite will become the end of you.

The problem with debt

If you’ve encountered a debt monster like this one, you’re not alone.

South Africans, on average, spend 75% of their disposable income on debt service. That’s monthly payments for home loans, car financing, credit cards, and bank overdrafts.

In Nigeria, credit cards charge interest rates of 2.5% — per month. In Kenya, many charge 3.5%.

And they come with a host of hefty fees on top of that. Annual fees equal to 2% of the total credit limit are common.

With terms like these, it’s no wonder that the debt monster takes a bigger bite out of your income with each passing month.

Debt reduction is sure-fire wealth creation

When it comes to finance, there are few guarantees.

Share prices rise and fall. Bonds can default. Even banks have been known to let their depositors in the lurch on occasion.

Paying down debt, however, always yields a positive return.

The more you reduce your obligation to creditors, the more cash you can keep in your pocket.

An unbeatable rate of return

And not only is the return on debt reduction guaranteed, it’s likely of a size to make the long-term performance of even the fastest-growing stock markets look puny.

Let’s imagine you have 100,000 shillings of debt on a credit card that charges an interest rate of 3.0% per month.

If you didn’t make any payments on the card for 12 months, how much would you owe at the end of the year?

Assuming, the credit card company didn’t charge any late fees and/or drag you into court, you would owe a total of Ksh142,576. And that doesn’t even consider the card’s annual management fee.

Therefore, each Ksh1.00 you pay toward your credit card debt results effectively results in a savings of 43 cents over the course of the year — a 43% annualized return.

At rates like that there’s nothing better to do with your excess cash than to pay down that debt as quickly as possible.

How to tame the monster

What’s the best way to tackle your debt?

  1. First, take your credit cards out of your wallet and hide them in a place where you won’t be tempted to use them to purchase inessential items. If you completed last week’s first step toward successful investing, this shouldn’t be too uncomfortable to do.
  2. Next, list all of your debts on a sheet of paper. Note each one’s outstanding balance and its annual interest rate. (Do you have credit card debt that’s stated in terms of a monthly interest rate? You can convert it to an annual rate here.)
  3. Now, start paying off the debt with the highest interest rate. Make sure you pay at least the minimum required on each one of your debts, but reserve the lion’s share of your disposable income to pay down the one with the highest interest rate. This will give you the best return and tame the monster most quickly.
  4. When that first debt is eliminated, move on to the debt with the next highest interest rate. Rinse and repeat until the only debt remaining is your home loan if you have one. Home loans generally carry relatively low interest rates, and, in many cases, a home increases in value over time – unlike a vehicle or piece of furniture. Thus, it probably doesn’t need to be a priority for you to pay off.
  5. Celebrate your success.

Have you tamed the debt monster?

Congratulations! You’re on your way to the next step toward successful investing.

It’s your turn

How did you tame your debt monster? Do you have any tips to share? Let’s hear them in the comments!

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Here’s Where You Start: The First Step Toward Successful Investing

Investing in shares is risky business. So, before you open a brokerage account, you need to ensure your finances are strong enough to absorb the blow when disaster strikes one of your shares.

This will allow you to take reasonable risks with confidence — knowing that you and your loved ones are safe no matter which direction the stock market is going.

Here’s how you do it.

Investing in shares is risky business.

Don’t let anyone tell you otherwise.

Sure, there are ways to minimize your risk and put the odds in your favor. But for every stock that explodes for a 1000% gain, there’s a stock that implodes, leaving its shareholders with a 100% loss.

I know this. I’ve experienced both outcomes firsthand.

So, before you open a brokerage account, you need to ensure your finances are strong enough to absorb the blow when disaster strikes one of your shares.

This will allow you to take reasonable risks with confidence — knowing that you and your loved ones are safe no matter which direction the stock market is going.

The key to financial stability is simply to spend less than you earn.

Here’s how you do it.

1. Track all money that enters and leaves your life

Start by becoming fully aware of all the money that flows into and out of your hands.

Get a good pen and a small, durable notebook. Carry them with you wherever you go, and write down everything you buy.

Taxi fare, chips, school fees, top-up cards, rent. Jot down every purchase — big and small — in your notebook at the exact same time you pay for it.

Make sure you note precisely how much you spend on each item. Rough estimates just won’t do. Don’t round to the nearest dollar.

Every penny. Every shilling. Every kobo. Every thebe. Must. Be. Recorded.

Do you have any automatic payments coming out of a bank account? Make sure you note all of those, too.

And, of course, don’t forget to track your income at the same time. Wages, income from selling vegetables from your garden, even the lost coin you find in the street.

(Note, this isn’t an original idea from me. Many financial advisers will suggest you start with a similar system. I was particularly inspired by Your Money Or Your Life by Joe Dominguez and Vicki Robin.)

2. Add it all up at the end of the month

When you reach the end of a month, add up all of your income and expenses.

Break your expenses down into a few helpful categories and tally up the amount you spent on each one.

Here are the categories Britany and I use:

  • housing
  • utilities
  • food
  • telephone and internet
  • transportation
  • entertainment
  • gifts
  • clothing
  • healthcare
  • insurance
  • taxes

You probably spend money on things that don’t fit in any of these categories. Or maybe you think it would be helpful to break them down into sub-categories.

That’s fine. Personalize them according to the way you live your life.

The important thing is to see where your money comes from and where it is going.

3. Review the results and note three things that surprise you

After you’ve summed all of your income and expenses, take a close look at the totals for each category.

Is there anything that jumps out at you? Is there anything that makes you look twice? Anything that puzzles you? Anything that embarrasses or disappoints you? Anything that makes you cheer a little bit inside?

On the next page of your notebook, take a moment to write down three things you find remarkable about your financial life in the previous month. You can write down more than three if you want. But write at least three.

When you’re finished, turn to the next page, and continue tracking your income and expenses.

4. Chart your income and expenses over time

You may have heard the old saying that “What gets tracked, gets improved.” In most things, I’ve found this to be true.

(Although no matter how much I track my consumption of jelly beans, it seems to go up and up every month. Hmmm… maybe that IS an improvement!)

My sugar addiction notwithstanding, close monitoring of a behavior typically leads to gradual change for the better.

This is why this next action item is so important.

First, you’ll need a piece of graph paper. If you don’t have any handy, you can modify and print this one.

This is where you will chart your monthly income and expenses.

At the end of each month, take a green pen and plot your total income on the graph.

Then mark your total expenses with a red pen.

Connect the green and red dots after each month and pretty soon your chart will begin to look something like this.

monthly chart

Now, hang the chart somewhere in your home, where you will see it often. Maybe behind a cupboard or closet door.

You want to see it often enough that it reminds you of the progress you are making.

(And, yes, if you’re savvy with Excel, you can have the computer make this chart for you and skip the green and red pen. But make sure you print out your graph each month and hang it somewhere that you will see it frequently.)

5. When you consistently earn more than you spend, move on to the next step

We’ve reached the decision point.

After several months of tracking your income and expenses, you should have a pretty good idea whether your income is greater than your expenses.

If it’s not, don’t panic. Look closely at your expense categories and see whether there are easy places to reduce your spending. And, if there are ways to boost your income, explore those, too. Continue to monitor your expenses and see if the red and green lines are any closer together a few months from now.

Is your green line consistently above your red line?

Congratulations! You’re ready to move on!

Proceed to the next step here. But be warned… a monster awaits!

It’s your turn

Does this seem like a good first step toward getting your financial house in order? Let’s hear your thoughts in the comments!

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Why a Mutual Fund’s Like a Herd of Cattle

Dear Ryan,

I have a unit trust that I track every day. One day it goes up R5.00 or more. The next day it’s lower. I fail to understand how that works. What makes the price change? Say I want to sell my units. What determines the price I will receive?

Brenda from South Africa

Dear Ryan,

I have a unit trust that I track every day.

One day it goes up R5.00 or more. The next day it’s lower.

I fail to understand how that works. What makes the price change?

Say I want to sell my units. What determines the price I will receive?

Brenda from South Africa

Dear Brenda,

Unit trusts, which are commonly known as mutual funds outside South Africa, are a collection of shares of from many different companies. Every day the stock exchange is open, people buy and sell these shares.

If the news about a certain company is good, the price of its shares will typically rise because investors believe that the company is more valuable than they had previously thought, and demand for the shares increases. But if the news is bad, the price of the shares will often fall. Why? Because the company’s prospects may no longer be so bright, and demand drops as a result.

Owning shares of a company is a bit like owning a cow. If your neighbor sees that your cow is becoming very strong, healthy, and producing a lot of milk, he will probably be willing to pay you a handsome price for it. If, however, he sees that the cow is growing sick or thin, he won’t be willing to pay as much.

If a share of stock is like a cow, then a unit trust is like a herd of cattle. Each individual cow (or share) has its own characteristics. Some are fat. Some are lean. Some are young. Some are old. Some are very productive. Some are not.

Thus, each individual cow has its own unique value. To determine the value of the entire herd (or unit trust), you sum the values of all the individual members of the herd. And because investors’ perception of each share’s value changes on a daily basis, so does the value of the entire mutual fund (or herd).

What is a mutual fund?
Photo by ILRI/Stevie Mann

So, when you sell your units, you will be selling at the price that investors believe the underlying shares of your unit trust are worth on that particular day.

Passive vs. Active Management

Now, let’s stretch this analogy a bit further.

Just like a herd of cattle is overseen by a rancher, cowboy, or herdsman, every unit trust and mutual fund is overseen by a fund manager.

Some ranchers take a “hands off” approach to managing their herds, doing little more than sending them out to graze every day.

But others become much more intensively involved. They nurture the healthiest cows, cull unwanted members of the herd, and search for strong animals to add to the group.

Similarly, the manager of a “passive” fund will trade individual shares infrequently, perhaps re-balancing them once per year. So, the fund’s performance will largely be determined by how the overall market behaves. Some shares will do well, some will not.

An “active” manager, on the other hand, will closely watch all of the shares in the fund in an attempt to maximize performance. He or she will sell those stocks that look like they will perform poorly in the future and use the proceeds to buy shares that they believe will perform well.

Mutual Fund Fees

As you might expect, the fees associated with an actively-managed fund are much higher than the fees of a passively-managed one.

The total expense ratio measures a fund’s total fees as a percentage of total assets. Most of South Africa’s best-performing unit trusts have expense ratios that fall in the range of 1-3%. This means that for every R1000 you invest in one of these funds, you can expect to pay between R10-R30 worth of annual fees. Passive funds will tend to have lower expense ratios.

It’s important to note that actively-managed funds don’t necessarily outperform their passively-managed counterparts.

Why not?

One reason is that high fees are a big drag on performance. The other is that some managers simply don’t know when to leave well enough alone. Because they buy and sell shares frequently, active managers have lots of opportunity to make bad decisions that hurt investors’ returns.

Choosing a Mutual Fund or Unit Trust

How do you decide which unit trust or mutual fund to invest in? I suggest that you compare their performances over the long-term – the past 10 years or more. Look for those that have consistently posted market-beating returns. Consider their expense ratios, too. Why? Because those with lower fees will have an easier time outperforming in years ahead.

Here’s a nice article that shows South Africa’s best-performing unit trusts over the past 10 years to get you started.

Do you have questions about mutual funds and unit trusts? Let’s hear them in the comments!

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9 Ways Smart Africa Investors Avoid Losing Their Shirts

Benjamin Graham, one of the best stock investors in history, provided some great tips for moderating speculative urges in his essential tome, The Intelligent Investor.

Here are nine from the first chapter alone, that can make you a better Africa investor.

I will always remember my first introduction to the stock market.

My fifth-grade teacher, Mr. Decker, devised a one-month stock-trading competition for my 11-year-old classmates and me. He taught us how to read a stock price chart and gave us each an imaginary $1,000,000 to “invest” however we liked.

“At the end of the month,” he said, “the person with the portfolio that has increased the most in value will win a candy bar.”

We dove headfirst into the game, selecting ticker stocks that looked like they had been going up in the previous few days, assuming that those whose prices were trending higher would continue to rise at a similar rate throughout the month.

It was fun. Some of us made vast imaginary fortunes. Others lost almost everything. I recall falling somewhere in the middle.

With only the vaguest understanding that these ticker symbols represented actual companies, we bought and sold them at the drop of a hat.

We were gambling, pure and simple. Or to put it in more sophisticated, respectable terms, we were speculating.

Investing versus SpeculatingThe Intelligent Investor

Warren Buffett, arguably the best stock investor in history, calls The Intelligent Investor: The Definitive Book on Value Investing by Benjamin Graham (affiliate link) “by far the best investing book ever written.” It’s essential reading for novice and experienced investors alike.

Graham devotes the book’s entire first chapter to making the distinction between investing and speculating.

In short, investing is associated with thorough analysis, prudent allocation, and reasonable expectations. Speculation, on the other hand, tends toward unproven assets, huge but unlikely payoffs, and short holding periods.

Speculation in Moderation

You can probably see where I’m heading with this, but before I sound like too much of a killjoy, let me make clear that as humans we are hard-wired to speculate to some degree or another.

And that’s a great thing.

Without speculation we’d have no explorers, inventors, entrepreneurs, or venture capitalists. Plus, just as I learned way back in fifth grade, speculation is a lot of fun even when you don’t end up winning a candy bar.

The key is to make sure that your speculative efforts don’t expose you to catastrophic levels of risk. Speculate only in amounts that you can afford to lose completely without jeopardizing your financial health and of the loved ones that are dependent on you.

This amount will be different for different people.

A very wealthy, young single person might be able to speculate with 99% of their total assets. A low-income parent of six children, on the other hand, may be scarcely able to risk even 1% of their funds.

Keep in mind, too, that anyone who buys and sells shares of stock, no matter how conservatively, is a speculator to some degree. Why? Because there are no certainties in the stock market. No one can predict with certainty which direction stock market prices will go one day from now, let alone five years from now. There are simply no guarantees.

Benjamin Graham’s Tips for Containing Speculative Tendencies

So, with that said, how can you invest intelligently in African markets and keep undue speculation within reasonable limits?

Here are a few hints from Benjamin Graham:

Graham's Tips for Not Losing Your Shirt
Photo by Domiriel

1) Don’t purchase shares with money that you can’t afford to lose

Graham says stock investors must “be prepared financially and psychologically for adverse results.”

Do you have any debt (apart from a home mortgage)? If so, pay it off. Do you have an emergency fund at the bank that is large enough to cover six months worth of living expenses? If not, start building one. Don’t invest until you’re debt-free and have a cash cushion.

2) Understand what you are buying and selling

Graham observed that many people thought they were investing when, in fact, they were speculating.

That’s often because they purchase shares of a company before they thoroughly understand the underlying business and what factors influence its success. Without such an understanding it’s extremely difficult to determine how much to pay for its shares.

So, don’t pick your stocks blindly like I did in Mr. Decker’s class. Take some time to get a sense of what each business does, how it makes money, and who it competes with.

3) Trade infrequently

Graham advises against “short-term selectivity,” the practice of quickly buying or selling a stock whenever one believes good or bad news is coming. He didn’t believe investors could reliably predict this news, let alone how the market would react to it.

He believed that buying undervalued stocks and patiently holding them until the market recognized their worth as a better strategy.

In African markets, I think there’s an even more compelling reason to invest for the long-term — the brokerage commission structure. To my knowledge all African stockbrokers charge commission based on a percentage of trade value (often 2%) instead of a flat fee. This builds into a huge headwind for short-term traders over time.

Assume Obi bought N100,000 worth of shares of a Nigerian company. He would be charged commission of roughly N2,000 to do so (N100,000 x .02 = N2,000). He holds the shares for one month and during that time they increase in value by 4%. He’s very pleased, because that’s a great one-month return! So, he decides to sell his shares for N104,000 and reinvest in another hot stock. Then he looks at his trade notice and see that brokerage commission on the sale was N2,080 (N100,000 x .02 = N2,080). So, instead of earning N4,000, he actually ended the month N80 poorer.

His broker, meanwhile, is now N4,080 richer.

4) Beware of IPOs

Graham says “the warning cannot be given too often – that the investor cannot hope for better than average results by buying new offerings (IPOs).”

Why is this the case? Because company managers want the absolute highest price they can get when they offer shares for sale. This means that you generally only see IPOs when everyone is excited about the stock market and share prices are in overvalued territory. When markets are in the doldrums, IPOs are as rare as a hen’s teeth.

Remember how long it took for Safaricom shares to rally above its IPO price? That’s partially because investors were “irrationally exuberant” at the time. Valuations were sky-high, and the issuers exploited it.

5) Don’t buy shares with money that doesn’t belong to you

While we’re on the topic of IPOs, let’s briefly touch on the subject of buying shares with borrowed money.

Graham strongly advised against investing on margin – money that a broker lends to its customers for the purpose of buying stock. To my knowledge, no African brokers are currently permitted to engage in this activity.

But when a big IPO appears on the horizon, African banks frequently offer their customers loans for the purpose of participating in the IPO. This often doesn’t work out very well for the investor. Why? Because, in order for the investor to make a profit, the new stock must not only increase in value, it must increase higher than the amount of interest that has accrued on the loan.

6) Buy shares of consistently profitable companies with low debt

Graham was a proponent of investing in high quality businesses, companies “with a long record of profitability and strong financial position.” In other words, companies that make money year after year and don’t depend on much borrowed money to do so. Such companies will be more resilient if the economic environment turns sour.

How can you identify such companies? Your broker should be able to help, but if you’d like to do the research yourself, the financial results library should help.

7) Diversify

Graham advocated for splitting your investment portfolio between stocks and bonds in order to reduce risk.

The exact allocation he proposed depended a bit on market conditions and an investors risk tolerance. Generally, however, young, risk-tolerant investors, in depressed markets can prudently allocate up to 75% of their investment portfolio to stocks, while their older, less risk tolerant counterparts would be better-served allocating a majority of their portfolio to bonds.

8) Entrust money to a proven manager

Graham recognized that many people don’t have the time, expertise, or inclination to manage their own investment portfolios.

In such circumstances, investors should consider entrusting their assets to a “well-established investment fund” with a proven long-term track record. Such funds charge a management fee on funds invested with them, but can be well-worth the price for the skill and diversification benefit they offer.

South Africa’s Coronation Fund Managers, Ghana’s Databank, Old Mutual Kenya, and numerous other asset managers across the continent fit the bill. And, of course, my colleagues and I at Africa Capital Group would be happy to help you, too.

9) Dollar-cost average

Another of Graham’s favorite strategies for reducing risk was “dollar-cost averaging.” It sounds fancy, but it’s simply the practice of investing a fixed amount of money at regular intervals.

For example, an investor could either invest 40,000 shillings in one lump sum, or divide it into four monthly installments of 10,000 shillings each. By investing in a lump sum, you are locking your risk into one purchase price – a price that may or may not be a fair one.

Investing in installments minimizes risk because the 10,000 shilling installment will buy fewer shares when the price is high and more shares if the price drops.

Safety First

So, there you have it. Nine ways to help ensure that investing in stocks doesn’t crack your nest egg.

Remember, if you invest in shares of stock for any length of time, you will inevitably make some bad calls along the way. That’s okay. The key is to have safeguards in place to limit your loss.

Your Turn

How do you make sure you’re investing and not speculating? Tell us your risk-reduction strategies in the comments!

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Africa’s 10 Most Transparent Countries (and Why Stock Investors Should Care)

Transparency International released its 2013 Corruption Perceptions Index last week. The index ranks 177 countries according to how corrupt their governments are perceived to be by investors, businesspeople, and international lenders.

Here are the ten African countries that ranked highest and why you as a stock investor should take note.

Transparency International released its 2013 Corruption Perceptions Index last week. The index ranks 177 countries according to how corrupt their governments are perceived to be by investors, businesspeople, and international lenders.

The report found Botswana to be Africa’s least corrupt nation for the 16th consecutive year, and Lesotho showed the most improved score – moving up in the global ranking from 64th to 55th place.

Unfortunately, the continent as a whole seems to have backslid a bit from last year, with many countries receiving poorer grades. Uganda, Nigeria, and Cote d’Ivoire all dropped a few notches.

But let’s focus on the positive. Here are the ten African countries with the cleanest governance.

Africa’s least corrupt countries

[table id=188 /]

You can see the full ranking of Sub-Saharan African countries here.

Why does corruption matter to stock investors?

So, you may be wondering what corruption has to do with investing in stocks.

After all, some of the least transparent countries also happen to be home to some of Africa’s best-performing stock markets this year.

This may be the case, but recent research shows that corruption behaves like sand in the wheels of an economy – not grease.

The diagram below illustrates why corruption should matter to you as a stock investor.

Corruption's vicious cycle

Corruption scares off investors

Fraud erodes trust in the integrity of capital markets, and, thus, deters potential investors.

Foreign investors are all too aware that they’ve got a disadvantage when investing in markets dominated by local institutional traders. That’s why they need as much assurance as possible that they will be playing on a level playing field.

They need to have confidence in the integrity of financial reports and be assured that they’ll be informed of developments that could positively or negatively affect their investment at the same time the rest of the market is. If they don’t trust that they’ll be treated fairly, they’ll simply keep their money at home.

Corruption reduces a stock market’s liquidity

Africa may be a large continent, but its stock markets are very small. Thus, foreign investors will be crucial to getting them up to scale.

Perhaps more importantly, however, foreign investors help provide liquidity to a stock exchange.

Liquidity is the relative ease with which a share can immediately be bought or sold at a sum close to its quoted price.

To illustrate, imagine a street vendor selling mangoes. Where would he have the best chance of making a sale? On a street corner where 20 people pass in an hour? Or on one passed by 200 people?

Photo: Leandro Neumann Ciuffo
Photo: Leandro Neumann Ciuffo

The busier street corner would likely be the more ideal location.

The same holds true for stock markets. Generally, the more investors that participate in a market, the more liquid that market will be.

Most investors avoid illiquid markets. Why? Because if they actually manage to purchase the shares that they want, it’s likely that they will have a difficult time finding a willing buyer when they eventually decide to sell their shares.

The Swaziland Stock Exchange is a prime example of an illiquid market. Over the past six months, not a single share has been traded on the entire market. The Kalahari Desert is more liquid!

Corruption increases the cost of growing a business

Corruption compounds the vicious cycle of reduced investor participation and illiquidity by raising the cost of capital.

When fraud is rampant, banks will be more suspicious of a borrower’s ability or intention to repay loans. So, they will charge higher interest rates to compensate for the possibility of default.

Moreover, raising expansion capital is substantially more expensive in illiquid markets because investment banks charge higher fees to seek out investors.

As a result, companies are less profitable and grow more slowly than they otherwise might. This reduces their attractiveness to potential investors, which leads to less investor participation, and the whole cycle repeats itself.

So, while corruption is far from the only factor to influence stock market performance, it’s worth keeping an eye on when deciding where to put your investment dollars to work.

Are things improving?

How pervasive is corruption in the country where you live, work, or invest? Are things getting better?

Let’s talk about it in the comments.

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