I ran 4 scenarios: Housing prices hold as they are, prices drop 10%, prices drop 20%, or prices rise by 10%. I calculate the gain or loss under each scenario and make the following reasonable assumptions about our hypothetical person:

* She owns a house worth $400,000 today, and has $100,000 equity with a $300,000 mortgage.
* She makes the decision to sell today, sells the house with a 3% commission, puts the money in the bank at 4%, and rents for one year at the same amount as the mortgage payment,
* After a year she buys another house at the new prices (0%, 10%, 20% or –10% lower). On the bottom line is what she gains or loses after each deal.

You could have easily predicted it. She makes money if prices go down and loses money if prices stay the same or go up. It costs her about $2500 per year extra to live and transaction costs are a big expense.

The surprising thing is the magnitude of the dollars involved. If housing prices drop by 10% then she makes over 25K, and hits the jackpot at over 65K if they drop by 20%. For some people 25K is more than their take-home pay for that year, which cannot be ignored.

Why are the dollars so big? Because the asset is large, almost too large to comprehend for those of us dealing with monthly expenses and paychecks. We have to remember is that the overall asset is at the centre, not the payment or the discount.

A $400,000 house is about a $1,600 per month mortgage payment and can be easily “owned” by a family making under $60,000 per year, or $5000 per month. A 10% slide in price has an immediate value of $40,000, not $160. The $40,000 is pure cash that could be sitting happily in your bank account, which is a lot better than the 10% off sign in mall shoe store. Worth a second look for sure, and I say that it is responsible and mature thing to look closely if you really think your house could lose 10% in value much less 50%.

So how do you profit?

#1: Decide what you know. Real estate markets follow similar patterns everywhere, just not at the same time. In Canadian Free by 55’s case, his province saw an oil boom just like neighbouring Alberta. The boom caused workers to swarm in like bees to the honey of oil jobs.

Prices shot up there because large numbers of houses take many months or years to build, just like in Alberta. Interest rates were low and optimism flooded everyone. Housing boom fever seized the speculators, who gathered up even more of the inventory and caused the shortage to be even more acute.

Since then, in Alberta, we’ve seen migration slow and the supply of houses catch up a lot, which has caused the market to crash by 20% or more in some places from the peak a year ago. There are thousands of units on the market and nothing sells with a bidding war on listing day anymore.

This scenario is standard and predictable. Booms always bust eventually, you just have to decide when. Why would one believe that Saskatchewan will not mimic the outcome of Alberta?

As an aside, to let you know that I practice what I preach, I escaped the Alberta oil boom market with a large profit, missed the Saskatchewan boom because I was already too invested, and got into the Newfoundland resource boom that is now proving to have been a very good move.

#2 Decide on what’s the worst that is likely to happen: The simplest form of risk management. If the worst result is still drinkable, or better yet, still tasty, then you can rest easy with your decision. If the worst is too bitter then you have tie up the analysis more. How can you wipe out the downside? How can you convince yourself that the worst is better than you think? Downside is mostly imagined and compounded by fear. See my post on beginner’s fear inoculation.

Trying to understand Saskatchewan’s housing market you can ask yourself a few things. Who bought the houses during the boom? Why did they buy the houses they did? Are they likely to want to keep their houses? Were there too few houses for the immigration? What kinds of houses were bought? Ask yourself all the same questions for the future and you will begin to form opinions as to whether housing will go up or down.

#3 Act: The old real-estate saying is that the profit is made when the deal is signed is totally true. Use your foresight to find an opportunity and then take it.

Before you say that you shouldn’t mess around with the family home you should remember that most young or middle-aged people don’t own anything larger than their houses. It’s the largest resource they have and can generate the largest transactions with the largest profit potential. Money is money, whether locked up in your home or in the bank. If you have access to a $400,000 asset and an opportunity to profit, why not take it?

I’ll put out a thought for you: Consumer Credit ought to be illegal!

There is simply no need for it, and no benefit either. Borrowing at very high rates to buy dinner, a stereo, a vacation, is uncalled for in society. The only benefit is that someone gets to immediately satisfy some desire they have without thinking or earning the money it costs. In their weakness they enslave themselves for some period in the future and increase the cost of whatever they are buying in a way that is inconspicuous. That stereo, which cost $500, might be paid for in $25 piece chunks as a little line on a bill over 3 years: costing $900!

Will anyone suffer from not getting the stereo? No! No harm will occur. None at all. If the purchaser wants the stereo he can always get it simply by earning and saving the money for it. The store doesn’t suffer because they’ll sell him the stereo next year or the year after when he has the money.

Who will suffer from buying the stereo? The purchaser, because of the enduring obligation he enters into and the increase in the cost of whatever he’s buying. And the one who gains from the purchaser’s suffering is the banker of course, who now has a slave producing a monthly income stream.

You can tell that the credit card companies really want you to run out and ruin your life. That would be ideal for them. They tempt you, like a drug dealer, with low rates, various cheap insurances, tiny 1% benefits (did you know they charge merchants more than 1% for processing a transaction?). Anything to get you to run up more than you can pay so they can get the shackles on.

That access to limitless spending power also has an effect on retailers. They’ve long known that they can generate desires to be satisfied on impulse, but now the objections of an empty wallet are gone. If the customer wants it, it can be had. So you go into stores and they just throw all kinds of garbage at you:

“Hey, this is half-off for today only; you better buy it!”
“Oh my gosh, there are only a couple of these left. Ya gots ta get one!”
“Here’s something you never knew you needed, but take it from me pal, you need it!”
“All your friends have one of these, you’re going to be a total loser if you don’t get one.”
“You need to make a statement by buying this colorful piece of garbage to decorate yourself or your phone or your car!”

Just cut that waste. My suggestion is that it should be legal to renege on credit card debt very easily thereby putting the onus on the lender to decide if it’s worth the risk.

Think of it this way: If a banks lends a person thousands of dollars for dinners and vacations, they should not be able to go after a person’s livelihood. After all, they provided only a night out on the town, which is disproportionate to the consequences of bankruptcy or access to credit related to something important like a mortgage or a business. Their recourse should simly be the removal of the right to use the credit card, plus they can take back whatever you bought with the card and try to hawk it.

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• My wife just quit her safe job to start a business, resulting in the loss of $40K of annual income and making me the only one with a job.
• The stock market is down and one of my accounts is down about $30K since March.
• I have loans totalling over $1 million, which need payments of about $5,000 per month.
• I’m thinking of retiring from my own job as soon as possible, which would of course result in the loss of all our job-based income.
• I have two young kids who will consume more and more money, not to mention my wife and myself, who would occasionally like a vacation or a nice night out.

Fear is something that seems to grow as age. Kids and teenagers will try anything for dubious payoffs. Leaping off the roof of a house into a kiddie swimming pool sounds like fun. Towing a bike behind the ol’ pickup over a home-made ramp is good entertainment! We’ve seen it on YouTube and it’s hilarious.

Old folks like us are more sensible. More responsible. Right? Wrong! We’ve become more cowardly. We’ve changed how we measure risks. We’ve changed how we imagine things will turn out.

Fear of Loss

Most normal people have a comfortable, if boring life. We grind out a job 10 hours including commute, cook dinner every night, maybe do a little recreation some evenings, have a BBQ on the weekend, spend the rest of our time cleaning or mowing the lawn. Everything we normally do is to add a little bit of comfort to this life. Buy a Wii, get a bigger TV, that kind of thing. Day-to-day, we don’t put anything on the line. There is no risk in our lives. We’re not used to it.

When a decision comes up that might include loss, for example deciding how to invest in your retirement, then the imagination starts working.

I don’t know much about investing. I’m bound to do something wrong and I could lose all my money. So much data; is any of it real? Can it save my portfolio? My friend knows someone who read an article about a dude who lost his home by daytrading. I think there was one guy in England who lost so much money THAT HE BUSTED THE BANK HE WORKED FOR!

Mr. Banker, you say you have a guaranteed return? How much? 4%. Can’t lose any money? It’s called a savings account? I’ll take it.

Are you one of those? I know a few. Practically impossible catastrophic events become well worth preparing for. Unlikely losses are bound to happen someday. Occasional hiccups become the rule of the day. They overweight the value and likelihood of loses to such a degree, and underweight success, that almost nothing is worth it. The only thing they go for is guaranteed returns, or at the very riskiest they throw money at a banker and let him take care of them while they ignore everything like an ostrich with a buried head.

They need an antidote!

Fear Inoculation

Fear inoculation is a term that I’ve come across and like.  It is about curing and preventing unhealthy fear that keeps you from success.  Below are some tips about how to inoculate yourself from financial fear.

Correctly Counting Losses: The losses most overly conservative investors forget to count are the opportunity costs. These are the fantastic gains that are missed by holding cash or bank accounts; the miraculous power of leverage that is left unexploited; the boundless riches of business and active investing.

Prove to yourself that the loss is greater. When you get your quarterly statement from the bank about how much interest you earned on your cash, do a quick check on what you could have earned. Be honest: You could have figured out how to invest in an index fund right?  Or if you already invest in funds then you could figure out how to upgrade to a margin account or buy some real estate. Take that difference and count it as a loss.

Internal Conservative Investor Dialog: Let’s have a look at my ING 4% Super Duper Savings Summary and find out that my $10,000 balance made me this quarter. $100! Wholly cow! I just made 5 hours worth of wages with all my investing strategies. Why am I so brilliant and unbelievably amazing? Did my parents teach me or have I just been gifted from God?

My Internal Dialog:  Jeez. $100 on $10,000. Stock market went up 3% so I could have made $300 in an index. If I had borrowed to invest I could have easily made $600 in the market. In reality my failure to use other easy options cost me at least $200 to $500 or 200-500%!

School Yourself: Some people are deathly afraid of getting AIDS. They might get it from looking at an infected person. Those in the know are not afraid unless they’re thinking of exchanging body fluids. Some tribes are said to be afraid of cameras because they capture the soul. Those in the know are not afraid because they know that a camera captures reflected light.

The more you know the better you are able to judge the outcomes and the less fatal they become.  Personal finance information is so abundant that you really have to dodge well to not get some of it on your jacket when you go out.  You could start with some of the entries on my blogroll, they’re decent.  Or pick up one of the classics from the library:  The Richest Man in Babylon or The Wealthy Barber or one of the continuous stream from Suze Orman, Dave Ramsey or David Bach.

Just DO IT Before You Imagine It: The imagination is a great thing. It is so powerful that athletes use imagination, or visualisation, as a substitute for practice. In their minds they can hit the perfect baseball or play the perfect tennis match, with results nearly as good as real practice. The imagined becomes the actual.

What do you think happens when you imagine bad things? You are making them more real too! The fear is certainly real. When athletes imagine, they are simulating something as realistically as possible for their own benefit. When some others imagine things they’ve never tried, they make up terrible outcomes that do not benefit them.

So stop it! Try substituting actually reality for your imagined reality. You’ll immediately see that you both win and lose, and loss is not as catastrophic as in your dreams. The real world will be more pleasant, and you also have the opportunity to improve. Then, based on your experiences, you can daydream about success and riches instead of devastation.

Familiarity is THE BEST way to get rid of fear.  You’re not afraid of the stairs in your house are you?  That’s because you know how to walk and climb them; but at one time you didn’t.  When you were a baby you fell down nearly every time you tried to stand.  Right now you would never try to climb those stairs if you were afraid of tumbling down.  But you do because you know exactly how to climb them and it’s just so easy.  Most everything is like that.  The first time is scary, but then you know how it works.

What’s the Worst That Could Happen?: Imagine very specifically some of the most devastating things that could happen with whatever financial decision you make.  Usually there is one:  A big loss of investment.  You put in $1,000 in a mutual fund and it goes to zero.  Can you handle losing the $1,000 on the slim chance that it disappears?  If so, then you have the ability to try.

By the way, total loss is usually impossible.  For a run-of-the-mill mutual fund to go to zero it literally has to have all the companies it holds go bankrupt, which would basically mean that a whole economy, or a whole sector, went bankrupt.  Not possible.  So imagine a loss of say 50% as being the absolute worst for an investment like that.  Make it real, don’t just pretend “If I invest $1,000 then a plague might be unleashed upon my heirs.”  If you really don’t know then figure it out!

Wrap-Up

There is so much more to say about developing positive drive, mental toughness, and optimism but that’s enough for now.  The basic message is to understand that your fears are mostly imagined, and mostly over-stated.  Get back to reality and use imagination to your benefit.

Back to the fears I started with. They sometimes feel like huge weights, and they’re not even imagined. They’re real! Financial gurus talk about latte factors and saving $2/day when I just lost 15,000 times that much in the stock market! I must be drowning!

Not at all. Those losses are staggering, but I counter them by tallying my real and imagined successes.

• My wife’s job was not helping her be happy, and life is more about happiness than grind.  We’ve analysed her business idea and believe that even within the first year she will be able to generate as much take-home money with less and more rewarding work.  It will still be a job of sorts, but she hopes it will be a happier one.
• That $30K stock loss was $30K higher just 6 months ago, and I believe the choice of investments is good.  The account has tripled the growth rate of the index for the past 3 years and even with the loss, it is still at the level that I ended last year at.  I could be doing a lot worse.  I rejoiced in the boom quarters so I have to take my lumps bravely.
• The $1M in loans are invested and generate $7,500 in revenue each month on average.  Therefore I gain $2,500 per month.  I just have to believe that the strategy is good.
• Quitting my job might be a boon.  This year, for the first time ever I hope to make more money from my side investments than from my job, and I only spend about 5% or 10% of my time on those.  If I spent more time that could easily mean better returns.
• We have the same number of mouths to feed as most families and we’re probably doing better so if they can have a great time doing it, so can I.  It’s a pleasure

I want to explore the minds of each type of person. These categories describe what people do with money, not how they make their money.
Part 1: Spenders

Spending is the same as consuming. Everyone spends, but a spender is someone who does nothing with their money but spend.

We all start off as spenders. Little kids, allowances in hand, shaking with excitement at the prospect of the candy we can buy. Children seem so angelic in their innocence about the costs of things or the efforts to get them. Price tags are arbitrary numbers. My kid asks me in the morning if we’ll buy him a toy stegosaurus and in the afternoon, with the same sincerity, if we can get a new car.

As we grow out of this kids stage most of us change:

• We are aware that we may still be alive tomorrow.
• We feel the efforts behind consumption, behind earning the money.
• We feel the fear of keeping no reserve and exposing ourselves to the most minor of calamities.
• We understand that spending our entire paycheque keeps us small. By accumulating we can do larger things.

Soon most people automatically lose the desire to spend every dime. For those that don’t I believe that there are three reasons for it, or three pofiles:

1. The Poor Spender: They simply can’t afford it. Although most of us can easily shrink our lifestyles to fit within our incomes, there are some for whom this is truly impossible. It is hard to think that there are many undeniable cases like this given the plentiful stories of immigrants unable to speak the language with $5 in hand wrestling a prosperous life out of society. For those reading this blog, I doubt that’s a problem.  Most people who think they fall in this category should compare themselves to the really poor people.  When I compare myself to my investment banker friend who makes 300K+ per year, I look plenty poor, but I know I’m plenty rich enough to have some money left over.
2. The Religious Spender. Spending everything you earn has a certain seductive philosophy to it. Spenders live in the moment, and they therefore really live. They work only to earn what they need now. I know many people like this, mostly young people. The ski bums who hitch a ride to the mountain to ski and party, paid for by giving lessons or working in bars. The travellers who take a flight to anywhere, find a little job, play for a few weeks or months, then take another flight to somewhere else.This class of spender is one who owns little. They find their delights from experiences, not things.I personally have not done this but I can imagine myself doing it, or more correctly I wish I would do it. How free I could be. Free of large possessions, free of obligation or service to bosses and lenders. It could be a good life!
3. The Feeble Spender: Many people I know are totally controlled, consumed from the inside by their desires. If they see something they like then they buy it. Willpower doesn’t exist for them. Waiting doesn’t exist.I knew a guy in his 40s, who worked with me at McDonald’s when I was in high school. He bought a new VCR or TV maybe 4 or 5 times per year! There was always something new coming out. 4 heads, auto-tracking, better sound, whatever. This guy was poor, making McDonald’s wages and renting a tiny apartment. I was completely shocked, even at that time, by this person’s helplessness to decide that he had enough VCRs and that he should use the $300 or so dollars for something else. He bought the next one before he finished paying off the previous!We can hope that they are happy in the moment because of the enjoyment brought by consumption. The spender lives a life that’s more fun, eats better, takes better vacations, is better dressed, parties more — for a while.

 The spender profiles have certain problems:

1. Spenders never grow: Since spenders blow cash out the door as fast as it comes in, they can never undertake a project larger than the quantum bundles of money they earn. The Religious Spender doesn’t really care about this, but the others probably do. That guy with the VCRs and TVs, he’s probably still buying TVs because that’s what he can afford.
2. Spenders take huge risks: Since spenders leave nothing in reserve and their outflow equals their inflow, any hiccup in the income is felt immediately by their lifestyle. A job loss means that they need to get a new job before the food in their fridge is gone.  A robbery, and accident, health problems; these are all devastating to someone who has no buffers.
3. Spenders in North America can Sell Their Futures: Anyone can get credit, which gives spenders a way to get in on some of the bigger fun. They can borrow to buy cars, furniture, vacations, anything. This enslaves The Feeble Spender because it gets right at their Achilles’ Heal, their inability to walk away from shiny things.  Unfortunately this makes their already risky situation even worse because now not only do they have no reserves, but more of their income is spoken for before it’s even earned!

In the end we are all spenders to some degree, but the pure spender has few redeeming qualities. Spenders, however, are necessary. Consumption is what drives the economy, and what makes the other “more sophisticated” money profiles possible. Every other use of money, excepting perhaps the government, eventually makes its way back into a consumer product or service; something shiny or tasty or fun that a spender will buy. For those who aren’t spenders, that means opportunity to transfer wealth from the spender.

Stay tuned for a survey of the other three profiles.

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I am 33 at the time of this writing and I can run 26 miles in 3 ½ hours: A marathon. I can run 13 miles on a whim without even bringing a drink while pushing my kids in a stroller. When I run I can sometimes catch people on roller blades or even bikes. I never get tired doing any of my ordinary activities like my martial arts class, my weekly aerobics courses, bike riding, swimming, or playing with my kids.

This accomplishment is mind-expanding for two reasons: First because I thought it was impossible and second because it was EASY! My intuition at the time was that marathon runners were genetically different from normal people. I couldn’t imagine my body being able to survive running that distance, which is annoyingly long even in a car. What pain would result from running those six miles I could barely do, then running twenty more afterwards?

One winter day four years ago a work friend made me an offer I couldn’t refuse: “Let’s train to run a marathon together in four months.” It sounded like torture, but I agree to his suggestion. The reason? He was a 50-something with a substantial pot belly who didn’t look like an athlete. I was a 29 year old who played outside a lot. Besides, I don’t back down from a challenge. Now how? Run more than six times the distance that I could currently barely run.

Here is how I accomplished the impossible.

1. Sweet-talked myself. If I could convince myself of any scenario that ended up with a victory then the task would at least become possible, which is a lot better. I figured that, worst case, I can walk about 3 miles per hour. So if I didn’t improve at all then I could run for 6 miles in one hour and walk the remaining 20 in seven hours. It would be long and boring and probably hellish but I could definitely do that. I could do it now!
2. Took all my friend’s advice, and all the training programs on the Internet , and distilled them into a simple rule of thumb: Run one long-distance run per week and increase the distance of this run by 10% per week.

So the weeks started. I ran my 6 miles first, but a little slower than I had been running it. It was still tough but running slower let me survive. I started to run at lunch a couple of times a week for ½ hour with a running crowd that went out nearly every day; I could not hope to stay with the good runners, but there were all levels so I found some who just jogged and chatted. I could keep up with them.

The next week I ran my six miles plus a little loop to add more distance. It was about as difficult as the 6 miles were the previous week. I continued running sporadically at lunch and increasing the distance on the weekend. After about a month or so of this I took notice of transformation in my body. I was up to about 9 miles, or 50% more distance than when I started, and I hadn’t really noticed it! My lunchtime runs became easier and I moved up to the next level of lunchtime runners.

It was about this time that I decided I could jump more than 10%. I decided, on my long run, to try adding 5 miles in one week. Amazingly enough, after about 9 miles a dark shadow descended upon me, making me very sad, and teaching me why I should not have added that much distance. By the end of it my legs were destroyed and they immediately seized upon getting home. I hobbled around like a cripple the rest of the day and was sore for a few afterwards as well.

I tried one more time to make a big jump from about 15 miles to 19, with exactly the same result. As I approached my previous limit the running became very tough very fast and I was shattered. I didn’t do it again, simply using the 10% rule until I was over 26 miles.

Then I ran my marathon, harder than my training runs since it was a race after all, and finished in 3:31. I got a shirt and a medal to prove that I’d done it, but I got a lot more from the experience.

The most important insight is that I don’t have a clue about what is possible or not, nor even about what is easy. Running 6 miles was very hard for me before, now it is trivial. Transferring a fork of food from the plate to the mouth is beyond imagination for my 2 year old, but I know this will be easy soon.

Nurturing an idyllic family life, becoming rich, escaping the grind, achieving bliss every day, simply surviving until tomorrow; these may all seem more-or-less impossible to some depending from where they look to these goals. Nowadays I don’t resign myself to categorizing anything as impossible. My rule is that if someone, anyone, has accomplished something then it’s been proven possible and the option is open for me to accomplish it too. In fact, it’s easier for me to accomplish it than those who came before me because they’ve already figured out how to do it.

The next most important insight is that people adapt naturally and easily. Small changes are absorbed transparently and humans don’t need to protect themselves or be afraid. Break down a huge transformation into a sequence of successive steps and the transformation can be accomplished with you barely noticing.

If you live completely on your own in the forest like an animal, or the first humans, then we can probably all agree that this is poverty.  You have nothing.  Any shelter was built by your own hands with tools you also built from nothing.  Any food was caught or harvested by you.  I consider this the base amount of wealth that an individual has.  Really no matter how smart anyone is, they’re going to have at maximum some variation of a hut, a fire, and some skins for clothes.  Nobody is going to have a Ferrari and a townhouse.

There are at least two ways to create wealth.  Both of these ways create wealth out of “nothing”.  Nobody has to lose wealth for these to work.

Very obviously, one way in which individuals are going to make their own lives easier is through ingenuity.  The person who invents a rabbit snare will probably spend less time catching rabbits than the person who merely chases them down.  Ingenuity is one of the big engines of the economy and it’s plain to see that our lives are much easier because of the invented machines doing the work we would normally do.

The other big opportunity to create wealth from nothing is cooperation.  Two examples of cooperation building wealth:

• Share duties so that in the end all of the people either save time or get more resources.  For example, it takes practically the same time to cook dinner for four people as for one.  It saves time to give that job to a single person rather than repeat it four times.
• People together can do more than alone.  For example suppose you want to move logs for a dwelling.  One person may not ever be able to move a heavy log, but five people together can move the log.  Therefore the only way you’re going to build log cabins for five individuals is to team up and move those logs together.

The key point to notice is that the individuals got wealthier by helping the group, not by taking from the group.  In your family you are better off by making dinner for your family than by making dinner only for yourself.

Combine many people with ingenuity now.  Pretend you are the only one in a village of 20 who knows how to make a rabbit snare.  Clearly you are going to be the rabbit hunter because you can catch enough rabbits in a couple of hours to make all the rabbit stew for the village.  Someone else is the cook, someone else fixes the houses, someone else takes care of the kids, etc.  Now we have a situation where everyone only works a few hours per day to have comfortable lives instead of working all day as individuals for minimalist lives.

You, the rabbit hunter, could not have achieved such a level of wealth without the rest of the group even though you would have still had the same skills.  You can catch rabbits enough for 10 or 20 people, but an individual can only eat enough for 1.

I call it cooperation while economists call it trade.  For me trade doesn’t carry the same benevolence.

This, by the way, is where most of the gurus gets it right.  To transcend the standard advice we need to know why.  Is this an edict from God?  Is it building good karma?  No, it is the very source of all wealth.  You become wealthy by making other people wealthy.  That this isn’t just a feel-good statement, it is critical.  It is the way things work.

Lots of the business advice is focused around capturing value for yourself.  Negotiating.  Advertising.  Locking customers into your products.  Protecting intellectual property.  Loss control.  Accounting.  Price optimization.  All of these topics are absolutely secondary to being able to make a better world for someone.

You will fail to be happy and you will likely fail to be rich if you spend your time thinking about how to get money.  Every day will be a grumble-fest about how under-appreciated you are or how you make slightly too little money.  Or maybe you’ll be a parasite, one of the few successful rich who swindle and extort from the rest.

It is far better to change your thinking to figuring out ways to make as many people better off in as dramatic a way as possible.  Strangers are not to be guarded against; they are to be partnered with; they are to be enticed into causes; their lives are to be improved.