Last week’s Carnivals

Carnival of Personal Finance #103 at Clever Dude

77th Festival of Frugality at My Two Dollars.

Carnival of Credit Card #15 at Credit Card Lowdown

Must Read Posts

David Bach’s Misleading Math on Real Estate Leverage by Money, Matters and Musings is a great piece by Golbguru. Finally, someone actually sits down and does the math on these ‘learn how to be rich books’. I never had great respect for David Bach after I attended a seminar by him which features pitch fest by salespeople selling their stock trading system, cookie cutter trust documents! $4000 courses on investing in real estate liens from information you can get free on the internet! To me, the book was just a means to get rich teaching people how to get rich in seminars! Well done Golbguru.

Massive Personal Finance Resource List by the Frugal Law Student is a very long list of resources that everyone will find helpful. The only quibble I have is that my blog is not included in the personal finance blog section!

Queercents had a very eye catching post on Miscellaneous Expenses – Where Did My Money Go?, which really resonated with me. The conveniece of putting everything that you cannot categorize into the miscellaneous section may not be such a good thing.

Pirates of the Credit Sea – Part 5 by The Investor Blog is summary of his continued with Citibank on his credit card. I won’t divulge all the details, but I must say this is one of the best post and saga I’ve read. Be sure to read this one. You’ll learn a lot from it.

Growing up, I always wanted Birthday parties. Somehow, it made me feel so special. So, when my kids wanted them, I can’t help but would do it because it made me feel like a kid again. However, my kids’ birthdays are all around the same time and it really puts a toll on me physically and financially. I am pleased to share my tips on how to organise a frugal yet fun birthday party for your kids.

1. Party Planner & entertainer : Mom & Dad – Free

There are tons of websites offering party themes and game ideas for birthday parties of all ages. Organizing a theme and all the games may seem stressful the first time. But after organizing a couple of parties, it becomes much easier and almost second nature. In my opinion, there is really no need to hire entertainers, clowns, face painters etc (you can be the face painter!). For example, a group of three face painters will cost one hundred dollars an hour. Renting a moon bounce will set you back $290.

2. Venue : Home – free

Having a party at home may be a clean up hassle, but it is free. We once rented a party room at a toy store and it cost $180. We have been to parties in a go carting track, children’s petting zoo, bowling alley, MacDonald’s, Chuckee Cheese. They were all fun, but it can be just as fun at home. It all depends on the games you organize.

3. Invitation Cards

Mr Credit Card makes the invitation cards. He will copy pictures of the theme that our kids would like to have to their parties and paste them into Microsoft Word. We are able to customize our invitations this way. After a couple of attempts, it only takes about ten minutes.

4. Food

There are a couple of rules with regards to food. Firstly, it obviously has to be kid friendly. It has to be easy to prepare and not messy to eat. Below are some examples of the type of foods I get.

Hot dogs – (Buy 1 get 2 free Ball Park Beef Franks) and Genuard’s hot buns – pack of 8 for $0.99, Lay’s chips – 1 get 1 free, Capri Sun drinks – 5 for $8 , Domino’s pizza 555 deal. Fast fixing dinosaur chicken nuggets are a big hit too and costs only $4.99 a pack when it is on sale.

5. Party bags

Below is where I typically shop for party bags :

Dollar Store gift bags, $1 for 25 pieces. Dollar Store or 5 & Below Stores for toys & candies givewaways. Oriental Trading for bulk purchases – usually free or discounted shipping for purchases above $60.

6. Party Supplies

I normally get all my party supplies from Partyland. You can save up to 20% on all purchases with coupons. Finally, blow your own balloons! They last longer, cost nothing (though they do not float in the air).

Thank You Cards

Instead of a traditional thank you card, we take a group picture and make postcard size copies with a heading “Thank you for coming !” & send them to all who attended. Many parents feedback that they like the idea and their kids love the picture. If you have a polaroid camera, take pictures of your birthday kid with the present together with the friend who gave the gift.

I am going to reveal our top five frivolous expenses that both Mrs Credit Card and myself had (as far as we could recall).

1. Shoes

Who needs more shoes. I guess for me, one or two working shoes, a pair of sneakers, a pair of flip flops and a pair of casual shoes, would be really all I need. However, there are about four pairs of dress shoes, three sneakers (which I hardly use these days), three pairs of flip flops and even a timberland boots in my shoe closet. Mrs Credit Card is a Carrie Bradshaw wannabe. What saved us was her tiny feet (youth size 2), which thankfully prevents her from ing Jimmy Choos and Manolo Blaniks. Nevertheless, there are more ferragamos and guccis in the shoe closet collecting dust at the moment.

2. Cell Phones

How often do you change your cellphones? Every time a new model comes out? No, both of us do not a new cell phone every time a new model comes out. But I tend to lose my cell phone every few months and I hardly even use my cell phone. All I need is a really basic simple phone. Yet, when I lose my cellphone, I end up ing the latest model (which is massivley under-utilized). Mrs Credit Card has threatened to unsubsribe my verizon service because I always forget to charge and carry my cellphone with me!

3. Unhealthy Snacks

We should all be eating healthy food. However, given the the types of food available in the supermarkets, it would not be unthinkable to find many of us thinking that regular snacks are ‘normal’ and ‘healthy food’! Even though Mrs Credit Card uses coupons, we find ourselves loading up on Ben and Jerry’s ice cream, and other snacks like mega size chips etc. Mrs Credit Card uses coupons to get free chocolates. So while we may think we are saving money, in reality, we should not have been spending that money at all! We should be instead ing more fruits.

4. Lipsticks

While Mrs Credit Card does not go crazy over cosmetics, she simply cannot resist ing lots of lipsticks. Lip gloss, lip shine, matt lipstick, long lasting lip stick, tinted lip balm with SPF – you name it, she has it. Light pink, shocking pink, fiery red, coral, neutral, plum,vampish & etc etc – one can never have enough.

5. Kitchen Equipment and Utensils

I am sure we all have a coffee maker and a blender. Really basic. However, life is so much more interesting with Cuisinart mixer (which does everything), crock pot, tabletop electric grill, juicer, rice cooker & all other kinds of fancy “I need that” gadgets. Bed bath & beyond is a very dangerous place to go. On top of all these gadgets, we always need differerent size pots & pans, glass vision pots, corning wares, pyrex dishes, serving dishes of all size and bakeware of all sorts. We probably use these “special gadget” 2 ot 3 times a year. Or like our pasta machine, once in 2 years !

Well, I could probably go one and make a top ten list. But I’ll stop here. I would like to hear about YOUR top five frivolous things you spend your hard earned money on?

Are you better off getting an independent financial advisor rather than someone working for a major “wireline house”? There’s been a lot of legal wranglings going on between the indepent financial advisors and so called “financial advisors” from broker-dealers.

Traditionally, independent financial advisors provided a financial plans on a fee basis. Execution of putting together a portfolio is left to another broker dealer. In this instance, the independent financial advisor is a registered investment representative and has fiduciary responsibility for his or her clients. A registered investment representative can also be a registered broker dealer meaning that he can execute trades (eg a portfolio of mutual funds) for his or clients as well.

Independent financial advisors who charge a fee for financial plan and call themselves “fee only” advisors claim their way of conducting business is the best because they have no conflict of interest because they do not represent any brokerage houses and any inhouse products. Independent financial advisors also claim that being registered investment representatives, they are held to a standard of a fiduciary. Brokers Dealers (ie traditional stock brokers) are not held to a fiduciary standard. But instead, when you deal with a broker dealer, you understand that he or she may recommend products because it may benefit them in terms of commissions.

However, nowadays, the lines are very blurred. Insurance agents now also provide financial plans and call themselves financial planners. All major brokerages hire financial advisors and also provide financial plans to clients as well. The independent financial advisors are not happy about this because ‘financial planners’ from insurance companies or brokerages are not held to a fiduciary standard. But once again, the lines are not that clear cut. Brokerages have different ‘platforms’ for their clients and some of these platforms are advisory in nature. That means that when a financial advisor from a major wire house puts a client into an advisory platform, they are essentially assuming the role of an investment advisor. Independent financial advisors claim that advisors from wirehouses cannot be objective because they would push their own ‘in-house’ products. However, that argument is becoming irrelevant as well as while many wirehouses have their own products from their own asset management division, they have offer tons of other funds and products from every many investment firms.

But does the argument that independent financial advisors offer better and more objecgtive advice hold true? Well, recently, I decided to interview a few financial advisors. The first was someone from Ameriprise (formerly American Express). They are supposed to have the largest network of financial advisors in the country. They charge a fee for a financial plan. The second advisor I interviewed was from Morgan Stanley. I then interviewed by CPA! and lastly Salomon Smith Barney. This was how it went.

Ameriprise : Fee was the big issue for me here. I actually had to put up an upfront fee. Actually, this was the second person from Ameriprise I spoke to. The first wanted to charge me $1,500 for a financial plan. I felt this was an outrageous fee. I called his bluff and said no way. I met another advisor from Ameriprise who was willing to charge me $250. We went through the usual interview where he digged into my financials, asked me about my retirement goals, filled in a questionaire. After about two weeks, we met again for a presentation. We went through a summary of networth, how much I had to save to hit my retirement goals. We also went through my insurance converage and it turns out that I was adequately covered. Finally, it got down to what I should do with my portfolio. I was recommended a growth portfolio. He recommended me a portfolio of index mutual funds from Vanguard only. He claimed that because most mutual funds do not beat the market index, indexing was the best way to go.

Morgan Stanley Dean Witter : My meeting with this person was a little strange. We did not do any proper financial plan. In fact, he did not bother about my assets in my retirement account or my 529 account. Instead, all he was concerned about was the performance in my non-retirement or taxable account. In our second meeting, he had a five page proposal on what funds he will put me into. This person’s pitch was more of performance. He showed me the history of the funds he was recommending (which looked impressive). Having said all that, I was not too impressed.

My CPA : Yes, the third person I interviewed was my CPA, who was also a CFA. He was very thorough and did a proper financial plan. We went through my networth, how much I needed to save, how much I need to save for my kid’s 529 plan, and also proposed an asset allocation for me. He recommended allocating to large cap and small cap stocks and bonds. He also gave me two alternative investment vehicles. Firstly, he showed me a portfolio of mutual funds A share class. For almost all of these A shares, I had to pay an upfront fee of anywhere from 3% to 5.25%. He explained to me that a having A shares was better than class C shares, which though has no upfront fee, but a higher annual fee (including higher 12b-1 fees). He mentioned that if I held A shares long enough, it would be cheaper than C shares in the long run. He also offered me a choice of a managed account. A managed account differs from mutual funds in that the stocks and bonds that the individual managers are actually owned by you and you see them in your statements. The individual managers in various asset classes are chosen by a team of ‘overlay managers’. By the way, I was charged $500 for this plan.

Salomon Smith Barney : My last interview was with a financial advisor from Salomon Smith Barney. We did a financial plan. At the second meeting, we went through the findings of the plan. He told me how much I needed to save for retirement, how much I needed to save for my kids education. He also told me analyzed my insurance needs (same findings as Ameriprise – I’m am adequately insured). But this person also talked about estate plannning and unified credit provisions (hmm – I was impressed). Then, it came to my investment proposals. After going through my objectives and risk tolerance levels, he also recommended a growth portfolio (about 65% equities and 35% fixed income). Before he went to the actual investments, he explained how he was going to allocated my portfolio. He said there will be international equities and REITs in the equity portion. In the equity portion, there will be large cap growth and value, mid and small cap growth and value. He also explained how the bond portfolio will be diversified across maturities and the different types of bonds (like government bonds, agencies, mortgages, corporate bonds, international bonds etc).

Like my CPA, he tabled two proposals – mutual funds and seperately managed accounts. He strongly recommended the seperately managed account because it gives you some leeway to harvest tax losses. He also said the money managers in a seperate managed accounts are institutional money managers who manage money for larger institutions (not your morning star funds). Both the mutual fund portfolio and the seperately managed accounts will be in a wrap account where I would pay roughly about 1.25% fees based on assets. For the mutual fund portfolio, I still had to pay the fees for the mutual funds. Hence, the seperately managed account was more cost effective. Furthermore, both platforms had automatic rebalancing and he explained why rebalancing reduces portfolio risk and volatility.

Who was I impressed with? – Well, let’s go through each financial advisors one by one. The Ameriprise guy was OK (at least i felt that way) at first. But after I had met with these four people, he seemed the least knowledeable. All he could recommend was the index mutual funds. The person from Morgan Stanley appeared only to be after my money to manage. My CPA was actually good. But at the end, I was most impressed by the guy at Salomon Smith Barney. He was professional and knew his stuff. He explained to why my portfolio was constructed the way it was and I felt at ease with him. He also talked to me a lot about estate planning and I think that made him stand out among the crowd.

Bear in mind that you can consider the person from Ameriprise as an independent fee only financial advisor. They only charge on the plans and because the person that I spoke to only did plans, I felt his knowledge of actual asset allocation and how to build a portfolio to be weak compared to the others. My CPA was also a fee based advisor and he was quite good. But, like I just mentioned, I liked the person from Salomon best.

So when it comes down to it, I think it is the individual person and financial advisor, rather than whether they are independent or not, fee only not. As the Ameriprise person demonstated, fee only does not equate to being a good advisor.

I think I will go with the guy from Salomon.

Everyday, I get (and so do all of you) tons of mails with discount coupons on all sorts of products. In fact, we get the sunday papers solely for the supermarket coupons. While collecting and using coupons wisely does help you save money, I wonder how many times have we bought something that was on a “sale” or “discount” simply because there was an offer, or because the discount was only “valid for the next few days”. As I reflect on this, I think there is an art and science to using coupons and discounts to be frugal, and there is a fine line when you are being sold to something you do not really need. This is how Mrs Credit Card and myself compartmentalize this issue :

Regular Coupon Use : The True Money Savers

Mrs Credit Card cuts out the coupon from the Sunday papers everyday. Her supermarket and grocery shopping is very strategic. She only s stuff which she can use the coupons. She is patient if there is no coupon for a particular item. She simply waits until a coupon appears. In fact, she has done this for such a long time that she knows the coupon cycle!

I’m glad she cuts these coupons because they are real money savers.

Opportunitic Use of Discounts and Sale

At the back of our minds, there is always something that we need, but have put off ing it because we either want to wait and get a better deal or simply do not want to spend that kind of money.

However, once in a while, lady luck smiles on you and you get an offer in the mail, a discount coupon or and store closing sale annoucnement. Very often, Mrs Credit Card is on top of these situations and we do end up taking opportunities of these occasions to something that we have always needed, but put off.

Impulse or luxury purchases because of sale

But once in a while, we all fall for the sale, discount coupons when we stuff either on impulse or stuff that we do not really need. We fall into this trap often when we are on a vacation and walking into shops with ‘sale’ signs outside.

So while we actually save on “full retail price” on these items, the fact is that we would have saved simply by not ing them. I have found that we tend to fall for these impulse purchases when we go through an extreme period of being very frugal. I think one way we get around this is by not being fanatically frugal and giving ourselves little luxuries once in a while. For example, I would not recommend depriving yourself on Starbucks simply because you have heard Suze Orman talking about how much you would have saved in 20 years if you stopped drinking Starbucks everyday. This is just like dieting. Once a week, you need to have a mini pigout session. Otherwise, there’ll come a time when you snap.

But this same phenomenon also happens when Mrs Credit Card uses her coupons for the grocery shopping. I sometimes think we are ing too much stuff simply because we have coupons for them. I get the feeling that sometimes we food not because we particularly want to eat them, but simply because they were on sale. And though we may be ‘saving’ because we use our coupons, we may have saved even more if we did not use all our coupons.

We haven’t really looked into this in detail yet, but I think the solution to this is to really write down what you really have to , or want. Then take advantage of it when there is a coupon or sale. If there is a sale on something that you do not want, then just ignore it. Easier said that done!

Once in a while, when my friends and myself hang out for a drink, we inevitably talk about business, work and how much will we be happy to live comfortably and even feel rich? I have given this topic a lot of talk and rather than having a firm number in my head, I have actually thought of several levels of networth and how they will affect my “standard of living”.

$1,000,000 in investible assets – Is this enough?

Studies have shown that if you want to ensure you have sufficient funds in your retirement, it is better to withdraw 3% to 4% annually. Withdrawing 5% annually increases the likelyhood of a shortfall. However, these studies assume that all you have is a million dollars. Think about this for a second, a million dollars only gets you $40,000 annually before tax!. That works out to slightly over $3,000 a month. Assuming your house is paid and you have no debt, $3,000 a month will probably cover basic expenses like food, health insurance and long term care. There is probably no room for luxury.

When you have only one million dollars to retire on, you have to essentially manage it to make sure you do not run out of money (that is assuming you are retiring at 65). When you are in your mid 30’s, 40’s or 50’s, you are in great shape if you have a million dollars because it will grow. But you still need your “job” or to “be in business”! I would only feel rich if I knew that I could not only live off the income that my investments generate but also not dip into the principal.

So What is Enough?

Before we get into how much is enough for me to fee rich, the first step I did was to look at my expenditure. Firstly, I assume I have paid down my house. I will then breakdown my expenses into three categories : essential expense, quality of life expense, anything you want expense.

Essential Expenses – Essential expenses include food, house maintenance, bills (utilities, cable, internet connection etc), insurance payments (home and auto), health insurance payments, long term care insurance. I think this amount will work out to about $2000 to $3000 a month for me.

Quality of Life Expenses, – This is a subjective area because we all have different meaning of quality of life. For some, it is a golf membership, for others it means having money to go on vacations with their grand kids.

For me personally, it means being able to subscribe to tons of magazines, not feeling guilty of getting a Starbucks Venti everyday, being able to eat out often, paying for gym memberships and perhaps even a golf membership. Plus four vacations a year. I think I will need an additional $3000 to $4000 a year.

Buy Anything You Want Expenses – That to me means being able to take a monthly 3-4 day vacation, fly first class, stay at a suite in a 5 star hotel. I guess for Mrs Credit Card, it means being able to any handbag or shoes that you want without feeling any guilt. It also means being able to donate to charity, do charity work and still really enjoy life. I do not live such a lifestyle and I’d guess an extra $15,000 a month would be great!

So where does that leave us?

In my opinion, to be able to walk away from your work and retire (chill out) straight away, I would need two million to feel rich and comfortable. Why? Well, with two million, I would invest my money in a balanced (growth and income) portfolio whereby 50% will be in bonds (tax free municipals) and the other 50% in equities. The one million in equities will give me about $36,000 in tax free income, which should just about cover essential expenses. But the other one million will be invested in equities for growth and to outpace inflation. Hence even if I’m 30 or 40 or 50 years old, I would be comfortable walking away from the rat race with two million dollars.

If I want to live really comfortably and walk away from it all, I would feel rich with about four million dollars. Once again, my logic is to invest two million dollars in tax free municipal bonds which will give us an income of about $70,000. The other two million will be invested in a diversified equity portfolio.

For me to live the extravagant life, I think I would need about fourteen million dollars. The way I arrive at this is by assuming I would need $25,000 in monthly income or $300,000 in annual income. To generate $300,000 in tax free income, I would need about seven million in municipals bonds. But to keep up with inflation and increase wealth, I would like to have another seven million to be invested in equities.

So Where Would I settle?

Well, I would feel rich if I have five million dollars. Though I will not be able to live my “dream” lifestyle, I would have enough to live comfortably and do the things that are important to me. With this level of wealth, I could also grow my wealth without having to dip into principal.

Do you agree with my analysis? Share your thoughts below.

Most of us have heard about the virtues of portfolio diversification. What does it mean? The truth is that it means many things and most retail investors portfolio’s are not diversified even if they think it is. Below are common diversification mistakes made by typical DIY investors.

Not diversifying your portfolio into value and growth components – The most sophisticated endowment funds, foundations and defined benefit plan all split up their equity investments according to market capitalization and styles (growth and value and core). Why? Simply studies have found that growth and value both have their days of glory. In some years, growth outperforms and in others value outperforms. The key is to split your equity portfolio equally among value, growth and core components and rebalance them.

Not Diversifying by Market Capitalization – The second error we make is not diversifying by market capitalization. But this is simply because most people do not even know the composition of the stock market and the definition of large, mid and small cap. Broadly speaking, if we do by the Russell Index, the Russell 1000 index which is the large cap component in the Russell 3000 Index makes up about 80% of the Russell 3000. That means the Russell 2000 index makes up about 20% of the market cap. The Russell 2000 is actually the small cap index. Mid Cap account for about 27% of the index (mid caps are found in both the Russell 1000 and 2000 index). A well constructed portfolio should have at least 70-80% in large cap, split between core, value and growth, and about 20-30% in mid and small caps (split among core, value and growth as well).

Not diversifying among funds – Yes, if you invest all in one fund family, you may get discounts and breakpoints on sales loads. But by doing so, you are not diversifying among different managers and fund family. Most fund families are only strong in certain areas. It is the nature of the business. No one fund family dominates every sector. Using only one fund family will almost certainly bring down your returns versus using best of breed funds.

Not diversifying Internationally – While the smartest endowments, foundations routinely have 20% to 40% of their equity portfolio in international equities, most retail investors have only about 5%. This is despite the fact that international equities makes up slightly over half of the total global equity market capitalization and it is expected to make up 75% in years to come. So the result is that most retail investors are only now pouring money into this sector now that it has been on fire. So rather than trying to time the market, get the allocation right from the start.

Not diversifying among international funds – While some retail investors will take the time properly diversify by market capitalization and styles in their domestic equity portfolio, they simply just one fund for their international equities. That is another common mistake. Like the domestic market, 80% of the international market is made up of large cap stocks. So you should be looking for a large core, value and growth international fund and supplement that with a mid/small cap value and growth fund.

Not Diversifying among fixed income investments – This is another common mistake. This stems from not understanding the compostion that makes up the aggregate fixed income market – like about 37% is in mortgages, 27% is in corporates. Find out what the composition is in the Lehman Brothers Index and make sure your bond funds have a similar composition. However, if you look into the best performing morningstar funds, most bond funds have their portfolios skewed towards having too much corporates or mortgages. The best solution is to seek a government and a corporate bond fund.

Not Diversifying Beyond Traditional Fixed Income – Just like international equities, most retail investors do not diversify beyond domestic fixed income. But there is more foreign debt than there is US debt. The most sophisticated investors like endowment funds have a name called “enhanced fixed income” as a seperate asset class. This consist of international fixed income, high yield debt and emerging market debt. To enhance diversification in your fixed income portfolio, make sure you have funds in these sectors as well.

Not using any index funds or ETFs – Yes, even sophisticated investors (like the endowments, foundations and define benefit plans) use indexing. Not for their whole portfolio, but for a portion of it. For the retail investors, indexing can be used when you cannot find a good manager to fill in a style box. For example, it is more difficult to find a good mid or small cap manager or fund. The good ones close their funds once they reach a certain size. In this case, indexing is a good solution.

Indexing Your Whole Portfolio – While some do not index, many retail investors take the extreme end and index everything. There is enough debate about the merits and demerits of indexing. But the truth is while indexing has a place in your portfolio, just indexing your entire portfolio restricts you in how you can enhance your portfolio. By simply indexing, you accept market risk. By varying your debt and equity allocation with indexing, you can only lower your risk by reducing your expected return and vice versa. Having active managers allows you to potentially enhance your portfolio by having better risk adjusted return. What do I mean? If you can find a manager who history has just matched the index, but with less volatility in the portfolio, you would be ahead investing with this manager rather than the index because in bear markets, this manager will outperform the index and though expected return (or average return over the long run) is identical, the active portfolio will come out ahead because it is less volatile.

This is also the real reason for diversification – to move up the “efficient frontier” and improve your risk adjusted return.

Not investing in REITs, Natural Resources Stocks and Alternative Assets – OK, not all of us are wealthy enough to have access to hedge funds and private equity. But we can all invest in REITs and natural resource stocks. These assets are much less correlated with the equity markets and really should have a place in your portfolio. 5% in REITs and 5% in natural resources would be good starting points.

Parting Words: Make sure you use the right index to measure your fund’s performance

If you truly want to diversify your portfolio, you may end up with probably 15 funds. Is that too much? Definitely NO. The largest money managers and asset allocators have hundreds of funds. Yes, we are retail investors, but if we really practice diversification, having 15 or more funds should not be an issue. It will be an issue because you may end up having 15 statements from 15 fund families and you will have a hard time rebalancing. One solution is to hire a financial advisor and use a wrap program where you pay a fee based on asset size. You will get just one statement and automatic rebalancing. (BTW – rebalancing reduces portfolio volatility).

Another thing to be aware of is that you have to use the right index to measure a fund’s performance. For example, you cannot compare a large cap growth fund to the S&P Index. The proper index to use is the Russell 1000 growth index. Similarly, a large cap value index has to be measured against a Russell 1000 value index. The reason why the mainstream media says more than 90% of actively managed funds funds fail to “beat the market” is simply because they should not be using the market index. Small cap managers should be measure against the small cap index, and not the S&P. If you measure funds against the proper index, the figure is much less than what the mainstream press and “finance celebrities” have you to believe. Check out my post on comning active and passive investing for details.

Joseph Lau, the Hong Kong billionaire who holds stakes in Hong Kong property developer Chinese Estates Holdings Ltd. (0127.HK) and department store owner Lifestyle International Holdings Ltd has ordered a Boeing 787 for his personal use. According to Forbes, his net worth is a very cool $2.1 billion dollars.

The price tag on this machine is a cool $151mm (but I’m sure he’ll either get a discount or could end up paying more for customization). I guess when you are worth $2.1 bn, throwing away $151mm for a transport is OK. This is in contrast to most mere mortals (us) who actually take out a loan for our cars (most people have to invade their emergency fund if they fully paid their cars!).

Somehow, I am wondering how much does it cost to maintain this beauty. Rather than taking a speculative guess, I did some research into how much a fractional ownership on a much smaller plane will cost and arrived at a rough estimate.

To own a one-eight share in a Learjet 31A, you will roughly need to cough up about $700,000. Monthly fees are about $5,500 a month and you pay $1,500 per hour on the airplane. As far as maintenance goes, that means it cost $66,000 a year in maintenance fees. This is for a one-eighth ownership. Assuming you fully own the jet, that will work out to $528,000 for maintenance fees. Now, assuming you fly 500 hours a year, that will work out to $750,000 a year. Fractional Jet companies have to cover their cost and make a profit too. So let’s assume eight owners will pay $750,000 X 8 = $6 million. Total cost is $6.528 million to maintain a private jet. That is just an estimated cost of owning a small LearJet 31A. With a Boeing 787, I’d guess it probably runs to about $10mm ?

But since Joseph Lau is worth about $2.1 billion (though they are concentrated positions!), I guess $10 million a year is nothing to him. Look at it this way, if you have $500 million in tax free municipal bonds, then the interest you will get is about 3.8% or $19 million on a $500 million portfolio. So it looks like the aircraft maintenance is easily covered.

For someone who s a private jet, I don’t think you can ever justify the cost based on hard numbers. But rather, you can only justify it by the time you save. How much is your time worth ? Presumably, Joseph is worth thousands of dollars an hour. As he is probably a frequent flyer, the time he saves, the ability to conduct business in his private jet will probably cover the cost of the plane and the maintenance cost as well.

How I wished I could fly a private jet !

P.S – Think of how much reward points he would rack up if he paid his aircraft loan with an American Express Card!