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As I update all of our investments for year end (it takes me until April, because many of our accounts don’t send year end statements until then), I like to compare our investment returns.

The stocks and index funds are easy, as Quicken computes the IRR. But I like to be able to compare our other investments too, like our real estate.

Unfortunately, it seems as if there are so many formulas to evaluate real estate returns, (ROI, ROE, Cash on cash, etc) pinpointing just one to use as a comparison is difficult. And everywhere I look, I find differing opinions on which formula to use. So, I’m going to work through multiple formulas:

Return on Equity

First up is return on equity. The return on equity formula I’m using is the ROE for properties beyond the first year of ownership:

ROE = Cash Flow After Taxes (CFAT) / (Property Value – Mortgage Balance)

For the first real estate investment we purchased (the house), I get this for 2011:

ROE = $1705 / ($248162 – $200926)

For the property value, I use the estimated fair market value on our tax bill, less the cost to sell the property.

The cash flow before taxes for this property was -$56 this year, but the -$5680 tax bill at 31% brought the CFAT up to $1705.

If the property was in the first year, you can divide by the initial investment in the property.

ROE = 3.61%

Another Return on Equity

However, it seems like the first ROE calculation is ignoring the change in equity from the prior year in the denominator, which I think actually should be part of the return. The principal is reducing, and the value is increasing (hopefully), without any additional contributions from us.

So, I calculated ROE method 2 for last year:

ROE(2) = CFAT + Principal Reduction + Appreciation / (Property Value Last Year – Mortgage Balance Last Year)

ROE(2) = $1705 + $2866 – $658 / ($248820 – $203792)

ROE(2) = 8.69%

Internal Rate of Return

So that brings me to internal rate of return (IRR). If I calculate the IRR for 2011 in isolation, using the following calculation in excel:

• -$45028 on 12/31/2010 (equity at beginning of year)
• $1705 on 12/31/2011 (CFAT)
• $47236 on 12/31/2011 (equity at end of year)

In excel, my formula looks like =XIRR(A1:A3,B1:B3). The amounts are in the first three cells in column A and the dates are in the first three cells in column B.

XIRR = 8.69%

The IRR matches the ROE(2), but only because I lumped the cash flow into one payment at the end of the year.

More Formulas

If you are working through the same exercise for your real estate, the other calculations I used to begin are:

• Cash Flow Before Tax (CFBT) = Net Operating Income (NOI) – Debt Service – Capital Improvements + New Loan Amounts + Bank Interest Earned
• Cash Flow After Tax (CFAT) = CFBT – Income Tax
• NOI = Income – Operating Expenses
• Debt Service = Principal and Interest Payments

Here are my numbers I used in the formulas if you are following along at home:

CFBT = $14716 – $14772 – $0 + $0 + $0
CFBT = -$56

Income Tax = -$5680 X 31%
Income Tax = -$1761

NOI = $32356 – $17640
NOI = $14716

When you calculate the returns for each of your properties using the formulas above, what did you get?

Note: I ran all of these calculations at our partnership level, and didn’t factor in my use of credit card balance transfers which covered some of my personal equity in the properties, and provided additional leverage. I wanted to start with the basic calculations first before I make them over complicated!

Our Other Real Estate

I ran the same calculations for our other real estate, the condo and the vacation rental.

The condo has a better ROE(1) at 4.01%, but a negative ROE(2) and IRR at -16.02% last year, largely because the fair market value of the property went down. I also calculated the IRR since we bought it: 37.7%. Because it was bought at an auction, most of the equity that we have is from appreciation in the first year, which makes the total IRR much higher. The IRR since we purchased the house is 1.3%

The vacation rental on the other hand breaks the calculation, with the negative cash flow, and the impact of the vacation home tax rules. I’m still trying to find a way that we’ll be able to compare that one in the same way after removing the impact of our personal use.

What is My Return?

I’m still trying to figure out if I can really use either the ROE(2) or the IRR to compare to our other investments. Is there a better way to compare on an apples to apples basis?

I know that some of you are heavily involved in real estate investments, so I’d like to hear from you! What do you think of my approach? Feel free to offer another way to evaluate the return. I tried to include all of my numbers for you to play with!

How do you calculate the return on your real estate investments? And how do you compare it to your stocks?

Click here to leave a comment on this article.
© My Dollar Plan

If you’ve been following finance news over the past couple of weeks, you would have likely read the headlines about the much anticipated Facebook Initial Public Offering (IPO).  With Facebook having the largest social network in the world with over 840 million active members and growing, they are moving towards Google like dominance, which has brought the interest of investors worldwide.

So what is an IPO?  It’s basically a way for a company to raise money by issuing shares to public markets.  In the process, it can make existing shareholders very wealthy.  In this case, Mark Zuckerberg, Facebook founder and CEO, will likely become one of the richest people on the planet.

How rich?  The $5B IPO will place Facebook at a valuation of $85 Billion to $100 Billion – yes with a B!  With the Mr. Zuckerberg retaining 28% or so of the company, it will bring his ownership stake up to $28 Billion promoting him to the top 10 list of the worlds richest people.

Back to the business itself, how does Facebook monetize their 840 million active members?  Like Google, Facebook has monetized the traffic on their site with ads.  While Google displays customized ads based on search results, or website content, Facebook displays ads based on demographics.  What makes Facebook attractive to advertisers is that they can tailor their ads specifically to their market.  For example,  a company could target and display ads specifically to 20-25 year old males, from Canada, educated, and only pay when their targeted audience clicks their ad.

How much revenue does Facebook generate?  In 2011, it’s reported that they generated over $3.71 B in sales, up over 88% from a year earlier.  After all expenses, net earnings are reported at $1B, up 66% from 2010.  With $1B in earnings, that brings a price/earnings multiple to an insane 100 assuming that the valuation reaches $100B on IPO day.  It’s starting to feel like the late 1990’s all over again!

Although valuations are sky high, it’s hard to ignore how much Google appreciated after their IPO in 2004.  The stock started trading in the $90’s and today, it’s a $600 stock.  A six bagger in seven years which is about a 31% compounded annual return.  Mind you, Google valuation is much more conservative at 20 times earnings (~$200B market cap).  Could Facebook take the same path?  Only time will tell!

Back to you, will you be buying Facebook on opening day?  Do you think that it’s over valued?

I read just about every article that has been written about the Patriots in the last week. Of the 6 articles, I narrowed the best down to these 6... 3 on Tom Brady, one on Bill Belichick, and one on Bob and Myra Kraft. If that last one doesn't bring the emotions, the last one on Marcus Cannon beating cancer earlier this year to contribute should:

• Tom Brady - As Advertised - Why he has the perfect life.
• Tom Brady - What You Don't Know - Here's what I didn't even know about him. And again, I read just about everything about him.
• Tom Brady - The Computer - He's not just good due to his physical abilities, it is the mental game.
• Bill Belichick - Inside his Head - Many love to hate Belichick, because his media interviews are curt and a league requirement. However, it's just his way of rebelling against the NFL
• Bob and Myra Kraft - The inspiration that makes the Patriots tick this season. Powerful stuff about how the Patriots saved the football season despite the heavy heart of his wife's death just days before. It's one of those things where football is just a game, but it can become more than a game.
• Marcus Cannon Beats Cancer - Tough break for Marcus being the #2 inspiration. Any year other than the Myra Kraft it would be a top story.

The $75 sign up bonus from Chase has one of the lowest amount of spending requirements we’ve seen in awhile.

How to Get Your $75 Statement Credit

1. Apply for the Chase Slate card.
2. Use the card to spend $300 within 3 months.
3. After 6-8 weeks, you’ll see a $75 statement credit on your account!

Chase Terms and Conditions

• No annual fee.
• One-time bonus offer & valid only for first-time cardmembers with new accounts.
• Previous and existing cardmembers/accounts are not eligible.

More on Chase

0% Intro APR. For those with good credit, Chase is offering a 0% intro APR for 15 months on purchases and balance transfers. For those with average credit, there is 6-month 0% intro APR offer. However, remember the balance transfer offer has a 3% fee.

Chase Blueprint. The Slate card offers Chase Blueprint, a unique set of features that can help you avoid interest, pay off balances faster and see spending trends at a glance.

Click here to leave a comment on this article.
© My Dollar Plan

For those who aren't aware, target date mutual funds are typically designed to start out with more aggressive investments (stocks) and gradually get more conservative towards, well, the target date. The philosophy is that want to take the risks and reach for those high rewards at the beginning of your career, but as you get close to retirement, you want to preserve the nest egg. One of the biggest advantages is that you can "set it and forget it" (please don't sue me Ron Popeil) - you can't have to manage the portfolio, it manages itself.

The Good Financial Cents article, which I'll get to in a minute, reminded me of my own story regarding target date mutual funds. A representative from USAA called my wife to make sure her investment objectives were being met. He suggested one of USAA's target date mutual funds. I asked him why go with USAA when Vanguard and Fidelity's have lower expense ratios. He didn't have good answer for that other than USAA was charging a substantial fee (if memory serves) to get into those mutual funds. Long story short, we went some Vanguard ETFs based around index funds that had low commissions. This do-it-yourself wasn't exactly what I was looking for, but it was the best use of money.

When I saw Jeff Rose's article about hating target date mutual funds, I expected to read about how the funds have two sets of fees. There are the fees that the individual funds have, and the fees for managing/re-balancing the portfolio of mutual funds. He did get to that, but he uncovered something else. Some of the mutual funds included in these target date funds are, in his words, "just plum horrible." (Side Note: Kudos to him for the use of plum as an adjective.)

Rose gives some examples of target date funds in some of his clients' 401k plans and shows with back-testing that he could have made the client more than 3.5% with other choices in the 401k plan. Using the magic of compound interest Rose shows that in 20 years, that difference could be $295,000. Yep, that's number is not a typo. We should all hate target date mutual funds right?

Maybe not so fast...

Here are a couple of thoughts that I had that may change your mind:

• In 401k plans, there are limited investing options. Perhaps the target date mutual fund option in these clients had bad stocks, but I think it is a stretch to say that they are ALL bad. Outside of a 401k plan you may find a good target date mutual fund.
• The 3.5% increase in returns in the examples are based on back testing a portfolio over the last ten years. Hindsight is 20/20. It's easy to say that you should been in Legg Mason Value Trust when Bill Miller was beating the S&P 500 year after year... until it got decimated in 2008 (even in comparison to the market). Haven't we read that past performance is not indicative of future results?

In the end, I realized that Rose's views are different than mine. He's into actively managing funds. I used to be that way, but I've settled into the low-expense index ratio camp. I haven't been able to find that active advisor who is going to guarantee me that they'll beat a broad index by 3.5% year after year, so stick with what I can control and that's the fees.

Related posts:

1. How to Invest in Mutual Funds? (and other questions you asked) Last week, I wrote an article Understanding and Avoiding Mutual...
2. I Bought a Mutual Fund… ... for the first time in maybe a decade. You...
3. Understanding and Avoiding Mutual Fund Fees Every now and again, I wonder if I'm writing at...
4. Should You Invest in the Top Fund of the Decade? I'm a member of bank that you may or may...
5. Don’t Chase Mutual Fund Winners When it comes to investing, mutual funds are one the...

In the midst of years discussing financial apocalypse – which is probably a little bit overstated – I realized that the idea of saving money in times of crisis is a lot different from saving money in a time of plenty.  Cutting back on Nintendo games is a lot different than learning how to heat the house with paper scraps.

A common debate that has occurred over the last decade in my consultant-infested workplaces has been the debate over “good” investments. I have had colleagues who cling to the stock market; some who swear by real estate; some who preach the mantra of gold and commodities; and some who have just decided to spend their money as it comes and damn the consequence.  I fall somewhere in the middle – increasingly skeptical of the stock market but more skeptical of the idea that commodities or real estate can pick up the slack for the whole US market.

But in times of distress, learning to save money on things that make a difference can matter a lot, too. Learning to grow your own food is different than chopping off a few bucks on eating out.  The former will create value out of nothing – the latter simply cuts out an expense you didn’t need to have.  For the record, I don’t think we’re there yet.  We don’t need to all start planting potatoes for the next great famine.  And I’m not convinced that we need to hammer down on luxuries yet, either.  If I dropped Netflix it equals less than .1% of my income.  You might say, well, take .1% here and .1% there and soon you have a few percentage points, but you don’t – I don’t have that many minor expenses.

I do think now is the time to start focusing on stupid expenses. Nobody needs a new TV now.  You might need a new computer, though.  You don’t need a new CD – but a book (depending on the book) might be money well spent.  Is it time to start wearing that crappy old shirt that’s out of fashion a bit longer?  Yes.  Is it time to keep wearing that worn-out old coat that doesn’t protect you against the cold enough – no.  Spend money like a smart person.  That means you need to apply a simple question to every expense:  do I NEED this?  If the answer is no, pass for at least a few days.  You’ll see a difference in your bottom line in a hurry.

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