Blending Investment and Labour Income

by Mr. Cheap

One and a half years ago I did a post about Labour vs. Investment Income and Mike did a post about Do You Really Earn Your Investment Income? The point of both of our posts was that there is an expected investment return (ROI) that an investor can’t really take credit for.  If you match the average market return, have you proven your skill as an investor, or have you just been in the pool when the water level went up for everyone?  In my post I focused more on whether you want to improving your ROI or on just increasing your income, depending on how much you have to invest.

Beyond these considerations, I also think there are a number of investments that blend labour and investment. Flipping real estate is a prime example. You can’t buy the run down property without some cash to invest, but then you get the (sometimes) crazy returns because you work 80 hour work weeks fixing the place up. Someone without many marketable skills might be best served starting their own company that they run (such as a convenience store or a franchise).  This, in a sense, lets them “buy” a better exchange rate on their labour then they might be able to get from a job by putting capital in with their labour.

In situations like this, it becomes very easy to fool ourselves about how well (or badly) we’re doing.  As Mike points out in his post, if someone was day-trading full time, they have to be making MORE money than they would get from an index-fund and a full time job to really justify it (which I think would be highly unlikely).  The day trader who looks at his account and is proud of the money he’s made is ignoring the opportunity cost of his lost salary.

Flippers are notorious for this.  Even when you get them to be honest about their actual costs (often they like to omit transactions costs from their profit statement), you’ll NEVER get them to even account for the amount of time they put into repairs.  Get them to include this and the time they spent setting up that deal, investigating deals that didn’t work out, marketing the repaired property, meetings with partners and completing the purchase and sale transactions and you’ve got a proper picture of their real investment INCLUDING their time (which will let them accurately calculate their profit).

Even people who buy-and-hold real estate long term are guilty of this.  If you aren’t hiring a property management company (and I’d personally be very cautious before you do this), you have to account for doing this work yourself.  The best way to do this is to pretend to “pay” yourself what a PM company would charge, and add this to your cost.  John T. Reed estimates that self-managed real estate takes 3.6-4.6 hours / unit / month to manage (remember although some months you don’t do anything, you’ll have the times where Murphy strikes and you keep having to go back to a unit to do one thing after another).  An index fund or GIC takes FAR less time and this has to be factored in if you want to honestly compare the investments.

One approach to honestly compare such investments is, as already mentioned, determine what others would charge for this and add it to your costs.  For real estate this would be what a property management firm or contract would charge, while for a self-run business it would be what you’d pay a clerk at your convinience store or a manager at your Subway® franchise.  If you’re unhappy working for such a low wage, then you’d be best served to hire someone to do that work for you, and get a job earning the higher wage you think you can make.  Don’t fool yourself into lumping the franchise profits into your salary and think of yourself as the highest paid convenience store clerk in the world.

Similarly, once you have an honest appraisal of the ROI from your venture, if it no longer looks lucrative with your time factored in, dump it and put your money where the ROI (based on your time and money) *IS* reasonable.

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{ 16 comments… read them below or add one }

1 Four Pillars

Pretty good post!

“Passive” investment income is another area where it’s not always clear about how passive it is.

A dividend portfolio for example take a certain amount of time to build, monitor, do taxes for. It might not be a lot of time but it is still time. For a smaller portfolio the ROI might be very low.

I think these days most house flippers make money from books and courses so it is not in their best interest to be truthful. :)

2 Jess

I agree except for rental properties. I self manage a property but I don’t spend 4 hours per month in it. In fact, I don’t spend time at all. The only time I spend is the beginning of buying a property. Just like any buying a house. You spend time looking for one, renovating it, and then marketing it. Get all the legal done and starts receiving cheuqes every month.

Anything Passive I like! I’m not into flipping. I do flip from time to time such as stocks, events organizing, doing web design, marketing, and etc..

3 Thicken My Wallet

Is your conclusion then that there is no such thing as passive income and this is all a mirage for people to sell you things?

4 Alexandra

Wow Jess, that’s pretty amazing. I have been renting units for years now, and even though I have been lucky at times to have some very low-stress renters, things still eventually break or need repair of some kind. You will have to spend some time at maintenance at some point in time.

If you’ve never had a leaky pipe, malfunctioning appliance, or HVAC issues, I’d be willing to bet that you just haven’t been in the rental business long enough.

And you flip web design and marketing? Huh?

5 Canadian Capitalist

That’s one reason, I became fully indexed. I wanted my investments on auto pilot because being active sucked up so much time. An active portfolio needs constant upkeep — doing the research, reading financial statements until your head hurts etc. Add in all that time you are spending and it may not be worth it.

6 Alexandra

As to the article, I think it is very, very difficult to consistently beat the investment market. The research that goes into pricing a stock based on it’s merits and the current market is beyond what I think a “normal” person at home can accomplish. As a layperson, you would have to be on the inside track of some knowledge the research guys somehow missed. Or you would have to get lucky. That can happen once or twice. Not consistently though.

7 Mr. Cheap

TMW: Sorry if I gave that impression, that’s not how I feel at all. Canadian Capitalist gives an excellent example of passive income (a fully indexed portfolio). At 15 minutes / year or so, I’d consider this passive income that certainly isn’t a mirage (and no one is trying to sell me anything).

My points with this post (I guess it wasn’t as clear as I hoped) were:

-don’t pretend an investment is passive when it’s not
-factor in both the time and money invested (and identify how each contributes to the return)
-make sure you’re satisfied with the return once both of these are factored in

Alexandra: I actually think it’s trivially easy to consistently beat the investment market based on ROI (see my post How to get a 49,250% return on investment). HOWEVER, you might not like the return so much once you’ve factored in time invested and considered the absolute amount of money gained.

I *HOPE* you and your husband are beating the market with your real estate investments. If you’re not, sell all your properties and just start putting cash in an passive portfolio (which I guarantee will be FAR less work than you’re currently putting into your real estate).

8 Jess

@ Alexandra,

I do rental condominiums not apartments or houses. In condo, the management do all the external stuff such pipes, parking, garbages, snow removal, security, and so on…

That’s why I have few issues. It also depends on the agreement, Renters agreed that everything is ok when they rented it ou. If there’s any issue, that will be there problem such as leaky toilets or sink.

If in case there’s major issue, I have insurance to cover it up. I also hire if there’s any problem such as door locks.

In regards to Index funds. Most Mutual funds are below the market so if you invest in an Index funds, you’ve eliminated 75% of a losing portfolio.

9 Jess

@ Alexandra

Yes, I do some web business also. I run a domain and hosting company! Where I sell domains, hosting, online fax, Toll Free, emails, ecommerce, and etc.. anything that small business needs. Most of them are Free and others are low cost. http://SmallBizPages.ca is an example of some of my sites. I just launched BizPR.ca where businesses can submit their press release for free and BizPR will distribute those Press Release automatically.

My style is work one time and let it go and make it work for you.

10 Alexandra

Jess, then all you are doing is paying huge condo fees to get someone else to manage your property for you. You should stop patting yourself on the back – the return on your investment there is awful!

11 Alexandra

Mr. Cheap, what I meant is that I agree that most investors probably do not take into account how much time it takes to properly research the company before they make a stock purchase. And my bet is that it would take either inside knowledge or incredible luck to consistently pick up stock that will go up in price beyond what the market researchers have already predicted. My own belief is that most stocks are priced very well these days due to an insane amount of research being done, research that isn’t available to the layman.

I have a friend who works in the reserach department of a hedge fund company here in Toronto. He has a business and math degree. He works all day long, investigating and researching possible investments for his company. They pay him six figures to do so. They buy risk-management aseessment software for tens of thousands of dollars, and which provides a service to them for several tens thousands of dollars a year (I work for that software company, so I know). He is one of several people on the research team. This company hires the very best people, and acquires the very best tools to search out stock and financial opportunities. And all the other hedge fund, mutual fund and investment houses do the same. Are you telling me that a guy sitting at home is going to have more knowledge at his hands to see a great stock deal than these guys (at least consistently)? I don’t think so. Or maybe I just don’t understand what you are saying.

You said I view it as a terribly self-limiting mistake for anyone to fall into the trap of thinking that it is not even possible to beat the market.

I was with you until you said that.

I think that it would be pulling the wool over your own eyes to think that you could consistently beat the market by yourself. But hey, some hedge fund managers do. They just have a budget of a million or so a year to do so. So maybe it’s achievable for them. I don’t think it’s achievable for you and I.

Let’s agree on something though –
Most people would almost always do better just to buy index funds.

12 Mr. Cheap

Alexandra: yes, as has been pointed out, that was another commenter. For what it’s worth, I agree with you 100%.

(my post about beating the market is a joke, although I think there’s an important point hiding in it).

13 Alexandra

Whoops, sorry about that!

I always read the comments before I post and I guess I mistakenly attributed that comment to Mr. Cheap.

Now that I realize it isn’t yours, the article makes so much more sense – LOL.

14 Alexandra

Rob, I have a question for you.

I am very good at saving money, but I really hate putting a lot of effort into managing my finances. About five years ago I filled out a risk portfolio and have an investment portfolio that matches it. Apparently, it auto-balances for me every month. In other words, I am always purchasing a fixed dollar amount of each fund, but when prices drop in a particular fund, I end up buying more shares of it, and when prices go up in another, I buy less.

I am 35 and cannot see my risk profile changing much over the next few years, so that has remained unchanged. But I will re-assess as I near retirement (I’m only 35).

What would you classify this as: passive or active investing?

15 Alexandra

Rob – I think I get what you are saying. Even though I may have felt comfortable with say a 15-65-20% split between bonds, US/Canadian index and foreign funds 5 years ago, now things might have changed?

But I knew that going in. That’s what doing a risk assessment is all about. Knowing the risk and being willing to assume that risk.

After that, re-balance, and every once in awhile re-assess your testicular fortitude.

I think I would rather be a (capital)Passive Investor than a Reactive investor.

16 Jess

@Alexandra
Its different style of running it. Im aware that you can pocket the maintenance fee but is it worth it? Plus Im not the one paying for it. Time is more valuable than money to me. Its Working IN your business versus Working ON your business excerpt from the book eMyth. I run properties the same way as I run hosting company. I dont personally buy the server, put all those cables, install and upgrade software, monitor the servers, secure it and etc Instead, I rent a server in a 24/7 secured locations and let them do all those technical stuff. I focus on creating the business instead. I always keep this thought, If you cant live your business in a year, you dont own a business, you own a job.

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