How Bitcoin Disrupts the Finance Industry

How Bitcoin Disrupts the Finance Industry .

Cryptocurrencies and their underlying blockchain technology are being touted as the next-big-thing after the creation of the internet. One area where these technologies are likely to have a major impact is the financial sector. The blockchain, as a form of distributed ledger technology (DLT), has the potential to transform well-established financial institutions and bring lower costs, faster execution of transactions, improved transparency, auditability of operations, and other benefits. Cryptocurrencies hold the promise of a new native digital asset class without a central authority.

So what do these technological developments mean for the various players in the sector and end users? “Blockchains have the potential to displace any business activity built on transactions occurring on traditional corporate databases, which is what underlies nearly every financial service function. Any financial operation that has low transparency and limited traceability is vulnerable to disruption by blockchain applications. DLT is therefore both a great opportunity and also a disruptive threat,” according to Bruce Weber, dean of Lerner College and business administration professor, and Andrew Novocin, professor of electrical and computer engineering, both at the University of Delaware.

Earlier this year, Weber, Novocin, and graduate student Jonathan Wood conducted a literature review on cryptocurrencies and DLT for the SWIFT Institute. Based on this review, the SWIFT institute recently issued a grant to conduct new research on DLT and cryptocurrencies in the financial sector. Weber and Novocin noted that just as disruptors like Amazon, Google, Facebook and Uber built software platforms and thriving businesses thanks to the connectivity provided by internet standards, next-generation startups will build new services and businesses with blockchains. “Many pundits expect blockchain, as a distributed technology, to become the foundation for new services and applications that have completely different rules from those running on hierarchical and controlled databases. Cryptocurrencies are an early example but many others will follow,” they added.

Kartik Hosanagar, a Wharton professor of marketing and operations, information and decisions, pointed out that the financial services sector is full of intermediaries such as banks that help create trust among transacting parties like lenders and borrowers. Blockchain, he said, is a mechanism to create trust without centralized control. “The power of eliminating intermediaries is the ability to lower transaction costs and take back control from powerful financial intermediaries.”

Regarding cryptocurrencies, Hosanagar pointed out that most of the value today is tied to speculative buying rather than actual use cases. But having a currency without a central authority offers “certain unique kinds of protections especially in countries with troubled central banks.” For example, Venezuela’s currency is rapidly losing value. For people who stored their savings in crypto, there was greater protection against such rapid currency devaluations. “Of course, cryptocurrencies have their own instabilities, but they aren’t tied to actions by central banks and that’s particularly relevant in countries and economies where citizens don’t trust their governments and central banks,” he said.

“Any financial operation that has low transparency and limited traceability is vulnerable to disruption by blockchain applications.”–Bruce Weber and Andrew Novocin

Hosanagar expects the first wave of applications to be rolled out in “private” blockchains where a central authority such as a financial institution and its partners are the only ones with the permission to participate (as opposed to public, permissionless blockchains where participants are anonymous and there is no central authority). Applications in the private blockchains, he said, will be more secure and will offer some of the benefits of decentralized ledgers but will not be radically different from the way things work at present. However, over time, he expects smart contracts (self-executing contracts when requirements are met) to be offered on public blockchain networks like Ethereum. “When securities are traded, intermediaries provide trust, and they charge commissions. Blockchains can help provide such trust in a low-cost manner. But trade of securities is governed by securities laws. Smart contracts offer a way to ensure compliance with the laws. They have great potential because of their ability to reduce costs while being compliant,” says Hosanagar.

According to Weber and Novocin, one area ripe for transformation is reaching consensus on important benchmark rates and prices. At present, they point out, different proprietary indexes are used to determine interest rates and the price of many mainstream assets. Blockchain can transform this. “Think of the London Interbank Offered Rate (LIBOR) and the recent scandals involving manipulation of benchmark values when they are controlled by a single entity that may not be capable of detecting false or fraudulent data. Blockchain could provide greater transparency around the process of creating agreed upon reference prices, and allow more people to participate in the consensus process.”

Weber and Novocin expect that in some areas intermediaries will find their roles reduced as blockchain allows for automation through greater transparency and traceability. In other areas, intermediaries will find themselves well-placed to take advantage of changing needs of their clients, as firms will need help to manage the shift to new standards as well as the greater complexity of open and traceable blockchain infrastructure. Intermediaries in areas that could potentially be disrupted, they said, “should get involved with projects seeking to set the standards, so that they can stay informed and position themselves to profit from becoming the leaders in the operations of the new markets that will emerge.”

Kevin Werbach, Wharton professor of legal studies and business ethics, and author of a forthcoming book The Blockchain and the New Architecture of Trust,  said that it’s usually not helpful to focus on what aspects of a major existing market will be “transformed” or “disrupted” by new technologies. Important technologies, he said, are far more likely to be integrated into the system than replace it. According to Werbach, while some firms will fail to make the transition and some new ones will take hold, “over the long-run, virtually every historic innovation that eliminated some forms of intermediation also created new forms.”

Blockchain will reduce the massive duplication of information that creates delays, conflicts and confusion in many aspects of financial services, Werbach added. For example, when a syndicate of lenders participates in a loan, having one shared ledger means they don’t all need to keep track of it independently. International payments and corporate stock records are other examples where there are huge inefficiencies due to duplicate record-keeping and intermediaries. “End users won’t see the changes in the deep plumbing of financial services, but it will allow new service providers to emerge and new products to be offered,” said Werbach.

Bumps Along the Way

Angela Walch, professor of law at St. Mary’s University School of Law and a research fellow at the Centre for Blockchain Technologies at University College London, offered another perspective. She said there is a lot of excitement about blockchain as a distributed ledger technology for the financial sector because many believe that it offers a better, more efficient and more resilient form of recordkeeping. However, making use of the blockchain is not as simple as just buying new software and running it. “Blockchain technology is, at core, group recordkeeping. To reap its full benefits, one needs all the relevant members of the group to join the system. This requires collaboration with and across businesses, which is a potentially big hurdle, and may be the hurdle that most limits adoption.”

Governance is the biggest challenge in decentralized organizations, said Weber and Novocin. Members participating in a blockchain-supported financial function may have misaligned incentives, and can end up in gridlock, or with a chaotic outcome. They cite the example of the ‘DAO Hack,’ which was the first prominent smart contract project on the Ethereum network to suffer a large loss of funds. The Ethereum community voted to conduct a hard fork (a radical change to the protocol that makes previously invalid blocks/transactions valid or vice-versa) — reversing the transactions after the hack and essentially refunding the DAO investors. This was in effect a breach of Ethereum’s immutability and it left a sizeable minority of the community bitterly dissatisfied. This group viewed the Ethereum community as forsaking its commitment to immutable, permanent records. They refused to acknowledge the hard fork, and maintained the original Ethereum blockchain, now known as Ethereum Classic (whereas the forked version supported by the Ethereum Foundation is simply Ethereum).

“The power of eliminating intermediaries is the ability to lower transaction costs and take back control from powerful financial intermediaries.”–Kartik Hosanagar

“Distributed organizations serving an open community need to take care to design their governance systems, incentive structures and decision-making processes to create consensus without unduly slowing down the decision-making,” said Weber and Novocin. “Scenario planning or war gaming are worth exploring at the beginning of blockchain projects. Forward planning enables organizations to swiftly respond in a predictable way that is supportive of stakeholders. Publicizing these plans in advance can also build trust and user confidence.”

Cryptocurrency Risks.

Werbach listed a variety of risks and vulnerabilities related to cryptocurrencies: Bitcoin has shown that the fundamental security of its proof-of-work system is sound, but it has major limitations such as limited scalability, massive energy usage and concentration of mining pools. There has been massive theft of cryptocurrencies from the centralized intermediaries that most people use to hold it, and massive fraud by promoters of initial coin offerings and other schemes. Manipulation is widespread on lightly-regulated cryptocurrency exchanges.

For example, roughly half of Bitcoin transactions are with Tether, a “stablecoin” that claims to be backed by U.S. dollars but has never been audited and is involved in highly suspicious behavior. Money laundering and other criminal activity is a serious problem if transactions do not require some check of real-world identities. “There are major efforts to address all of these risks and vulnerabilities. Some are technical, some are business opportunities, and some are regulatory questions. There must be recognition among cryptocurrency proponents that maturation of the industry will require cooperation in many cases with incumbents and regulators,” added Werbach.

Hosanagar cautions that while decentralization offers significant value — and a significant number of miners/validators must verify the transaction for it to be validated — it is still susceptible to collusion. If one or a few companies running lots of miners/validators in a small network collude, they can affect the sanctity of the network. The big risk with cryptocurrencies, he added, is that most activity as of today is ultimately tied to speculation. It’s important for cryptocurrencies to discover a “killer app soon so there is some underlying value created beyond speculation of its future value,” Hosanagar concludes.

The Way Ahead?

Given all these challenges, what is the current mindset in the financial sector towards adopting these new technologies? And, importantly, should one push for wide acceptance and deployment, or is there need for them to stabilize first?

According to Werbach, “It’s not an either-or” choice. Cryptocurrencies and blockchain technology in general, he noted, are immature currently. However, there are some areas where they are already able to be deployed effectively. The best way to work through today’s problems, is “to build working systems and see where difficulties arise,” Werbach said. Looking ahead, integration with law, regulation and governance will be critical. Blockchain and cryptocurrencies represent a new form of trust, he added. They will only succeed if they become sufficiently trustworthy, beyond the basic security of the distributed ledgers. “Law, regulation and governance are three major mechanisms to produce trustworthy systems that scale up to society-wide adoption. We need to find ways to address the legitimate concerns of governments without overly restricting the innovations that blockchain technology enables. I’m optimistic about that process over time.”

“We need to find ways to address the legitimate concerns of governments without overly restricting the innovations that blockchain technology enables.”–Kevin Werbach

Walch noted that while there are claims that some consortia are putting ‘blockchain’ systems into production, in many cases it appears that what they are calling a blockchain bears little to no resemblance to the original blockchain technology behind Bitcoin. In many instances, she said, existing shared databases are being called ‘blockchain’ for marketing purposes. “If people do use something they call DLT or blockchain technology in important financial systems, my hope is that they make the decision based on actual capabilities of the tech rather than its widely hyped and generally overstated capabilities,” Walch said. “Permissioned blockchains, which are the variation most likely to be used for financial systems recordkeeping, are very different from public blockchains like Bitcoin or Ethereum. I hope that a more modest and accurate understanding of the actual characteristics of permissioned blockchains sinks in before they are widely adopted.”

Regarding cryptocurrencies or cryptoassets, Walch said that the financial sector’s interest is “less about recordkeeping and more about a new financial asset that it can make money off of.” She pointed out that at present there is no clarity on how power and accountability work in these systems. The ongoing operation of crypto systems and the value they embed and support is reliant on the competence of, and ethical behavior by, unaccountable software developers and validators. “The financial sector believes it understands and can manage the risks of cryptoassets, but I am less certain and worry that hubris and greed are driving the push to create cryptoassets as a real asset class. This has been a bad mixture in the past,” says Walch. “I think it would be more responsible to let cryptosystems exist on their own for a while longer to let more of the kinks get worked out — if they can be; I’m not sure the governance ones can — rather than to rapidly integrate them into the financial system as we seem to be doing.”

“I … worry that hubris and greed are driving the push to create cryptoassets as a real asset class.”–Angela Walch

Conversely, Weber and Novocin feel that the financial industry is cautious about the new DLT technology. According to them, to build confidence in new blockchain systems there needs to be transparency around how the processes work and what the benefits are, and in order to secure adoption, they need to be straightforward to use. “Pundits have drawn parallels to the open source Linux operating system. Although only a few individuals use Linux directly, it quietly runs the vast majority of servers and cloud processors across the world. Similarly, early adoption of blockchain will likely happen in the background of business processes. Companies should get involved now, even if it is just to experiment with the concepts. By gaining familiarity with these new tools, they will be ready as the space continues to develop.”

Weber and Novocin expect that in the next few years, many more businesses will implement private blockchains to improve the transparency and traceability of their financial operations, supply chains, inventory management systems and other internal business systems. Clearer standards will be adopted and a few high-profile projects will emerge. Meanwhile, they said, R&D will continue among the many decentralized blockchain projects to invent more scalable public ledgers whether it be blockchain, Tangle, Hashgraph or something new. “Work is needed on better and more efficient consensus models, whether it be a new form of proof-of-stake or proof-of-work, or something else. There are many established groups, startups, companies and research teams that organizations can join, partner with, or support in order to contribute to research and expand their capabilities.”




Bitcoin (Currency),Bitcoin,Finance (Industry),Industry (Organization Sector),Brad Templeton,Singularity University,Innovation,Internet,Web,Website,Google,Disruption,Technology,Technological,Money,Currency,Gold,Big Think,BigThink,BigThink.com,Education,Educational,Lifelong Learning,EDU

July 16, 2020

How the Blockchain Will Impact the Financial Sector

How the Blockchain Will Impact the Financial Sector.

Cryptocurrencies and their underlying blockchain technology are being touted as the next-big-thing after the creation of the internet. One area where these technologies are likely to have a major impact is the financial sector. The blockchain, as a form of distributed ledger technology (DLT), has the potential to transform well-established financial institutions and bring lower costs, faster execution of transactions, improved transparency, auditability of operations, and other benefits. Cryptocurrencies hold the promise of a new native digital asset class without a central authority.

So what do these technological developments mean for the various players in the sector and end users? “Blockchains have the potential to displace any business activity built on transactions occurring on traditional corporate databases, which is what underlies nearly every financial service function. Any financial operation that has low transparency and limited traceability is vulnerable to disruption by blockchain applications. DLT is therefore both a great opportunity and also a disruptive threat,” according to Bruce Weber, dean of Lerner College and business administration professor, and Andrew Novocin, professor of electrical and computer engineering, both at the University of Delaware.

Earlier this year, Weber, Novocin, and graduate student Jonathan Wood conducted a literature review on cryptocurrencies and DLT for the SWIFT Institute. Based on this review, the SWIFT institute recently issued a grant to conduct new research on DLT and cryptocurrencies in the financial sector. Weber and Novocin noted that just as disruptors like Amazon, Google, Facebook and Uber built software platforms and thriving businesses thanks to the connectivity provided by internet standards, next-generation startups will build new services and businesses with blockchains. “Many pundits expect blockchain, as a distributed technology, to become the foundation for new services and applications that have completely different rules from those running on hierarchical and controlled databases. Cryptocurrencies are an early example but many others will follow,” they added.

Kartik Hosanagar, a Wharton professor of marketing and operations, information and decisions, pointed out that the financial services sector is full of intermediaries such as banks that help create trust among transacting parties like lenders and borrowers. Blockchain, he said, is a mechanism to create trust without centralized control. “The power of eliminating intermediaries is the ability to lower transaction costs and take back control from powerful financial intermediaries.”

Regarding cryptocurrencies, Hosanagar pointed out that most of the value today is tied to speculative buying rather than actual use cases. But having a currency without a central authority offers “certain unique kinds of protections especially in countries with troubled central banks.” For example, Venezuela’s currency is rapidly losing value. For people who stored their savings in crypto, there was greater protection against such rapid currency devaluations. “Of course, cryptocurrencies have their own instabilities, but they aren’t tied to actions by central banks and that’s particularly relevant in countries and economies where citizens don’t trust their governments and central banks,” he said.

“Any financial operation that has low transparency and limited traceability is vulnerable to disruption by blockchain applications.”–Bruce Weber and Andrew Novocin

Hosanagar expects the first wave of applications to be rolled out in “private” blockchains where a central authority such as a financial institution and its partners are the only ones with the permission to participate (as opposed to public, permissionless blockchains where participants are anonymous and there is no central authority). Applications in the private blockchains, he said, will be more secure and will offer some of the benefits of decentralized ledgers but will not be radically different from the way things work at present. However, over time, he expects smart contracts (self-executing contracts when requirements are met) to be offered on public blockchain networks like Ethereum. “When securities are traded, intermediaries provide trust, and they charge commissions. Blockchains can help provide such trust in a low-cost manner. But trade of securities is governed by securities laws. Smart contracts offer a way to ensure compliance with the laws. They have great potential because of their ability to reduce costs while being compliant,” says Hosanagar.

According to Weber and Novocin, one area ripe for transformation is reaching consensus on important benchmark rates and prices. At present, they point out, different proprietary indexes are used to determine interest rates and the price of many mainstream assets. Blockchain can transform this. “Think of the London Interbank Offered Rate (LIBOR) and the recent scandals involving manipulation of benchmark values when they are controlled by a single entity that may not be capable of detecting false or fraudulent data. Blockchain could provide greater transparency around the process of creating agreed upon reference prices, and allow more people to participate in the consensus process.”

Weber and Novocin expect that in some areas intermediaries will find their roles reduced as blockchain allows for automation through greater transparency and traceability. In other areas, intermediaries will find themselves well-placed to take advantage of changing needs of their clients, as firms will need help to manage the shift to new standards as well as the greater complexity of open and traceable blockchain infrastructure. Intermediaries in areas that could potentially be disrupted, they said, “should get involved with projects seeking to set the standards, so that they can stay informed and position themselves to profit from becoming the leaders in the operations of the new markets that will emerge.”

Kevin Werbach, Wharton professor of legal studies and business ethics, and author of a forthcoming book The Blockchain and the New Architecture of Trust,  said that it’s usually not helpful to focus on what aspects of a major existing market will be “transformed” or “disrupted” by new technologies. Important technologies, he said, are far more likely to be integrated into the system than replace it. According to Werbach, while some firms will fail to make the transition and some new ones will take hold, “over the long-run, virtually every historic innovation that eliminated some forms of intermediation also created new forms.”


Blockchain will reduce the massive duplication of information that creates delays, conflicts and confusion in many aspects of financial services, Werbach added. For example, when a syndicate of lenders participates in a loan, having one shared ledger means they don’t all need to keep track of it independently. International payments and corporate stock records are other examples where there are huge inefficiencies due to duplicate record-keeping and intermediaries. “End users won’t see the changes in the deep plumbing of financial services, but it will allow new service providers to emerge and new products to be offered,” said Werbach.

Bumps Along the Way

Angela Walch, professor of law at St. Mary’s University School of Law and a research fellow at the Centre for Blockchain Technologies at University College London, offered another perspective. She said there is a lot of excitement about blockchain as a distributed ledger technology for the financial sector because many believe that it offers a better, more efficient and more resilient form of recordkeeping. However, making use of the blockchain is not as simple as just buying new software and running it. “Blockchain technology is, at core, group recordkeeping. To reap its full benefits, one needs all the relevant members of the group to join the system. This requires collaboration with and across businesses, which is a potentially big hurdle, and may be the hurdle that most limits adoption.”

Governance is the biggest challenge in decentralized organizations, said Weber and Novocin. Members participating in a blockchain-supported financial function may have misaligned incentives, and can end up in gridlock, or with a chaotic outcome. They cite the example of the ‘DAO Hack,’ which was the first prominent smart contract project on the Ethereum network to suffer a large loss of funds. The Ethereum community voted to conduct a hard fork (a radical change to the protocol that makes previously invalid blocks/transactions valid or vice-versa) — reversing the transactions after the hack and essentially refunding the DAO investors. This was in effect a breach of Ethereum’s immutability and it left a sizeable minority of the community bitterly dissatisfied. This group viewed the Ethereum community as forsaking its commitment to immutable, permanent records. They refused to acknowledge the hard fork, and maintained the original Ethereum blockchain, now known as Ethereum Classic (whereas the forked version supported by the Ethereum Foundation is simply Ethereum).

“The power of eliminating intermediaries is the ability to lower transaction costs and take back control from powerful financial intermediaries.”–Kartik Hosanagar

“Distributed organizations serving an open community need to take care to design their governance systems, incentive structures and decision-making processes to create consensus without unduly slowing down the decision-making,” said Weber and Novocin. “Scenario planning or war gaming are worth exploring at the beginning of blockchain projects. Forward planning enables organizations to swiftly respond in a predictable way that is supportive of stakeholders. Publicizing these plans in advance can also build trust and user confidence.”

Cryptocurrency Risks.

Werbach listed a variety of risks and vulnerabilities related to cryptocurrencies: Bitcoin has shown that the fundamental security of its proof-of-work system is sound, but it has major limitations such as limited scalability, massive energy usage and concentration of mining pools. There has been massive theft of cryptocurrencies from the centralized intermediaries that most people use to hold it, and massive fraud by promoters of initial coin offerings and other schemes. Manipulation is widespread on lightly-regulated cryptocurrency exchanges.

For example, roughly half of Bitcoin transactions are with Tether, a “stablecoin” that claims to be backed by U.S. dollars but has never been audited and is involved in highly suspicious behavior. Money laundering and other criminal activity is a serious problem if transactions do not require some check of real-world identities. “There are major efforts to address all of these risks and vulnerabilities. Some are technical, some are business opportunities, and some are regulatory questions. There must be recognition among cryptocurrency proponents that maturation of the industry will require cooperation in many cases with incumbents and regulators,” added Werbach.

Hosanagar cautions that while decentralization offers significant value — and a significant number of miners/validators must verify the transaction for it to be validated — it is still susceptible to collusion. If one or a few companies running lots of miners/validators in a small network collude, they can affect the sanctity of the network. The big risk with cryptocurrencies, he added, is that most activity as of today is ultimately tied to speculation. It’s important for cryptocurrencies to discover a “killer app soon so there is some underlying value created beyond speculation of its future value,” Hosanagar concludes.

The Way Ahead?

Given all these challenges, what is the current mindset in the financial sector towards adopting these new technologies? And, importantly, should one push for wide acceptance and deployment, or is there need for them to stabilize first?

According to Werbach, “It’s not an either-or” choice. Cryptocurrencies and blockchain technology in general, he noted, are immature currently. However, there are some areas where they are already able to be deployed effectively. The best way to work through today’s problems, is “to build working systems and see where difficulties arise,” Werbach said. Looking ahead, integration with law, regulation and governance will be critical. Blockchain and cryptocurrencies represent a new form of trust, he added. They will only succeed if they become sufficiently trustworthy, beyond the basic security of the distributed ledgers. “Law, regulation and governance are three major mechanisms to produce trustworthy systems that scale up to society-wide adoption. We need to find ways to address the legitimate concerns of governments without overly restricting the innovations that blockchain technology enables. I’m optimistic about that process over time.”

“We need to find ways to address the legitimate concerns of governments without overly restricting the innovations that blockchain technology enables.”–Kevin Werbach

Walch noted that while there are claims that some consortia are putting ‘blockchain’ systems into production, in many cases it appears that what they are calling a blockchain bears little to no resemblance to the original blockchain technology behind Bitcoin. In many instances, she said, existing shared databases are being called ‘blockchain’ for marketing purposes. “If people do use something they call DLT or blockchain technology in important financial systems, my hope is that they make the decision based on actual capabilities of the tech rather than its widely hyped and generally overstated capabilities,” Walch said. “Permissioned blockchains, which are the variation most likely to be used for financial systems recordkeeping, are very different from public blockchains like Bitcoin or Ethereum. I hope that a more modest and accurate understanding of the actual characteristics of permissioned blockchains sinks in before they are widely adopted.”

Regarding cryptocurrencies or cryptoassets, Walch said that the financial sector’s interest is “less about recordkeeping and more about a new financial asset that it can make money off of.” She pointed out that at present there is no clarity on how power and accountability work in these systems. The ongoing operation of crypto systems and the value they embed and support is reliant on the competence of, and ethical behavior by, unaccountable software developers and validators. “The financial sector believes it understands and can manage the risks of cryptoassets, but I am less certain and worry that hubris and greed are driving the push to create cryptoassets as a real asset class. This has been a bad mixture in the past,” says Walch. “I think it would be more responsible to let cryptosystems exist on their own for a while longer to let more of the kinks get worked out — if they can be; I’m not sure the governance ones can — rather than to rapidly integrate them into the financial system as we seem to be doing.”

“I … worry that hubris and greed are driving the push to create cryptoassets as a real asset class.”–Angela Walch

Conversely, Weber and Novocin feel that the financial industry is cautious about the new DLT technology. According to them, to build confidence in new blockchain systems there needs to be transparency around how the processes work and what the benefits are, and in order to secure adoption, they need to be straightforward to use. “Pundits have drawn parallels to the open source Linux operating system. Although only a few individuals use Linux directly, it quietly runs the vast majority of servers and cloud processors across the world. Similarly, early adoption of blockchain will likely happen in the background of business processes. Companies should get involved now, even if it is just to experiment with the concepts. By gaining familiarity with these new tools, they will be ready as the space continues to develop.”

Weber and Novocin expect that in the next few years, many more businesses will implement private blockchains to improve the transparency and traceability of their financial operations, supply chains, inventory management systems and other internal business systems. Clearer standards will be adopted and a few high-profile projects will emerge. Meanwhile, they said, R&D will continue among the many decentralized blockchain projects to invent more scalable public ledgers whether it be blockchain, Tangle, Hashgraph or something new. “Work is needed on better and more efficient consensus models, whether it be a new form of proof-of-stake or proof-of-work, or something else. There are many established groups, startups, companies and research teams that organizations can join, partner with, or support in order to contribute to research and expand their capabilities.”




Bitcoin (Currency),Bitcoin,Finance (Industry),Industry (Organization Sector),Brad Templeton,Singularity University,Innovation,Internet,Web,Website,Google,Disruption,Technology,Technological,Money,Currency,Gold,Big Think,BigThink,BigThink.com,Education,Educational,Lifelong Learning,EDU

July 16, 2020

How to Stop Being Broke

How to Stop Being Broke.

If you're sick of being broke, it's time to take control of your finances! Whether you need to work on your spending habits, learn how to save, or find ways to earn more money, you can find a way to stop being broke. Follow these steps to start working towards financial freedom and better peace of mind.

Part 1 Getting into the Right Mindset.
1. Set goals. If you want to change your financial situation, you need to get specific about want you want to accomplish. Think about exactly what you want your finances to look like and what you can do to achieve those goals.
Setting short-term goals in addition to long-term goals can help keep you motivated by providing you with a sense of accomplishment.
Create a budget for non-essential items and hold yourself accountable for it each month. If you go over-budget one month, tell yourself that your budget for the next month is reduced as a result.
2. Stop comparing yourself to others. If you're spending beyond your means because you feel that you need to keep up with your friends or show others that you can afford a certain lifestyle, you're not doing yourself any favors. Stop worrying about what others can afford and think about how you can live within your means.
Stop equating your self-worth with your ability to buy things. This kind of thinking will make you extremely unhappy in the long run and will probably get you stuck in debt forever.
3. Track your expenses. To understand exactly where all your money is going, keep careful track of every dollar you spend. You can do this with a pen and paper or electronically if you use a card for everything, but make sure to account for everything. This simple habit will help you spend more wisely.
Try categorizing your expenses and adding them up on a monthly basis. For example, you could create categories for food, housing, transportation, utilities, insurance, entertainment, and clothing. Then calculate what percentage of your income you are spending on each category. You might realize that your expenses in some of these categories are way too high.
To understand how much you can afford to spend each day, subtract your fixed expenses from your monthly income and divide the remaining amount by 31.
4. Make a plan for getting out of debt. If you are broke because you have credit card debt, a car payment, or student loans, think about what you can do to pay off these debts faster.
Making even a few extra payments each year can help you pay off your debts much faster.
5. Start saving. This may seem impossible if you are always broke, but planning for the future will help you get out of this cycle. Start small by just putting $50 in an emergency fund each month.
Don't forget to save for retirement! Take advantage of the 401k offerings at your company or open an IRA account.

Part 2 Avoiding Money Traps.
1. Avoid lending to others. While you may want to help out your loved ones who are in need, you really shouldn't be lending money if you can't afford to pay your own bills.
2. Avoid payday loans. While they may seem like a good solution if you're strapped for cash, the interest rates are ridiculously high, so they will only get you further into debt.
3. Understand how much it will really cost. Before you take out any kind of loan or finance any purchase, be sure to calculate what your monthly payments will be, how long it will take you to repay the debt, and how much you will be paying in interest.
In some cases, paying interest may be worth it. For example, most people cannot afford to purchase a house without taking out a mortgage, but depending on the price of the house and the average cost of rent in your area, you might still be saving a significant amount of money by choosing to buy with a mortgage instead of renting.
Be especially wary of high interest rates for depreciating assets like vehicles. If you decide to sell your vehicle after you have owned it for several years, it may be worth less than what you owe on it. This can also happen with real estate when the market conditions are poor.
4. Avoid impulse buys. If you always have a plan for what you will buy, you will have a much easier time managing your finances.
If you have a hard time controlling your purchases when you go to the mall, try to avoid going to the mall at all.
Write out a list when you go shopping so you will always know exactly what you need to buy.
5. Use credit cards wisely. If you have a harder time keeping track of your expenses and sticking to your budget when you use a credit card, stop using it.
Paying with cash instead of a credit card will allow you to visualize how much of your available funds you are spending on a given purchase.
If you are able to stick to your budget when using a credit card, look for one that has no annual fee and will reward you with cash back or other incentives. Just make sure you always pay your bill on time or these incentives will not be worth the price you are paying in interest.

Part 3 Spending Less.
1. Assess your daily or weekly spending habits. Once you have a solid grasp on what you are spending your money on, you can start cutting out expensive habits.
2. Buy used items. You can save on everything from your next car to furnishings for your home by buying gently used items.
You can sometimes find really great clothes that have barely been worn at thrift shops for a fraction of the price.
3. Look for monthly expenses that can be cut. If you pay for monthly memberships or subscriptions, carefully assess how much they cost, how much you use them, and whether you could give them up.
Make sure you're not paying for services that you never use. For example, if you have premium cable channels that you never watch, you can cancel them without feeling like you are making any sacrifices. The same goes for your cell phone bill if you are paying for more data than you ever use.
4. Compare items or brands when shopping. If you're on a tight budget, you want to make sure you're always getting the best deal on absolutely everything. Take some time to compare prices for items you purchase regularly and for large purchases.
If you've had the same auto insurance carrier or cable company for a long time, there might be better deals out there, so be sure to comparison shop regularly.
Shopping for necessities online can be cheaper in some instances, but make sure you take shipping charges into account.
Use coupons to save some extra cash. Keep in mind that many retailers accept competitors' coupons.
5. Ask for a better deal. You can always ask your service providers for better deals, especially if you've been a loyal customer. The worst they can say is no.
Try this with your cable and internet providers, insurance companies, and cell phone carriers.
6. Spend less on entertainment or at restaurants. Whether it's dining out or going to amusement parks, entertainment can eat up a big chunk of your budget. Look for less expensive ways to have fun.
Learn to cook at home and keep the fridge well stocked with ingredients for things that you know you can cook from scratch when you come home late and don't have much time to whip up a grand meal.
Instead of going out to eat with friends, invite them over for a potluck.
7. Do more yourself. It may be convenient to use a laundry service or to have someone else shovel your driveway, but if you're physically capable of doing these things yourself. Think about the money you can save.
If you're not very handy, try to teach yourself to do more around the house. If you need a simple repair done, you may be able to watch a video online or take a class at a local home improvement store to learn how to do it yourself.
8. Save money on energy. Go green around the house to save money on your utility bills each month.
Sealing up air gaps can reduce your heating and cooling bills. If you own your home, investing in a properly insulated attic can make a huge difference.
Turning your heat down just a few degrees in the winter can make a big difference in your energy bills as well. A programmable thermostat will let you automate the temperature of your house so you won't spend money on heating the place to a comfortable level when you're not at home.
9. Avoid bank and credit card fees. Choose your bank and credit card providers wisely in order to avoid unnecessary fees.
Make sure to only use the ATM at your bank if you will get charged for using outside ATMs.
10. Aim to have a few no-spend days a month. After a while, it becomes a game: "How can I run my life today without writing anything down in my little blue book?" "How ingenious can I be to make do with the things, food, and resources I already have at my disposal?" See how often you can turn this into a habit.

Part 4 Earning More.
1. Get a better job. If spending less is just not enough, it may be time to get a better job that will allow you to make more money. Start by updating your resume, searching for listings online, and networking with other professionals in your field.
Don't forget to look for advancement opportunities within your company.
2. Do something else on the side. Using your skills to provide freelance or consulting services is a great way to earn additional income. If this won't work with your profession, get a part-time job or find creative ways to make some extra cash on the side.
You can make some extra money by performing jobs like mowing lawns, cleaning houses, or even walking dogs for people in your neighborhood.
3. Sell stuff you don't need. You probably have at least a few possessions that you no longer need or want, and you can turn those items into extra cash by selling them to people who do want them.
If you have lots of unwanted items, try having a yard sale.

Community Q&A.

Question : My family barely has any money. My dad has his own company, but it hasn't gotten any business in a long time. I have some money saved up, and I was think of leaving a little in my dad's wallet. What do you think?
Answer : Definitely do. Work as much as you can and give and much as you can. Also putting your family's money in a good, interest-bearing account can help a lot.

Tips.

To always have money in the bank to pay regular bills, add them up for the past year and divide by 52. Round up to the next 25, 50, or 100 dollars. Remember to add in quarterly or annual bills, too.
Buy clothes that can be used for several different occasions instead of only one-time events.
Use coupons on items whenever you can.
Start a Christmas Club account, but put in more than you expect to spend on gifts. The excess is great for a mini-vacation or special purchase.
Get a jar to collect your spare change. When it's full, take it to the bank. (Don't take it to one of those coin counters, as they charge for counting your change.)
Take it a day at a time. Start small, set goals, reward yourself (not with any type of shopping, of course) and enjoy playing the game.

July 02, 2020

How to Work out a Rental Yield

How to Work out a Rental Yield.

Rental yield, essentially, tells you how much you can expect to earn from an investment property that you're renting out. It's typically expressed as a percentage of the cost of the property. You can use this figure to determine if a property you're thinking about buying would be a good investment or to understand your return on investment (ROI) in a property you already own. This figure is also helpful if you're trying to decide if a "buy-to-let" mortgage is affordable for you. To work out the rental yield, you need to know the total costs of buying and owning the property as well as the amount of rent you'll collect.

Method 1 Totaling Property Costs.
1. Calculate your yearly mortgage payments. If you have a mortgage on the property, total the mortgage payments you would make over the course of a year, including interest, taxes, and any associated fees. These payments are part of your cost of owning the property.
Even if you don't have a mortgage, you're likely still responsible for property taxes on the property. Those would also be considered part of your costs of ownership.
If you don't own the property yet, use an estimate of mortgage payments or get an offer from a mortgage company for the property and use that number instead.
2. Get a quote for insurance. If you rent out the property, you'll typically need landlord insurance, which may have different rates than homeowner's insurance. If you don't already own the property, a quote from a reputable insurer will help you estimate this cost.
In addition to landlord's insurance, you may also want to consider other types of insurance to cover damage to the property.
Rent insurance may also be available to you, which provides you some money in the event your tenant breaks their lease or needs to be evicted for nonpayment of rent.
3. Include any management fees or other property expenses. If you've hired a management company to run the property on your behalf, their fees are considered part of your costs. You may also have other property expenses or fees, depending on where the property is located.
For example, if you only own the building but not the land, you may have to pay rent for the land that the property sits on.
If you have a unit in an apartment building or condominium complex, you may also have association fees to consider.
Tip: Include in this category expenses you might incur in the event you have to advertise for a tenant. Fees for listing the property or doing background checks on tenants are also costs of owning and renting the property.
4. Estimate costs for repairs and maintenance. Over the course of the year, your tenant may have things break that need to be repaired. While you can't necessarily predict all of these expenses, you can typically come up with a reasonable estimate based on the age of the property and its fixtures.
You also want to consider major repairs that may be necessary in the event of a natural disaster or other event. While your insurance may cover some of this expense, you'll likely still have to pay a deductible.

Method 2 Determining Gross Rental Yield.
1. Total your yearly rental income. Evaluate how much you charge in rent, then multiply that amount to get the total rent you'll collect each year. If you collect weekly rent, multiply the weekly rent amount by 52. For monthly rent, multiply by 12.
For example, if you rent the property out for $500 a week, you would have an annual rental income of $26,000.
2. Find the current value of the property. If you plan to purchase the property this year, the value of the property would be equal to your purchase price. However, if you already own the property, use the most recent appraisal to determine the current value.
If you're looking at a property for sale, use the asking price as the value of the property, even if you think the asking price is too high and plan to make a lower bid on it.
3. Divide the rental income by the value to find the gross rental yield. Once you have those two figures, complete the equation. Your result will be a decimal value. Multiply that number by 100 to get a percentage.
For example, if your yearly rental income is $26,000 and the property is valued at $360,000, you have a gross rental yield of 7.2%. Gross rental yield is considered ideal if it's somewhere between 7 and 9%, so the gross rental yield for that property is good. Any lower than that, and you likely wouldn't have the cash flow in the event emergency repairs were needed.
Warning: While gross rental yield is easy to calculate, it doesn't take a lot of other factors into account that can affect the investment value of a property, such as the property's location, age, or condition.

Method 3 Calculating Net Rental Yield.
1. Start with your total yearly rental income. Just as when working out gross rental yield, you'll need the total rent you collect from the property in a year. Multiply weekly rent by 52 and monthly rent by 12 to find the annual amount.
For example, if you rented a condominium for $2,000 a month, your annual rental income would be $24,000.
Tip: Net rental yield is typically calculated at the end of the year, looking back at real numbers. If the property was vacant for any period during the year, don't include the rent you would have received for that time in your yearly rental income total.
2. Subtract your annual expenses from the rental income. For net rental yield, you'll also take into account the other costs of owning the property. Include all fees, mortgage payments, interest, taxes, insurance premiums, and other costs associated with the property for the year. Typically these will be monthly expenses, so don't forget to multiply them by 12 to get the annual total.
For example, suppose your annual rental income was $24,000 and the condominium unit cost you $900 a month to maintain. Your annual cost to own the property would be $10,800. When you subtract $10,800 from $24,000, you get $13,200.
3. Divide the result by the current value of the property. The current value of the property is not your mortgage payment, which likely includes interest, taxes, and other fees. Instead, look at the value of the most recent appraisal of the property. That's the amount you could likely sell the property for.
For example, suppose the condominium you own is worth $250,000. You have an annual rental income of $24,000 for the property, which decreased to $13,200 by the costs of owning the property. When you divide $13,200 by $250,000, you get 0.0528.
4. Multiply by 100 to find your net rental yield. Net rental yield, like gross rental yield, is expressed as a percentage of the value of the property. To get that percentage, take the decimal you got when you divided the annual rental income less costs by the current value of the property and multiply it by 100.
To continue the example, if you had annual rental income less costs of $13,200 divided by $250,000, you would have a net rental yield of 5.28%. This is considered a relatively low rental yield, but might still be sustainable depending on the location of the property or your reasons for owning it.

Community Q&A.

Question : When you say an acceptable yield is 7-9%, are you referring to the gross yield or the net yield?
Answer : A yield of 7 to 9% is considered a good yield regardless of whether it is a gross yield or a net yield. The net yield simply gives you more information about the actual cost of owning and managing the property. A property with a gross yield of 7 to 9% may have a much lower net yield, for example, if the property needed extensive renovations or repairs. In that case, it likely wouldn't be a worthwhile investment. However, a lower net yield might be acceptable depending on your reasons for owning the property and its location. For example, you might be willing to take a lower yield in a high-growth area where the property was rapidly appreciating in value.
Question : Does net yield include interest-only costs to the bank?
Answer : Net yield includes all costs of owning the property. If you have a mortgage on the property and are paying interest on that mortgage, those costs would be subtracted from your annual rental income along with all the other costs.
Question : What is the acceptable yield?
Answer : It depends on your goals. I'd say an acceptable average would be a 7-9% yield, but you may be happy taking as low as 4% if it's just supporting a pension, or if the property is located in an up-and-coming area where the value will increase significantly over time.
Question : Is there a good online calculator that will do this for me?
Answer : Excel or Google Docs can do this for you. Both are very good at it and keep track of it too. They both allow you to manipulate data to extract even more information.

Tips.

Work out your rental yield at least once a year. It will change depending on operating expenses and changes in the value of your property. Keeping tabs on your rental yield will help you determine when it's best to sell the property.
There are many real estate and finance companies that offer free rental yield calculators online. Simply search for "rental yield calculator" followed by the name of your country. The country name is necessary to ensure the calculator uses the same currency as you.

Warnings.

If you're comparing investment properties to buy, look at the property's past appreciation and potential to appreciate in the future as well as its rental yield. A high rental yield doesn't necessarily equate to a good investment if the property is in an undesirable area.

June 04, 2020

How to Use the Rule of 72

How to Use the Rule of 72.

The Rule of 72 is a handy tool used in finance to estimate the number of years it would take to double a sum of money through interest payments, given a particular interest rate. The rule can also estimate the annual interest rate required to double a sum of money in a specified number of years. The rule states that the interest rate multiplied by the time period required to double an amount of money is approximately equal to 72.
The Rule of 72 is applicable in cases of exponential growth, (as in compound interest) or in exponential "decay," as in the loss of purchasing power caused by monetary inflation.

Method 1 Estimating "Doubling" Time.
1. Let R x T = 72. R is the rate of growth (the annual interest rate), and T is the time (in years) it takes for the amount of money to double.
2. Insert a value for R. For example, how long does it take to turn $100 into $200 at a yearly interest rate of 5%? Letting R = 5, we get 5 x T = 72.
3. Solve for the unknown variable. In this example, divide both sides of the above equation by R (that is, 5) to get T = 72 ÷ 5 = 14.4. So it takes 14.4 years for $100 to double at an interest rate of 5% per annum. (The initial amount of money doesn't matter. It will take the same amount of time to double no matter what the beginning amount is.)
4. Study these additional examples:
How long does it take to double an amount of money at a rate of 10% per annum? 10 x T = 72. Divide both sides of the equation by 10, so that T = 7.2 years.
How long does it take to turn $100 into $1600 at a rate of 7.2% per annum? Recognize that 100 must double four times to reach 1600 ($100 → $200, $200 → $400, $400 → $800, $800 → $1600). For each doubling, 7.2 x T = 72, so T = 10. So, as each doubling takes ten years, the total time required (to change $100 into $1,600) is 40 years.

Method 2 Estimating the Growth Rate.
1. Let R x T = 72. R is the rate of growth (the interest rate), and T is the time (in years) it takes to double any amount of money.
2. Enter the value of T. For example, let's say you want to double your money in ten years. What interest rate would you need in order to do that? Enter 10 for T in the equation. R x 10 = 72.
3. Solve for R. Divide both sides by 10 to get R = 72 ÷ 10 = 7.2. So you will need an annual interest rate of 7.2% in order to double your money in ten years.

Method 3 Estimating Exponential "Decay" (Loss).
1. Estimate the time it would take to lose half of your money (or its purchasing power in the wake of inflation). Let T = 72 ÷ R. This is the same equation as above, just slightly rearranged. Now enter a value for R. An example.
How long will it take for $100 to assume the purchasing power of $50, given an inflation rate of 5% per year?
Let 5 x T = 72, so that T = 72 ÷ 5 = 14.4. That's how many years it would take for money to lose half its buying power in a period of 5% inflation. (If the inflation rate were to change from year to year, you would have to use the average inflation rate that existed over the full time period.)
2. Estimate the rate of decay (R) over a given time span: R = 72 ÷ T. Enter a value for T, and solve for R. For example.
If the buying power of $100 becomes $50 in ten years, what is the inflation rate during that time?
R x 10 = 72, where T = 10. Then R = 72 ÷ 10 = 7.2%.
3. Ignore any unusual data. If you can detect a general trend, don't worry about temporary numbers that are wildly out of range. Drop them from consideration.

Method 4 Derivation.
1. Understand how the derivation works for periodic compounding.
For periodic compounding, FV = PV (1 + r)^T, where FV = future value, PV = present value, r = growth rate, T = time.
If money has doubled, FV = 2*PV, so 2PV = PV (1 + r)^T, or 2 = (1 + r)^T, assuming the present value is not zero.
Solve for T by taking the natural logs on both sides, and rearranging, to get T = ln(2) / ln(1 + r).
The Taylor series for ln(1 + r) around 0 is r - r2/2 + r3/3 - ... For low values of r, the contributions from the higher power terms are small, and the expression approximates r, so that t = ln(2) / r.
Note that ln(2) ~ 0.693, so that T ~ 0.693 / r (or T = 69.3 / R, expressing the interest rate as a percentage R from 0-100%), which is the rule of 69.3. Other numbers such as 69, 70, and 72 are used for easier calculations.
2. Understand how the derivation works for continuous compounding. For periodic compounding with multiple compounding per year, the future value is given by FV = PV (1 + r/n)^nT, where FV = future value, PV = present value, r = growth rate, T = time, and n = number of compounding periods per year. For continuous compounding, n approaches infinity. Using the definition of e = lim (1 + 1/n)^n as n approaches infinity, the expression becomes FV = PV e^(rT).
If money has doubled, FV = 2*PV, so 2PV = PV e^(rT), or 2 = e^(rT), assuming the present value is not zero.
Solve for T by taking natural logs on both sides, and rearranging, to get T = ln(2)/r = 69.3/R (where R = 100r to express the growth rate as a percentage). This is the rule of 69.3.
For continuous compounding, 69.3 (or approximately 69) gives more accurate results, since ln(2) is approximately 69.3%, and R * T = ln(2), where R = growth (or decay) rate, T = the doubling (or halving) time, and ln(2) is the natural log of 2. 70 may also be used as an approximation for continuous or daily (which is close to continuous) compounding, for ease of calculation. These variations are known as rule of 69.3, rule of 69, or rule of 70.
A similar accuracy adjustment for the rule of 69.3 is used for high rates with daily compounding: T = (69.3 + R/3) / R.
The Eckart-McHale second order rule, or E-M rule, gives a multiplicative correction to the Rule of 69.3 or 70 (but not 72), for better accuracy for higher interest rate ranges. To compute the E-M approximation, multiply the Rule of 69.3 (or 70) result by 200/(200-R), i.e., T = (69.3/R) * (200/(200-R)). For example, if the interest rate is 18%, the Rule of 69.3 says t = 3.85 years. The E-M Rule multiplies this by 200/(200-18), giving a doubling time of 4.23 years, which better approximates the actual doubling time 4.19 years at this rate.
The third-order Padé approximant gives even better approximation, using the correction factor (600 + 4R) / (600 + R), i.e., T = (69.3/R) * ((600 + 4R) / (600 + R)). If the interest rate is 18%, the third-order Padé approximant gives T = 4.19 years.
To estimate doubling time for higher rates, adjust 72 by adding 1 for every 3 percentages greater than 8%. That is, T = [72 + (R - 8%)/3] / R. For example, if the interest rate is 32%, the time it takes to double a given amount of money is T = [72 + (32 - 8)/3] / 32 = 2.5 years. Note that 80 is used here instead of 72, which would have given 2.25 years for the doubling time.


FAQ.
Question : When would I need to use the rule of 72?
Answer : It's a handy shortcut when considering compounded, monetary gains or losses. For example, you might want to know how long it would take for invested money to double in value, given a specific rate of interest.
Question : How do I calculate compound interest?
Answer : The formula for annual compound interest (A) is: P [1 + (r / n)]^(nt), where P=principal amount, r = the annual interest rate as a decimal, n = the number of times the interest is compounded per year, and t = the number of years of the loan or investment.
Question : What is APY for an APR of 3.5% compounded?
Answer : It depends on how often the interest compounds: annually, semi-annually, quarterly, monthly or daily.

Tips.

Let the Rule of 72 work for you by starting to save now. At a growth rate of 8% a year (the approximate rate of return in the stock market), you would double your money in nine years (72 ÷ 8 = 9), quadruple your money in 18 years, and have 16 times your money in 36 years.
The value of 72 was chosen as a convenient numerator in the above equation. 72 is easily divisible by several small numbers: 1,2,3,4,6,8,9, and 12. It provides a good approximation for annual compounding at typical rates (from 6% to 10%). The approximations are less exact at higher interest rates.
You can use Felix's Corollary to the Rule of 72 to calculate the "future value" of an annuity (that is, what the annuity's face value will be at a specified future time). You can read about the corollary on various financial and investing websites.

Warnings.
Let the rule of 72 convince you not to take on high-interest debt (as is typical with credit cards). At an average interest rate of 18%, semiretired credit card debt doubles in just four years (72 ÷ 18 = 4), quadruples in eight years, and becomes completely unmanageable after that.

April 10, 2020

How to Build a Diversified Portfolio

How to Create a Profitable Property Portfolio.

You've been thinking about investing in property. Although investing in real estate can be an overwhelming thought for some people, it can also bring great rewards. You may want to consider investing as a way to create cash flow or build a nice nest egg. Becoming profitable in investing requires a certain degree of skill and know-how, but once you stick your toe in the water, you may become hooked.

Method 1 Planning and Researching.
1. Know why you’re buying. Before you buy an investment property, you need to consider your investment strategy. Put some thought into what type of investment interests you and meets your needs. Perhaps you would like to diversify your holdings besides stocks and bonds. Maybe you would just like to build your wealth or improve your cash flow. Whatever your reasons are for wanting to invest, it is good to be clear on them before you start. A few common reasons for investing in real estate include the following:
You want to increase your current income. Getting a monthly rent check, for example, can give your income a boost.
You're interested in capital gain — buying a property and later profiting from its sale.
You want to take advantage of the tax write-offs that come with real estate investments.
2. Learn about the various types of real estate investments. Ask yourself how much time you are willing to invest in managing the property, and whether you have the necessary skills to manage the property. Different types of investments have different risks and rewards, so it's important to consider which type of investment best meets your needs. Consider these investment choices:
Raw land investments. Raw land requires little management and has the potential for big appreciation if it's in an area that becomes attractive to developers. However, there is limited cash flow from this investment through leasing to farmers/ranchers short term, mineral royalties if included in purchase, or appreciation. Also, government restrictions on how the land may be used can impact its value.
Residential real estate investments. Fixing up a residence and "flipping" it is a popular type of investment. The profitability of this type of investment is dependent on the state of the local housing market; location is very important.
Commercial real estate investments. Investing in commercial real estate, such as an apartment building, office building, or retail building, can yield a steady flow of cash, since you'll be getting a regular rent check from your tenants. However, the property requires significant upkeep to make sure it's up to code. You also run the risk of getting bad tenants who damage the property or do not pay rent on time.
3. Decide whether to flip or hold the property. "Flipping" generally applies to residential properties that are purchased, improved, and sold for higher price. Most real estate requires long term holding, and is not conducive to short-term trading. When considering what type of investment to make, determine which situation works best for you.
Consider whether you need additional income now or in the future.
Review your short- and long-term financial goals and if bringing in income now makes sense for you.
Factor in your income tax bracket and how that could be adversely affected by bringing in more income.
Consider the real estate market and if it is rising or falling at this time.
Evaluate your financial situation and see if you have other income that you can tap into if your rental properties become vacant.
Think about your available time and capabilities to manage or improve properties. Using third parties for such services may decrease expected return.
4. Obtain statistics on the town in which you are considering investing. Check the local state government website about the area you are targeting to see how it compares to other locations. It is important to have as much information and knowledge as possible on property investing before you dive in.
Find out the local median income.
Research the population growth of the area.
See what the unemployment statistics are in the area.
Check to see if the community is continuing to grow.
Find out what the real estate taxes are compared to nearby towns.
See if there is a supply and demand of rentals in the area.
Check out the schools to see how good they are.
5. Research online or take a course. A lot of research can be done online, but you may also check your local directory and sign up for a reputable real estate investment course or seminar. Make sure you bring some paper and a pen so you can jot down notes as you listen to the experts speak.
6. Work with a local realtor, property investor, or developer who also invests in real estate. Someone who has been investing on his own will know the pitfalls from his own first hand experience. A realtor with substantial knowledge in investing can teach you as you go along and help make you feel more comfortable with the process. However, remember the money you are investing is yours, not the realtors, so trust your intuition.

Method 2 Pinpointing your Property Needs.
1. Decide on your location. When you are searching for your investment area, look for a place that has clear signs of growth and economic stability. If you aren’t familiar with the area, take a drive around the town or city and get to know it. Check to see if there is adequate shopping and amenities close by. If you like the area and what it has to offer, chances are your renters will too.
2. Pick the right property. See if the properties you are interested in have desirable features, like a great view or ample parking. If so, take that into consideration. There are other issues to consider when picking your property, as well.
If you're deciding between investing in a house or an apartment, keep in mind that houses seem to have a better capital growth rate and apartments tend to have a better rental yield.
Also, the quality of the neighborhood in which you buy will most likely influence the type of tenants you attract. For example, if you buy near a college, you may be renting to students. There is a possibility of vacancies in the summer when the students return home.
Make sure you find out what the property taxes are. Take into consideration that high property taxes may not be such a bad thing if the property is in an excellent area and suited for long-term tenants.
Check to see if the area has any criminal activity. Go to the local police department to learn about the specific area you are interested in. Things to ask about might include vandalism, gang activity or any recent serious crimes. You have a better chance of finding out the facts from the police department, than from the person selling you the property.
Make sure the property isn't in a natural disaster zone. The insurance on the property can get pricey if you are in a questionable area so it is worth checking into. Many property owners are underinsured for natural disasters which can lead to devastating property loss in the event of a major storm or earthquake.
3. Have your property inspected by a professional inspector. You want to make sure the property is in good shape and has up-to-date repairs. You are looking for a property that, with a few minor repairs, will attract tenants who are willing to pay higher rents. In addition, find a contractor who you trust to give you the right advice on any repairs that may be required, especially for older properties. There are some things that you can check yourself, however.
Check the drains to make sure there are no problems with flooding.
Open and close all the windows to make sure they are in working order.
Turn on all the faucets to make sure they are working.
Light a fire in the fireplace to see if it's working.
Flush the toilets to make sure they flush properly.
Open the electrical panel and make sure there are no loose wires.
Turn on the heat and air conditioning to see if they work.
Make sure there is no basement moisture as this can be a sign that there is a more serious problem.
Pull the carpet back to see if there are hardwood floors underneath.
4. Know your target tenant. If you're investing in commercial real estate, your choice of tenant should influence the type of property you buy and where you decide to buy it. For example, families with children will potentially be interested in different amenities than young, single people.
See if the property is near any schools.
Check to see if there are any parks in the neighborhood.
See if the shops and cafes are within walking distance.
Find out how close the transportation options are.

Method 3 Examining the Finances.
1. Check into your credit history. Make a plan to get your credit in better shape if necessary. Having a good credit score will help you secure a loan with better terms. If your credit is compromised, check your local listings for agencies or nonprofit organizations that can help you clean it up.
2. Decide how you will finance your property. There are several ways to begin investing in your property portfolio. You may consider selling an asset or refinancing a property to get the funds. If you're investing in raw land, it's common to get financing from the seller. You may also choose to take out bank loans to finance your property.
If you have the money, you can pay all cash, or you can put down a percentage and get a loan for the remaining amount.
There are different loan requirements depending on the bank and your financial history.
3. Visit with a mortgage broker or your bank. Find out how much money you can afford to borrow responsibly for your investment. The quickest way to find out if you can afford a loan is to ask the bank. If you get a "no" from your bank, then consider trying another one as each bank is different in their approach. You may also consider looking into a credit union or a smaller bank to get your loan through.
4. Find properties that produce positive cash flow. Unless the property has good cash flow, there is really no reason to consider purchasing it. Examine the financials on the property to make sure it is supplying a good source of income. The rent you receive from your tenants should be enough to pay all of your expenses, including your mortgage payment, utilities, property taxes, and insurance.
This excludes raw land investments, which generally yield no income unless leased for farming or another purpose.
5. Examine your investment expenses. A common mistake first time investors make is underestimating their expenses. Rental buildings are always needing touch ups and repairs. There are several areas of expense to factor in when considering your purchase. The amounts will vary depending on the property.
Water and sewer, Garbage, Utilities, Legal fees and accounting, Evictions, Vacancies, Scheduled maintenance.
6. Consider hiring a property manager. You may want to factor in a salary for a property manager if you don’t have the personality, skills, and availability to manage your own property. There are many benefits to hiring a property manager.
The manager advertises and rents for you and will show your property when vacancies arise.
The manager meets with prospective tenants and handles all of your lease agreements.
The manager collects the rent from the tenants and performs the move-in and move-out inspections.
The manager deals with all the tenants complaints.
The manager serves legal notices in the case of a dispute and starts the eviction process if necessary.
The manager usually has a list of reliable contractors that he or she has used before.

FAQ.

Question : How would I stay up to date on pertinent laws, regulations, and real estate terminology?
Answer : Become a member of an apartment owners association. If they are very large, they will send you magazines that have all the new problems that laws are causing for home owners and what they need to do to avoid these problems.

Tips.
Take your time doing the research. Rushing into a property purchase without significant knowledge may bring unwanted results.
If you are considering buying with a partner, make sure you have a proper partnership or joint venture agreement.
Don’t be afraid to walk away if the deal isn't working out.
Stay up to date with pertinent laws, regulations and real estate terminology.
Understand the risk you are taking when becoming a real estate investor. Success is not always guaranteed.
Find a mentor, lawyer or a supportive friend that has experience in investing to bounce your ideas off of.

April 01, 2020

How to Finance Investment Property

How to Finance Investment Property.

You might find the perfect investment property, but before you can buy it you need to obtain financing. Many people will go to a bank and ask for a conventional loan with a repayment period of 25-30 years. Before doing so, however, you should analyze your credit history to check that you are a good credit risk. You have more options than simply relying on a conventional loan. For example, you could cash out the equity in your home or seek owner financing of the investment property.

Method 1 Obtaining a Conventional Loan.

1. Pull together a down payment. You can’t rely on mortgage insurance to cover your investment property. Accordingly, you will need a sizeable down payment, around 20-25%.

2. Consider a neighborhood bank. Smaller banks might be more flexible about lending to you if you don’t have a large down payment or if your credit score isn’t perfect. Local banks also may have a stronger interest in lending for local investment, so they are a good option.

You might not know anything about smaller lenders, so you should do as much research as possible. Ask people that you know whether they have ever done business with the bank.

You can also check online. Look for reviews.

3. Gather necessary paperwork. Before approaching a lender, you should pull together required paperwork. Doing so ahead of time will speed up the process. Get the following.

two months of bank statements, prior two months’ statements for investment accounts and retirement accounts, last two pay stubs.

information about self-employed income, such as last two year’s tax returns or business financial statements, driver’s license.

Social Security card, papers related to bankruptcy, divorce, or separation (if applicable).

4. Work with a mortgage broker. A mortgage broker will apply for loans on your behalf with many different lenders and will compare the rates. The broker can also try to negotiate better terms for you. Using a mortgage broker is a good idea if you are too busy to comparison shop by going to many different lenders.

Mortgage brokers don’t work for free. You typically will pay about 1% of the loan amount. For example, if you borrow $250,000, then you can expect to pay around $2,500 to the mortgage broker.

You can ask other investors or a real estate agent for a referral to a broker. Before hiring, make sure that you interview the person and ask how much experience they have and what services they offer.

5. Compare loans. If you don’t want to work with a mortgage broker, then you will need to educate yourself about the basics of home financing. You might be an experienced pro who has borrowed before. However, if you haven’t, then remember to consider the following when comparing loans.

Interest rates. An interest rate is a percent of the loan amount that you pay as a privilege for borrowing the money. Interest rates can be fixed for the entire length of the loan or fixed for only a portion of the loan term.

Discount points. For some loans, you can pay points, which will lower your interest rate.

Loan term. This is the length of the loan. A shorter loan will cost more each month, but you will pay it off sooner and with less interest.

Origination charge. This amount of money covers document preparation, fees, and the costs of underwriting the loan.

6. Seek pre-approval. You should try to get pre-approved for a loan before searching for properties. Make sure to request the pre-approval in writing because sellers might want to see that you are pre-approved.

7. Don’t forget other team members. Purchasing investment property requires the expertise of many different professionals. You should begin assembling your team early—even before you get financing. You will probably need the help of the following people.

An accountant who can help you understand investment tax strategies.

A realtor who can help you sign an appropriate real estate contract.

An attorney who can help you protect your assets, for example by forming a limited liability company to hold the property.

An insurance agent.

Method 2 Using Other Finance Options.

1. Use the equity in your home. You might be able to use the equity in your current home to purchase an investment property. Generally, you can borrow around 80% of your home’s value. There are different ways you can tap the equity in your home, such as the following.

You could get a Home Equity Line of Credit (HELOC). A lender will approve you for a specific amount of credit, and you use your current home as collateral for the loan. The credit is available for a certain amount of time. At the end of this draw period, you must have paid back the loan.

You might also get a cash-out refinance. The lender will pay you the difference between the mortgage and the home’s value, but is usually limited to 80-90% of the home’s value. For example, if you have $20,000 remaining on your mortgage, but your home is valued at $220,000, then $200,000 could be available. You could get 80-90% of $200,000 ($160,000-180,000). This option usually has a lower interest rate than a HELOC.

Both a HELOC and a cash-out refinance put your home at risk if you can’t make repayments. For this reason, you should think carefully before tapping the equity in your home to finance investments.

2. Obtain a fix-and-flip loan. You might be able to get this type of loan if you want to purchase a property in order to renovate and then quickly sell. The loan will be short-term and is secured by the property. Fix-and-flip loans have high interest rates, so you need to renovate and sell quickly.

You might find it easier to qualify for a fix-and-flip loan compared to a conventional loan. However, lenders will still look at your credit history and income.

The lender will also want to know the estimated value after repair, which can impact whether they extend you a loan and the terms.

3. Research peer-to-peer lending sites. Peer-to-peer lending connects investors with lenders who are willing to lend. Two of the more well-known peer-to-peer lending sites are Prosper and LendingClub.

Peer-to-peer lenders will require that you complete an application. They look at your credit score and credit history. They may also have minimum credit scores in order to qualify.

You might not be able to get a large personal loan through peer-to-peer lending. However, small businesses can typically borrow more, so if you create an LLC then you might be able to borrow up to $100,000.

4. Find a business partner. You might not be able to secure a loan on your own, in which case you will need to consider other options. One option is to find a business partner who you can invest with.

You will want to screen any potential business partner, just as a bank would screen you. If you are counting on the partner to help pay for the loan, then you will need to check their credit history and employment.

You also need to consider how you will hold the investment property. For example, it might be best to create an LLC and to both be owners of the LLC. The LLC will then hold title to the investment property.

5. Consider owner financing. With owner financing, the owner lends you the money that you use to buy the property. Sometimes the owner will lend only a portion of the price, which you then supplement with a conventional loan. You should analyze the pros and cons of owner financing.

A benefit of owner financing is that an owner might be willing to lend if you don’t have perfect credit or a huge down payment available. You and the owner can work out loan terms that are acceptable to both of you.

Typically, the seller’s loan will be for a short period of time (such as five years). At the end of the term, you are obligated to pay off the loan with a “balloon payment.” This usually means you need to get a conventional loan to make this balloon payment. You should analyze your credit to see if you can qualify for a conventional loan in the near future.

See Owner Finance a Home for more information.

Method 3 Analyzing Your Credit Score.

1. Obtain a free copy of your credit report. Your credit score will have the largest impact on your ability to get a loan, so you should obtain a copy of your credit report.[18] You are entitled to one free credit report each year from the three national Credit Reporting Agencies (CRAs). You shouldn’t contact the CRAs individually. Instead, you can get your free copy from all three using one of the following methods.

Complete the Annual Credit Report Request Form, which is available here: https://www.consumer.ftc.gov/articles/pdf-0093-annual-report-request-form.pdf. Once completed, submit the form to Annual Credit Report Request Service, PO Box 105281, Atlanta, GA 30348-5281.

2. Find errors on your credit report. You should closely look at you credit reports to find any errors that might lower your credit score. If your score is below 740, then you will probably have to pay more to borrow. For this reason, you should do whatever you can to increase the score. Look for the following errors.

credit information from an ex-spouse, credit information from someone with a similar name, address, Social Security Number, etc.

incorrect payment status (e.g., stating you are late when you aren’t), a delinquent account reported more than once.

old information that should have fallen off your credit report, an account inaccurately identified as closed by the lender.

failure to note when delinquencies have been remedied.

3. Consider whether you should fix certain problems. There may be negative information on your credit report that you want to fix. For example, you might want to pay an old collections account. However, you should think carefully before fixing certain problems.

Negative information must fall off your credit report after a certain amount of time. For example, an account in collections should fall off after seven years. If the account is six years old, you might want to wait and let it fall off rather than pay it off.

If you need help considering what to do, then you should consult with an attorney who can advise you.

4. Fix errors. You can correct errors by contacting each CRA online or by writing a letter. To protect yourself, you should probably do both. Mail your letter certified mail, return receipt requested.

The Federal Trade Commission has a sample letter you can use: https://www.consumer.ftc.gov/articles/0384-sample-letter-disputing-errors-your-credit-report.

See Dispute Credit Report Errors for more information on how to fix errors.

December 15, 2019

how to finance investment property

How to Finance Investment Property.

You might find the perfect investment property, but before you can buy it you need to obtain financing. Many people will go to a bank and ask for a conventional loan with a repayment period of 25-30 years. Before doing so, however, you should analyze your credit history to check that you are a good credit risk. You have more options than simply relying on a conventional loan. For example, you could cash out the equity in your home or seek owner financing of the investment property.

Method 1 Obtaining a Conventional Loan.

1. Pull together a down payment. You can’t rely on mortgage insurance to cover your investment property. Accordingly, you will need a sizeable down payment, around 20-25%.

2. Consider a neighborhood bank. Smaller banks might be more flexible about lending to you if you don’t have a large down payment or if your credit score isn’t perfect. Local banks also may have a stronger interest in lending for local investment, so they are a good option.

You might not know anything about smaller lenders, so you should do as much research as possible. Ask people that you know whether they have ever done business with the bank.

You can also check online. Look for reviews.

3. Gather necessary paperwork. Before approaching a lender, you should pull together required paperwork. Doing so ahead of time will speed up the process. Get the following.

two months of bank statements, prior two months’ statements for investment accounts and retirement accounts, last two pay stubs.

information about self-employed income, such as last two year’s tax returns or business financial statements, driver’s license.

Social Security card, papers related to bankruptcy, divorce, or separation (if applicable).

4. Work with a mortgage broker. A mortgage broker will apply for loans on your behalf with many different lenders and will compare the rates. The broker can also try to negotiate better terms for you. Using a mortgage broker is a good idea if you are too busy to comparison shop by going to many different lenders.

Mortgage brokers don’t work for free. You typically will pay about 1% of the loan amount. For example, if you borrow $250,000, then you can expect to pay around $2,500 to the mortgage broker.

You can ask other investors or a real estate agent for a referral to a broker. Before hiring, make sure that you interview the person and ask how much experience they have and what services they offer.

5. Compare loans. If you don’t want to work with a mortgage broker, then you will need to educate yourself about the basics of home financing. You might be an experienced pro who has borrowed before. However, if you haven’t, then remember to consider the following when comparing loans.

Interest rates. An interest rate is a percent of the loan amount that you pay as a privilege for borrowing the money. Interest rates can be fixed for the entire length of the loan or fixed for only a portion of the loan term.

Discount points. For some loans, you can pay points, which will lower your interest rate.

Loan term. This is the length of the loan. A shorter loan will cost more each month, but you will pay it off sooner and with less interest.

Origination charge. This amount of money covers document preparation, fees, and the costs of underwriting the loan.

6. Seek pre-approval. You should try to get pre-approved for a loan before searching for properties. Make sure to request the pre-approval in writing because sellers might want to see that you are pre-approved.

7. Don’t forget other team members. Purchasing investment property requires the expertise of many different professionals. You should begin assembling your team early—even before you get financing. You will probably need the help of the following people.

An accountant who can help you understand investment tax strategies.

A realtor who can help you sign an appropriate real estate contract.

An attorney who can help you protect your assets, for example by forming a limited liability company to hold the property.

An insurance agent.

Method 2 Using Other Finance Options.

1. Use the equity in your home. You might be able to use the equity in your current home to purchase an investment property. Generally, you can borrow around 80% of your home’s value. There are different ways you can tap the equity in your home, such as the following.

You could get a Home Equity Line of Credit (HELOC). A lender will approve you for a specific amount of credit, and you use your current home as collateral for the loan. The credit is available for a certain amount of time. At the end of this draw period, you must have paid back the loan.

You might also get a cash-out refinance. The lender will pay you the difference between the mortgage and the home’s value, but is usually limited to 80-90% of the home’s value. For example, if you have $20,000 remaining on your mortgage, but your home is valued at $220,000, then $200,000 could be available. You could get 80-90% of $200,000 ($160,000-180,000). This option usually has a lower interest rate than a HELOC.

Both a HELOC and a cash-out refinance put your home at risk if you can’t make repayments. For this reason, you should think carefully before tapping the equity in your home to finance investments.

2. Obtain a fix-and-flip loan. You might be able to get this type of loan if you want to purchase a property in order to renovate and then quickly sell. The loan will be short-term and is secured by the property. Fix-and-flip loans have high interest rates, so you need to renovate and sell quickly.

You might find it easier to qualify for a fix-and-flip loan compared to a conventional loan. However, lenders will still look at your credit history and income.

The lender will also want to know the estimated value after repair, which can impact whether they extend you a loan and the terms.

3. Research peer-to-peer lending sites. Peer-to-peer lending connects investors with lenders who are willing to lend. Two of the more well-known peer-to-peer lending sites are Prosper and LendingClub.

Peer-to-peer lenders will require that you complete an application. They look at your credit score and credit history. They may also have minimum credit scores in order to qualify.

You might not be able to get a large personal loan through peer-to-peer lending. However, small businesses can typically borrow more, so if you create an LLC then you might be able to borrow up to $100,000.

4. Find a business partner. You might not be able to secure a loan on your own, in which case you will need to consider other options. One option is to find a business partner who you can invest with.

You will want to screen any potential business partner, just as a bank would screen you. If you are counting on the partner to help pay for the loan, then you will need to check their credit history and employment.

You also need to consider how you will hold the investment property. For example, it might be best to create an LLC and to both be owners of the LLC. The LLC will then hold title to the investment property.

5. Consider owner financing. With owner financing, the owner lends you the money that you use to buy the property. Sometimes the owner will lend only a portion of the price, which you then supplement with a conventional loan. You should analyze the pros and cons of owner financing.

A benefit of owner financing is that an owner might be willing to lend if you don’t have perfect credit or a huge down payment available. You and the owner can work out loan terms that are acceptable to both of you.

Typically, the seller’s loan will be for a short period of time (such as five years). At the end of the term, you are obligated to pay off the loan with a “balloon payment.” This usually means you need to get a conventional loan to make this balloon payment. You should analyze your credit to see if you can qualify for a conventional loan in the near future.

See Owner Finance a Home for more information.

Method 3 Analyzing Your Credit Score.

1. Obtain a free copy of your credit report. Your credit score will have the largest impact on your ability to get a loan, so you should obtain a copy of your credit report.[18] You are entitled to one free credit report each year from the three national Credit Reporting Agencies (CRAs). You shouldn’t contact the CRAs individually. Instead, you can get your free copy from all three using one of the following methods.

Complete the Annual Credit Report Request Form, which is available here: https://www.consumer.ftc.gov/articles/pdf-0093-annual-report-request-form.pdf. Once completed, submit the form to Annual Credit Report Request Service, PO Box 105281, Atlanta, GA 30348-5281.

2. Find errors on your credit report. You should closely look at you credit reports to find any errors that might lower your credit score. If your score is below 740, then you will probably have to pay more to borrow. For this reason, you should do whatever you can to increase the score. Look for the following errors.

credit information from an ex-spouse, credit information from someone with a similar name, address, Social Security Number, etc.

incorrect payment status (e.g., stating you are late when you aren’t), a delinquent account reported more than once.

old information that should have fallen off your credit report, an account inaccurately identified as closed by the lender.

failure to note when delinquencies have been remedied.

3. Consider whether you should fix certain problems. There may be negative information on your credit report that you want to fix. For example, you might want to pay an old collections account. However, you should think carefully before fixing certain problems.

Negative information must fall off your credit report after a certain amount of time. For example, an account in collections should fall off after seven years. If the account is six years old, you might want to wait and let it fall off rather than pay it off.

If you need help considering what to do, then you should consult with an attorney who can advise you.

4. Fix errors. You can correct errors by contacting each CRA online or by writing a letter. To protect yourself, you should probably do both. Mail your letter certified mail, return receipt requested.

The Federal Trade Commission has a sample letter you can use: https://www.consumer.ftc.gov/articles/0384-sample-letter-disputing-errors-your-credit-report.

See Dispute Credit Report Errors for more information on how to fix errors.

December 15, 2019