Monday, August 24, 2009
Friday, August 21, 2009
You see in the beginning you likely have a small amount of investments so optimization of your investments and related taxes is a minor issue. A 1% lower rate of return on $50,000 is a mere $500 a year or equal to about $42/month. So you could either do a ton of research and self learning on taxes and investments to get that extra 1% return or just stop buying a coffee everyday on the way to work. Guess which one is much easier to do?
So that’s why I’m suggesting don’t worry about everything else in the beginning. Your first priority is to start using frugal ideas and reduce your spending to increase your amount of money for debt repayment and future savings. You start with the big stuff of paying off your credit card debt and work you way down to $2/month savings here and $5/month there. Every dollar counts so look at everything and ask yourself, "does this make me happy for the dollars I’m spending on it or do I require this". Not “would like” or "kinda enjoy it" but rather "I love doing this" and "I need to eat something to keep breathing" kind of thing.
In the beginning you will likely go over kill and cut back too much. That is fine, once you find those areas you really miss spending on go back and put some cashflow back in. After all
FI is a nice goal, but no one should be miserable on the way to getting there. Life is a once through processes so you might as well enjoy the ride.
In the end you will find out how much you really need to spend to make you happy which then you can use to build a real estimate of how much you need to get to FI. Also after this much time you would have likely had some time to slowly learn a bit more about investments and taxes so now you can go back and investigate doing better there. Just don’t try to take on too much all at once, it is recipe to fail to get anything done.
Read books, talk to successful people (make sure they really are successful and not living on time/credit), watch shows and educate yourself. Most people tend to learn from their parents - whether that advice is good or bad does not matter. Ask around and find out what others are doing. That doesn't mean you need to become an expert. Many people do fine as do-it-yourself investors. They don't need an advisor to hold their hands and seem to come out ahead. If you don't see your self in this category, then stick to the basics:
- Pay cash whenever and wherever possible
- Save 10% of your income for emergencies, retirement, child's education
- Pay your bills and live within your means
- Decide on whether an item is a need or want
- Do a budget and stick to it
Stay Well and Pay It Foward.
Tuesday, August 18, 2009
The theory that you should ratchet back on risk as you age is generally a good one. A popular rule of thumb was to subtract your age from 100, the difference being the percentage of stocks you should keep in your portfolio. Then people started living longer, and the target number to subtract from became 110. For example, if you’re age 40, 70 per cent (110 minus 40) of your portfolio should consist of stocks when you're building towards retirement.
Even when you're done working, you'll still likely need to have at least some of your retirement portfolio in stocks to provide inflation-beating growth, however. In fact, some advisors believe the stock allocation shouldn't drop below 50% for many retirees.
But it’s important to realize that close to two thirds of your investment earnings may actually come from post-retirement returns, says Russell Investments Canada. Good news, considering that most investors haven’t been having much luck recently making money before they retire.
Based on Russell’s 10/30/60 ratio, the pattern of your investment earnings during retirement will likely be derived something like this:
- 10% from money you saved during your working years
- 30% from the growth of your savings before you retire
- 60% from growth that occurs once you retire
Because the scheduled withdrawals go up relentlessly every year, they take an increasing bite out of your nest egg. Withstanding that ever-growing bite requires stability, which means minimizing volatility and negative returns like those we’ve seen lately.
The key, therefore, is having the right portfolio mix in place during retirement – one that balances the stability of bonds with the continued growth potential of stocks. What’s the optimal mix? A relatively conservative blend of 35% stocks and 65% bonds, Russell suggests.
How does your portfolio match up?
Stay Well and Pay It Forward
Friday, August 14, 2009
While the information I am about to show you is old, rest assured it will explain the problem/crisis we face in the future. These numbers are from the 2003-2004 fiscal tax year. During that year, the federal government brought in $186B in revenue. The largest single expense that year? Interest payments on Canada’s federal debt (money borrowed by previous federal governments, which has not been repaid). These payments – to institutions and individuals who hold federal bonds, Treasury bills and other forms of the debt – cost $35.8 billion. This represents 19% of all tax revenue.
Transfer Payments are cash payments that go directly to individuals, to provincial and territorial governments, and to other organizations. Overall, these three categories of transfers combined make up just over half of all federal spending, or almost 51 cents of each tax dollar. Of this group, the biggest transfer category was Major Transfers to Persons. Altogether, these payments cost almost 23 cents of every tax dollar. These transfers included payments to eligible elderly Canadians through Old Age Security payments, the Guaranteed Income Supplement and the Spouses Allowance.
Here is a simple point - for every dollar the government brings in, 42 cents goes to pay the debt and provide OAS and related benefits. Now here is the crisis part - what happens when the first wave of baby boomers turn 65. This will lead to lower tax revenues and higher transfer payments. Over the past several years, the federal government has been paying down the deficit at the rate of about $10B per year. The past 12 months changed everything and it is expected to put us back where we began. The federal debt level was still substantial at $467 billion in 2006-07. expect to see a number in the $550 billion range next by 2010.
If you think we have it bad, the US is in much deeper trouble. I found this best illustrated their problems going forward.
Let's turn to the state of the Canada Pension Plan. Canadians currently receiving their CPP benefits have no cause for concern. The plans has a total (March 2009) of $105.5 billion in it's portfolio. In fact, it will be another 11 years before a small portion of the CPP Fund’s investment income will be needed to help pay pensions. Beyond that time, the CPP Fund will continue to grow for decades to come. The $105.5 billion CPP Fund is broadly diversified and structured to help secure Canadians’ CPP pensions over the long-term and the funding structure of the CPP means that it is able to weather an extended market downturn.
CPP contribution levels have increased dramatically over the past 15 years to their current levels of 9.9%. The reason for this was to preserve future benefits. According to the Office of the Chief Actuary of Canada, the CPP fund needs a real rate of return – that’s return after inflation – of 4.2 per cent, over the 75-year projection period in his report, to sustain the plan at the current contribution rate. Over this long time frame we expect that there will be periods where returns are above or below this threshold. In the ten years since the CPP Investment Board began investing, returns for the CPP Fund in all four-year periods prior to fiscal 2009 exceeded the 4.2 per cent real rate of return.
Our mandate is to contribute to the financial strength of the CPP by investing in the best interests of 17 million CPP contributors and beneficiaries and by maximizing returns without undue risk of loss.With approximately 45.5% of our portfolio (or $48.0 billion) invested in Canada, we will always have a large part of the fund invested here but we do not want to be overly dependent on the strength of the Canadian economy and so are systematically looking for opportunities to diversify internationally. But portfolio diversification by asset class and by geography is a fundamental part of the CPP Investment Board’s long-term investment strategy to manage the growing complexity of the fund. On its own, Canada does not provide sufficient diversification opportunities. Canada’s stock market is small, representing less than 2% of the world market capitalization, and it is heavily concentrated in a few sectors. The flow of contributions to the CPP varies directly with the health of the Canadian economy. By reducing the fund’s reliance on the Canadian economy, global diversification offers a source of returns for periods of weak performance by the Canadian economy.Summary
Since the Canada Pension Plan is funded by contributions from it's "members", there are fewer issues of affordability. Nonetheless, as explained in a previous blog, there are changes pending to the plan and the amount of benefits people can/will receive. Expect lower benefits in the future, as well as possible increases in costs. If I were a gambling man, I would bet on CPP being around for 50-100 years. As to the Old Age Security (OAS) program? I think that the future definitely holds some snake eyes.
Stay Well and Pay It Forward.
Tuesday, August 11, 2009
Occasionally, words of wisdom stay with us and remain relevant decades later. When I was in business school in the 1970s, my finance professor used a phrase that I find useful in markets like the one we're in today: "The pendulum never stops in the middle."
He was talking about market valuations and investor sentiment, and the reality that markets inevitably swing from one extreme to another - from periods of outlandishly elevated valuations to ridiculously beaten-down levels, from periods of unquestioning euphoria to absolute pessimism. The adage applies in lots of other cases as well. Look at the market's and the media's attitude to risk and leverage. Not long ago, companies that were fiscally conservative and didn't borrow to the hilt to boost profits were criticized for failing to maximize shareholder value; you may recall some of the commentary about the failure of Canadian will when foreign companies were outbidding our domestic competitors for acquisitions. Many articles were written about how Canadian banks had fallen behind in global rankings, as they limited themselves to careful, small-scale acquisitions and rejected large bold moves.
By contrast, in today's environment, even prudent risk has become a dirty word. Just a few weeks ago, the most popular article in the online New York Times portrayed Canadian banks as the model for the global banking system - a notion that six months ago would have been absurd. From pitied to paragon is common when the pendulum swings. Consider investors' attitudes to owning resource stocks. Not long ago loading up on these was all that many investors wanted to discuss. Today, those same investors don't want to hear about owning resources. This is also reflected in expectations on oil prices. A year ago, the "peak oil" theory held sway and demand from China and India was going to push oil to $200 (U.S.) by year-end. Today, we've begun to hear about the "peak demand theory," the view that demand for oil peaked last year and we'll never see demand at that level again. With the benefit of hindsight, the first forecast is now clearly absurd - as, almost certainly, the second will prove to be.
Finally, think about the wild swing in consumer sentiment on appropriate spending that's taken place in the span of just a few months - from the norm of lavish expenditure to "the new frugality." While the stock market may be efficient and rational in the mid and long term, in the near term the "swinging of the pendulum" creates opportunities for companies and investors who maintain perspective. That was true 30 years ago, and it's true today. That's because the notion of the pendulum of market sentiment swinging from one extreme to the other captures two of the most important and widely recognized truths about investing.
The first truth is that what really drives markets at their extremes are the twin emotions of greed on the upside and fear on the downside. Both can be costly - and it takes real discipline and resolve to withstand the forces of those emotions as the pendulum moves through its arc.
The second truth is that the costliest advice for investors is "it's different this time." Seasoned investors know it's never different. Investors who listened to market prophets saying that the historical rules didn't apply to tech stocks in 2000 and resource stocks a year ago ended up paying a huge price. Chances are that those investors taking counsel from the most extreme voices of doom today will pay a similar price in wrong-headed investment strategies and missed opportunities. It would be foolish to deny that the global economy and stock markets are facing formidable challenges. That said, open markets, the spirit of innovation and the entrepreneurial ethic have demonstrated remarkable resilience in the past in working through periods that seemed at the time as dark as the one we're in today.
We may not be all the way to the extreme of despair and pessimism, but we are almost certainly well past the midpoint - and into an area we may remember more fondly years from now. We'll see that the drastic shift in sentiment has created significant value for those disciplined and bold enough to look past the swinging of the pendulum.
Back in June, Dan appeared on BNN and discussed the best way to approach finding a new advisor. This is definitely worth watching.
Stay Well and Pay It Forward.
Friday, August 7, 2009
"The Chinese use two brush strokes to write the word 'crisis'. One brush stroke stands for danger; the other for opportunity. In a crisis, be aware of the danger - but recognize the opportunity."
The basic idea is that a moment of crisis presents two possible outcomes: either growth and positive change or regression and failure. Sounds like some pretty deep ancient wisdom, right?
Far be it from me to criticize someone like JFK, but many native Chinese speakers don’t see it that way (though some do), saying it’s only coincidental that “crisis” (wei ji) contains parts of the terms for “danger” (wei xian) and “opportunity” (ji huay). But then “wei” and “ji” each have a range of meanings that suggest “crisis” really is a combination of the two ideas, whether the wisdom we attach to the term was intended or not. And isn’t that even deeper?
So where are we on the "investment cycle" now? The only person who can answer that question is the one who looks at you in the mirror each morning. I would like to think that the denial, fear, desperation and panic stages are well past us. Capitulation, despondency and depression are now in our rear view mirrors too. Are we approaching hope, relief and optimism? Maybe over the coming months.
Markets are cyclical in nature (see 10 different blog postings in the past year) and so are the emotions of investors. The best investors (Warren Buffett and his ilk), liken a financial crisis to an 80% off sale at your favourite boutique which you can not, or will not normally shop in. Billions and perhaps trillions of dollars were there for the making if you were bold enough to buy at the bottom.
For the average investor, the chances of getting rich or losing it all are remote. When it comes to investing, 8% of your returns are determined by which fund and when you bought it. The other 92% of returns are determined by the types of funds and where the monies are invested. As I have often said, one of the most important roles for an advisor is to simply ensure you are invested according to your risk tolerance. People don't worry about the markets when things are going well - but when they head in the other direction, advisers change from providing advice to holding hands and acting as babysitters. I apologize if that analogy offends anyone. Perhaps the best analogy I ever heard was from a successful advisor at a conference in the US. He stated very plainly:
I manage investments portfolios and protect clients from themselves.
Advisers cannot afford the luxury of panicking. In uncertain times, people become frightened about the viability of their "commodities" - the things they buy and the jobs that they hold. The best advisers tend to disregard their own "commodity". They don't try to "sell"you something - people at the best of times hate getting sold something. What people want at all times is value creation - solutions that help them eliminate their dangers, capture their opportunities and reinforce their strengths.
The best analogy of a good trusted advisor? They act as the Chief Financial Officer (CFO) for their clients in their personal and/or corporate lives. Their work provides their clients the time to focus on what is truly important to them, both now and in the future.
The trusted advisor is usually busy, but always seems to be available to help a client no matter how trivial the matter. They have a plan for the future and share it with their clients. They are also honest with their clients - even at the risk of losing that client. Having a YES man/woman for an advisor is a ticket to financial ruin for many people. When you find that advisor, hold onto them with all of your strength. While the work they do for you adds a little something to their own bottom line, their effects on you and your family can be rewarding. I can put a price on many things - how do you put a price on confidence, satisfaction and piece of mind. What do I mean by that? Read this...
When we first met our advisor, we were living in a two bedroom apartment with our son and daughter, and sleeping on a pull out couch. We had high interest rate credit cards, car payments, all the usual debts. Our advisor started us on the right track, contributing to RRSP's, taking out life insurance and insurance for disability which we didn't think we needed. Within a couple years we bought our first home.
Whenever we needed him, he was there, guiding us along, even when it didn't pertain to his job. He helped our children get started with their homes, and gave us piece of mind. Last year, my husband had to take an early retirement due to a work related disability, and with the benefits of the disability insurance and the savings, we are now mortgage free and living in our dream home in New Brunswick.
Even in the face of chaotic markets and disappointing performance over the past nine months, most investors are hanging in with their financial advisers. In a recent Ipsos Reid survey, 87 per cent of Canadians said their current adviser will be their primary adviser a year from now. Most recognize that even the best managers didn't foresee last fall's financial meltdown and that almost everyone is in the same boat.
Of course, that's not universal. Some investors are rethinking the relationship with their adviser, while others are responding to invitations to a “second opinion” on their portfolio. Some investors are questioning whether they want to work with an adviser at all and are considering switching to a discount broker.
Working with the right adviser can have a huge effect on achieving your long-term financial goal. The wrong one can result in you looking like our friend at the left. It's a decision that shouldn't be rushed. Some investors select the first adviser they speak to or make a decision based on an adviser's glitzy office – and later regretted the choice. When looking for an adviser, most investors begin by asking people they know for suggestions. While a referral from someone you trust increases the odds things will work out, just because an adviser is a good fit for a friend doesn't mean he or she will be right for you.
Selecting an adviser is like any important decision. First impressions matter, but to tilt the odds of getting this right, you need to first identify the key things you're looking for (ideally in writing) and compare what you hear with that list before deciding. There's nothing wrong with telling an adviser you'd like to sit down for a couple of in-depth discussions before making a decision.
During these meetings, you have two goals. The first is to get a sense of whether this a good fit. For example, here are some questions focusing on the past 12 months: How did you suggest positioning portfolios like mine going into the beginning of last year? What kinds of changes have you recommended to clients in my situation since last fall? What kind of advice are you providing to clients like me today? How are you managing risk amid recent uncertainty? In general terms, would you share what you held in your own portfolio going into last fall and what your portfolio looks like today? What are the most important lessons you've learned from the past year's events?
The second component in making the decision is getting a reading on chemistry. Are you comfortable talking to this financial adviser? Does he really listen to your answers and appear truly interested in your situation? Does he talk in plain English? Do you like him as a person and feel you could be absolutely open with him? Do you feel that you would have confidence in his advice?
Remember, it's not only you making an assessment; in these initial meetings discerning advisers are also evaluating you and often have tough questions of their own. Today, it's not only investors who have choices as to who to work with: The best advisers can pick and choose their clients. Don't believe it? This video should be required viewing for all investors.
Stay Well and Pay It Forward.
Tuesday, August 4, 2009
The Dow Jones industrial average gained 7 per cent on the month, making it the best July since 2002 for the index. The S&P 500 rose 6.95 per cent in July. In Canada, the economy contracted by 0.5 per cent in May, worse than consensus estimates of 0.3 per cent. Still, the S&P/TSX rose 4 per cent in July.
Recessionary forces are still prevalent in Canada, but the effects are easing. As most experts had predicted, the third quarter is looking very promising. In the past year, the Canadian economy shrunk 3.5%, most of that in goods production which shrank 9.9%Does this mean we can pack away the panic button? Not yet. Unemployment remains at 15 year highs, and eventually interest rates will climb pushing those who racked up "bad debt" to the brink. Personal and corporate bankruptcies will continue. Nonetheless, as mentioned previously, there is light at the end of the tunnel (and it no longer says AMTRAK on the side).
What are the best lessons from the past year? Looking at things from the bottom up, consumers need to better heed the want/need approach to life. I would love a new 52 inch flat screen and blue ray player. Do I need them? No - I simply want them. Would I be better served spending my money replacing a perfectly good TV with a newer flashier model or paying off a debt. How about a blue ray with great picture quality versus saving for retirement or a child's education. If you can afford to go out and buy these types of items and pay cash, please feel free to do so. If no one spends money, the economy will never turn around. That being said, it is frightening how many people know so little about finances. They run amok and spend without regard to their futures. I'm not a fan of CSI Miami, but the other night they had an episode where a young "couple" attempt to commit suicide. The reason? A credit card company that preyed on students by offering them credit they could not afford or qualify for. Sounds suspiciously like the US banking and housing crisis doesn't it.
Gail Vax-Oxlade has a television show where she works with people with poor finances. In her recent blog, she states:
"I’m not sure what this comes from… this don’t-much-care attitude toward our money and the role it plays in our lives. It could be that we want to distance ourselves from the “money-grubbing,” “money means everything,” “money is what counts” attitudes some people display. We don’t want to be those people so we throw out the baby with the bath water. We spend years ignoring the most basic rules of money and then, if by chance we convert to Money Maniacs, we spend years trying to make up for what we’ve missed by becoming rampant Frugalistas. Or we come to believe that nothing can ever be different and that we might as well just blow it all now and have a great time.
Fact is people, money is the tool that gets us the things we need and the things we want. And since we work so hard for our money, we should be willing to work equally as hard making it do what we want. No control doesn’t mean you’re free, it means you’re stupid! And over-control means you become a slave to the tool. Balance is the key. We must balance today’s needs and wants with tomorrow’s dreams, while taking care of any mistakes we’ve made in the past. Balance is how we get to have money AND a life.
So how do you get through to your young person just how important it is that they save something of what they earn and that they put it to work early? How do you convince them that just because they’re making more money doesn’t mean they have to spend it all? How, in a society where credit is as common as air, do you convince the young-and-wanting that they should NOT use credit? And is the old saying, “take care of the pennies and the dollars will take care of themselves” really going to have an impact on our next generation?
Wow! Could not have said it better myself.
Stay Well and Pay It Forward.