Market Jitters – Why the Chaos

 

market-jitters

Have you been reading the news lately? There has been a massive sell off of equities on the worlds largest stock exchanges. It seems to have started in China, but has spread like a virus.

There are a lot of factors involved in the sell off. Generally, when investors don’t have confidence in the market their money’s in, they sell their shares. How does this work if we’re supposed to be like Benjamin Graham and use a buy-and-hold investment strategy? Shouldn’t all investors be holding?

The thing to remember is that there are different kinds of investors. Most of the money that’s in stock exchanges doesn’t come from people like me or you, it comes from massive funds that need to constantly withdraw money from their investments and need to be sensitive to short term happenings.

Take pension funds for example. Massive pension funds worth billions of dollars exist in most states and provinces (Ontario Teachers Pension Plan has over $150 billion in assets). Pension funds are constantly withdrawing money and need to make sure they have enough money to see them through any slowdown without draining too many funds.

So though large institutional investors like pension funds will use a buy and hold strategy, they will also need to withdraw some money when they think the market might dip too much. What they are doing is basically guessing what the market will do.

Does that mean you should too? No, it is nearly impossible to accurately and consistently predict what stock markets are about to do, there are simple too many uncontrolled factors to take into consideration. For large funds, decisions are largely based on statistics. Institutional investors will attempt to time the market with mixed results, but the idea behind a buy and hold strategy is to buy into companies that will be resilient through a market downturn. In fact, if your favorite company’s share price goes down 20% because everything else has gone down 20%, what a great opportunity to buy more and watch it regain 20% almost as quickly as it shed it.

When the market has its bad days (and there will be plenty more bad days mixed with the good days), your best strategy is to take comfort in the fact that you’re in it for the long haul and to see momentary blips as opportunities to buy premium stocks at discounted prices, not reasons to panic and sell as a knee-jerk reaction.

As for the latest market shenanigans, it is largely a Chinese phenomenon that has reverberated around the world. In the years leading up to the current crisis, Chinese investors plowed money into the Shanghai Stock Exchange, inflating the value of many companies and effectively created a bubble. The Chinese government hasn’t helped by interfering in the market and introducing measures designed to keep the value of the stock market artificially high, rather than letting the market run its course and correct itself.

Start Here

start saving here

If you’re new to the world of personal finance, or new to looniewise.ca, below is what I consider to be the core articles for gaining understanding and confidence in managing your money.

To start with, motivation. Surely there are more important things for you to do other than read articles about money? Knowing what you want your saved money for is important for knowing where to put it until you need it. Having a goal helps get you going.

  1. Savings Accounts, everyone should be familiar with the pros and cons of savings accounts
  2. Mutual Funds, money invested here will generally grow faster than savings accounts, but there are more risks
  3. Bonds, not quite as popular these days, thanks to a low interest rates
  4. The S&P 500, the best place to put your long-term money
  5. To put these things in perspective, you should re-acquaint yourself with the awesome power of compound interest

These are some handy articles for how to conserve or grow your money. These articles explain how to avoid costs that take your money:

  1. UTIC, the Unavoidable Trifecta of Investment Costs
    1. Inflation
    2. Taxes
    3. Fees
  2. RRSPs, how to avoid the taxes of of UTIC
  3. TFSAs, another way to avoid taxes

For those with an appetite for more risk, and potential reward, there’s the stock exchange

  1. An overview of a solid investment strategy: invest in what you know
  2. How to actually start investing

Wills – Even Death Has a Fee

death-tax

I recently got a will. I went through a lawyer, and was quoted a notarized will for my wife and I at $400 each. With the lawyer, it was an intimidating experience at first, but I did some research on my own and found that you can get a will drafted for free, and notarized for as little as $15. Currently, I am in the process of trying to get a more competitive rate.

How did this all come about? I remember a few months ago seeing a story about a wealthy, well respected family being torn apart over an inheritance. Millions were collectively spent on lawyers. I don’t know how that mess turned out, but I’ve heard about crazy family members who launch lawsuits over an inheritance dispute. To add to the deep emotional damage such a conflict would inflict, the truth is that the only people guaranteed to benefit will be lawyers.

It seems that every family has crazy relatives, and it seems that if you have any considerable worth in your estate at all, you might want to spend the extra time and money to be clear on how you want your estate divided and passed on and stop any potential conflicts from ever happening.

What kind of things are part of your estate? The first thing to be factored is any debt you have, including credit cards, mortgages, and car loans. They are paid off before your estate and any estate beneficiaries. Once debts are settled, all your remaining assets with financial value, such as insurance policies, cash, TFSAs, homes, cars, appliances, and furnishings are added up and considered to be the value of your estate. If your spouse survives you, your estate is considered to be shared 50/50.

Once the value of your estate is ascertained, the provincial government will then proceed to tax it. As per the Ontario Ministry of Finance, the inheritance tax will be $3100 on an estate valued at $240,000.

Note that your RRSPs can be directly transferred to a family beneficiary with no tax penalty at all. You can setup an RRSP tax beneficiary at any time. If you don’t, your RRSP will be converted to cash and taxed as income in your final year and added to your estate to then be subjected to the inheritance tax.

If you don’t have a will, it will be up to the government to decide how to divide your estate. You should check how your province divides your estate as different provinces follow different guidelines. Often, your spouse and/or children will get everything. If you want to leave something for siblings, friends, charities, your community, university, or any other person or thing, you’ll want to put a will together. If you are looking for some ideas, you should search to see what unusual things people have left in their wills.

 

Interest Rates – Controlling the Economy

interest rate

If you’ve ever borrowed money from a bank, you’re probably familiar with the Bank Of Canada’s (BOC) key interest rate. It’s the interest rate the BOC sets on loans banks must pay on money they borrow from each other, that ultimately sets the cost of borrowing money for all Canadians. And this is subtly very important because our economy works by people investing in ideas and realizing business opportunities, both of which require money and create jobs.

The higher the interest payments on a loan, the more risky loans become. In the 1980’s, interest rates were near 20%, meaning you would pay interest of $20 per year on a loan of $100. Compare the 1980’s to today where interest rates are at a near record low of 0.75%, or 75 cents per year for a $100 loan. It becomes clear that buying a home or starting a business would be virtually impossible in the 1980’s for a lot of people who have done just that today because of much lower interest payments on loans. Money was just too expensive in the 1980s.

A rock bottom interest rate is the biggest reason for Canada’s housing market being as frothy as it is. If you look at interest rates over the last 25 years, you’ll see that the steady decrease in the interest rate over the decades matches an equally steady increase in the cost of a home in Canada. At 20% interest in the 1980’s, you would have paid the banks several times the value of your mortgage amount by the time you finish paying off the home. Today, you just pay twice the value of your mortgage, if that.

Being able to control interest rates is a powerful tool used by the BOC (and the Federal Reserve in the US, and other central banks around the world) to help steer the economy. It is one of several tools the BOC has at its disposal in managing the Canadian economy and financial system.

The BOC’s key interest rate is the interest rate that banks use when they borrow money from each other, otherwise known as the over night rate.

Banks will transfer billions of dollars between themselves throughout the course of a day. They will conduct transactions on behalf of their many clients, at different times during the day (as the value of the Canadian dollar fluctuates), and across different currencies. As a result, at the end of a business day, their numbers typically don’t add up. Some banks end up with more money than they should, others end up with less.

To make sure they have enough money available to conduct their near-term business, banks will typically borrow from each other at the end of a day.To minimize the risk of banks defaulting, the BOC dictates that they must have a certain amount of cash on hand, to prevent 2008 American-style bad loans undermining the whole system. So often banks need borrow money just to conform to BOC regulations.

The money banks borrow from one another at the end of the day is what the key interest rate actually applies to. The over-night rate doesn’t directly apply to anyone but the big financial institutions. Because banks are for-profit organizations, they will always pass down the key interest rate to all their other interest rates, such as mortgage rates, but with extra interest added for them to make profits.

Thus, by controlling the interest rate on the main source of money for financial institution funding, the BOC is able to determine interest rates for everyone else downstream, because banks will always lend out money at the current interest rate, plus a little extra for the banks themselves.

When I first discovered the great power the BOC wields, I wondered why the BOC just doesn’t keep interest rates at 0% to make money more easily available to everyone. But unsurprisingly, the more you know, the more you realize how important, complex and entwined the economy is.  The short answer to why interest rates aren’t at 0% is because that’s how bubbles happen, and bubbles have the potential to devastate a country’s economy. Witness the housing bubble in the US that popped at the end of 2008.

The problem is that when you make an asset easy to obtain, the risk of everyone buying it and inflating its value to unjustifiable levels increases. From the Dutch tulip crash in the 17th century, to the great depression of the 1930s, to the dot-com crash and the great recession of 2009, bubbles have wrecked havoc on economies, decimated whole industries and left millions without jobs or homeless.

It is for this reason that central banks around the world don’t want to make money free for banks to borrow, but don’t want to make money too dear either. It is a delicate balancing act.

 

First Rule of Investing in Stock

first tip investing

If you had invested in Microsoft back in 1986, when they went public with their Initial Public Offering (IPO), you would have made 44,000% return on your investment (ROI). If you had invested $1000 in Microsoft then, it would be worth  $44 million today. This is why Bill Gates is still the richest man in the world, he owned the majority of Microsoft when it went public some 29 years ago.

Stories like this aren’t uncommon. Pretty much every publicly listed silicon valley company started off like Microsoft, and consequentially has amazingly wealthy founders. And thanks to stock markets, the ability to invest in other people’s good ideas and hard work is available to anyone.

There are many books, websites and careers based on investing in the stock market. So for this introductory post on the subject, I will simply say this: Invest in what you know.

To better illustrate this concept, consider this story that took place in the 1930’s. It was a party that a celebrated banker was throwing, he invited his business clients and colleagues. At the time, women weren’t involved in money matters much, especially the money matters of their extremely wealthy husbands. But the banker’s wife had inherited a small fortune from the death of a relative and wanted to grow the money herself.

She knew from listening to her husband and his friends talking about investing all the time that putting her money in the stock market was the best way to grow it. She saw one of her husband’s investment friends, Benjamin Graham, who at the time was a well respected investor (who later went on to define value investing, and teach other greats, like Warren Buffet).

The banker’s wife asked Benjamin, “What should I invest my money in?” to which Benjamin answered, “never invest your money into something you don’t understand. Invest your money in something you not only understand, but use every day.”

No one knew what the banker’s wife did with her money. Decades later, after her death, it was discovered that she had made a massive fortune, much more than her husband ever made, on the stock market. As it turned out, she followed Benjamin’s advice directly and invested in a revolutionary idea that she was uniquely positioned to appreciate, Tampax, the first makers of modern tampons.

If you don’t know what you’re investing in, you are literally relying on luck. It is possible that some solar panel company that just started up is going to go somewhere, but unless you know about solar technology, or how that industry works, all you can do is hope to get lucky, because you don’t understand what needs to happen for a company to be successful in the solar energy market.

I can’t tell you how much the concept of investing in what you know has changed my money outlook. I have invested in Google, and Visa because I use their products almost every day and I understand how their business models work. I love Netflix, and am very happy that I invested in them 5 years ago, before everyone had a subscription.*

In fact, all my dud investments (and there are a lot of them) have all been in companies I didn’t use or understand.

If you have some extra money you want to play with, and a couple good investment ideas that you personally use daily, then there is no shortage of companies for you to invest in. This means that if you love comic books and video games, invest in Disney (as they own Marvel now, and Star Wars, and have bankrolled all the big superhero movies in recent years). Like playing video games? Put your money where your mouth is, EA and Activision are on the Nasdaq, so is Sony and Xbox. Making lots of money with your home made goods business on Etsy or eBay? Maybe your unique experience makes investing in those companies a good idea to you.

A little more grown up than games and comics, and short of ideas? You should pay for an annual subscription to a publication that analyses individual companies for you. I have subscribed to the Motley Fool before, and indeed, that’s where I first read about investing in Netflix or Marvel. It is a great way to read about what other investors have to say about a lot of popular, and up and coming companies.

* As a full disclosure, I currently own shares in Disney, Google, Netflix and Visa. Though they have been a good investment for me over the years, they might treat you differently tomorrow.

Cars – The Prestige of Yesteryear

cars-waste-money

According to Statistics Canada, transportation costs consume 20.5% of the average Canadian’s household budget. In 2013, that amounted to $12,041 in transportation per year, of an average after-tax budget of $58,592. Only the cost of housing took up a larger portion.

According to the US Bureau of Labor Statistics, a 2009 study compared the household expenditures between the US, UK, Canada, and Japan and concluded that Canadians spent the largest portion of their income on transportation.

Transportation, however, includes cars, trucks, public transit, flying, and every other way to get around. Nevertheless, Canadians still spend an average 8.6%, or $5038, of their budgets on automobiles specifically each year, compared to the US, which spent the 2nd most at 6.1%. This includes buying/leasing a car, gas, maintenance, parking, insurance, etc. And though Canada has a higher tax on gas than the US, it is lower than what people in Japan or the UK pay.

After shelter, vehicles are likely to be the 2nd biggest expenditure in your life. At $5000 per year, over a period of 50 years, you’re looking at $250,000 for a lifetime of driving.

For a lot of Canadians, there simply is no option other than owning your own car or truck. Most smaller communities have very limited public transit options. Many jobs, schedules, and circumstantial realities make getting by without your own wheels impossible. And the harsh winter that we experience makes walking and cycling difficult (if not impossible) for half the year. Incidentally, our harsh winter also puts the percentage Canadians spend on clothing highest between Canada, UK, USA, and Japan.

There are many instances where cars in Canada are simply the only option for getting around. But, Canada is an urban country, more than 13 million of us live in its 5 biggest cities. Large Canadian cities usually have good alternative transportation options, including public transit and bike lanes.

Myself, I live in Toronto. I pay $140 per month for my public transit pass, and an average of $100 per month on Zipcar (which lets me rent a car by the hour). So $250 per month for 12 months equals $2500 I spent per year in ground transportation.

Compare that to the parking at the building I work at, which charges $16 for a full day of parking. $16 for 22 work days equals $352 per month only in parking.

parking

The biggest problem with cars is that they don’t appreciate in value, your typical car is always a horrible financial investment. Cars are famous for depreciating in value the second you roll them out of the dealership. If you drove your brand new car 1 km home and tried to sell it, you would not be able to sell it for the same price you just paid.

$250,000 per lifetime on a car is only the average. You really start to burn money when you pay for premium automobiles. This could be why driving a luxury car, like an Audi, Benz, or BMW, is such a status symbol. It tells the world that you have money to spend. Your average luxury car might cost 100% more than something more modest. But BMWs don’t have 100% better gas mileage, or last 100% longer, or go 100% faster. In fact, they don’t do anything 100% better than a typical car, so why spend the extra money?

This isn’t news. Perhaps it’s the crippling student debt and less job security that a lot of them face, but millennials are famously not interested in driving. In the US in 2010, only 60% of 18 year olds had a drivers license, compared to 80% in 1983. There seems to be a cultural shift away from driving happening. I haven’t even mentioned other negative effects of driving, such as pollution or spending hours a day commuting.

traffic

Combine changing attitudes towards automobiles with self-driving car technology and the emergence of the sharing economy and we are on the cusp of a revolution in transportation. If my hunch is right, getting around is going to get easier and less expensive.

Unavoidable Trifecta of Investment Costs (UTIC)

unavoidable-trifecta-investment-costs

There are costs that can be eliminated, like the constant buying of disposable razors, and costs that can merely be reduced. When it comes to investing your savings, there are 3 costs that are unavoidable: taxes, inflation, and fees.

These 3 costs are especially repugnant because they add up to a lot. Bill Gates, still one the worlds richest people, claimed in 2013 that he had paid over $6 billion in taxes. You lose about 2 cents for every dollar you have in a regular bank account every year to inflation. And fees are baked in to nearly every financial service you can think of.

Though you can never be free of any of these costs, you can certainly reduce how much you end up paying. You could get a financial adviser or an accountant. Indeed, legally avoiding taxes is a giant industry. But the more help you get, the more fees you incur. Generally, fees are lower than taxes, but not always.

If advisers and accountants aren’t for you, or if you at least want to better understand all this stuff, there is, of course, this blog :)

In a nut shell, to minimize tax payments, put your savings in a Tax Free Savings Account (TFSA), where it can grow tax free. If you’ve maximized your annual TFSA contribution, there’s always Registered Retirement Saving Plans (RRSP).

The best way to avoid fees is to learn about how your money works on your own. The more comfortable you are with saving and investing, the less need you will have for more expensive services, like advisers or accountants.

Unlike the other two prongs of this trifecta, inflation is truly unavoidable. The only thing you can do is make sure your money is growing faster than inflation, which isn’t always the case with high interest savings accounts.

 

Avoidable Costs – Disposable Razors

razors

I have mentioned the UTIC (Unavoidable Trifecta of Investment Costs) before. These are things that erode your savings, and the only thing you can do about it is make sure your savings grow at least as much as the unavoidable costs of taxes, fees and inflation.

But there is another way to increase your savings, that is to reduce your cost of living: the money you have to spend for living comfortably in Canada. This includes housing, clothing, food, cell phones, parking, transit, Netflix, etc. Some of these are unavoidable, everyone needs shelter, food, and clothing. But there are ways to reduce most costs, and today, I’m going to write about a personal favorite cost-saving decision: shaving with anything other than disposable razor cartridges.

There are definite environmental advantages to avoiding disposable razor cartridges, but this is a finance blog, so let’s look at the numbers. I’m certainly not the first blogger to look at the cost of shaving, sharpologist.com has a fun write-up about the costs of various shaving options.  According to sharpologist, straight-edge razors are the least expensive, by far.

I can vouch for that. I personally shave with a straight-edge. I spent $70 on the initial blade, $40 on a strop, $35 on a brush, and $50 on a sharpening stone. About $200. That was almost 10 years ago. That’s really all the money I’ve spent on shaving in the last 10 years, about $20 per year.

According to Gillette, I could get 5 weeks of shaving out one disposable razor cartridge. According to walmart.ca, 12 cartridges cost about $52. That means, I could get just over a year’s worth of shaving for about $50. Over 10 years, that works out to $500, $300 more than what I’ve actually spent. Consider the next 10 years, my real straight-edge cost remains at $200 while the cost of using Gillette’s disposable cartridges will rise to about $1000.

Over my lifetime, I can expect to save $2000-$2500 from using a straight-edge.

Given the more intimidating learning process, straight-edges are not for everyone. But that’s ok, there are still better options than disposable cartridges. Classic safety razors are also inexpensive, as are their replacement blades.

Bonds – Lending to the Man

bonds

I’ve been a big proponent of investing savings in the S&P 500. It offers great long-term returns, and is safe. But it’s not that safe.

The S&P 500 isn’t the safest investment because when you buy equity/shares in a publicly traded company, you are buying a slice of ownership. Your fortunes rise and fall with the fortunes of the company you partly own. And you can sell your shares the same way people sell barrels of oil or any other commodity, through a market.

But if the company you partially own goes bankrupt, chances are, you’ll end up with nothing. That’s because a long line of people and organizations that the bankrupt organization owes money to are first when it comes time to cash in on whatever is left of the company. This includes banks, employee wages and bond holders. Share holders are usually last to get any pay outs in the event of a bankruptcy, and usually get nothing.

Bonds are basically IOUs that a large government or company will issue. They are cheap loans that a government can make because all western governments are so large and have been around for hundreds of years, that they can guarantee your return.

A bond is a financial certificate, it means the bank owes you money. But it also means you have no say in any of the banks matters, unlike a share holder. So bonds are creditor stakes in a company, whereas share holders have equity stake in a company. When a company goes bankrupt, creditor stake holders will have priority over equity stake holders when it comes time to dividing the remains.

Western countries are basically impervious to bankruptcy for the foreseeable future. Even though headlines can be grim, and all governments take on more and more debt, there has also been an increase in Gross Domestic Product (GDP). If you totaled the value of every financial transaction in Canada, every exchange in goods or services for money, you would have the gross domestic product. In 2014, Canada’s GDP was $1.8 trillion USD.

Of that $1.8 trillion, the Canadian Federal Government took $276.3 billion in taxes and other revenue. With that kind of growing revenue, it is easy to be convinced that a large government can guarantee the bonds that it issues.

Bonds are usually sold at specific times, in Canada, Canadian Savings Bonds (CSBs) are sold every October and November. They have a 10 year maturity. That means that you get the money back on your bonds after 10 years. You get your interest payments once a year.

Bonds backed by most western governments are so safe, they are considered to be risk-free. As such, they offer a low interest rate of return tied to the interest rates set by the Bank Of Canada. The annual returns for the CSB can be found online here. As you can see from its previous returns, bonds don’t make you a lot of money. In 2014, Canadian Savings Bonds would yield only 1% per year, it would be easier to just get a high interest savings account in 2014.

Bonds are something that you can buy through various Exchange Traded Funds (ETFs), but you can also buy them yourself directly through the government every October. For more information on buying Canadian bonds directly, information can be found on their website.

Financial Goals – What It’s All About

financial-goals

What am I saving money for?

For myself, this is the most important of all financial matters to get right. If I didn’t have a financial goal, I would simply lack the motivation to save. Having a goal constantly reminds me of what I’m working for, and gives me a light at the (far) end of the tunnel. To me, it is the most reassuring thing to think about after a rough day, knowing a plan is in place, and underway and that I’m not simply spinning my tires.

As I mentioned in my first post, my personal financial goal is to become financially independent as soon as possible. How will I be financially independent? I will be living off the the interest of my savings! The S&P 500 has a long term annual return of 12.65%. If you had $1,000,000, that would be $126,500 in interest a year! Of course, once you factor in inflation, fees and taxes, you would be looking at a more modest, but still ample, return.

My goal helps me in more ways than giving me a sense of purpose, it also helps me know where to put my money. The S&P 500 is a great long term (at least 5 years) investment, which is what I need for my personal financial goal.

But what if your reason to save money is more short term? What if you are saving up for a down payment on a house, or something that will require you to spend your money within 5 years?

The S&P 500 is pretty safe as far as stock investments go. But it still has its down years, like 2008, the year of the great recession. Had you invested at the end of 2007, it would have taken 5 years for the S&P 500 index to grow back to the price you bought it at.

If you are investing for the short term, that probably means you have something fairly specific in mind you want to buy (house, car, vacation, etc). If you say “I want to save up $100,000 for a down payment on a house in 5 years,” you may value the added certainty of knowing your money will be there in 5 years with a little bit of interest accrued, rather than be less sure your money will be there in 5 years, but with more interest accrued. The cost of safer investments is a lower return, and is a cost worth bearing if you are looking for a more short term place to invest your money.

For shorter term investments, I suggest looking at government bonds, GICs, or even a high interest savings account. There are also many safe mutual funds and Exchange Traded Funds (ETFs) that will also achieve the same effect. They will not grow your money much, but they are very safe. The small amount they grow is better than nothing. Having anything offset the constant encroachment of inflation is important. And if you need a place to stash your cash short term, these are great savings options.

 

 

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