Tag Archives: money

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.

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.

Inflation – The Hidden Dark Horse

inflation-bw

You remember when you were a kid and a chocolate bar cost far less than it does today? This phenomenon happens because of inflation, and the same thing that happens to chocolate bars happens to your money too.

I don’t see inflation talked about as much as I think it should be, especially when it comes to personal finance. This blows my mind because every year all money, including yours, loses a bit of value to inflation. In fact, since 1993 the Bank of Canada has been openly committed to an inflation target of 1-3%, meaning a little inflation is good for the economy in general, just not your savings.

Inflation is a big, complicated, abstract concept which is why I think it is so often overlooked. But after looking at various ‘high interest rate’ savings accounts, I started to think that people not familiar with inflation are losing money when they think they’re gaining money.

To better illustrate inflation, let me offer a basic example:

You are king/queen of a small village of 100 people. To avoid everyone bartering, you decide to create a currency based on gold, you have one kilogram of gold and you decide to create coins for your 100 subjects. So you take your gold and make 200 royal coins. Your people are happy, they now have something that allows them to price their goods and services more accurately than if they were trading for other goods and services.

Your plan works well. The villagers find it easier to buy and sell goods, and thus easier to make money. But you only have 200 coins, and your inventive villagers start coming up with new ways to make money, new goods and services to sell and you soon notice a coin shortage in your economy. Your more successful inhabitants are saving coins from their successful business endeavors, taking fewer and fewer coins out of general circulation. You discover that of the 200 coins you made, only 100 seem to be exchanging hands regularly, making the coins more scarce, and thus more valuable to the point where one coin can buy a villager enough grain to feed a mule for a whole year.

So you decide to buy another kilogram of gold (perhaps by introducing taxes) and mint another 200 coins, doubling the amount of coins in your economy. Because so many more coins are now in general circulation, they are no longer scarce and one coin will now only buy a villager enough grain to feed a mule for only half a year. Those who saved coins before you introduced more coins would find that their savings have effectively been halved because they can now only buy half the goods for the money they had saved.

By doubling the amount of coins available, you’ve effectively halved the monetary value of all your coins. Inflation went up 100%!

The Canadian economy works on the same principle, except it isn’t based on gold and is more sophisticated. In addition to introducing new money into an economy, rising costs in manufacturing or a commodity scarcity are also big factors in inflation.

The Bank of Canada is the institution that manages the Canadian Dollar; it issues new money and sets the interest rates. It also has a target inflation rate of 1-3% that it uses to steer the economy.

The Bank of Canada measures inflation by measuring the change in the Consumer Price Index, which is a “basket” of thousands of consumer goods (for example: a kilogram of Royal Gala Apples, a new Toyota Camry, a pair of Levis 501s, etc.) and tracks the price changes. In fact, the Bank of Canada has a handy inflation calculator that lets you see exactly what inflation has been. Using this calculator, I can see that in 2014, inflation was at 0.97%. In 2013 inflation was 1.48%. Since 2000, inflation has gone up 32.94% with an average annual inflation rate of 1.92%.

Looking at the inflation calculator, I see that $100 in 2000 would get me the same amount of goods then as $132.94 in 2015. Put another way, a chocolate bar that cost $1 in 2000 would cost you $1.33 in 2015.

Inflation means each year $1 will buy you less, so if you have money just sitting in a bank account collecting little or no interest, you aren’t losing money, but as the cost of goods grows, the value of your money does not, and you will be able to afford less things as the years go on with the same amount of money.

To use another example, if $11,000 was a median annual salary in 1950, and I worked for a year and managed to bank my entire salary (somehow avoiding taxes and the cost of living), I would have $11,000 in the bank today. Which won’t get me nearly as much as if I had today’s median annual salary of $45,000 in the bank.

If you have $1000 in the bank today, what do you think you’ll be able to buy with it in another fifteen years?

Next week, I’m going to look at various savings accounts and see how those “high interest” rates stand when you apply inflation.

 

First Things First – Getting Burned At An Early Age

the liberating feeling of losing your shirt

My interest in personal financials started in my mid-twenties when I realized that working for the Man for the rest of my life might be a bit too soul-sucking, and that I should have a plan to be financially independent as soon as possible so that I have as much time in my life to pursue my own projects and goals, no matter how daffy they may be, without worrying about money.

There is a lot in the above sentence, and a lot of assumptions. So you know, I’m a thirty-five year old software professional who lives in Toronto. I am married with no children. I rent an apartment, I do not own a car, I pay my credit card fully every month and our household has an above-average income. I consider myself good with my money: I generally don’t buy things I don’t need and for all my big purchases, I ask myself if it is worth the money, or if that same money would be better spent going toward my early retirement. Should I get that Xbox One, or retire a week or two ahead of schedule?

If you are like me, you probably have a lot of things on your mind and taking time to understand how to maximize your money is both confusing and really boring. I had trouble understanding a bunch of things:

  • What is a mutual fund exactly?
  • What is a hedge fund? I keep hearing about those…
  • How do I decide what to invest my money in?
  • What is an RRSP?
  • What is a TFSA?
  • Should I just buy a house?
  • Can’t I get a financial adviser to properly manage my money?

I decided to start with the last question and talk to a financial adviser. I was impressed with the whole ordeal. For me, I had to go high up in a downtown office tower and sit down with a guy in a suit who had his own office with an amazing view; he looked really professional and confident. He worked for a large financial services company that had their own mutual funds. I didn’t really understand what the adviser was saying but I didn’t want to act as clueless as I felt. He proudly showed me some numbers that seemed impressive and soon had me convinced that I had to give him all my money so that I could start getting my money to work for me. I ended up investing in two mutual funds: a fund that put people’s money into the Canadian resource sector, because I thought that that would always be in demand, and an American mid-cap equity fund, because the adviser advised I do so.

When next tax season rolled around, I ended up owing the government more than $2000 in capital gains taxes. I didn’t even know what a capital gains tax was. I looked up the value of my two investments and saw that they barely budged. How was it that I invested in something that didn’t gain in value, and get slapped with this capital gains tax?

Needless to say, I was really upset and took all my money out of the financial institute that gave me such crappy advice and decided to investigate things myself. It occurred to me that I was a fool to think I would give all my life’s savings to some guy in a suit because he had a good presentation.

To be fair, the vast majority of financial advisers are much better than the one I got. In fact, my current financial advisor has a background as a tax accountant and has been instrumental in helping me pay the CRA as little as possible every April.

In a way I was glad this happened as it forced me to look into my own finances more and understand what was actually happening to my money. As it turned out, a mutual fund is really a bunch of guys in suits who decide to buy equities (shares of a company, stocks), and combine them into one fund. The fund’s value is totally dependent on what equities the fund managers decide to buy and sell, and how much of each equity they hold.

A capital gains tax turned out to be a tax people pay when they sell an investment (can be equities, government or corporate debt [aka bonds], or a house). So even though I didn’t sell anything, the fund managers were buying and selling specific fund equities on a daily basis to try to maximize the return of the fund.

And I discovered that because my fund wasn’t registered (I.e. protected from the tax man), I was taxed every time the fund managers sold equities and made a profit. Of course, those same fund managers sold some equities at a loss so that overall, their fund broke even. But because of the way the system works, I ended up paying taxes on their gains without the benefit of my investment value going up.

And so started my foray into the world of finance and understanding personal banking. It wasn’t long after this that I realized I knew nothing about money, that specifically I didn’t have a point of reference for anything. So when I saw gains of 8% I just assumed that was good without knowing why. When I was told to invest in mid-caps, I did without knowing what my other options were. I then realized that most financial advisers are really commission-based salesmen selling their company’s products. There is nothing wrong with that in general, except that when it comes to my money, I really want to know what my best options are, not what a given financial institution’s options are.

And there are a lot of options for saving your money. From high interest savings accounts, to various funds and stocks, to taxes, we will be looking at what really is happening with your money behind the scenes, what your best options are, and why.