Tag Archives: savings

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.

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.

 

 

Taxes – The Unavoidable Cost of Civilization

taxes

It is said that only 2 things are absolute in life: death and taxes. Taxes have been around for thousands of years. The purpose of taxes is to pay for the government, and various government expenditures, like police, fire, hospital, garbage collection, clean drinking water, education, food inspectors, military, and wars.

All these things cost money and various levels of government have been able to find ways to get more tax revenue every time someone discovers a new way to make money. Because taxes have been around for so long, everywhere, they are ingrained in the very fabric of society. You simply cannot avoid paying taxes in some way, which is why, along with inflation and fees, taxes are the 3rd and possibly most costly of the Unavoidable Trifecta of Investment Costs (UTIC)

Kinds of taxes include:

Consumer Taxes

In Canada, consumer taxes are:

  • Goods and Services Tax (GST), which is a federal tax (ie. national, run from Ottawa) and is spent across the country.
  • Provincial Sales Tax (PST), which is run at a provincial level, so the money is directly collected by Quebec City, Regina or Halifax and is not shared with other provinces. Only Alberta has no PST.
  • Or Harmonized Sales Tax (HST), which is a combination of PST and GST in one tax. Currently, only 5 provinces have HST instead of PST and GST:
    • Ontario
    • Nova Scotica
    • Prince Edward Island
    • Newfoundland
    • New Brunswick

As its name suggests, you will pay a lot more in consumer tax if you buy a lot of stuff, ie. consume.

Income Taxes

In Canada, both the federal government, ie. the Canada Revenue Agency (CRA), and provinces, eg. Fredericton, Regina will take a significant chunk of your paycheque before it even reaches you. Every year, you have until the end of April to complete your income tax return. Your income tax return is basically you telling the government how much money you made in a given year (including money from investments, foreign properties, and pretty much anything else you can make money on), and the government making sure you’ve paid your fair share of taxes on the income you claimed.

The CRA, ie. federal government, takes 15% of your income if you made less than $44,701, up to 29% on anything more than $138,586.

The provinces each take a different amount of your income. In Alberta, the provincial government in Edmonton simply takes 10% of your taxable income, no matter how much you made. In other provinces, your income tax will be determined by your income: the provincial government will take as little as 5% in BC and Ontario for low income earners, up to 21% in Nova Scotia for high income earners.

Property Taxes

Canadian cities and towns are all run by local governments and mayors, but the only taxes they are legally allowed to collect are property taxes. Because there are so many municipalities in Canada, there is a wide range of property taxes. Typically, your land will be assessed by the municipality you live in to determine the value of your property, taking into account renovations, the local housing market, amenities, proximity to good things like schools and transit. You will then pay an annual tax on the estimated value of your property that goes straight to city hall.

Capital Gains Taxes

This one is just for investors. If you make an investment, and sell it to collect a profit, you have to pay taxes on that. It doesn’t matter if it’s a house (as long as it’s not your only house) or stocks in your favorite company, the government wants you to give a share of the proceeds back to public coffers.

In Canada, you pay a capital gains tax on 50% of your investment profits. That means if you invest $10,000 in an unprotected fund (ie. outside of a TFSA or RRSP), and make a 40% profit, and then withdraw your $14,000, you would need to pay your current income tax rate on half your profit of $4000.

50% of $4000 (the income from your investment) is $2000. If your income tax rate is 37%, 37% of $2000 is $740 in capital gains taxes. The CRA has another example of calculating your capital gains here.

 

There are many other kinds of taxes and fees governments charge, like corporate taxes, inheritance taxes, carbon taxes, custom taxes, tariffs, etc. But there are also many kinds of tax deductions / breaks you can apply for to avoid paying a significant portion of your regular taxes.

It is controversial to say if tax payers get good value for the taxes they pay or not, but certainly, it is hard to argue that society would be better off without the kinds of services governments offer.

Taking Action – Buying Stock

taking action - buying stock

Tired of savings accounts that lose you money? Want more growth and less fees than your bank’s mutual funds can offer? Thinking about giving the S&P 500 a whirl, but don’t know where to start? This post is for you!

Last week, we looked at stock markets and how their purpose is to let the public buy and sell shares in publicly traded companies. I mentioned that to invest in the S&P 500, you’ll need to buy an Exchange Traded Fund (ETF), like Vanguard’s S&P 500 index fund.

In order to buy and sell shares on a stock market, you need an stock broker, someone who has gone through various training programs and is regulated by the stock exchanged they work on. A stock broker is traditionally a person who takes buy/sell orders from individuals and fulfills those orders on the stock market floor by yelling and screaming at other stock brokers. Stock brokers usually charge a commission on every trade, that means if you want to buy some shares in company A and sell shares in companies B, that would be 2 separate trades, and your broker will charge you for each.

These days, the job of stock broker has been largely replaced by computers. So what we really need is a web broker. For you and I, a web broker is a website where we fill out a form specifying how many shares to buy or sell, at what price, etc. We then hit ‘Enter’ to buy and sell stocks. The web broker then trades your money with another web broker. The whole transaction could take seconds.

There are dozens of web brokers to chose from and every major bank in Canada has one, they are cheap and easy to use. How cheap are they? Well, that depends on what kind of investing you’re going to be doing and how often. As I mentioned, they will typically charge you per trade and web broker prices currently range from limited-time-free to $10 per trade.

The cost of a web broker is a fee, the third prong in the trident of costs (taxes and inflation being the other 2) and means that if you want to invest money every month, that could be $120 per year, which won’t be that big in the grand scheme of things, especially compared to some mutual fund fees. But I suggest planning on buying shares of TSE:VFV every 3 or 4 months to cut down on fees. Some web brokers can set up automated buying so all you need to worry about is having money in the bank.

Finding and opening a web broker account is easy. I would go to whoever your current bank is and tell them you’d like to open a web broker account. Here is a list of the 5 big banks and their web brokers:

If you aren’t with any of the above banks, you can still open a web broker account with them, or google around for another one. As long as the web broker allows you to trade on the Toronto Stock Exchange (TSE or TSX), you should be fine.

To open a web broker account, I would suggest physically walking into your bank and telling them that you want to open a web broker account, and someone will meet you to go over whatever steps are needed to setup an account. The banks do all the work for you, but there are quite a few forms they have to fill out, the process can easily take 30 minutes.

I would open up a web broker account for your TFSA, and a second web broker account for your RRSP. This will allow you to transfer money into your tax sheltered accounts, and buy and sell as much as you want without incurring any taxes. You would only pay taxes when you withdraw money from your RRSP web broker account. You will never pay any taxes on money withdrawn from any TFSA account, and you are able to withdraw money from your TFSA whenever you want.

Once your account is open, and you have a trading password, you are ready to buy a stock! The stock we want to buy is Vanguard’s S&P 500 ETF I mentioned earlier. It trades under the symbol: TSE:VFV.

This means <stock exchange>:<company stock symbol>, so TSE is the stock exchange, VFV is the symbol of the fund or company we want to invest in.

Things you’ll need to know to buy stock on any exchange:

  • The account the funds to make the purchase are coming from.
  • The action you wish to take (buy, sell, other stuff we don’t care about).
  • The company symbol.
  • How many shares you want to buy.

When deciding how many shares to buy, remember to factor in any web broker fees. If you have $1000, you can only buy 9 shares that cost $100 (9 x $100 = $900, + $6 (web broker fee) = $906)

You can buy VFV from your web broker’s website, or you can phone up the web broker directly and have a human to actually make the trade for you. Note that web brokers are neutral parties when buying/selling shares. They will not give you investment advice, so don’t bother asking them if buying particular shares is a good idea.

Don’t bother trying to time when you buy the S&P 500, in the long run, that won’t matter. Once you’ve bought your shares, hold them. Literally do nothing for decades and watch the value of your investment grow.

Stock Exchanges – The First Sharing Economy Market

exchange

A stock exchange is really a large auction, like ebay, but for company shares. Stock exchanges allow anyone with a bank account to buy shares in companies and Exchange Traded Funds (ETFs). Companies sell small amounts of themselves to the public in exchange for ownership shares in an Initial Public Offering (IPO).

For example, Acme Inc might try and sell 1,000,000 shares of itself for $50 per share in order to raise $50,000,000, or more if investors think Acme Inc is going places. If things go well for Acme Inc, they will have traded tiny slices of ownership for at least $50,000,000. This would be called Acme Inc’s IPO, they can then use the new money to invest in their business (maybe acquire a rival, update their factories, etc).

IPOs also allow founding shareholders the chance to sell some of their shares to the public for what can be a small fortune.

For Acme Inc, raising money on a stock exchange might be better than borrowing money from a bank, or raising $50,000,000 from one person or small group of people who would then be able to exert control over the inner workings of a company.

Companies that have shares on a public exchange, like the TSE or the New York Stock Exchange (NYSE), are called ‘public companies‘ because any member of the public can own a part of these companies by buying shares on a stock exchange. Companies on exchanges are subject to various rules and restrictions though. For example, they have to publicly announce the status of their operations and finances every 3 months (quarterly reports), they have to publicly declare who is on their board of directors, which typically represents the biggest share holders of a company. Also, their finances have to be in good shape, or they will kicked off the exchange.

Most of the time, when you buy shares on a stock exchange, you are not buying them from the company you wish to invest in, but from another investor. You are only buying shares from a company directly if it has an IPO, or secondary public offering, or third, etc. Otherwise, you are buying from another investor. It is important to know that people will sell shares for many reasons, but will generally only buy shares in a company if they feel that the worth of the company will go up.

And the worth of the company is often described as its market capitalization: the number of available shares it has, multiplied by the value of each share. So Apple, the largest company in the world currently, has a market capitalization of $740 billion, and a current share price of $127.09, making the number of Apple shares available at 5.8 billion. Market capitalization is generally considered how much it would cost to buy a publicly traded company, if you wanted to completely buy Apple, the company, that would cost you $740 billion today.

But we’re not looking to buy a company, only the S&P 500. Our next step is setting up a self directed investment account.

In order to invest your money with the S&P 500 you need to open a special kind of bank account, a self directed investment account. Because the specific S&P 500 investment we want to make takes the form of an ETF, we need access to the Toronto Stock Exchange (TSE).

The S&P 500 itself is an index, an index that can be easily duplicated with a basic formula. Other financial companies have created funds using this simple formula, and made these funds available on the TSE, Canada’s main stock exchange.

RRSPs – The Taxman Giveth A Bone

taxtreat

Deciding to invest your retirement money in something like the S&P 500 is an important step in setting up your personal finances. Being able to safely grow your money is important, but so is avoiding paying as much tax as possible when it’s time to retire and begin withdrawing from your savings.

Taxes are one of the three main agents of money corrosion (fees and inflation are the other two). If you follow the law, you will always pay some taxes. The trick is to figure out how to pay as little as possible.

Because the Canadian Pension Plan (CPP) pays out so little (currently $640 – $1060 per month), the government has given Canadians an incentive to take care of their own retirements by introducing Registered Retirement Savings Plan (RRSP).

RRSPs are a type of investment account that is registered with the government, they are designed to defer tax payments until you retire. They are not themselves accounts, but an account designation. That means that many types of bank accounts can be used as an RRSP: savings accounts, web broker accounts and mutual funds can all be designated as RRSPs.

The idea behind RRSPs is this:

When you are working, you are making much more money than when you retire. That means you are also paying more income tax too. By putting your money into an RRSP, you get a tax break next time you file your income taxes. If you make $100,000 per year, and you invest $18,000 into RRSPs, the tax break you get is the difference in tax you would pay if you made $82,000 instead of $100,000. The government lets you pay less income tax when you put money into your RRSP.

But later in life, when you retire and start tapping into your RRSPs, you pay regular income tax on whatever you withdraw. Because what you withdraw when you retire is likely to be less than what you made while you were working, you would be paying less income tax on that retirement income. Withdrawing $50,000 a year (for example) will still require you to pay income tax as though you had a regular income of $50,000. But a $50,000 income is in a significantly lower tax bracket than $100,000, you would end up paying far less tax overall.

Not only are you paying less tax when you invest in an RRSP, the money you get back allows you to immediately invest it so that you have even more money that can grow over the years.

Some RRSP facts:

  • The maximum amount you can contribute for 2015 is $24,930, or 18% of your income, whichever is lowest.
  • You can buy and sell equities (stocks) and take a profit in an RRSP without paying any taxes.
  • You cannot contribute if you are 71 or older.
  • You can withdraw up to $25,000 to help with the down payment on your first home, but you have to pay that amount back within 15 years.
  • If you can’t contribute the maximum amount, the difference will be carried over to the next year.
  • You will be charged 1% per month if you contributed more than your contribution limit.
  • When you are ready to retire, you need to convert your RRSP into a Registered Retirement Income Fund (RRIF). You can do that at any time.

Because the money you get back from the government when you contribute to your RRSPs is based on what income tax bracket you are in, the higher the tax bracket, the greater the tax break. But if you are in a lower income tax bracket, the benefits of contributing diminish. You can use an RRSP contribution calculator to see what you would get back from the government if you contributed to your RRSPs.

Using an RRSP calculator, you will notice that if you live in Ontario, make $40,000 per year and contribute $5,000 you will get a return of $1003. But if you make a salary of $100,000 and contribute $5,000 your return more than doubles to $2170.

RRSPs are a great way to help grow your money tax-free, but they are designed for average to above average income earners or households. If that’s not you, that’s OK, because Tax Free Savings Accounts (TFSAs) offer an even better way to save your money, and the benefits of TFSAs apply equally to everyone, as I will explain next week.