June 29, 2007, 1:47 am

Why most people think it is less risky to invest on the house market instead of the stock market

by: The Financial Blogger    Category: Investment, Market and Risk

Several baby boomers take for granted that their property is the best investment that they could ever made. It is true that most of the time, they are making a good profit when they sell. Therefore, they plan on downsizing their house when they retire and they will be all set to play golf every single day. In fact, they would have probably made more money from investment than from their property. But why do they all have examples of people that made money form their property but not from their investments? The answer is simple; it is all about rationality. I read an article in Les Affaires (a French business related newspaper) about the perception of an individual’s property and his perception of his investments.

 

Imagine that, every morning, you could sit down in front of your computer, coffee in your left hand while you are surfing the internet. You go on Yahoo! Finance and the price of your property is listed. It fluctuates every single day like any other stocks or mutual funds. Then, imagine that you are back in the 80’s and your house value goes down month after month. At one point, you panic and you put your house for sale to minimize your lost.

 

This is exactly what is happening with most people when they look at their investments. Stocks do fluctuate on a day to day basis. Markets do go down for a long period of time. But in the end, if you keep your position during the storm, your investments will flourish again and you will end up making money.

 

As there are too much information available theses days, people analyze and over analyze as much as they can. The result; their thinking doesn’t make sense anymore and they buy and sell according to their feelings. This explains markets’ violent mood swings.

 

The purchase of a main residence is a long and complicated process. You have to visit properties, make offer, receive counter-offer, negotiate dates, go through the banks’ approval process for a mortgage, chose a lawyer and move all your stuff to another place. You will most likely buy three to four houses in your life because of the above mentioned reasons. However, trading is totally different. You can buy, sell, short within seconds. This is why you will take more time to choose a property that meets your need than buying and holding a strong company’s stock. At the first drop, you will be tempted to sell. It will never happen with your house as the process is way more complex and you can’t follow your property’s value on a daily basis.

 

The fact that individuals are more rational about transactions related to properties than stocks is an important factor in their overall investment return. As they don’t take the same time and energy (without mentioning patience) as they do for a house, they increase their investment risk of loss.

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June 28, 2007, 2:52 am

Financial Cliché V: My house is my retirement plan

by: The Financial Blogger    Category: Financial Cliché

First, I would like to follow up on yesterday’s post on “Where is Prosper.ca”. I’ve been in contact with David Andreatta from the Globe and Mail and he wrote an article in today’s edition. You can read more about it on the Globe and Mail. I was glad to hear that a lending community will be established in Canada. Many thanks to David for mentioning my blog in the Globe!

Now, back to today’s post :

This is definitely on of the major source of financial discordance between the baby boomers and the generation X (or is it Y? maybe Z? anyway, I’m 25 so you can figure it out!). Several baby boomers think that their property is their retirement plan. If it’s completely paid off, they think they have enough money sitting there to live long and prosper. If they don’t have other source of income other than the government’s pension they are probably wrong.

Your main residence is not necessarily an asset. As we previously discussed on this blog, an asset must create income or positive cash flow. This definition is even more important when you retire and you depends on your assets to meet your financial needs. As most retired individuals are not renting their basement or are not operating a company within the house, their property is not an asset. Every month, they have to pay their utility bills, their taxes and cost of maintenance. With $800 a month, you might find the road to be a little longer than expected.

I just have to sell my house and I’ll make 400K, they will answer back quickly. That part is true, but do they really want to leave their house? All their memories and souvenirs are within those walls. In addition to that, they still need a place to live. The other thing is that they might not be able to find something that suits them for a lower cost. House market is pretty high right now and downsizing often means going back to that small 1960’s bungalow with several reparation to be made.

Cost of retirement home are sky rocketing and you are not getting much service for the price you pay. It will easily be $1,000 a month if you need services such as nurse inside the building. Besides that, you can always rent a nice apartment or downsizing you house. In both cases, you just increase your monthly payment. Therefore, you will need more money to live on and your profit from the sell will slowly disappear.

Your property surely worth something and the day you will sell it, you will get a big chunk of money. I’m not questioning that at all. However, it will never create income as is. Unless you sell it, you won’t benefit from the equity in your property. Reverse mortgage is another option but I will write about it another day.

There is still a way to make you property an asset and still live at the same address. By doing a Smith Manoeuvre, your new mortgage will become tax deductible and you will earn monthly income from your investment. This could be a good way to benefit from the equity lying (I prefer the expression dying) in your house.

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June 27, 2007, 3:25 am

Where is Prosper.ca?

by: The Financial Blogger    Category: Make Money Online

Have you ever heard of prosper.com? This website is a P2P community that allow regular people to lend/borrow from other people. Basically, they created Financial Napster 2.0. This might be another way to diversify your assets and to start thinking as a bank. You think that you are smart enough to be the banker and lend to the right individuals, here is your chance!

The system is pretty easy. You have two sides: Borrowers and Lenders. Lenders are registering on their own name or they can create groups with common characteristics such as personal profile, profession or goals. They post their request and provide information such as employment status, TDSR and motivation. The borrowing rate is determined by their credit score (established from E to AA) and the amount requested.

For lenders, they have access to borrowers’ credit bureau and other more specifics information such as a Q&A’s section. They also have the possibility to form lender groups. They don’t have to lend the full amount requested by the borrower. They can lend small amounts to several individuals and therefore spread their risk among their credit portfolio. This is exactly how banks are working despite the fact that they fund the full amount of your request.

Loans are usually over three years maximum which decrease your risk of default. The website is working as a platform where lenders and borrowers can meet. Obviously, prosper.com does not offer any guarantee that you will be repaid partially or fully by the borrowers. You are the only one playing in the game of credit.

Why people would use Prosper as an investing option? It can be an interesting way of diversifying your portfolio and earn money. You can make money by lending to several individuals by managing your credit portfolio carefully. There is little difference between the stock market and lending to people. In both cases you will place your faith and (most important) your money into a few individuals’ capacity of performing.

Why people would use Prosper as a lending option? Some individuals might have difficulties to prove their income source such as self employed and business owner. There are also people that are getting paid the Canadian way, but that is another story for a later post. For others, they might have run into financial difficulties due to a divorce, sickness or bad credit management. All those people will find in Prosper an alternative to regular banks.

But my question remains, as propser.com is getting bigger and bigger, where is prosper.ca? Is there any reasons why we don’t have a Canadian version of this company? Unfortunately, I don’t have the answer to this question. However, I will surely investigate this further and let you know about it!

 While I was writing this post, canadiancapitalist alreay find out about the answer. You visit his site here.

***This post was not made to promote prosper.com, just to give some thoughts on the p2p lending. I don’t know if it works as only US citizen can be part of this lending community***

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June 26, 2007, 1:39 am

Financial Cliché IV: A financial consultant is required to become wealthy

by: The Financial Blogger    Category: Financial Cliché

This is definitely a highly debated topic. I recently heard about a US study on the added value of a financial consultant managing your personal finance. They were explaining that in most cases, the investment portfolios were not showing a better performance with the help of a financial consultant. There are several good and bad points to financial consultants but one thing is for sure, you don’t necessarily need one to become wealthy.


In fact, several individuals are doing just fine without them. They created assets generating sufficient income to meet their needs and they are fine with that. Some others don’t believe in the stock market and invest in real estate properties or other assets. I can’t really blame them after the techno bubble and other market’s fluctuations.


You can also learn everything by your own and be a pro of personal finance. There are enough resources on the internet (such as this blog and many others!) that you can make your own decision and create wealth from your own knowledge.


If you are not passionate about personal finance or you simply feel unsecured to manage tax laws or leveraging strategies, I strongly suggest you get a financial consultant to help you out. The main point of this post is to reposition the role of a financial consultant. He should draw up the main guidelines and provide you with technical advices. However, you need to remain in control of your finance and be able to dig up if you don’t understand completely his explanation.


In the end, financial consultants are definitely a good support for personal finance. However, you don’t need them to be rich and there is no consultant that will make you a millionaire if you can’t get it done by your own. They are there to help you out with what you have. Unfortunately, they are not magicians.

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June 25, 2007, 2:57 am

The Way Banks Look at You Part3: It’s a Baseball Game

by: The Financial Blogger    Category: Banks and You

I’ve recently explained the 5 C’s of credit and demonstrate how banks will based their credit decision. You might not always understand why you are declined or why they would not lend as much money as you wish. I often say that credit is like a baseball game. Your about to hit and the bank is the pitcher.

 

Strike One: Bad Credit Management

The first strike is the most important as it sets everybody up for what’s coming next. Showing late payments on your credit bureau or having all of your revolving credits are maxed out to the limit will bring almost your application into the garbage bin.

 

Strike Two: High Total Debt Servicing Ratio

The second strike is related to your spending habit. Even if you make all your payments on time, banks are interested to dig a little further. They want to know how much you earn and how much is your minimal financial requirement. That includes payments on personal loans, credit cards, lines of credit, mortgage or rent, municipal taxes, heat and car leases. You can find more information on TDSR on this site.

 

By the same token, banks will be in a better position to determine your ability to save money. Are you spending all your money? Are you buying goods or investing with your money? What happens in your financial situation if interest goes up? All those questions will be answered by a simple debt ratio calculation.

 

Foul Ball: Cars, Furniture, Unjustified Income

You just hit the ball, it went far, but it’s no good as foul balls don’t count for much. Having for $150,000 of cars in your parking lot will surely get people to look at you while you are driving. Unfortunately, banks are not very interested in porches and BMW’s. Cars are depreciable assets that don’t count for much in the calculation of your net worth. Usually banks take the car value to offset a loan linked to it. If not, your vehicle won’t make them small.

 

I better tell you right away, expensive furniture worth nothing for the banks. Don’t even bother mentioning it. That’s a foul ball that never left the diamond. Another thing that won’t add much weight to your application is undeclared or unjustified income. If you don’t have valid proofs such as Notice of Assessment, pay stub or other official documents showing your income, it won’t be taken in consideration. This is why self employed and business owners have so much difficulty having loans. Their real income is not shown anywhere as they are writing off several personal expenses.

 

Strike Three: Negative or Not Liquid Net Worth

The final strike is having a negative net worth or being house rich. We recently heard about the new term “accidental millionaire”. Those are people that bought a house a long time ago and benefit from the recent boom. Their property is boosting their net worth. They are millionaire in term of net worth, but they don’t show the ability to save money. If they would have to sell their house today and move, they would have to pay the same price for a similar house. Having a high net worth is good, but having liquid assets is perfect.

 

However, if you don’t have any kind of assets, it’s even worst. When banks are calculating their risk, they look at the possibility that you have to sell all your assets to pay off your debts. If after selling all you have, you still have debts, they won’t be very tempted to lend you more money.

 

Batter’s out: Changing the rules

What? You are already out and you didn’t swing three times? This is no Baseball! You are right, this is the credit game and banks are not only pitchers, they are referees as well. Unfortunately for all of us, they decided that two strikes out of three are sufficient to decline a file.

 

Nonetheless, you can play with rules as well. If your batter is out after two strikes, you can always bring another batter that will hit a homerun for you. Having a strong co-applicant might erase your strikes and get another chance to hit the ball. The good thing about the credit game compares to Baseball is that the game is never really over.

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