*** Hey! Where is part 5? It’s over at INO Blog… It’s about asset allocation according to your age. (link will be updated later on today)***

If I was to start over my financial life, I would do something differently: I would buy a property right after signing my first employment contract. During almost 4 years, I gave $30,000 in rent instead of building equity within my own property.

When I was young, my parents basically lived on the profit made on each property sold. They used to buy a property, move into it, do renovations and sell it 2 years later. They always though (and they still do!) that real estate was a sure value. In fact, they always told me that property values always go up. Wrong!

Those who bought big properties back in 2007 and 2008 in USA or Western Canada can surely tell you about it. Making money from real estate is not an absolute basic of personal finance. While the real estate market is more stable than the stock market, it doesn’t mean value cannot drop.

Property value in Alberta and British Columbia dropped by 20% so far and it is even tougher in some states down south such as Florida and California. Back in the 90’s, several North American regions saw their property value remain stable for 5 years straight. Considering inflation, those people had probably to wait 10 years to make a decent return on their “investment”.

The main risk when you purchase real estate relies within liquidity:

#1 To ensure the property maintenance. There are no points of buying a huge property when you can’t put furniture in it!

#2 If you plan on sell your property to pay something else or do another project, it may take more time than expected.

#3 It is harder to get the equity from your property (you either have to sell it or request a mortgage). In both cases, fees can occur.

#4 Your main residence should not be considered as an investment. It constantly requires that you inject money for taxes, maintenance, improvements, etc. On the other side, your main residence will never generate stable income. The only gain will be realized once you have sold it (usually to buy a bigger one and stick to the very same situation!).

You Are Better Be A Owner Than A Renter: Revisited

Real estate should not be considered as the Investor’s El Paradiso. There should be a big difference to be made between owing your main residence and rental properties. While the first remain an expense that you must buy according to your means, the latter can generate interesting profit (and stable income from rent over time).

In both cases, it is highly important to revised your budget and consider all expenses related to real estate before making a decision. If you can afford it and you do not face liquidity problems previously mentioned, investing in real estate may be quite profitable.

I hope you liked my series on investing rules revisited. Do you have any other investing rules that don’t fit our financial landscape anymore?

Find the full 6 investing rules revisited:

Part 1: Stocks Always Go Up

Part 2: Blue Chips Are Safe Investments

Part 3: Diversification allows reducing portfolio risk

Part 4: Gold Goes Up When Stock Markets Go Down

Part 5: You Are Better Be a Owner than a Renter

Part 6: If You Are Young, You Should Invest the Biggest Part of Your Portfolio into Stocks

image source: flickr

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• 6 Investing Rules Revisited Part 1: Stocks Always Go Up
• 6 Investing Rules Revisited Part 3: Diversification allows reducing portfolio risk
• 6 Investing Rules Revisited Part 4: Gold Goes Up When Stock Markets Go Down
• 6 Investing Rules Revisited Part 2: Blue Chips Are Safe Investments
• Canadian Mortgage Rules To Change Says Flaherty

Before I was born, gold was used as the reference value for our monetary system. Each country had their dollar linked to gold and depending on the fluctuation; they had to purchase more gold to maintain their economy. Since history is written, gold always played an important role in the economy. It was once used as a payment method but we now prefer credit cards… they are lighter

This would probably explain our unconditional faith in gold. When the world is about to fall apart, we all agree that gold will remain a sure value. When we are not able to give a value to a piece of paper written $20, we will still recognize the value of a golden piece.

This is how several investors though of selling their stocks and transfer most of their investments into gold. They though it would be a good idea because:

#1Gold always has an intrinsic value (so do good company by the way)

#2If several people do the same thing, chances are that the price of gold will go up and they will have made a good investment being one of the first player to play their card.

Unfortunately for them, the price of gold hit the very same brick wall than stocks, bonds and real estate. Therefore, gold has proven its limit as a “sure value” during market crashes.

There is a strong mechanism regulating the price of gold: the consumer. When the price of gold goes up, it is followed by the price for golden jewelleries. Then, the demand for jewelleries decreases and the price of gold is back under pressure.

An additional factor to consider is the recent investment from mining companies in the discovery for golden mines. This should increase the offer of gold on the market and stabilize the price.

So while we think that people may leave the US dollar to buy gold, the price of this precious metal might not jump. The above mentioned mechanisms will slow down the price progression and help create equilibrium.

Gold Goes Up When Stock Markets Go Down: Revisited

It is still true that gold will show a smaller volatility and may protect a part of your investments from the market turmoil. However, this should not be used as the ultimate solution to protect your portfolio against markets drops. Those who think that investing in gold will bring back their losses from the stock market might be deceived.

However, holding 10% gold in your portfolio will improve your diversification and reduces your risk.

image source

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Related Post

• 6 Investing Rules Revisited Part 6: You Are Better Be A Owner Than A Renter
• 6 Investing Rules Revisited Part 1: Stocks Always Go Up
• 6 Investing Rules Revisited Part 3: Diversification allows reducing portfolio risk
• 6 Investing Rules Revisited Part 2: Blue Chips Are Safe Investments
• Why Stock Markets Are So Volatile? The Tale of 4 Masters

I remember my finance classes where our teacher was hitting our brains with a bunch of theories explaining why diversification was the only way to insure an optimal yield while reducing the volatility (called risk by the common investor) of a portfolio. There was tons of big brain that became famous in the finance world providing investing strategies based on diversification. This is also the main reason why we have so many mutual funds and why they are so popular. Everybody is selling them

The point of being well diversified still stand. However, we are not as protected against a drop in the market as we thought we were. The point was to invest in several industries among several geographic markets. Therefore, if the oil industry in Canada was stalling, you could always hope that the manufacturing industry in China would perform or that the big blue chips from the USA would consolidate their position and grow stronger.

Unfortunately, in 2008, there were no escapes. While the S&P 500 were losing 38% of its value, the Brazilian stock market dropped 40% and the Chinese companies fell by 51%. This is a surprising consequence of having a global economy: each country is linked to others and influences their global economy. It’s like 50 kids in a daycare: if one gets the flu, the daycare is half empty by the end of the week!

The only survivors from 2008 were the money market and government bonds… Not much to keep investors happy about their “well diversified” portfolio! They look at their statements and they only think about calling their financial advisor and ask about investing in several countries in order to reduce their risk…

Diversification allows reducing portfolio risk, revisited:

Being diversified will optimize your investment return and reduce the volatility of your portfolio. However, this does not mean that it will save you from important market crashes. There are several ways to be diversified:

- Economic sectors (financials, materials, techno, health, etc.). Having all your money invested in a few economic sectors makes your vulnerable to them… Just think about financials and resources in 2008 or the techno’s back in 2000.

- Countries (USA, Canada, International). Even though all economies are linked to each other, you are better off not taking the chance of not picking the right country. Worst comes to worst, you will still benefit from the markets come back.

- Asset classes (stocks, bonds, commodities, real estate). Then again, if you are invested solely in real estate, you might miss great opportunities on the stock market and vice versa.

However, I do not believe in being diversified by:

- Financial institutions (this only duplicates your investment statements and makes it difficult to follow).

- Mutual fund companies (you may be able to find a good mutual fund company and stick with them. You will probably save more money on fees with a bigger amount).

- Financial advisors (you are better off with only one financial advisor as he can see the full picture and give you proper advices. What if he doesn’t know that you have 30% in the US market elsewhere and suggests US investment products since you don’t have any in your portfolio with him?).

- Mutual funds (by selecting more than one fund doing the same thing you automatically select one with higher MER’s than the others and therefore, pay more for nothing.)

Those methods are more related to “diworsification” than diversification

The key point to remember is diversification reduces the risk but does not make it disappear.

image source: flickr.com

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Related Post

• 6 Investing Rules Revisited Part 4: Gold Goes Up When Stock Markets Go Down
• 6 Investing Rules Revisited Part 1: Stocks Always Go Up
• 6 Investing Rules Revisited Part 6: You Are Better Be A Owner Than A Renter
• 6 Investing Rules Revisited Part 2: Blue Chips Are Safe Investments
• Diversification through commodities investing?

The year 2008 showed us the worst face of capitalism and made several people rethink their investment strategies. The stock market fluctuations were bad enough to actually shake some of the most fundamentals financial lessons we have learned. Blinded by our greed (or by our naivety!), we though, once again, bad things could only happen to others; that our economic system was stupid proof. Well, we actually proved that it was stupid Based on what recently happened on the stock market, I decided to revisit some fundamental investing rules.

Stocks always go up

Before 2008, most people agreed that if you buy stocks and hold them long enough, you are able to make a decent profit. Or at the very least, get back your initial investment . While I still believe that stock markets always go up over the long term, there is a problem with this investing rule: defining what is a long term investment horizon.

Most projections are made for investment over 5 to 10 years when we talk about investment yield or investment expected return. The sad truth is that someone who would have invested $1,000in the S&P 500 in 1999, would be left with the devil in his pocket ($666 so -33%)). I let you imagine if he would have decided to invest in the NASDAQ .

On the opposite side, investing in bonds for the past 10 years would have given a positive return.

The theory still stands

If you consider an investing horizon of more than 25 years, all graphics will show a better return for stocks than bonds or any other investment products (rental properties, GIC’s, etc.). However, you must be able to stay in the market for at least 25 years! If you are 30, this is not a problem, but if you are 55, you might think about it twice.

It also all depends on the timing. As you may conclude, you can make say anything to numbers. If you wait 2 years and you take the numbers from the S&P 500 from 2001 to 2011, I’m pretty sure you will show very positive results. The proof is that the S&P 500 shows a positive annualized return of about 7% on the past 15 years (this brings us back before the techno bubble).

Stocks always go up: revisited:

The key is to define long term investment for more than 10 years. Therefore, you age and the age you want to retire will play a determinant rule in regards to investing in the stock markets. As you age, you should slow down on stocks and buy other investment alternatives such as bonds, linked notes, GIC’s or rental properties (is you wish to manage renters ).

However, if you invest in the stock market today, consider long term as being 15 – 20 years to make sure you don’t lose your money. I have seen too many people thinking they could make good returns within the next 5 years and crying a few years later.

One last point; I would not give too much importance to past returns showed by mutual funds. Looking behind won’t give you much information about what is coming up on the stock markets. Investing rules are changing since last year and it will never be the same…

For more information on stocks, you can look at free video at INO TV. They offer great videos answering all kind of questions about trading.

If you liked this articles, you might want to sign for my FULL RSS FEEDS. Then, you will get my daily post to your email and can read it at any time. To subscribe CLICK HERE

Related Post

• 6 Investing Rules Revisited Part 3: Diversification allows reducing portfolio risk
• 6 Investing Rules Revisited Part 4: Gold Goes Up When Stock Markets Go Down
• 6 Investing Rules Revisited Part 6: You Are Better Be A Owner Than A Renter
• 6 Investing Rules Revisited Part 2: Blue Chips Are Safe Investments
• Diversification through commodities investing?

While I am definitely not convinced that you need a financial consultant to create wealth, I am even less convinced that an emergency fund is something useful! It is definitely a financial cliché.

What is an emergency fund anyway?

Here’s a definition of an emergency fund: it is a highly liquid part of your assets invested in non-risky investments in case you need money to cover for a job loss or unexpected expenses. This money should remain dormant unless a financial catastrophe strikes your wallet.

This money is a waste of potential return

Obviously, if you invest in a low risk financial product, you are wasting your potential return. As an emergency fund requires to be available on the spot, most funds are deposited into a money market account or a savings account. In both case, you can rarely expect more than 4,5%. Therefore, this money could have been used to pay off debts that may bear a superior interest rate or you would have simply invested this money into something that is more profitable. Since higher return is often meaning higher risk, it defeats the purpose of an emergency fund. The goal when you invest your money into an emergency fund is primary to protect your capital. On the other side, if you are 30, you could loose a good 30 years of good returns.

There are alternatives

My favourite alternative is the line of credit. In fact, this financial product doesn’t cost a penny if you don’t use it. You can withdraw money from your line of credit at any time, so it is very liquid and the available limit is stable. Having a 20K flex line would be the best alternative to having an emergency fund. In fact, it is more convenient as you don’t have to put money aside to build a reasonable fund. The money is available 24/7 upon the opening of the account.

Another solution is to build equity in your property. Banks will more likely lend money if they have collateral. Therefore, if you can give your property as collateral and refinance your mortgage, you will be able to access enough money to survive for three to six months.

What is the difference between borrowing or having liquidity

This is where it gets interesting. Normally, an emergency fund is used to cover for regular expenses for a period of three to six months. Let’s say than an individual’s monthly expenses are 5K and that he would be able to borrow this money at 10%. If he takes off the full amount (30K for six months) on the very first day, he will have to pay $250 per month in interest until he can pay back the full amount. This would be the real cost of borrowing money instead of keeping 30K into a savings account. However, you have to figure out how much time it will take to actually gather this sum of money and how much could you earn from it if you would have invested in the market.

I think it is a small risk to take when you think about how much you could earn on the market over time. If you invest money already, you probably have a part of it invested in low risk investment. Why don’t you use this money if anything bad happen? Worst comes to worst, you will still have your line of credit to cover for the unexpected.

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