I wanted to talk about how you can prevent money ruining a friendship and to look at ways to overcome awkward financial situations:

Loaning money.

I personally am totally against the idea of loaning money to friends. A financial loan between two long time friends or family members is always going to be awkward. You’re either going to have to be on the side where you swallow your pride and have to ask a friend for money or you’re going to be on the side where a friend comes to you to ask for money. Both sides suck.

My advice on this issue is simple and I feel that one question needs to be answered by both parties: how will this money be paid back? If a friend can’t pay you back the money for whatever reason this will cause obvious hardship on your friendship. This is why you need to come to an understanding right away before the money is handed over. There needs to be a plan for paying the money back and a deadline in place. If not, then you might not see your money for a long time, which would definitely kill the friendship. I also recommend that you loan an amount of money that you’re comfortable with never seeing again. There’s always the slight possibility that your friend won’t be able to pay you back. You don’t want this amount to be high enough to ruin your own financial situation.

Splitting the bill.

Loaning money will get odd and so will splitting the bill when you go to a restaurant that’s way out of budget for one of the people involved. It’s easy to get envious here. If you make $30,000 a year and your friend that you’re at dinner with just pulled in a new salary earning him $100k per year, the natural instinct will be to want them to cover the bill or to pay a larger chunk. They make more money than you, so they should pay more of the bill. This isn’t how it works though.

From my own experience I found that the best way to deal with splitting the bill is by deciding on the location in advance. Everyone should agree on the location in advance, instead of being surprised about getting dragged into an expensive place. If you’re budget is tight you really don’t want to get stuck in a restaurant where the main course is over $50. If you’re the friend that has a deep financial buffer, you don’t want to put your friends in a position where they’re spending way too much money on food. By deciding on an affordable location in advance you guys can all enjoy your evening with worrying about how much the dinner will put you behind on your budget.

At the end of the day there’s a solution to every awkward situation that will arise between you and your friends as it relates to finances. This is just apart of life. With that being said, it’s time for some general tips to help you not resent your friends for making more money and how you can benefit from hanging out with friends that make more money than you:

Don’t hate someone for working hard.

We have a friend that makes lots more money than us. The major caveat is that he works insane hours. I’m talking 18 hour days with no social life at all. I’ve heard others make remarks about him and how he’s so rich. It’s simply unfair to resent someone that’s willing to put in the long hours to earn more money. We all have different values in life. Some of us value money more, while others place a greater emphasis on the relationships in life. Either way, it’s not worth resenting anyone for holding different values than us.

Use this as motivation.

You have tangible proof that it’s possible to earn lots of money in life. Don’t fall behind in life by chasing false hopes and trying to get rich quick. Very rarely does anyone get rich quick or while slacking off all of the time. Being around like-minded people should motivate you to strive for more.

You should never let money get in the way of a solid friendship. Hopefully after reading this article you’ll be able to better deal with financial situations with your friends.

(photo credit: petroleumjelliffe)

I was driving my car to work this morning (an hour ride each direction, there’s time to think a lot!) and I was thinking about the recent economic events and how they were reported in the media. I got this idea because as a banker, you are constantly confronted against what has been reported in the news and how your clients perceive that news.

When you look at how the media reports economic news, there are 2 big issues:

#1 Most individuals have a very limited background in finance/economics but since we all deal with money, think that they know what they are talking about. Therefore, they will take any economic news to the first degree and won’t do further research to understand fully why there is a recession or why there is a bull market.

#2 The Media industry (especially newspapers) is in the midst of a business model crisis. Therefore, the new “good” journalist is the one who reports the “biggest news”. So let me ask you a question:

What is more interesting between the following news items:

#1 The housing market in Canada will generally slow down based on our economic review and some inflated markets such as Vancouver, Calgary or Toronto might be facing a more important correction in housing prices.

#2 There will be a housing bubble burst in Canada! Interest rates will rise to 7%, people will lose their jobs and then their homes. Florida is nothing compared to what is coming our way!

I’d say that most editors will take option 2 as their headline . I have my opinion on the topic (housing bubble in Canada?) but let’s take a look at some major economic news from past years:

2007: Oil price will rise to $200/barrel; We don’t have much oil left.

Back in 2007, we were surfing on a huge oil price rise and more and more “specialists” with tons of diplomas were writing theses on how little oil was left on earth. Gasoline was ridiculously high, people were investing in oil income trusts like they were GICs offering 10% interest and Alberta was so prolific that they cut their taxes and their inflation went through the roof.

Result in 2010:

- The barrel of light sweet crude is struggling to get to $80

- Nobody talks about the lack of oil anymore or about all that was spilled into the Gulf of Mexico

- We don’t even care to report US oil reserves in the news (at one point, it was reported weekly!)

2008: Economic crunch; this is the end of the capitalism and all banks will follow it to the grave

In 2008, the market plummeted like it was the end of the world. Economists on Oprah were declaring that our economic system will never survive and that our banks will collapse. Even in Canada, it was the end of our Canadian banks. They saw their stock price fall by 50% in a span of a few months.

Result in 2010:

- We are getting out of a big global recession but capitalism is not dead.

- Most banks survived and Canadian Banks showed interesting profits, even throughout the crisis.

- The stock went back up almost to their peak prices in 2008.

2009-2010: Economy is back in Canada; Interest rate to jump through the roof!

After seeing Australia increase their interest rate in late 2009, some economists increased significantly their Canadian interest rate forecasts. We were talking about the Bank of Canada increasing their rate faster than expected. I even heard about variable interest rates going up to 7% within the next five years (I wonder if the same guy called the lowest interest rates for 2008 back in 2003 ).

Result in 2010:

- The Bank of Canada didn’t budge until June 2010 (which was announced 18 months prior)

- Variable interest rate hikes by 0.50% so far and no important increase is forecast for the rest of the year.

- Inflation is under control and there is no need to hike the interest rate anyways.

So back to 2010: Canadian housing bubble to burst or housing market going to slow down to a normal level?

image credit

*** 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

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

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

]]> http://www.thefinancialblogger.com/6-investing-rules-revisited-part-3-diversification-allows-reducing-portfolio-risk/feed/ 2 http://www.thefinancialblogger.com/6-investing-rules-revisited-part-1-stocks-always-go-up/ http://www.thefinancialblogger.com/6-investing-rules-revisited-part-1-stocks-always-go-up/#comments Thu, 16 Jul 2009 10:41:15 +0000 The Financial Blogger http://www.thefinancialblogger.com/?p=1777

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.

You are being a good man; you decided that you will take care of your personal finance. The very first thing you realize is that you require help to manage your investments, debts, insurance, budget and so on. Then, you decide that having a personal planner or a financial advisor would be a great help to create wealth. I can guarantee that they will talk to you about creating an emergency fund.

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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The investors are much interested to buy to let mortgages for the enhancement of the maximum range of the profitability. The credit card companies are introducing the different kinds of cards for the customers with different interest charges. The social welfare organizers are very much interested to run debt help programs for the welfare of the debtors. The organizers are trying to find out better debt solution in order to escape the worst conditions of bankruptcy of the victimizers. The home mortgage loan is issued on the guaranteed security of the real property of home of the borrowers. The insurance agents of different companies offer the insurance quotes and leads for the potential customers. You may get start your own work at home by availing the different golden opportunities of internet marketers.

 

Nonetheless, it is a fact leveraging strategies were first designed for wealthy people. Why is that? It is pretty simple. As it is the case with any other new techniques, the first tries implicate way more risk as many factors might not have been considered up front. This is the reason why planners were looking for people that could afford loosing money to try leveraging. They are more likely to take this kind of risk.

 

Not only that but the more you have money, it is easy to make money. You can diversify your assets over many investment vehicles such as rental properties, private companies and investments. Rich people are leveraging on most of their assets. But is does not mean you can not do the same thing. Pay yourself first is a good way of thinking. But pay yourself first with other’s people money is even better!

 

If you are a home owner, you are probably leveraging over your main residence. Your mortgage is a great example of leverage for your own benefit. This benefit turns into money when we are talking about leveraging strategies. There are two rules of thumb to respect in order to not over leverage. In “How Much Should I Leverage?” I explain that as long as you are comfortable with the loan payment and that you never borrow more money than half of your net worth; you should be in a good position.

 

You definitely not need to be rich to leverage with a 25K investment loans. At 7% interest rate, that makes monthly payments of $145. Technically, you need a net worth of 50K and about less than half of your car payments as cash flow. By eliminating your debts through a defined plan, you should be able to liberate enough cash flow to afford a payment on a 25K investment loan.

 

As previously mentioned on this blog, risk is a perception of a “possibility”. Thinking leveraging is too risky for the middle class is wrong. Not knowing what you are doing is risky. Therefore, get yourself a good planner, make your own researches, ask questions to financial bloggers (or to The Financial Blogger ), bankers and financial advisors. You will find out about a new world of financial opportunities.

Individuals with an aversion to risk, senior citizens or simply those who listen to most bankers have GIC’s in their portfolio. They hold on to this product the same way my son is holding to his mom’s leg when he is scared. Is it good to keep this product in your investment portfolio thinking that you are preserving your capital? I don’t think so.

Then why bankers are selling GIC’s as on of the best product on earth? It is because all financial institutions are regulated by compliant rules and investment rules. This is also why you have to fill in one of those questionnaires to create your investment profile. In order to avoid any law suits or any other problem with their clients, banks will offer GIC’s and other similar products to averse to risk individuals. After all, you can’t technically lose with a GIC’s. Therefore, in most cases, banks are protected as they act diligently and clients are happy as they think can not lose money.

This is where the catch is. You can lose with a GIC. Actually, you are almost sure to lose money with this investment product. How can you lose when your capital is 100% guaranteed? Unfortunately for those who think so, other calculations must apply.

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First of all, GIC’s revenues are categorized as being interest revenues. Therefore, they are taxed at your marginal tax rate. Let’s take 40% as an example. After all, if you have savings, you must be making at least 45K. On average, a conventional GIC will give you around 4% yield. Taxed at 40%, you 4% become 2,4%. This is how much you are making after taxes.

Then, you are still making money at this point. Really? How about inflation? Inflation rate in Canada is between 2 to 3% every year. You can count on that as the Bank of Canada aim 1 to 3% with at 2% median goal year after year. Therefore, you 2,4% will become 0,4% in the best case scenario and can show a negative return of -0,6% if inflation rate goes up to 3.

This is how banks are selling products that are comforting for your mind, but they are also gradually taking your money away. Don’t blame banks; after all, they are only selling what you have been asking for. I must admit that they are also trying to create products that are very similar to GIC’s with a guaranteed capital so you can hope to make more than 4% and make a few pennies!

Funny note: For those of you who understand French, a GIC is a CPG (stands for Certificat de Placement Garantie). However, there is another meaning for CPG: Certificat de Pauvreté Garantie. Cheers,

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.