Million Dollar Journey

Scams of the Modern World – I

Clark — Wed, 08 Feb 2012 12:30:19 +0000

As most of us would agree, greed and gullibility fuel the growth of unscrupulous people and their myriad ways of deceiving the public through various channels. The scams we read about are diverse in nature and the investment industry has not been left untouched either. Below are some of the typical scams that we should be aware of and also let our near and dear ones know.

Pyramid Schemes

These schemes depend on the availability of enough victims to perpetrate the con. Pyramid schemes are sometimes referred to as network or multi-level marketing schemes. A well-known type is the Ponzi scheme, where the con artist uses the principal from the latest investor to pay interest/dividend to the previous investors. The scheme inevitably fails when the money owed to such previous investors exceeds the inflow from new victims.

Off-shore Investing Schemes

Such schemes are marketed with the promise of “great” and/or “guaranteed” returns through investments in exotic locations. The perpetrator seldom provides concrete details about the business they are investing in and if they do, the documents are likely to be forged. It should not surprise you if the cheating party goes as far as to set up a fake website about the business, thereby lending purported credibility to the scheme. Sometimes, the company could be legitimate but the marketer/tipster may wait for enough buyers to drive the stock price up and then, sell their own shares for a gain (see Pump and Dump and Short and Distort). The Internet can be a boon and bane and it is tough for local authorities to prosecute such foreign criminals.

Guaranteed Job or Work from Home Scams

As you would guess, such stellar opportunities almost always require a fee for processing the application or providing the operating procedure/plan for the business. Spam emails and cold calling are commonly used to lure victims. The tougher the financial/family situation of the victim, the easier it is for the scammer.

Investment and Real Estate Seminar Scams

Some con artists thrive by promising to share their secret to stock market or real estate riches. These con artists use high-pressure sales tactics and profit from the attendance fees paid by the victims. In addition, they could offer information about high-risk strategies masked as low risk/high return opportunities. Please note that there are legitimate seminars being offered and this section is not an attack on all seminars.

Business Proposition Scams

These could be once-in-a-lifetime email offers to assist a Nigerian prince or Malaysian business tycoon’s son. The victim is promised hundreds of thousands or millions of dollars (I am yet to receive a believable offer of just a few thousand dollars) if they assist the said person, who has access to millions of dollars. All one would need to do is call a number or reply to the email to discuss the details (provide bank info or pay fees along the way) about getting the money out of the originating country.

The next part of this series will touch upon a few more scams that are prevalent today. Have you or anyone you know fallen prey to one of the scams above? What recourse did you (or they) have?

About the Author: Clark works in Saskatchewan and has been working to build his (DIY) investment portfolio, structured for an early retirement. He loves reading (and using the lessons learned) about personal finance, technology and minimalism. You can read his other articles here.

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Facebook IPO – Will You be Buying?

FrugalTrader — Mon, 06 Feb 2012 12:30:37 +0000

If you’ve been following finance news over the past couple of weeks, you would have likely read the headlines about the much anticipated Facebook Initial Public Offering (IPO). With Facebook having the largest social network in the world with over 840 million active members and growing, they are moving towards Google like dominance, which has brought the interest of investors worldwide.

So what is an IPO? It’s basically a way for a company to raise money by issuing shares to public markets. In the process, it can make existing shareholders very wealthy. In this case, Mark Zuckerberg, Facebook founder and CEO, will likely become one of the richest people on the planet.

How rich? The $5B IPO will place Facebook at a valuation of $85 Billion to $100 Billion – yes with a B! With the Mr. Zuckerberg retaining 28% or so of the company, it will bring his ownership stake up to $28 Billion promoting him to the top 10 list of the worlds richest people.

Back to the business itself, how does Facebook monetize their 840 million active members? Like Google, Facebook has monetized the traffic on their site with ads. While Google displays customized ads based on search results, or website content, Facebook displays ads based on demographics. What makes Facebook attractive to advertisers is that they can tailor their ads specifically to their market. For example, a company could target and display ads specifically to 20-25 year old males, from Canada, educated, and only pay when their targeted audience clicks their ad.

How much revenue does Facebook generate? In 2011, it’s reported that they generated over $3.71 B in sales, up over 88% from a year earlier. After all expenses, net earnings are reported at $1B, up 66% from 2010. With $1B in earnings, that brings a price/earnings multiple to an insane 100 assuming that the valuation reaches $100B on IPO day. It’s starting to feel like the late 1990’s all over again!

Although valuations are sky high, it’s hard to ignore how much Google appreciated after their IPO in 2004. The stock started trading in the $90’s and today, it’s a $600 stock. A six bagger in seven years which is about a 31% compounded annual return. Mind you, Google valuation is much more conservative at 20 times earnings (~$200B market cap). Could Facebook take the same path? Only time will tell!

Back to you, will you be buying Facebook on opening day? Do you think that it’s over valued?

Are Junk Bonds for You?

Clark — Wed, 01 Feb 2012 12:30:10 +0000

As we have seen in earlier posts, a bond is a loan made to a government or corporation with the borrower obligated to pay back the principal with interest at maturity. The creditworthiness of the borrower (bond issuer) is reflected in the bond’s credit rating; the better the ability of the issuer to meet their debt obligation, the higher the credit quality of the bond.

Bonds with superior long-term credit ratings (AAA, AA+, AA, etc.) are known as prime or high-grade bonds. These bonds are issued by companies with a solid track record and the high rating is a testament to the issuer’s ability.

On the contrary, there are some corporations that have a poor record of meeting their debt payments (whether late or default) or do not have a long history but still need money to finance their activities. Since investors would be unwilling to part with their cash for such a corporation’s bond, the company will have to lure investors through their high bond interest rates. Due to the speculative nature of such bonds, they are called junk bonds or, to put a positive spin, high-yield bonds. Usually, the credit rating of such junk bonds are BB, B+, B-, CCC, etc. to reflect the potential risk of default.

Junk bonds in the current interest rate environment

Until a few years ago, the Canadian junk bond market was virtually non-existent after it went into a dormant state in 1990 and companies sought refuge in the established US junk bond market. However, due to the current low interest rate environment, a few companies have started borrowing in Canada by issuing junk bonds; a short list of junk bond issuers is available here (second page of above link). A point of note for junk bonds is the yield spread; in other words, the difference in yield between a junk bond and government debt. The yield spread is important as it helps in identifying whether the reward (higher yield) outweighs the risk (default).

Junk bond ETFs

As with other asset classes, junk bonds are also available as ETFs to help mitigate the impact of default that gains focus when buying a few individual junk bonds. iShares iBoxx High Yield Corporate Bond Fund (ticker: HYG), SPDR Barclays Capital High Yield Bond Fund (ticker: JNK), and PowerShares Fundamental High Yield Corporate Bond Fund (ticker: PHB) are some of the options available to investors interested in going this route.

A short list of high-yield junk bond ETFs is available at ETFdb. As the stock markets alternate between fear and confidence, the market rallies have fueled the performance of such junk bond ETFs. Nonetheless, the pickings seem slim in the Canadian junk bond category with the AGF Canadian High Yield Bond Fund being the prominent player.

Similar to other bond ETFs, it would be useful to look at the liquidity, expense ratio, default rate, yield spread, fund composition, and direction of the fund (strategic changes) when looking to invest in junk bond ETFs.

Are junk bonds for the average investor?

As should be evident from above, the risk with junk bonds is that the investor may never get their principal back due to the poor creditworthiness of such bond issuers. In addition, if looking for individual junk bonds, the investor should be fairly knowledgeable about credit quality. Typically, institutional investors have the resources to conduct elaborate research to filter the better ones. Although an average retail investor may get the chance to diversify across different asset classes by buying some of these high-yield junk bond ETFs, the risk may not be worth their while.

Do you invest in junk bonds? Individual or ETF? How have your investments fared? Do you have any tips to offer for interested investors?

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Net Worth Update Jan 2012 (+2.16%) – A Fresh Start!

FrugalTrader — Mon, 30 Jan 2012 12:30:24 +0000

Welcome to the Million Dollar Journey January 2012 Net Worth Update – The first update for 2012! For those of you new to Million Dollar Journey, a monthly net worth update is typically posted near the end of the month (or beginning of the next) to track the progress of my journey to one million in net worth, hopefully by the time I’m 35 years old (end of 2014). If you would like to follow my journey, you can get my updates sent directly to your email or you can sign up for the Money Tips Newsletter..

With a new year comes a fresh start, new goals, and the financial checklist of accounts to fund.

TFSA contribution? Check! Deposited $5,000 in each account for $10,000 total.
RRSP contribution? TODO – I typically wait for our Notice of Assessment as we contribute to pension plans which affects our RRSP contribution room.
RESP contribution? Check! Deposited $2,500 for each child for $5,000 total.

Besides the contributions, not a big change from the last update. Similar to previous years, I adjusted our home value up to match historical inflation even though the real market value is likely much higher due to the local real estate boom. I tend to stick to the conservative side for valuations as it keeps me motivated to keep my numbers growing and it helps buffer any down turn in market values if that were to happen.

Readers have made a few suggestions for changes to this balance sheet update. First, with the cash balance building on the corporate balance sheet, readers have mentioned that the value of the corporation should be included in these updates somehow. After giving it some thought, when I move some cash to a corporate trading account, then I may consider including the after tax value of the account in these updates.

In addition to that, some readers think that RESP values should be included in my net worth but the problem is that I consider the RESP to be my children’s money. I can see their point as “technically” the contributions are mine until my kids withdraw it to pay for post secondary institution. What do you think? Should I include the RESP my net worth? Do you count it as part of yours?

On to the numbers:

Assets: $679,880 (+1.94%)

Cash: $4,500 (+0.00%)
Savings: $58,000 (-15.94%)
Registered/Retirement Investment Accounts (RRSP): $121,400(+2.36%)
Tax Free Savings Accounts (TFSA): $40,200 (+35.35%)
Defined Benefit Pension: $37,600 (+1.08%)
Non-Registered Investment Accounts: $28,980 (+1.05%)
Smith Manoeuvre Investment Account: $88,700 (+1.37%)
Principal Residence: $300,500 (+3.00%) (purchase price adjusted for inflation annually)

Liabilities: $82,000 (+0.37%)

Principal Residence Mortgage (readvanceable): $0 (0.00%) (Paid off in 2010!)
Investment LOC balance: $82,000 (+0.37%)

Total Net Worth: ~$597,880 (+2.16%)

Started 2011 with Net Worth: $585,228
Year to Date Gain/Loss: +2.16%

Some quick notes and explanations to net worth questions I get often:

The Cash

The $4,500 cash are held in chequing accounts to meet the minimum balance so that we pay no fees (accounting for regular bill payments – ie. our credit card bill). Yes, we do hold no fee accounts also, but I find value in having an account with a full service bank as the relationship with a banker has proven useful.

Savings

Our savings accounts are held with PC Financial and ING Direct. We usually hold a fair bit of cash in case “something” comes up. The “something” can be anything that requires cash such as an investment opportunity that requires quick cash or maybe an emergency car/home repair. We also need cash to cover any future tax liabilities.

Real Estate

Our real estate holdings consist of a primary residence and REITs plus a rental property. The value of the principal residence remains valued at the purchase price (+inflation) despite significant appreciation in the local real estate market.

Pension

The pension amount listed above is the value of both of our defined benefit pension plans. I basically take the semi annual statement and add the contribution amounts (not including employer matching) on a monthly basis. The commuted value of the pensions are not included in the statements as they are difficult to estimate.

Stock Broker Accounts

Another common question is which discount broker do I use? We actually have accounts with multiple institutions. I’m hoping to reduce the number of accounts that we hold in the near future. Here is a review of some of the more popular online stock brokers.

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Last Chance for Newsletter Offer, Lost Decade, Mens Health and More

FrugalTrader — Fri, 27 Jan 2012 12:30:17 +0000

Remember the Successful Investor Stock Pick Newsletter offer that was supposed to end Jan 15? Due to interest from readers, I managed to convince TSI to extend the offer until the end of January! So as it stands right now, you can still get a one year subscription for the exclusive MDJ price of $30, which is $109 cheaper than their regular price and $59 cheaper than their current promo price on their site. Check it out the deal here.

Europe and the Lost Decade @ Canadian Money Forum

Grading Men’s Health’s Tips to Build Wealth in Trouble Times @ Lazy man and Money

Why Use Cloth Diapers? @ Sustainable Personal Finance

How To Squash Your Nagging Money Worries @ Money Smart Life

Comparing Currency-Hedged and Unhedged Holdings @ Canadian Capitalist

What Is My Expected Net Worth? Median Net Worth By Age & Income @ Digerati Life

What to invest in for 2012? @ Retire Happy

How to be a Conservative Investor @ Generation X Finance

Is There Really Such Thing As Passive Income? @ Canadian Finance Blog

What is Your Adjusted Gross Income? @ My Dollar Plan

Extreme Penny-Pinching Tips for Tight Times @ Financial Highway

Locking in a Natural Gas Price @ Michael James on Money

A Shift in Perspective: Micro-Budgeting to Big-Picture Finances @ Frugal Dad

RESP Canada Learning Bond (CLB) – Why Aren’t More People Claiming it? @ Money Smarts Blog

(Cheap) Must-Haves for Parents @ Sun’s Financial Diary

Financial Outlook for 2012 @ Balance Junkie

the questions you need to succeed in business @ brip blap

How Much Do We Spend On Our Pets? @ Boomer and Echo

Welcoming Sysco to my portfolio @ My Own Advisor

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Joining a Pension Plan? A Closer Look at PAs, PARs and PSPAs

Guest Blogger — Wed, 25 Jan 2012 12:30:01 +0000

We live in uncertain economic times and pensions are no exception. Employers looking to bring some certainty to their pension plans are opting to convert their Defined Benefit (DB) plans to the more predictable Defined Contribution (DC) plan at an alarming rate – in a recent survey, 51% of private sector employers admitted to switching their DB plan to a DC plan.

With pension plans constantly changing, it’s important to understand the impact they can have on your personal financial situation – let’s take a look at three important aspects of pensions: Pension Adjustments (PAs), Pension Adjustment Reversals (PARs) and Past Service Pension Adjustments (PSPAs).

Pension Adjustments (PAs)

If your employer has switched to a less generous DB plan requiring higher contributions or a DC plan, you may consider opting out of the pension plan altogether. If you’re a younger worker and you don’t plan to stay with your employer long-term, opting out of your company’s pension plan and instead investing and managing your RRSP may make sense.

That’s because a PA, which is the value of your accrued benefit assigned by CRA, reduces your RRSP Contribution Room and is generally higher for younger works. CRA assumes that your employer is providing a generous 2% DB plan, which isn’t usually the case – if your employer is offering a lot less, your PA is being overvalued, leaving you with less RRSP Room. If you plan to max out your RRSP Room each year, it may be beneficial to opt out of your company’ s plan and use the extra RRSP Contribution room to invest. Learn how to calculate your PA here.

Depending on your province of employment and the generosity of your pension plan, your plan may offer immediate vesting or you may have to wait up to two years. Again, this takes away unnecessary RRSP Contribution Room if you don’t plan to stay long-term with your employer.

Pension Adjustment Reversals (PARs)

As I mentioned in my previous article, a PAR restores the lost RRSP contribution room that the PA has taken away in past years. This seems simple enough, but this can be complicated by how your employer administers its pension plan. If your pension plan has a transfer deficiency and you terminate employment, your PAR could be held back for up to five years, prolonging the time it takes to restore lost RRSP Room.

A transfer deficiency is when your employer’s pension plan is not fully funded (there are insufficient assets i.e. investments to cover liabilities i.e. member pensions if the plan were to end today). Also, if your employer offers a Flex Pension Plan (a pension plan that offers ancillary benefits like bridge benefits or indexing) or a DC plan, your PAR will be held back until you withdraw the full amount from those plans. This can cost you years of tax-free compound growth inside your RRSP.

Past Service Pension Adjustments (PSPAs)

The trend as of late has been for employers to reduce pension plan benefits, but if you’re part of a union where pension plan improvements are negotiated or your employer is really generous, they may make retroactive improvements to your pension plan. This is when Past Service Pension Adjustments (PSPAs) come into play.

PSPAs only affect years of service after 1990 for DB plans – while PAs reduce RRSP Contribution Room for the subsequent year, PSPAs reduce unused RRSP Contribution Room carried forward from previous years. For example, if your employer decides to retroactive improve your DB plan from a 1.3% final average earnings plan to a 2% plan then you will most likely be subject to a PSPA. The PSPA accounts for the fact that you should have received a higher PA in past years and thus been able to contribute less to your RRSP. The formula is quite complicated for PSPAs and your employer must obtain CRA approval, so it’s best to discuss with a financial advisor if this occurs.

Final Thoughts

As you can see, there is a lot to consider before joining your company’s pension plan. In most DB pension plans you’re automatically opted-in, so be sure to ask your employer all the details on your company pension plan before deciding if it’s worth joining. Most of the time it’s worth joining since it’s essentially “free money.” Speak with your financial advisor to see if your company’s pension plan is right for you.

About the Author: Sean Cooper is a single, 20-something year old, first time home buyer located in Toronto. He has experience in the financial sector as a Pension Analyst, RESP administrator and Income Tax Preparer. He holds a Bachelor of Commerce in business management from Ryerson University.

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Reader Mail: New Graduate, TD e-Series, RRSP or Non-Reg?

FrugalTrader — Mon, 23 Jan 2012 12:30:18 +0000

New graduate, Mike, emailed me with some investing questions. He’s new to the work force, and is diligently looking to find ways to invest and save money.

I am a new grad, just started working permanently last year. I have contributed every year to my TFSA (right now, it’s parked with Canadian Western Bank, which offers 3% on their Demand account). I haven’t contributed to RSPs because I haven’t earned sufficient income to justify doing so. As such, I have carried forward my totals every year.

I project that I will contribute by Jan/Feb 2013. In the mean time, I have excess funds in my account that I don’t use. Because of the lower MERs, I want to either invest in ETFs or TD E-series funds. Right now, I’m leaning towards the E-series, but will definitely consider ETFs with Questrade as I get a better handle on how to select ETFs (though your advice with this would be appreciated as well).

1) If I were to start a non-registered TD E-series fund this year, would I have to start another account next year if I were to contribute to my RSP through E-series? Or is it possible to convert my non-registered into registered?

2) How does taxes work if I were to start up a non-registered E-series fund? I assume TD would send me a T3. Can I rely on their tax slip information or do I have to keep track of additional information? I’m likely taking the couch potato strategy on this by just leaving it there without selling (unless I require the cash) and contributing every four months or so.

Before I start, I must say that new grads asking these types of questions, especially regarding index investing, are already way ahead of the pack. Second, jumping on the soap box for a moment, I believe that consumer/student debt should be paid off first before jumping into the investment game.

Now, onto Mikes scenario. He has savings money in a TFSA, no money in RRSPs (not yet anyways), and is curious about non-registered investing with index type investments, like TD e-Series. If there salary income in the mix, then over the long term, it’s more efficient to keep investments in tax sheltered registered accounts first. Then, if/once the contribution room and cash get used up, then look into moving into non-registered accounts. More about this subject in the portfolio allocation article.

Another point is that Mike mentions being in a lower tax bracket, so he doesn’t contribute to an RRSP. One strategy that I would suggest is to contribute to the RRSP but carry forward the tax deduction to a higher income year. That way, investing within the RRSP can start before going to the non-registered route.

Yet another benefit of putting the investments in a registered account is that it simplifies income tax filing. No need to hold onto those T5’s and other investment slips, or track your capital gains/losses or return of capital.

Say that I’m not convincing enough, and Mike would still like to invest in his non-registered account. To answer his questions:

1. If investments are in a non-reg account, they can be transferred “in-kind” to a registered account, it’s not really “converting” per se. The only issue with that is that if there are any capital gains on the date of transfer, capital gains tax will be accrued. To add salt to the wound, capital losses cannot be claimed when transfers are made in-kind from a non-reg to a registered account. To get around this, simply sell the shares and contribute cash to the registered account.

2. As mentioned, taxes and tracking the adjusted cost base is a real turn off when using a non-registered account. TD, or any mutual fund would send you tax slips for any distributions (dividends, interest, etc), but the investor is responsible for tracking capital gains/losses and the adjusted cost base if he/she buys in small increments.

To be a bit repetitive here, if I was in this position, I would look at investing within registered accounts (TFSA/RRSP) before considering investing within a non-registered account.

Do you have a financial question that you would like answered? Email me and I’ll give it a shot!

P.S. For readers of Chinese descent – Gung Hay Fat Choy (Happy Chinese New Year)!

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Financial Quackery Video

Ed Rempel — Fri, 20 Jan 2012 12:30:34 +0000

Video is a medium that I haven’t really considered with this blog, but I can see how it can be useful when educating about certain concepts. Let me know what you think about introducing more video to MDJ.

“Financial Quackery” is one of the main reasons why most people struggle financially. This video is my attempt at humour (I have to point this out in case you don’t recognize the humour) to explain what to look for to get real advice, rather than the typical industry foolishness pretending to be advice.

If you find finance confusing, this video explains in “plane language” how to avoid ruining your retirement plan, and why, for the same reason that you have one family doctor instead of 3, having one advisor that knows your entire plan is how you “get to California”.

I have written many articles, but the most favourable reviews were on the article about “Financial Quackery”. This issue speaks directly to the difficulties most people have with the financial industry. Even people not interested in finance should understand this. I hope you find it funny.

The video is a bit small on this page, so hit the “full screen” button on the bottom right.

Watch this video on YouTube.

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A Primer on American Depositary Receipts (ADRs)

Clark — Wed, 18 Jan 2012 12:30:06 +0000

American Depositary Receipts (ADRs) are securities of non-US corporations that trade in the US stock markets. Individual shares of such foreign securities represented by ADRs are called as American Depositary Shares. ADRs are created when a broker purchases shares of a non-US corporation on its home stock exchange and transfers them to a local custodian bank, which issues the receipts.

ADRs provide North American investors the means to buy shares in a foreign company such as those listed in the UK, China, or France to name but a few. These ADRs, denominated in US dollars, are traded similar to domestic stocks on the US exchanges, pay dividends in US dollars, and enable an investor to diversify their asset allocation using their local brokerage account.

Why are ADRs used?

For a foreign corporation, issuing a depositary receipt:

Widens and diversifies their market share.
Provides an avenue to increase their capital pool.
Facilitates mergers and acquisitions.

For an investor, buying a depositary receipt:

Allows investment in successful foreign companies, while using their local brokerage account and local currency (US dollars).
Does not pose any unfamiliar transaction requirements due to the known trade procedures.
Provides global stock diversification, while avoiding the management fees associated with mutual funds and ETFs.

What are the drawbacks?

Apart from the usual due diligence required before purchasing a domestic stock, investing in foreign corporation needs added attention (inflation risk, credit risk, etc.). The fundamental and technical aspects of stock analysis may remain the same for foreign stocks but there may be geopolitical issues in that country that an investor would need to be aware of.

For example, buying shares of a corporation based out of a dictatorial regime may be recipe for investment disaster as political unrest may throw the country into an economic tailspin. In addition, the currency of the home country throws another variable into the mix. Since ADRs are based upon the shares of the corporation in its home country, a fall in the valuation of the home currency will reflect on the depositary receipt.

Levels of ADRs

There are different levels of ADRs available.

Level I. These ADRs are highly speculative investments that are traded over-the-counter and not on US exchanges. Information about these ADRs is not easily available as reporting regulations across the world are not as stringent as North America.

Level II. These ADRs follow more stringent reporting requirements than Level I ADRs. Foreign companies registered as Level II ADRs fall under US SEC regulations. These corporations are required to file an annual Form 20-F, which is similar to the Form 10-K for a US company. In addition, the reports created by the foreign corporation must follow standard accounting principles such US GAAP or International Financial Reporting Standards.

Level III. Being the highest level of ADRs, companies under this program have to abide by more stringent rules than Level II ADRs. Under this program, a foreign company is using its depositary receipt to raise capital and hence, files Form F-1 (format for Offering Prospectus) in addition to Form 20-F. Information disclosed to investors in its home stock market must be filed with the SEC (Form 6K) to provide transparency.

Tax Issues

ADRs are treated similar to US stocks; so, capital gains and dividends are taxed at the same rates as US stocks. Nonetheless, an investor should investigate if withholding taxes apply on dividends paid by the foreign corporation and if so, use the appropriate deduction/credit (US/Canada) while filing their income tax.

Do you invest in ADRs? If so, do you buy companies with solid fundamentals or are you using your “play money” to ride a wave? How have your ADR investments fared till date?

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The Basics of the Health Spending Account

FrugalTrader — Mon, 16 Jan 2012 12:30:28 +0000

If you are a shareholder of a Canadian Controlled Private Corporation (CCPC), have employees with or without health coverage, and looking for a way to save overall taxes, then this article may be for you.

With health care costs increasing every year, an entrepreneur reader emailed me to ask about the Health Spending Account (HSA). The HSA is basically a registered account with a CCPC that allows an employee of that company to receive tax free health benefits. In addition to the tax free benefit to employees, the company funds the HSA with pre-tax dollars, which means there is 0% tax paid overall on the health benefit.

What are the Benefits

A funded HSA can be used by employees, their spouses and their dependents towards medical or dental expenses. It can be used in conjunction with health insurance to cover the deductible or as a stand alone benefit. Putting my employee hat on, I can see this as a real perk, especially since it’s a tax free benefit, in other words, free money! In addition, if the health insurance plan is on the lighter side (ie. no orthodentic coverage), then the HSA can be used providing the expense qualifies as a medical expense under the Income Tax Act (link).

Switching back to the entrepreneur, not only does this add an extra incentive in the employee pay package, it has the benefit of using pretax corporate dollars.

One thing to note is that the HSA can only be used for real employees, and not just shareholders. If my online company is still around when my kids get older, I will be looking into the HSA to pay for orthodontic work (ie. braces) or other big ticket health items.

How is it Used?

The employer sets up an HSA for each employee and funds the account at their discretion (no maximum). If the employee does not use all the credits in the account, it can be carried forward (with restrictions). Claiming using the HSA should be relatively straight forward as well. On most insurance claim forms, they’ll have a section for the HSA details.

Drawbacks

The one drawback that I could find from using the HSA is that since it’s a registered account, claims are required to run through a third party which leads to extra fees. When the HSA is used as a standalone account (ie. not for paying the insurance deductible), the third party services out there charge a setup fee and another fee equivalent to 5%-10% of the claim. Fortunately though, the fees are paid for by the company and are tax deductible.

I couldn’t find the fees that insurance companies charge to cover the deductible, but i’m willing to guess that they charge about 10% to process the HSA claim.

Final Thoughts

Drawbacks aside, I think the HSA is a great tool that isn’t talked about enough. With medical expenses on the rise and health insurance policies covering less, companies can fund the HSA using pre-tax revenue to fill the gap and add real tax-free value to employees.

Do you have a Health Spending Account benefit at your work place? If so, I’d like to hear about your experiences.

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A Primer on (Market) Equity linked GICs

Clark — Wed, 11 Jan 2012 12:30:05 +0000

As seen in an earlier post, traditional GICs offer security of principal with a low rate of return (in the current interest environment) for locking in the money for set time periods. The longer the term, the better the rate offered. Callable GICs provide a better rate than traditional GICs to compensate for the risk that the issuer retains an option to call the GIC after a set time period. Another type of GIC that is available is the equity-linked GIC, which we will discuss in detail below.

The Return

As the name suggests, an equity-linked GIC offers an investment return based upon the performance of a major equity index such as S&P/TSX 60 Index, S&P 500, or a weighted basket of international stock market indices. Such a GIC offers principal protection, while providing the opportunity for potentially higher returns than a traditional GIC. However, the return of an equity-linked GIC is variable as it depends on the performance of the underlying stock market index.

Equity-linked vs. Traditional GICs

As with other investment vehicles, the risk versus reward profile is applicable to equity-linked GICs also. These GICs seem to offer the best of both worlds – security of the investment and potential for higher returns. Nonetheless, in the event of the underlying equity index performing poorly, the GIC may not pay any interest upon maturity. So, the investor would receive his principal “as is”, while inflation may have eroded the purchasing power of that amount. Depending on the amount invested and term of the GIC, the erosion may be significant.

Let us consider an example to understand the impact better. Investor A has $1000 in an S&P 500-linked GIC for a term of 3 years, while Investor B has $25,000 in the same GIC for the same term of 3 years. Unfortunately, due to global crises, all equity markets, including the S&P 500 Index, perform poorly over the next 3 years. Both investors will receive their principal amounts back ($1000 for A and $25,000 for B) without any interest paid at maturity. What are their initial investment amounts worth after 3 years (i.e., upon maturity), if the annual rate of inflation remained constant at 2.5%? Investor A is left with $928.60 and Investor B has $23,214.99 in real dollars after accounting for inflation.

The above examples may portray equity-linked GICs in poor light, while making traditional GICs seem better. Traditional GICs offer a guaranteed rate of interest, albeit low, to aid in mitigating the impact of inflation. However, there is no chance to partake in stock market gains, if they happen. The bottom line is that both GICs face the threat of losing purchasing power to inflation. It is the responsibility of every investor to weigh the opportunity cost and decide if they prefer the low but guaranteed interest rate of the traditional GIC or the potential for higher returns offered by the equity-linked GIC, while running the risk of receiving no interest at the end of the term.

Typically, money invested in equity-linked GICs cannot be accessed until maturity. This is in contrast to most traditional GICs, where the funds can be withdrawn by paying a penalty in the form of a reduced interest rate or no interest receivable (for very short terms).

Editors Note – Market Linked GIC Downsides

Market returns are based on a participation rate. Basically, this means that if the market does gain over the term, you will only be paid a portion of those gains.

From what I can gather, market returns on these products do NOT include dividends, which can be a large portion of market returns.

Canada Deposit Insurance Corporation (CDIC)

CDIC insures investments ranging from $1 to $100,000. Investments could be in savings/chequing accounts, GICs, and other term deposits with a date to maturity of 5 years or less. So, equity-linked GICs with terms less than 5 years are eligible to be insured by the CDIC. However, please be aware that investments including GICs held at credit unions are not backed by the CDIC but insured by respective provincial bodies.

Are equity-linked GICs suitable for a portfolio?

As with any stock market investment vehicle (e.g. individual stocks, mutual funds, or ETFs), an investor with a long investment time horizon (several years) can consider holding an equity-linked GIC in their portfolio. Conversely, if an investor is using GICs as a short-term parking spot for money to be used as the down payment on a house, for a car, new furniture, etc., then it would be prudent to use traditional GICs or a savings account. As always, read the features and benefits section of the investment vehicle before committing your money.

Do you hold equity-linked GICs? What is your investment time frame? Did your decision to buy such GICs turn out to be fruitful?

Why I Don’t Use a Dividend ETF for my Leveraged Portfolio

FrugalTrader — Mon, 09 Jan 2012 12:30:33 +0000

A reader left a comment in my last Smith Manoeuvre/leveraged portfolio update questioning why I don’t simply use CDZ since my holdings are similar.

My leveraged portfolio consists of a basket of Canadian dividend stocks that mostly have a history of raising their dividends. The Claymore Dividend ETF, CDZ, tracks the Canadian dividend achievers index which holds stocks that have increased their dividend at least once annually over the past five years.

Since my leveraged dividend portfolio and CDZ both have similar strategies, thus holdings, why don’t I simply buy CDZ and reduce all the hassle of buying and selling individual stocks and reducing my commissions paid to the online stock brokerage? Here are my reasons.

1. Control the Yield

One of the main reasons I started a dividend portfolio is for the tax efficient income with the goal of having the investment income grow enough to pay a significant portion of our household expenses. With that goal in mind, it’s important to have a relatively high sustainable yield that grows with inflation.

If I were to choose the CDZ or XDV (iShares) ETFs, I would not have control over the yield of my portfolio because those ETFs weight their portfolios (thus yield) based on the market capitalization of the company. For my portfolio, I have a watch list of stocks that I like, then wait until yield reaches a level that I’m happy with (ie. when the stock becomes cheap). Here is a tutorial of when to buy dividend stocks.

2. Return Of Capital (ROC)

Oh the dreaded ROC. With leveraged portfolios, receiving Return of Capital as a portion (or all) of a distribution can have implications on tax deductibility of the investment loan. ROC is typically distributed by income trusts, which CDZ still holds a couple. There are ways around this, namely withdrawing ROC, paying down the investment loan, then putting the money back into the trading account. However, that is too much hassle for me.

In addition to that, ROC reduces the adjusted cost base of the stock position which needs to be tracked manually for the capital gains calculation when the position is sold in the future.

3. Management Expense Ratio (MER)

Finally, CDZ has a relatively high MER coming in at 0.60% per year. While some may argue that I have pay trading commissions, the strategy is to buy and hold most positions forever, which means trading commissions occur with a relatively low frequency. To put this in perspective, a $100k portfolio paying 0.60% is $600 per year, every year. With $4.95 commissions and infrequent trading, the expense ratio of my leveraged portfolio will be a fraction of the ETF.

What are your thoughts? Do you use leverage for your stock holdings? Do you use ETFs?

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Attributes of a Successful Entrepreneur

Clark — Fri, 06 Jan 2012 12:30:15 +0000

Becoming self-employed by starting a business, be it a convenience store or service-oriented work, is not an undertaking that many of us can relate to. Many of us are used to working for someone else and having the security of a steady cheque at the end of every pay period. Benefits such as RRSP matching, flexible spending accounts, health and dental insurance, etc. that come with a corporate position are nothing to complain about either. However, being an entrepreneur may provide the freedom to express one’s creativity to the maximum extent, whereas a corporate employee may be limited by the company’s directional objectives.

Knowing oneself is critical to either. I have had the chance to watch two friends transition to entrepreneurs, while leaving behind their degree and job. This post is my observations about what makes such successful entrepreneurs tick. Needless to say, many of the attributes below would benefit any person, entrepreneur or not.

Time Management

Entrepreneurs are willing to work long hours, especially immediately before and after the launch of the business. They are able to modify their lifestyle to accommodate the single-minded pursuit of establishing their business.

Planning and Organization

A good entrepreneur has a profitable plan for the business and also maintains a backup plan (such as emergency funds). They set the short-term agenda to match their long-term plan and stay organized enough to overcome any mishaps that might occur.

Self-Confidence

Unsurprisingly, they have a lot of confidence in their idea and have the ability to push it to a potential lender or business partner.

Communication

A continuation of the above really! A great idea is no good without the skills to express it. Most entrepreneurs are very good communicators. One does not have to be a great public speaker but certain attributes such as being a good listener, patience, politeness, taking a stand for the right things, and willingness to learn from all comers are noteworthy.

Integrity

This trait is essential for any human being but gains significance for an entrepreneur due to the lack of a corporate brand name as support. A good reputation goes a long way and the word of mouth can do wonders in positive and negative ways.

Modesty

An entrepreneur, just like any other person, should be willing to take blame when a mistake occurs and apologize, be it to a customer or employee. Being presumptuous will not take most people very far.

Commitment

There will be times when the business is going through a lean patch and the urge to pack it in will surge. There may be the naysayers who will add fuel to the fire at such times. As long as one had done their due diligence, they should maintain their motivation to stay committed and make the business work. The support of a spouse, friends, relatives, mentors, and/or business contacts is critical. However, staying committed does not mean that an entrepreneur should not reevaluate at any cost or fall prey to the sunk cost fallacy.

Cost Management

Frugality is an oft-repeated word in the personal finance world and it is vital for an entrepreneur. Spending cuts may become essential during bad times, not just on the business front but also on the personal side. Firing an employee to cut back on costs, while taking a Hawaiian vacation with the family will not be good for the team (if one exists) morale. Even if the vacation is funded with money that had been in savings, it may be prudent to postpone the grand “stress-relief” vacation or opt for a less exotic local getaway.

Work/Personal Life Balance

Although successful entrepreneurs may seem to work long hours, they do not do so at the cost of ruining their relationships. They take care to spend time with family and not let them feel ignored. They never forget that the efforts they make to build a profitable business are for the relationships/family and not to supplant them.

Bookkeeping

A good entrepreneur is usually a good accountant or knows one. Maintaining proper documentation is important for determining business performance and to be prepared at tax time.

Are you an entrepreneur or have you watched a close one succeed? What are the other attributes that are necessary for being a successful entrepreneur? What are the pitfalls to avoid?

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Top Stock Picks 2012 and Results

FrugalTrader — Tue, 03 Jan 2012 10:30:20 +0000

Over the past few years, a group of bloggers have enlisted in a friendly competition as to who can pick the best stocks for the year. In 2011, I was a little less aggressive and picked well known names that appeared to be relatively undervalued at the beginning of the year. My top stock picks for 2011 were: VISA, Royal Bank of Canada, Husky Energy, and Encana.

While Q3 results were in the negative (-5.65%), Q4 was much stronger which lead to a positive overall return for the year. Here’s what happened:

My Top 4 Stock Picks for 2011

VISA (V) – Everyone knows VISA! The stock has recently sold off due to news that debit card transaction prices may be regulated in the US and VISA has a portion of their business in the debit market place. As one of the worlds most recognized names and the largest card issuer in the world, I’m betting that the stock price will bounce back. Trading price as of Jan 3, 2011: $70.38 (open).

This stock continued to be the star for the year, in fact, it was the biggest gainer of all stocks picked in the competition! Trading price as of Dec 30, 2011 closing: $101.53. Combined with a $0.67 dividend brings an annual return of 45.21%! Disclaimer: I own shares of V.

Royal Bank of Canada (RY.TO) – Although Royal Bank is the largest bank in Canada in terms of market cap, it has been severely under performing relative to the other big banks in Canada. As with all the big 5 banks, RY sports a healthy dividend and I’m hoping that RY bounces back this year! Trading price as of Jan 3, 2011: $52.32 (open).

Bouncing back from a very weak third quarter (-5.2%), the rally and particularly the dividend helped push this one in the positive for the year. Trading price as of Dec 30, 2011 closing: $51.98. Combined with a $2.08 dividend brings an annual gain of 3.3% . Disclaimer: I own shares of RY.

Husky Energy (HSE.TO) – I picked this one a couple years ago and I’m picking it again for some oil exposure. They own oil producing assets in NL, new assets in China in addition to paying a healthy dividend. Trading price as of Jan 3, 2011: $26.55.

Despite a valiant effort, HSE was unable to climb out of the red by year end. Trading price as of Dec 30, 2011 closing: $24.33. Combined with a $1.20 dividend brings a loss of 3.8% for the year. Disclaimer: I own shares of HSE.

Encana (ECA.TO) – A little while back, Encana split into two companies to divide their natural gas and oil operations. CVE took over the oil side, and ECA took the natural gas. Last year, I picked CVE which was a winner, but this year, I’m going to try my luck with ECA. Even though I’m not bullish over natural gas prices, ECA appears cheap with low Price/Earnings, Price/Book ratios and the dividend does not hurt either. Trading price as of Jan 3, 2011: $29.09

While the other three picks held their own, ECA was the portfolio killer. Trading price as of Dec 30, 2011 closing: $18.89. Combined with a $0.783 dividend brings a loss of 32.4% for the year.

Overall the portfolio did relatively well resulting in a gain of 3.1%. This was good enough for second place in the competition and outperforming the Canadian index (XIU) by approximately 13% and the S&P 500 (CAD hedged) by 4%.

Top 4 Stock Picks for 2012

With our 2011 picks outperforming the market and most of the other bloggers, we have a lot to live up to in 2012! Economists are calling for another volatile year which may mean that dividend stocks may outperform again. This year, I’m picking a financial stock, a big US consumer stock, a large Canadian minerals company, and a well known Canadian oil company.

Bank of Nova Scotia (BNS.TO) – With Canadian banks retreating from their highs in late 2011, their dividend yields have reached an attractive range. Scotia Bank, with a current yield of approximately 4%, is known for their international operations and I believe has some upside coming in 2012. That is providing that we don’t have a global financial meltdown. :) Trading price as of closing Dec 30, 2011: $50.83. Disclaimer: I own shares of BNS.TO.
3M Co. (MMM) - This company is a great example of a Dividend Achiever where it has increased their dividend for 53 consecutive years with a current yield of 2.69% and P/E ratio of 13.74. Who is 3M? They are a large diversified technology company with seven large divisions. However, they are likely most well known as the inventor of the Post-It note. 3M shares sold off in late 2011 but it looks like the stock has already started its recovery. Trading price as of closing Dec 30, 2011: $81.73. Disclaimer: I own shares of MMM.
Teck Resources (TCK.B.TO) - Teck Resources is my mineral play where the company is engaged in the exploration, development and production of copper, coal, gold and zinc. It faced a steep decline in 2011 and I believe will start climbing again once confidence in the economy thus commodities returns. Teck currently yields 2.23% with a P/E ratio of 8.92. Trading price as of closing Dec 30, 2011: $35.91. Disclaimer: I own shares of TCK.B.
Suncor Energy (SU.TO) - Suncor Energy is Canada’s largest integrated energy company. It has a large stake in the oil sands and is involved in numerous other energy plays across the country. While this is not a huge dividend stock with a yield of 1.50%, I believe that the energy sector is oversold and has a large upside should the buyers return. Trading price as of closing Dec 30, 2011: $29.38.Disclaimer: I own shares of SU.TO.

Here are the the picks for 2012 from other bloggers and results from 2011:

Dividend Growth Investor: 15.36%
Million Dollar Journey: 3.12%
Intelligent Speculator: -4.90%
Money Smarts Blog: -9.55%
Where Does All My Money Go: -17.04%
My Traders Journal: -19.00%
The Financial Blogger: -21.73%
Wild Investor: -33.34%
Beating The Index: -44.08%
The Passive Income Earner: new blogger
Dividend Mantra: new blogger

What are your top 4 picks for 2012?

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Net Worth Update Dec 2011 (+0.97%) – Year End Summary

FrugalTrader — Fri, 30 Dec 2011 12:30:56 +0000

Welcome to the Million Dollar Journey December 2011 Net Worth Update – The Year End Summary. For those of you new to Million Dollar Journey, a monthly net worth update is typically posted near the end of the month (or beginning of the next) to track the progress of my journey to one million in net worth, hopefully by the time I’m 35 years old (end of 2014). If you would like to follow my journey, you can get my updates sent directly to your email or you can sign up for the Money Tips Newsletter..

This year was a wild ride! The buoyant market of 2010 carried over into the first half of 2011 then the bottom fell out with the bears taking over the remainder of the year. The financial news was dominated by the debt problems within the European Union and how it’s the end of the world as we know it. The fear of course is that the insolvency of a single country within the union could have repercussions throughout global markets. Insolvency or not, the fear in the market has lead to large swings in the market, and has resulted in a negative year for most market indices.

With a significant portion of our net worth invested in equities, the down market this year took a bite out of net worth growth. We had a long stretch of positive monthly updates, but then the markets humbled me bringing losses in August and September. Fortunately, we had gains in the other 10 months of 2011 bringing a total net worth gain of 15.70% finishing the year at $585,228.00. The goal of reaching $1 Million in net worth over the next three years is quite the task but I believe that it’s achievable providing that I stay aggressive.

Similar story to last year, cash savings (ways to save money) played a huge role in our net worth in 2011. Without strong cash flow and subsequent savings, I’m pretty certain that our net worth would be in the negative overall.

This year was also exceptionally busy! With my full time work picking up, having our second child, working on new web projects while running Million Dollar Journey and Canadian Money Forum, I was stretched pretty thin this year. Oftentimes writing articles during the week until after midnight (like this post). I’m hoping that 2012 brings some sanity back to my schedule.

On to the numbers:

Assets: $666,928.00 (+0.86%)

Cash: $4,500 (+0.00%)
Savings: $69,000 (+6.15%)
Registered/Retirement Investment Accounts (RRSP): $118,600.00(+0.59%)
Tax Free Savings Accounts (TFSA): $29,700.00 (+1.37%)
Defined Benefit Pension: $37,200.00 (+1.09%)
Non-Registered Investment Accounts: $28,680.00 (-3.43%)
Smith Manoeuvre Investment Account: $87,500 (+1.39%)
Principal Residence: $291,748 (+0.00%) (purchase price adjusted for inflation annually)

Liabilities: $81,700 (+0.06%)

Principal Residence Mortgage (readvanceable): $0 (0.00%) (Paid off in 2010!)
Investment LOC balance: $81,700 (+0.06%)

Total Net Worth: ~$585,228.00 (+0.97%)

Started 2011 with Net Worth: $505,800
Year to Date Gain/Loss: +15.70%

Here is a summary of our monthly net worth totals for 2011, note that we started 2011 with $505,800 :

Some quick notes and explanations to net worth questions I get often:

The Cash

Savings

Real Estate

Pension

Stock Broker Accounts

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Smith Manoeuvre Portfolio – December 2011

FrugalTrader — Thu, 29 Dec 2011 12:25:14 +0000

For those of you just joining us, below is my portfolio that is leveraged with money borrowed from my home equity line of credit (HELOC). As the money borrowed is used to invest, the interest charged is tax deductible. I write an update every so often to show new positions added along with any market gains/losses. For more details on the strategy and procedure, check out my modified smith manoeuvre strategy and my comparison of online stock brokers.

It’s been half a year since the last update (June 2011) with quite a bit of activity in the leveraged portfolio for a change. We have added to a couple of our existing positions, added several new positions, and despite the market downturn, I’m happy to report that several of our picks have increased their dividend in the second half of 2011.

With the volatility and aggressive sell off of some strong dividend paying companies, I added to a couple of my existing holdings, namely, Royal Bank (RY) and Ensign Energy Services(ESI). New additions to the portfolio include: Pason Systems (PSI), Corus Entertainment (CJR.B), Thompson Reuters (TRI), Brookfield Properties (BPO), Canadian Pacific Railway (CP), Canadian Oil Sands (COS), and Leons Furniture (LNF).

Quite a number of companies stepped up to the plate and rewarded shareholders for investing in their companies with a dividend increase. From my portfolio, they include: CIBC (CM), Scotia Bank (BNS), Toronto Dominion Bank (TD), Fortis Properties (FTS), AGF Management (AGF), Enbridge (ENB), Canadian Utilities (CU), Pason Systems (PSI), Ensign Energy Services (ESI), Corus Entertainment (CJR), and Canadian Oil Sands (COS).

My dividend watch list remains similar where I am looking to increase my position in BMO, TD, ENB, FCR and possibly add new positions in Canadian National Railway (CNR) and Bell Aliant (BA) when their valuations become attractive.

The Smith Manoeuvre Portfolio as of Dec 27, 2011:

Stock	Symbol	Shares	Avg Buy Price	Total	Div/Share	Yield
Royal Bank	RY.T	100	$48.39	$4,838.99	$2.16	4.46%
CIBC	CM.T	45	$67.14	$3,021.25	$3.60	5.18%
Power Financial	PWF.T	105	$35.14	$3,689.65	$1.40	3.98%
Scotia Bank	BNS.T	105	$41.91	$4,400.52	$2.08	4.96%
Manulife Financial	MFC.T	125	$33.12	$4,139.48	$0.52	1.57%
Fortis Properties	FTS.T	150	$25.63	$3,843.98	$1.20	4.53%
TransCanada Corp	TRP.T	100	$33.50	$3,349.74	$1.68	4.52%
AGF Management Limited	AGF.B.T	50	$22.71	$1,135.49	$1.08	4.40%
Bank of Montreal	BMO.T	25	$44.17	$1,104.24	$2.80	6.34%
Husky Energy	HSE.T	135	$32.53	$4,391.27	$1.20	3.69%
TD Bank	TD.T	50	$48.24	$2,412.23	$2.72	5.47%
Enbridge	ENB.T	80	$18.43	$1,494.39	$1.13	5.32%
TransAlta	TA.T	50	$21.47	$1073.49	$1.16	5.40%
First Capital Realty	FCR.T	160	$9.72	$1,574.99	$0.80	8.23%
Canadian Utilities	CU.T	50	$36.40	$1,819.99	$1.61	4.29%
Ensign Energy Services	ESI.T	200	$14.98	$2,995.98	$0.42	2.80%
Mullen Group	MTL.T	100	$14.54	$1,453.98	$1.00	6.88%
Rogers Communications	RCI.B.T	100	$34.39	$3,439.48	$1.42	4.13%
George Westin Ltd	WN.T	50	$68.64	$3,441.99	$1.44	2.09%
Pason Systems	PSI.T	100	$14.14	$1,423.99	$0.40	2.81%
Corus Entertainment	CJR.B.T	100	$19.87	$1,996.99	$0.87	4.36%
Thompson Reuters	TRI.T	90	$33.40	$3,006.18	$1.24	3.71%
Brookfield Properties	BPO.T	150	$16.01	$2,401.23	$0.56	3.50%
Canadian Pacific Railway	CP.T	30	$53.90	$1,626.99	$1.20	2.21%
Canadian Oil Sands	COS.T	150	$19.14	$2,871.48	$1.10	5.75%
Leons Furniture	LNF.T	100	$11.65	$1,164.99	$0.40	3.43%

More Stats

Total Cost Base of Equities (inc. fees): $68,093.19 (vs. $50,718.61)
Market Value of Equities (Closing Dec 27, 2011 – not including dividends or cash): $73,429.05 (vs. $58,508.90)
Total Dividends / Year: $2,897.03 (vs. $2,201.53)
Portfolio Dividend Yield: 4.25% (vs. 4.34%)

Sector Allocation (based on market value)

Financials: 32.22% (vs. 43.38%)
Utilities: 12.38% (vs. 15.00%)
Energy: 28.01% (vs. 24.82%)
Resources: 0.00% (vs. 0.00%)
Real Estate: 7.12% (vs. 4.57%)
Consumer/Telecom: 14.27% (vs. 12.23%)
Other: 6.01 (vs. 0%)

With regards to sector allocation, you may notice that this portfolio is fairly concentrated in financials and energy. Note though that this is one of my accounts where I treat all of my accounts as one big portfolio. In other words, my international and other sector equity exposure are in other accounts.

Disclaimer: There have been a lot of readers who have mentioned that they are interested in a leveraged portfolio. Over the long term it may be lucrative. However, over the short term, equities are volatile and can put the portfolio deep in the red. My portfolio during 2008 is a prime example of what can happen. If you can’t stomach losing 20-30% in the portfolio in any given year, then your risk tolerance isn’t suited for leveraged investing. Here is an article I wrote answering a reader question “Should I Start the Smith Manoeuvre?” Finally, the securities mentioned in this post are not recommendations to buy or sell.

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Lifecycle Investing – The Benefits of Diversifying Across Time

Ed Rempel — Wed, 28 Dec 2011 12:30:20 +0000

“The point is simple: if diversification across asset classes is so good, why not also seek greater diversification across time periods?” – Ian Ayres

Last Decade Risk

There is a big risk in the way most people save for retirement. The big risk is that the vast majority of the investments most people own during their working years are in the last few years before retirement. We call it “Last Decade Risk”.

Since the 2000-2009 was the second worst decade ever for the stock market, there are many stories of people who saved and invested consistently for 40 years and yet found that one bad decade in investing just before retirement left them far short of the retirement they want.

For example, let’s look at Robert. He invests $10,000/year in his RRSP starting at age 25 and increases that by inflation every year as he gets more RRSP room, like many Canadians do. With an average 8% return, here is how his investments grow:

Age	Ending Investments	% of Total
25-34	$ 176,000	2%
35-44	$ 617,000	9%
45-54	$1,649,000	25%
55-64	$3,988,000	64%

Here is the scary part – 64% of all the investments that Robert owned over 40 years (age 25-65) were owned in just 10 (after age 55) – and 80% were only owned after age 50!

Just to be clear, “last decade risk”, is not necessarily the end of the world, since statistics show that most Canadians will have another 25+ years of retirement ahead of them to make up for it. But having a lot less than you need in the year you start retirement can still be a huge worry.

How do you avoid “Last Decade Risk”?

Lifecycle Investing – Diversifying across time

The solution to “last decade risk” is the subject of a groundbreaking book by two Yale professors, called “Lifecycle Investing”.¹ They advocate borrowing to invest when you are young and paying it off in your 50s. They show how this actually reduces risk by “diversifying across time”.

The book is quite technical and obviously written by two math geeks. But their concepts are very practical.

First, let’s understand “diversifying across time”. Here are the stock market holdings of two brothers at two points in their lives:

	Peter	Paul
Age 30	$100,000	$200,000
Age 60	$1,000,000	$900,000

Note that they have the same exposure to the stock market during their lives, but Paul is more diversified across time. His “last decade risk” is lower.

The concept of “Lifecycle Investing” is that Paul could do this by borrowing $100,000 to invest at age 30 and allocating $100,000 of his stock market investments to bonds at age 60.

Most people are comfortable with the benefits of diversifying by different types of investments. Why not also diversify across time?

Does Lifecycle Investing Make Sense?

A better question is – does the traditional method of investing really make sense when it usually means having 10-30 times more money in the stock market at age 60 than at age 30?

Lifecycle Investing is what we tend to do with our homes. Most people would think nothing of putting $25,000 down on a $500,000 home. The advantage here is that if you live in that home for 20 years, you have $500,000 invested in real estate each year. This is the Lifecycle Investing concept – borrow a large amount early and slowly pay it off in order to have the same amount of investments every year.

Just to be clear, borrowing to invest is a risky strategy and is not for everyone. If you cannot stomach the ups and downs, may sell or invest less after a crash, or if you chase performance, then borrowing to invest probably is not the right strategy for you.

However, this study proves that if done right as part of a long term strategy, borrowing to invest can actually reduce your retirement risk. If you define risk as the ups and downs of your investments, then borrowing to invest in the early years is obviously more risky than not borrowing. However, if you define risk as the risk of not having the retirement you want, then the risk over your lifetime can be lower with Lifecycle investing.

Asset Allocation with Lifecycle Investing

The solution of “Lifecycle Investing” is to allocate your investments between stocks and bonds based on the total you will invest during your lifetime. This is called “dollar years”.¹ If you are going to invest $10,000 every year for 40 years, then you have $400,000 “dollar years”.

You can think of the $10,000 you plan to invest in each of the future years as a bond when you are determining how much to invest into stocks vs. bonds.

For example, let’s say that you want to invest 70% in stocks and 30% in bonds. Instead of investing the $10,000 based on 70/30, with Lifecycle investing you would add up the total investments you will have over the next 40 years ($400,000) and invest 70% of that figure, or $280,000, in stocks.

Since you only have $10,000 in year 1, you would borrow the maximum you are comfortable with each year and invest 100% in equities until you reach $280,000.²

The actual formula³ calls for a very high amount of leverage in period 1. Since the Yale professors are math geeks and not investors, they are not aware of all the methods of borrowing to invest and therefore only advocate 2:1 leverage. The concept is to borrow what you are comfortable with and what you can qualify for in the early years.

Stages of Life with Lifecycle Investing

In practice, this process leads to 3 periods through your working life:

High leverage period – Leverage 2:1 (or more) and invest 100% in stocks – no bonds. If you have $10,000 invested, borrow an additional $10,000 (or more) to invest each year. Typically this period is the first 10 years of your investing life. This period lasts until your stock market investments reach your target percentage of your lifetime investments (e.g. 70% of $400,000 = $280,000).
Reducing leverage period – Reduce leverage portion slowly and maintain 100% in stocks. Typically eliminate leverage by early 50s.
No leverage period – Start introducing bonds moving to your desired allocation (e.g. 70% stocks/30% bonds) by the time you retire.

Does Lifecycle Investing Work?

The study results proved that it resulted in a better retirement for people born every single year since 1848! Lifecycle Investing would have improved the retirement 100% of the time for anyone retiring in the last 96 years.¹

Lifecycle Investing can be applied to either provide the same returns as traditional investing with less risk, or to have the same risk but a higher return.

In the book, each strategy is named by the percent in stocks in year 1 and the percent at retirement. For example:

Traditional investing: 75/75 means a constant 75% in stocks.
Lifecycle strategy: 200/50 means borrowing so you can invest double the cash you have in year 1 (200% in stocks) and then moving down to 50% stocks/50% bonds by retirement.

Here are the results of lifecycle investing strategies vs. a 75/75 traditional portfolio:

200/50 – Same returns as 75/75 with 21% lower risk. Same average investment in stocks as 75/75.
200/61 – Same risk as 75/75 with 18% more investments at retirement.
200/83 – Same worst-case scenario as 75/75 with average 63% more investments at retirement.

Here are the actual results for people that retired between 1914 and 2009 investing a constant percent of their income for 45 years¹:

Retirement Investments	75/75	200/50	200/61	200/83
Worst case scenario	$ 167,000	$ 291,000	$ 299,000	$ 167,000
Average result	$ 749,000	$ 749,000	$ 881,000	$1,220,000
Best case scenario	$1,330,000	$1,210,000	$1,460,000	$2,280,000
% Chance of beating 75/75		99%	100%	100%

You may be wondering – is this just better because they invested more in stocks? The answer is no. The 200/50 strategy has the same average investment in the stock market as the 75/75 strategy. This is why the average result is the same. The range between the highest and lowest returns is narrower, though, because of the reduced risk from diversifying across time.

I actually was surprised that the results were better 100% of the time. Remember, this includes people that had the Great Depression of the 1930s either at the beginning or the end of their working life.

Lifecycle Investing vs. Smith Manoeuvre

This strategy is different than the Smith Manoeuvre, which involves borrowing to invest slowly as you pay off your mortgage. The Smith Manoeuvre often involves maintaining the investment credit line through retirement (since this provides a higher retirement income if done right), while Lifecycle Investing suggests paying it off before retirement.

These are two of many possible strategies that can all be valid options to the traditional approach of just slowly investing your hard-earned dollars every year.

Having the right plan & strategy trumps investment returns

Lifecycle investing is worth discussing, because it points out the huge “last decade risk” with traditional investing and shows that the right leverage strategy over many years can sometimes reduce risk.

Most investors in their 30s and 40s believe that the most important part of their future retirement is the rate of return they get on their investments. This often leads them to ignore financial planning and just focus on investments. The concepts here show that having a plan and using the right strategy is far more important than rate of return.

In fact, most people will have 80% of the investments they will own during their working life after age 50. The rate of return you have before age 50 is not that important because it is on a relatively small amount of money.⁴

For example, the 200/83 strategy only has a moderate $10,000/year of leverage, but still produced a 63% higher retirement income and produced a higher retirement income 100% of the time.

It is difficult for many investment-focused people to believe us when we tell them that the most critical issues for their future are having a comprehensive plan and using the right strategies. The concepts of Lifecycle Investing provide a useful example of the importance of having the correct focus.

Summary

The traditional way of investing money each year creates a big “last decade risk” because 80% of your investments over your working life are usually after age 50. If your last decade is a bad decade (like the last decade), it probably means your rate of return for your entire working life is low. One bad decade can put you far below your retirement goal.

Lifecycle Investing reduces “last decade risk” by diversifying across time. Essentially, you borrow in your first decade of investing and invest 100% in stocks. Then you slowly pay off the leverage by your early 50s, when you start adding bonds, moving to your desired mix by retirement.

The study by two Yale professors proved Lifecycle Investing for your entire working life provided a better retirement 99-100% of the time. This is a practical example of how having a plan and using the right strategies are the most critical issues in having the future that you want.

About the Author: Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching. If you would like to contact Ed, you can leave a comment in this post, or visit his website EdRempel.com. You can read his other articles here.

1 “Lifecycle Investing”, Ian Ayres & Barry Nalebuff, 2009
2 They have scenarios ending at retirement and scenarios including pensions during your retirement years.
3 The actual formula would involve calculating your “dollar years” every year as the sum of your investments today plus all the amounts you plan to invest in the future.
4 Many people become more conservative and allocate more to bonds in the last 10-15 years before retirement. This probably means a lower rate of return. Every 1%/year lower return they make after age 50 wipes out 4%/year of the return they made for the first 25 years from age 25-50, since they will own 80% of their investments after age 50.

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Anniversary Giveaway Winners and Christmas Links

FrugalTrader — Fri, 23 Dec 2011 12:30:02 +0000

The Successful Investor Investment Newsletter Reminder

Last week, the team at The Successful Investor offered MDJ readers the lowest cost on the web for their award winning investment newsletter for Canadians. Regular price is $139 annually, the MDJ price is $30.

Heads up that this limited time offer will expire on January 15th, 2012. More details about the newsletter and the offer via last weeks article – The Successful Investor newsletter .

Anniversary Giveaway

Early December marked Million Dollar Journey’s 5th Anniversary. To celebrate, we held a giveaway of $500 (20 x $25) worth of amazon.ca gift cards and up to $500 in a charity donation depending on the number of facebook likes we could generate. The turn out was quite impressive where we generated a little over 100 new facebook followers and hundreds of contest entries.

As promised, we donated $1 for every new facebook like to the Make a Wish Foundation ($100) and for good measure, we donated another $100 to a local childrens hospital.

Now, what you’ve been waiting for, the gift card giveaway winners! All entries were thrown into an electronic hat and numbers randomly dawn using an online random number generator. The winners are..

1. mike (comment 151)

2. J (comment 23)

3. henry56

4. parnold

5. Timmy (comment 37)

6. Jason T

7. InstruMike (comment 50)

8. lori n

9. Janine (comment 47)

10. Danny G

11. RWN

12. Bobby Aves (comment 162)

13. Lyne (comment 73)

14. Martin O

15. Greg T

16. David G

17. Richard (comment 190)

18. Steven S

19. Louise (comment 153)

20. michael (comment 185)

Congratulations to all the winners. If you didn’t get anything this time, no worries, there are many new giveaways coming in the new year.

Christmas Links

Investing $10,000 / month ? @ Canadian Money Forum

‘Twas the night before Christmas…Personal finance and bloggers edition @ My Own Advisor

Top Frugality Blogs of 2011 @ Frugal Dad

Does giving kids money really help them? @ Retire Happy

Throw a Holiday Party without Breaking the Bank @ My Dollar Plan

iShares DEX Floating Rate Note ETF (TSX: XFR) @ Canadian Capitalist

The 12 Days of Christmas Price Index Reflects Consumer Prices @ Digerati Life

Green Christmas Tree Options @ Sustainable Personal Finance

fear of making money @ brip blap

Christmas Is Cancelled @ Canadian Finance Blog

ETFs vs. Mutual Funds: Which One is Right for You? @ Generation X Finance

The Real Cost of Holiday Overspending @ Financial Highway

Lazy Man Holiday Gift Guide 2011 @ Lazy man and Money

The War on Loyal Customers @ Michael James on Money

Last Minute Cheap Christmas Gift Guide @ Money Smarts Blog

Will You Be Better Off Financially Next Year? @ Boomer and Echo

Get a Head Start on the New You @ Money Smart Life

Why Not Just Give Ca$h? @ Canajun Finances

I will be taking a few days off to spend quality time with family and friends so the next post will be Wednesday December 28th. Happy Holidays to you all!

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Ultrashort Term Bond Funds

Clark — Wed, 21 Dec 2011 12:30:50 +0000

Ultrashort term bond funds (not to be confused with shorting) are mutual funds that include government bonds, corporate bonds, and mortgage-backed securities. As seen before, bonds offer fixed income with maturities varying from a few months to several years.

The ultrashort bonds have short maturity periods ranging from a few months to a year, thereby making them less sensitive to interest rate changes. So, are ultrashort bonds a solution to park cash needed in the short-term? Are the risks worth it? Lets find out.

Ultrashort Bond Funds vs. GICs and Money Market Funds

Apart from savings accounts, GICs and money market funds are used to park cash required in the short-term such as amounts meant for a down payment, vacation, car, etc. In terms of yield, ultrashort term bonds are supposed to provide better returns than GICs and money market funds. However, this increased return comes with higher risk.

Due to the need to provide a higher return than other typical short-term investment vehicles, these bonds invest in securities with average credit ratings. In addition, unlike GICs, the ultrashort bonds are not guaranteed by CDIC, leaving the principal prone to market risk; an increase in interest rates would entail a drop in bond prices.

Money market funds are also mutual funds (like ultrashort bond funds) but they are required by securities legislation to invest in low-risk instruments and their NAV does not vary too much.

Factors to Consider

Credit Risk. It is possible that corporations or, sometimes, governments can default on their debt obligations. With ultrashort bonds investing in such debts, the credit risk can be lowered by choosing funds that invest mainly in federal and provincial/state debts. The yield may not be great but the chances of default or downgrades are minimized significantly. The higher the exposure to the corporate segment with lower credit ratings, the better the chance of falling prey to credit risk.
Maturity Date. The shorter the term of bond maturity, the less the risk involved with regard to interest rate changes. Here’s an explanation about the relationship between interest rates and bond prices.
Duration and Bond Price. It is known that bonds with a high duration have a greater price variation than those with a lower duration. The coupon rate, maturity date, and yield to maturity have a significant impact on the price volatility seen in bonds.

Is it for the Average Investor?

Ultrashort term bonds are a lot of risk for too small a gain. GICs and money market funds may be a better option for many investors looking for a short-term parking spot for their cash (not to mention a savings account at a bank). However, for investors who see otherwise, there are several options available to invest in them.

There is a list of top-performing ultrashort funds at MSN Money that could help your search. More funds of the same type can be found on this page but there may be some repetitions from the previous link. Canadian funds are limited; TD seems to be the only big player in this market and the performance of their ultrashort funds can be found on Page 7 of this PDF link.

Have you invested in ultrashort bonds (mutual funds or ETFs)? If so, how did your fund/ETF fare? Do you think they are worth the risk?

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Why Cash is King

FrugalTrader — Sun, 18 Dec 2011 12:30:30 +0000

During my net worth updates, one question that often comes along is why I hold so much cash. I believe the rationale behind the question is that under normal circumstances, cash could be put to work and grow instead of sitting in a “high” interest rate savings account that barely keeps up with inflation. I also believe in the rationale of putting cash to work, especially putting cash towards bad debt. However, I also believe in holding a stock pile of cash in case “something comes up”.

For as long as I can remember, I’ve been a saver. I recall being 8 or 9 years old with my own bank account and enjoying watching the numbers in my bank book (remember those?) increase. This behavior has continued throughout the years and now I get the same satisfaction from my net worth updates.

Back in my University days, I worked part time (sometimes full time hours) while participating in alternating academic and paid work terms. With some frugal discipline, I came out ahead with some cash in my bank account. I believe that the earlier that you start building cash savings, subsequent large purchases become more manageable, which reduces debt over the long term and ultimately starts a long term positive financial cycle. But even if you weren’t an early saver, the next best time is now. Here are some reasons why cash is king.

Cash Savings Gets you Ahead

In our case, cash savings from University allowed us to put a large down payment on our first house within a few months of graduation. This resulted in lower payments and less interest paid to the bank over the term of the mortgage. Combined with lower payments and renting out a portion of the home, it didn’t take long before our savings grew again.

A growing cash war chest gave us options. We could pay down the house to save even more interest, pay down consumer debt to increase our cash flow even further, or invest the proceeds in the stock/real estate market. What did we choose? We paid off a student loan followed by a car loan within a few years.

Within four years, we sold the two apartment to build a custom home for our growing family. As the positive financial cycle momentum kept building, it eventually lead to paying off our new home mortgage in three years.

Cash Savings Gives you Opportunity

As mentioned, our expenses were very low while living in our two apartment home. At the time, real estate was my focus so when there was an opportunity to purchase a relatively new home that was in great shape for a great price, I took advantage of it. My article on buying foreclosures in Canada explained how I purchased a rental property via bank sale. The catch was that in order to purchase a house from auction (in NL), the winning bidder needs to fork out a 10% down payment on the spot or within that business day. As we have a tendency to build our cash reserve, we had enough for 10% to close the deal quickly.

You may have noticed that I’m a bit of a deal seeker and as it turns out, I’m the same way when it comes to the investing as well. Having a bit of dry powder (ie. cash) sitting in the sidelines can allow an investor to quickly take advantage of buying opportunities without having to sell a position first.

Cash Savings Reduces Stress

It may depend on temperament, but for us, having cash in our bank accounts give us a sense of security. This comes back to the argument of emergency funds – should people hold cash or simply have a line of credit in case the worse happens. We’ve discovered that when we needed things like a new hot water boiler, or a new fridge for an apartment, going into debt would simply add to the situation. Simply put, we prefer to pay cash (although we use a credit card to collect the points first) and stay out of debt where possible.

What are your thoughts about cash? Do you try to keep a cash war chest? Or do you deploy cash whenever possible?

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