What Hath I Wrought?
I've been trying to decide what, if anything, I should post about my ongoing education about finances. Partly, I don't want to come off as being gauche, nor do I wish to give a full and complete accounting of how much is going where (not a lot). It's true: talking about money is far more taboo than talking about sex.
I'm also very much aware that these are personal decisions I'm making for me, based on my own reading and understanding. I've a general idea of the theory about it all, but really, I don't have practical experience to back up what I'd be saying. Still, the Singer feels that I have a sickness, so perhaps some blog therapy will shut me up a bit.
Obstacles
By far, the largest obstacles I'm going to face are inflation and market risk (i.e., DOW Jones dropping like a rock). Given that I don't expect to require access to my money for about 30 years, if I were to drop my retirement savings into a guaranteed investment, I would earn compounded interest of about 4.5% a year. So, $10000 would turn into about $37500.
But, eating into that is inflation, which is the percent by which prices increase over a given year. Typically, inflation hovers around 3% a year. As an example, what costs a dollar now, will really cost about 2.50 in 30 years thanks to inflation. So, if I were to invest in a guaranteed investment, at 4.5% for thirty years, I would have to subtract the rate of inflation from that number.
So although I'd have 37500 in future dollars, it would only buy me what $15000 would buy now. The cost of that safety would be to see my purchasing power erode over time.
In order to ensure that I can retire eventually, and I'll admit, wanting it to be comfortable, I need to find a higher rate of return. This higher return is generally found in stocks, bonds and real estate. Of course, this means I need to take on more risk; the risk of course being watching my investments lose their value so that I end up further back than where I started. Anybody who has been remotely aware of the world around them has seen the stock markets drop, and I know I've seen the value of my savings decrease.
Still, if I want to beat inflation, I need to risk the markets. Fortunately, there are two ways to limit the risk; time and diversity.
Time is on my side
Time reduces risk for a couple reasons. That which goes down will come back again and overtime, it will be an average increase. In fact, from looking at the market returns for the past 30 years, on average, I'd expect about 8.8% rate of return each year. To be sure, there have been some real stinker years in that time, but there have also been some great years too. So, in that time period, 10000 would have grown to 125,500 before inflation (assuming annual compounding). Taking inflation into account it though that would end up being 54,250 in real dollars.
Also, if I make systematic, regular investments then when the market is down, I'll be buying more with the same amount, and less when the market is up. Now, when the market comes back, the fact that I bought when the market was down means that what I have is now worth more.
When I get closer to retirement, I'll need to reduce the amount of risk I'm undertaking, and as such will need to periodically move some of what I've invested into safer, lower return, holdings such as bonds or other forms of guaranteed investments.
One rule of thumb I've read for that is to keep your decade in bonds. So, as a thirty something person, that would be a 30% Bond/70% Stock split. In reality, I'm sitting at about a 80% bond/20% stocks as I'll need to access my RRSPs as part of the Home Buyers Plan in the next couple of years.
Variety is the Spice of Life
In the midst of good years, and bad years there are investments that excellent and investments that are dismal. Without getting to much into math I barely understand, let us suffice it to say that I should not put all your nest eggs into one basket. Rather, I should have a large number of baskets, spread out across the globe to achieve the necessary diversity. There are several ways to accomplish this.
1) Buy a selection of carefully selected and vetted stocks, based upon a great deal of research and understanding of financial principals such as cash flow, earnings per share, debt to capital ratio etc. Certainly, a financial adviser or stock broker can help me navigate this myriad of information and probably recommend the stocks that would suit me. Of course, this comes with the attendant fees and commissions.
2) Buy a couple of news papers, pull out the stock sections and tape them up to the wall. Now, throw darts at them and buy those stocks. Odds are I'd land on a couple of winners, and some losers. This, of course, frees up a great deal of time for things such as cooking cauliflower soup and since I'm not paying a brokers commissions, I can invest that money too.
3) Buy an index fund, which is a fund that tracks the performance of certain index, e.g. Dow Jones Industrial Average, S&P TSX etc. Index funds do this by buying shares in the same ratio as on the index, as the index rises, so to does the fund. Conversely, as the index lowers, so does the fund. Still, it results in a lot lower fees (I'll get into this in a bit) and assuming it's a no-load fund, no commissions and right off the bat, I'm buying the necessary diversity.
So, for a variety of reasons, I'm inclined to choose index funds as my stock of choice:
It certainly has been an interesting financial year for me. I've gone from almost drowning in debt to reaching a point where I feel more in control of my present finances and have a good idea about where I'm going.
Saving for the Future
It's been said many times, by many people, "Pay yourself first". This is certainly required in my case, as if I have money in my account, it tends to spend itself quite freely and quickly. I've been quite good about contributing to my RRSP - it's one of the really important lessons I learned from my parents. Fortunately, both companies have allowed me to do payroll deductions towards my RRSPs, and I honestly haven't missed the money.
In order to do the same with my non RRSP cash, I've opened up an INGDirect.ca account, and set up an automatic savings plan. So, every 2 weeks, 10% of my pay will go into savings that I can't immediately access. Very much out of sight, out of mind.
I've also started carrying cash again; one of the things I found on our England trip was that having cash prevented me from automatically pulling out the credit card. It works back home too, since by carrying cash, I'm less likely to whip out the debit card and/or credit card. Since my primary expense seems to be eating out, forcing myself to pay in cash means I'm more likely to cook supper at home.
This is a new experiment, but so far seems to be working out OK.
RRSPs
The main hiccup I had with RRSPs, and what got me started along into maze of twisty corridors, all alike, was realizing what my retirement was costing me. Yes, my RRSP was bleeding money, left, right and center, but what finally caught my attention was the management expense ratio (MER). Every fund has a MER, even no-load funds, and that is the percentage of money I pay to be able to purchase the fund.
Just as inflation eats away at future earnings, so to does the MER. However, unlike inflation, which I can't control, I can control the MER by selecting low cost mutual funds. So, I've gone from losing money in a fund which was costing me 2.45% a year, to losing money in funds which cost me ~0.4% a year. Right off the bat, I've earned two percent... or at least not lost it.
Of course, after reading over the prospectus, I noticed that the bank reserves the right to charge 0.5% transaction fee, with 60 days notice, on both the initial purchase and all purchases since then. I don't know how, or if, that will affect me but I'm sure it will result in a strongly worded letter to someone.
Debt
Lastly I'm working my way through my debt consolidation loan, and will be aggressively paying it down. The theory being the sooner it gets paid off, the sooner I can take that money and a) top up my RRSP and b) start a non registered investing portfolio in hopes of starting my own business some day.
At the very least, the return on just paying down the loan will be at least the money saved in the interest. And as I've come to find out, a percent saved here and there can really add up in the long run.
Final Thoughts
Now, I've not really gone into what I've invested in. I'm still figuring that portion out, and certainly I'd like to make some corrections. At the very least, I want to try and avoid duplicating holdings. I'm trying to temper the fact that I'm still learning, and that, yes this is my money and I really should understand what I'm doing and why I'm doing it.
Related Reading:
The Wealthy Barber, David Chilton
The Best Investment Advice You'll Never Get, Mark Dowie, San Francicso Magazine
Transparent Investing, Patrick Geddes
A Random Walk Down Wall Street, Burton Malkiel
Currently reading:
The Four Pillars of Investing, William Bernstein
Personal Finance for Canadians for Dummies, Eric Tyson and Tony Martin
I'm also very much aware that these are personal decisions I'm making for me, based on my own reading and understanding. I've a general idea of the theory about it all, but really, I don't have practical experience to back up what I'd be saying. Still, the Singer feels that I have a sickness, so perhaps some blog therapy will shut me up a bit.
Obstacles
By far, the largest obstacles I'm going to face are inflation and market risk (i.e., DOW Jones dropping like a rock). Given that I don't expect to require access to my money for about 30 years, if I were to drop my retirement savings into a guaranteed investment, I would earn compounded interest of about 4.5% a year. So, $10000 would turn into about $37500.
But, eating into that is inflation, which is the percent by which prices increase over a given year. Typically, inflation hovers around 3% a year. As an example, what costs a dollar now, will really cost about 2.50 in 30 years thanks to inflation. So, if I were to invest in a guaranteed investment, at 4.5% for thirty years, I would have to subtract the rate of inflation from that number.
So although I'd have 37500 in future dollars, it would only buy me what $15000 would buy now. The cost of that safety would be to see my purchasing power erode over time.
In order to ensure that I can retire eventually, and I'll admit, wanting it to be comfortable, I need to find a higher rate of return. This higher return is generally found in stocks, bonds and real estate. Of course, this means I need to take on more risk; the risk of course being watching my investments lose their value so that I end up further back than where I started. Anybody who has been remotely aware of the world around them has seen the stock markets drop, and I know I've seen the value of my savings decrease.
Still, if I want to beat inflation, I need to risk the markets. Fortunately, there are two ways to limit the risk; time and diversity.
Time is on my side
Time reduces risk for a couple reasons. That which goes down will come back again and overtime, it will be an average increase. In fact, from looking at the market returns for the past 30 years, on average, I'd expect about 8.8% rate of return each year. To be sure, there have been some real stinker years in that time, but there have also been some great years too. So, in that time period, 10000 would have grown to 125,500 before inflation (assuming annual compounding). Taking inflation into account it though that would end up being 54,250 in real dollars.
Also, if I make systematic, regular investments then when the market is down, I'll be buying more with the same amount, and less when the market is up. Now, when the market comes back, the fact that I bought when the market was down means that what I have is now worth more.
Unfortunately, what it seems like most people do is buy at or near the top of a rise, watch the stock crash and then sell out at or near the bottom.
Month Amount Price/Share # Shares Value Total Gain
Jan 100.00 10.00 10.00 100.00 0.00
Feb 100.00 8.00 12.50 180.00 -20.00
Mar 100.00 5.00 20.00 212.50 -87.50
Apr 100.00 10.00 10.00 525.00 125.00
==========================================================
400.00 8.25 52.50 525.00 125.00
By continuously buying a given amount, at regular intervals, and then holding on through the bad times, I should be able to avoid the risk associated with the bad times. It's kind of a firefighter investing strategy; while everybody else is running out of the burning building, I'm running in to see what I can save.
Month Amount Price/Share # Shares Value Total Gain
Jan 400.00 10.00 40.00 400.00 0.00
Feb 0.00 8.00 0.00 320.00 -80.00
Mar -200.00 5.00 -40.00 0.00 -200.00
Apr 200.00 10.00 20.00 200.00 -200.00
============================================================
400.00 8.25 20.00 200.00 -200.00
When I get closer to retirement, I'll need to reduce the amount of risk I'm undertaking, and as such will need to periodically move some of what I've invested into safer, lower return, holdings such as bonds or other forms of guaranteed investments.
One rule of thumb I've read for that is to keep your decade in bonds. So, as a thirty something person, that would be a 30% Bond/70% Stock split. In reality, I'm sitting at about a 80% bond/20% stocks as I'll need to access my RRSPs as part of the Home Buyers Plan in the next couple of years.
Variety is the Spice of Life
In the midst of good years, and bad years there are investments that excellent and investments that are dismal. Without getting to much into math I barely understand, let us suffice it to say that I should not put all your nest eggs into one basket. Rather, I should have a large number of baskets, spread out across the globe to achieve the necessary diversity. There are several ways to accomplish this.
1) Buy a selection of carefully selected and vetted stocks, based upon a great deal of research and understanding of financial principals such as cash flow, earnings per share, debt to capital ratio etc. Certainly, a financial adviser or stock broker can help me navigate this myriad of information and probably recommend the stocks that would suit me. Of course, this comes with the attendant fees and commissions.
2) Buy a couple of news papers, pull out the stock sections and tape them up to the wall. Now, throw darts at them and buy those stocks. Odds are I'd land on a couple of winners, and some losers. This, of course, frees up a great deal of time for things such as cooking cauliflower soup and since I'm not paying a brokers commissions, I can invest that money too.
3) Buy an index fund, which is a fund that tracks the performance of certain index, e.g. Dow Jones Industrial Average, S&P TSX etc. Index funds do this by buying shares in the same ratio as on the index, as the index rises, so to does the fund. Conversely, as the index lowers, so does the fund. Still, it results in a lot lower fees (I'll get into this in a bit) and assuming it's a no-load fund, no commissions and right off the bat, I'm buying the necessary diversity.
So, for a variety of reasons, I'm inclined to choose index funds as my stock of choice:
- Lower fees - since index funds are passively managed, the fees are lower
- Less turnover - as the fund is tracking a target, it's not subject to a persons whim or wishes or gut feelings. So, there is less chasing the hot new thing.
- More grounded in reality - When it comes down to the stock market, I believe that it is an example of the power of faith (note small F). Simply stated the market rises as people tend to believe that the good times are here and will go on forever. This tends to happen until such time as the Wizard is revealed as nothing more than a man, and there's an exodus of the now disillusioned and the house of cards falls down.
It certainly has been an interesting financial year for me. I've gone from almost drowning in debt to reaching a point where I feel more in control of my present finances and have a good idea about where I'm going.
Saving for the Future
It's been said many times, by many people, "Pay yourself first". This is certainly required in my case, as if I have money in my account, it tends to spend itself quite freely and quickly. I've been quite good about contributing to my RRSP - it's one of the really important lessons I learned from my parents. Fortunately, both companies have allowed me to do payroll deductions towards my RRSPs, and I honestly haven't missed the money.
In order to do the same with my non RRSP cash, I've opened up an INGDirect.ca account, and set up an automatic savings plan. So, every 2 weeks, 10% of my pay will go into savings that I can't immediately access. Very much out of sight, out of mind.
I've also started carrying cash again; one of the things I found on our England trip was that having cash prevented me from automatically pulling out the credit card. It works back home too, since by carrying cash, I'm less likely to whip out the debit card and/or credit card. Since my primary expense seems to be eating out, forcing myself to pay in cash means I'm more likely to cook supper at home.
This is a new experiment, but so far seems to be working out OK.
RRSPs
The main hiccup I had with RRSPs, and what got me started along into maze of twisty corridors, all alike, was realizing what my retirement was costing me. Yes, my RRSP was bleeding money, left, right and center, but what finally caught my attention was the management expense ratio (MER). Every fund has a MER, even no-load funds, and that is the percentage of money I pay to be able to purchase the fund.
Just as inflation eats away at future earnings, so to does the MER. However, unlike inflation, which I can't control, I can control the MER by selecting low cost mutual funds. So, I've gone from losing money in a fund which was costing me 2.45% a year, to losing money in funds which cost me ~0.4% a year. Right off the bat, I've earned two percent... or at least not lost it.
Of course, after reading over the prospectus, I noticed that the bank reserves the right to charge 0.5% transaction fee, with 60 days notice, on both the initial purchase and all purchases since then. I don't know how, or if, that will affect me but I'm sure it will result in a strongly worded letter to someone.
Debt
Lastly I'm working my way through my debt consolidation loan, and will be aggressively paying it down. The theory being the sooner it gets paid off, the sooner I can take that money and a) top up my RRSP and b) start a non registered investing portfolio in hopes of starting my own business some day.
At the very least, the return on just paying down the loan will be at least the money saved in the interest. And as I've come to find out, a percent saved here and there can really add up in the long run.
Final Thoughts
Now, I've not really gone into what I've invested in. I'm still figuring that portion out, and certainly I'd like to make some corrections. At the very least, I want to try and avoid duplicating holdings. I'm trying to temper the fact that I'm still learning, and that, yes this is my money and I really should understand what I'm doing and why I'm doing it.
Related Reading:
The Wealthy Barber, David Chilton
The Best Investment Advice You'll Never Get, Mark Dowie, San Francicso Magazine
Transparent Investing, Patrick Geddes
A Random Walk Down Wall Street, Burton Malkiel
Currently reading:
The Four Pillars of Investing, William Bernstein
Personal Finance for Canadians for Dummies, Eric Tyson and Tony Martin
Labels: Finances
posted by Serdic at 10:37
4 Comments:
I have my investments in mutual funds with a long proven track record. I think that individual stocks are way too risky. I think real estate is only good if you can pay cash outright for it. Bravo for paying down your debt and yes, it's harder to spend cash. :)
Yeah, I'm not about to dip my toe directly into the stock market yet. Education, and as you said, paying down debt come first.
Um, you lost me about 4 paragraphs in. But man, I am so freaking impressed that not only did you write all that out but that YOU understand it.
Quick question, does your (new - yeah!) employer do any retirement matching? Hubby's does and that is quite handy. I know he does other things too, and he really has explained it to me, but my eyes glaze over after awhile. :)
Oh, and I'm with you. I hate spending my cash. That's why I like to take a $20 now and again and stash it away. Sure, it's not making any interest but I'm not spending it either.
And yeah, we are (sadly, again) back to paying off debt. Hopefully, for the last time.
/hugs!!!!
Kiy
P.S. I so owe you an email, and I have written it ... in my mind while rocking Emi to sleep ... at least a dozen times. It's seriously on my to-do list! :)
P.P.S. Give Singer a kiss for us. I love that gal. Especially because of this: "Still, the Singer feels that I have a sickness." I love love love that she gets you, and can tell you what for ... and love you. <3
Hahahaha ... that comment ended up being a novel. I wonder, does that count as an email?
No, I didn't think so either. :)
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