Playing the Game

The first job I ever had was horrible. I worked at a chicken farm gathering eggs on weekends. The job was very manual, and entailed me pushing a heavy-duty metal cart up and down very dusty and smelly rows of tightly caged hens picking up 4 eggs per hand and throwing them down into 30-egg flats over and over again for 3 to 5 hours (depending on what stage the chickens were at). At the end of the day, I would have averaged around 10,000 eggs gathered and needed to take a twenty minute shower to get the smell of the barn off of me. I was paid piecemeal, at (if I remember correctly) around four or five cents per dozen – it didn’t work out to a lot of money, but for an eleven year-old, it was quite a bit more than I had been making prior to that.

My parents instilled the habit of saving to me early, and would not let me just spend the money how I wanted to. I was “forced” to save money, and given very little access to the majority of funds. Through my parent’s investment advisor, a mutual funds investment, which I still remember (over 20 years later) being a Templeton emerging markets fund. Every weekend, I would check the finance section of the local newspaper and watch my “fortune” shrink and grow.*

One thing that I was allowed to buy was a Sega Genesis. My mom ordered this for me from the Sears catalog (I lived in a small town that had no electronics store, and this was pre-Internet 1991), and I had to impatiently wait the 3 to 5 business days for this awesome new toy to show up. My first ever game was “Sports Talk Baseball” and I probably played that for hundreds of hours – whenever nobody was watching our family’s one television that had 4 channels, I was on my Genesis, probably killing brain cells.

Since my Sega Genesis, I moved on to a Playstation 1, 2, and 3, as well as owning a Wii and X-Box 360. These days, I don’t play as many video games – It’s not due to anything other than I have other stuff I’d rather do – read more books or watch more sports, or spend more time with my wife. For 15 or 20 years of my life though, I probably averaged around two hours of video games per day. I liked the challenge of starting off in a game, being TERRIBLE at it, and slowly but surely getting better and better, gaining skills (useless skills in real life, but skills nonetheless) until I hopefully beat the game.

Personal finance is similar to video games. My personal finance life started with that terrible job, and having a savings plan strictly imposed on me by my parents, and continued on until today. Along the way, I have learned quite a bit from both experiences as well as following people’s lessons who are much smarter than I am. I somehow single-handedly paid for a University education, as well as the loans associated with those. I bought my first car, got a place to live, and paid off the entire mortgage of my house.

Similar to the video games that I probably spent too many hours playing, the whole process of personal finance is basically a grind. You save relatively small amounts of money, and slowly but surely through experience, luck or skill build up confidence and assets until you’re hopefully in a position that you can win. In my case, winning will be having a large enough portfolio that my wife and I will be financially independent by the time I’m 45.

Right now, I’m kind of at the beginning of the game – my portfolio is fairly small, the investments held are creating very little overall wealth on their own, and it’s kind of a frustrating process. I read as much as I can about investment planning and investment vehicles, but I am still pretty much a rookie at the whole “put money here and it will hopefully be worth more than it is now in a few years” strategy. Hopefully as time goes by, my odds of winning “The Personal Finance Game” will increase significantly.

*While I was writing this, I looked up the historical performance of this fund, and it has remained at essentially the same price point over the past 20 years.

Better to Start Now

I meant to post this yesterday, but had to re-work some of my calculations in the examples below that didn’t make sense.  I’m definitely not advocating this type of investment for anyone, but wrote this post as part of my own investigation into possibly doing it for myself.

I am far from an innovative investor. I lean heavily on stealing other people’s ideas as my own, picking and choosing the best stuff that seems to fit into my own risk profile and investing strategy, as well as for the time I’m able to use to research the investments going into my portfolio. I continue to read books and blogs of people who are smarter (and probably more interested) at investing than I am.

Ever since I initially read “Rich Dad Poor Dad”, I had a dream of being a real estate mogul – of building a business that was outlined in his book from a couple of small houses to eventually a full portfolio of buildings that would make me a multimillionaire. I read that book over 10 years ago, during my initial rush of inhaling every personal finance book that I could. While I think that in general, most of what was talked about in the book doesn’t really apply to me, the picture of being a real estate “player” as a means to wealth never really left my mind.

One thing that has kept me out of the physical real estate market is that I really don’t like people. I know what I was like as a fairly responsible tenant during my renting days, and I wasn’t ideal – I can only imagine the problems that I could come across with some of the “horror story” tenants that I read and hear about from landlords. My wife and I can barely manage our own house, let alone look after several properties at a time. While I know I could hire a property management company to look after the houses I’ve bought, that would mean I’d have to hire and fire those “employees”, something I wouldn’t look forward to doing.

A couple of weeks ago, Nelson from Financial Uproar wrote about an alternative method of having a leveraged real estate portfolio.  Most of my adult life, I have been against most forms of debt, I don’t like to have it hanging over my head and have avoided most forms of borrowing as much as I can. I am generally a risk averse individual when it comes to investments, but this kind of leveraged investment has me intrigued. I am currently invested in a couple of REITs in my RRSP portfolio (RioCan and Dream Office), but these items make up a fairly small portion of my current overall investments. A much larger exposure to real estate wouldn’t really shift the diversification of my portfolio.

Example

As an example of how this investment would work, let’s say my wife and I were to start a “mini” real estate portfolio. Like most real estate starts, our intention is to use 20% of our own money (similar to how we would have started with buying a small house to rent to a small family or students) and borrow 80% of the amount from our bank using a home equity loan. I have made the following assumptions (taken from Nelson’s blog post, as well as September 15, 2015’s return for the REIT TSE:ZRE) :

Interest Rate Charge – 2.70%
Annual Charge = $2,160
Monthly Charge = $180

Return on the REIT investment – 5.71%
Annual Return = $5,710
Monthly Return = $476

I’m going to assume there is no change in distributions or interest rates for the period of testing.

Basic calculation:
On a monthly basis, we could, on a 20,000 investment earn $295.83 (distributions less interest charges) as long as interest rates never increase, or cash distributions aren’t adjusted in the for the index fund. Annualized, this investment would provide an additional $3,550 in income for our household – not a huge amount of money, but a pretty good return of 17.75%. If our goal at retirement is to have passive income of $25,000, we would be 14% of the way there, with minimal effort.

Paying down the debt:
If, over the next 9 and a half years (114 months) if we didn’t spend any of the income received from the investment and use the total net amount to pay down the principle on the loan, we would be making $382.22 per month ($4,586 per year). At the end of this period, we would owe $21,604 on the loan we took out

“Letting it Ride”
A more aggressive method of utilizing this kind of investment, would be to pay interest only, and utilize the money earned to purchase more shares. This kind of strategy would be similar to a “small-time” real estate investor starting with a single house, and using the equity created by the investment, to extend the investment to the maximum. At our projected retirement date, we would be generating annual income of $6,100 with our investment, an increase of $2,550 over the year 1 investment returns, or about an 8% increase on return (hopefully greater than inflation).

A Mix
The investment could be paid down like a mortgage, increasing the investment and paying down the debt at the same time. In month 1, the net return of the investment is the calculated $295.83. The $295.83 could be split in two, with half of the distribution used to pay down the debt and the rest used to purchase more of the security, more of a “blended” payment. This method of debt payment would reduce the debt outstanding, which might insulate any future impact of an increase in interest rates, while increasing income associated with the investment.

Tax Implications:
If I were to utilize this kind of investment, I would do it through a taxable account. With a taxable account, there are implications that need to be taken into consideration over holding a REIT in a tax-sheltered account.

On the taxable income side, REITs are much more complex than normal securities, due to the methods used to create income. The Globe and Mail wrote an article about tax filing for RioCan in previous years, which included the following items in income:

31.24% – Other income – taxable at the marginal rate.
1.72% – Capital Gains – 50% taxable at marginal rate
4.57% – Foreign non-business income – taxable at the marginal rate
62.47% – Reduction in adjusted cost base (return on capital or ROC) – A bit of a complex calculation – the Globe and Mail writer explained it as:

When you receive ROC, you are not taxed immediately on the amount. Rather, you subtract the ROC from the adjusted cost base of your units. This gives rise to a larger capital gain, or smaller capital loss, when you ultimately sell your units. Because of the tax deferral, ROC is considered tax-efficient income.

Interest on investments is an allowable expense, provided the investment is used to try to earn investment income (can’t be used for capital gains investments). This allowable expense will reduce the taxable liability on the interest earned, provided I would fill out a schedule 4 tax form.

Risks:

The two main risks with this type of investment would be a decrease in the distribution paid out, or an interest rate increase. Both of these risks are a little scary when it comes to the investment as a whole, but there is (currently) a 3% spread currently between the interest charge and investment return to “play” with.

Verdict:

I’m still not sure if I’ll do this or not. If I do make a leveraged investment, the earlier it’s made the better, as it would give more time to get either interest paid down or to increase the investment earnings by reinvesting into the security.

Chasing Yields

I enjoy sports betting. Having a bit of money on a game makes it much more interesting to me, than just watching a bunch of super-athletes try to beat each other. My favourite sport to bet on is NFL football, and I’ll usually have between five and twenty dollars bet on the outcome of a few Sunday afternoon games I’m watching over the winter. I’ve tracked my win and loss totals over the past few years, and seem to come out ahead when I’m betting straight-up on the game – especially when I’ve done some reading and paid attention to how the teams are doing over the week. Where I lose money is when I start chasing the “big” win (big being a 300% win instead of a 200% win on games bet). I’m not sure where my logical brain goes when it decides that instead of winning by 7 points (the public “line”), the team I’m betting on is definitely going to win by 15 – chasing the gains, a strategy that generally doesn’t make much sense at all.

I really try not to chase the same type of high yields in my retirement investing – going for the big score so that I can exit a few months earlier than I had originally planned. There are a lot of sketchy companies available to put money into that could lead to more of a setback than just investing in basic index funds.

I attempt to hit a middle ground of investing where I believe my investment funds are being used efficiently. I’m willing to take on risk in my investments for the return provided, but I really do try to filter out the companies that seem much too good to be true. I will admit that I am probably too enamoured with dividend yields, in comparison to capital gains. Dividends (for me) provide a tangible and more dependable return in comparison to capital gains. Their yields can be measured and are somewhat more predictable based on company reports. As an example, a significant cut in the Canadian Oilsands dividend was somewhat predictable after a string of bad news reports – while I couldn’t predict this cut outright, I think it’s more understandable than a stock decreasing 10% due to something overseas that doesn’t necessarily have any relationship to what the stock is doing.

So, while I look at yields, and am attracted to the reported current investment returns I could possibly attain, I try to look much further into a stock than this number to ensure it will be a good investment a year or two down the road.

Are you hooked on dividends? Have you ever chased a high yield from a “bad” company?

My Retirement Nightmare

I read a really well-written blog post by Go Curry Cracker! The article looks at how a portfolio would fare through the worst stock market downturn in history, which, coupled with continuously high inflation rates lead to an almost 0% real (inflation adjusted) return. The writer went through a very well thought out strategy of how someone could adapt their retirement to survive through a multi-year downturn.

This really long market downturn is my own personal finance nightmare. Once I retire and my wife and I are fully dependent on the funds I’ve accumulated, a significant downturn would cause a great deal of stress. Watching my retirement account dwindle over time due to market decreases would be like losing my job and coming near the end of my Employment Insurance period with no real job leads in sight.

The problem that I can see in this kind of downturn is the same issue that happens with any “bet” that includes unknown information – you’ll never know when the bet will successfully “hit”. In the case of the stock market, nobody ever really knows if a market downturn will last 4 years, or in inflation-adjusted terms 27 years, like the 1965 to 1992 period. From a gambler’s perspective, it’s like playing roulette and deciding that just because “red” hasn’t come up in a while, it’s a good idea to put money on red on the next spin, even though the same odds exist around the next spin of the wheel as on the previous.

Our household could adapt to a downturn for a few years – we could change our household expenses significantly if we needed to, eat cheaper food, or even sell the house to live someplace that costs less than our current condominium townhouse. If this sort of thing went on for decades though, eating a few beans and rice might not really cut the mustard to save our entire retirement plan if 80% of the equity disappears.

This line of thinking is what causes me to question my target “number”. It causes me to wonder if my wife and I would ever be able to save enough money to be totally secure. If my wife and I have spent $20,000 for 12 years, can I predict that $20,000 per year will be enough to last for a few decades? Do I need to factor in significant market changes by reducing our projected withdrawal rate? Or, in the end do we just retire with a plan and hope it works out for the best and enjoy our financial freedom for as long as we can?

My Private Mortgage Investigation

After learning I wasn’t rich enough to engage in peer to peer lending online, I went on a search for other alternative investment opportunities. It turned out there was a place that was right across the road from my house – a mortgage broker. I sent the broker’s office a general inquiry, stating I was interested in learning about private mortgages (for potential investments) and wondered if they had some time to discuss this with me. They booked an appointment a for a couple of weeks later, and I met this past Monday with a nice broker named Doug who went over all of the questions I had regarding the private lending business. I’ve listed the questions I had and the answers that were provided to me below:

How much are they (the broker) looking for individuals to invest?

The broker stated they really had no minimum – they were willing to work with investors with all levels of funds.

This was a good answer, because I don’t think I would make this a major part of my portfolio, I was just looking for an alternative investment outside of the stock market to get into.

What type of loans do investors usually get involved with?

A “normal” type of loan is a second mortgage on a home that is being used as a bridge until the first mortgage’s term has expired – usually in 1 – 3 years.

How safe are the loans?

The broker who I was talking with said that they won’t even touch mortgages that are below a Loan-to-Value rate of 75%. Loan-to-Value is the amount of the loan as a percentage of the property value, meaning that on a $100,000 home between the first and second mortgage, the maximum amount that would be loaned out would be $75,000. The 25% “cushion” allows for market declines without impacting the debtor’s asset to fall below the loan amount (hopefully reducing the instance of a market loss).

Full credit checks are carried out, along with property appraisals both paid for by the individual who is looking to be loaned money. In addition, legal fees associated with lending the funds are also covered by the debtor.

What kind of return is usually seen?

The vast majority of loans that this broker sees come across his desk, which is approximately 3 – 5 per month on average work out to a rate of between 8% and 12% returns. They have institutional lenders for loans below 8% and really aren’t willing to look at customers that would warrant an interest rate in this climate above 12%.

Conclusion:

Those were the main questions I was curious about, as there really isn’t a huge pile of information available for research purposes on this kind of investment. I haven’t really decided whether I will end up investing in this type of thing. I like the fact that the investment is secured by an asset (a house) that could be sold, so may not result in a complete loss due to non-payment. I also like that I can review the financial details of the loan before making a decision. I think I would have a better idea looking at an individual’s monthly cashflow, compared to a complex corporation’s. If I were to invest in this type of thing, it would probably make up no more than 10% of my total investments. The upside on the investment is high, but there is also the possibility of losing the entire amount.

Would you, or have you done this type of investment?

DIY Money

I helped one of my friends doing her taxes this week. The past few years she just brought her stuff into H & R Block and had them do it. This year, rather than paying them, she asked if I could do them. There wasn’t anything complex to do with her income earned or expenses incurred during 2014, so the whole file completion process took $20 (the cost of using Ufile) and about 20 minutes to complete. I saved my friend a good chunk of money, all for the amount of time it takes to set up a CRA account (so that she could have a direct deposit on the calculated refund).

I started doing my own taxes when I was 18 and found out it actually cost quite a bit of money to get my own money back as a tax refund. I read the information package that came with the (then paper) tax package and filled out the forms necessary to get my information filed. At the time (1999), filing online wasn’t an option available to me, so I painstakingly entered my tax return into the CRA database over my touch-tone phone (I’m impressed that this technology existed at the time). A few weeks later, a cheque showed up for my return.

There’s always a bit of fear when you hit the “Submit” button on the CRA site, due to the risk of audit. I’ve been audited once, and mailed in the receipts requested with no issues identified. An audit is like most things – as long as you aren’t doing anything “sketchy” with your taxes or income, you’re probably not going to have much trouble with the tax collectors.

Much like doing taxes, most people (including half of my two-person family) would rather just dump off the responsibility of investing onto someone else. A lot of people spend quite a bit of money to other people to invest on their behalf. While I can understand the intimidation factor of the marketplace may be a bit of a barrier to entry, there is more than a little bit of information out there (books, classes, internet sites, blogs) for anyone out could learn.

It is scary to invest by yourself. If you make a poor investment, there’s nobody to blame but yourself. If the entire market collapses like in 2008, it takes a bit of courage to continue buying shares in stocks. It is much easier to just send money to someone else to invest on your behalf, even though it may cost you considerable amounts of commission dollars over time, compared to doing it yourself.

Money “stuff” is more important than most things going on in people’s lives. Not many people want to work until they can’t work anymore. Knowledge in investing and retirement planning, as well as taking an interest in what could be done with the money people spend all of their free time making shouldn’t be as much of a bother as people make it out to be.

Patience While Investing is Hard

Investing is the worst for someone who likes instant gratification. You put money into a company, and hope that something positive happens and the money invested grows over time. I personally hate the waiting – waiting to see if my master plan pre-investment holds up over time.

Even the Index Funds I have invested in take a lot of patience. Buying in over time, I’m basically making a bet that capitalism prevails and that companies continue to increase over time. There is a chance when I’m putting money into the market, that it’s in the middle of a downturn and I won’t see a return on the shares I purchased until the early part of the next decade.

I play a game of “watchful forgetfulness” with most of the stocks I have purchased over the last year, when my investing “career” started. I do my initial research, put together a hypothesis of what I think the stock will do, purchase the shares, then try to forget about owning it for the most part. I set a Google alert that I get sent to me once every two weeks to learn of any big news that would change my initial views that I have on the stock, but otherwise try not to focus on tracking the price each day.

Whether it’s a “boring” Index Fund, or an individual stock investment, if the investment is going down, I’m going to second guess myself on an almost daily basis, constantly checking to see how my investments are doing. I do much better just leaving the investments alone – believing that the research I did, the opinions I read about the stock and the hypothesis I came up with that made me buy it is going to work. This works better for me than having immediate doubts after a 5% decline in the investment.

It works the other way for me too – if an investment I’m involved with has increased in value, I am always questioning myself whether I should sell and buy something else, in order to lock in the profits (before anything goes wrong). As you can see, it’s just better that I don’t pay close attention to my investments, or my portfolio would be in shambles. I’m not a patient person, and seeing the possibility of profits being lost on an “up” stock or capital losses taking place on a “down” stock would stress me out on a daily basis.

How closely do you watch your investments – daily? monthly? annually?