Tag Archives: financial planning

Random thoughts – keeping you on your toes

Risk Adjusted Return

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I read an amusing article on on the weekend in which an investment advisor noted he finds many clients and even other advisors struggle with the concept of risk adjusted returns.

The greater the risk an investment might not be returned, the higher the return expectations.  Why would anyone  make a high risk investment without motivation; ( e.g., a higher return).

For Example

The article was about a typically Canadian investment vehicle, the Mortgage  Investment Corporation (MIC).  Created years ago by the Federal government to entice some alternate funding into a generally highly regulated sector (retail mortgages).

The advisor in question noted how a number of high net worth investors crowed to him each year how they were invested in a low risk high return mortgage investment corporation.

He asked these investors why the borrower took a mortgage loan from the MIC at 9% when all the major banks were offering mortgages at around 3% or less.

Do you think maybe the banks considered the loan too risky with a higher potential for loss.   That is the borrower represented a high risk investment.

In that case, the borrower took a mortgage from the MIC because they were the only ones that would take a chance on him.  And for the privilege he paid a premium (i.e., 6% above mortgage market rates).

Smarter than the Banks

It is doubtful those that invest in MIC’s have a good understanding of risk adjusted return, but these mortgage investment corporations are a great example of the principle.

Unfortunately there are far too many ill informed investors (and the MIC salesman isn’t going to tell them). It is not unusual for someone to make a large investment in an MIC only to be stunned when they can’t get their money back.

So, while these funds sell well, probably only a small number of the investors won’t be surprised if they suffer a risk event.  Sadly many are potentially in for a shock.

Random thoughts – keeping you on your toes

Banks Sell Services – OMG what a surprise!

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The recent negative publicity afforded to the TD bank about aggresive sales practices has raised questions about Financial Services employees selling their companies products to customers.

Seriously

These stories make me laugh out loud.  The banks in Canada are not altruistic institutions, don’t kid yourself, they are in it for the money.  As a shareholder of almost every major financial institution in Canada, my view is, go for it, sell your products and services for a profit. The more sales the better.

A paid employee is complaining about their employer setting sales gaols and monitoring their progress.  And some are sympathizing with the employees and chastising the employer, really, give your head a shake.

Lets Get Real

When you ask a financial advisor for assistance, whether it is to buy insurance, get a loan or make an investment, or even just give advise, don’t kid yourself, they are not helping you out of the goodness of their hearts.

Probably, selling you a product or service (e.g., advice) to satisfy their performance goals or increase their compensation (like a commission,bonus or tip) is the prime motivator.

That is not to blanket all financial services employees with a single brush stroke.  Of course most do want to be helpful and viewed to be such.  That can after all drive both referals and repeat business ( more sales, commissions bonuses, etc).

That being said, they are still ultimately going to try and sell you something, after all that is what they are paid to do.

Am I schocked TD employees are complaining about sales targets?  Not really, getting paid while not having to work hard is probably easier.

Am I surprised that the public does not seem to be aware that employees working for a company that makes money from product and service sales are expected to be sales people?  It does make me wonder.

Speaking from Experience

Full disclosure, I worked in Financial Services for more than 37 years and sold a lot of products while providing exceptional service and I don’t feel guilty at all.  It was a job I chose and was good at.

It never occured to me to try and figure out if the customer needed the product, only if they wanted it – which really equates to need.  That is, if you want it, you need it. Who am I to question that?

 

Random thoughts – keeping you on your toes

Managing Investment Risk

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When you invest your money the basic objective is to get the highest return with the lowest potential you will not get all or even worse, any, of your investment back.

Risk Aversion Basics

The number of processes and techniques to avoid loosing money while maximizing return is virtually impossible to list.  New methods pop up every day.

I am referring to things like laddered bond etfs indexed to central bank rates when giraffes dance in Africa.   For me, the best place to start is simple and basic.

Weird esoteric investments and associated practices have their place but these are contextual.  If you are a day trader, a bank or a fund manager, things like covered calls, long puts or rate swaps might appeal.

For the average retail investor there are much simpler and possibly more effective approaches to consider first.

Top Three Risk Mitigators

1) Do the research – If you are struggling to understand how an investment works, stop.  Only invest in things you personally fully understand how the returns or losses occur.

2) Leverage Asset Classes – There are three basic asset classes.  Balance the assets within your investment portfolio according to your willingness to take losses while seeking high returns.

Cash – things like GIC’s, savings accounts, paper money under the mattress.  These investments typically have the lowest return and the highest likelyhood at a minimum you will get your original investment back. Cash and savings accounts are typically very liquid.

Fixed Income – things like Government and Corporate bonds the inestments are usually granted a higher priority in terms of security in event of bankruptcy and will pay regular income (monthly, yearly, etc)

Equities – This type of investment is the least secure but can offer the opportunity for the higest return.

3) Balance the Sector – all investments fit into some category.  For example real estate, transportation, financial and so on.  Overweighting your investment in one sector or another can be profitable but also exposes a greater risk in the event that sector comes under stress.  An example of this was financial investments in mortgages  suffered as a whole in 2008 due to the crash in the real estate market.

Starting with these three simple to understand concepts can lead you to more advanced concepts, however, understanding the basics will lay a foundation for trying the more complex in the future.

 

Random thoughts – keeping you on your toes

What is Retirement?

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Typically we would say retirement is a point where a person ceases employment completely.  This is differernt from ceasing employment voluntarily (quitting) or involuntarily (fired or laid off).

Of course, we often think of employment as the condition of having paid work.  So if you do volunteer work or focus on raising children or other ways of spending your time, other than paid employment, with no intention of ever taking up paid employment; are you retired?

Out of Retirement

If you cease employment completely (so you are “retired”) but decide to take up employment again at a later time, are you “unretired” or just employed again.  Or is the paid work called your retirement job?

That is, you retired and elected to receive a pension.  You then seek and gain employment and so have two incomes – one income for doing nothing and paid employment.

Why Retire?

Interestingly many cases of working in retirement have little to do with monetary status (although some do). Studies have shown after a lifetime of focusing on participating in paid employment, stopping suddenly can effect a big psychological impact, a negative one.

Suddenly stopping your paid employment has been  shown to be a statistically valid causal factor in early demise.

Working in paid employment or unpaid employment (e.g. volunteering) provides a purpose .  Leisure activies, technically not classified as work also provide a purpose.

In considering retirement, it is important to remember the key factor is not always financial.  Although it is nice not to worry about income, the psychological impacts of not having a purpose or objective could be deadly.

 

Random thoughts – keeping you on your toes

Personal Financial Management

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Having a financial plan ( that is a document of what is going to be done by whom and when relative to your finances) is a critical underpinning of your personal financial health. However, without validation, the plan looses a lot of value.

Annual Review

Personally I think a review as least annually is the minimum although some probably like to check how there are doing more often.  Less often provides to great a risk that important adjustments get missed and ultimately result in the plan no longer being achievable.

I do my reviews on a calendar year basis and have 2016’s currently underway – hence this post.

What is it?

Simply put the review should consist of four things:

  • Income – How much was it and where did it come from.    This could be on a before or after tax basis (if after tax you don’t need to track taxes as a separate expense item).
  • Expense – what did you spend your income on, the use of categories here to group expenses is pretty well mandatory so the document is not unwieldy.  It should have enough detail though to be enable meaningful analysis and decisions.
  • Income less Expense –  This is pretty important.  If you are spending more than your income some adjustment is likely needed.
  • Investment Income –  I do a more detailed separate breakdown on this income because of the risk and volatility associated with it.   The focus of this review is obviously realized and unrealized capital, interest and dividend incomes (or losses but I try to avoid those.)

For What time frame?

The longer period the data covers the better and this is really key for good retirement planning.  For me the data covers 20 years.

Now the question is, based on this data, are things proceeding as you planned?

That means focusing on questions like;

  • Are there unexpected increases in expenses?
  • Considering what stage your plan is at is the increase in net income or decrease as expected?
  • Is inflation occurring at expected levels (e.g., checking the average cost of property tax over time – assuming the base property is the same gives a sense of what percent it is creeping up – 20 years of data really help with this.)

And so on.  The same type of thought process can be applied to your investment portfolio.

And finally, figure out what you need to change, adjust the plan and you are good until next year.

Note:  Net worth analysis and change over time, future income forecasts, and expense forecasts, market and inflation analysis, security considerations (e.g., insurance) are all advanced attributes but this post is focusing on the basics.

 

Random thoughts – keeping you on your toes

Leveraging your Financial Advisor or Broker

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I regularly recommend managing your financial plan and investments yourself if at all possible.  It is not a trivial effort but no one is as invested (pun intended) in your financial affairs like you are.

Whatever you do, the impact on your financial advisor/broker is irrelevant.  I mean it’s nice to make money for them as well as for yourself I guess, but really they are just a tool to help you.

Fess Up

I am a big proponent of do it yourself investing.  No one can do it better than me.  However, I must confess I am fortunate to have an equal partner when it comes to financial planning and investing (my wife).

Without this  partnership I probably would consider employing a professional to assist me.

Fortunately that is not the case.  The real nice thing is my wife and I complement each other beautifully.  While she plays the financial analyst/ broker role I am the feisty client.  For us this interplay is natural and really works.

Self Serve  Financial Mgmt

If you can manage your own finances the results are probably better than trusting another person.   It does require a lot of effort though and the optimal scenario is probably the kind of partnership my wife and have created.

We are fortunate in being able to share equally the effort while collaborating and playing off each other to get the best from our skills.   We also share equally in successes and failures.  No finger pointing here.

 

Random thoughts – keeping you on your toes

Financial Planning

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There are many places to get advice on financial planning.  For example,  books, articles, journalists, financial planners, financial product sales people and the list goes on.

Of course many sources results in multiple perspectives.  Probably most of these positions have contextual validity.  That is mapped to the data representative of the situation being analyzed. Howeveryou look at it though, it’s complex.

What about starting simple?

Intuitively, starting with simple basic concepts and gradualy  morphing into more complex ideas over time seems a practicle approach.

At it’s simplest, a financial plan is simply a list of actions, with responsible owners and completion dates, actually that is what any plan is. In others words who is going to do what by when?

The only difference between a financial plan and any other is the nature of the activities, that is things related to your personal finances.

Of course to develop the activities, owners and time frames you do need to know what you are trying to achieve.  Under the keeping it simply principle just start with this simple generic goal “A plan that will enable living the life you want to live”

Start here!

Create an activity list.  That is the things that need to be done to achieve the life you want to live.  These activities will be as personal as the life you want and will have dependencies on each other.

For example; spend money freely without worry  as an activity might be dependent on activities like earn enough money to be able to spend freely or save enough money to be able to spend freely.  Or reduce personal taxes so you have more money to spend freely.

(Just a caveat,  the activities must be realistically achievable, the above is a purposeful exaggeration for illustrative purposes.)

As you work through the plan completing an activity might result in new activities (and owners with completion dates).

The key princples of personal financial management should always be followed as you work through your plan:

  • it’s your plan, you can delegate support and get advice but never delegate decisions
  • monitor the activities and if they are not providing the expected result or the time frames are not achieved address the issue – resolve it to your satisfaction, don’t ignore it

Have fun!

Random thoughts – keeping you on your toes

Choosing your investment vehicle

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As noted in yesterday’s post you can use your money to make money (generally called investing).  Of course, you need some money to start.  You can engage in money making activities and save some money to use for investing ( basically working for others or working for yourself at activities that generate cash).  Or you can borrow money from others to invest (using others money to make money is often called leverage and results in higher rates of return, but more risk).

What’s the best way to invest my money?

Unless you are engaging in money laundering (which has a slightly different objective, although similar) the object of investing for most people is to earn the greatest return over the shortest time with the lowest risk of incurring losses.

Unfortunately such a generic objective is too high level to measure and thus difficult for ongoing management (i.e., determining how you are doing and modifying approaches accordingly on an ongoing basis).  The best first step is to define the underlying goals with a little more specificity.  The second step is to use these goals to select investments that match to the goals (more on that in future posts)

Here are the three key things to consider:

  1. ) Target Return –  Ask yourself what level of return on investment would satisfy your needs.  Many Corporations I have worked for in the past set this bar at various levels (known as the hurdle rate)  usually somewhere between 22% and 40 %, but for the individual investor this is probably unrealistic and the current economic environment needs to be considered when determining your goal.

    Many use the performance of stock market indexes over time as benchmarks.  I consider this a useful influence but personally also include my personal needs;  amount of effort I intend to expend, my level of competitiveness and other factors like these that are largely personal to me.  Taken all together I come up with my personal target – this is the annual return I am shooting for.  I revisit this goal once a year.

  2. ) Time Frame –  Determine the duration you expect for your investments to continue to perform.  For example this could be until I die or for a specified time frame.   You might select to invest for ten years after which you are okay spending the capital and reducing investment return, even down to nil.  The latter case would usually apply when you calculate after spending starts the capital won’t run out before you still need it.

    In some cases you may engage in a specific investment you only expect to produce income for X number of years (e.g., a diamond mine with limited reserves of say 10 years) and this goal should be understood at the start of the investment to avoid surprise.

  3. Appetite for Risk –  This is the most complex considerations.  Libraries of books exist on this topic and I do not intend to fully explore it in this post (I have written some posts in the past just about managing risk and will be writing others in the future).

    For this summary of key factors, the main point is really the importance of understanding and defining your risk tolerance in conjunction with the other two factors (target return and duration) before investing.  Overtime the amount of risk acceptable to you will change and the risk events you actually encounter with ongoing investments will be one key influence on these changes (bit once, shy twice).

    Remember, as a general rule lower risk tolerance over leads to lower returns and most stable long term performance.

Random thoughts – keeping you on your toes

Managing your money

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The basic framework to money management begins with your overall objective.  This is supported by specific goals, overtime as performance to the overall objective is measured the specific goals may be modified.

Some go with multiple objectives, personally I have always been a believer in simplicity and focus.  You might have a number of specific goals (shorter term and changing over time) but the objective should be straightforward and longer term (15 to 25 years).

How it could work

Objective:  Have more than a million in joint net financial assets by age sixty-five

Goals:

  • maximize registered retirement saving plan contributions each year
  • maximize tax free savings contribution each year
  • Achieve a dividend return for total net financial assets of 3% a years
  • Minimum internal capital growth rate (i.e., net of new investments) of 5% (both realized and unrealized gains)

And so on …….  (You could have goals around asset mix, interest income, etc)

The key thing to note is each goal is very specific and easily measurable, that is either it was obtained or it was not.

What Next

Use the specific goals for detailed planning.  Consider how to achieve the goals using the tools at hand.  I have previously done a number of posts about things like financial and retirement planning.  This posts provide some good ideas about the many of the tools and techniques you can use to assist with achieving your goals.

For example, if a specific goal is to maximize your TFSA contribution each year, financial planning tools can assist is defining an approach and the associated steps to achieving this goal.  Intuitively it’s pretty obvious you are more likely to achieve the goals with planning than otherwise (although with luck goals can be achieved randomly too).

Why Bother?

One of my favorite sayings is “If you don’t know where you are going, how can you plan to get there and when you arrive how will you know it?”  Setting your objective is the first step in answering that question.  Specific goals provide the flexibility to change direction over the long term,  as to how you achieve the objective.

 

Random thoughts – keeping you on your toes

Does personal financial planning make sense

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For any activity I am considering engaging in, the first question I ask is about value.  Value is a measure which considers both the associated effort and benefit.

Let’s say you are planning to spend days researching the best route to drive to work.  This entails determining what the route options are, than trying them out, timing them, maybe trying and comparing them during your leisure hours.   The extra trips have a gas cost associated with them.  In the end you may find the difference in travel time and gas costs between the four routes you found is a maximum time saving of less than 5 minutes.  Also the difference in gas cost negligible and the stress in rush hour is about the same for each route.   I would classify this route planning exercise as low value, the effort to develop the plan is not justified by the benefit.

Unfortunately sometimes it’s much easier to gauge value with hindsight than foresight (just an observation at this point).

This value discussion is relevant mainly because financial planning  is usually considered by most to be high effort and hard to do (often people hire others to do it for them).  While the effort is perceived to be hard the benefits are long term and usually not immediately tangible.    This thinking often leads to the conclusion that the exercise is of lower value,  not worth doing now, maybe later.

Money and Lifestyles

Financial planning is an ongoing exercise covering a lifetime or at least to retirement.   Plans that are developed should be flexible and need to change with your circumstances,  The objective is to enable your personal lifestyle to meet your expectations.

The Price of Entry

Data!  Building a financial plan, monitoring and updating it are 100% dependent on the historical data.  First and most important answer the question, what are you spending your money on?  Spending and saving objectives are the predictive part of the plan and frankly just gazing into a crystal ball to make predictions generally does not work.

The planning exercise starts with capturing and documenting your spending patterns over a reasonable period (at least one year).

You can use this historic spending to help predict future spending.  This includes saving plans and investing returns.   Then keep tracking ongoing to see how you are mapping to your predictions.

If your predictions are not going to achieve your goals short and long term using the past spending patterns and personal lifestyle behavior analysis to determine how you can achieve what you seek.

The bottom line

In future posts I will be exploring financial planning activities in more specific detail.  Basically a simple “how-to” primer is to come.   The purpose of this post was set the basic principles plant the idea that the planning effort might well be worth it – i.e,  high value overall.