Tag Archives: More finanical insight

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

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.

Random thoughts – keeping you on your toes

The Fractional Reserve System

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Around the world the money supply is managed under a fractional reserve/ capital requirements system.  This is a great system for supporting the growth of a country’s economy.  There are some pitfalls though and their are economists that believe some if not all the current worldwide economic challenges can be attributed to the fractional reserve system.

What is it?

The fractional reserve concept is based on the theory that only a small percentage of money will be withdrawn from a bank at any time.    The bank keeps a minimum amount on deposits (i.e.,  that cannot be lent out) and lends the rest.  Over time the borrowers pay it back and as long as there is not a run on the bank that exceeds the amount of cash on hand at a given point all is fine.

Given the people the money was lent to spend it, ultimately it gets returned to the bank as a deposit.  As a deposit the amount can be lent again (to the reserve limit). You can see the cycle continues and the money supply grows.

NOTE: Some country’s regulate the amount of money bank’s actually hold based on capital requirements versus a mandated % reserve (Canada is one of these).

How about an example?

Consider a country with only one bank.  The central bank issues currency of $100, and to make the example simple all of this currency goes to Bob.  Bob deposits the $100 in the bank.  The bank is required to hold at least 3% but can lend $97.   The bank lends it to Jerry who spend it on a house Bob owns  (ie, he pay’s it to Bob)  Bob deposits the  $97 in the bank and they in turn lend all but 3%.  The bank is now holding  $5.91 in cash,  has liabilities of $197 (Bobs deposits) and assets of  $191.09 (the loans they made) plus the reserve cash.  The country’s money supply is now  $394.   The money supply has increased more than  288%.  And the cycle continues as the money is paid back, then lent out the to the reserve limit, then deposited, so more money to lend.  And so on.  The money supply grows and can be used to build stuff and sell it, and pay salaries and buy stuff.

So the system is all good, the economy grows, there is good liquidity, money is available when needed.  What can go wrong?

The upward cycle is dependent on goods and services being created and purchased.  These also need to maintain their value at least for the cycle to continued unimpeded.   Say you borrow $97 and buy a house.  If the value of the house drops to $50 you might walk away from the loan.  This puts the bank at risk of being able to return the depositors money.  Simply put this scenario can cause the upward spiral to go the other way (down).  Ooops.

What’s my point

The fractional reserve/ capital requirement economic system is extremely complex and I have grossly simplified it. .

There are many other factors and processes at play in our modern currency based economies but it all is underpinned by the money supply.

My intent is really to prick an interest which would lead you to research and knowledge gathering.   There are alternatives to our current currency based economies (e.g., barter systems/ money supplies based on a fixed standard).  And the world has tried some of these, for example the gold standard.

My own real question about the whole modern economic system questions the up and down cycle of the money supply that is intrinsic in the fractional reserve system – are we all really okay with that?

Random thoughts – keeping you on your toes

Venture Capital

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I don’t intend to get bogged down in a financial theme with my ongoing blogs, however a discussion I had today about Coursera (a company that provides access to MOOC’s – massively open online courses) triggered a discourse about venture capitalists, so it’s on my mind and it is interesting (“Interesting to whom?” says my significant other)

What is it?

Say I have some money I want to invest.  Standard investment vehicles options include, of course, equity, fixed income, real estate, mutual funds/ETF’s,  etc.  I could also take the entrepreneur route and use my capital to fund my great idea; my venture so to speak.  Or, I can take the lazy person’s way out and back some other entrepreneur’s great venture.  This is not really less work as I would need to do due diligence  to mitigate the risk my capital was being subjected too and probably provide some sage advice and wisdom (to help ensure my capital was used wisely.)  Ultimately I would get some ownership piece  of the venture  (i.e., shares representing my % stake) or perhaps a royalty arrangement.  As the business grows and makes money and becomes more valuable I can return my capital and make a profit from either ongoing dividends (or royalties) or sale of my stake  for more than I invested.

How about an example?

First comes the idea (and of course it is someones idea and they have the desire, motivation and skills to execute it).  For example, a takeout restaurant that sells shoes on the side – combining a healthy lifestyle with good food (very trendy in today’s market) We could call it Wok with Steve.  Anyway, lease, lease hold improvements, furnishing, kitchen equipment, professional consulting (lawyers- yuk)  etc, all cost $100,000.  Based on a solid business plan (remember this is just a mythical example) positive cash flow won’t be realized for six months.  Given the first six months of operation will cost $50,000 – food stock (leveraged), salaries etc. the minimum start up is $150.000.  So our trusty entrepreneur sells the venture capitalist on his idea (using of course his fabulous business plan) and gives him 60% of the company for $150,000.  Even though our trendy entrepreneur put in no capital he gets 40% of the company for the idea and all the hard start up work.    Our fearless venture capitalist has studied the business plan and is convinced his 60% share can be sold via IPO (initial purchase offering) or back to the entrepreneur or maybe a competitor for $300,000 in 2 years.  This of course is based on the revenue projections, business growth, contained expenses and so on.  So our friendly venture capitalist makes a 50% a year return on his money, of course there is some risk (or a lot of risk).  And let’s not forget our business owner, with a stake worth $200,000 for all his hard work.

So how do I get started?

Well there is “Dragon’s Den”.  Or perhaps you can think of the next face-book or you-tube idea, the dollar figures for that kind of venture are much greater than my example – start-up challenges probably greater too.  Venture capitalist’s will salivate and line up to give you money.

Or perhaps you could be like Vancouver entrepreneur Marcus Frind who stared “Plenty of Fish” on line dating service in 2004, with no venture capital.  He just grew the business reinvesting the profits ($ten million annual profit by 2008 while working 10 hours a week).  So come 2015 and he owns the company (no venture capitalist involved) and decides to get his investment back (whatever 10 hours a week is worth).  Match.com purchases it from him for $575 million.  Not a bad return on his part for 11 years work.  I guess this might make you think about doing it without venture capital (beyond your own that is)