(as a brief editorial note, the last week of the Supermarket experiment and a final analysis will run early next week. Thanks for your patience.)

I have never been a supporter of buying a new home. Why? Firstly, workmanship in many new homes and condos is poor; I visited a friend’s new condo earlier this month to discover that the developer’s painter had painted over the electrical sockets because they were in such a hurry to finish the unit. In booming local economies, there simply are not enough qualified trades-people to properly finish a new home or condo; a lot of amateurs are learning the trade on your home!

More importantly, there are a myriad of hidden costs to purchasing a new home or condo which the developer tends to gloss over during the sales period which are not found in pre-existing home.  Suddenly, your affordable new home or condo comes with a lot of financial strings attached. This post dove-tails with Million Dollar Journey’s post about the costs of buying any home; I would suggest that you read his post first since I am going to avoid over-lap as much as possible.

The process of buying a new home/condo always reminds me of the saying: “the devil is in the details.” Somewhere in 9 point font on your 15 page Agreement of Purchase and Sale is a clause which states additional costs which have to be paid on closing. These additional costs can run in the thousands. How bad can it be? Try 1-2% of the purchase price of your home in some cases. Some common additional costs, and which be included in the purchase of a pre-existing home/condo, include property taxes, utilities etc.

However, purchasers of new homes and condos are also responsible for a large additional cost known as the developer fee (sometimes referred to as a “developer impact fee” or a “system development charge”). The development game is much like a bazaar; a lot of haggling goes on between developer and the city. Since many cities are too cash poor to pay for infrastructure, they make deals with developers. Cities will allow greater densities and/or variances in zoning in exchange for the developer helping to pay for the cost of building sewers, sidewalks and other servicing needs (in some extreme cases, the developer will build the local school). The costs incurred by the developer are passed down to you, the home-buyer, on closing. In new or rapidly growing communities, the development fee can be quite high given that the city is building infrastructure from scratch rather than extending existing lines in older communities. Thus, the cost savings of moving out into the suburbs are off-set somewhat by higher development fees.

The real catch is this- if you read your agreement of purchase and sale, additional costs are sometimes classified as “in addition” to and not part of the purchase price. Since mortgage companies loan you money based on a % of the purchase price, the additional costs have to be paid by you out of your own funds and not through the proceeds of the mortgages given that these costs are not part of your purchase price (in some cases, a friendly mortgage company will include additional costs into the purchase price). This means you may have to come up with another 1-2% of the purchase price to close your home (the 1-2% figure is derived from a friend of mine who had to pay 1.4% of the purchase price in development costs alone causing him to describe the process of buying a new home as “highway robbery by developers”).

The best way to fight these hidden costs is to negotiate a cap on additional costs when you are buying a new home/condo. Builders are always happy to throw in free upgrades to entice you to buy. Rather than take a marble counter-top and be stretched to come up with the funds to close, ask for less in upgrades in exchange for a cap on additional costs. You can always upgrade to a marble counter-top later but the upgrades mean nothing if you can’t close due to lack of funds or you spent so much money on closing that you can’t afford to buy a toaster to put on that new counter top.

How can you tell if your development costs (and, correspondingly, your additional costs) will be high or not? Use your eyes. A development being created out of farm land is going to require more infrastructure and servicing costs than an in-fill project. Larger developments which stretch city blocks are also going to have higher development fees than smaller projects. I would suggest that you speak with a real estate agent- a good one should have some sense of the development charges. If you are using a mortgage broker, they may also be able to help you calculate closing costs quite accurately.

Have a great weekend.

Just an update on a previous post about contributing to retirement or paying down the mortgage. I am contributing to retirement this month even though mortgage rates are generally going up. Why? I am self-employed and my income fluctuates from month to month. For whatever reason, this month’s deductible expenses are unusually low meaning that my taxable income is higher than usual. Out of an abundance of caution, I keep a reserve fund to pay taxes. Given the higher than expected level of taxable income this month, my tax reserve fund is under-funded and the most immediate measure to cover some of this short-fall is to accelerate my retirement contributions to lower my taxes on a dollar for dollar basis (I was going to be slightly under my maximum contribution room this year at my current pace).

I understand the argument that paying down my mortgage would give me an imputed return equal to my mortgage rate. However, the one lesson I have learned from advising businesses is that many financial difficulties begin with owing the tax-man money- the interest and penalties on late tax payments can be crippling and, of course, we know about the power of government when applied against an individual. If the choice is lowering my tax burden and keeping the tax-man away or paying down the mortgage, I am going with the former. Of course, if my circumstances change, I may be more inclined to pay down the mortgage. As always, context is everything.

(excuse the appearance, we are under construction)

Last week, I received a notice from my potential disability insurance company that I had not completed all the pre-requisites for obtaining disability insurance and my pre-approval had expired. I would once again have to apply for insurance. What happened was that my doctor did not complete the insurance company’s paperwork in time (it turns out that he has a notorious reputation among the insurance companies for being extremely tardy in his paperwork). Although I am a little perplexed by my doctor’s actions, I have decided not to reapply for disability insurance for the very simple reason that I am now eligible for these benefits under a group plan.

However, this did get me thinking about who really needs insurance and why we should obtain it. At the end of the day, insurance shifts the financial risk of certain events from yourself to the insurance company. Thus, in the event of death, it is the insurance company who will pay out the debts of your estate. In the event of critical illness (cancer, blindness etc.), the insurance company will pay you monies to treat the illness and maintain a certain lifestyle and, in the event of a disability, disability insurance replace your wages.

But’s here’s the catch when you really think about insurance; its not the risk of a certain event happening, its the risk of what happens after the event occurs. For example, I am not insuring against a disability; I am insuring against my lost income if I cannot work due to a disability. If I insured against a non-existent risk after an event has occurred, I am over-insured. For example, I have no dependents so what monetary risk is there in me passing away (assuming that my assets are more than my debts)?

Having said that, I will be obtaining life insurance even though I have no dependents given that it is cheaper to obtain insurance when I am younger and for tax reasons. Life insurance is a great vehicle to pay taxes in the event of death.

Everyone gets taxed when they die- either in the form of estate taxes, probate or the deemed disposition of the deceased’s assets on the date of death triggering capital gains (in plain English, the tax authorities rule that the deceased sold everything on the day of death and any gains on those assets are taxed accordingly). The taxes can be quite onerous and can take up to 40% off the value of your estate. It is not unusual for an estate to declare bankruptcy if there isn’t enough insurance to fund tax liabilities arising from death (yes, the tax authorities even get you after death).
I have every intention of contributing my maximum allowable contributions to my RSP; I also intent to have a large portfolio of stock outside my RSP. This means that I will have a large tax bill on death. I intend to leave a legacy to loved ones and to educational institutions to fund scholarship for worthy but needy applicants. I do not want an unreasonable portion of my estate being used to pay taxes before it gets to the beneficiaries. Thus, life insurance to me is to insure against the risk of not leaving enough for my beneficiaries and various educational institutions; the insurance proceeds can pay my taxes and my estate can be used for the purpose it was intended for.

If there is a morale to this post it is this- ask yourself what risks will occur after a traumatic event and have you insured yourself against this? Or, to look at is another way, is it really necessary to insure yourself against the risk arising from certain events? Your comments are always appreciated.

Next to “my taxes are too high,” a frequent saying I hear among all people (regardless of investment acumen) is that “the condo market is over-built” or “don’t invest in a condo- the market is going to collapse!” One of the local news-stations is running a series on whether Toronto has too many condos under construction and what this will mean for real estate buyers and investors. In certain cities, like Miami, condo investors have had to sell their units at substantial discounts given the over-supply of condos. All of this has fueled talk of a condo bust (if it has not occurred in some cities).

However, according to the Internet chat boards, 400 of the 470 units in the L Tower in Toronto- a high-end condo designed by world famous architect Danial Libeskind- have already been pre-sold before ever being released to the general public and the Ritz-Carleton Hotel-Condo project in Toronto sold enough units to commence building quite quickly. Finally, Fortune Magazine reported that 90% of the units in the MGM Mirage project in Las Vegas were sold in the first two weeks of release- starting price: $1.5 million.

How do we explain the perception of a condo bust and the above paragraph?

Essentially, it is difficult to describe the condo market as homogeneous. Based on observation, the condo market has really splintered since the last condo downturn of the early 90’s. You now have world-class architects building high-end luxury condos (I define high-end in Toronto as anything over $500/sq. foot) in a scale not seen in the 1990’s. In Toronto, we have the Ritz-Carleton hotel-condo, The Trump hotel-condo, the Four Seasons Hotel-Condo, the Shangri-La and other high-end boutique projects all being sold at the same time. Vancouver will be the site of Norman Foster’s first mixed use residential building in North America (he did the Millennium Bridge in London). Finally, Santiago Calatrava (the architect du jour) is designing a 2,000 ft. condo next to Navy Pier in Chicago. Some of these designs are award-winning, project-defining pieces that attract buyers internationally.

On the other hand, you still have cookie-cutter condos being built for real estate investors and first time home-owners.

It is these cookie-cutter condos that I would stay away from if you are investing in a condo- the supply is over-whelming in some cities; Fortune Magazine reports that Naples, Florida has a 36 month supply of condos coming on-stream with 42 months worth of supply already on the market (Naples, Florida?). The over-supply is causing some real problems for real estate investors. In Toronto, there is a huge supply of our cookie-cutter end condos along the lake front and, having just helped someone rent out their unit in this area, it is becoming very difficult to rent these units out since a new building goes up every other month which is newer and cheaper than the last and people are throwing in LCD tv’s to entice people to rent. We got very lucky with our tenant who had to relocate on very short notice but nothing happened for 2 weeks after we advertised (and we used an agent too).

And, of course, the rich do think differently. The rich, according to this study, want to buy more real estate since the luxury end of the housing market has held up in the United States. They may see this downturn as nothing more than a buying opportunity (which supports my argument that you can never have too much cash lying around).

It appears that the condo market is collapsing depending on which end of the market you are at and where. On the low end, supply appears to eating into prices and, in areas of great over-supply, real estate investors are fleeing the market at a loss. On the high-end, there seems to be some down-side protection. Most of us cannot afford to purchase a top of the line unit on the high-end building but consider that most high end condos do sell smaller units (500-600 sq. ft) at half-way affordable prices which can be rented out for an attractive gain, investing in a starter unit in a higher end condo may not be a bad investment if you like to play real estate (a big if depending where you live). To give you a real life example, I ran the figures if I rented out my condo at the same rent as the previous owner and, based on my carrying costs and maintanence fees, I would be returning 17% a year (assume no cost of upkeep). My condo is not high end but it is not cookie-cutter either but it returns more the cookie-cutter unit by the lake (carrying costs are approximately the same).

If real estate investing is for you, recent trends in the condo industry seem to support the real estate rule that you should buy the worse unit in the best location/condo. Even if you are buying/investing in a tiny unit in a high-end condo, you may have some protection in the event of a downturn.

Someone commented recently that I should be spending more time attempting to save money on big-tickets items, such as house-hold appliances or a car, than on smaller items such as groceries (this comment was made as part of the supermarket experiment). I believe that saving money on the small items many times over will save me more money than getting the best price on a big ticket item every few years. I believe in this money saving strategy for two reasons.

The first comes down to opportunity cost. Do I spend days on end researching who offers the lowest price on a depreciating asset, such as a car or a washer/dryer set, or do I spend that time making money at work or doing research on investments (i.e. appreciating assets) or thinking about my financial future? Don’t get me wrong- I want to save money on big ticket items. However, at some point, the opportunity costs outweigh any savings that you may have. To quote the book Millionaire Next Door: “There is an inverse relationship between the time spent purchasing luxury items such as cars and clothes and the time spent planning one’s financial future.”

The same book found that the more one planned their financial future, the more likely they were to be financially independent. Thus, at some point in time, it makes no sense attempting to spend hours on end to find the best bargain on a big ticket item if the cost may be a less secure financial future (I am not even going to mention maintanence costs on big ticket items wiping out most of your savings).

Saving money on big ticket items is still important to me. What I have done is adopted a strategy that a friend of mine uses. My friend has to purchase vehicles every other year for work-related purposes but simply doesn’t have time to visit every dealer in the city. Thus, when he has to purchase a vehicle, he conducts a quick review of the market prices. He test drives the vehicle at one dealer close to him (it also makes it easy to service the vehicle if its close to his house). If he likes it, he tells the salesperson to call when the price is below X Dollars (usually slightly below the lower end of the spectrum). They will have an immediate sale at that point. If it is not below that amount don’t bother calling him or you will lose this sale and all future sales. It saves him time going from dealer to dealer attempting to haggle prices.

The second reason I concentrate on saving money on smaller items is frequency. I have to purchase milk and eggs every single week. Over time, the savings on this will begin to add up. If anyone has read a financial aid book on the amount of money you can save by packing a lunch or not buying Starbucks coffee, you understand how this adds up especially if you have the discipline to invest the money saved into investments.

I would like to know what people are doing to save money- are you concentrating on the big items or the small items? Any strategies on negotiating the purchase of big ticket items?

One last thing, since I am writing about saving money… John Chow dot com, a blog that helps you make money, is giving away a 24″ wide screen LCD monitor! Since I am a sucker for promotions, this is my entry.  Now give me the monitor! The contest is sponsored by BlueFur, who wants to let you know that they’re hosting Canada and the rest of the world. Wish me luck.

Here are week 3 results of my little experiment at the supermarket. The rules are stated here and week 1 and 2 results here and here respectively. As a weekly experiment there hasn’t been too many changes from week to week. I did hit my first sales item in tissue but it doesn’t seemed to have altered the fundamental trend arising.  Here are the results for this week:

Baked Beans (398 ml can)

Ideal location- $1.19 (Heinz)
Less ideal location- $0.79 (Compliments)
Difference- $0.30
% Difference- 21

No change from last week.

Olive Oil (1 Litre bottle)

Ideal location- $10.79 (Bertolii)
Less ideal location- $7.99 (Carapelli)
Difference- $2.80
% Difference- 26 *

No change from last week.

I am putting a huge asterisks here again though- the products have no ideal or non-ideal location- located on same shelf. Hindsight being 20/20 I should have used corn oil or vegetable oil instead.

Snack Bars (175g box)

Ideal location-$3.19 (Kellogg’s Nutri Grain)
Less ideal location- $2.99 (Quaker Chewy Bar)
Difference- $0.20
% Difference- 6

No change from last week.

Shampoo

Ideal location- $2.19 (Finesse, 330 ml)
Less ideal location- $1.99 (European Formula, 350 ml)
Difference- $0.20
% Difference-9

No change from last week.

Tissue

Ideal location- $1.99 (130 sheets of 3 ply tissue by Kleenex)
Less ideal location- $1.29 (140 sheets of 3 ply tissue by Royale Ultra)
Difference- $0.70
% Difference-35

The only change this week. The ideal location tissue was on sale and the less ideal location price also declined. The price difference expressed as a percentage decreased by 5%. However, I would attribute this decrease to the sale of the tissue in the ideal location more than anything else.

It is pretty clear with one week to go that location clearly makes a difference when it comes to pricing. As I stated last week, I am surprised that a staple like beans has as large a price difference. It also appears that the result in olive oil has to be thrown out.  Next week we finalize the experiment and report on results. Have a great weekend.

Someone asked me the other day what lessons I learned advising entrepreneurs/businesses which could be applied towards personal finance. As the book The Millionaire Next Door states, an entrepreneur has a higher chance of being a millionaire than employed individuals; thus, the lessons I have learned from my successful clients about business are fundamentally rooted in successful money management and translate well to personal finance. To put this in some context, most of the businesses I advised were small and medium sized enterprises so the lessons are from successful entrepreneurs and not high level executives of major corporations.

In no particular order, these are some of the personal finance lessons I have learned from the business world. The business lessons are in bold and I have translated this lesson into the personal finance field in italic

Find a niche and stick to it/Find an investment strategy your are comfortable with and stick to it

Businesses and personal finance tend to fail because we wander from strategy to strategy, usually as a result of trend chasing. For example, does anyone remember “convergence” in the late 90’s? It was a business strategy to have content providers be integrated with content. AOL and Time-Warner merged as a result, creating a text-book case of what not to do in business; on a very simple basis, the companies wandered from strategy to strategy as the i-bankers dictated the next big thing.

Most successful entrepreneurs I know carve out a niche and stick to it; its the same with personal finance- find a strategy which you are comfortable with (passive investing, active investing, stocks, bonds, real estate investments) and stick to it. I do know someone (not a client) who has both a business and personal interest in mining; he’s done it for 30 plus years buying what most of us would not (penny stock mining company/mines which have been abandoned) as both a business person and investor and never changed his course in spite of real estate booms, oil booms, tech booms etc. Mining was what he knew and mining was all that he ever did. I suspect he had enough to retire on 20 years ago.

Strategy is cheap, execution is the key/Stay invested in your strategy no matter what

In other words, will you blink when the going gets tough and the markets crash or will you stay the course? As much as I love bank stocks, I know someone who loves them even more- that’s the only industry she buys. Year after year, no matter what, she bought bank stocks. When interest rates were in the high teens in 1982 (banks tend to suffer in high interest rate environments) she bought banks. When the S&L crisis hit, she bought banks. When bank after bank hit their version of Enron, she bought banks. Yes, there is a diversification issue with her portfolio but the point is she stuck to her strategy (and hindsight being 20/20, investing in a bank isn’t the riskiest thing you could have bought in the last 25 years).

Surround yourself with the best people and build a good team/always seek investment advice from qualified people

It never ceases to amaze me how many accountants and lawyers entrepreneurs have around them. Not because they are sue happy or love to talk about the changes in GAAP. It is because accountants and lawyers bring different perspectives to the table which help refine decision making. Watch any successful business person on t.v.- most of them have their lawyer close by. It is the same thing with personal finance; the more qualified opinions you have, the better off you are (emphasis on qualified). It may shock the DIY community but I actually have 2 investment advisors (you can kick me out of the membership now) for reasons I will explain in another post. I also have two lawyers and a good friend who is a tax lawyer (good legal/tax advice for the price of dinner) and an accountant. I do not surround myself with these people because I like paying professionals. It is more to do with the fact that their experience and expertise can help frame a particular personal finance question in a different light and I am not making decisions with blinders on.

Focus on Cash Flow and then the Balance Sheet/focus on cash flow and then the balance sheet

I believe it was Buffet who said the best way to become a millionaire was to start a billionaire and buy an airline (someone better help me on this one). Airlines are great balance sheet companies because of the assets they own but poor cash flow companies because their fixed costs are so high; any small down-turn and the airline is losing money.

I suspect I may get some comments on this but net worth (which is what a balance sheet is in personal finance) has never been the top priority for me; its important but not the top. Generating a positive cash flow is key to me. Businesses, like households, run on cash. The greater amount of free cash you can generate, the greater your ability to increase assets. Obviously, I am assuming that someone will have the discipline to convert free cash into assets but I always focus on maximizing cash coming in rather than my net worth. Again, this belief is based on the fundamental assumption that you will convert free cash flow into assets.

Fail a lot when it doesn’t count as much/make your investing mistake young

This may be a strange lesson given Buffet’s first rule (”never lose money”) but, and I believe most parents can relate to this, people don’t learn unless they fail. Failure teaches us lessons better than reading about it in a book. My 20’s was an investing nightmare but my losses were small, I had no one to support and not mortgage. More importantly, I learned from it. If someone were to ask me what my qualifications were for running a financing company, I would answer, in part, that I learned how not to deal with money by failing at it and now I know how to handle money and finance. Far be it for me to criticize Buffet, but “never lose money” for most investors tends to create paralysis- people become more focused on not losing than winning. If you watch any sports, you know that teams that play not to lose tend not to win either. Its a counter-intuitive argument but best to take your investing lumps early and learn from those experience rather than do it when the stakes are high.

Let me know if you have any lessons you want to share, I may post on this topic from time to time given that my clients have taught me so much and I kept thinking of more lessons as I wrote.

Cash. For the last five years or so, a lot of financial advice has been about investing your money into product- whether it be a mutual fund, stock, GIC, ETF etc. Now that the market is going sideways, it may be time to assess your cash position. First and foremost, cash gives most investors an emotional comfort zone to work with- no matter how bad a return on an investment, you still have the comfort of knowing you have some cash on hand. Cash also allows you to pursue buying opportunities for fundamentally sound stocks and/or real estate when a correction occurs. Finally, cash allows you to weather an emergency without having to liquidate assets which you may have to sell for a loss or pay taxes if you sell for a gain. Cash, as they say, is king.

My cash strategy is quite straight-forward. In my non-registered accounts, I try to keep at least 3 months take-home pay in a high-interest savings account (given I am self-employed, I measure a month’s pay to be the average of what I pay myself). This is my comfort zone money. Given that interest income is not taxed efficiently, there is always a push-pull factor in amassing large cash reserves outside a registered account but, emotionally speaking, there is nothing like knowing that you have money to pay the mortgage if something happens to you so paying tax is a small price to pay for this comfort (consider it a “comfort tax”).

In my registered account, I have approximately 5%-10% of my portfolio in cash. 10% is an artificial limit. This is no real reason why I cannot hold more. In fact, I previously posted that the rich held more than 10% last year. As a general rule, the greater the uncertainty, the greater my cash holdings. This is my acquisition reserve- I use this money to hunt for bargains or to enter into the market when others are exiting. As another general rule, the greater the cash holdings of successful mutual fund managers, the greater my holdings are on the theory that you model the best in the field.

I believe one of the reasons why some investors lag market returns is that they have no cash to buy when its time to go bargain hunting. They know, fundamentally speaking, that the best time to buy is when the markets are low but don’t have the means to do so. I learned this lesson the hard way years ago when bank stocks were cheap but I had all my money locked up (in Science and Tech funds no less- the follies of youth!).

I have read a lot of articles recently about what to do now that the bond market is officially in bear territory and bond yields are pushing up (which, in turn, is moving money out of stocks and into bonds as bond yields begin to look attractive). Why not build up a cash position? For anyone who has graduated recently, this may be a prudent move given how many contradictory things are being written about the state of the economy. Save some money. Pay down debt. Research what you believe to be a good investing strategy is for you in the meantime.

I would be interested to know what % of a portfolio people keep in cash.

[as a post-script to yesterday’s post on Leveraged Investing, please read Canadian Capitalist’s thoughts on the same issue]

I once remember an investment counsel friend of mine who met a potential client with a high net worth who wasn’t happy with her current investment advisor. When he asked her what she expected him to provide by way of return on investment on her stock portfolio she said 15%-20% with no risk. My friend has common sense and his common sense told him that this was not going to be a happy relationship. Rather than lose the rest of his hair, he walked away.

I am reminded of this story lately as we tackle potential returns on investment in the financing company (for those new to the post, please see here for a back-ground). For those lawyers out there, we are not guaranteeing any returns on investment to our investors but, on a structural level, we have to consider what type of investment we are: conservative, moderate or aggressive since this goes hand in hand to who are ideal investors are. However, what I am beginning to find is that the market-place is full of unrealistic expectations. Perhaps this is due to the fact that the stock market has generated historically high returns for the last several years. Perhaps the Internet has trained us to have 4 second attention spans and to conveniently forget last year much less the dot com bust (or even Enron). Perhaps we all collectively think that this time it really will be different and the good times are here forever.

Regardless of the reason, by observation only, I have found that many people now consider 15% plus to be an “acceptable” rate of return. While achievable, a company that attempts to return 15% ROI to investors year over year exposes its investors to a variable of risk that, if you thought about it for a second, is too risky for most average investors. Companies that are supposed to return 15% plus are supposed to have venture capitalists as investors who could lose their money and not worry about it too much. We worked on some financial models and to consistently achieve 15% plus year over year the financial company would have to invest almost 100 cents on the dollar in riskier plays and hope that the market conditions stayed the same. Oh, we also wouldn’t get paid either. We would be constructing a potential deck of cards hoping that the economic winds didn’t blow us over. Being a big supporter of how banks manage their risk, we have set aside a reserve of money which we will not invest and taken a prudent approach on how the money will be invested. We hope that this will produce a steady rate of return over time rather than promise big, peak early and have the house of cards come down on us.

Cheap money since 9/11 has conditioned us to turn a blind or partially obscured eye towards risk. As I mentioned yesterday, there are some who support leveraged investing without educating people on downside risk; I suspect if this was 1982 the voices for leveraging people’s homes to invest in the stock market would not be so great. I watch mutual fund managers stock-pile cash and I begin to get nervous. I’ll update you on how our prudent approach works.

After the pay down the mortgage vs. contribute to retirement debate, one of the more contentious issues in the financial blogging world is whether to use leverage in order increase investment returns. To be clear, I am using the term “leveraged investing” to describe borrowing against assets and using the proceeds of the loan to invest in stocks and bonds. I am going to lump into this discussion all the various permutations of leveraged investing, whether it be the Smith Manoeuvre or trading on margin; the concept remains the same- you are using collateral (your house or your equities) to gain access to funds to invest . I am not going to tackle real estate investing in this discussion since successful real estate investing requires, at its very core, the use of leveraging for financing and tax reasons.

I do believe that, technically speaking, the strategy is sound. However, my issue with the leveraged investing is the same as the mortgage vs. contribute to retirement debate- many of the supporters tend to advocate it in the absence of context. Leveraging requires knowledge of financing, taxes, cash flow management and investing. Depending on the terms of the loan, leveraged investing may also require more time and effort than purchasing real estate as an investment (assuming that you have a tenant and barring no major emergencies, your job as a landlord is to collect the cheque and carry out some minor repairs).

As has been frequently quoted by other bloggers, most “average” investors tend to (and excuse the generalization): (i) spend relatively little time thinking about their money; (ii) ignore or pay little attention to educating themselves about personal finances; and (iii) perform worse than the market indexes. If these assumptions are true, the last thing an “average” investor needs to do is add an extra layer of complexity to their personal finances by engaging in leveraged investing. If, indeed, an average investor is performing below market, the more contextually correct advice should be to advise them to fix their portfolios first rather than use leveraged investing as a solution to their problems.

As I have mentioned in the past, I use to provide advice to businesses and I make the analogy that leveraged investing for under-performing investors is equivalent to a business that has received a lot of start-up capital and struggles to turn a profit. Rather than attempting to fix the structural issues with the business, which may not be linked to the amount of start-up capital, the business borrows more money, does nothing different in how the business is run, and wonders why they can’t turn around the business (if this story sounds familiar, this was the issue with the dot com boom- tech companies thought the solution to their problems was more money and not fixing bad product/management). You are throwing good money after bad and your risk exposure has just increased because you are using other people’s money.

Am I anti-leveraged investing? As I stated before, I believe its a technically correct approach to take- depending on how your portfolio is performing. I have no issues with savvy investors executing leveraged investing (for example, I look forward to the Million Dollar Journey’s posts on leveraged investing). However, I do have issue with more aggressive proponents of leverage investing who believe it is for everyone or you are wrong for not supporting it. Again, my approach begins with looking at context before supporting any investing strategy.

Thus, before anyone thinks about leveraged investing, ask yourself the following: (i) is my portfolio under-performing? (ii) do I have the time and attention to engage in such a strategy?If your answer is yes and no respectively, it may make more sense to fix (i) since it needs more attention than seeking more access to capital. I have no intention of engaging in leveraged investing- I am still adjusting my portfolio and I am going to focus on that goal rather than divide my time and attention on other matters.

Two final notes- does anyone remember the hay day of day trading on margin? The on-line brokerage lent you money using the stocks you purchased as collateral and a lot of people began to do it. How many people do you know that still day trades? Only a select few ever made money trading on margin. Just because they have re-named trading/investing on margin to leveraged investing does not mean that the risks haven’t changed (just as corporate raiders being re-branded as private equity does not change the nature of their business). My second observation is that leveraged investing has become quite popular due to unrealistic expectations of investment returns- something I will blog about tomorrow.