I joked with Million Dollar Journey this week that I am stalking him with two nearly identical posts. If you didn’t win a copy of Retire Rich from Real Estate by Dr. Marc Andersen from Million Dollar Journey, here’s your 2nd chance this week. My review is found here. Contest is really simple- all you have to do is post a comment (please enter a valid email address) between now and 5:00 (EST) on Friday February 8, 2008. One winner will be picked at random. One entry per person. North American residents only.

Feel free to make your prediction about the Super Bowl too if you post before the game.

If you are interested in books on real estate investing, I would visit Sphinx Publishing’s website who were kind enough to send me a copy to give away.

Good luck and have a good weekend.

The “reluctant entrepreneur” is the term sometimes used to describe people who have been forced to become entrepreneurs not necessarily by choice but by circumstances beyond their control. More often than not, it is entrepreneurship born out of a layoff during down-times. With no other immediate job prospects available, one sets off on their own. We could be entering into a period where a lot of reluctant entrepreneurs are born.

But what about money? I joked last month that entrepreneurship was French for poverty. Since cash flow is the life-blood of business, big or small, anyone facing the prospects of becoming a reluctant entrepreneur (much less a willing one) has got to start thinking of money. How do you become a successful reluctant entrepreneur if the circumstance of this life choice was born out of an economic shock like a lay-off?

First, it is not the end of the world if you are becoming a reluctant entrepreneur with little to no personal financial resources. One of my most successful clients started his business in his basement with two used computers. You just have to be savvy. Second, we are re-entering the age of entrepreneurship (the concept of the employee is a relatively modern concept) and this re-emergence has resulted in a re-focus on the entrepreneurship issues.

I am not a HR expert so I am not going to attempt to blog on when you think the axe is coming and its time to be a reluctant entrepreneur but here are a few finance issues to think about:

• YOUR FIRST CLIENT SHOULD BE YOUR EX-BOSS

Many an entrepreneur has started their business by being retained by the company that down-sized them. Some are shrewd enough to know the axe is coming and to negotiate a deal with their employer- instead of paying me severance, hire me as a consultant.

What’s in it for your ex-boss? Cheaper labor and familiarity with work product. Consulting fees can be written off as an expense and your employer doesn’t have to work about your health care benefits anymore.

I see this occur quite often in the software and the media fields; labor markets with a great deal of employee fluidity. Now, if you hate your work and what to do something else, this is clearly not a good solution.

• THERE ARE A LOT OF FREE RESOURCES TO TEACH YOU TO BECOME AN ENTREPRENEUR

This may ruffle feathers but the worse place to learn to be an entrepreneur is at MBA school. The rough and tumble, unpredictable nature of entrepreneurship does not fit well into neat and tidy case studies and text books. The best place to learn entrepreneurship is through other entrepreneurs.

Having said that, there are many free resources to help you “learn” entrepreneurship. There are obviously blogs. I enjoy reading this blog on entrepreneurship. Many larger cities have economic development departments who devote some resources to providing resources to small business. In Canada, BizLaunch provides free training seminars for start-ups. These are only some examples that came to mind. There are a lot of other free resources to help you soak up knowledge so do your research.

• GOOD BUSINESSES GROW ORGANICALLY SO MONEY UP

Statistically speaking, word of mouth referrals is the best way to capture new business (although studies also state that it costs 4 times more to land a new client than to keep an existing one which tends to lead one to believe you are better off keeping what you have than chasing the next big client). This takes time so you best to “money up” because you are in it for the long haul and businesses consume a lot of money.

One couple I knew basically sold every non-essential item they owned to generate cash. Others take part-time or one-off jobs during down seasons. As I have mentioned before as well, the entire household has to make a commitment to entrepreneurship; many entrepreneurs need a spouse to carry the financial burdens of operating household for a while as well as providing emotional support. If this all sounds terrible remember that entrepreneurship is born out of passion so the sacrifices made are to pursue a dream and not a job.

• LEARN REVENUE RECOGNITION

Revenue recognition is just MBA speak for good debt. You spend money to the extent you know it will generate income. No fancy office furniture. Instead, spend it on marketing and advertising and things that will bring clients into the door.

• WHAT’S YOUR EXIT STRATEGY FINANCIALLY?

Are you going to retire by selling the business? Be a reluctant entrepreneur until you find a steady paying job? Become a serial entrepreneur? It is always good to have an exit strategy from a business and financial perspective since it will also dictate how you deal with your cash flow. For example, selling the business means having to pour financial resources into growing the business and making it attractive for sale. Always try to begin with the end in mind.

Many reluctant entrepreneurs end up loving the life of an entrepreneur so always keep an open mind.

Hindsight, as they say, is 20/20. Thus, I found it timely that I received Dr. Marc Andersen’s book Retire Rich from Real Estate in the same week as the global markets came to the realization the American economy may, indeed, be headed for recession (if not already so) due, in part, to the bursting of the real estate bubble.

Although published in 2008, the book was most likely written in 2007 with an eye to the real estate collapse currently unfolding. Andersen highlights in several instances the shift in this decade away from fundamentally sound principals of real estate investing (such as declining capitalization rates, appreciation of property outstripping rental rates and falling net operating income) as a harbinger of real estate collapse (Vancouver real estate investors pay heed!). Although Andersen refuses to state explicitly that we were living in the midst of a real estate bubble, his quantitative analysis, and as history is proving, certainly suggested as such.

Retire Rich from Real Estate is not your typical real estate investing guide. The book takes as its underlining analytical tool the Property Owners and Mangers Survey (POMS) conducted by the U.S. Census Bureau which is the first known survey of its kind. The POMS survey came to a shocking conclusion- only 41.4% of property owners in the survey reported they made a profit on real estate investing! The findings appear to shatter the commonly held belief that real estate investing is “safer” than investing in stock.

Why is real estate investing unsuccessful for over 50% of investors? Andersen undertakes a step-by-step analysis on how to find, buy and rent real estate using the POMS findings as a guide on what to avoid. For example, investing in highly appreciating properties is not necessarily a good thing. Why? Appreciation does not always equal good cash flow- a fundamental cornerstone of real estate investing. Andersen’s analysis suggests a Goldie Locks approach to buying investment property- not too hot and not too cold- which will be both cash flow positive and appreciate over time. I also found it interesting that Andersen’s analysis suggest that average operating expenses (the cost of keeping up a property less mortgage payments) should be in the range of 40-45% of monthly rents; personal experience tells me that most people dramatically under-estimate this figure and end up with zero to negative cash flow.

The book is full of great tidbits on finding good investments in an uncertain real estate market. For example, look for properties that rent for less than the carrying costs of a mortgage in the same area. Why? The tenants cannot convert from renters to owners that easily since they make enough to pay the rent but not enough to carry a mortgage. I also found it interesting that the bigger the unit, the more effective word of mouth referrals was to finding tenants.

Retire Rich from Real Estate is an excellent resource for guiding someone through real estate investing in these turbulent times. One caveat though- the author makes no attempt to dumb down the subject matter. There are times his analysis is very numbers driven and dense. It is not a book for the timid or tire-kickers on the subject.

Thus, my main criticism of the book is that it does read a little too much like a text-book. The copy is long at times and unbroken. There should be a more liberal use of text-boxes, graphs and other devices to break up the analysis. Some more real life examples would be helpful as well to bring the numbers into perspective. Perhaps this is something for the 2^nd edition which, may have to be written sooner rather than later, given what is occurring in real estate.

Million Dollar Journey reviewed the same book yesterday. Clearly, he reads at a slightly faster pace!

I’ll be giving away one copy of this book. Details on Friday.

One of the more curious aspects of dividend investing is that some investors slavishly focus on dividend yield above other indicators of a healthy dividend yielding stock. For definitional purposes, dividend yield is ratio derived from: (amount of dividend paid annually/price per share). The higher the dividend yield, the higher the dividend paid relative to its stock price. Thus, a stock paying $1 in dividends and trading at $20/share has a yield of 5% whereas a stock paying $1 and trading at $50/share has a 2% yield. In the abstract, and if you assumed the stock price never goes up, the 5% yield stock is “safer” in the sense you know you are getting a 5% return a year. So, do we always look at dividend yield first when assessing a good dividend paying stock?

I would argue no. The Globe and Mail has been running a series on the best dividend stocks to invest in during 2008. Last week, they listed some of the following as U.S. Dividend Winners: Allstate, Bank of America, Anheuser-Busch, Home-Depot and JnJ. Home Depot was the only stock on this list which is also made the list of this year’s Dogs of the Dow (the Dogs of the Dow is an annual list of stocks who are members of the Dow Jones Industrial Average which has the highest dividend yield as of December 31 of each year).

Why was Home Depot the only stock to make both the analyst list and the Dogs of the Dow? This requires a look at context. If you are like me, and you have a 20-30 year window for investing, chasing the highest dividend yield is not necessarily the best strategy. Remember that dividend yield is a function of both dividend paid and stock price. The issue is that high dividend yield stocks occur in the following situations:

1. The dividend paid is extremely high BUT that means, in most cases, there isn’t much room for dividend increases. If you have a long investment window, you want steady dividend increases since it generally indicates that the business is healthy enough over long period of time to return cash to shareholders.
2. The stock price is, relatively speaking, low which means either the market believes the business is not going to grow that rapidly (remember that a stock price is really a predication of future performance) or the business has suffered a set-back and you may better off investing in a healthier competitor (Citigroup is a good example of this phenomenon; it had a dividend yield of over 7% entering into 2008 based on rapidly declining stock prices; its smaller rival, Wells Fargo (Buffet’s favorite bank) had a lower yield and, arguably, better prospects going forward).

There’s also a larger contextual issue with chasing the highest dividend yield if you have a long investing window. High dividend yield stocks traditionally consist of leaders in mature industries. This year’s Dogs of the Dow consists of members in stodgy and mature businesses like: General Motors, DuPont, AT & T and Altira (a tobacco company). They are under competitive pressures which they have not faced before. I am not sure if the highest dividend yield stocks today will be leaders 10-20 years from now. We are living in an age where massive political and economic change is occurring and we can’t rely upon the industrial leaders from by-gone eras to boast our portfolio.

In a perfect world, my analysis is not to chase dividend yield but to find dividends yielding between 2% -4% in a normal market (I would not rely on dividend yields for financial stocks in this market), with a 5 year annualized dividend growth of 15% and a conservative dividend payout ratio (the % of profits paid out as dividend and written about in my post is my dividend payment safe?). If I had to prioritize these three factors, I would pick the following:

1. 5 year dividend growth: This shows the business is healthy from a cash flow perspective, committed to raising dividends over time and, statistically speaking, the best stocks to invest in relative to their steadier dividend paying peers and non dividend paying stock.
2. Dividend payout ratio: This shows whether the business has room to grow its dividend. Once you have a dividend payout ratio over 50%, there isn’t too much room to grow the dividend payments. This is not desirable if you have a long investment window and are looking for a “raise” every year.
3. Dividend yield: If a dividend yield is high, the stock price is relatively low (which, I readily admit, may present opportunities to engage in value investing) or the dividend payment does not have too much room to increase. I want the happy medium- a growing dividend which can grow year over year and an appreciating stock price.

I wanted to make one final point. Chasing the highest dividend yield is tantamount to investing in bonds on steroids. No one would argue that dividend payments are desirable but extremely high dividend yield stocks (5% plus)  do not appreciate that much relative to its lowest yield counterparts. You create an appreciation ceiling in many respects by investing in too many high dividend yield stocks (having said that, if you can find a stock that has a high yield because the price has been affected negatively in a one-time event, then it may be worth investigating). The point of good dividend stock investing is to benefit from the best of both worlds- cash flow and appreciation. If you chase yield at the expense of increasing dividend payments, you are forgoing appreciation potential.

Do I avoid high dividend yield stock altogether? No. One suggestion I have heard is to anchor your dividend stock portfolio with a high dividend yield stock where the stock appreciation is limited but the dividend is quite secure (typically in a sin industry or utility where profit does not need to be reinvested into the business). Then, invest in several high-fliers- stocks that have increased dividends rapidly over time. The anchor stock mitigates any issues that may result from the high-fliers. I am looking for an anchor now.

As I mentioned, my analysis is contextual to my own situation. For some people with varying risk tolerance, different life circumstances etc., investing in the highest dividend yield stocks may be right for them. As usual do your own due diligence before investing.

Finally, if you want to know more about dividend investing, I would start with the Dividend Guy Blog and Dividend4Life as good resources. Financial Jungle has also constructed a 4.69% dividend yield portfolio for informational purposes.

This post is a companion piece to my previous post on financial goal planning and, given we are coming up to the end of month, it would be an appropriate time to muse about this topic since most new year’s resolutions tend to fade after the initial euphoria. I have always felt it was easier to write down goals then to stick to them. For most of us, we make a goal on new year’s day but you have another 364 days to execute on them. As they like to say in business, it is not the best idea that is the most profitable but the best executed idea. I would rather have modest goals and great execution than a earth-shattering goals and poor execution.

As an opening note, I have found there seems to be a real correlation between tracking your goals and sticking to them. After all, how do you know if you are sticking to your goals if you don’t know how you are doing? If I keep tracking my goal, as opposed to saying “I feel I am meeting them,” I know how far away I am from my goals and have to make an extra effort to reach them if I am falling behind. If you want a great example, think of the other bloggers who post their net worth monthly. They are constantly tracking their goal and they know what adjustments they have to make to reach their goal. They also do well for that reason- tracking goals keeps you disciplined.

Here are a couple of methods of goal tracking I have tried over the years. The key is to mix and match in a combination that works for you and not to do just one unless one method works effectively from the outset.

WRITE IT DOWN AND LOOK AT IT EVERY SINGLE DAY

My friend introduced me to this one. He had a number written on a bulletin board. It meant nothing to anybody but him. The key was that the bulletin board was positioned in a way that he could see it every single day when he woke up. It was a constant remainder of his goal and this method made him think “how close am I to my goal?” as the first thought of the day.

I tried this but this was never my cup of tea. Others have had great success to the constant reinforcement of the goal.

SET ASIDE THE SAME TIME TO TRACK GOALS AND MAKE ADJUSTMENTS

I use to be very poor on following through with my goals. Part of the reason was that I would track my goals when I felt like it. Thus, I would look at my goals once, wait 6 weeks, look at it again, wait 9 weeks, look at it again, wait 14 weeks…and then just forget about them.

I spend every Sunday now looking at my goals, tracking them and making adjustments as need be. Some of you may think once a week is too much (especially if you have young kids). You have to make your own decision on what is an appropriate interval to look at your goals and make sure you are meeting them. However, I have found if you leave more than 4 weeks between goal checking intervals too much time elapses and the damage, to the extent there is any, is done. A short interval allows you to make adjustments quickly.

I wanted to end this method with one comment. Goal tracking is not a comfortable exercise at all. It forces us to look at our own warts and confront ourselves on why we are falling short. You have to will yourself out of comfort zone in order to track your goals and make sure you are sticking to them. If you are a creature of comfort, remember this- do not confuse comfort with happiness. Every successful person I have ever met always says the same thing to me- it takes a lot of hard work to get ahead in life. The comforts they enjoy now occur after years of hard work.

USE THE PROFESSIONALS

Perhaps other bloggers do not mention this, but I appear to be an anomaly in that I have an investment advisor or I openly blog about the fact that I have an advisor. I am not sure if my advisor likes me- I always force him to review my portfolio with me and ask him what we are doing right and wrong (I write this with tongue firmly planted in cheek- we get along great). Basically, what I do is make my advisor my goal enforcer. He knows where I want to go and he reminds me if I stray offside.

Some readers may ask does my advisor try to push product on me? No. In fact, it is the other way around. I call him at least once a month with my “I have an idea…” conversation. Very rarely do I implement the idea. Instead, it is more of a sounding board. Once I verbalize my idea to someone with expertise, I hear how off-track some of my ideas are and I regain my senses (and some of these ideas were completely off the wall).

Why doesn’t he push product? Very early on in our relationship, we had a conversation of what I want and don’t want in my portfolio and then I put it in writing and he has that on file. We have a very clear understanding of wants and needs and it has set the map of where I am heading.

If you have an advisor and you are frustrated, pick up the phone and call them. Tell them what you want and how you want the relationship to progress. If you don’t know what you want, have a conversation about that too with the understanding they will not push product but discuss strategy. There are many advisors who are waiting for their clients to have this constructive conversation with them. If you have an advisor who is not willing to do this, then it may be time for a change.

SURROUND YOURSELF WITH OTHER GOAL SETTERS

Join a group of like-minded people. Arrange to have coffee at set-times. Stop associating with people who think goals are “silly” or “you’ll never reach them.” Stay positive, stay focused and build a support group that looks at life the same way.

I have the privilege of having friends who are all of the above. Their influence in my life is incalculable. Before that, I worked at large law firm- taken as a whole, with notable exceptions, a collection of highly intelligent but extremely negative people. You would always be afraid to stick your neck out on the line or be positive. As an ex co-worker once said to me: “they don’t pay us danger pay, they pay us fear pay. They pay us well to live in fear.”

The other idea written at length by Nancy Zimmerman is to start an investment club with like minded people. The clubs are excellent opportunities to engage in something educational in a social setting.

ADJUST THE TACTICS BUT NOT THE STRATEGY

The surest way to sabotage a goal is to change the rules by changing the goal when you hit the first bump on the road. If you keep changing goals, you will never reach them. Its like that friend we all have that always says “once I have [insert person/object/job]…I will be happy” then they hit a bump in the road to that magic bullet that will cure all their life’s woes and they say “ok, once I have [insert new person/object/job… I will be happy.” It becomes a never ending cycle of non-reachable goals and frustration.

I ran into an obstacle with my goal to increase net worth by 7% in 2008. The markets refuse to co-operate! Thus, instead of lowering the bar, I am changing tactics. My emphasis has shifted from capital growth to a combination of capital preservation and more aggressive debt repayment. I also realized that I am too over-weighed in banks- but I love financials (I love any business where they use other people’s money, charge you for the use of your own money and then put up barriers to get your own money out)- so I am adjusting into other industries where they get paid first or there is pricing power.

MAKE THEM PUBLIC

One of the largest criticism of the personal finance blogging community is that we are smug in that we appear to have mastered the art of managing money (guess they never read the posts where we collectively admit we fell on our faces many times over). However, I look at it the other way- bloggers are mastering (since no one ever masters) the art of managing money because they have made their lives public to one extent to the other- the threat of public embarrassment has a way of really focusing one’s attention to the task at hand. I made mention to a friend that I have become a much more disciplined investor since I started writing this blog (now I make mistakes in the single digits and not double digits). I don’t want to look like a fool in front of my readers.

I am not suggesting you all start a blog (although it is therapeutic on some level). What I do suggest is sharing your goals with someone you trust and who will be supportive of them and vice versa. Making your goals public creates an external pressure to fulfill them which will complement whatever internal drive you have that initially lead you to set the goals.

A good start is to have that person meet with you at a set time to discuss your mutual goals. Respect their time and them- make sure you have something to report and come prepared. It shouldn’t become a forum to complain. After all, you are supposed to be helping one another.

These are some of the things I do, anyone want to suggest other ideas?

I am taking a one week hiatus from the Business of Blogging series. In the next three posts, I will address the following topics: (i) to incorporate or not to incorporate? (ii) what happens after I incorporate? (iii) how much can I get if I sell my blog?  I am always looking for new topics on this topic. If you have any suggestions, please feel free to email me. Thanks.

Today’s post is a continuation of a discussion Preet Banerjee and I are having about the financial industry, investing strategies and money in general. The first part can be found here. Today, we discuss working with advisors, how to sabotage your portfolio and fees (my comments are in bold and Preet’s are in italics). The usual disclaimers apply about both product discussed and picking the right investment advisor for you- please do your own due diligence.

As a programming note, I am going to be running a series of “insider conversations” the rest of the year. My next insider conversation is with hedge fund consultant Richard Wilson. I am working on finding a banker and commercial landlord for you as well. If you want me to have conversations with other insiders, please give me your suggestions. Thanks.

WORKING WITH YOUR INVESTMENT ADVISOR

Let’s move on to something more practical. What do you think are the most common mistakes people make in finding an investment advisor?

On average, people don’t take their finances seriously enough; they really do take more time making decisions about a new fridge or their next car then they do selecting the person who will manage their financial lives for (potentially) decades.

It use to make me really uncomfortable when people use to hire me as a lawyer after meeting with me for 15 minutes and handing me a cheque. I am not talking about referrals from existing clients but people who cold-called me. I use to have the following rule: if I felt I could have lunch with a potential client and not bite my tongue because they were offensive/not a good personality fit/just generally crazy then I would consider them as potential clients (most people over-look that professionals pick their clients).

However, it takes time to figure out whether you could have an enjoyable lunch with somebody. How much time do you think someone should spend looking for an investment advisor?

Excellent question. I have consciously not pursued client accounts I knew I could take over with minimal effort due to various reasons similar to the ones you mention. But from the investor’s perspective, you should be spending quite a bit of time trying to figure out which advisor to use (if you choose to use an advisor). These days, you’ll certainly want to Google the advisor’s name and do your own digging. Check that they are registered with the appropriate regulatory bodies, and ask for a sample of work. Ask them how they would pick a financial advisor if they were in your shoes – you can tell a lot about someone’s character based on the level of candour you would get from an answer to that question!

What about common mistakes you see once someone hires an advisor?

A big mistake is a lack of communication with their advisor. This goes back to the average investor’s negligence with respect to their finances. Personal finance education needs to be integrated into the school system starting the year after kids start learning math and all the way up to through secondary and post-secondary education.

There should be a two-way client service agreement that outlines the expectations from each other. Also, I think many people are too polite – you need to demand more from your advisor in terms of service and accountability. If you give them slack, they will take it.

It might not hurt to “compare notes” with your friends and colleagues. You don’t have to share intimate details of course, but it doesn’t hurt to second guess your advisor’s opinions and strategy recommendations. This will require more work on your part, but shouldn’t you be more interested in your finances than anyone else? There is a danger of having opinionated friends who have no real clue what they are talking about, but appear to – so be careful.

I should point out that the average investor has multiple advisors as their asset levels grow – except at retirement when they tend to consolidate their assets to one advisor (usually a financial planner).

LEARNING FROM OTHER PEOPLE’S EXPERIENCE

I understand that you have some net worth individuals as clients or you have made an attractive ROI for your clients. Are they doing anything different than the “average” investor? If so, what is it (other than listening to their advisors!)?

Everyone gets a financial plan with full blown Monte Carlo sensitivity analysis projections run on their current plan versus what I come up with (average financial plan is 50-100 pages – I leave little uncovered). Less than 1% of advisors provide this.

Most people find that they over-estimate their risk tolerances after we go through the plan – so perhaps I reign in their expectations to a more realistic level. When people get what they expect, they are happy.

I don’t have one set investment portfolio that I use for everyone, but many are a mix of 80% passive, 20% active. I also tend to incorporate two-year flow through LP ladders. From what I’ve seen, it doesn’t really matter TOO much which one you choose in a given year, they all tend to be slaves of the sector and invest in the same entities. So if you can just keep rolling them over every year (which can be done with a two year ladder since the holding periods are generally 18 months) then you can save some serious tax. There not for the feint of heart though and even for speculative investors, the total exposure at any time to these flow-throughs is 5-10% of the total portfolio (and I might adjust the equity/fixed income split of the rest of the portfolio to compensate as well.)

What do you mean by over-estimating their risk tolerance? Do they start by saying they want to buy penny stocks and then end up with General Electric?

If anyone wants to buy penny stocks, I send them right to a discount brokerage. I was referring more to one’s perception of how much of a loss they can withstand over different time periods (1 month, 1 year, etc.), or even more to the point – what their equity/fixed income split should be. If they say then can handle a 10% drop in their portfolio, they normally can’t. If they are making regular contributions we can afford to take on more volatility, but for lump sums we normally have to reel in the equity exposure. People answer those risk profile questionnaires as if they are being graded on their knowledge of risk/return, which is the wrong way of doing it.

Let me ask the question that everyone wants to know though- what is the one thing that rich people are doing that I am not? I can tell you in business, very successful business people have a disciplined approach to cash flow management. What about investing? Any tips on how the rich invest?

For the most part, it’s more about what you put into your investments than what you put your investments into. The “rich” have simply put more money into their accounts to begin with. Along that vein, they tend to be more focused on capital preservation as opposed to new/young investors who are more focused on capital growth.

If your portfolio loses 50% in one year, just to get back to ground zero your portfolio has to return 100% the next year.

More emphasis is also placed on financial planning and taking a holistic approach to the family’s finances. Lots of time is dedicated to long term tax planning especially. I can usually add a lot more value to a family’s estate through tax planning than through improvements to their investment portfolio strategies, for example.

THE 2008 MARKET

(Please note that Preet and I had this conversation last week)

Let’s move on to how NOT to get rich. If you look at the 2008 stock market the volumes seems to indicate that the retail investors are selling while the big mutual funds and institutions are keeping cash on the side, waiting until you and I have shot ourselves in the foot and then buying up assets at discount. It is like Nortel all over again. Is history repeating itself?

It always will. People seem to forget that for every transaction, there is a buyer and a seller. So if the markets are going down, it can only happen because someone is willing to purchase the security you no longer think is worth owning. More often that not, these are the pros. I’m oversimplifying it of course, but you’ll know when things get bad when liquidity dries up – and we’re not there yet. The S&P500 corrects by 10% once every 20 months or so on average (since 1940). 20% corrections happen every 4 or 5 years on average. This is nothing new.

Some investors may naturally say “the North American markets are not good markets to invest in. I am moving my money to emerging markets.” I still believe it is too early to get into some emerging markets- there needs to be a good correction in emerging markets to get the excesses and pretenders out of the market; there are still too many fly by nights traded on the Shanghai exchange. Do you believe the same thing?

I believe too much energy is expended trying to figure that out. The world’s different markets are losing their negative correlation with increasing globalization, and North American and European multi-nationals will expand and operate in emerging markets because if anything, their management teams see the same thing you and I do. They’ll get the exposure with less risk since they are more mature companies. A lot of the emerging market entities will have teething problems – which translates to higher returns AND risk. I guess that means I’m thinking along the same lines as you: I have some exposure there, but not nearly as much as in North America, Europe and other developed markets.

Is the media making the situation worse? You would think reading the paper a recession is like the plague. It is part of the natural economic cycle.

I remember someone saying that if you left the design of elevator buttons to the media, there would be no “Up” and “Down” buttons – they would read “SOAR!” and “PLUNGE!”.

FEES

Let’s talk about fees? What are you charging?

For my fee-based accounts my client advisory fee is 1.00% ($150,000 minimum). Since I use ETF’s predominantly, the all-in expenses will be in the 1.2% range. The clients get a statement that shows how much my fee is, and for non-registered accounts the 1% is potentially tax-deductible. At the highest marginal rate of tax, that translates to a 0.54% client advisory fee. Fee-based accounts are for those who are not comfortable with their finances and need a lot of financial planning expertise and customer service. There are no costs for buying and selling on top of this (the fee covers everything).

For those using mutual fund portfolios, I can replicate their asset allocation, increase their performance and save them many thousands of dollars per year.

If they prefer, I can instead charge them by the hour and they can set up their own portfolios at a discount broker. My hourly rate is $400/hour which is also potentially tax deductible. If I can’t improve someone’s finances by at least how much my fees are, I won’t charge them. (And I’ll know that within minutes.) Why would I?

But consider I showed someone how to save $400,000 in taxes last week over what he had planned on doing and you’ll see it’s all relative.

Who is more suited to hourly vs. a percentage of fees?

Fee-based (percentage of assets) is better if you really take a back-seat with your finances. The advisor is managing the portfolio and financial planning advice and should be actively in contact with you. As the portfolio gets really big, you would switch to hourly (or fee-only).

Hourly (or fee-only) is good at lower assets levels if you are comfortable with managing your own investments – you can quantify the exact cost of the financial planning advice you are getting. You will also drastically reduce your fees in many cases. You probably won’t be as engaged with your advisor on an ongoing basis with this arrangement, so as I mentioned, this is more for those who would be pro-active in contacting their advisor for financial planning needs and/or yearly investment reviews.

Thanks for your time and thoughts. I am going to write a review soon on your book. Here’s your chance to plug it.

It is now available through www.TheRRSPbook.com.

The total cost (to Canadian mailing addresses) is $25.00 CAD – that includes tax and shipping. Considering that almost everyone who buys this book will find a way to save a lot more than $25 in taxes or fees – I think it’s a great investment. You can give it away as a gift when you are done with it – who doesn’t need to learn more about RRSPs?

It will be available on a more mainstream basis (through Amazon and Chapters/Indigo online) towards the end of February. I have yet to line up the distribution in physical bookstores, but I estimate that will take place in late spring ‘08. So if you want a copy NOW, you’ll have to order it from the website. I should point out that it’s perfectly fine to buy the book in any month other than February! These planning strategies do not revolve around the contribution deadline!

Thanks to Preet for his time and interesting conversation. Preet’s blog can be found here.

Do you ever want to know what investment advisors think about their own industry? What started out as a Q & A about Preet Banerjee’s new book RRSPs: The Definitive book on Registered Retirement Savings Plan morphed into a wide ranging discussion between Preet and myself on the financial industry, dealing with financial advisors and the excesses of the people who manage our money as follows (I have grouped this into headings for ease of reference since Preet and I go all over the place. My comments are in bold and Preet’s comments are in italics). As per usual, anything that Preet or I may mention in terms of products are informational only and not a solicitation to buy. If you are interested in the products mentioned, please make sure you conduct your own due diligence:

INVESTMENT ADVISORS- GOOD OR BAD?

Investment advisors and planners get a bad rap on the personal finance blogs. I’ll give you an opportunity to refute the argument. Why should someone hire an investment advisor instead of becoming a DIY investor?

In the case of dealing with an investment advisor (who in the truest sense is an advisor who looks mainly at managing your investment portfolio) versus being a DIY investor: If you are a passive investor and have a good understanding of asset allocation models, then there is little (if any) reason to use an investment advisor. Today, it’s very cheap to create and maintain properly diversified portfolios. There is one caveat though – the DIY investor has to commit to proper self-education. You just don’t know what you don’t know. So it’s important to read books (and blogs) on a constant basis. You may not necessarily agree with them, but it’s wise to get all sides of the story.

It can be tough to stick to your guns and you may end up second guessing yourself (especially in times like the present). But many DIY investors who take a predominantly passive approach will probably recognize this…

I mentioned that a good understanding of asset allocation is probably a good pre-requisite if you are trying to build your own diversified portfolio. This goes beyond figuring out what your level of exposure to equities and fixed income should be (i.e. 70 % equities and 30% fixed income.) Perhaps a minimum knowledge requirement would be to be able to understand the difference between systematic and non-systematic risk, correlation, and modern portfolio theory before embarking down the DIY passive investment path…

ACTIVE VS. PASSIVE INVESTING

(for definitional purposes, Preet and I use the term “active” management/investing to refer to trying to outperform the indices/benchmarks by actively buying and selling stocks- whether directly or through the purchase of a mutual fund- whereas “ passive” management/investing means one invests in investment vehicles that mirrors some part of the stock market)

Here’s the issue though- most DIY investors I know (including our fellow bloggers) become DIY investors because they hire an investment advisor, experience below market returns and then learn to do it themselves and fire their advisors. If you have the DIY investor “personality”, isn’t it almost inevitable that there will be a natural progression from being a client of an investment advisor to being a DIY investor?

Agreed: if you have the DIY personality and an interest in personal finance and/or investing this is probably the path that you will take. Some may start as DIY investors from the get go as well.

There are some people who shovel their own driveways, build their own decks, finish their own basements, etc. But in the case of home renovations and investing, the vast majority use professionals. The disconnect is that the guy who built your deck doesn’t charge you a trailer for the rest of your life like many financial advisors do. It’s more acceptable if the advisor is providing ongoing value (perhaps through proper financial planning, good customer service, etc.) – but this is not normally the case.

Portfolios in the beginning are small which means fees tend to be magnified if your advisor puts you into mutual funds.

For the active-management investors with assets under a certain amount (call it six figures for argument’s sake), it’s hard to create a diversified, actively-managed portfolio unless you use some sort of managed product like a mutual fund. Since it has been shown over and over again that mutual funds under-perform and over-charge, a better tool-set to get some semblance of active management might be to actively adjust the asset/sector mix and/or market-time passive products – like index ETF’s or index mutual funds (like the TD e-series).

BUT, trying to time the markets is usually a futile exercise as well. So, for the most part, history and experience have shown me that during the initial accumulation phase, using a passive approach and foregoing any type of timing is generally the best way to go for the average investor. Also consider that as you are starting up, how much you save has a greater effect on your net worth accumulation than how much your investments grow. Of course there will be those who will want to make concentrated bets – that’s fine as long as you understand the risk/return trade-off you are making – it’s your money after all.

What you are suggesting though is almost opposite to what we all do; I started as an active investor and now I am going to passive; my next trade is an ETF. If you start as a passive investor and all you are doing is opening a self-directed account and buying products that track an index why do you need an advisor at all?

You might not need an investment advisor, but you would probably need a financial planner. There is a difference between these two types of advisors. An investment advisor will focus mainly on rate of return and portfolio management. A financial planner will look at so many other things: cashflow management, long term tax planning, estate planning, insurance planning, mortgage planning, retirement planning. This is where a financial planner will make more of a difference.

But here’s the rub. I am going to assuming an investor with the six figures you cited is going to be flooded with calls from every John, Dick and Mary in the financial industry trying to get their business. If I have been smart enough to save or protect that portfolio size why would I hand this over to an investment advisor?

If you built this up on your own, you probably wouldn’t hand it over unless you were out of your comfort zone at higher asset levels, didn’t have the time to manage the portfolio(s) anymore, or found someone you think can outperform you. All three scenarios seem pretty unlikely if you were already a DIY investor though.

There is one example of an advantage of using an investment advisor, even if you are a DIY investor: Assuming you have a collaborative relationship with your advisor (non-discretionary account) and you decide you want to make a purchase of security X – once the transaction sizes get higher, your advisor might call down to a special group of traders (sometimes called large block traders) and they will bypass just throwing up an order on the exchange and call another trader directly to negotiate a better price – and that price savings might be more than what you would pay in commissions with a discount brokerage and a full service brokerage put together. In a case like this, you can see that they have earned their fee. This really only applies to active management.

IS THE FINANCIAL INDUSTRY CORRUPT?

And therein lies the problem… how many advisors would actually advise their clients that they can give a discount in fees instead of selling other products? The entire industry is slanted towards pushing product across their divisional lines and not reducing my costs. I got mail from my mortgage company last week pushing insurance offered by another division of their financial empire.

The last twenty years has been about pushing the “consolidation is good” mantra on the financial industry but this only helps the players and not the customer (it is even arguable that this has helped the shareholders; consolidation seems to help the CEO’s and the board, with share options, first and foremost).

My bank has a new bank manager and the within 3 minutes of meeting him he was trying to get me to move my mortgage to his branch as well as my RSP. I get the sense saving fees is the last thing the industry is taught to do. Instead, my experience is that the industry is taught to push product with trailers and get referrals from other salespeople in the larger financial company.

I echo the negative sentiment directed at financial advisors and the financial advisory services in general. The current (predominant) model of compensation promotes an inherent conflict of interest within the client-advisor relationship and it breeds unscrupulous advisors. It’s archaic and I think a case could be built to argue that it contradicts our fiduciary responsibility to act in the best interest of the client. Unfortunately the profitability of this model will ensure that it continues for some time. We are long overdue for a paradigm shift in the industry. The shift should be to a model that unbundles products, advice and fees in a clear fashion. That’s not even close to being on the horizon though…

The fees specifically attached to the portfolio execution and management should be clearly delineated and the fees specifically attached to the financial planning advice should be kept separate as well.

Yes, but there is no financial impetus to do that. In fact, there would be a disincentive to undertake this model. There are great advisors out there but most retail based brokerages I come across are pumping out glorified sales-people. “Advisors” are there to pump product and not give advice. Why give advice? It creates liability, takes time and there’s no trailer on advice.

You are absolutely correct. And there are some really intelligent, great advisors out there who really make positive contributions to their clients’ finances, but many are bound by the parameters of their firm’s business models or delivery platforms. The system’s compensation structure as it stands right now makes way too much money for way too many people – there is a tonne of inertia to overcome.

With due respect to your industry, it is too easy to get in. I meet too many guys (and, let’s face it, it is still mostly a male profession) that backed into the industry as a 2^nd or 3^rd career because the other ones didn’t pan out (either that or they sell insurance). Compared to other professions where you deal with client money, the barriers to entry are way too low. I had to go to school for 7 years, apprentice for 12 months and then write 3 months of exams to even have the right to call myself a lawyer and I never held in my trust accounts the amount of money an average advisor manages for clients.

You really hit the nail on the head with this one. If I had carte blanche to re-write the rules of the industry, one of the top priorities would be to raise the education requirements for financial advisors BEFORE they get into the industry. They should have some sort of dedicated multiple year educational requirements similar to law school, medical school, etc.

Maybe the delivery system could be a hybrid of the lawyer/doctor professions in which we charged only by the hour or service and then issued a prescription to be filled elsewhere. Take 2 ETF’s and call me in the morning…

Part II tomorrow

Not knowing what was going to happen on Monday, on Sunday night I wrote a post about buying gold as a hedge against inflation and then Monday hit. Today, I settled on my sale of some money market funds to buy gold- am I buying it? Not on your life. Gold went up 5% this morning in a mad panic. These were my precise instructions to my broker: “Everyone is being stupid. Let’s wait out the stupidity. I’ll speak with you next week.”

Let’s just put some of this week’s events thus far in perspective. Recessions are natural parts of economic cycles; they cleanse the system of publicly traded companies that shouldn’t be around and remove excesses from the system. Since July 1953, there have been 9 recessions (not including this one), the longest recession in this time period lasted from July 1990 to March 1991 (the shortest was March 2001- November 2001- oh how we forget!) [added note: based on S & P 500]. The lesson to be learned are that RECESSIONS ARE SHORT. Think of them like a band-aid being ripped off fast- it sure hurts but the pain doesn’t last.

Second, we have entered the age of tabloid journalism. Every little story gets blown up like the Iron Curtain was falling or someone walked on the moon every day. Ignore chicken little and plot your own course. A lot of the hue and cry is from Wall Street who fear that their 7 figure salary days are disappearing; given the proximity of the traders to the media centers in Manhattan, the hue and cry has been magnified. Strangely, I feel little sympathy for the potential loss of the unsustainable life-styles of the Gordon Gecko’s of the world. STAY THE COURSE.

Third, do not take generalities and apply to all situations. Certain industries will continue to perform well during recessions (everyone drinks, smokes, gambles, take drugs, eats, buy basics etc). Certain neighborhoods will always be desirable to buy in short of a depression. People still need to consume- just not new iPod’s every 6 months consume, but consume. Context is everything. There will always be niches which are profitable. Remember in panics, oxygen mask makers do well. CONTEXT IS EVERYTHING.

Fourth, this is the time to really pay attention to your portfolio. Most people tend to close their eyes during bad times under the “ignorance is bliss” theory. I am doing the exact opposite. I am really looking for deals now. PAY ATTENTION.

Here’s why- RBC released the following study today- in the 12 months following every recession since 1953, the market returned an average of 14% (I am excluding the tech bubble numbers) [added note: returns from the S & P 500]. If you close your eyes, how will you find bargains? To give you a better sense of the issue- in the same study, RBC found that the average market return during a recession was 1.5% (it is in the 12 months before a recession that your portfolio really takes a hit since average losses are greater during that period than in the recession). And you cannot capitalize on opportunity if you play chicken little. CHANGE = OPPORTUNITY

Finally, I end with a quote:

“The way to make money is to buy when blood is running in the streets.” - John D. Rockefeller

Last week, my luggage broke upon arrival. It had survived 3 continents and lots of trips so I am not surprised it finally broke although Air Canada probably didn’t help matters. This meant I had to go shopping for a new one and, to my utter amazement, I found a Swiss Army medium sized luggage regularly priced at $249.99 for $89.99! This got me thinking of items I would only buy on sale and why.

LUGGAGE

I ended up telling a friend who was once a part owner of a luggage manufacture about my find and his response was almost all the luggage in the world is made in China. Given the low cost of manufacturing it, the mark-ups are almost criminal. No one should ever pay full price because the manufacturer and retailer will make money even if they have to sell it for a massive discount to retail price. By the way, for those planning March break trips, look around- luggage is on sale everywhere. Best to pick up some cheap luggage now than wait for March when the price will go up again.
CARS

This item may be a surprise considering it is typically the 2nd most expensive item we will ever buy in life after our house. But here’s the dirty little secret the dealership doesn’t tell you. Almost all manufacturers give dealers incentives to sell cars- the incentives are NOT tied to how much profit the dealer can get for each car but the NUMBER of cars they move in a period of time (the business model of dealerships is not to sell new cars but to service them over its life and sell used cars for massive mark-ups- this is why they totally low-ball you when you sell your car as part of the process of buying a new car. Selling a car and selling printers now have the same business model- they both move units for the primary purpose to make money on after-purchase service.).

All the industry wants is to move inventory off the show-room floor. Profit is secondary in selling new cars (the exception to the rule are luxury cars where demand out-strips supply) Don’t believe the salesperson when they say the dealer needs to make money on selling a car. Tell them you know about the dealer incentive to move units and they make money no matter how much or little they sell the car for (Million Dollar Journey has a great post on negotiating the best price for a car).

TOILET PAPER/NAPKINS

Ever notice that these are always on sale? Also notice that they are always advertised on sale? These are nothing more than loss leaders to get you into the store so you can buy pharmaceuticals, cosmetics and other high-profit goods. You would be a fool to buy toilet paper and napkins at full price.

TOWELS

Same reason as toilet paper. Department stores have white sales so you can buy furniture along with your towels.

BEST- SELLER BOOKS

There’s a huge imbalance between publishers and retails now. The retailers are now huge chains (Borders, Barnes & Noble and Chapters) who can force the publishers to do whatever they want- including putting best-sellers on sale to move product. Retailers can also return books with impunity to the publisher. Rather than accept these, it allows the books to go on sale or moves them to discount book-stores.

Of course, there’s the effect of the internet on book prices. Amazon discounts most books because it has no bricks and mortar costs to pay for since it has no stores so it can force the industry into price wars. Take advantage of it.

What do you never buy for full price and why?