It appears wherever you go now the question on everyone’s lips is not “are the good times over?” but “how bad will it get?” It appears, in certain parts of the United States, a lot further. An often-cited indicator of how far the real estate bubble has to fall is the price-rent ratio. Often called the price to earnings ratio for real estate, the price-rent ratio is calculated by the formula of (house price/annual rent in an equivalent housing unit).

A price-rent ratio has no meaning in the abstract. A price-rent ratio of 10, for example, isn’t necessarily a good or bad ratio. The ratio has to be compared against historical price-rent ratios in the same area (here is a sample of price-rent ratios in the south-western U.S. which have to revert back to the norm) and this is where things get scary.  The Federal Reserve of San Francisco published a report in 2004 about a possible housing bubble forming since price-rent ratios where significantly above historical ratios (this study has been cited quite a lot lately with hindsight, as always, being 20/20). The issue is that this same study, and others after it, have found that price-rent ratios only return to historical averages through a great dependency on decrease in housing price (i.e. housing values fall back to historical averages) rather than increase in rent. This makes sense because rents are subject to external factors, such as rent control and available rental stock, which do not affect non-renters. The conclusion? In order for the real estate market to get back to “normal”, there will have to be a fall in housing prices.

How far? Depends where you live. Fortune Magazine published projections on 25 real estate markets poised to fall. They tend to be clustered in California and Florida. This supports the view that recessions tend to have regional impacts; certain regions will be the real losers of recessions while others will get off much more lightly.  But how much are we talking about on average? Noted economist, Paul Krugman, stated in the March 31 issue of Fortune Magazine, an average decrease of 25% nationally and up to 50% in some areas (Miami and L.A. were specifically mentioned).

For those who are (happily) owning real estate not located in the United States, you are not immune. When I started looking up research for this post, I noticed the global price-rent ratios are at historical highs. MoneyWeek, an English publication, had a few choice words for Vancouver real estate comparing it with Syndey’s housing bubble that popped. Locally, a developer is introducing a condo with introductory prices at $1.5 million- when prices on any asset get that outrageous, it is usually a sign we are on the last legs of any boom cycle (the parallel analogy being the BCE going private transaction- the dollar figure is obscene and marked the end of the private equity deals in this cycle- if they even complete it).

What does this all mean for you?

• if you are in your 20’s-40’s, and are going to live in your house for 10 plus years, the short term effects on these adjustments will be negligible. If you have a weak stomach, do not bother even asking what the neighbor sold their house for until at least 2010. Like any other asset, the longer you hold on to it, the greater the possibility you will not lose money.
• if you are in your 50’s and 60’s and (i) recently bought a home; and (ii) have little equity in it; and (iii) and intend to sell soon, depending on where you live, you could be in for a rough ride (the trinity of troubles).
• Regardless, remember the primary reason you buy real estate- shelter. In the grand scheme of things, real estate is still a good investment if the primary purpose is shelter for the long term; a place where you can raise your family safely and put down roots. The larger issue is that, over the last ten years, societal views on real estate have increasingly shifted towards treating real estate as an investment you leverage, flip and hop in and out of like we were real estate day-traders. Most day-traders earlier this decade lost their shirts or stopped doing it after a while. Looks like history is repeating itself.

RBC recently launched a blog aimed at the youth market called RBC p2p. To quote the website: “…a site for students by students.” The first bank, as far as I know, who went into the blogging world as extended advertising was Wells Fargo which took a much more eclectic approach as their bloggers hit all target markets (although the virtual blogger unsettles me). As a shareholder of RBC, a very innovative venture but, as an entrepreneur, I am disappointed at the lost opportunities.

Don’t get me wrong, I like the writers: good content and well-written and this criticism is not aimed at them (keep up the good work). Rather, the criticism is aimed directly at the feet of executives comfortably sitting in the golden towers of RBC headquarters (and, yes, it is actual gold-leaf on the windows of RBC Plaza) There are six writers- only one of which is female and none of them appear to be visible minorities (although one appears to be Greek by his last name). Has anyone walked a campus of a university lately? Women outnumber men in many faculties (when I graduated law school, the incoming class was 57% female) and there are a lot of visible minorities as students. Where are their voices on this blog?

Beyond the obvious lack of under-representation of certain demographic groups (and surprising insensitivity in this day and age) is RBC ever leaving a lot of money on the table. Studies show two largely untapped and growing markets for financial services are female and immigrant communities. In the UK, there are now more high net worth female clients than male. Locally, the number of single women buying homes is increasing with the average age of first-time female home buyers being 29 (yes, young men everywhere, we are readily replaceable!). In other words, if a bank can earn loyalty during the university years, the pay-off could be quick. But, other than Kate, where are the female voices on the blog? Where is the outreach to half the population?

The immigrant market is estimated to be a multi-billion industry annually (on the conservative side). A lot of ATM’s now have multiple language options: CIBC is converting all their ATM’s to incorporate Chinese in addition to Italian and Portuguese. And, yet, no attempt to reach out to young first and second generation immigrants? Remember that younger immigrants are, literally and figuratively, the translators for older generations in new societies and major influencers. As a result, banking choices and recommendations tend to flow upward and downward between generations. Again, where are these voices?

What makes theses absences stranger is that RBC knows where the growth is. From the November 20, 2007 Globe and Mail:

“Reaching out to the immigrant market is one of the Royal Bank of Canada’s “key priorities,” said Mark Whitmell, director of cultural markets [for RBC].”

So, you know its important to tab into immigrant markets but you do little to market to young immigrants? I believe in MBA speak this is called “poor departmental integration” or, in plain English, “your branding needs work.” RBC has a Director of Cultural Markets and they didn’t ask him about the blog? Study after study shows that women are outdoing men financially and there is no substantial outreach to young women?

By comparison, Wells Fargo has 4 female blogs out of the 8 “human” bloggers. They also appear to miss the boat on potential growth in immigrant markets. To RBC’s credit, it is not an overtly sales tool like Wells Fargo’s.

Verdict: good content, good lay-out but, as a marketing vehicle, needs tactical adjustments to reflect the market better- not only as a good corporate citizen but for potential growth opportunities. They could do a couple of things quickly and cost-effectively to make the blog more reflective of the market: a few on-line tools would be a start.

Any comments on the blog?

Peer to peer lending for personal and small business loans have been the latest incarnation of the micro finance trend. Traditionally confined to borrowers that banks otherwise would not lend personal and small business loans to in developing nations, such as the Oprah endorsed Kiva, peer to peer lending has gone upstream to a more retail markets. Prosper, described “…as an online community for lending and borrowing money…” for personal and small business loans, has a distinctively more mid-America focus to it than traditional micro financiers. Prosper works on a pretty simple premise: borrowers post for desired personal and small business loans and lenders bid on the interest rate they are willing to lend monies to such persons. Loans are unsecured (i.e. not backed by collateral in the event of default) and capped to relatively modest terms of 3 years and no greater than $25,000 a loan.

I am neither pro Prosper or anti Prosper; like any other alternative investment, it is important to understand what you are getting yourself into and understand risk/reward before proceeding. Thus, I took a look at the loan documentation consisting mainly of a promissory note and the Sale and Servicing Agreement (aka the Lender Registration Agreement). I am looking at this purely as an investment vehicle. Hence, my focus on the lender side documents.

I do not have too many comments to the promissory note; it is commercially reasonable and, as an unsecured note, its effectiveness to collect money, despite multiple clauses to help the lender, is limited by the fact there is no collateral securing performance of payment. The only clause I will highlight is what is known as the acceleration clause (see section 8 of the note) whereby upon default the entire principal and interest to be paid due and payable immediately (it is a typical clause but if you are lending for the first time please note its impact). My comments are primarily on the Lender Registration Agreement.

Let’s be clear- you are lending to Prosper who is lending to the borrower. Prosper is the bank.

Prosper, on one level, is analogous to a traditional bank in that we deposit money to the bank and the bank lends it out (in other words, the bank is using other people’s money). On another level, it is not. You get to pick what loans to fund whereas the bank picks for you. Depending on your risk tolerance, this is both a good or bad thing. Bankers are hated for a reason- in theory, they only lend to the safest borrower’s possible. They do the due diligence for you and, on a personal loan basis, they are mostly conservative. In Prosper, you pick your loans but Prosper is the bank in the sense that it is lending your money to the borrower as stated in the first paragraph:

“…you are not actually lending your directly to Prosper borrowers, but are, instead, making loan purchase commitments and purchasing promissory notes representing loans made by Prosper to borrowers. All loans originated through Prosper are made by borrowers by Prosper Marketplace, Inc. from its own funds and sold and assigned to you…” [emphasis is my own].

In other words, Prosper is the primary lender who mitigates its risk by transferring loans to you (granted you picked the loans) on the day after the bid period ends [see section 3(c)]. Keep this mind- Prosper itself has no down-side risk (as explained below). Despite the marketing spin, Prosper’s business model is the same as the banks- it takes your money, charge you fees for taking your money and lends it out. The only difference is you pick who the money gets loan out to but…

You own the loan but Prosper controls the administration

In section 5, the agreement states “Prosper will sell, transfer, assign, set over and convey to you…the Notes; provided however, that Prosper will retain the Servicing Rights…” [emphasis added]. What are Servicing Rights?

They deal with anything as mundane as the administration of the loan (filing, book-keeping, backing up computer records) to “any and all rights to service the Notes…any payments to or monies received by Prosper for servicing the Notes…” and, in return for such services, the Servicing Fee is paid. What does this mean in plain English?

Prosper collects the borrower’s payment into their bank account and disburses it for you. Prosper provides reports and Prosper makes sure you know if a loan is late, a cheque bounces etc.

What happens if a loan goes bad?

Prosper collects it for you (although you get to pick collection agencies) as part of Prosper’s servicing of the loan (see section 6). They will contact the borrower as a reminder of non-payment and, when payment is 30 days past due, Prosper will assign the loan to a collection agency and the collection agency does its thing. If the loan cannot be recovered 120 days after it is past due, it is “charged off” (i.e. written off) and sold to a 3rd party (and, you guessed it, you give authority to Prosper to sell the Note at whatever price it sees fit- if it can).

Here is the thing to note- Prosper is not a guarantor (nor should it be in an unsecured loan) [see section 10] and you are not allowed to take any action yourself to collect the delinquent loan (such as contact the borrower, sue them in court, contact the collection agency who is doing the collections) other than set out in the agreement [see section 14(d)-(g) and (i)].

Is this a good or bad thing that I have given Prosper the right to enforce my loan?

Depends.

Pros

• someone is doing the “dirty work” for you
• there are “professionals” collecting money for you (although most collection agencies resort to verbal thuggery quite quickly rightly or wrongly- it is just part of the game trying to collect loans from riskier borrowers)
• collection may be difficult if the borrower lives in another state and you need help

Cons

• Prosper has little down-side risk and thus no added motivation to collect. It is your money at risk. It may make honest attempts at collection but, after 120 days, its off to the collection agency but how motivated can someone be if down-side risk is quite limited? To use a real life example, would you be more motivated to collect if you lent a book to someone and they didn’t return it or if the library you work for lent a book and it wasn’t returned? Professionally speaking, you would make an effort to get the book back if it was the library’s but it doesn’t affect your bottom line directly so how much extra effort would you put in?
• the collection process is the same whether you are lending $5,000 or $25,000- hardly seems fair if you lent the latter
• Prosper has a right to sell the uncollected loan at pennies on the dollar if that’s what it can get for it

If you are interested in Proper of any of its competitors, one of the key questions to ask yourself is

Prosper’s website states from the period of Jan. 1, 2007 to Dec. 31, 2007, the ROI on a loan to AA borrowers (the best borrowers) was 7.07%. Is your risk tolerance high enough to invest in unsecured loans to achieve this level of return?

I’ll let you make your own judgment based on your own personal situation but I hope I shed a little light into what you would be getting yourself into. I would make a few comments though:

• don’t invest in any p2p lending because you believe it is the way to stick it to the “man” and start the collapse of the banking system (recent history suggests that it can do that without any of your help). Investing out of spite is not a path to financial independence. Spite investing begets more spite.
• Don’t believe the hype on any investing trend. Do a thorough review of its track record, do your research and test the waters before plunging in. In other words, read the fine print and not the marketing print
• only invest what you are willing to lose in unsecured investing (that includes stocks)

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For more information, the Pro Prosper blogger camp are tagged onto their website.

Here are the anti-Prosper bloggers (for lack of a better term)

My Money Blog doesn’t think the numbers add up

The author of the book Freakonomics wades into the topic of p2p lending (the comments are interesting in and of itself)

Four Pillars on why he doesn’t invest in P2p lending networks.

Good luck. Any one willing to share their experiences on Prosper on any p2p lending network?

Many see the fire sale of Bear Stearns to JPMorgan Chase as the first horsemen of impending financial apocalypse but, more than a week since these events, it may be prudent to look at Bear Stearns and financial stocks in a discerning light and removing the sheer panicked tones that surrounded the reporting of the event.  Lest one stock up on military rations believing our stock market will send us all into ruin, let’s remember a couple of things.

• Bear Stearns couldn’t get out of its problems because it wasn’t a deposit taking bank. I am not going to admit to knowing in precise detail the collapse of Bear Stearns but its fundamental problem wasn’t a lack of money; more precisely, it was they didn’t have any short term money lying around. All their money was tied up in either bad commercial paper or financial commitments which could not be paid back fast enough. Think of Bear Stearns as a trust fund kid who owes a lot of money to the wrong people but the trust isn’t going to give him his trust entitlement until he’s 25- and he’s 23…which means he’s about to have his knee-caps broken. Deposit taking banks can at least rely upon the fact it can use deposits to fend off any short term cash crunches. The investing lesson? As I blogged about before, invest in banks that have good retail operations. Think of banks like Wells Fargo, RBC, Bank of America (not a recommendation; for disclosure, I own RBC). At the very least, they can use our deposits to buy their way out of their stupidity.
• Banks don’t go under. We keep them afloat. Regardless of whether central banks have private interests or non-private interests sitting on the board, the results are the same. At the end of the day, the government will always bail out the banking system and the damage will always contained- something that cannot be said for every industry. Whether it is through nationalization (England and Sweden) or other relief (what the Federal Reserve is doing now), the central banks will use taxpayer money to maintain the integrity of the system. Yes, the risk has shifted from the banks to the taxpayer and, while the banks may have averted disaster, the cost to you and me is most likely government induced inflation and less money to fight deficits or pay for programs (makes you wonder if you might as well buy bank stocks since the central banks are taking money out of your pocket and indirectly putting them into the banks; at least with a dividend from a bank stock, you get some of your money back).
• A lot of babies got thrown out with the bath water. There are banks who have little to no exposure to subprime or ABCP that are collateral damage to the selling of financial stocks in the market (exhibit A: TD which I own). Insurance companies and mutual fund companies, with little to no exposure to subprime or ABCP, have been swept up in the selling of bank stocks. Remember not to paint the entire industry with the same subprime brush when looking in the bargain bin. Look for stocks with little subprime exposure that have a history of timely and full disclosure to shareholders.
• Its not over…this is a multi-trillion dollar problem and billions are being thrown at it (an analyst wrote earlier this week that subprime may take 2.5 years to completely unwind itself). Plus… the banks got off too easy. The Federal Reserve bailed them out relatively quickly so I am not sure if they learned their lesson. They may go back and think of some new exotic financial instrument to shoot themselves in the foot (never under-estimate smart people to be too cute by half). As I said above, look for banks that adhere to the KISS principal in order to ensure some safety cushion.
• Nature abhors a vacuum. One of the more interesting phenomenons occurring is that non-financial stocks are raising their dividends to attract money that once went to the financial stocks (look at General Mills, Encana, Rogers and Harley Davidson(!) raising dividends in higher than historical fashion as examples). The good thing about the financial melt-down is that other companies are rushing into the breach as alternatives for investors to put their money.

If you believe that now is the time to buy financial stocks (and I am not going to predict whether it is or not- just remember even an “expert” like Jim Cramer has put his foot in his mouth recently over financial stocks), look for fundamentally sound companies- good cash flow, good deposit taking institutions, management committed to full and timely disclosure, lots of revenue streams (retail banking, credit cards, M&A, wealth management) and the dividend payout ratio is relatively low (under 40% ideally)- to let you sleep at night. For specific stocks, some other bloggers have looked at:

• Citigroup by See Me Get Rich
• BMO by the Money Gardener
  
• Bank of America by the Dividend Guy
• A collection of research at Canadian Banks and Insurance

I am going to fully admit my bias up-front: I do not consider residential real estate a good investment. The costs of residential home ownership or upkeep of residential real estate investments are too great relative to other forms of investments (commercial real estate or residential on scale are different ballgame since the rules are different). Real estate should be considered shelter and no more. However, when real estate prices eventually find their true valuation, what type of return can only expect from real estate?

It depends on who you asked (to be as impartial as possible, despite my bias, I tried to find the high and low end)

• Fidelity Research Institute (funded by the mutual fund giant) found from 1963 to 2006 the average appreciation in real estate was 5.9% with great regional variances. Keep in mind who funded the research but a great piece on how we have moved from viewing our homes as a an asset of last resort to leveraging the door knobs off.
• The S&P/Case-Shiller Home Price Index found the that the value of residential real estate grew by 9.31% in the U.S. from the period of 1998-2007 (the survey period excludes the real estate crashes of the 80’s and 90’s). The study excludes new housing and any pricing out of the ordinary in a region (i.e. someone massively overbidding or a fire sale relative to other prices).
• Jack Francis and Roger Ibbotson published an academic paper called “Empirical Risk-Return Analysis of Real Estate Investments in the U.S., 1972-1999” updated in 2004. The researchers found real estate values grew at 8.6% annually during this period (sorry, I couldn’t find the paper, I am relying on Money.com as a source).
• The University of British Columbia Sauder School of Business summarizes nominal and real growth rate (growth after inflation) for real estate in selected Canadian cities from the period of 1985-2003. Real return growth rates varied from 1.65% to 3.89% implying real estate growth at mid to high single digits factoring in inflation.

With the exception of the last study, all the real estate growth/appreciation rates do not factor in inflation. However, assuming inflation runs at 2-5% annually, real estate returns historically are inflation protectors with a few percentage points of gain built in. All the studies find that real estate tends to return between 5%-9% but, once you subtract inflation from the return, real estate has t-bill like returns (on a pre-tax basis).

The perception that real estate is a good investment appears to derive from the fact inflation is not stripped out of the return and prices keep going up because of inflation and not necessarily a great return.

By comparison, Jeremy Siegel, in his book Stocks for the Long Run, found that the historical nominal rate of return on stock was 11.2% from the period of 1946-2006. After inflation, the return is 6.9%. All the studies cited above (with the exception of the Shiller index) show that stock had greater returns than real estate over the period studied (and the Shiller index finds REITS, which are stock, to be more profitable than real estate).

Having said that, I don’t believe the real estate market has collapsed completely (remember that the media reports on exceptions rather than the rule and ignores the 90% silent majority). Certain areas will maintain their value and certain types of housing will always be desirable. This chart is often used to discredit real estate investing altogether- careful how it is applied since it lacks any context (although I agree with Millionaire Mommy Next Door’s argument that, in some circumstances, it is better to rent than own). Real estate has its place; just don’t expect it to return double-digits over the long term. Four Pillars blogs about whether real estate investing is profitable from a slight different angle at Twice Paid.

Thoughts?

There’s an old saying in the law: “the big print giveth, the small print taketh” and no where is this truer than when buying insurance. Buying insurance is like buying a car now: the base model is attractively priced but you really need to buy quite a number of upgrades to really make it work for you. In insurance lingo, an upgrade is called a rider. Keep this in mind when you obtain an insurance quote- the initial price may not get you what you need.

Last week, someone showed me a quote for critical illness and disability insurance and I was shocked but how little you get in a base policy; the insurance is cheap but how much are you really getting without the appropriate riders? Insurance is more about what you are not getting then getting now a days. If in doubt, ask for an insurance quote with all the bells and whistles on it and get your broker to sit down and explain everything to you. Remember that in some cases, you cannot add riders to your insurance policy after it is issued.

Given the amount of fear and paranoia on the street now, I suspect insurance will be aggressively pitched by the industry to provide piece of mind but do your research carefully before you buy since you are worse off paying for a bad policy than having no policy at all. The issue is that insurance quotes are so full of lingo and finance terms, it really makes your head spin something (when I looked at the quote last week, I scratched my head a lot and had to look up a lot of things). Thus, here’s a quick and dirty on critical illness and disability insurance, the problems with base policies and the common riders to consider.

CRITICAL ILLNESS INSURANCE (“CI”)

WHY DO YOU NEED IT? If you contract a critical illness (see below for what this means), the insurance company will give you a lump sum of money to pay for medical costs/loss of income/expense coverage (usually either $100K, $250K, $500K, $750K etc depending on the amount of coverage you buy). The amount of money given to you will obviously depend on the amount of your policy premium. Payment is usually made within a set period of time after you are diagnosed with a critical illness. CI can be thought of as emergency health care insurance.

WHO IDEALLY NEEDS IT? Those not on health care plans (whether individual or group plans) or the health care plan is quite limited (it does not provide a lot of coverage if you are on medical leave, the coverage is quite short in time, the coverage is quite low monetarily etc.) and those without the support network (monetary or otherwise) to protect themselves in the event of prolonged illness (i.e. those without family to help them through an illness etc.)

WHAT ARE YOU COVERED FOR IN A TYPICAL BASE POLICY? Increasingly, little. Base CI policies cover the following critical illness: heart attack, life-threatening cancer (emphasis on life-threatening. Thus, it does not cover “minor” cancers) and stroke and…that’s it. The list use to be a lot more but the cost of insuring an aging population is resulting in decreasing insurance coverage. If you contract any of these three illness, the insurance policy will pay you a certain lump sum amount upon satisfactory proof until you turn 65 (typically). The insurance company does not care what you do with the money; if you, and let’s hope this all happens to us, have a fast recovery then you can pocket whatever money they gave you after you pay for medical expenses, replacement income, fixed costs etc.

In other words, in most basic policies I have seen, your CI will cover you for little.

WHAT RIDERS MAY BE APPROPRIATE?

• Enhanced Cover: You can add other critical illnesses to coverage such as blindness, coma, MS, Parkinson’s and loss of limp. The suitability of this rider depends on your family history, the environment you live in (are you exposed to a lot of chemicals and toxins?) and your age.
• Return of premium: This comes in various options now: (i) a return of part or your full premium at designated time (5 years, 10 years etc.). A full return of premium means you cancel the policy; (ii) a return of your full premium at the expiry of the insurance policy (typically 65 years old unless you buy another rider to increase coverage); or (iii) return of premium upon death.
• Fixed/Guaranteed premium: You pay the same amount to the policy even if the costs of insuring you are increasing. Typically, the policy is more in the beginning but evens out over the years as inflation catches up.

The biggest weakness of a base CI policy is that you become ill for illnesses other than for heart attack, life-threatening cancer or stroke, you are healthy for the life of the policy (strange to describe this as a weakness) and your premium is never returned (although it is not typically indexed to inflation) or the industry is just poor at risk management and the premiums go up without corresponding additional value. Thus, concentrate on riders that address these concerns or you could be sending your money unwisely.

DISABILITY INSURANCE (“DI”)

WHY DO YOU NEED IT? DI is an insurance against income loss. If you become “disabled” (as defined by the policy but generally meaning you are not able to work and generate income; there are exceptions if the disability is caused by mental breakdown or substance abuse), the policy will pay you a set amount of money monthly (as a replacement to your pay cheque at the time you obtained the policy and NOT when you become disabled) for a period of time as stated on the policy. Most policies are sold as payment until 65 although you can pay less and get less coverage. Coverage stops when you resume working. DI is income replacement insurance.

WHO IDEALLY NEEDS IT? Sole bread winners in families. People who have little to no workers compensation insurance/government provides poor disability benefits/employers have poor disability coverage. Those, for whatever reason, are highly leveraged in their lives (whether through bad financial planning or by circumstances- most entrepreneurs have be highly leveraged to capitalize their business) and would not have sufficient cash around to pay for fixed costs.

WHAT ARE YOU COVERED FOR IN A TYPICAL BASE POLICY? Payment of set payments monthly (determined by your monthly income when you obtained the policy) after the “elimination period” (which is the time between disability and when the cheques comes) until the coverage expires.

WHAT RIDERS MAY BE APPROPRIATE?

• Future Increase Option: A DI policy typically will pay you a set amount of money based on your current income when you obtain the policy. For example, if your take-home monthly salary is $3500/month when you obtain a DI policy, you will not be entitled to more than this amount, even if you are making more later, unless you buy this rider. If you are young, your income is increasing or you are making little, the initial coverage may not be adequate if you become disabled down the road. This rider allows you to up the payments payable to you (with an appropriate increase in premiums of course). Ideally for those who are younger and who’s potential income will increase substantially over time.
• Cost of Living Adjustment: the amount paid to you is indexed to inflation. More ideal for younger policy holders since the effects of inflation are greater than their older counter-parts.
• Non-Cancellable and Guaranteed Renewable: Basically, the insurance company has to pay you the agreed upon rate of coverage even if your income goes down or you change jobs. Ideal for those who may want to “down shift” in their careers/become part-timers/go free-lance.

The biggest weakness of a base DI policy is that it is not indexed to inflation or your income and life-style are significantly better after you obtain the policy. In such a case, if the policy has to kick in, the amount of money received is less than what is required when you first obtained the policy. Thus, if you are young or have large income earning potential, focus on riders that will match your earning power over the years and mitigate against the effects of inflation. Otherwise, you could pay a lot for little protection.

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Insurance is a very complicated financial product. Thus, educate yourself accordingly; just don’t take the first thing given to you or the cheapest insurance quote since the policy could not provide to you adequate coverage. If you have to squeeze the most for limited dollars, keep in mind the limitations of base CI and DI polices and buy the riders that cover up the biggest holes in the policy in the context of your life. Good luck.

…if I wrote “priceless” who would be madder, Visa or Mastercard? (I am in my hotel room on business travel mucking about so I though I would add a bonus post this week.) The final price for the Visa IPO is $44/share which is $2 more than the initial maximum share price. Public trading starts today. Following up on my initial post last week on the Visa IPO, this would push the p/e to close to 30. This is an extremely high valuation (can you think of any mature company this size growing 30% a year?).

Who is one of the lead underwriters in the VISA IPO? JPMorgan Chase. Who is the largest bank shareholder of Visa? JPMorgan Chase (who pocketed a reported $1.25 billion). Who has the biggest slice of the underwriters’ estimated $500 million pie? JPMorgan Chase. Who just paid hundreds of millions to bail out then buy Bear Stearns (albeit with very cheap money from the government and at 1/15 the market value)? JPMorgan Chase. Hmmm…..someone needed to increase the pricing of Visa shares to pay for some recent expenses.

I read into this pricing jeux casino gratuibonus de casino en lignejeux de planche a roulettejeu gratuitesvideo poker en lignecasino jeucasino achat en lignefree crapsjeu baccarat en ligne gratuitesjeu de hasardloterie en lignejouer stud pokerle meilleur poker en ligneseven card studjeu poker gratuijeux frle poker téléchargement gratuitesapprendre texas holdemtélécharger le jeu de poker gratuitesregles poker ouvertjeu poker macstrip poker virtuelapprendre a jouer au pokerla règle du jeu de pokerregles du poker texasjeu poker internetcomment jouer au pokerjeu de poker gratuitstournoi de poker gratuitespoker en ligne gratuites texastelecharger poker texastournoi poker gratuitespoker a telechargergagner poker onlineworld poker tournamentsites poker en lignejeu flash gratuitesplay 7 card studpoker texas holdem en lignejeu video pokerpoker en ligne gratuitesjouer poker tour gratuitespoker holdemregles du jeu du pokerjeu poker freewarejeux tour de pokermalette de jeu de pokerjouer poker en ligne gratuitespoker tour reglesjeu online poker tour that the IPO market will be flat to non-existent this year and Wall Street grabbed with both hands with the only sure-thing IPO this year (not to mention that a lot of brokers could be laid off after public trading commences today- the VISA IPO could be the last kick at the can for a lot of traders, not that I am shedding any tears). Probably another reason to avoid the hysteria today.

I wanted to end my post today with a mea culpa. You may have noticed I inadvertently posted both guest posts on the same day. I seemed to have lost the ability to count this weekend when I was posted both contributions with the same time-stamp and didn’t catch it while traveling. Apologizes to both Expat and Mom2KG; both excellent pieces should have been posted separately for the readers to enjoy. I hope to get them both to post again in the near future.

Mom2KG is our monthly columnist on TMW. Starting in 2008, her family has resolved to get a control of their financial house and every month she updates us on their progress. February’s report can be found here.  Today, Mom2KG muses about the cost of taking care of two young children. Take it away Mom2KG.

I’m astonished by how quickly I have gone from being wilfully blind to my family’s finances to being addicted to anything having to do with money management. And it took relatively little in the way of general reading to start to understand financial language.

The RRSP deadline has gone by. I put my money into a cash-holding RRSP from which I can make trades into something more exciting than mutual funds. I am putting about 40% into 5-year compounding GIC’s. It was going to be more but with the markets going down I’m looking for good stock buys (see-addicted!). I bought TD shares as well as Fortis, a great Canadian company regularly recommended and have enrolled in their DRIP programs (rumors persist Fortis will replace BCE on the TSX 60 when (if?) BCE goes private- TMW).

We’re following through on our savings commitments, so our bank accounts are getting nice and fat. We’re renovating the kitchen in the summer (and starting our budgeting and planning now), and once that’s done we’ll make a big mortgage prepayment. We intend to pay off the mortgage at the end of the term we just renewed, which makes things a bit tight. But we’re so excited the investment opportunities we’ll have when that income is freed up!

Just saw the news about the $5000 deduction for RESP contributions – we’re all for it! I hope that bill goes through.

I thought I’d write a little on the cost of babies and toddlers – also a good exercise for me to determine how much the little ones are draining from our coffers. We have two toddlers.

Maxing out RESP contributions: $208/month/kid=$416/month

Diapers: 4 diapers/day for toddlers (8-10/day for young babies). A giant pack of 144 Huggies is about $40. So we spend about $60-70/month.

Formula: Buy the no-name brands – great value. A President’s Choice ($12.00) tin will last a fully-formula fed baby 2 weeks, much longer than Nestle ($19.00). (Our kids just drink milk now, but formula was a huge expense during their first year.)

Milk: 4 litres (non-organic) is about $5.50. That lasts the family about five days.

Food: Hard to say. We are spending a little more, but buying much more, and less of the really expensive stuff you feel entitled to when you’re single (premium ice cream, exotic cheese). Groceries for us (family of 2 adults, two toddlers and one live-in nanny) is about $1000/month. This includes the milk, baby-centric toiletries and Disney-branded band-aids.

Live-in Nanny: $1700/month, plus a bonus last year of $600, plus occasional perks like buying her dinner if she babysits during the week – let’s say $200

Nursery school (one kid): Half day, three times a week – $290/month (and you pay even if you take your kid out for vacation)

Babysitting: We pay about $8/hour and feel cheap. A night of babysitting is about $50-65, about once a month.

Clothes: People will give toddlers boatloads of clothes for birthdays and holidays. Plus ours are the first grandkids in each side, so we’re spoiled. On the other hand, we’re the first in our group of friends to have kids, and our siblings have not procreated, so we’re the hander-outers of barely-worn clothes, and not the recipients. I shop cheap, at Joe Fresh and second hand stores, and I would say I keep the clothing expenditures to less than $500/year.

Toys: Ditto on the gifts from other people. We have spent about $700 for birthdays and holidays. Also figure in toys and clothes we give to other peoples’ kids, which I intuit we would not be doing if we didn’t have kids ourselves.

Cribs: We bought the first one brand new, nice and shiny and sterile for our little treasure, plus a change table and dresser – $1000. We bought the second one off Craigslist, no extra furniture, for $20 (the younger child gets screwed again- TWW). Crib mattresses were a total of $200. Plus bedding (for two cribs), and I went a little nuts at Pottery Barn late in my first pregnancy – $500. (I should add we had our kids really close together, necessitating two cribs – better planners would space out the kids more.) We were given a used toddler bed and mattress by a friend.

Gear: Premium stroller (not the Bugaboo Frog I coveted for $1000) plus carseat and base, on sale, $600. Two convertible carseats, $415 in total.

Entertainment: Family memberships to the Toronto Zoo and the Ontario Science Centre, $200 (well worth it). Birthday parties: about $500/year for our own kids.

Some of these expenses are ongoing, others are one-time only or annual. Most will only increase, such as the nanny and nursery school costs, and clothing costs. Eventually, we’ll have no more need for diapers, but I can’t see much to delete from the list. Notably, some things are impossible to quantify, such as how much extra we’re paying in water, electricity and gas because of the kids and the live-in nanny, and I have not even included an estimate. I was also exceptionally lucky to have had a total of four huge baby showers and received over $1200 worth of clothes, blankets, gear, books, and necessities for the babies.

It’s a lot, and makes cost control a challenge. I know TMW is not a political column, but thank god for socialized healthcare and workplace drug plans. My little dude has an ear infection, and it will cost me $3.15 in drugs, after the underwriting by the drug plan and whatever subsidy the government provides.

While I am on business travel, Expat, a regular reader of TMW, has agreed to guest-post on personal finance issues in Japan. As his pen name implies, Expat is a North American now making Japan home. As the post indicates, personal finance issues are the same the world around; it is only the names and institutions involved that are different. Thanks again for the guest post Expat!

Mari Sato has nodded off on the train again. It’s been happening a lot lately, the result of sleepless nights worrying about a money crisis. Like most Japanese wives, Mrs. Sato is the family’s money manager, therefore it’s up to her to resolve this financial problem. So she lies awake at nights trying to figure out how.

To put it bluntly, Mrs. Sato needs cash — a lot of it, and soon. Her daughter, Sumiko, will likely be admitted into a prestigious university. That would ensure a good career with an excellent salary. But the Satos will have to pay an annual tuition fee of $8,500.

Then there’s Mrs. Sato’s son, Hideshi. He isn’t as good a student as his sister, but because he’s the son, the Satos desperately want him to pass the admission exam of a top university. That means Hideshi must attend a supplementary“cram” school after regular school to help him pass the challenging university entrance examinations. The fee will come to $600 per month, or $200 per subject. By the end of a year, Mrs Sato will have paid the cram school more than $7,200.

To complicate matters, there will be one year in which both children will be in university at the same time, so the Satos will be paying out more than $16,000 in that year alone. Altogether, the cost of the children’s university tuition, not including the cram school fees, will be $68,000. And the $68,000 dollar question is: Where is Mrs. Sato going to get all that money ?

Taking inventory

Mari Sato’s husband has a secure job as a middle manager with a large firm that pays $95,000 a year. He’s earning $20,000 more than the average wage earner for a family of four. Nevertheless in Tokyo, one of the world’s most expensive cities, Mr. Sato’s wages don’t go far.

Mrs. Sato’s salary is a help. She works 20 hours a week in an office, and receives $9,000 a year for typing and making tea for visitors. If she earns much more, the family will lose some considerable tax breaks and pay higher health premiums.

Accommodations costs are high and have put the family heavily into debt. The Sato’s bought their apartment for about $800,000. It has three rooms, a kitchen, toilet room, and bathroom. Total space is 650 square feet. There is no central heating. Insulation is poor. The mortgage is 3.8%, locked in for ten years, and the Satos pay it off in
monthly installments of $1,750. That’s about what they would pay in rent. But as a renter, Mrs. Sato would have to pay the rental agent a fee worth one-month’s rent, and the same amount to the landlord as a “thank you” gift every two years when the lease is renewed. Mrs. Sato would also have to pay one month’s rent upfront, and two month’s rent for the damage deposit. That’s $8,750 in payments before the family moves in. Finally, the Satos would need a sponsor — someone to pay the rent if the Satos skipped out.

Health care

As Mari Sato ponders the looming financial crunch, she thinks the family’s health care payments are steep, but better than paying all the medical bills herself. Based on the Sato’s income, annual fees for the government-run healthcare system are $7,200, but Mr. Sato’s employer pays half. The healthcare plan pays 70% of all bills from doctors, pharmacists and dentists, while the family pays the rest. Mrs. Sato shudders when she thinks of the news stories about disastrous malpractice and incompetence in Japan, including ambulance patients dying when emergency wards refuse admittance because they’re full. However, Mrs. Sato is satisfied with the family doctor, and relieved that when her husband had those headaches last year, he was CAT-scanned and treated by a specialist 24 hours after his initial visit to the GP.

Bargain shopping

In the morning, Mrs. Sato cycles to the supermarket. There are several in each neighbourhood, catering to different budgets. She prefers the Peacock chain which has good quality food for moderate prices. For example, a 140-gram Australian steak costs $4.00. Japanese steak, which is much more marbled, costs 30% more. 10 large eggs sell for
$2.30; and a liter of Tropicana orange juice costs $3.00

There are also good savings at a nearby Isetan store, and when Mrs. Sato gets the chance, she cycles the extra mile to be there at 7pm when the price of prepared food is cut. Items like cooked chicken thighs, fried squid, and sushi rolls are marked down by 30%, and even 60% near closing time. Like her friends, Mrs. Sato keeps costs low by buying
only what she needs, when she needs it, although it means she is in the supermarket almost every day.

Investments – taking stock

Today she decides to stop for a coffee to boost her flagging energy. She slips into one of the two Starbucks in her populous neighbourhood, and pays $3.20 for a small cafe latte. As she sips it, Mrs. Sato’s mind is on her financial problem. Even though she, like so many Japanese, has been fastidiously salting away money for years, banks pay only microscopic interest rates to fight deflation. Right now, in fact, her institution is paying .0025%. Mrs. Sato, a conservative woman, is wary of private banks after several failed in the 1990’s. As a result, she had felt the family savings were more secure in an
account at the banking arm of the government-run Post Office. After all, Japan Post is probably the world’s most reliable. As well, many Japanese felt the government had the resources to protect their savings. But wouldn’t you know it ? Recently, the government privatized the Post Office, so Mrs. Sato’s life savings are in private hands again.

The closest thing Japan has to an RESP is GPS — grandparents’ savings. But in Mrs. Sato’s case, there’s a hitch. Both Mari Sato’s parents have passed away. As for her husband’s parents, Mrs Sato figures that if they are living on the national average income for retired people, they’re only receiving 29,000 dollars. Obviously they depend on their savings. At least her father-in-law is receiving the state pension, thinks Mrs Sato. With the government losing 50 million pension files, some retirees cannot legally link their name to contributions from a lifetime of work.

Nikkei nosedive

Why hadn’t Mrs Sato invested in the stock market all these years ? Likemost Japanese, she sees investing as a big gamble, one she’s sure to lose. She remembers all to well Japan’s Nikkei average soaring to almost 40,000 during the Bubble Years, then tumbling to 8,000 a few years later. To make things worse, the housing bubble burst at the
same time.

She also understands the mentality of Japanese corporations which have little concern for the interests of ordinary shareholders. Corporations form clans and support each other by cross-share holding.

The government isn’t too encouraging either. A cabinet minister has just said that Japanese companies should have the right to choose their shareholders. Although he was reacting to foreign investors buying up cheap shares and increasing foreign ownership, Mrs. Sato thinks it reinforces poor attitudes toward all shareholders.

The Sandman

After weeks of deliberation, Mrs. Sato makes a decision. When she reluctantly approaches her parents-in-law about their grandchildren’s’ future they agree to help without hesitation. Not only is it a duty, they really do want the best for their grandchildren. The elder Satos will draw upon their savings. The children will get the education they need, and Mari Sato will finally get a good night’s sleep.

This post is a prelude to next week’s post about Prosper and personal and small business loans loans via peer to peer lending networks (to give you a preview, I am looking at the loan documents provided by Prosper and translating them into plain English). However, with certain regions of North America in a full-out recession, it is topical to address the best way to obtain a personal or business loans from traditional and non-traditional lenders. There are two contradictory trends occurring if you are looking for a loan- money is getting cheap with interest rates going down but lenders are becoming increasingly stringent in who they lend to (“there is more good money than good deals” as the bankers like the say; typically a sign we are at the end of a economic cycle). Thus, attempting to obtain a personal or small business loan is increasingly become an art and lenders are not handing out (stupid) money like it was 2004 all over again.

Having represented lenders in a past-life, sat on loan review committee and lent money in business, here are a few tips to increase your chances of obtaining a loan:

COME PREPARED

Run your own credit score first and clean up anything that can be cleaned up. Obtain letters of reference from other people you have borrowed money from, employers, banking reference (you usually have to pay for this letter) etc. Find your tax returns from the last three years. Compile all the data to complete a net worth statement.

In other words, have your documents ready. Even p2p lending groups like Prosper, which require minimal paperwork, still requires you to dig up some documentation about yourself (like your social insurance number).

Never, EVER, say you need money NOW

To a lender, the phrase “I need money now” sends warning flags up. Why are you in such a rush to get money? Is another creditor after you? Are you behind on other types of payments? Are you desperate? Desperate people do desperate things including lie on their loan application. The practical consideration is that lenders need to conduct due diligence before they make a loan. This takes time (the amount of due diligence a lender has to conduct is the same for a $10,000 loan as it is for a $200,000 loan- this is why lenders tend to shy away from smaller loans).

Plan ahead. If you need money 30-45 days from now, start applying for loans now. Most lenders, even the non-traditional ones, need at least 2-4 weeks to look at your application, interview you, arrange to transfer money to you etc. (I am not talking about payday loans).

WHAT’S IN IT FOR THE LENDER?

What is the difference between investing in equity (stocks) and debt (lending people money)? In equity, you are foregoing certainty on a return on investment for upside potential (save for dividend payments). In debt, the lender seeks certainty of payment in exchange for foregoing upside potential (I am not including convertible debt instruments). Most borrowers fail to appreciate this difference and this difference sometimes costs them a loan.

A lender is not particularly concerned that you could take a $5,000 small business loan and make $200,000 with it. The lender’s primary concern is that they get the $5,000 back at maturity and the interest payments are paid on time. When applying for a loan tell the lender how it will be paid back. Most borrowers spend all their time telling the lender how it is going to spend the loan proceeds. (this raises the question of what’s in it for the lender for borrowers on Prosper who need money to go on vacation- um…). The story you tell cannot be all about you- address what’s in it for the lender.

I will give you an example. I once heard of a private individual who lent money to people to buy cars no matter how bad their credit score was. All the borrower had to do was show the lender that they needed the car to work- either as a traveling salesmen or the job was not accessible by public transit and prove that this job paid enough to pay back the loan after all other expenses (i.e. show a pay-stub, get a letter from the employer etc). The theory behind this loan criteria was that the lender (who I never met) believed someone would bounce a rent cheque before their car loan since the car was absolutely essential as a means of producing income. The lender made the borrower show what’s in it for the lender since they had to prove that the loan was being used to generate income which would increase the chances he got paid.

DELIVER THE BAD NEWS TO THE LENDERS FIRST

There is an old saying in politics- be the first to deliver the bad news. The same rule applies to applying for a loan. If you have a skeleton in the closet (bad credit score, taxes outstanding, behind on support payments), reveal it during the application and provide a plausible and reasonable story on why this is not an issue (I was young and didn’t used my credit card improperly but that was 5 years ago, I have a payment plan set up with the tax authorities etc. etc.). If the lenders have to find this out during their due diligence period, it slows down the application process and a borrower has a better chance of crafting a story around the bad news and mitigating its impact then the lender finding out this surprise and jumping to its own conclusions.

WHAT HAPPENS IF YOU DON’T GET THIS LOAN?

This is a typical question that a lender will ask a borrower. The wrong answer is “its this loan or bust!” In a small business context, the lender is trying to ascertain whether you will put your own money into the business and share in the risk. In the personal finance context, the lender is looking for the same thing- will you come up with more of your own money to buy the house/car/boat etc.; the more money you have in (or the more lenders you find), the less the risk for the lender (and, hence, the entire problem with subprime- the borrowers had no risk having put no money down…).

HAVE YOU SHARED THIS RISK WITH THE LENDER?

To dovetail on my last point, the worse type of borrower is the one who is proposing that the lender put up all the money (and financial risk) and the borrower puts in nothing. Let me put it this way: you go to Vegas and the house gives you $10,000 free as opposed to you putting in $5,000 and the house giving you $5,000. You have one hour to gamble and, at that point, you have to return the free money whether it is the $10,000 or $5,000. Will your betting pattern be the same with $10,000 free or half of your money at stake?

The reasoning behind the borrower “putting skin in the game” is simple: if you have money in, you have shared in the risk. For entrepreneurs, sweat equity is often discounted as skin in the game so keep that in mind. The more risk you have/the more money you are putting in yourself the greater you will want to pay off the loan and the more likely the lender will look upon you favorable and give you a favorable loan term.

For larger loans or loans obtained to acquire assets, collateral will be required. Collateral is a guarantee (usually an asset) to secure the payment of the loan in the event of default (i.e. I take your car if you default on a payment). This is called a secured loan and is probably a much larger topic onto itself. However, the point is you have to show you have a personal stake if things don’t go well. If there is no personal stake then, well, you get subprime and its assorted messes.

Just one final note: lenders may reject your loan for reasons that have nothing to do with you. They may have reached their loan quota, be low on money (remember that lenders have lenders), have too many of one type of loan etc. Don’t take a rejection personally- perfectly good loan candidates can be passed up. Don’t burn your bridges. A lender may remember your professional conduct the first time you applied and give you the benefit of the doubt the next time you approach them for a loan. Good luck.

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On March 13, 2008, I wrote “….I waiting for the other shoe to drop and have some mid-tier financial institution go under; every bubble seems to have some semi high-profile causality which usually marks the bottom.” On March 14, Bear Stearns required emergency funding and, last night, JP Morgan Chase acquired the firm for $2/share (financed by government money). Wow, that was fast. Unfortunately, we are no where near the bottom. Best not to watch bank stocks on the short term.

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I am on business travel this week so there will be two guest posts this week and no posts on Thursday or Good Friday. I have guest posted at Million Dollar Journey on the Smith Manoeuvre (SM), the Lipson case and audit risks of the SM. Thanks for the opportunity FT. I understand it is running this Wednesday. Hope you enjoy it.