Our regular columnist , Mom2KG, checks in with her monthly column. As per your request, I have (finally) given Mom2KG a well-deserved category of her own. As usual, comments are highly encouraged from readers.

Thanks so, so much to everyone who posted with their thoughts on my July post. As always, there were lots of good suggestions, but the encouragement really helped me.

We have gone to see a new financial advisor, recommended by our tax guy. He was certainly nice, but he didn’t wow us with anything exciting. And he’s leery of real estate investing (as was a poster from July), something we’re interested in, so he may not be the guy for us. (Caveat – yeah, I know I’ve mentioned this ad nauseam and never seem to get anything done about it. It’s been a busy summer, okay?) But he’s going to draft a plan for our review. He sang the same old song of long-term conservative investing being the best bet. Ho hum. (Not to mention, my husband has had his RRSPs in super-low-risk mutual funds for fifteen years, and his portfolio is worth only slightly more now than at inception. We only have so many 15-year increments in our investing careers, and can’t afford another one like that. How long is long-term?) Are we expecting too much? Should all investments be self-directed? We are actually moving that way, and will soon consider ditching all mutual funds.

Very interesting comments on what people out there count as savings. I am all for counting RRSPs, RESPs (there was some dissent on that) and the extra mortgage payments as savings – it’s all part of net worth, right? Seems straightforward to me. Tell me how to convince my husband. He refuses to count anything other than cold hard cash sitting safely in a high-interest bank account as savings. I went online and did a comprehensive net worth statement, and showed it to him – he made a pfffft sound which I interpreted as “I am entirely dismissing your attempt to argue a financial point other than my own. Your so-called net worth statement is nothing to me, woman.”

I suppose this is why TMW asked me to blog on this as a family matter – how do two people, both well read and reasonably informed, working towards the same goals, sort out issues like this? This is, I will say, exceptionally frustrating. I was, as I noted last month, disappointed not to have met our savings goals (as in cold hard cash), but as many readers pointed out, we’re doing quite well with other forms of money management and allocation. My husband cannot seem to accept this, grieving anew each month. (I am, of course, utterly blameless in our financial sins- statement made with tongue firmly planted in cheek.)

TWM asked what our goals are. My husband has an idea about retiring at 55 and sitting on a beach. Won’t that be great…for six weeks? I think of all the things we’ve planned and fought over, that vision is actually the least realistic, but I frankly haven’t put much thought into it. I’m the first to admit, the point is probably having that option, though acting on it is another matter. Goals – life-long and short-term – were mentioned in the July comments, and I will try to set down my own as a financial exercise.

We’re both career-driven, both sets of parents are still working, happily, into their sixties (though they are financially set). You can see – this is a long road to financial happiness, and it’s not the money (or lack of it) standing in our way. There’s a fundamental divide in that it’s not even clear what we’re working towards, in terms of family plans (of course we have some concrete goals).

And there’s perhaps an even greater divide between my husband and I when it comes to attitudes towards money. He thinks I’m the prodigal wife; I think I’m reasonable. I think he’s needlessly frugal; he thinks we’re on the brink of bankruptcy. Is every couple like this? How do we reconcile these two solitudes?

Perhaps it is the time of the year but, lately, I have been thinking about my school days a lot and the time immediately after graduation when things were so new and shiny about working life and every piece of advice given was gobbled up like cotton candy by children at a county fair. It may be a reflection of the fact that my work day is so long- not in length per se but in spirit- and I find myself imparting those great pieces of advice of yesteryear as opposed to getting them. Such is the movement of years one supposes…

I had to replace a suit recently and it got me thinking about one of those new and shiny pieces of advice I got when I first graduated. If you are going to work in an office environment, the first three suits you buy are in order: (i) a dark one; (ii) a grey one and (iii) a blue one. You are not attending the NBA draft so stay away from the four-button yellow suit, lest they call you Big Bird at work behind your back. The point being don’t wear anything you may see a Hollywood star or athlete wear to a movie opening- that’s probably their 25th suit and they are rich, they don’t care what you think. Stick to the fundamentals and you’ll be solid middle management material kiddo.

This got me to think what would be the personal finance equivalent of the dark suit, grey suit and blue suit: building blocks of wealth building and financial security required before buying all those new exotic products being sold out there. We are attracted to the shiny objects but the dull ones get us further. Here are my picks:

Black Suit = Manage Your Debt. Unless you are a trust fund kid, 99% of us under the age of 50 are probably in debt in one form or another whether it is a mortgage, line of credit, student loan, car loan etc. With credit still so easy to obtain, one of the easier self-inflicted wounds of personal finance is not being able to manage your debt. If the carrying costs of your debt is more than 43% of your gross income, you generally have a small margin of error. Anything over 50% and most experts believe you are in trouble. Thus, manage your debt. Pay down the highest debt to carry first (usually a credit card). Use excess cash to pay down debt. Don’t get too many credit cards.

Grey Suit = Learn to save money. I do consider debt management more important than saving money. Compound interest is a double-edged sword. If you are earning it, you are in a great position. If you are paying it off on a loan with interest compounded (and what isn’t now a days?), it can be a run-away train unless you keep on top of your payments. Once you manage your debt, start saving money. 10% of take-home has been the standard for ages as a good savings benchmark. If your bible of personal finance is the Millionaire Next Door, the book suggests a savings rate of 20% and over will result, over time, in financial independence.

Here’s an interesting question- is there such a thing as too high of a savings rate? Its a topic of a future post but anyone have any thoughts?

Blue Suit = Asset Allocation. Asset allocation is fancy talk for don’t put all your eggs in one basket. I do not remotely pretend to be an expert in this topic other than the fact I peg my asset allocation at 15% cash, 25% fixed income and 60% equity (I am not a big believer in being fully invested so my ideal allocation has a higher than recommended cash position but, truth be told, I am always closer to 10% cash; its more of a mind trick I play on myself to not always buy something by having a higher ideal cash allocation). Everyone has a different ideal allocation based on age, risk tolerance and life situation so consult an expert or search around the blogshere for information. One of the more astute commentators on asset allocation is Canadian Financial DIY. I suggest you read through his articles.

… I am a big advocate of passive income, building wealth through owing businesses, buying the proper insurance etc. but, fundamentally, I believe you can’t do that without managing your debt, saving money and allocating your savings properly.

Anyone have a different order for black suit, grey suit and blue suit of personal finance?

I have created a new category called “negotiations” and added all my previous posts on negotiations into them. I hope you enjoy this once in a while series. Today’s negotiation tip comes courtesy of our friends at Last Minute Training who suggested that one of the cardinal sins of negotiating is to take absolute positions or make definitive pronouncements.

When I was a junior lawyer, I was taught many things about communicating by some great mentors. One of the key fundamentals I was taught was that any statement made or written should not be definitive unless it is an undisputed fact by the other side. Try to put escape routes in your communications and generally make things as broad as possible (the other side’s mission is to make you as “narrow” as possible in your position; hence  trial lawyers are taught to phrase questions that only have yes or no answers). For example, if you read this blog frequently, you will notice I like writing using the words “generally” or “i understand” or “subject to” or “assuming…” Generalities have exceptions. Understandings can change. Subject to means a set of conditions must apply before a statement is true. Assumptions shift.

All of these phrases couch a particular statement to some exception (fundamentally, legal drafting is based on a rule, an exception to the rule and an exception to the exception). Non-lawyers call them “weasel words” for a reason. They allow you to get out of positions since the position itself has a built in escape hatches. It is probably 1 of 9,862 things that drive people crazy about lawyers (and why lawyers marry other lawyers- its fun to win arguments but not so good for personal relationships).

The opposite are the absolute statements: “Daddy is always right,” “This is the best used car ever,” “you can get great returns with no risk,” “this is the cheapest Blue-Ray machine in the city.” They paint you into a corner and if that absolute is proven to be wrong, several things can happen:

1. You look like a fool and your creditability just went down several notches;
2. You immediately become on the defensive about your absolute statement (”…did I say no risk? Well, there’s risk in every investment isn’t there…”) which means you are not negotiating from a position of strength; or
3. You spend an inordinate amount of time trying to prove your absolute statement was right instead of negotiating the real point.

I was once told that there are three absolutes in life: taxes, death and change. Everything else is a varying shade of gray so why be absolute when so little in life is not?

As part of the much-maligned decision of the Canadian government, the income trust industry (except for real estate investment trusts) will be part of the newly phased in income tax regime by 2011 which is specific to the income trust industry. Given that the oil and gas industry has been bought up by everyone, Canadian and non-Canadians alike, this move has global implications given that many income trusts are oil and gas trust. As the title of this post suggest, the results will not be pretty.

The Cole’s Notes version of the taxation of income trusts is as follows: prior to 2007, Canadian income trusts could distribute their profits (or cash since some income trusts were not profitable and basically eating into cash) tax-free to the investors (this is a simplified review so, armchair tax lawyers, please bear with me) this resulted in some alarmingly high yields since income trusts had a huge advantage over dividend-paying corporations by not having had to factor in tax in its distribution policy. For political and economic reasons which is not the subject of this post, the government implemented an income trust tax which taxes income trusts 31.5% tax on all distributions paid to investors by the end of the phase-in period of 2011 (31.5% being the average tax rate which corporations pay in Canada). In other words, an income trust now has less money to distribute since it has to pay 31.5 cents on every dollar to the tax authorities. I can’t speak for the tax implications if you are a non-Canadian purchasing income trust to ride the oil and gas boom so please speak to your advisor.

In anticipation of 2011, income trusts have already started converting back into corporations- some public and others fully privatized which has begun to give us a sample size of income trust distributions post-2011.

One would think, that after conversion, an income trust would simply take a 31.5% reduction on distribution to account for the tax. Right?  Well… the issue is that many businesses who had no business converting into income trusts became trusts anyways lured by the siren song of the greedy investment banker (and remember what happens to sailors who heed the call of mermaids in tales of old). Income trusts are supposed to be structures for mature businesses that were not going to grow that much or all their capital expenditures were substantially completed (think of a landlord who can eat off of long term rental revenue, an oil company extracting oil at a consistent rate year over year from an oil-field or an infrastructure company collecting tolls off a busy highway). But too many businesses that are growing jumped on the bandwagon.

These businesses are, in a sense, using the conversion of trusts back into corporations as a smoke-screen to cover up the fact they should have never been trusts and slashing their distributions dramatically as a result.  The business reasoning is quite legitimately- they are cutting back distributions to grow the business- but the hard question remains why did you do it in the first place? The easy money and greed over-took them and now investors are going to pay on the back-end: first they took our money on the IPO now they are going to slash the distribution converting back to a corporation (which could be used for expansion but a cynic thinks, in this age of willful blindness to corporate malfeasance, that this extra money may end in the board’s pockets some how). The easy blame will be to look at the government but there were also a lot of greedy business people who were the harbingers of this mess

(…its pretty obvious I think the income trust saga is nothing more than another huge debacle that is becoming frightfully more common- people got greedy in a manner that would make Gordon Gecko blush, people got stinkin’ rich peddling generally bad or mediocre products (with some notable expectations) to the investor,  government had to step-in with their usual heavy-handedness after things got out of control, the investor loses again and the people who created the debacle walk away richer and legally blameless with an appropriate scape-goat in the government. Makes you want to go back to a barter economy but I digress….)

How bad are the cuts in distribution? Andrew Willis of the Globe and Mail summarized the following cuts or proposed cuts:

• BFI Income Trust: 73% reduction in distributions annually (proposed)
• Trinidad Drilling : 57% reduction; now paying dividends (converted)
• Transforce Income Fund:75% reduction; now paying dividends (converted)
• Aeroplan: 40% reduction; now paying dividends (converted)

In summary, based on a small sample size, expect a 40% cut in distribution in a best case scenario and 75% in the worse. The general trend being the more acquisitions the income trust undertook during the glory days, the bigger the acquisition (the reasoning being these types of trusts need to save money to service the loans to acquire companies given that the government also barred the issuance of new shares by a trust).

What can you do? You can wait until they announce the conversion and collect the distribution in the meantime or you can convert to other vehicles which distribute cash. As mentioned, real esate investment trusts are generally not subject to the new tax regime and have been suggested by some as a good alternative. Most of all, consult someone about your options. There will be a flood of conversions next year which may cause a panic and a drop in share price so the early worm gets the worm.

The larger lesson? At the end of the day, it always comes back to the Buffet rules. Buy businesses with large economic moats. Buy something easy to understand (if you boil it down, how were people sold income trusts? Its advantage was tax-driven and, in most cases, not a fundamental business edge- in other words, in assessing most trusts, we didn’t buy on the fundamentals; we bought on a tax loop-hole which most of us did not understand). Buy something you know.

As an administrative note, I moved to a new WP template last week- hence, the lack of posts as I sorted out the technical issues. If you have subscribe to this blog on the site, kindly subscribe to the RSS feed since the only subscription option will soon be the RSS feed. Thank you.

In a couple of weeks, parents send their kids back to school which is the happiest or saddest day of the year depending on which side of the care-giver/dependent side of the fence you sit on and how long or short the summer was. For parents sending away their kids to college/university, the advice is the usual series of don’ts: don’t spend all your money, don’t party too much, don’t fall behind in class etc. etc. But how many parents actually tell their kids: “Don’t forget to apply for every bursary possible. Its free money. Apply early, apply often.“

When I went to law school, there was a general bursary fund awarded to students on their second degree� if they could prove need by the second semester of school. “Need” was a bit of a loose term. I remember a class-mate who was quite well-off by student-terms (lived by themselves in a nice apartment in the good part of town, owned a car outright, not on student loans) who applied as a lark and got $1500. FREE MONEY. Now, if your sense of justice cries out that this classmate was abusing the system, I would actually suggest not. No one applied to this bursary so every year the school had excess money sitting around. They had to give the money away. They employed people to administer this program and, as urban myth had it, the employee was bored to tears. No one applied. Thus, it wasn’t like this class-mate was taking money away from more needy applicants.� There was more than enough to go around.

One more story- I once won a $500 scholarship in undergrad. How? I was the only one that applied. In the entire country. Time to complete the application? About an hour. Other Costs? Try a $1.00 to photocopy my transcripts. $500.00 for one hours work is not bad. Hell, most lawyers don’t bill that much per hour.� How did I find out about it? They desperately wanted someone to win and I happened to bump into someone who knew about the scholarship and lack of applicants.

It stupefies me how much free money we leave on the table. I was once asked by a client to research some grants opportunities for them. Starting a tech company in west of Manitoba? The feds have a grant for you.� An entrepreneur in Prince Edward County? The province has a grant for you. Employing employees under 35? The feds will subsidize their wage. Hiring someone on EI? The feds and the province will pay for their first 6 months of salary.� Yet, after speaking to some of these grant officers, NO ONE APPLIES. Entrepreneurs always need more money but they never bother researching grants, subsidies and low-interest loans and approach banks who are anything but small-business friendly.

There’s a ton of other examples: people not applying for child-care tax credits, not applying to your local city for rebates when you purchase energy saving products (City of Toronto gives you $60 if you buy a front-loading washer), not completely maxing out every single tax deduction you are eligible for, not applying for credit cards that give you cash back etc.

Since I don’t have a post tomorrow, I will leave you with this thought for the weekend- what parts of your life are you leaving money on the table? I do not mean being frugal. I mean instances were you could be eligible to receive money but do not do it because you don’t want to apply, you don’t look into it, you don’t think you will win etc.

For those with student loans, MoneyGrubbingLawyer gives some tips on tackling student debt (incidentally, isn’t the term Money Grubbing Lawyer redundant? Haha, sorry had to go there).

Have a great weekend.

Four Pillars has organized a cross blogsphere theme today about wills and estate planning (read his post on his last will and testament). Thus, this is an opportune time to dis-spell some common myths about wills. A will, no matter how straight-forward your life, is not a simple document. The Law Society of Upper Canada (which governs lawyers in Ontario) estimates that a wills and estates lawyer needs to understand over 10 pieces of legislation when drafting a will from tax to family to estates law. In a world of such complexity and regulation, a simple piece of paper which says “give it all to my spouse” just doesn’t cut it.

What makes planning and drafting a will all the more difficult is the number of urban myths surrounding wills. We have all seen television shows and movies where the family is summoned into a lawyer’s office after the death of a family elder and, with pregnant pause, the lawyer announces Daddy screwed Mommy and the kids of their inheritance and gave it all to the maid or kids have to bury Mommy standing up in New Zealand facing east on the 3rd Tuesday of November. Many of these dramatic scenarios are just that- scenarios that make for good television.

The following are some common myths are wills. A few more caveats and disclaimers than usual apply. First, laws on estates and wills differ widely from jurisdiction to jurisdiction. I only comment on Ontario but also add some general comment applicable to all. Second, terminology in wills vary greatly from jurisdiction to jurisdiction. Wills speak Law not English and Law has a lot of local dialects. American law has a different language than Canadian law which has a different language than Scottish law. So, copying a will of an American when you live in Canada is not going to do you much good. Third, as usually, wills have a wide variety of legal and tax implications to them so please seek qualified legal advice in the jurisdiction you live in on how to best plan your will.

Now that I have lawyered you to death, without further ado, let’s tackle some common myths about wills.

1. “I want my ashes shot to the moon.” Contrary to popular opinion, an executor or trustee or estate executor of an estate (which is the legal term used to describe the sum of a person’s property upon death) does NOT have to follow funeral instructions or directions. An executor/trustee/estate executor’s primary duty is to the orderly administration of the deceased’s estate by winding up the affairs of the deceased and distributing the estate to beneficiaries. If the funeral instructions are so expensive or impractical as to deprive the beneficiaries of their distribution, the executor or trustee can ignore the instructions in the will. In fact, funeral instructions are not legally binding on an executor or trustee. Not to mention the practical issue that wills are read after funerals. Thus, unless funeral instructions were made explicit before one’s death and there is money to pay for it in the estate, funeral instructions are really funeral preferences.
2. “What’s in the house is mine as well right?” Not necessarily. Here is a crash course in the distribution of an estate. First, pay off all debts of the estate (including taxes) and the remainder is what you have left to distribute. Then, the deceased gets to gift specific property to people at their discretion and subject to relevant laws. In legal terms, any gifts which are not real estate is known as a “legacy” and a gift of real estate is known as a “devise.” For historical reasons, real estate (known as real property legally) and personal property (all property that is not real estate- i.e. everything else) are treated differently (if you really want to know why, all lands is ultimately owned by the state as a foundation of its sovereignty whereas you can own absolutely non-property). Thus, the gifting of land, which is treated as one class of property legally, does not necessarily entail the gifting of the contents inside, which is treated as another class of property. You cannot assume what’s in the house goes with the house. In the absence of clear intention, the contents of the home, if it has not been gifted, is considered part of the residue of the estate (everything left over after debt, legacy and devise) and distributed to whomever the beneficiaries of the residue are.
3. “I see my kids every third week and should have custody if my ex passes away…” Better check the law where you live. In Ontario, only those who have custody of a child can appoint a guardian (someone who takes care of your kids) which does not necessarily have to be an ex-spouse or birth parent. A person with access rights to their kids have NO rights to appoint a guardian. Where there is joint custody, there must be agreement on who the guardian is and there may not always be agreement (in which case the Court will have to decide based on the best interest of the child). In other words, do not assume just because you are the other parent with access or joint custody, you will be the guardian of your child upon the death of the primary giver. That power goes with the primary care-giver or parent with custody. As indicated above, this point of law varies jurisdiction to jurisdiction depending on how pro-access parent the jurisdiction is so please seek advice from a lawyer on this point and make sure, if you are going through a separation, this point is clearly negotiated into a settlement.
4. “My wife was a terrible spouse and she gets nada!” In most jurisdictions, there is now legislation which bars no or little distribution of an estate to a spouse, child or persons who were dependents on the deceased. There must be some level of support to dependents after death or those dependents can apply to the Court for support payments out of the proceeds of the estate. In some jurisdictions, your will must allow for a distribution that is at least equal to the amount of support a spouse received as if you got divorced. Children who were supported by the deceased, whether under or over 18, may also have an entitlement to a support claim if the will does not allow for it. In other words, yes it is true. You supported them in life and you shall support them in death. Please seek qualified legal advice to see if this applies where you live.
5. “Janice gets the chalet in Whistler and the winter-home in Palm Springs…” Not so fast. If you have assets in various jurisdictions, you need to have separate wills for the asset in each jurisdiction. Why? Some jurisdictions do not honor the validity of other jurisdictions and deceased in those other jurisdictions can be considered to have died without a will and the distribution of the estate is subject to the law and Courts and not the deceased’s wishes. If you have assets in various jurisdictions, make sure you get a will for each jurisdiction. It may not be a chalet in Whistler but a bank account with a few thousand dollars in India is a lot of money.

As the above shows, a will is not a very simple document. Given my obvious bias as an ex-lawyer, do spend some the time and money to have a proper will drafted by a lawyer no matter how simple you think your affairs are.

Other posts on wills today include:

Common Mistakes in a Will

Why you need a will

Getting your will done through a lawyer

Benefits of a professional executor

Enjoy the series.

“How do you know where you are going, if you don’t know where you have been?”

I am a big fan of measuring performance through numbers. Numbers have no political agenda or emotions. They simply measure a result. In business, if I spend $10,000 on a trade-show, how much business have I got back from that? If its less than $10,000 then perhaps we shouldn’t sign up again next year. But most of us do not take this type of analysis in our personal lives because we don’t have a proper record keeping system. Watch any television show where they do a financial make-over and what’s the first thing the host does? Makes the person organize their financial lives so they know where they are at. You can’t plan the future without figuring out the results of your past and adjusting accordingly.

When I was a little kid, my parents always argued about our “great” dining room filing system (he says with sarcasm). Everyone just threw the mail into piles onto our dining room table (we ate in the kitchen). My Mom always tried to clean it up and my Dad was always saying “don’t touch my stuff!” (I suspect a lot of you are nodding your heads remembering similar discussions at home). Of course, come tax-time, there would always be a mad scramble to find this tax stub or that statement, buried somewhere in piles.

I am known at work as the pile guy- I file in piles at my desk (gee, wonder where that came from?) but I believe I am pretty good at getting myself organized on my personal finance side. I am not a personal organizer but this is what I do:

1. I had my desk built-in with a shelf over it when I first moved into my condo. This is where I put all my current filing. My last year’s records are in the condo for easy access and everything else is in storage.
2. I have two magazine files on my shelf over the desk. I bought them at Ikea for a couple of bucks each. One is labeled “bills” and the other “filing.” As soon as I get the mail, I file into one of the two files- immediately; no mail piles. Everything that doesn’t fall into those two categories, I recycle. Every Sunday I empty out both by either paying the bills or filing.
3. I have separate binders for the following: (i) financial statement (bank statements, transaction records from stock trades, portfolio statements etc.); (ii) mortgage and condo related material (this is where I keep the legal documents from the purchase of the condo and mail from the mortgage company); and (iii) car and home insurance (my original insurance policies, I keep in a safe). These binders are on my shelf over the desk. If I sell a stock, I immediately find the stub where I bought the stock and stapled them together- it makes it easier to calculate capital gains that way (well… if I actually sold things at profit…).
4. I have a separate file folder for receipts where there may be a warranty attached to them (i.e. computer hardware purchase, television etc.) and for credit card statements. This I keep in a drawer.
5. All the tax related correspondence goes into another file folder in a drawer. This helps me keep organized for tax time.

That’s it. I can access data easily, compare against last year (non)performance and don’t have to worry about piles. Plus, its all close to my work area so its contained. This system probably cost me about $25 in binders, file folders etc.

For goals, I have a bulletin board in behind my computer. I write my goals down on a sheet of paper and stick it to the board. I have to stare at my goals every single day. I also put these goals in my binder containing financial statements. Its a reminder of where I need to be every time I file.

If you are reading this blog to get your personal financial life in order then think about literally getting yourself organized first.

Any readers care to share tips on organizing their personal financial lives?

I am back from my one week vacation from the blog. Thanks for your patience. While I was gone, Philip Morris announced that it will purchase all of the shares of Rothmans Inc. at $30.00/share as endorsed by Rothman’s board of directors. On the surface, this sounds great since this is a 16.9% premium to Rothman’s stock price as of July 30 (the last trading day before the offer was announced) and the transaction, subject to shareholder approval, would close at the end of October 30. Thus, the shareholders get their money quick. BUT, Rothmans is suspending the dividend it usually pays in September. Given the dividend is quite substantial (over 5% dividend yield), this is a pretty significant and adverse move for shareholders.

Coming on the heels of BCE electing to suspend its dividend until it privatizes (maybe Bell’s new marketing campaign should incorporate “we are cheapER” as a slogan on top of all its other marketing slogans ending with a word with an “er” on it), this is a troubling new trend for dividend investors. In light of recent reports that it is not anticipated most banks will increase their dividend this year, which is not altogether surprising, we appear on the cusp of some bad news on the dividend front. As smart investors, what troubling signs should dividend and income trust investors look for before its too late?

1. A large spike in dividend payout ratio not attributed to a dividend increase: A dividend payout ratio is the percentage of yearly earnings/profits paid to investors in the form of annual dividends. If a company has earnings of $1 million a year and pays $200,000 of that in dividend, its dividend payout ratio is 20%. In other words, the ratio depends a lot on how much profit a company makes every year. A large spike in the dividend payout ratio would indicate the company is beginning to be less profitable. If the ratio begins to accelerate upward quickly without a dividend increase, the company is in big trouble if you are a dividend investor. A good example is Bombardier several years ago as its profits crashed quickly and the dividend was cut immediately as a cost cutting move. More recently, a lot of banks in the U.S. saw their dividend pay ratio go from the 30-40% to 60-70% very quickly and dividends were predictably slashed.
2. The number of shares is increasing for non-business reasons. This was a favorite trick of the income trust industry during its peak. The formula basically went like this: payout most if not all of your profits in distributions/dividends (in some cases, some income trusts paid more than their profits in distributions and were dipping into their bank account). To keep the machine going, keep issuing new shares not for acquiring the competition or investing in new technology but to keep paying your shareholders. In other words, you are robbing Peter to pay Paul- you are raising money to pay your older shareholders (almost like a Ponzi scheme). Banks in trouble have begun doing this- they are issuing millions of preferred shares to prop up their balance sheet and as a way to keep paying dividends but all they are really doing is loading up on more debt (albeit safer than the junk they bought).
3. Large debt raises. This is probably not as large a factor since most lenders do not have appetites for lending large amounts of money. As I have indicated previously, large amounts of debt begin to impair the ability of a company to pay dividends.
4. The business stops investing or maintaining its machinery/equipment. This is another favorite trick of the income trust industry. Dividends and/or distributions are paid out of free cash flow (defined as cash flow from operations minus capital expenditures). Thus, there is two ways to increase free cash flow: (i) become more profitable; or (ii) stop spending money on capital expenditures by not maintaining machinery and equipment or not replacing machinery or equipment. The best analogy would be a city who holds the line on tax increases by running their 30 year buses one more year. Eventually, this catches up to you- productivity falls, competitors who invest in growth gain more market share, talented employees leave etc. While this move may forestall any short-term dividend halt or decrease, it bodes poorly for long term dividend growth. Most financial reports will list capital expenditures as a reporting line. The other way to find out is look at the free cash flow reporting line on annual reports. If it goes up but cash flow from operations is steady, it may indicate the company is making this number look good by decreasing capital expenditures (in mature business, this is not as large an issue)
5. Business begin to diversify. Other than Wal-Mart, there is no such thing as a category killer business anymore. Businesses make money by dominating a niche or industry (hence, the hue and cry to break up GE). Transcanada is now a model dividend paying stock but it began to diversify several years ago, ended up doing nothing well and slashed the dividend. Bombardier in the early 2000’s built railway cars, airplanes, snowmobiles and engaged in financing. It did none of them well and the company had to slash its dividend as part of the restructuring process which saw non-core assets sold off. Brookfield Asset Management, speculated by some as a next dividend stock, only became market darlings once it began to focus on infrastructure and infrastructure asset management and sold off all of its non-core holdings. Most businesses have one edge to beat the competition. As soon as it takes its eye off of maintaining its edge, history shows it gets into trouble.

The above are early warning signs that a dividend paying stock may be going off the rails. In these times, its best to drill down beyond dividend yield and see what, in fact, the company is going to maintain and, hopefully, boast your dividend payment.