Our regular columnist, Mom2KG, is back for this month’s updates on what’s happening with her family on the finance front. This month she needs your help! Please read on and provide any comments, suggestions or encouragement. Thanks.

Hello readers. This month I have to report on a huge setback that occurred over the last few weeks. You might think I’m referring to the market crisis, but I’m sanguine about that. We said good-bye to that money when we invested it, intending it to be long-term, and knowing we’d have to weather market fluctuations. It’s in nice secure (Canadian) bank stocks, and if historical data can be trusted, we’ll be fine in thirty years when we cash out.

Instead, my husband and I had a setback personally. Lately there have been some…emotions, surrounding money. In the last several weeks, I began feeling like something wasn’t right. I felt like the budget and goals were actually working negatively: there were too many constrictions. The goals were too long-term. What about now? What about if we ever wanted to move to another neighbourhood? What about a manicure?

We have prioritized paying off the mortgage and making major savings. In spite of my feelings, I do not want to change that. But where will the money come from? Perhaps a better question is, what do I want? A manicure is not exactly a budget-buster. Even a new patio set won’t kill us financially. But will those things help?

I think I may just be looking for more flexibility and less guilt related to spending. I do most of the family-related purchasing, which means I’m “at fault” if we blow the budget. Which we do, pretty much every month.

And maybe that’s another point. TMW readers, please, please help me here: I know you don’t meet budgets by increasing them to meet a certain lifestyle. You set a budget and live within it. But we’ve been blowing ours every month for years now, in spite of genuine best efforts. The guilt. The frustration. What do we do? Comments and advice welcomed.

On another front, we are doing a reno of the kitchen. It’s old, not just dated. We debated long and hard about whether to do basic changes (new cabinets, countertop, backsplash and a few new appliances), or really go all out. That would mean tearing down walls, at least very least. But we put off the dream kitchen to be a little more prudent. We bought at IKEA on their big kitchen sale (we were literally the last couple to place an order on the last day of the last extension – we were really waffling!). So far, we are even on budget! We saved up for the kitchen and aren’t putting any on credit. My husband will do the demolition and most of the installation as well. We’ve been planning this for a long time – can’t wait to see how it turns out.

Preet from Where Does All My Money Go and I had so much fun in our initial insider’s conversation about investing that we decided to go head to head again to muse about surviving and investing in bear markets, high-dividend yield stocks and the best exchange traded funds on the market (by the way, to be clear, Preet is not my investment advisor). As usual, neither Preet nor I are offering investment advice. Our conversations are purely informational in purpose and not a recommendation to buy any product mentioned herein. Please conduct your own due diligence. (What a cop out- Preet :P)

We have changed things up this time around: the conversation starts here and continues on Preet’s blog. Hope you enjoy our conversation. My comments in bold; Preet’s in Italics.

UPDATE

Preet, let’s get an update on you. How is the RRSP Book doing and what are you up to next?

The RRSP Book did very well in February. Strangely, sales were slow in the US.

That’s because you had too many “eh?” in the book and spelt too many words with the letter “U”!

But seriously, the sales did drop off after the RRSP deadline as to be expected. I’ve had a two library wholesalers pick up some small bulk orders and it should be available on-line soon through more recognized sites like Amazon and Chapters. Proper distribution set-up is painstakingly slow. In the meantime, people can still only buy it directly from http://www.theRRSPbook.com.

I’m almost done my next book (more of a booklet really) on Charitable Giving in Canada. This one will be free for everyone electronically, and I’ll probably print a small run of physical books with all profits going to cancer research and care. I’ll also be making the e-manuscript available to any charitable organizations that would like to print their own copies and will allow them to customize it.

The blog is going well, we continue to grow at 25-30% per month and I’m finding that a lot of financial advisors are subscribing to the email updates which is pretty cool. It’s also really handy to refer clients to when they have questions on anything we talk about.

Thanks for the update. Let’s get the show on the road shall we?

SURVIVING THE BEAR MARKET

Let’s start with separating the stock market from “real life.” If you read personal finance resources, you would think we are in the middle of a depression. But the U.S. Department of Labor reports the unemployment rate at the end of February 2008 to be 4.8%. [note to readers: this conversation occurred before the March unemployment numbers were released]. An unemployment rate of 4.8% is quite healthy and, setting aside the traditional manufacturing sector, there is actually a shortage of workers in industries like healthcare, construction and engineering. Are we placing too much emphasis on the stock market as an indicator of what is happening in the rest of the world?

To a certain extent I would agree that. When I look around me I see that nothing has really changed in my little world. By that I mean the neighbourhood I live in, the businesses I see on the way in to work and the people at the malls, movie theatres, etc. But of course if you watch TV and read the paper you would think it is time to build a bunker to fortify yourselves for the impending doom and gloom. Not only will everybody be defaulting on their homes, they will be losing their jobs, contracting skin and lung cancer, running out of gas, become sterile, etc. Not only is fear a big motivator – it sells a lot of advertising in its dissemination.

That’s not to say there is no link between the capital markets and the world we live in. I do believe that earnings drive the markets in the long run and that economic cycles of various nations/industries are linked with capital markets. I also believe that over the long term GDPs goes up – and that’s largely due to the ingenuity of people. There’s always something to be improved, technology to harness, and as a future trend: failing infrastructure to repair (not to mention new infrastructure to create). Infrastructure now plays a long term role in my portfolios.

I looked long and hard at infrastructure stocks. In particular Brookfield Asset Management (BAM) and all of the Macquarie products. BAM was once the darling of Jim Cramer and he publicly stated he was wrong (he’s been doing a lot of that lately…) and the Macquarie limited partnership structures had some structural issues to them (priced way high and really benefiting Macquarie more than the investor). Where is the infrastructure play besides just buying materials?

There are two infrastructure ETFs, but they are not pure plays on the space. You can track the S&P Global Infrastructure Index through IGF or Macquarie’s index through GII. I use IGF as it is more diversified. GII is over 80% utilities, whereas IGF is 40% utilities with broader exposure to railroads and highways, oil and gas storage and transportation, marine ports etc. A lot of exposure to industries that may have more government regulated contracts which tends to keep the income, earnings and stock prices buoyant in otherwise dark times is nice for the correlation matrices of the portfolios.

What are you generally telling your clients?

I’m lucky I suppose, as for the last 4 years I’ve kept harping on the fact that returns are above the average we should expect long-term. Less than 10% of my clients have had any questions or concerns about the markets that I hadn’t addressed ahead of time or during a regular meeting. I did make it a point to meet face to face with as many clients as possible during Q1 – these are the times that will make or break your investing success if you make the wrong choices.

But what I always tell people whether they are prospective clients or current clients is that very few people seem to really grasp the relationship between risk and return. We know that markets correct from time to time and that if you just buy and hold you will be fine. According to Peter Lynch and the Fidelity research team, between 1940 and 1992 (a span of 52 years) the S&P500 corrected (had a decline from peak of 10%+) 31 times. That’s around once every 20 months. Get used to it.

But to be more specific, I explain the nature of the sub-prime problem and its origins and possible outcomes. Then we put it into context of past financial crises, and develop a short term game plan that fits with our long term game plan. For example, if they have a large deposit to make we would think twice about blindly deploying it and look more at putting it into something safe that we systematically switch over into the long term investments over time. Some choose to buy on this dip.

As an advisor it’s my job to explain the advantages and disadvantages of each possible strategy, so that the investors make the choices themselves.

Every client has different objectives and risk tolerances, but I have not sold any positions as a result of the sell off for a single person.

Do you believe there is a natural reaction to do something in bad times when, in certain circumstances, the right response would be to sit on our butts and wait this out? I read a lot about shift your assets from this industry to that industry or reallocate your assets from equity into bonds. However, setting aside the disadvantage of increased transaction fees and the tax hit of frequent selling, by the time someone says to shift money from one sector to another the investing trend is basically over or you are getting in at less than good value. For example, my Dad reads Fortune Magazine. One day, he asks me about Potash stocks. I suspect from the time that article was written to publication potash stocks most likely went up quite a bit.

I absolutely believe that the natural reaction of many investors is the worst possible thing you could do (sell during a decline and buy after the market makes back the losses and then some). I know an advisor who actually has clients fill out a simple one page document that only requires one check mark and a signature. It asks them to check if they would either like to A) Buy Low and Sell High or B) Buy High and Sell Low. While most would laugh at it, he gets them to fill it out and keeps it on file. The odd time a client will call during a market decline wanting to sell and he faxes them this sheet and asks them to change their answer and fax back.

I also remember meeting with someone who showed me a multi-decade history of mutual fund transactions. His portfolio was flat over 20 years and all the funds he held had returned between 8% and 12% individually over those 20 years (i.e. if you just sat on your hands the whole time). But since they move in cycles, obviously some holding periods would be negative and some would be above the long term returns. Well, this poor guy had successfully managed to switch between funds based on emotions and past performance data such that he was always a step behind. He basically fell into the trap that most do: invest in a fund because it’s been on a tear (on an absolute basis), experience poor performance for the next year or two as it reverts to the mean and then switch into something that did better during that time. Of course what he switched into then started reverting back to its mean.

Really, everyone should have an Investment Policy Statement (IPS) that their advisor creates with them, or you create yourself if you are a DIY investor. You should address Strategic Asset Allocation, Dynamic Asset Allocation and Tactical Asset Allocation strategies (and know the difference between these and market timing). You’ll never worry about your portfolio ever again (within reason).

Probably the key if you are a DIY investor is to write it out and then post it somewhere you can see it every single day and then co-op your spouse or a friend to remind you of your investing goals every time you get antsy.

The more thought out your IPS, the less likely you are to get antsy.

The U.S. markets are obviously in trouble right now-most likely the recession started late last year and we won’t know it until the summer of this year. Are you a believer in the de-coupling theory that what happens in the U.S. will be largely contained? I am not. Capital moves too quickly cross-borders now a days and too many of these exotic financial instruments had counterparties which spanned across borders. As some of these contracts become unwounded or mature, I believe you could sell the subprime flu give other countries colds?

The “Decoupling Theory” has a nice ring to it, but I haven’t seen enough evidence of decoupling to believe it either. I think you hit the nail right on the head with as to why. But let me ask a question for the readers to ask themselves: When the “new world order” countries like India and China experience double digit growth in GDPs, isn’t it convenient that developed economies are “re-coupled” and stand to participate in that growth in the future?

Not only are developing world countries not decoupled they have their own structural issues; the Chinese and Indian stock markets have suffered more than North American markets this year (the Shanghai exchange is down 34% this year compared to a loss of 7.5% for the S&P 500). In exchanges still in their growth phase, there continues to be a lot of “junk” trading in it; some stocks are junk, financial disclosure can be a bit murky at best and regulators don’t want to crack down for fear of killing the golden egg (hmmm… sounds like the Vancouver Stock Exchange in its hey day…). These are additional risk factors no one wants to talk about.

This gets back to my earlier point that people really don’t understand the true nature of risk and return. Additionally, the volatile emerging capital markets are in their infancy compared to developed nations – and they will go through some of the same mistakes and headaches that we’ve been through over time with respect to regulatory matters, overheating, etc.

HIGH DIVIDEND YIELD STOCKS

Many bank stocks have historically high dividend yields. I believe BMO’s dividend yield went above 7% for a short period of time. When is a high dividend yield stock a value trap?

First we’ll define a “Value Trap” for those unfamiliar with the term. It’s quite simply a stock that has declined in price enough that it may now appear to be a good value stock that is just temporarily under-priced for no good reason. An investor would buy a value stock in the hopes that the market will accurately price it in the future (i.e. the stock’s price will increase). A Value Trap is when you mistake a stock for a value play when in fact the business or fundamentals have deteriorated (in other words, the market is accurately pricing in the decline).

I suppose that answers the question. A high dividend yielding stock is a value trap when the business or fundamentals have indeed deteriorated. Time will tell what is in store for certain banks. Of course hindsight is 20/20 as always, but what clouds the issue is that the sub-prime mess has indeed affected the banks – the question is how much and is the market accurately pricing it in?

Given that there may or may not be value traps in high dividend yield stocks is now the time to employ a dogs of the Dow strategy (you buy the top 10 dividend yield stocks on the Dow Jones Industrial Average)?

Only as long as the investors understand the trade-offs, and really it is a long term strategy as any proponent of the strategy will certainly point out that it can underperform during short timeframes (as with most strategies), as well as long timeframes. Historically the Dogs have beaten the Dow by 3% per year for the last 50 years. I’m pretty sure that the next 50 years for the U.S. will be different than the past 50 years – I have no idea in what ways though. I’d be more comfortable using the Dogs for part of my US equity exposure as opposed to for my entire portfolio.

I would look at high dividend yield stocks and value traps by trying to answer this question- is the dividend safe? The best way of answering that question is how quickly does a sale become cash (I believe they call this cash velocity in i-banker speak)? We never think about it this way but when we visit an ATM to deposit money, it is a “sale” where the cash is made instantly by the bank. That’s why I do not like tech and construction stocks- it takes too long for the cash to come after the initial sale (with notable exceptions).

I would look at other things as well, such as the payout ratio. If it was high to begin with and there is some business or fundamental problems, the dividend may become unsustainable, it may be a hindrance to operations and these would make it more likely for the cut. Even if the payout ratio was low, a debacle could necessitate cutting the dividend. Ultimately, the question is “Is the dividend safe for a long time?” which can be estimated more prudently if you take into account the fundamentals, the business prospects and the business model (including looking at cash velocity). I suppose what I’m trying to say is “Yes Virginia, you still need to do your homework.”

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Part Two of this conversation where we speak about the future of ETF’s, PPN’s and fun investing can be found here.

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.

Mom2KG, my regular monthly columnist, decided to do double duty in March and wrote a book review on Preet’s The RRSP Book. Preet’s regular blog can be found here. Hope you enjoy and have a great weekend.

The sub-sub title of this self-published book is “41 Strategies Canadians Need to Know About Our Country’s Single Greatest Tax Planning Tool”. I have to say, hats off to Banerjee, for itemizing, understanding and writing about forty-one aspects of RRSPs. Forty-one! I’d already vaguely become aware that RRSPs were more than tax deductions and RRSPs, but his work certainly opened my eyes.

Banerjee notes there are exactly zero books out there on RRSPs, and only a few focussed on the Canadian financial framework. This in an interesting things to ponder on its own, but I do wish Banerjee had elected another option besides self-publishing. It’s a bugaboo of mine, but the text is distracting for its lack of editing, ranging from poor punctuation to the inappropriate use of emoticons. I hope he shops the next edition around, because the book is otherwise engaging (for a book about RRSPs) and full of great information.

Banerjee absolutely provides a wealth of information, tips and tricks. He also provides excellent critiques of certain apparent benefits, such as using the $2000 over-contribution limit (see strategy # 13).

Not all forty-one strategies are applicable to all Canadians all of the time, but I would bet most of them eventually become applicable for most of us. I nearly fell over to learn I could finance a possible return to school through my RRSPs – a much better option than going back to student loans (see strategies # 9 and 10)! I knew about the Homebuyer’s Plan (see strategy # 8), but was flabbergasted to read about holding the mortgage in my RRSP and essentially becoming my own bank. It may not actually be feasible (Banerjee warns there are a lot of conditions) but at least I now know to ask about it (see strategy # 23).

There were so many things I – and likely others – had assumed about RRSPs. Turns out it is an unbelievably flexible tax-planning tool. My kids will thank Banerjee, as I intend to take his advice and start creating RRSP room for them as soon as they can push a broom (see strategy # 15).

Some – but not all – of the strategies are very technical, let’s face, not riveting reading. The important point is that Banerjee demonstrates the potential and flexibility of the RRSP. With a financial advisor such as the author providing guidance, I bet many Canadians could benefit from his strategies.

Today’s federal budget introduced the concept of a tax-free savings account of up to $5,000 per year. Canadian Capitalist described the tax-free savings account in his usual eloquence.  Being the entrepreneur that I am, I am going to look at the tax-free savings account in a different manner- how to profit from its creation (and all indications are that the budget will pass) and operation starting in 2009. You guessed it- the usual disclaimers apply- this is for informational purposes only and not advice. Given the tax-free savings account is literally less than 12 hours old, I am being very speculative in my thinking. Thus, please seek your own professional advice.

The government’s brochure (found in the link above) has the following buzz words- “savings” (mentioned 4 times in 8 headlines) and “tax-free.” Lots of tax-free savings that need to be protected eh?…  I can see the financial industry’s marketing material now: “What to protect your tax-free savings account? Buy a Principal Protected Note…” Principal Protected Products (PPN’s) are being flogged like hot cakes (I am dating myself- flogged like iPod’s?) given the market has become so unpredictable so what do you think is going to happen when we have tax-free savings account? We are going to be sold to death on making sure we protect our contribution with the requisite selling on fear. Cue more PPN’s, high interest savings accounts and other “secure” investment vehicles, like money market mutual funds, with built in fees.

It appears from preliminary review that the tax-free savings account will be administered by the same people who administer our RRSP- the banks and large financial institutions. Thus, the two sets of players to benefit the most from tax free savings accounts are:

1. Banks who have great retail operations and can capitalize on their existing clientele and attract new clients to open tax-free savings accounts; and
2. The big mutual fund companies and wealth management companies (who are basically one and same) who can create a myriad of PPN’s and more funds or will manage these accounts for seniors (who stand to benefit the most since there is no claw back against pension payments).

Who exactly are these players?

On the banking side, Royal Bank of Canada (RBC) and TD (known as the “Big 2″) are traditionally known as having the best retail banking operations- they are noted for being savvy marketers (at least for bankers) and attracting money from new sources. For example, when RBC launched its high interest bank account, it attracted $1.6 billion from outside its existing clients in the first 90 days of its launch.  TD, with its Canada Trust customer-friendly lineage, is well known for having great retail operations such as its long hours. Expect to see a lot of blue and green when the tax-free savings accounts are opened in 2009 (I own stock in both banks).

On the mutual fund side, the two largest mutual fund dealers by market share are IGM Financial Inc. and RBC (assuming you count Phillips, Hager & North’s market share which RBC is buying). IGM’s traditional lead is now approximately $2 billion over RBC which is not that great considering IGM is managing approximately $102 billion in assets (I own IGM indirectly through my holdings in PWF).

Assuming that these companies can capitalize on opening, managing or selling products to your and my tax-free savings account, they may not be bad stocks to own since sales will not occur until 2009 so there will not be an immediate impact on these companies’ bottom line. The good news is that these stocks are quite cheap relative to recent prices. The downside is that, for the banks, there may still be unknown subprime exposure. Thus, opportunity abounds with risk (or as the Chinese say, change equals opportunity). As usual, this is not a recommendation to buy or sell any stock- please do your own research.

Last month I introduced a guest blogger, Mom2KG who is writing about her family’s quest to take control of their finances and become better money experts. Mom2KG is posting once a month and updating us on how her and her family are doing. January’s post can be found here. I am passing along her request to provide as many comments, suggestions and recommendations as possible since she found January’s comments so helpful.

Thanks to the readers of TMW who offered support and encouragement. It was interesting that the comments noted that my husband and I are doing more or better than a huge percentage of Canadians with our savings and investing. However, one can always do better, and our goal is to be as good at the planning and saving etc. as we can, not simply better than the masses.

One reason is that we have pretty lofty goals (I liked TMW’s blog on goals and tracking). The main one is to “retire” at age fifty, less than 20 years away. At that point, we’ll live off our savings while pursuing our “real” dreams. No doubt I’m going to get some flack for this plan. It’s a trite comment that the best way to make money is to find way to make money doing something you love. But we are conservative, with a combined fourteen years of postsecondary education we don’t want to “waste”. We are risk-averse, and simply not willing (or brave enough) to gamble on our incomes.

Having said that, the “dream” involves real estate, and we are getting on the road to investing in that area. We are progressing with one group in particular in a buy, rent and hold model. It’s slow going, but we are learning along the way.

We have gotten some basic stuff done, like maxing out the RESP contributions for the kids. We’ve been looking closely at our budget, and are determined to save a certain amount in cash each month as a priority. However, we keep blowing the budget and still have no idea how to control our spending. Seriously, we’re ramping up the potty-training with our kids so we don’t have to buy diapers anymore – is that ridiculous? Next I’ll be growing our own food in the backyard.

We will meet with our financial advisor next week, at which point I’m going to be pretty demanding about why in hell my RRSP portfolio (almost 100% mutual and money funds) has shown a dismal overall return of only 6% over the last 11 years! My husband started his only a few years ago and has consistently lost money (and his portfolio is in much less riskier funds than mine). And why hasn’t the advisor called about this? What’s going on? Oh yeah, I am ready.

I’m going to get out of mutual funds and into GICs for a bit. I like the “G” part of GIC. There’s no “G” in mutual funds. I note that if it were not for my newfound determination to involve myself more in personal finance, I never would have realized 6% ain’t so hot (actually, I probably wouldn’t have read my statements to realize this miserable fact). I used to think I just had to wait and wait and eventually I’d make money. [editors note: Mom2KG and I had a little discussion about asset allocation after I read she was going into GIC’s. Maybe that will be next month’s blog?!?]

As for our weekly money meetings, they’re going well. There was one moment involving an if-you-know-so-much-then-you-do-it. One great thing about having scheduled meetings is that any money issues coming up during the week can be noted and put away for our scheduled time. We’ve made some good progress in goal-setting (and achieving), both weekly and long-term.

TMW mused about whether men and women think about money differently. I’m not sure I can generalize based on gender, but I have noticed, among couples, that one tends to be the spender and the other is the anal retentive saver (no prize for guessing who is who in our marriage). No wonder couples divorce more over money than anything else. Notably, however, The Millionaire Next Door found that millionaire families almost invariably had partners with the same – frugal – attitude towards money. How nice for them. At least the rest of us support industries in second marriages, divorce law, and therapy.

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

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

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

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

• YOUR FIRST CLIENT SHOULD BE YOUR EX-BOSS

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

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

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

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

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

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

• GOOD BUSINESSES GROW ORGANICALLY SO MONEY UP

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

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

• LEARN REVENUE RECOGNITION

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

• WHAT’S YOUR EXIT STRATEGY FINANCIALLY?

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

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

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

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

WORKING WITH YOUR INVESTMENT ADVISOR

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

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

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

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

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

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

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

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

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

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

LEARNING FROM OTHER PEOPLE’S EXPERIENCE

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

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

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

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

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

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

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

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

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

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

THE 2008 MARKET

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

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

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

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

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

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

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

FEES

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

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

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

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

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

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

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

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

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

It is now available through www.TheRRSPbook.com.

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

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

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

(Mom2KG is TMW’s first regular guest columnist. Thanks Mom2KG. She has volunteered to write periodically on her household’s 2008 resolution to become better with money and investing. Here is her tale. I hope, if your resolution is the same, her thoughts echo some of your own. I hope you can all give her some suggestions).

Thanks to Thicken My Wallet for giving me a chance to share my financial resolutions of 2008. Actually, there’s just one resolution: get better at the money stuff.

My husband and I make what most people would be considered to be good money. Now, we do have two small kids, employ a full-time nanny, live in the most expensive city in Canada, and run a large house. We make our RESP and RRSP contributions, and are paying the mortgage down somewhat aggressively, but, other than that, we don’t do any financial planning. We were shaken to find we’d saved only 5% of our net income last year as cash. As a result, we’ve forced ourselves to make some real commitments to finding achievable financial solutions.

Learn more. I’m getting through Smart Couples Finish Rich. It hammers a few points that have motivated me. First, couples have to plan as a couple. Second, Bach encourages his readers to list the values they want in their lives, such as security, or health, or power, and then consider how money will help achieve those values, as opposed to things. (I think Bach has seen Fight Club several times.) My husband is reading Good Debt, Bad Debt because we are becoming more interested in investing. He’s particularly riveted by The Millionaire Next Door. The author emphasizes frugality, which echoes Bach’s Latte Factor theory of nickel and diming yourself out of significant savings opportunities.

Plan More. We’re committing to one meeting a week about money. Think of us next Sunday, at 1pm EST, when our kids take their afternoon naps. We’ll be sitting down to discuss past spending, goals, a weekly to-do list, and, eventually, the budget. Cross your fingers we don’t kill each other. By the end of January, we’ll have spent more time discussing money together than in all of last year.

Invest more. We’ve been talking about real estate investing for a number of years. Our first choices are student rentals or single family starter rental homes, and eventually build up to flipping. Also in this category is spending more effort on the basic investment vehicles, like RESP’s, RRSP’s, and insurance.

Spend less, save more. I manage the household, so I’m doing all the buying. When we continually go over budget, I feel it’s my fault, yet I’m hard put to see where I could have spent less. We don’t live hand to mouth, but we don’t take three vacations a year, or drive a Hummer, either. This will take some real teamwork, but we’re hoping the spending can get under better control, or at least within a reasonable expectation.

Like most New Year’s Resolutioners, we’re very motivated and excited right now. The weekly meetings should help, as should concrete rewards for meeting goals. Anyone out there have any suggestions for us? I’m especially interested in how to spend less.

…other than a quick update that I did get my money back from the bank for the ATM fraud that occurred last week. No comment provided by the bank as to where my ATM number was used.  It took 12 days for them to do an investigation which is neither a good or bad turn-around time. See you tomorrow.