Sunday, September 30, 2007

S&P TSX Composite Index - 148 percent return

Over the last 5 years, since the end of the bear market, this Canadian Stock Market Index has risen from about 5900 points up to the last new high close to 14,600 points. That's a total increase of about 148 percent over 5 years which is also equivalent to an annual compounding rate of 20 percent. Not bad!

I determined the annual rate by using a trial and error method in the following equation.

Future Value = Present Value (1 + i) to the power of n, where i is the annual interest rate and n is the number of years. One could also use a table of values if they are handy. In this case the future value is 14,600 and the present value is 5900. You can check it by multiplying 5900 by 1.2 and repeating (compounding) for a total of five times.

Some might think that this bull market is getting long in the tooth both in age and in total returns.

Friday, September 28, 2007

2007 Expenses Jan-Aug

I updated my monthly cash flow spreadsheet the other day by adding in the last few months and thought I should share the information. Here are a few 8 month totals for two retired adults living on Vancouver Island.

Groceries $4,632
Restaurants $2,061
Entertainment $1,681

So far the actual totals generally agree with my estimated total for 2007. I estimated a total of about $38,000 for the year. This total includes a $2,000 - $3,000 savings toward the cash purchase of our next replacement car. Boating costs, a special retirement entertainment expense, is not included in this total. That has been running at about $3,000 per year. We own our home so there is only maintenance and property tax included in the $38,000 total.

A few times each year I compare our actual cash flow to my forecast. I find that having this cash flow information eliminates any money concerns both before and after retirment.

Friday, September 14, 2007

Trip Photos...100th Post!

We were out on the boat over at Desolation Sound for a few nights. Desolation Sound is located between Vancouver Island and the mainland about half way up Vancouver Island. Here are a couple of photos I took. Star fish are not just pretty decorations...they clean up the leftovers. This one, at Squirrel Cove on Cortes Island looked like it was slowly heading for the dead crab just above it. The tide is low so they are both temporarily out of the water. The tide change can be 10 feet over night so when we anchor the sailboat this has to be taken into consideration. The other photo is taken from the Curme Islands looking toward the mainland...where the Grizzly bears still run free.
Other than the base cost of owning the boat, whether we use it or not, we don't spend a lot of money while we are out cruising. It is like having a small waterfront cottage with a fantastic view. We are mostly at anchor so we don't use a lot of gas and there is no charge to anchor the boat. We use our dinghy with a small outboard motor or just rowing to explore while the sailboat is at anchor. We like to anchor near hiking trails if possible so we can get some exercise on shore.

Thursday, September 6, 2007

Reading Other Blogs - September 6, 2007

I continue to be impressed with the quality of information available on the web. In the workplace, I always believed that if you encouraged people to think and communicate in a group environment, that everyone would learn together. The web is the ultimate communication tool for this type of thing. When I read the different blogs it is almost like being back at work and discussing investments over coffee break. In fact, it's much much better... since the quality of discussion is 1000 times better.

For Example
Canadian Dream
posted his recent interview with Derrick Foster about his new book. Just yesterday I read on another blog that DF had written a new book. I expect to read both of DF books this winter. However, because of the information I found on the web about dividend stock investing and the tax breaks available, I have already invested some money in a dividend stock mutual fund.

Four Pillars posted an overview of his investment plan. One point I liked is that he has limited his leveraging to a level he is comfortable with, currently about 10% of his investments. I strongly encourage anyone with a mortgage to take a hard look at the SM opportunities in conjunction with a financial planner. It is normal to be wary of leverage, but rather than do nothing and let the years slip by, one can follow FPs lead and start with a percentage limit on the leveraged portion of one's portfolio. I recall having trouble sleeping when I took out larger mortgages years ago but I quickly forgot about it. After a short while the extra debt "was normal" and I never gave it much thought. In the final analysis we all leverage our investment in real estate when we take on a mortgage.

The Financial Blogger is posting his real time experience with the SM. I look forward to following his progress. It is a good blog to read if your afraid of the SM. It doesn't sound very scary because the numbers start out quite small. It gives one a chance to "grow into it" over time.

Million Dollar Journey's blog has a great guest post by Melanie McLister that summarizes the SM and provides a link to a table of comparison for Canadian sources of special mortgages needed for this strategy.

Wednesday, September 5, 2007

Buy Order...TSX Index Mutual Fund on Sale Today

Anyone else buying into the downturn?

The market news this morning is on the negative side and my earlier expected drop below 12500 for the S&P TSX Comp Index is still a possibility. The volume continues to decline as the index climbs above the low made in August. However, a drop below 12500 in the near term is not guaranteed, so I bought a little more index-e fund at this time. A buy at this time builds in a 6.5 percent advantage compared to buying after the market recovers from this temporary setback. My plan is to buy more units if the index goes lower, averaging down.

I wouldn't do the same thing with a stock issue...that would hold too much risk for my liking but history teaches us that the index always comes back.

Monday, September 3, 2007

Canada Bank Rate History 1956-2006

Since the prime bank rate is such a key factor in many financial decisions, I found a history on the web and graphed the January Rate. The average prime rate over the 50 years from 1956 to 2006 was 7.58 %. The extreme range was a low of 3.5 % in 1956 and a high of 20.0 % in 1981. The highest stretch of rates was the seven (7) year period from 1979 to 1985 when the rate never went below 10.5 %. Talk about 7 years of bad luck!

Keep in mind that these are prime rates and fixed rate mortgages are always higher.

Sunday, September 2, 2007

Smith Manoeuvre Review...September 2, 2007

I'm still reading the book and reviewing some comments on other blogs. It took me awhile to understand the basics. Not because I am older, and not because I am new to this kind of financial stuff, my resistance goes much deeper. It is contrary to my basic emotional programming. I guess I also thought that this sounds too good to be true.

I must admit that I am still trying to "get use to the idea". It makes a lot of sense logically and mathematically but like most everyone else I have been brain-washed with the working-class belief that debt is bad and that we should run away from it as fast as we can. Our beliefs come from our parents, friends, relatives, books and the media. Were all driven by fear. When I read other posts on the SM I know I am not alone on this issue.

Smith makes some excellent points beyond just using leveraging. That when it comes to investing in things that go up in value such as equities or real estate, "time is our friend". That is not a new concept, I have "know it" for many years. But Smith has found a way around the "big rock" in the stream, he shows us a way that we can overcome an imaginary obstacle, like the migrating salmon, we can jump over it. He gives us a solution that we never had before. It is positively brilliant.

It then follows that to wait "to invest", until the mortgage is paid off is not the best course of action. It is a "missed opportunity".

The reality of it all is that in order to become financially independent and retire at an early age, we need to own our own home and own other investments as well.

The SM is much more than just leveraging to buy investments. Smith also demonstrates the benefits of selling current investments like CSBs, Term Deposits or equities, using that money to pay down the mortgage, then borrow it back to re-invest. Many of us have a mortgage and money invested in other things at the same time. I was in that position for a couple of decades.

By simply re-arranging our financial house to take advantage of the tax benefit, we can keep our total debt the same, own all the same stuff, and get a big tax refund on top of it all. The tax refund can be used to pay off the mortgage sooner or to buy more investments. One's dollar level of debt never goes higher than the original size of the mortgage. And, with inflation, that debt actually reduces over time. A debt of $100,000 today is really less than a debt of $100,000 ten years ago. So one's debt level and amount of leverage actually reduces over time using the SM.

What about our fears...what if a bear market occurs? What if interest rates rise? These are excellent questions and I think one needs to go into the SM with eyes wide open and with "an emergency plan". Having an emergency plan reduces stress.

I don't know if my emergency plan ideas for the SM are the best ones, but here are a few initial thoughts.

Emergency Plan Ideas
If interest rates go crazy, like they did back in the early 1980s - and mortgages go above 20 percent, what can one do with leveraged investments? I can think of several options.

Owning equity investments, in addition to one's home, is not the same thing as owning a more expensive house. You can't sell half of your home quickly, easily or conveniently. In comparison, with the SM you have more control. Equity investments can be easily sold to reduce the amount of leverage.

Using the SM one owns the equity investments free and clear. They are not "bought on margin"(the old scary method) so you will never see a margin call that forces you to sell anything during a market crash. You won't be tempted to jump off a 10 storey building. You will therefore always have total control on the degree to which you are leveraged.

When and if it happens, you will have to weigh the pros and cons of selling equities and losing the tax refund. Higher interest rates will also bring higher tax refunds to your door to mitigate the situation. It may come down to whether or not one can meet higher monthly payments. Keep in mind that interest rates don't go from 6% to 20% overnight. You will have some time to consider your options.

During a long bear market one could sell some equities in the SM leveraged portfolio and replace them with interest paying things like Term Deposits, GICs or CSBs. During periods of high mortgage rates, these things would also be paying much higher interest rates. I can recall getting in-the-order of 18% on term deposits back when mortgage rates went above 20 %.

Another option may be to lock into a fixed interest rate loan for the investment account.

Smith also discusses the option of capitalizing interest. CI means borrowing more to pay the interest. Doing some of this would also be a way to control monthly payments.

Saturday, September 1, 2007

The Smith Manoeuvre Review...September 1, 2007

I'm currently reading "The Smith Manoeuvre" by Fraser Smith, 2002. ISBN 1-55369-641-7.
So far I'm finding the book quite good and easy to understand. It is a quick and easy read if you don't stop to check the math. Theoretically, in hindsight, had I discovered the SM back in the mid 1980s, when the author first invented it, and had I implemented it on my mortgage, and had I understood the market, as much as I do today... back then... then I would be a lot richer than I am now. Hindsight is 20/20 and there are a lot of "ifs" in this statement!

One of my initial concerns was that the SM required one to take on additional debt. This doesn't seem to be the case. As I understand it, for the Plain Jane version, one's total debt never exceeds the initial amount of the mortgage for the life of the mortgage. That is less scary than taking on a mortgage plus additional debt for investments.

I also like the fact, that for young people, the investments grow slowly over time, giving one time to adjust to the reality of market volatility. It forces one to "dollar cost average" into the market. Even if one understands very little about the market, dollar cost averaging builds in a safety factor against really dumb moves. But be very careful here....dollar cost averaging alone is not enough to save one from big stock market mistakes.

The SM depends upon using financial leverage to help one grow their net worth over time. However, financial leverage can also make a bad move much worse. In general, the SM alone does not guarantee success and it could make things much worse.

When applying the SM one should have a solid understanding of how the stock market works and the historical pitfalls. "The Four Pillars..." book is a good primer on this issue. In particular, learn about the historical mistakes that keep repeating themselves with each generation. Each and every time market participants think "this time is different".

A worse case scenario for the SM would be where one invests a very large "lump sum" into the market, in the wrong (high risk) investments, at the worst possible point in time. This could happen with a mature SM account, where the owner gets caught up in a buying mania, sells and buys a large sum of investments within the portfolio, or where one begins the SM with a large lump sum borrowed on a home that had been owned free and clear before the SM.

For example, if an investor (gambler) made a lump sum purchase of stocks such as Nortel (NT)or Cisco (CSCO) or even the entire Nasdaq Index near the peak of ~5000 in late 1999 or early 2000. This was a classic case of "irrational exuberance" when many people treated the market like a gambling casino. Then, during the subsequent severe bear market, the investor/gambler "lost heart", gave up on the "buy and hold" philosophy because the pain was too great, and sold it all at a large loss. That loss would then be in the form of debt, debt that the investor/gambler must pay interest on until it is paid off.

One redeeming fact is that the interest on that debt is all income tax deductible. Also, if the SM had been in place for a number of years with significant profits accumulated, prior to the dumb mistake, these profits would help offset the big error.