Monthly Archives: October 2009

Is it over?

Last night I was meeting with clients, and once again I was asked the big question.

Is the recession over yet?

This is one of those questions where the answer depends on where you are standing.

In the world of economics there are leading indicators, lagging indicators, and current statistics and reality. They may all be very different things. We see patterns in the data, and some people try to make predictions based on past experience. Forecasting can be a deadly game, and you are sure to get shot down by someone who is blessed by 20/20 hindsight. Also all forecasts are subject to bias. Are you a cup half full, or a cup half empty type of person?

What I will say at the moment, is that given the current situation, it looks like we might be on the road to a gradual recovery. The Bank of Canada has declared the recession over in Canada, the EU is optimistic, and the US believes that they are beginning to turn around.

But my client’s unspoken question was “when will I see a recovery”. Firstly, remember that during past recoveries, we have progressed in “two steps forward, one step back” fashion. There will be ups and downs as we wander in a generally forward direction.

So we have to ignore the day to day hysteria of the business channels who spend the day trumpeting some piece of useless news as the stock market rises, only to beat their chests and tear their hair out the next day as the market falls 50 points, and they cry crocidile tears over today’s dire statistics which are an obvious indication that the experts were wrong, and the sky is indeed falling. Hog wash. They need to garner ratings. They need the next breathless piece of news to justify the fact that they are taking up valuable airwaves 24 hours a day.

When the markets began to fall last year, I began to talk about the pattern we normally see in these situations. Usually, you can expect the market to fall to a certain (unfortunately unknowable) point. Then we would expect to see a period of time where the market kind of bounces along the bottom. When things begin to look better, the markets will begin to turn upwards in a two steps forward, one step back dance, as we see a gradual return to normalcy.

TSX Oct 27,2009

So far, so good. But the stock markets are not the real world.

Stock markets are generally a device for forcasting the future profits and profitablity of a company. So a stock price is the assumed future value of the income which a company is expect to produce. The markets will usually be 6 to 9 months ahead of the real economy.

Since the markets began to turn around in April, if history repeats itself, this would indicate that somewhere in the next few months we should begin to see the real economy begin to improve. Business should pick up, inventories will need to be replaced, total sales should improve.

Now employment is a different thing. Employment is a lagging indicator. Companies will wait until their business has picked up, and the order books are full before they begin to hire people back. Many companies delay hiring until they are spending too much on overtime, and hiring new staff or recalling old staff from layoff is more economical. Normally this will be 6 to 9 months after the general economy begins to improve.

So for the average person, the recovery will become a reality when everyone is back at work, and everyday life is back to normal. That is going to take a little while yet.

Barring any horrible setbacks, right now we can say that we are headed in the right direction, and so far things are proceeding according to historical norms. Fingers crossed.

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Filed under Economy, Employment, Investing, Recession, Recovery, Stock Market

Cashing out Your Pension

I hear it all the time. A person comes to see me, and tells me how someone (perhaps a friend or a so called investment advisor) suggested they cash in their pension when they retire. Oy vey. Please people, stop it already.

I have heard all the arguments why this is such a terrific idea. And I have seen all the tears when things don’t work out according to somebody’s overly optimistic plan. So lets recap.

Yes, when you leave a job, either quitting or retiring, you are often offered the opportunity to convert (or commute) your pension. This is where the first misunderstandings come into play. Yes, you can commute a pension. You can take the money in your company pension account, and put it into a Locked In Retirement Account (LIRA). A LIRA works similar to a RSP, except (1) it is locked in until you turn 55, (2) there are minimums and maximums that you can withdraw each year.

However, there are pitfalls which these so called friends and advisors neglect to either mention or give proper emphasis. Firstly, like an RRSP, your investments will be subject to market forces. So yes, you get to decide how it is invested, in stocks, mutual funds or GICs as you wish. And if they go down in value, like most investments did in 2008, you alone suffer the consequences.

Secondly, in Alberta, BC, Saskatchewan and Quebec, additional voluntary contributions you might have made in the past are not subject to creditor protection, and could be seized if you were ever sued. In Ontario, Quebec, New Brunswick, Manitoba and Saskatchewan locked in accounts are subject to garnishment for child support.

Thirdly, it is possible that not all of the money in your pension plan account will be eligible to be transferred directly to a LIRA. You may find that there will be a cash portion which will be paid directly to you, and you get walloped by income tax deducted from this amount at your top marginal rate. Peachy eh? Especially if you weren’t warned.

One of the things that really has people excited are rule changes in some provinces which will allow you to take up to 50% of your pension money in cash after January 1, 2010. Hooray! The government will then grab taxes from this amount at your top marginal rate. So if you live in Ontario you could lose up to 46.4% right off the top to the government. Dalton McGuinty  and Jim Flaherty will thank you.

My concerns with this whole process are many.

1. Canadian pension plans are generally well funded and regulated, and unless your company goes bankrupt, you will get all the money you are entitled to.

2. Canadian pension plan managers have shown better long term investment returns than the average RRSP investor. Especially Teachers, HHOOP, Hydro and many of the Union plans. Do you really think that you, as an amateur, can do better than the professionals who work in the business all day every day, who are able to utilize economies of scale and instant preferential access to the most up to date information when making their investment decisions?

3. In a defined benefit pension if there is a shortfall, the employer is on the hook to make up the difference. If your LIRA has a bad year, guess who makes up the difference?

4. If you take out 50% of your pension as a lump sum, what are you planning to live on when you retire?

Now, I know that you can never say never, and there are a few people for whom commuting a pension might actually be a good idea. However, they usually fit into certain limited categories.

A. You have multiple tiny pensions which individually will pay very small amounts every month. In this instance you may not suffer any great penalty by combining them and investing them as a unit.

B. You have a diminished life expectancy, no spouse, and wish your pension assets to go to your heirs. If you can make the argument that you will not live long enough, because of a pre-existing illness, to collect the bulk of your pension, then it might make sense to roll it over into a LIRA so that it can become part of your estate. However – big however – this will expose the entire pension to estate and probate taxes.

So exactly why are some people so quick to advise you to commute your pension?

First, is often the friend who read something someplace, and in whose hands a little knowledge is a dangerous thing.

Secondly, and most egregiously, is the so called advisor who assures you that he can put you into investments that will outperform the “pitiful” returns attained by pension plan managers. This guy is solely driven by commissions. Really, really big commissions. Thousands of dollars in commissions. Big, big, fat, juicy, buy a new Cadillac commissions.

Please don’t listen to these people. By the time you come to see me, I can’t fix it. I can’t correct the mess they have made. I can’t restore the long term value that they destroyed.

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Filed under Estate Planning, Investing, Locked in Retirement Accounts, Mutual funds, Pensions, Saving

More on the Loonie

The Bank of Canada announced today that they were keeping interest rates the same for the time being. The Canadian central bankers have been on a campaign to talk down the Loonie, which has been rising against the American dollar, yesterday closing over 97 cents. Inflation is under control, commodity prices are stable, and the GDP forecasts are on track for a sustainable recovery. 

There is concern that the rising Loonie could impact the price of Canadian goods on foreign markets which could stall the momentum of our economic recovery.

At least part of the worry is because the increase in the price of the Loonie has been uncoupled from an increase in the value of the commodities like oil, gas, minerals, lumber which we produce and export. An increase which is driven by speculators betting on the direction of the currency, and not on true economic value could have very negative consequences when the speculators turn to play in another area, and abandon the Loonie for richer pastures, leaving us to pick up the pieces and repair the damage to our economy.

http://www.bank-banque-canada.ca/en/fixed-dates/2009/rate_201009.html

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Filed under Canadian Dollar, Finance, Inflation, US Debt, US Dollar

Getting Paid to Sit and Wait

Many of you have heard me talk about Dividend funds over the past couple years. I am obviously a fan. I can think of nothing better than getting paid to just sit and wait.

There are a few different types of Dividend funds, the tradition Large Cap fund, and the Dividend Growth fund. These can then be broken down into Canadian, US, Global or sector funds. Although they generally hold different types of investments, they basically operate in the same way.

A Large Cap Dividend fund, formerly known as a “Blue Chip” fund, is made up of the big boys of the stock market. Banks, Insurance Companies, Utilities, Pipelines. These companies have a large enough capitalization (number of stocks outstanding) that their price usually doesn’t move a great deal on a daily basis. Their stock price just grows at a rather slow and steady pace over a longer period of time. Boring! And for a long term investor, boring is fabulous.

A Dividend Growth fund is usually made up of a mix of larger and smaller companies, who may have more potential for year over year corporate growth than the big guys. This can provide more capital apreciation than you might get from a Large Cap fund, but because of this, can introduce more volatility, and the price swings of the individual stocks in the fund can be greater. They still pay a dividend every three months, just like the big guys. Not as boring, but it’s still not exciting enough to be a conversational topic at your next dinner party.

So why is boring good? We are interested in the main underlying feature of any Dividend fund, The Dividend. Every three months these companies pay out their corporate profits in a quarterly dividend of cash to their shareholders. In this case, the fund, and and fund holders, you and me.

This is the good part –

At the end of each year, the fund manager takes all those dividends they have collected during the year, and pays them out to the unit holders of the fund (you) in the form of more shares (units) of the fund. So now, not only have the basic underlying stocks in the fund increased in value, and thereby the fund itself has gone up (we hope), but you now have extra units of the fund. So next year your fund will get dividends on the original units you owned, but also on the new ones you just recieved. Which will in turn be used to buy you more units next year.

And the shares go up, and cash rolls in, and you get more units…

And so on, and so on…..

 

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Filed under Finance, Investing, Mutual funds, Saving

Rising Loonie, Falling Dollar

Hi, just a few thoughts about the rising Loonie. Another instance of happenings south of the border, affecting us here in Canada.

Last year we saw the loonie rise past $1 US, and watched it put a dent in the posted value of US denominated investments you held. Once again the Loonie seems to be on the rise, now passing the 96 cent mark. While this makes shopping and vacationing in the south more attractive, it will have a negative effect on some things closer to home. Purchasing power does not rise in lock step with the loonie. It takes 6-9 months for prices to equalize, although pressure is often placed on Canadian retailers to match their counterparts across the border, by the time the effect of the higher loonie works it way through the system, it will likely have settled back down, and any perceived advantage will have been lost.

The value of US denominated stocks and mutual funds might drop on your statements. The dollar conversion may not offset the rising US stock market. It is quite possible for the price of an investment to be rising in US dollars as their stock market continues to rebound (the Dow is once again closing in on the 10,000 mark). And yet because of the rising loonie, your stocks or mutual funds have stayed flat or even decreased. This should be corrected when/if the loonie returns to an equilibrium state.

Will the loonie drop back? Historically it does tend to trend towards equilibrium, and usually drops back to a normal range after a spike. Is this time different? Maybe. The US is in a difficult situation, they have a great deal of debt they must deal with at a time when their unemployment rate is still over the odds, and their tax receipts (government income) are falling. When their economy turns around their tax receipts will increase, and they should be able to reduce some of their recession induced spending (one would hope). If this is the case, then we can expect them to get their house in order.

However – and there are two big howevers. First the US government historically has been good at increasing spending and very poor at pulling in the reins on special interests once the situation changes. They also have a very poor record of increasing tax receipts (income) by raising taxes in the good times, in order to pay off debt run up in the bad times. Secondly, the Chinese are a wild card in all this. They currently hold a very large proportion of US debt, and are making noises about shortening the reins. We can only hope that they do not want to do anything that would devalue their own investments, and so will not undertake any precipitous actions.

Regardless, even if everything goes along as expected, without any major disruptions, it is quite conceivable that the only realistic way for the US government to get out from under the burden of debt they currently carry will be to allow inflation to rise. Inflation will devalue the dollar and the concurrent debt. So they will be able to pay back today’s debts in tomorrows inflated cash. Good for anyone currently carrying debt, bad for the purchasing power of your savings and RRSPs. Keep this in mind for the future, and when you are thinking about future savings decisions, and planning options.

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Filed under Canadian Dollar, Finance, Inflation, US Debt, US Dollar

Hello world!

Well here I am, starting on a new adventure. I’m going to add something new to my communications repertoire. Watch this space for my thoughts on finance, investing and planning.

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