Thursday, November 30, 2006

Should I open my own coffee shop, or just flush $20 bills down the toilet for the next few years?

I found a fantastic article on today which pokes holes in every faux artistic type's fantasy business -- owning their own quaint little neighbourhood coffee shop.

I have the utmost respect for entrepreneurs. It's a mindset that I sadly just don't have, but one I admire immensely in others. Owning your own business is a brave thing to do no matter what you're selling. But as the article points out, with low profit margins, a hectic workload and high costs, a coffee shop might be the worst or all. Yet, so many people are lulled into the romantic mystique of a quiet, satisfying life as a coffee-shop owner.

Not that I ever flirted with the idea of opening one myself, but I do fondly recall wiling away the hours during my unversity days, sipping back cappucino's and chai teas in the popular independent coffee shop just off campus. I'd go in mid-morning, grab a $1.20 medium coffee and nurse it for an hour while I read and waited for class. Then I'd come back in the afternoon and relax for a few hours with new-found friends until dinner with a $2 chai latte.

Imagine my surprise when the place went bankrupt just a few months later. Apparently it's hard to make a profit off of notoriously poor and stingy university students when they sit in your business for an average of 2 hours a day, taking up seats other people might have used, all in exchange for about $3.

My favourite part of the article:

The house brew too cold to be sold for $1 a cup was chilled further and reborn at $2.50 a cup as iced coffee, a drink whose appeal I do not even pretend to grasp.

Sounds very familiar. Top-notch writing once again from Slate magazine.

Wednesday, November 29, 2006

Risk vs. Reward -- a rethink

Please forgive the following brief mathematical interlude. It's been a long time since I came across the phrase "standard deviation" in everyday life.

Conventional wisdom has it that the more tolerance for risk that an investor has, the higher they can expect their investment returns will be over the long term. In practical terms, this means investors who gravitate towards things like bonds and GIC's trade off higher potential returns in exchange for safety, security, and -- let's face it -- peace of mind. Conversely, risker investors expert better returns for their efforts.

There's nothing particularily revolutionary about that concept, but it's important to remember that the relationship between risk and reward does not necessarily go in a straight line.

Generally speaking, adding acceptable amounts of risk -- investing in emerging markets or volatile small cap stocks, for example -- to a balanced portfolio does allow for the possibility of superior investment returns over the long term. But in real terms, it's not a linear relationship: more risk does not necessarily mean exponentially more reward.

If you could put a numerical value on the level of risk you're taking, then doubling it doesn't necessarily mean you can expect to double the reward, depending on how much your initial risk. This graphic sums up what I'm clumsily trying to say quite well.

My apologies for usurping the original intentions of the chart-maker but essentially, stock data from the last 80-odd years seems to suggest something I've always believed to be true myself: The relative gains to be had from increasing one's risk exposure tend to decrease the more risk you're taking on.

See how the curve flattens out the further to the right on the "risk" axis you get? In practical terms, that means the bump you'd take from moving money from a GIC, for example, into a diversified blue-chip equity fund is a lot more, in relative terms, than the one you get from moving from one volatile sector into an even risker one.

The lesson? As always, diversify.

And don't take on more risk than is worth your while.

Wednesday, November 22, 2006

How I got my bank to pay me to fly to California

Alternate title -- Growth in Value's credit card experiment

After being bombarded by all the offers for new credit cards that my bank seems to send me on a quarterly basis (it's amazing what paying off your bill every time in full can do for your reputation) a few months ago I finally caved in and signed up for one of RBC's annual-fee cards.

I know, I know -- I can hear you all saying, "What? I can't believe it -- after the way he blathers about low-fee investing on his blog, he has the audacity to get suckered into paying for a credit card when there are so many free ones available."

I get it. But hear me out. While it's true that I have experienced a small amount of buyer's remorse after seeing the sweet deals that places like PC Financial and CIBC are offering (free groceries and cash back on purchases sound pretty damn tempting to me) I didn't just blindly go into this. I figured out, based on how much I was putting on my card in an average month, added to the bonus points I was being offered for singing up, I could get myself a free flight out of it.

Here's my plan:

I signed up for RBC's Platinum Avion card. It comes with all the usual accoutrements these cards tend to have -- deals on extended warranties, rental car insurance, traveler's cheques and insurance, etc. -- for a pricey (to me anyway) annual fee of $120. They gave me 10,000 points just for signing up, and 5,000 more points when I renew after the first year. So right off the bat, I'm at 15,000 RBC Rewards points even if I don't put a penny on the card for two years.

On my old, no-annual-fee card, I used to rack up a few hundred dollars a month, largely on purchases from retailers and online purchases. I think my most expensive month ever was about $500, and I had months of well under $100. The average was probably between $200 and $300 a month.

For my new plan to work, I need to start putting more money on the card to rack up points -- with the important caveat being that I'm not actually spending any more money than I would otherwise have spent through other means like cash and debit cards, because that would obviously negate any "savings" from points I was accruing.

Keeping in mind that I always pay off 100% of my bill on-time, I figured, if i start putting things like restaurant bills, groceries and gasoline on the card -- stuff I used to pay cash for -- I'd quickly rack up the points to get some sweet rewards. And it wouldn't actually be costing me any more in real dollar terms, since those are all items I'd be paying for anyway.

I've been doing this for six months so far, and my theory appears to be working. I haven't had a bill yet that was under $500, and I'm knocking on $1000 a month more often than not. It's amazing how much groceries you can buy!

So let's make a conservative estimate and say I'm putting an average of $700 a month on my new card. After two years, at 1 point per dollar, this means I will have accrued 18,000 points -- bringing my total to something in the neighbourhood of 33,000 points.

What does that do for me? According to the handy chart they provide, 30,000 points earns me a flight anywhere in continental North America. So essentially, for $240 (two years' worth of annual fees) I get a flight anywhere in North America. And having seen what friends pay to visit family on the West Coast, I know those sort of long-haul round-trip flights can easily cost close to $1000, and certainly over $500, even when you get a deal.

It's not perfect, and I acknowledge there are great credit card deals out there that give you things like cash back and gift cards at retailers that you don't have to wait two years to build up enough points to make it worthwhile to redeem. Which is why I doubt I'll renew the card for year 3, when RBC isn't offering me any free points to stay with the card.

In the meantime, it's a nice little financial experiment I've undertaken for myself. Meet me in California in 2008 if you want to tell me I've made a mistake... :)

Monday, November 20, 2006

My first credit card

A lot gets written about the evils of credit cards, and how one of the best things someone having financial difficulties can do is to just cut up their credit cards. That may be the case for some people, but I've never really thought that applies to me.

I got my first credit card in university. It was a basic, no-fee student card. I think my initial limit was something like $500 to start with.

I remember some friends and I were planning a trip together, and the easiest way to book those sorts of things is to put it on a credit card. A friend of mine didn't have one, so she cut me a cheque, and I put her fees on my card too. The charge for the two of us combined would have put me over my limit, so I nervously called the bank to ask them if they might be kind enough, to, uh, bump up my credit limit to $2000 a month -- just this once, pretty-pretty please.

The lady on the phone was quite nice, and she briefly put me on hold while she reviewed my file. I was sweating it out on the other end, certain she was going to figure out I was only earning about $25,000 a year, eking out a frugal living in Canada's most expensive city, living with 4 roomates in a crappy student house. She was probably in the process of telling the whole office about my audacity, having a good laugh at me before coming back with a "who the hell do you think you are?" speech, I reasoned.

Little did I know.

Imagine my surprise when she came back on the line: "Certainly sir. I've reviewed your file and am pleased to tell you that not only has your credit request been approved, but I'm further authorized to offer you our platinum card with a limit of $10,000 a month."

I was stunned. It was mind-boggling to me that the bank was willing to front me 40% of my annual salary, sight unseen, every month. I'm now a lot more savvy about the way banks operate and the way they make their money, but at the time I was positively shocked at the kind of money they were throwing my way.

I ended up signing up for RBC's no-fee platinum card -- how's that for an oxymoron -- and used it diligently for 2-3 more years, never coming anywhere near that $10,000 limit. I've since upgraded cards once again and my credit limit has been once again bumped up -- still to a level I can't fathom ever approaching in any given month. But I'll never forget my shock at the way that played out. I think that's the moment my eyes were really opened up to how the financial system works.

Banks have a bad reputation with a lot of people. They get accused of trying bankrupt people, but really, having you go bankrupt is the last thing any bank wants. If I was a cynic, I'd say a bank's goal is to keep you in a manageable amount of debt for your entire life. Never deep enough to make you go under, but just enough so that they can rely on your for a constant flow of steady income in the form of debt repayments. Giving people who aren't good with money a credit card is one of the best ways they can achieve this.

I've been lucky to have parents that helped finance my education, and I know they're still behind me today, ready to bail me out if I ever go in any serious finacial problems. Happily enough, and largely thanks to the financial education they've given me, I've never been in a position where I had to use that safety net.

I think VISA has earned a total of less than $100 from me in the past 10 years, all from one month when I couldn't pay my bill off in full and had to resort to only paying the minimum balance. My interest charge was $87 the next month, and it hurt so much to pay it that I swore to myself I'd never let that happen again. I suppose $87 isn't too much to pay for nearly 10 years of convenience, plus special perks like extended warranties and travel insurance. But something inside me found it fundamentally abhorrent, so I've never done it again.

I guess what I'm saying is that for people like me who pay off their balance in full every month, having a credit card is a great, convenient way to learn about money, build up credit, and squeeze a few perks out of your bank.

But if you find yourself in any sort of debt problems, cutting up the credit cards with their 18% interest rates is a great place to start.

Friday, November 17, 2006

Things that make me go hmmm.....

'ENERGY STOCKS TAKE COMPOSITE INDEX NEAR RECORD HIGH' the teaser on the front of ROB gushed yesterday.

'TUMBLING OIL PRICE HITS ENERGY SECTOR' that same space laments this morning.

Just a gentle reminder to all of us -- don't get too carried away chasing short-term trends.

Buy. And hold.

Oh -- and stay away from oil.


Thursday, November 16, 2006

I'm losing my will to save

Yes, yes, I know that saving a little bit every paycheque and putting it aside for a rainy day is one of the best things I can do for myself.

And I also know that buying a house as early as possible and socking money into an RRSP in my 20's will put me in a better financial position that about 99% of my peers.

But dammit -- it's hard. I've been a good little saver this year ($7,000 into my RRSP for the year, and it's increased in value by about 15% already) and my automatic savings program diverts a good chunk of my paycheque into a high-interest savings account before I can even sniff it.

Sure, the ever-so-slowly up-moving squiggly line that represents my net worth does give me a nice little sense of accomplishment -- but my self-satisfied smugness is no match from the joy I'd derive from liquidating my Combine enemies on a brand, spanking new Xbox 360 system. Nor is it any match for, say, tossing back mojitos like Lindsay Lohan at a frat party while lounging around on the beach at one of these places, for example.

In short, I need a bit of a break. Christmas is coming up, and in addition to the myriad gifts I'm planning to give to friends and family, I think some treats for me are in order.

But don't worry, pfblogosphere. I'm sure my little anti-frugality protest will be short lived. Come January, I'll once again be waist-deep in the forests of paper that the financial press annually puts out on where to park those tax-free RRSP dollars. And I don't think the new video game console I've been jonesing for qualifies as a buy-and-hold investment.

If I don't re-discover my saving mojo, I'm sure you people will remind me of it.

I'm just sayin' -- if the diet ain't fun, you're not going to stick with it.

Tuesday, November 14, 2006

Conservative investors take more risk?

Conventional wisdom has it that conservative investors are more likely to save up a solid downpayment in the neighbourhood of 25% of the value of the home before jumping into the real estate market, while riskier people are the ones who sign up for no-money-down, 35-year mortgages and the like.

But an interesting post out there in the pfblogosphere is aiming to try to turn that notion on its head.

This post makes the contention that truly conservative investors are in fact more likely to go for 0% downpayment options, where the purchase price of the home is 100% paid for by the bank.

Basically, the argument is that in 100% financing deals, the bank is the one swallowing 100% of the risk -- both that the buyer won't be able to pay off the mortgage, and that the value of the asset will depreciate.

The reality is the conservative financing option is 100% financing. You have pushed all risk to a third party -- the bank! In doing so, you remain completely liquid -- the true goal of a conservative investor.

I'm not sure I buy the argument myself (the author's job as a mortgage broker clearly gives him an agenda that colours his opinion, IMHO) but it's certainly an interesting viewpoint.

My own nature tells me the best plan is to save up a significant amount of the purchase price for a downpayment, as a hedge against some calamity happening later on -- like losing a job, having to move, or a real estate crash.

So that's what I'm doing. Apparently that makes me a risky investor. :)

Monday, November 06, 2006

Emptying the notebook

In the proud tradition of lazy newspaper columnists everywhere, let's hammer out a smattering of unrelated tidbits on several different personal finance topics, shall we?

Item the First -- Kudos to City Girl for hosting the Carnival of Personal Finance this week. Lots of good stuff there, as always. And, unlike always, one entry by yours truly.

One day, when I'm so inclined, I'll have a go at hosting one of these.

B -- Loyal readers (Hi mom!) will recall my ambitious plan to have a net worth of $20,000 by the end of September.

Yes, I know it's the start of November now, but I'm pleased to say that I've more than met that goal. With a little over 16K in the brokerage account and $7,000 gathering dust over at ING, my net worth currently stands at around $23,000. I don't have any schmancy graphic to commemorate the event -- maybe I'll get on that. And maybe it's time for me to set myself another short-term financial goal, since the first one went better than expected. I suspect as the holiday season approaches (already!) finding the excess funds to save is going to get a bit trickier. So I'm glad I've got this benchmark to hang my hat on for now.

iii --On the trading desk, I put in an order in today for 140 units in Claymore's new Dividend Achievers ETF. Designed to emulate the Mergent Dividend Achiever's list, Claymore Investments only launched the product in September.

I like it for a variety of reasons: it's a decent defensive play since I think the economy is starting to cool off a little bit: it gives me excellent exposure to Canada's strong financial sector (something I've been lacking) and it has a higher yield and is more diversified than it's closest competitor, iUnits' XDV. Sure, it has a slightly higher MER, but I'm confident that the ETF's focus will make up for that. Plus, I like the focus on companies with growing dividends -- not just dividends per se.

If that's not enough, Canadian Capitalist is a fan. Works for me.

Thoughts, kudos, comments and critiques are welcome as always.

Friday, November 03, 2006

Berkshire Hathaway hits $100K

With a single share in Warren Buffett's company, Berkshire Hathaway, eclipsing the $100,000 mark for the first time in history recently, it seems like a good time to look at some of the world's most expensive stocks.

MSN Money has an article up which does just that.

Since I'm a Baby Berk owner myself (it's been a nice little investment already, as it's increased from $3,100 to more than $3,500 in the less than a year that I've owned it) it was interesting for me to note two things.

1 - Berkshire Hathaway really is in a class by itself
2 - The other expensive stocks come from a wild variety of sectors

Google, by the way, didn't make the top 10 list. It sits at #11.

Wednesday, November 01, 2006

The 80/20 rule of personal finance

"Watch the pennies and the pounds take care of themselves," the old adage goes.

It's a theory a lot of pfbloggers hold near and dear to their hearts. And truth be told, it's not a bad axiom to live by, but a few posts out there in the blogosphere have me rethinking this sort of conventional wisdom.

Does the small stuff really add up?

I found Canadian Capitalist's candid piece on the $8,000 he spent to have an unused van parked on his driveway for a year quite compelling.

I'm paraphrasing him a little bit (and my apologizes if I'm in any way taking his views out of context or misquoting him) but essentially, CC stretches his dollars further by doing things like coupon clipping and brown-bagging lunches to work. Yet on major purchases like homes and cars, though he tries to have a similar nose for bargains, a lot of the time there's wasted money because the item either wasn't really needed in the first place, or wasn't acquired at quite the same bargain level as that 99 cent loaf of bread from the bakery on the other side of town. I think the point is, overpaying for a house or a car you arguably don't need dings your wallet a lot more than those nickel-off-toothpaste coupons can ever hope to offset.

The tone jibes very well with this older Uncommon Way to Wealth post in which the author realizes that while it's nice to mind the little stuff, the decisions that make your net worth grow by leaps and bounds are always the bigger, albeit less frequent, ones.

The inspiration for the piece is the so-called Pareto Principle -- a theory, incorrectly attributed to early 19th Century Italian mathematician Vilfredi Pareto which states that in any given experiment, 80% of the results can be attributed to 20% of the variables.

Pareto originally used the theory to explain how 20% of his country's citizens were responsible for 80% of the income earned in his country. But over the years, it's been used, abused and watered down to the point where other disciplines borrow the same 80/20 ratio for themselves.

For our purposes, I think my own Pareto Principle of personal finance goes something like this: 20% of the decisions we make involving money are responsible for 80% of of how much money we have.

I don't write this to discourage people from doing little things like cutting out expensive lattes, choosing no name products over brand names, and cutting coupons from the newspaper. Those are all great things that can add up.

I just wish people were as exhaustive about the major decisions. Do you really need that new car? Are you sure you couldn't save money by calling a mortgage broker? Maybe they could turn that 5.2% variable rate into a 5.1% variable rate.

At the end of the day, it all adds up. It's just that with the big things, it all adds up a lot faster.