Desperate Times
Posted by Gail | Filed under Money Management
The level of desperation in the letters I’ve been getting has ratcheted up quite a few notches over the past couple of months. People who haven’t been paying their taxes are watching their bank accounts being tapped by the Tax Man and having to explain to their mortgage lender why they can’t come up with a payment. Creditors are calling non-stop. Families are watching as their weaker links break; desperate as they are to help, they have little enough resources of their own.
I’ve done a fair amount of interviews with the media recently. While doing The Motts on CFRB, I got one call from a man in his sixties who had lost 40% of his retirement portfolio and wanted to know what to do now. A little like trying to close the barn door after the horses are out, dontcha think?
If you are less than 10 years from retirement, you do NOT have a long-term investment time horizon, and you should not be heavily invested in stocks (which include stock-based mutual funds). I told this man he should have been more conservatively invested. He said he was. I replied that no conservative portfolio lost 40% in the recent shake-out, so he’d best have a word with his financial advisor.
People, if you’re going to be investors – if you’re buying mutual funds, bonds, stocks, anything other than boring GICs – you HAVE to know what you’re doing. You can’t just take someone else’s word for it.
As is typical, now that people are “scared of the markets” diversification is still NOT the name of the game. The solution to having been overly weighted in equities when the crash came is NOT to be overly weighted in fixed-income investments in the aftermath. The solution is to figure out what your asset mix should be, and then execute a plan and stick with it. Diversification is all about balancing your need for return with your time horizon and your risk personality. Running and hiding isn’t a solution.
For those of you who think this is a once-in-a-lifetime opportunity to get into the market, you may be right. But don’t just throw your money wherever… there are still a lot of downs to go. Create a plan, and then dollar-cost-average into the market. Think about where the world will be 10 or 15 or 20 years from now. Course, if you’re gonna need the money any time soon, the market’s not for you. But if you won’t, if you’re 20, 30 or 40 and putting this money away for retirement, create a plan NOW.
As for all the people whose knees are knocking together and who just want a safe place to park their money: Canada Savings Bonds, GICs (stay under the CDIC limits), and high interest savings accounts are all still here. Just don’t whine and complain about the current interest rates. With prime the lowest it has ever been, interest rates aren’t really at the top of their game right now.
If you’re tempted to take advantage of the miracle investments springing up that guarantee a much higher rates of return, then you were the sucker born today. There’s no such thing “a great return guaranteed”… just ask all the people who got soaked in the ABC debacle. If it sounds too good to be true, it’s too good to be true.
People are doing all sorts of dumb things in reaction to the markets, and because they weren’t prepared for anything going wrong ever. People who are losing their jobs, losing their homes, losing their retirement nest eggs are panicking. But responding to the current economic turmoil emotionally isn’t going to get you where you want to be. So stop, breathe, and take rational, well-thought out steps to get to where you want to be next.
Pay down your debt. It doesn’t matter if you have to work three jobs, get the debt paid off. Give yourself a V8-Slap and swear you’ll never do it again! If you can’t do it on your own, head to a bank… it doesn’t have to be your bank… and get them to help you figure it out. Or find a friend who can help. And if you’re really desperate, go see a bankruptcy trustee to determine if that’s the only option left.
Don’t stop saving. If anything should prove to you the need for a pool of money for emergencies, this should be it. It may be tough to find $50 to stick away, but things can always get worse, so make like a boy scout and be prepared.
Look to the future. You’re still going to need money for retirement, so don’t stick your head in the sand on the investment front. NOW is the time to figure out how money works and what you can do to make it work for you.
Don’t stop saving for your kids’ education. Don’t take money out of your retirement plan to make ends meet (get a job!). Don’t use a line of credit as your emergency fund.
Do pull together with friends and family to figure out the best ways to weather this storm. Do keep on top of where your money is going every single day. Do make a plan for staying on budget, getting out of debt, and building a nest egg for the future.
There’s no magic to creating a sound financial foundation. I’ve been saying it for years, and you should be bored by now: spend less than you make, create an emergency fund, get your debt paid off, save some money. I know it doesn’t sound like rocket-science. It isn’t. But money management isn’t rocket-science, it’s discipline. The basics work, and if you’re not doing them, you’re never going to be anything but financially unbalanced… and miserable.
March 16, 2009 at 9:33 am
For those with outstanding tax debt, call your tax office, make arrangements just like you can do with every other creditor. Make sure that you follow through. If you don’t follow through, they will demand the whole outstanding amount at once.
March 16, 2009 at 10:16 am
As I’m a long time out from retiring, I’m keeping me money in equities and continuining to make a regular monthly contribution. While my book value has dropped over the past year, at least I’m buying good stock for bargain prices. The economy will get better, it’ll just take time. I think the worst thing you cn do is get out of stuff, because then you’ll be selling at a significant loss. If you don’t need the money, be patient and stay the course.
I would think long and hard before I invested in bonds, GICs, and “safe investments”. While your principal is safe, you won’t get enough of a return to adjust for inflation. But if time is a factor, this may be an option.
No doubt about it, these are hard times. I know people who were struggling to make ends meet before the economy took such a hit. Now with their jobs in trouble, its just getting worse. Gail’s advice is sound: pay down debt, don’t acquire more debt, and make regular savings to cover emergencies. Oh and have a plan for what you spend, unlike my husband who is going to get a V8 smack when he flies home tomorrow!
March 16, 2009 at 10:36 am
Gail’s last two sentences speak the loudest, I think.
“But money management isn’t rocket science, it’s discipline. The basics work, and if you’re not doing them, you’re never going to be anything but financially unbalanced… and miserable.”
Yes, these are tough economic times. People are losing their jobs. Everyone has seen their investments take a hit. And yes, people are doing dumb things with their money. But panicking is not the answer. Be rational.
Don’t stop squirreling away what you can for savings. See what you can help friends and families with, and, in turn, what they can help you with. Stick to your budget. Trim as much as you can. Shop the specials, and meal plan around what is on sale. Get creative.
“Hope for the best, but prepare for the worst.”
March 16, 2009 at 10:58 am
I think that most people are afraid of the short-term investment options because of the low return, but it just makes sense if you a) plan on retiring soon, or b) are young and plan to need the money soon, i.e. if you intend on buying a home, having a wedding, etc. Sticking to low yield investments can require discipline, too. Sometimes going against the crowd or doing something that seems safer or more boring, is difficult, especially for those of us who are eager to accumulate wealth.
March 16, 2009 at 11:32 am
GICs:
If you want your principal safe but hate the current return on GIC, look into GICs that are index based! Not all guarantee a return, but if the index jumps up you could get a piece of the pie! This product varies from one bank to another but it is usually covered by the CDIC. It is one way to diversify and sleep at night.
March 16, 2009 at 1:34 pm
Marie – GIC linked Indexes, like other PPN (principle-protected notes) are notoriously BAD investment choices. You pay a high MER/fees, the impact of an uptick in the market is usually limited (ie 50% of the upside goes to you, 50% to the bank) and dividends are usually confiscated by the bank, not given to you. Like many products, these ‘best of both world’ type products are usually the worst of either world. Anything PPN is usually all marketing (like a life stage fund) that while they claim to provide ‘protection’ all they really do is charge a sizeable premium of fees/dividend confiscations in the extremely unlikely event that $20 today will be worth less than $20 in 5 years from now.
March 16, 2009 at 1:53 pm
Totally agree with Geoff! “The best of both world products are usually the worst of either world”….genius! And so true.
March 16, 2009 at 2:23 pm
Geoff:
The product varies with banks. No MER in my case, just a maximum return over the time of the loan. The biggest risk is the loss on the time value of money (the last point you mentioned). If I start with the index at 100 and it goes to 120 at maturity, I get my principal + 20% (FULLY taxable outside RRSP and TFSA). However, if a 15% maximum return is allowed, I would get my principal + 15% only (again, fully taxable). If I start at 100 and the index drops to 75, I get all my principal back (no taxes). Some have a minimum return and a lower maximum return. It’s the cost of the guarantee.
One of mine came to maturity and while the index dropped, I did not loose my principal and I can repurchase while the index is low. No regrets to my cost for diversification.
March 16, 2009 at 2:26 pm
Sorry about “No MER in my case, just a maximum return over the time of the loan”: I meant to investment (obviously).
March 16, 2009 at 4:55 pm
Marie, can you tell us which product/bank you have? I’m basing my position on the index linked GICs at most banks that I’ve seen recently (March 2009) Now I’m not saying that there aren’t good reasons for this type of purchase, just that they aren’t the silver bullet of investing that they are often marketed as.
Here (from my own sources and some blogs that are not my words but I agree with) are reasons why I think they are bad products:
1) Taxes are a huge problem as you acknowledge but it needs to be explained more. “If you invested $50,000 in a stock linked GIC for five years which had a maximum return of 60 per cent and you reached that maximum, you would have $30,000 of taxable income to report for the year of maturity. You cannot apply any of the income to earlier years and it is all treated as interest income and is fully taxable at highest rates. A regular gic earns interest that year and gets reported as such. “(Not me but I lost the link) As for your no taxes at least if the market goes down, that’s actually because you earned no income on the product, hence no taxes.
2) You are paying what I would consider an MER, even if they don’t call it that. Unless I misunderstood you, I think your math is slightly wrong when you say that you start at 100 and if the index goes to 120 (ie up 20%) you get 120% of your original investment. You actually get only a % of that 20%.
For example, take a TSX 60 index gic that you buy for 3 years at $100,000. For example, if the TSX 60 goes up 50%, your $100,000 GIC won’t grow to $150,000.
Your bank charges you a participation factor PF to cover its bet. So, if your PF is 60%, and the TSX 60 goes up 50% (or $50,000), your return on $100,000 is 60% of the $50,000 increase in the index, or $30,000. Your $100,000 would grow to $130,000. Guess who keeps the extra $20,000?
So in your scenario, to get a 20% return, the index needs to go up high enough to offset your participation factor. In other words, the index needs to go up 33% for you to get your 20% return (60% of 33% = 20%)
Google: Michael James on Money blog and you can find ways to build your own PPN note with a lower participation factor. (also a source)
3) You earn money only on the difference between the index when you started and when you matured. No dividend payments is a huge drawback that can not be understated, when a good portion of the return on a stock is dividend paid while owning it, not just the +/- value when selling it. Again, guess who’s collecting?
March 16, 2009 at 5:34 pm
Geoff:
your point #1: I agree!
your point #2: TD Market Growth GICs (not the PPN website of TD Securities… I see the formulas for PPNs… It requires some thinking). When I bought the first product, I asked about how the gain is calculated (because some banks have a ‘PF equivalent’ that you mentioned) and I was told that it was the index itself. If that is not the case, my advisor has A LOT of ’splainin’ to do. (Thanks for the reference.) Now I have to go check the fine print just in case!
your point #3: That’s part of the cost of a guarantee. I remember people comparing exchange-traded-fund and the dividend effect and there was a claim that a company that pays good dividends will be in demand and their stock value will go up as well… I wish I could see some numbers for comparison!
This is NOT a perfect product and I expect the bank to make money off me or they would not offer the product! There is a compromise on both parts!
March 16, 2009 at 5:40 pm
Geoff:
TD Market Growth GIC, see FAQ point #7 for calculation of the return.
March 16, 2009 at 6:34 pm
About that last tidbit….
I have an open question to Gail and all the readers out there.
This summer I saw help-wanted signs everywhere (you could be a slack jawed brat and still find work, and quit every 3 weeks if you wanted ’cause there was a help-wanted sign next door too). Now it seems that the people that have lost their jobs to this “economic downturn” can’t find work! HOW did it happen so fast? Where did all these jobs go? The stores are still open around here with the same hours, people are still buying gas, buying food, etc…. ? It’s all a little strange to me.
March 16, 2009 at 6:58 pm
It’s not strange – someone who has trained for years in one type of work may not be able to do or suited for just any job. That rude taxi driver might be a brilliant engineer in another circumstance. A naturally outgoing people-loving store clerk could be a disaster working an assembly line…
Plus, even though good honest work is just that, it would be hard for some people who have commitments like childcare, other dependents, debt etc. to simply move into a minimum wage job and make that work for them – often it makes more financial sense to pull the kids out of child care and not have that cost if the work that is available won’t even cover it. And work is about more than just bills you have to pay, you spend most of your life working and there is an emotional and professional side to things – one has to be happy in what one does, and for some that means a longer wait for employment that suits them both financially and in terms of well-being – so you can commit to the job, do it well, progress, regardless of what type of work it is. I think every job is perfect for someone and someone is perfect for every job. It’s just getting the match that is tricky…
March 16, 2009 at 7:58 pm
I read Gail’s blog and saw my mother’s situation in her writing. I don’t know if anyone in this club has a parent whose savings got put into the equities market by an advisor who said that there was low to moderate risk involved. When I showed what the advisor’s firm had called low to moderate to another person – my insurance agent – he just went off on the fact that it wasn’t low to moderate risk – it was high risk. Of course, the market just kept eating up her money (paper losses). The only thing that was good about it was that the fund was insured to pay out the principal if no profits existed. This was a segregated labour sponsored fund – notorious for disasters and why he suggested it I don’t know. The fund ties up money for 8-10 years so there was no interest to be seen but there was a considerable loss of capital over those years. At 75 and not too savey, she was sold on equities – hoping that the market being good that there would be some interest to be seen – way back then. It never appeared. Two months ago, the advisor’s company wrote (no phone call nor visit requested) that she consider talking with them when the money came in this month. They provided the same profile to her as she had signed 15 years ago. She was to sign and then to initial repeatedly – 10 times on the document after all their various clauses and return it to them before the meeting. Her profile was the same as 15 years ago! She had signed for low to moderate risk – Equities (potential) growth market for monies to be invested over 5 years maximum for 10 years ago. Unfortunately, low didn’t mean the same to the advisor as it did for my mother and I wonder how she would have known better? I guess you never put trust in advisors who don’t think about money the way you do. If they think that money is something that you should be able to lose when you give it to them, then you’re in the wrong office setting – probably a horse track would be as good a choice. Mom didn’t like GICs paying such low interest and wanted something but what she didn’t want to lose was all her capital – even if it was on paper. I guess you ask many people about the choices suggested and you walk out of the office and say I’ll think about it. Now, most sales people know they have lost you when you leave, so what was my mother’s problem? Being too polite, too unaware of all the products, too risk oriented, too naive, or hoping to believe what she was told? My mother is now nearly 86 and not as good at anything anymore. When she received the forms and looked at them, she thought to hand them to me. I was shocked. How could an advisor’s company think that equities for growth with at least 5 years time to acquire such growth would be appropriate for an 86 year old with only a little time left to live? I blew my top and called my insurance agent and we got her money out of those people’s hands immediately. Mom may not have had income from her investments but she does have some of her capital still intact. She’s better off than most people who put their retirement funds into the market.
March 16, 2009 at 8:52 pm
Gemini:
That is horrible! There must be an office to which this advisor should be reported. Licences are needed to sell some products and it might be worth a good conversation with a person with power! Get hold of the profile questionnaire she answered at the time of purchase.
March 17, 2009 at 9:28 am
@ Marie — yes I see that this is slightly different, they do give 100% of the index return but its capped at 20%; this means that you get a maximum annual return of 6.5%. This means that relative to the market, your maximum upside is +0% while your downside is -6.5% (in other words, your guaranteed return if the market performs well doesen’t increase, but if it doesn’t your guranteed return decreases). Combine this with the other points + the basic fact that your gic comes due the day it comes due with no input from you (ie selling this week versus selling last week) and it’s a terrible product and I’ll go to my grave saying so. You can build your own PPN — basically on the same day buy a GIC and invest the interest you’ll earn on that GIC in the future into equities for a better approach where you have more control if you’re that interested in a PPN + get dividends too with no cap.
Re: Gemini – a sad but all too common story. Until the financial industry starts taking accreditation and accountability seriously it will never be considered a true profession in my opinion.
March 17, 2009 at 12:20 pm
Geoff:
Different banks calculate the return differently (some average, so your odds are better). Laddering is an important toll to use against the drawback of calculating returns based on two specific days.
Like I said, it is not perfect but it varies your risks
March 17, 2009 at 1:58 pm
Marie – averaging doesn’t necessarily make your odds better, it does however flatten the spectrum between no returns and high returns — so you the peaks aren’t high but the valleys aren’t quite so low. The ultimate winner in these products is the banks, who get most of the upside and the only downside is they may have to return the original investment you provided, but not adjusted for inflation. It’s pretty easy to bet coming up with $20,000 in the future is going to be easier than coming up with it today. But to each their own, If I were that smart I’d be rich after all!
I have a no problem with a traditional GIC ladder, just these products are somewhat predatory in how they gloss over important details. I still think its better to separate your fixed income products from equities (and I know people are wisely cautious of equities, but my basic rule is if I buy products from this company regularly, I’ll buy stock of it too — coke, gas, banks, etc). I’m just not willing to bet yet that tommorow I’m going to wake up in a mad max world gone mad scenario like some anti-stock people seem to be
March 17, 2009 at 3:39 pm
Gail,
Thanks for your article, can you explain a bit more why you thing that LOC (line of credit) is a bad replacement for emergency fund?
Thanks.
March 17, 2009 at 4:11 pm
Alex – Gail has covered this before – it’s because a LOC, unlike an emergency saving account – has specific requirements to be paid back and you will pay interest until you do so. Paying a $5000 car repair out of $5000 in savings doesn’t necessarily mean you have to rebuild your emergency fund absolutely as soon as possible (in fact, if you think about it, it actually will take a while) but pulling the same $5K out of a line of credit means you should repay it right away. Now that said personally I have an emergency fund that is much smaller than my (untouched) line of credit but I do hope to have equal amounts in both in the future.
March 17, 2009 at 4:51 pm
Alex, the point of an emergency fund is to get through the emergency in tact financially. If your essential monthly expenses are $2500 and you lose your job and are out of work for 5 months, using a LOC as an emergency fund means you’ll be $12500 in debt when you’re done! ditto if the roof blows off, the car gives up the ghost or your partner throws your butt out and you have to find a new place to live. Having cash in the bank is a real safety net.
March 17, 2009 at 5:54 pm
I would not be surprised if a bank can cancel a LOC at will. It must be written somewhere in the fine print. Your emergency money is yours!
March 18, 2009 at 2:03 am
Thanks Marie for the advice. I wish I knew if there were any rules for this situation. Not contacting a client but forcing them to contact you is not my way of building a client base or credibility in the marketplace.
My insurance agent made a copy of this agreement (one signature and 10 initialled clauses) and talked about it in his firm. He is tied to making yearly visits to all his clients and no one escapes the visit. Otherwise, he’d be drawn and quartered which is something I’d like to see for this advisor. Unfortunately, my mom only had $50,000. to invest with him. He probably doesn’t worry about such small fry and his vision is maybe more of a gambling vision for people who want to invest. My mom was left to junior people who obviously didn’t clean the accounts up properly and since the money was tied up for so long, all she got were yearly letters asking the clients to inform the advisors of changes in their profiles. It had to come from the client to ask for whatever advice or help in changing the goals. My mom just collected the paperwork and stored it. Why call when you can’t do anything but lose real money by touching it.
The funny thing is that in the last three months there have been three requests for updating her profile (since we called about the date for the full amount returning to mom from the bad investment). Unfortunately, they sent out the same forms with the same profile info and highlighted all the spots to initial – which also had yellow arrows pointing to the place where she is to initial. No calls – no conversations over the phone. Just fill out the forms and return them (which probably means – we need our asses covered – so just send it in without query).
Sad world.
April 18, 2009 at 9:59 am
[...] Comment on Desperate Times by Gemini [...]