Wednesday, August 27, 2008

The Thirties - The Sandwich Years, Part I

This is a continuation of my decade-by-decade plan toward financial freedom and the pursuit of prosperity.

I anticipate the thirties will present exciting moments in my lifetime, but they will also present some of the most difficult financial decisions I will ever have to make. I know that during these years my parents will both retire full-time, and live off one pension, and their RRSP investments. I also anticipate that my wife and I will start a family during this time as well. I well then officially become the "Sandwich Generation" - potentially having to take care of my parents above me and my children below me. This means conflicting financial decisions, and potentially less room to contribute to savings and investments. My plan, and suggestion for anyone in this stage of life: don't sacrifice your retirement funds for any other costs, no matter how difficult that appears.

I know, I know. I won't "get it" until I become a parent, but I am a firm believer that you must, must, MUST fully contribute to your retirement plans prior to any education funds. The power of compounding is a very powerful thing, and many people miss its value. $10,000 invested in a tax-deferred retirement account compounding at a rate of 8% will become $46,610 in 20 years, about the same time as a child enters their junior year of college/university. While that sounds great for a child's education fund, it's more critical that this money is invested into a retirement fund first: by allowing this investment to compound in a tax deferred (or tax-free) retirement fund, it would grow to $100,626 10 years after initial contribution, and $217,245 10 years beyond that. By deferring your retirement funding by the 20 years, in favour of contributing to your child's education, you are actually burdening your child with your retirement: you will have missed over $170,000 of funds in this example. Imagine the loss of 20 years of contributions!

Remember: you can't mortgage your retirement - nobody is going to lend you money so you can not pay them back. You can always help your children fund their education in other ways, including loans while you have the chance to work to pay them off.

To conclude, my plan is to continue to put maximum contributions into my retirement funds (RRSPs and the new TFSA), and beyond that contribute whatever I possibly can into my children's RESP. After all, I don't want to burden my children with my retirement expenses.

Tuesday, August 26, 2008

Should corporate bonds be part of a basic portfolio?

(Please note that I have read several books on the subject of asset allocation and fixed income securities before arriving at my opinion, including "The Art of Asset Allocation" by David Darst, "The Aggressive Conservative Investor" by Martin Whitman, and "Unconventional Success" by David Swensen. I would advise any novice or serious investor read books authored by investment giants such as these before arriving at their own conclusions.)

It's often overwhelming thinking about investing, let alone getting involved in the actual process. Researching stocks, purchasing investments, and hanging on through the emotional and financial highs and lows can certainly take a toll on even the strongest of investors. Perhaps the most nerve-racking issue for many novice and seasoned investors alike is asset allocation, and asset class selection. Many portfolios fail before they are even created simply through misallocation, chasing returns, and misunderstanding various asset classes and their correlations.

One of the most difficult asset classes in which to invest is the corporate bonds asset class. The novelty associated with them is simple: corporate bonds provide a premium over government bonds and government treasuries, with "less risk" as compared to corporate equity (preferred or common shares). As with equity, there are many types of debt securities that an individual can invest - regular corporate debt, convertible debentures, junk bonds, etc. The variety of private debt available to public investors alone should caution the average investor.

While corporate bonds can provide much higher returns than Treasury or government bonds in shorter timeframes, it is simply a matter of risk vs. reward. Corporate bonds attract higher yields the more doubtful their interest payments become. If an investor is fortunate to find a high-yield bond that performs well, great! You can outperform Treasuries, at least in the short run. I argue there are several problems with investing in corporate bonds that are both deep and resoundingly negative.

1. Callability: One of the biggest issues with corporate debt is the result of callability. Many investors buy into higher yield debt, expecting to be the next Michael Milken. Unfortunately, usually, investors of debt junk debt, or even lower grade investment debt face the unenviable and helpless callability of debt. You see, as debt becomes more attractive to investors, providing higher yields, the greater the chance that the debt will be called in the future. If a company starts with a lower debt rating, such as a CCC, it will garner a higher coupon rate than a similar bond holding a higher debt rating, such as BBB or AAA (a rare debt rating to achieve). If an investor were able to successfully decipher that the CCC company had attractive future prospects, or was "turning the corner", they may believe that they can achieve greater returns with less risk - a perfectly acceptable conclusion. The issue, however is that, as bondholders, the investors are unable to stop the corporation from calling their debt (literally buying them out - or more generously termed refinancing), in order to reissue debt at more favourable terms. Although investors may be astute in finding a great investment opportunity, they will fail to reap the rewards as a debt rating improves. In the meantime, the shareholders reap maximum rewards of the turnaround company, as the interest load decreases, and cash flow increases.

2. Risk: Most investors have been educated to believe that debt is less risky than equity, and therefore any debt security investment is valuable to individuals. In my opinion this is simply untrue. Consider the situation: a corporation continues to show deterioration in its operations, and this begins to hinder its debt ratings. As debt ratings decline, interest yields need to increase, and the market value will continue to fall to meet investors demands for risk premiums. An investor in these debts would hardly conclude that they are experiencing less risk. In fact, one could argue that the risk of such debt is similar to equity itself. In the quest to decrease risk and reduce portfolio correlation, corporate debt hardly provides assistance to either of these goals.

3. Risk premium: Currently, corporate bonds carrying a triple A rating (AAA) carry a forecasted yield of 5.53% (source Moody's Corporate Bonds Yield Forecast, July 2008, At the same time, the 30 year U.S. Treasury Debt (also carrying a AAA rating) carried an arguably risk-free projected rate of 4.52% ( The 1% premium is hardly conducive of adequate risk-reward payoff, when considering many companies have lost their coveted ratings in the last ten years, including the likes of Coca-Cola and 3M. At last count (April 2008), there were only six companies in the United States to hold AAA ratings, and only two, Exxon Mobil and General Electric have held these ratings since 1980. Considering the risks associated with holding bonds, even of the most highly regarded debt-worthy companies, the risk premium is just not there to justify purchasing these bonds either.

To conclude, in my humble opinion, any purchase of corporate bonds, even the most trust worthy of such bonds, fails to provide ample reward for individual investors. In my eyes the results are clear: (1) corporate bonds fail to reward investors for their intuitive research and insight, as bonds are called before they provide the great returns; (2) the risks of corporate bonds, especially in tougher economic times (like the times we are experiencing now) hardly provide any portfolio protection or diversification from equity risk that is expected (too highly correlated to equities) to warrant introduction of a large investment in them; and (3) even the most highly rated corporations fail to provide ample risk premium versus the risk free Treasury rate available in the marketplace. In light of these results, I have maintained minimal exposure to such assets (under 2% of my portfolio), and believe that all but the most sophisticated investors should keep minimal allocation in these securities. Most of my fixed income securities are held in e-Series TD CDN Bond Index funds to reduce my fees, allow for multiple monthly purchases, and avoid risks associated with more "profitable" endeavors in the fixed income space.

Monday, August 25, 2008

The Roaring Twenties

Although I'm nearing the end of this decade of my life, I have learned quite a bit about finances, investing, taxation and myself during these years.

My twenties did not go exactly as planned when it came to my finances. In retrospect, I realize that I spent more of my money on frivalous things than I should have, and this has probably deferred my ultimate goal several years. Only in the last two years, with the coaxing of my wife, did I really arrange my finances in a more effective way. Sure, I enjoyed the care-free and worry-free lifestyle, but only now do I realize that I could have balanced this with some sound financial decisions. The last couple of years have been most beneficial: I have begun the process of catching up on past years' RRSP (IRA) contribution limits, have realized the value of asset allocation, and have emphasized paying down my mortgage as quickly as possible.

For those of you starting your own path to riches, if you are in your twenties, I only have two major suggestions for you. First, enjoy yourself! While money is an important aspect in life, so are the memories of life. Go out there and search the world, your city, and your neighborhood. Learn as much as you can about the things around you. Life is too short to worry all the time, but always keep mind of my second suggestion: start saving inside and outside your RRSP (IRA) accounts.

It's important to save for your long-term future, but it is also important to build your nest egg for important decisions in your future, like homes, marriage and children. Savings and liquidity are the key to an financially free future.

The best way to start your savings program is to simply "pay" your savings and retirement accounts on a weekly, biweekly or monthly basis, as though it were any other bill. More importantly, you need to avoid cashing out your savings at all costs, as they are not there for day-to-day spending. By socking away at these two plans, you will save for both intermediate and long-term goals. The funds in your non-retirement accounts should only be used for life-changing events, like the purchase of a home, preparation for your marriage or covering the initial costs of bringing a child to this world. If you already have a home, are already married, or have children, these additional savings can provide the seed monies to an emergency fund, or can be used to build your retirement egg even faster.

The key to this type of savings is also to constantly save in this way during your lifetime. In future decades, you will expand on this savings program. By saving up front, you will be forced to reduce your spending, in favour of your automatic savings. I suggest that you commence with saving of 5% inside your RRSP and 5% outside your RRSP. This level of savings will allow you to still enjoy the early years of adulthood. As you grow accustomed to this savings rate, you can consider giving yourself a raise, and increasing your savings rate. In future posts I will discuss asset allocation, tax issues, etc., as I have encountered issues, etc.

The Basics

Over the next few days, I will describe my plan for financial freedom over the next few decades. In addition, I will also set guidelines for an individual starting their own journey in their twenties, thirties, forties, and so on. Today, I present my accomplishments in my twenties, and what I suggest other individuals in their first few years in the workforce do to build a solid foundation to a more sound financial outlook in the years to come.

Saturday, August 23, 2008


Hi all,

Welcome to my blog, where I'll be talking about everything and anything on my mind about money. As is the case with most people, I am looking forward to being financially free. Join me on my lifelong journey to achieve this goal. Along the way, I will try and share my experiences to help readers meet their goals, and not make the same mistakes as I've made in my past.

Feel free to let me know if you have questions or have anything on your mind.