Mutual Fun…ds – Part II

In Part I, we went through mutual fund basics; what they are, the different types, and what to keep in mind when certain mutual funds are being recommended to you by your friendly neighbourhood financial adviser or investment professional.

So why buy mutual funds in the first place?

–          Diversification is the main advantage. If you do not have the time (or desire) to research individual stocks and bonds, owning a mutual fund gives you exposure to a large number of them. Therefore, the inherent risk in owning shares in a company is spread out. In other words, if a company goes out of business, the impact on your mutual fund portfolio would be less than if your portfolio consisted of just shares in that company. Mutual funds also give you the opportunity to own a lot more than you would normally be able to do the amount of cash you have invested. i.e. All I want for Christmas is ONE share of Berkshire Hathaway – all yours for the low, current price of $117, 925.

–          Transaction Cost Savings – because mutual funds trade in larger volumes, their transaction costs would be cheaper than what it would be if you bought the stocks yourself.

–          Liquidity – for the most part, mutual fund shares should be pretty easy to sell which will then be converted to cash.

–          Simplicity – just hop on over to your nearest bank, investment or insurance company and they will be MORE THAN happy to sell you some of their products. You can make lump sum purchases or set up automatic purchases every month.

–          Professional Management – TECHNICALLY this is an advantage. It is probably the main advantage that your financial planner/adviser will tell you. Come on, you have a PROFESSIONAL investment manager handling your portfolio for you! Unfortunately, there has been no statistical data proving that actively managed funds perform better than the stock market on a long term basis. Every year, there are managers who do achieve returns higher than the market, but very seldom can they consistently do it year after year. So I will, very grudgingly, add it as an advantage. Cause it is… sorta. Not really. But I digress.

So what are the disadvantages?

–          Professional Management – So I kind of cheated. 🙂 Like I mentioned before, there is no statistical proof that actively managed mutual funds perform better than the market itself. If it was, then everyone who has mutual funds should be RICH! Ya, right. You know who is though? The mutual fund managers and companies. Why is that? When we MAKE money on our mutual funds, they MAKE money. When we LOSE money, they still MAKE money. Something wrong with this picture?

–          Costs – mutual funds aren’t cheap! They are, after all, a product. Not only do you have to pay for the professional fund management, you also have to pay for all the shiny advertising material that you receive when you first purchase the mutual fund. You also pay for someone to keep track of how many shares you own. Oh, and that friendly neighbourhood financial planner of yours? Yup, you are also paying them for selling you the mutual fund in the first place.

–          Taxes – if you are purchasing mutual funds in your RRSPs, then this isn’t an issue. If you are holding mutual funds in a non-registered account, you have to be aware of the tax implications! When the fund manager sells a security, it may trigger a capital gain. These gains are then passed on to the investors, who bear the responsibility of paying for the taxes associated with it.

Like I said, there is a lot to learn about mutual funds. So a question that may follow all this juicy information would be: so, what mutual funds do you own? Er, well, like I mentioned before, I don’t personally own mutual funds. BUT, that doesn’t mean I wouldn’t recommend them. Stay tuned for Part III in the series where I will delve into the world of index mutual funds! I will show you how you can make the most of the advantages that are provided by mutual funds, while limiting the inherent disadvantages as well. All for the low price of… kidding!

What do you think? More info than you ever wanted to know about mutual funds? 🙂

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Mutual Fun…ds – Part I

Tis the season! RRSP season that is! If you haven’t heard from your financial planner or investment representative yet, expect a call from them pretty soon. I can only imagine what percentage of their annual business is completed during the first few months as people are rushing to make their RRSP contribution before the deadline (February 29, 2012).

The mutual fund industry has done a brilliant job of advertising and convincing people that Registered Retirement Saving Plans (RRSPs) and mutual funds are one and the same. Remember, RRSPs are an investment VEHICLE that can be filled with different types of investments, such as Exchange Traded Funds (ETFs), Guaranteed Investment Certificates (GICs), mutual funds, bonds, and even good old cash. Ditto with your Tax Free Saving Account (TFSA).  Just because you have RRSPs DOES NOT mean you are limited to just mutual funds.

I think a large percentage of my readers currently own mutual funds. But if I were to ask them what they are, what percentage would be able to answer? Can you tell me what mutual funds are? If you hesitated, don’t feel guilty. I’m sure a lot of people would be stumped; at least they are from my experience. Yet, we are all rushing to throw hundreds or thousands of dollars to invest in them.

What are they?

A mutual fund is essentially a portfolio of stocks and/or bonds. Instead of you going out and buying shares in companies (stock) or bonds (either company bonds or government bonds), mutual funds do that for you. They collect money from a group of people, and in turn, their professional fund manager buys and sells stocks, bonds and other securities based on goals of the fund. As an investor in a mutual fund, you own shares, and this represents a portion of the holdings of the fund.

In Canada, we are fortunate enough to have the largest variety of mutual funds in the world! Unfortunately, we are also subject to some of the highest fees in the world. There are a lot of types of mutual funds you can buy, but they boil down to three main types:

–          Money market: These funds usually consist of short-term debt, such as T-bills. The return is very minimal and it is a relatively safe place to park your money. Notice that I said PARK your money, not INVEST your money.

–          Fixed-income/Bond Funds: The purpose of these funds is to provide income on a steady basis. They invest primarily in either corporate debt or government debt. In other words, you are lending money to companies or the government, and they’ll pay you for it. These funds are riskier than money market funds, especially in a low interest rate environment (which we are currently in). All you need to know is that when interest rates GO UP, bond values will GO DOWN.

–          Equity Funds: Basically funds that hold different stocks. Different funds have different investing goals, which will affect the different types of stocks the fund manager will buy and sell. These are the riskiest types of mutual funds, but also the ones with the potential to provide the most gains.

If you invest with a bank or investment company, they will go through the exercise of figuring out your asset allocation. You will have to sign off on this, which essentially will cover their butts if you lose your money and want to sue them. With this allocation, they will proceed to recommend a portfolio that contains either one (or a collection) of mutual funds. Although it may feel like you are handing your money over to a ‘professional,’ do not blindly trust that they have your best interests at heart. Ultimately, their paycheque and bonuses are based on the volume of products (mutual funds) they can sell. Before purchasing any mutual funds, ask them what the MERs are, and if there are any additional sales charges associated with the recommended funds. As a general rule of thumb, you want to own funds with the LOWEST MERs and do not have any additional sales charges at all. Expect some resistance. After all, higher sales charges = more money for them.

Phew.. there is a lot to say about mutual funds. I want to give you a brief overview, so stay tuned for Part II, where we will go over the advantages and disadvantages of mutual funds, and my favourite types of mutual funds (index funds!). Following this will be some information on Exchange Traded Funds (ETFs) as requested!

Are you going to make a last minute RRSP contribution? Are you planning on investing it in mutual funds?

I need your help! As this is a new blog, please spread the word on Facebook, Twitter, or email the link to a friend or family member. Thanks for the support!

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Income – December 2011 Update

Income can be earned in two forms: active and passive. Active income is money you earn during your job; you have to actually be working to receive the money. Passive income, on the other hand, is earned by the money you have invested (cash, stocks, etc.). Even if you are not working, this money is still working hard for you, and earning money for you even while you sleep! Or while you are playing video games. Or watching TV. You get the idea.

It’s been just over 13 months since I last had a job, so I haven’t earned any active income from a day job during that time. As a result, my main source of income I have these days is earned passively. I thought it would be interesting to document this going forward, as it may help me set up some financial goals for this year, as well as determine whether or not my current asset allocation is ideal. Who knows, I might even get a real job or something crazy like that. 🙂

So my income for December is as follows (rounded to the nearest $10):

Active income from financial consulting: $100 (Cheap labour people! Get it while you can!)

Interest income from my savings: $80

Interest income from my investments: $760

Dividend income from my investments: $500

Total income: $1,440

Some notes on the above:

– This is not a normal month as a lot of my investments have either annual or quarterly payouts, and December is definitely one of the higher (if not the highest month). An annual summary would be more useful as my monthly income will fluctuate greatly, but it is still interesting. (For me anyways! :))

-My investment income is automatically set to reinvest in more shares. If the money is not sufficient to buy additional shares, then it will increase my cash balance.

To actually be financially free, my passive income should be enough to cover my monthly expenses. I still have a ways to go to get there, and this will always be my long term financial goal. Now.. how to do that without having a 9-5… 🙂

What do you think? Do you think of the money you earn as being active or passive? Is this something you would want to start tracking?

I need your help! As this is a new blog, please spread the word on Facebook, Twitter, or email the link to a friend or family member. Thanks for the support!

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Case Study 1: January 2012 Update

We first met our case study about a month ago. Even though I have met up with them a couple times since then, I figured a monthly update would be sufficient to monitor their progress and their unique journey to a better financial future.

The following net worth summary is based on information that was accessible at our last meeting. You will notice that some numbers are unchanged as new information was not yet available.

January 2012

Assets
Chequing

1,996

Savings 1

127

Savings 2

1,200

Term deposit

16,149

RRSP 1

15,242

RRSP 2

30,849

Total

65,563

Liabilities
Credit Card 1

23,073

11.99% interest rate

Credit Card 2

5,292

21.99% interest rate

Credit Card 3

0

PAID OFF!

Credit Card 4

0

PAID OFF!

RSP Loan

19,240

13% interest rate

Credit Card 5

7,918

19.99% interest rate

Home Renovations

1,870

0% interest rate

Total

57,393

Net Worth

8,170

                  + 5,494

Month 1: Action items

  1. Cash only. No more credit cards or debit cards. No more credit cards; still required some debit transactions.
  2. I set up a budget for them. Yes, I know, most will hate this step, but we need to have an understanding of where the money is going and learn to curb the spending. Done!
  3. I want them to reduce their fixed expenses down to 42%. This will involve steps such as cutting out unused cable services, removing an unnecessary cell phone and paper billing (cell phone companies charge you money to send you a bill. Seriously?), and remove any unnecessary bank charges. Done! The toughest part for them was cutting down their cable services. We are working on alternative shows and/or channels that can supplement the change. Last thing I want is for them to be miserable! 🙂
  4. I want them to reduce their variable expenses down to 13%. This is going to be the interesting part. They will have $700 that will be used for groceries, transportation including gas and any transit passes, as well as all entertainment, clothing, haircuts, subscriptions or eating out with friends. This has been pretty good. With a month under their belt, they realize that they can use another $200 for discretionary spending, and we figured out where the money was going to come from.
  5. Change any credit cards with annual fees to cards without annual fees. Done!

Month 1: Goals

  1. Credit Card 3 will be paid off. Done!
  2. Additional payments, beyond the minimum payment, will be made to credit card 4. I want to systematically pay down their credit cards, starting with the ones carrying the highest interest rates. Done! With an additional paycheque this month, they were able to completely pay off credit card 4! Woot woot!
  3. Set up an ASP after opening an ING Savings account. This will serve as their emergency fund. Done! We are starting with a monthly contribution of $100 each to their accounts and will hopefully increase this once we have a better understanding of their cash flow.

With a month under their belt, they realized that the spending plan that I set up for them is pretty reasonable, but have negotiated an additional $200 for miscellaneous expenses. They are currently contributing $400 a month to an advisor to invest in mutual funds on their behalf. After a couple of discussions, I have (hopefully!) convinced them that their priority should be paying off their very expensive debt instead of investing in mutual funds for the time being. Once their consumer debt has been cleared, then we can start chatting about investing, with the primary goals of setting up a comfortable emergency fund and maximizing their TFSAs. So if they discontinue this $400 contribution to their RRSPs, they can use $200 towards their discretionary spending and use the other $200 towards paying down their debt.

It’s been a pretty good month overall! They’re working hard sticking to the spending plan I set up for them and they especially enjoy the credit card balances shrink to zero!

Month 2: Action items

  1. Their saving accounts are earning pennies (literally!) every month. The balances will be transferred to their ING savings accounts to earn 1.5% instead.
  2. They have noticed that there are service charges showing up on their bank statements and are unsure what they are. They will investigate these charges with their bank this month.
  3. They are going to call credit card companies 2 and 5 to see if they can get a reduction in the interest rate. This is a tough call for anyone to make, so it will be interesting to see what kind of response they will get.
  4. They have to cancel their current $400 contribution to their RRSPs in order to boost the amount of money they have in their spending plan as well as have some additional money to put towards their credit cards.
  5. They are currently contributing $100 each to their ING savings accounts. Based on this month’s cash flow, I would like to see this number increased a bit going forward.

Month 2: Goals

  1. Make additional payments towards Credit Card 5 beyond the minimum payment, and have it completely paid off by April.
  2. Have Credit Card 2 completely paid off by June.

The best part about this month’s goals is that they were their OWN goals. Pretty ambitious, but I know they can do it!

What do you think of their progress? What do you think about the action items and the suggestions I made for them? Are you in a similar situation? If so, have you made any steps towards fixing the problem? Do you think it would be easier to do if you had someone to keep you accountable?

Are you enjoying the case study and the update? Would you like to see more case studies on here?

I need your help! As this is a new blog, please spread the word on Facebook and/or Twitter! Or email the link to a friend or family member!

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Emergency Fund

One of the initial financial goals I would recommend to people is to set up an emergency fund. This may seem counter-intuitive, especially if they are carrying hefty credit card debt at outrageous interest rates. Wouldn’t the money be better spent paying down the debt? I think a balance between the two is ideal.

Life happens. Your car breaks down and needs a new transmission. A family member or child falls ill and you have to take time off without pay to take care of them. You need to get your wisdom teeth removed and your employer’s health insurance only covers 50%, and you’re responsible for the rest. Or, your company restructures, and you find yourself without a job.

If you are living paycheque to paycheque, you will be scrambling to make ends meet. Without an emergency fund, you will be forced to rely on credit, whether it is from your line of credit, your credit cards, or even those evil cash advance places. These sources may provide the additional funds required make ends meet in the short term, but you may end up paying for those expenses for years to come.

How much?

Experts usually recommend 3-6 months of living expenses. How much is that? If you have a budget, you would know exactly how much money you would want to target for this account.  😛 If you have never had an emergency fund, start with whatever you can. Set up an account that will automatically withdraw a certain amount from every paycheque. Even $20 helps. See if you can slowly increase this amount once you get a better handle on your finances.

WARNING

The biggest issue with a hefty emergency fund is that the definition of emergencies becomes more and more interesting.

Example 1. Problem: I am so stressed!

Solution: I need to head to Vegas or to the beach somewhere hot.

Reality: I want to party. This is not an emergency.

Example 2. Problem: I want to save money but still have fun!

Solution: I should buy a hot tub or a pool table. I will spend more time at home with friends and save money!

Reality: I want to party. This is not an emergency.

Example 3. Problem: I have been working sooooo hard!

Solution: I deserve a new outfit or a new tv or a day at the spa.

Reality: THIS IS NOT AN EMERGENCY

You get the idea. Ultimately, the goal with an emergency fund is to have a bit of money set aside in case sh*t happens. It will happen. But when it does, you won’t have to rely solely on credit to deal with it.

Do you currently have money set aside for an emergency fund? Would this be a good thing to add to your list of financial goals this year?

I need your help! As this is a new blog, please spread the word on Facebook, Twitter, or email the link to a friend or family member. Thanks for the support!

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Peanut Budget Jelly Time!

It’s time for the talk. It’s been almost two months into this relationship of ours. Some good times. Some tougher times. But before we go any further into the relationship, we have to have this talk. You knew it was coming as I’ve brought it up before, but I think it has reached the point where it is now or never.

I am talking about Budgets. What else did you think I was talking about? 🙂 I don’t personally understand the inherent dislike and hatred of budgets. I personally ❤ keeping track of the dollars and seeing what they’re doing, whether they’re coming in and staying for awhile or heading out to purchase a cupcake for me. It’s like stalking people on Facebook and seeing what they’re up to! Well, not exactly, but you get the idea.

If you have never kept a budget before, I recommend doing this for just 3 months. This will give you an idea of what your cash flow is like, and helps tell your financial story. Most people I talk to believe that budgets are unnecessary but when I ask them what they spend their money on, their guesses are WAY off from reality. With a more accurate understanding of your cash flow, you will be then equipped to answer stressful money questions such as: Can I buy a house? Am I saving enough for retirement? How much can I invest each year? Or the most important question of all: Am I spending more than I am earning?

The toughest part of a budget is keeping track of all your daily transactions. Some find that a little notebook in their pocket is the best to jot down every purchase. Some prefer to jot down their transactions on a spreadsheet similar to this Budget template. You can customize it and print it out to write down your expenses, or just track it in excel. Others prefer to use an electronic tracking tools (Quicken, Mint, etc.) to accumulate the data to make it easier to manipulate. Whatever you choose, try to stick with it for just 3 months.

Once you have 3 months worth of information, you can sit down and figure out where your money is going. More importantly, you can determine if you are spending your hard earned money on things that are important to you. Are there categories where the amount of spending surprised you? Are there categories that you are willing to cut back on? Are there categories where your spending is perfectly aligned with your priorities in life? From this, you can determine which level you are at in my Financial Well-being game. If you are at Levels 1 or 2, you can now see which spending categories you can cut back on to put yourself in a better financial position. If you are in one of the later levels, congrats! Using this information will allow you to set savings and investment goals.

If you have completed this challenge for 3 months and absolutely HATED keeping track of every transaction, there are other options. I only recommend you do this if you have progressed beyond Level 2 in the game. Until then, I believe you should still be tracking your expenses, as 3 months may not be sufficient enough for you to have a full understanding of why you are spending more than you are making and why you are being forced to use credit cards to supplement your lifestyle.

For those who are looking for other options, you can set things up automatically. The concept is basically PAY YOURSELF FIRST! You basically treat your savings and investment goals as bills. As a result, you make these payments to yourself BEFORE paying every other person in your list. This way, your goals will be achieved without too much effort and thought on your end, and you do not risk paying everyone else first and leaving nothing for yourself at the end of the month. This can be a tricky to do though without a having a good understanding of your cash flow; you DO NOT want to end up in an overdraft position with your chequing account!

Ideally, if you can put a percentage towards saving and investing at the beginning of every month and don’t run out of money at the end of the month, you are good! You can start off small, say 5% of every paycheque is paid to yourself at the beginning of the month. If you find that you have a bit of extra money at the end of the month, boost this percentage up. What’s the ideal number? Depends on your savings goals and your priorities in life. My personal saving % has ranged from zero (sigh.. although I am enjoying my current lifestyle) to almost 60%.

Do you keep a budget? Is this something you have thought about and keep meaning to do? Is the effort worth it? Is this something you can use some help on?

I need your help! As this is a new blog, please spread the word on Facebook, Twitter, or email the link to a friend or family member. Thanks for the support!

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Credit Score Sucks A**; Now What?

After you read my previous post about credit reports, I’m sure ALL of you rushed out to order your free copy of your credit history! (I can hope, can’t I?) So what if your credit score is less than ideal?

Here are some quick tips for using credit responsibly:

  • All your bills should be paid on time with at least the minimum required payment. Even though most bills are not reported to credit agencies, some cell phone companies may pass along late payment information.
  • Debts should be paid off as quickly as possible.
  • You shouldn’t be maxing out the credit available to you. Try to keep the amount you use (borrowed) under 30% (or even 10%!). The higher the ratio between the amount of credit you are utilizing vs. the amount of credit you have available to you will have an impact on your credit score.
  • To increase your credit score, avoid loan consolidation. This also affects the previously mentioned ratio (amount utilized vs. amount available). In other words, it is better to have smaller balances on a larger number of cards than to have a bigger balance on one card. (No balance is ideal. Just throwing it out there).
  • Understand the difference between hard inquiries and soft inquiries. Whenever you check your credit score, this is a soft inquiry. Soft inquiries also occur when a business you already have an account with checks your credit report, or if a business checks your credit report for promotional purposes. Soft inquiries will not affect your credit score. Hard inquiries are made by lenders. One or two hard inquiries a year are considered normal, so avoid applying for multiple credit products (new credit cards, loans etc.) within a year.
  • A long credit history is beneficial to your score, so avoid cancelling ones with a longer track record

There are no easy fixes to your credit score unfortunately, but it can be done. Ultimately, if you are looking to improve your credit score, one of the first places I would look at would be your spending habits and cash flow, as this would be the root of the problem. Calculate your net worth and set up a budget (even if it is only for a few months) to have a better understanding of where your money is going. One of the things I have learned from working with my clients is that there is a BIG disconnect between what people THINK they are spending, and what they are ACTUALLY spending.

Do you keep apprised of your credit history? Do you have an idea of what your credit score is? Have you ever been refused credit?

I need your help! As this is a new blog, please spread the word on Facebook, Twitter, or email the link to a friend or family member. Thanks for the support!

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