Canadian Personal Finance Blog

Archive for the ‘Rich’ Category

For two days week we had been talking about where Risk fits in our day to day financial decision points, and I have been adding in examples of Risky Business in my life, today (finally) we wrap this whole thing up.

Previous Posts: Risks in Life I and Risks in Life II

When to Sell?

Yup this one is the big risky one that, I can assure you, I have no idea of when the best time to sell a security is, blind luck has been my best methodology. Most of my “great” financial decisions have been forced upon me (i.e. I needed to sell to get the money in question), so deciding that a security should be sold is something I am not very good at prognosticating.

I have read many books who state unequivocally that if your investment decisions are made emotionally, you will lose in the long run. Going with your “gut” is a dangerous game to play in poker and also in investing, the danger is that if your “gut” is right once, you may rely on it far too much in the future.

Take your profits is the best methodology I have heard (e.g. re-balance your portfolio) in the world of investing. If your portfolio has one area that is doing great, maybe it is time to take your profits and lock them in, instead of “letting it ride”? Maybe you are very risk averse like me (i.e. burned so many times, I have very little nerve left), if that is the case taking your profits, when you see them might be your best decision point.

Am I espousing a specific investment methodology? No, my regular readers know me better than that, you need to find a methodology that fits your needs and I am NOT in any way shape or form advising you on what to buy, what to sell and when to do either, I am simply pointing out in my case, “Take the Money” has worked. I’ll let the REAL investment blogs talk about that kind of stuff.

The risks in this scenario is obvious, take your money now, or will you have more later?

RRSP or Mortgage?

Is this a risk area? That’s a good question, I don’t think it is a high risk area, unless you are doing something whacky like the Smith Manoeuvre or something like that, if you do either of these (pay down mortgage or build up RRSP), you are doing OK.

I have seen a few different models done about the optimal model for paying down debt/mortgage and RRSP contributions, but I am very debt averse right now, and also am in a relatively stable pension situation, so my decision has been to attack debt as much as possible (with a little success).

The risk again comes down to present money value vs. possible future gains. Get a plan for how you want to deal with it and then stick to it.

So What About Risk?

As we have seen the past few days, risk comes into most major (and a lot of minor) financial decisions but you need to weigh risk against the benefits and make your decision in a calm and rational manner.

Analyze the risks, weigh them in your decision, and you should do just fine.

Yesterday we started out by discussing NFL football, and then got onto the topic of Risk and it’s importance in key financial decisions in your life. Today we continue on with more examples from my life about Risk and how it played part in my decision process.

Example 2: Exercise Options or Not?

When I worked at Nortel, I had stock options and there was always the question about whether I should exercise the options or hold onto them in case the stock went up in price. Luckily for me, they were never worth more than $389.67 (yes I remember the exact amount), and no I didn’t exercise them, because I was foolish, so that money was never mine.

Many people I worked with had the same decision to make but with MUCH larger valuations on their options, and they didn’t “pull the trigger” either. I do know a few folks who simply said, “Give me my money”, every time their options came up, and didn’t care about whether the stock might go up, they simply wanted their money, and those folks (in hindsight) are the ones who did the best in the options game.

Risks are high in options, and luckily it’s a game I won’t be playing any more.

Example 3: Buy or Lease a Car?

Many of my friends have leased cars, but I never thought for me it was a good deal. I have owned used cars most of my life (I did buy a GM product new, which luckily I had an extended warranty on) and I have typically driven my cars until they were dead (or 5 months after that), or until my mechanic told me I had to get rid of it (he did refuse to fix a Honda Accord I owned that was in very bad shape).

My view of a car is purely functional, it is not an extension of my masculinity or of my prestige, so having a new car is nice, but not an important variable for me.

Leasing usually means you can afford “more” car than you can afford, however, after 3 years you own nothing (and if you have driven it too much, or worse dinged it once or twice, you are hit with extensive punitive fees). You can simply walk away from the lease, or you can buy your car at that point, however the money you paid in lease hasn’t gone towards the car really, you are simply paying the current value of the car.

Is there risk here? If you BUY a lemon (i.e. a car that is just overrun with defects and issues) you are going to have a problem getting rid of it and it will cost a lot to maintain it, whereas you can walk away from it if you lease the car (typically the lease period and warranty period are about the same time frame).

I’ll continue to buy cars, unless I get a job where leasing might make sense (i.e. you can write off the value of the lease as a percentage of how much it is used for your job/business).

Tomorrow: Final examples and an epilogue

On Sunday NFL Coach Bill Belichick (of the New England Patriots) took a calculated risk and instead of punting on a 4th down late in the game he tried to make the 1st down. This in itself is not that risky a play in Football, however there were circumstances around this choice that made the decision very risky:

1. His team was leading at the time by 6 points (more than a field goal, less than a converted touchdown)
2. The ball was on the Patriots 28 yard line
3. There was 2:08 left in the game
4. His team needed to get 2 yards on the play (not a small amount).

If he punts the ball to his opponent he leaves the game in the hands of his defense, and his opponents most likely have to cover over 80 yards to score (and must score a touchdown not just a field goal).

The risk (in my opinion) was far too high for the decision made, and in hindsight the decision was proven wrong, as his team failed to get first down and left their opponents only 28 yards to score a game winning touchdown (which they did), but it is easy to second guess that kind of decision after it has been proven wrong (i.e. Monday Morning Quarterback club, which I am a charter member)

So What?

So what does this have to do with Personal Finance you might well ask?

Do you take into consideration all the risks that are part of your financial decisions? Do you look before you leap, or do you just roll the dice and let the fates take care of things for you?

Risk is involved in all decisions, and you can paralyze yourself worrying about risks, especially in personal finance, but with larger financial decisions it is imperative to think about what you are about to do, and what risks are involved in the decision.

Let me run through a few personal experiences with major decisions and risk.

Example 1: Lock In or Float?

With folks buying their first home, the question always arises, should you lock in your interest rate, or should you go with a lower but floating interest rate? Back when I was looking at houses for the first time, I locked in at 11% thinking I was getting a great deal (given interest rates had been at 18% previously), so I locked in for 5 years. The decision was made because we could afford the payments at that rate and didn’t want any surprise increases in our budget.

The decision was wrong in hindsight because interest rates dropped to much lower rates after that, but I don’t view that as a wrong decision, more a conservative decision.

I now live on a floating interest rate loan vehicle, because I can withstand a sudden sharp interest rate increase.

The risk here is, can I withstand catastrophic interest rate increases?

Tomorrow: More examples…

Michael James (nominated by the Globe and Mail as one of Canada’s top Financial Bloggers) and I were having a discussion on Friday night about an interesting article written by Jon Chevreau at the National Post: Even Young Millionaires Need to Worry About Financial Planning.

The article outlines how young athletes who suddenly come into large amounts of money tend to expand their lifestyle and spending to reflect their new riches and many times don’t learn the importance of Personal Financial Planning until much too late in their lives. I quote:

Within two years of retirement, 78% of former NFL players have gone bankrupt or are under financial stress, while an estimated 60%  of former NBA players are broke within five years of retirement, according to the March 23, 2009 issue of Sports Illustrated magazine.

Michael James did not believe the number and questioned whether it was as bad as all that (he agreed that there is a problem, he just couldn’t believe it was as bad as all that). My view is this is very possible and I would not be surprised if it was worse than the numbers quoted by Sports Illustrated or by Mr. Chevreau.

The allure of a “rich” lifestyle and the fact that you have worked very hard to receive this monetary level does tend to throw off a lot of people’s Financial Gyroscopes (as it were). I have seen this at a smaller scale with folks that have got University degrees have lived a frugal lifestyle to get through the studies and when they graduate and get a good paying job, at first they remain frugal but then some folks just decide, “Heck, I deserve it!”, and start to lose their financial minds (I will plead guilty to this once or twice as well).

My guess is this is what happens with Professional Athletes, but they have the added problem of an entire species (for lack of a better term) of humans that seem to exist to prey on them, the hangers on (much like lampreys or other parasites). These people raison d’etre seems to be to leech off these walking banks, and this does not help these young people who suddenly get more money than they could ever dream of having. They get very odd financial advise from alleged professionals, and maybe trust people they shouldn’t trust (or worse trust people who then betray that trust). The players unions are trying to fix this, we shall see how well they might do (see the Sports Illustrated article for an eye opening statement by Raghib Ismail).

I remember when I was growing up and pro athletes did not make a lot of money (they made more than most working folks), but I remember a scout leader I had telling us about Dick Duff, because he played for the Canadiens (and the Leafs), but he had gone back to school to become a teacher, so he had a job after he finished with hockey. Do today’s athletes need to do this? Depends on the sport, and their pay level, but if they don’t plan their finances and plan for their ENTIRE life they are doomed to fall into the Rich Lifestyle trap.

Would I fall prey to this trap? We’ll never know, since my athletic talents were never a danger of putting me in this predicament.

In Ottawa this week our Hockey team fired yet another coach, meaning our team is actually paying for 3 different coaches right now (the one we fired last year, the one we fired this year, and the current coach), which is not very good planning (paying 2 people NOT to do a job), however, the main statement is that the previous coaches did not hold the players accountable for their play (i.e. the players were allowed to do what the heck they wanted without concern of less playing time, or punishment for sloppy play in practice) and thus the players were “lazy”.

This got me thinking this accountability concept is vital in business and a few of the bigger problem areas of the economy there is a lack of accountability seen as well.

Bank CEO’s

We are seeing the Canadian Bank CEO’s making an attempt to appear to be “tightening their belts” and “taking one for the team” by eschewing some bonus money. While my opinion is this isn’t enough, at least the optics of the acts show at least some penitence for their actions, and thus some perceived accountability.

High Tech

There I don’t see as much. Nortel’s CEO has still not really shown any contrition or accoutability in his actions, which makes a lot of folk wonder does he feel accountable for the companies current situation? Employees who are about to get laid off with little or no severance are not as likely to “go to the wall” if they know their CEO is still raking in big money.

John Chambers from Cisco on the other hand for a while (and might still now, I can’t find any coroboration) took a salary of $1 per year (he got other compensation), but that alone has great optics for employees. Is he still very rich? My guess is it is not likely that he is trying to create extra income for his family by taking a part time job at Home Depot.

Overall Accountability

Accountability of the folks in power and of anyone you deal with directly (especially when it comes to your money) is a vital thing to look for. 

If you have a financial advisor, how are they accountable to you? If they give  you bad investment advice what happens? Ask that if you are talking to your advisor. If their answer is, “… well, I’ll try to do better next time”, you might want to think about not hiring them. How can you make this person accountable for their decisions with your money?

How do we make CEO’s of large firms accountable? Make sure if you are a stock holder you vote for your Board of Directors, since they are supposed to represent your best interests (whether they do or not, is another question). Go to the yearly stockholders meetings, ask questions and read the company prospectus (no matter how painful it might be).

You can’t hold someone accountable for anything, if you aren’t sure of what they are doing, and you can’t ask pointed questions about what is being done, if you don’t know, “what is being done”.

Make yourself accountable for your decisions, but also make the folks you deal with directly (and those that work for you) accountable for their actions and decisions, it will make the whole system work that much better.