I'm in Asia! learning stuff!

granted there are lots of cost saving ways to travel in south east asia.

the downside? you have to travel for at least 24 hours and fly literally to the other side of the planet.

as well, depending on where you go, no one will understand english.

I'm in the philippines because it still is an undeveloped tourist destination: it's even cheaper than thailand or vietnam and many of the beaches and resorts are pristine.

the best part: everyone one here loves Americans (they don't distinguish between white people from north america) and everyone (even those with little or no education) can understand rudimentary english.

It's very easy to get around and no one will over-hustle you: they simply aren't used to a tourism industry like thailand or vietnam (depending on which city and region you choose).

So what am i doing here? well, i mentioned previously that i spend a lot of time looking for alternative investments since i left the world of traditional asset mixing. Just so happens that i have a personal connection with a fellow who is highly connectd with the asian development bank, head quartered in manila.

did i ask for a specific deal, strategy or investment opportunity? NO.
what i did is called networking. I took the effort and time to find this person and to simply have a conversation. In essence, it was a global cold call.

We talked at length about my personal background and i had the opportunity to seek his opinion on much of the global turmoil taking place. His views on what counts as stable, what counts as volatile and what counts as a bargain are all well informed and based in the real world of securing credit (from a multitude of central banks and global financial institutions) for medium to large size firms involved in import/export trade throughout all of asia.

What did i learn that i can relate to you?
a few basic opinions, with the caveat that my new friend admits even the most informed cannot predict the future.

but he did point out the long, protracted nature of the current recession.
he pointed out that there is still a great deal of bad debt that has not worked its way through the global financial system (credit card debt is now just starting to become a serious problem for global financial institutions).
when asked, he pointed out that automatically, the rest of the world has been moving away from the american dollar as the international currency.
a basket of international currencies used by large, global financial institutions for transactions, referred to commonly as "special drawing rights" (SDRs) are now gradually becoming the defacto world currency.
He also noted that among international central bankers, there already exists a consensus that the world will eventually eliminate free-floating currencies and create a single world currency.
THis is a very difficult thing to accomplish and will not be realized for years, perhaps decades (if ever- no guarantees on the future)

But he was very clear, the old currencies: the pound, the american dollar, even the euro are in for a very, very bleak future. If you hold investments in these currencies, if you attempt to trade with these currencies, you will be very stressed for a long, long time. you may even lose a great deal of money.

what does it mean for the canadian bondage freak?

a declining US dollar will destroy the majority of canadian exporters. this will completely overwhelm any short-term recovery efforts and likely drive up unemployment, drive down exports and delay any significant growth in the economy.

the consequence is lower earnings across the board. your mutual funds are not coming back. you will be lucky if they remain at their current levels.

your fixed-income? keep it 7 years max. and widely diversified

why? every central bank in the world is printing money. those who ignore history are doomed to repeat it. we're in for inflation (not a guarantee, but an educated guess). if you're strictly buy and hold, you have to avoid the long-term (even if it means taking a lower total yield). if you stick with a bond mutual fund or buy something 10-year, 20-year or god forbid 30-year, you could stand to underperform the market dramatically.

don't buy stocks, unless they are a totally dominant company that is having a down period, and don't overly invest in stocks.
keep buying bonds, but remember, inflation will be higher than people might expect and you need to be able to purchase new issues at higher interest rates, because interest rates will rise. the federal governments have done as much as they can to hold rates down for the time being, but if this really is the big bad unravelling of the empire of debt the West has built, it's going to be a long, slow, painful road to recovery

Rainy day money, why not double-down?

For a young investor (say under 35).

You are starting out your investment career.

You are determining how much money you dream of having when you are an old fart.

You don't want to work very much or at all for spending money

You want to pass some money on to people (spouse, kids, and relatives) after you die.

You want to feel wealthy and independent (you want income to exceed expenses without busting your ass all the live-long day)

Wouldn't it be nice...

So what do you do?

Typically, you go to the people you've been banking with all your life (likely a service rep. at your local financial institution)

Or you can trust your parents to tell you what to do

Or you can trust someone who is older than you and followed a path to riches and is open and honest with you about money.

But you will typically know someone who works at a bank, and they will refer you to an investment advisor.

It's not entirely unlike asking someone if they know a good dentist- if they've ever been to a dentist, the odds are they know a relatively competent one.

Emphasis on relatively. With respect to dentists, relative means that from one certified dentist to the next, there may be a few perks like softer chairs or newer equipment, but the skill and dexterity of every dentist is extremely consistent across ages, areas, sexes, etc. for all dentists.

Relatively speaking, the 'average' competent investment advisor is competent relative to someone who throws darts at a board or bets on cock fights as a way of determining your investment strategy.

Relative to a skilled and honest investment advisor, the average advisor is no better at generating consistent returns than the average DIY investor.

What I'm speaking of relates directly to why I feel that young investors are told they are 'young enough' and 'therefore have a high enough risk tolerance' to invest heavily in the stock market. This line of reasoning introduces the theory that because the investor is so young, inflation, the rise in their wages, and taxation liabilities will require the need for immediate tax relief in the short- medium- and long-term.

Within this world-view of investment, bonds will never be profitable (even if they guarantee to return your money) because of historic returns of bonds vs. Stocks, inflation and taxation issues.

Sadly, this world-view does not correspond to reality. This world view makes sense only on the premise that stocks are capable of beating bonds by at least a factor of 2-1 and also relies on the notion that stocks will always be taxed at a rate that is almost 5-1 in favour of stocks (this changes completely once you retire and depending on rrsp and now tfsa context).

Tell someone to save up $500 000 (or better still save only $250 000 and borrow the rest at 5% interest), tell them they can get a 10% return, pay about 10% in tax because of the dividend tax credits you'll receive

Bingo, you are some old fart earning about $ 45 000 every year after tax. That should be enough to support a healthy and affluent lifestyle for a long time, still leaving a nice chunk of change to pay for your funeral, burial, headstone and give something to the kids, etc.

There are now millions of westerners who were sold this line of reasoning, told that they could sleep at night and are now facing the sad reality of impoverishment and never being able to retire.

This line of reasoning has earned thousands of investment advisors a steady income of anywhere from $ 75 000 - $125 000 every year. Every year that they were telling people not to worry, telling people that the bull market was on, telling people it was too late to sell, it goes on.

But there are always people who understand that excessive return means excessive risk. There are people who demand that they get their money back in less than 10 years, no matter what. There are people who understand some of the basics of macroeconomics and follow the news and history. These people are not afraid of inflation or taxes. These people instead focus on working hard, proving their worth in the world and getting compensated for a job well done. To these people, your best weapon against inflation and time is your own two hands. Your labour is what fights inflation because wages rise faster than stocks or interest rates in inflationary economies.

For these brave souls, these 'bondageers', there is but one simple rule: DO NOT GIVE AWAY YOUR SAVINGS!!!

If you intend to save something, it must never go down in value. That is why it is 'saved'- think evangelicals getting into heaven, they go only up.

High yields be damned, my capital is there for the future, for emergencies, it must never be allowed to fluctuate in value and must always be contractually guaranteed to be repaid in my name by whoever holds it as investment. Furthermore, never trust someone more than you can throw them. 20 years until you repay me? Forget it. 10 years? In this environment, it's a stretch.

The bondage freak is into power. "I give you my money. You better repay me. Pay me back my money and give me points for every day that you have it. Don't like it? Too bad, there are all kinds of players out there who are happy to hold money, and make enough of it on their own to gladly give me points."

It is these people who fear not the economy, its mood swings, the rise of china, inflation, Caesar, Huns, Visigoths, it matters not.

Seek to protect what you have saved from this cruel world. Seeking growth from that which is the product of labour is to seek derivative output from a non-productive entity. This is akin to gambling. Gambling is what you avoid by saving money. Gambling is not what you do with saved money.

This is not happy news for anyone who plans around the 10% fantasy. You are more likely to go back in time and have sex with Bo Derek while on the set of '10' then achieve your financial goal.

How does a bondage freak fare when interest rates plummet?

Bit of an unrelated article, but it's always interesting to see how George Soros is doing and what he's thinking.

George Soros, in case you were unaware, is a Hungarian born immigrant to the US of humble beginnings. Soros said that when he was young he wanted only to be a philosopher (a seeker and debater of truth and knowledge). In his twenties and without a family depending on him, Soros rationalized that if he was able to get a job on wall street, and frugally save up his salary over a ten year period, he should be able to save approximately $500 000 of which he could sustainably invest and draw upon as needed for the rest of his life. With that nest egg, Soros would then be free to write and comment on the world and hopefully earn extra income from becoming a published philosopher.

By the time the 10 year period was expired, Soros was a billionaire investor and worldwide guru. He was described as 'the man who beat the bank of England'- correctly predicting a sell-off of the British pound on the eve of major fiscal announcements.

So what lessons can we draw upon for the bond market investor?

Well, we are living in a time of historically low interest rates. This has frightened many retail investors away from bonds. They fear the boogie man of 'inflation down the road'.

Have you heard people in the media throwing this phrase around? It's not a legitimate fear. Economists understand that society actually needs a constant level of inflation in order for the entire economy to continue to expand. This is why all the intelligent analysts were more concerned with fighting deflation (which we are still experiencing). History has shown that preventing any form of inflation causes much more havoc than benefit.

So 'inflation down the road' is not only an expected thing, it's a good thing. This is counter-intuitive to what everyone in the media or the investment advising industry tells average retail investors.

But how can it be a good thing for a bond investor if interest rates, even long term, are declining and declining and declining? Surely this will expose an investor to the risk that inflation will rise more rapidly than it has in the past, while their bond investments are earning a very small yield- so small that it might be less than the inflation rate.

This is why you ladder your portfolio, and this requires you to change the way you think about earning money.

If interest rates plummet, and you have bonds coming due- you should follow the advice of what George Soros is talking about in the CNN article.

I'm not saying buy a mutual fund or etf for China (though you probably will make money with that investment), but you should find "the right assets rather than saying 'I'm not interested in investing'".

What this means for the bond investor is that you GO SLOWLY.

If interest rates for short term and long term bonds drop substantially, it may be in your best interest to take more short term bonds to provide flexibility in 1-3 years if inflation rises. It may be in your best interest to buy lower quality, but still investment grade BBB bonds that still pay interest that's around 6-7%. It may be in your best interest to move some of that returned money into the stock market (this spring was probably the greatest time to buy banks stocks in Canada ever).

Or you might buy any other asset that you feel is profitable.

When you keep over 90% of your money in guaranteed investment vehicles you can shift money around to 85% bonds 15% stocks, so long as you remain overall conservative, you can adjust to provide a steady cash amount of income every year.

But if you stick with bonds, and interest rates plummet and remain depressed, your overall portfolio will eventually start showing a lower total % yield, and this will eventually translate into smaller amounts of cash.

So what will this mean? So long as inflation and interest rates are at historic lows, the price for a great many of the goods and services we consume will remain at a steady and/or declining level. Your portfolio of diversified issuers and maturities will reflect the general growth and contraction of inflation and the economy. You will receive less total income, but your standard of living and ability to plan for your financial future will likely be completely unaffected.

Once the gradual rise in interest rates begins again, you will begin to buy new issues at higher rates, meaning you may be at the beginning of an economic cycle and earning less compared to new entrants into the market. However, the flexibility of a laddered portfolio will provide consistent opportunities to catch up and eventually rise above the average market returns.

10 percent is a fantasy

People need to consider the difference between real and nominal.

Nominal is what you see, real is what it actually means

I've noticed that a lot of young investors, trying to plan for their retirement are using 10% as their expected annual return.

They expect that if they can earn a long-term average 10% annual return and reinvest everything, the power of compounding will eventually turn them into multi-millionaires.

Starting out with a house worth $ 400 000, a mortgage worth $300 000.

Savings from their job is about $ 150 000, imagine if they borrow an additional $100-150 000 to invest in the stock market.

Imagine they have to pay interest on all their loans at around 5%

Imagine someone tells them that they can get 10% return from their investments every year.

Seems like the investments might be able to pay off all the interest on your loans and then some.

After the loans are paid off, the investor is much wealthier than if they had not borrowed money to put in the stock market.

But how long does it take to pay off the principle? That makes a big difference in the time the investor ever actually sees any improvement in their standard of living (eg. Having a big wad of cash in your hands at all times).

But here is the most important thing: that 10% number is not guaranteed. In fact, in every document you ever read, it clearly states somewhere that there are explicitly no guarantees anywhere on anything in the financial industry.

So where does this 10% figure come from? From the article I linked last post, the argument is made that this figure is basically a fabrication of the investment advising industry. Why would an investment advising industry pick this figure and promote it as the way to make your retirement dreams come true?

Because it is double the average return of bonds, which averages around 5% annual return over the long run. I'll comment more in the future about this number, but it's also in my original post.

So what happens to people who sign over their money because an investment advisor is telling them it's a 'more efficient' way to make money?

They get convinced that they are 'young enough' and have a high-enough 'risk tolerance' to put most, if not all of their hard earned savings into mutual funds or the stock market. All products which do not promise to repay your capital.

Why do people buy into this? Greed is an obvious answer. So is the lack of good information on the real returns offered in the long-term for the various asset classes.

It's a simple rule: you can't make good decisions without good information. Investment advisors have promoted a long-term annual return from the stock market at 10%, 8%, 7%. It doesn't matter. The truth is, whatever the return has been it is characterized by extreme long-term volatility. You essentially have to hope (for your entire working life) to be lucky when you retire and begin to start drawing on your investments, ask anyone who is experiencing that now (old, tired, lost lots of money and can no longer afford to retire).

The bond market? It fluctuates along with economic cycles as well. But unless the issuer is bankrupt, your principal was protected the whole time.

Bonds have beaten stocks over the past 40 years. That is an entire working lifetime for the average middle class investor. What will the next 40 hold for us? Where should we really think about putting our money? And what should we really expect to earn for doing nothing?

Bonds are the new black.

Time for a rant on what I've learned about the DIY Canadian investment blog community (if that is indeed a thing that can have a name like that), people posting online about what everyone else in their situation should do with their money (this is regardless if they are a financial advisor, some dude, or a big outfit), following this or that bit of information. Lots of times there is a nice little graph or a box of numbers next to another box of numbers.

Many people enjoy posting their own financial information. Not just their particular investments but their whole list of debts and assets, their jobs, incomes, how big is their family, etc.

I have no problem with people who want to share personal information, especially if their intention is to selflessly help others. However, most of what people consider to be their business is in fact just that- it's their business and no one else's. Privacy is about minding your own business. This isn't a rejection or defensive posturing, just a mutual understanding that my economic and social context is unique to me. It's what makes me 'me' and not 'you', the 'other'.

 

What am I talking about?

 

I'm talking about how I've learned to ignore information (like the analysis and trends and fancy equations and statistics) as the key to distilling, understanding and utilizing the underlying reality of the various investment strategies and attitudes.

This is what philosophy is all about. Those guys that people talk about- Plato, Aristotle, they were guys who had a holistic (if still primitive) view of what a person should do with their life (their view of the soul is like how we view our retirement nest eggs) and how to go about doing it in the best way possible.

 

What does philosophy really have to do with investing?

1) Philosophy is about the pursuit of truth.

2) Investing is about weighing risk with return.

3) Return is cash money in your hands; risk is the absence of certainty about that return.

4) If Philosophy is about truth (which is about validity and certainty) and investing is about risk (which is about the certainty of making money),

then

5) understanding certainty and using that understanding to our advantage will allow us to maximize return (cash money) while minimizing risk (uncertainty).

 

So what happens when, in a variety of quips, comments and suggestions, you present the consequences of this line of reasoning to the Canadian DIY financial community?

The answer is not much.

You see, when people have 'bought in' to a line of reasoning, and worse still, put their own financial nest egg behind a line of reasoning, it becomes a very touchy subject.

Though it's easy to divulge how much we have with who and where and how much we owe on this or that, it's actually much more psychologically (and philosophically) difficult to admit compete and total failure.

Indeed, it was Nietzsche who best espoused the idea that without the understanding and acceptance of complete and total failure, one can never enjoy true success. Though he lived a lonely and miserable life, he viewed humanity in organic terms and, wishing in an alternate life he could have been a gardener, Nietzsche argued that the failures of ordinary people are like the dirt and roots and worms and detritus. If they are understood and cultivated properly, they will combine and yield a beautiful flower. If they are mismanaged, they will rot.

This is an apt analogy for a flawed investment strategy. When the reality is that stocks do not always beat bonds, and over the last 40 years bonds have beaten stocks http://www.marketoracle.co.uk/Article9713.html, an individual who attempts to understand and accept reality will adapt.

A logical adaptation, if we attempt to remain consistent, would involve less effort attempting to make significant gains or investments in the stock market.

You see, this is essentially my line of reasoning before the market crash and I took it from my parents (who got it from their parents) before me and it meets a lot of static.

The static takes the form of people who believe that bonds are not available with high enough interest to beat inflation (consistently proven incorrect when dealing with a properly laddered portfolio), people who believe that investment-grade corporate bonds are at a significantly higher risk of default than a government bond (consistently proven incorrect over time), and (perhaps worst of all) people who view the return of capital as a burden- best avoided by purchasing a stock or mutual fund and holding it forever (this is a philosophical disagreement, I buy some equities but I love when I see I have cash waiting to find a new home in my accounts and argue it is never a burden if you always have the ability to wait for a good value investment).

I believe the accepted notion of a 30-70, 50-50 or 40-60 asset allocation, the belief of diversification, and professional management has been completely compromised and undermined by the real world experiences of ordinary people. People who could have been convinced of any asset allocation so long as it beat inflation and preserved a nest-egg, were lead into investment vehicles that charged a lot of money and in the end provided little or no protection from stock market volatility.

As a logical consequence, I have determined that the entire investment community is as flawed as the products they sell, analyze, discuss and throw their money behind. People who argue about the benefit of estate, tax and insurance planning do a disservice to the role an accountant provides (at a fraction of the cost and with no conflicts of interest) and exaggerate how difficult it is for the average person to determine their need for those things on their own for free.

Financial advisors are your best friend, but only when they understand how to treat you and your money with the respect you deserve. If you remain uneducated to the actual returns of the various asset classes that you can invest in, you will drastically increase the likelihood that you will unknowingly lose money when you think you are helping to 'grow' it.

There are some people, like 'NurseB911' who writes his blog about his financial journey, that are starting to catch on to reality.

The rest would rather refuse to look at their financial profile and continue to hope and pray the DOW magically goes back to 13000. The smart money has been slow and steady FOR ALL ETERNITY.

Is Obama Reading My Blog?

NO.

But here are two articles that are consistent with the investing philosophy of the fixed-income investor. A.K.A. the bondage freak.

It is also totally contrary to what all DIY investors believe, but just look at the articles first.

 

http://money.cnn.com/2009/05/15/news/economy/obama-stocks/index.htm?postversion=2009051518

 

http://moneyfeatures.blogs.money.cnn.com/2009/05/18/obamas-favorite-mutual-fund/

 

So, there are two reasons I use the title space to ask if Obama is paying attention to my investing philosophy (which is by no means unique, and as this article shows is actually quite old)

 

1. Obama keeps approximately 90% of his family's savings in cash and bonds. The articles say that he keeps about 90% of everything in US Treasury notes and a chequing account. It does not disclose the maturities, or the specific nature of his treasury notes (we should assume Obama is getting a pretty good price and yield from his broker).
   
2. Obama had several mutual funds, but chose to put all the equity investments (about 10%) in a mutual fund, which is an index fund. It invests large amounts of the investors' capital in shares of companies that fit on a list of social issues that are an important part of the life and values of the Obama family.
   

 

I look at those two points which are featured in the article and it reinforces the attitude towards investments that I have been advocating on this blog and in my life.

 

The fundamental approach and attitude is that you need to protect and preserve your capital.

Once you have done this, you should be free and confident (and, in essence, obligated) in pursuing the accumulation of wealth through a successful career you enjoy (not through growth of an equity portfolio), as well equity investments can be made to reflect your interests and personality without overly risking capital.

If I can speculate about the investment strategy of Obama:

1. Best Case Scenario:
   

He is taking this conservative asset allocation strategy and using it as a way to provide the financial security to allow him to focus on his career. He can likely earn money above the inflation rate, and he can pay his taxes and this would provide enough money to support the quality of life he had enjoyed before he became "Chocolate Jesus". He's in the perfect position, after he serves the public, to accumulate and mobilize vast amounts of 'money capital' because of the tremendous amount of 'social and political capital' he will have created if his investments in his career strategy (aka. Domestic and foreign policy of USA) are successful.

 

1. Obama is prudent and imagines what would be his Worst Case Scenario?
   

His government is corrupted and ineffective. American influence, prestige and power are reduced along with the value of the US Dollar and the stock market. Obama is ushered out of office in a single term after Sarah Palin and the re-animated head of John McCain sweep the 2012 elections. In this worst of all futures, Obama is left with no fame (except failure, disappointment and disgrace), no connections and no or little ability to build and/or mobilize vast amounts of money.

 

If Obama starts his presidential life with about 1.2 million in investments and about 1 million in his home, and then follows most DIY investors, he could be looking at a 39% loss in his investment portfolio.

This could mean that his 1.2 million in investments could shrink to 750 000, with no job, no ability to earn big money, and two daughters who have high expectations about their future education. Obama would not be left with enough retirement savings....

However, follow Obama as he follows the age-old strategy, where you stay conservative with your cash and savings, and are aggressive and bold in your career- and your small equity investments, investing in whatever you are respectively passionate about. Even if currency depreciation afflicts the holders of American investment vehicles like treasuries, the highly liquid nature will allow Obama to move his entirely protected nest egg into higher-income earning vehicles. He won't have to worry about taxes, because Palin will eliminate all taxes as a way to eliminate all abortionists, gays and minorities.

Interest rate trends and GICs

So I talk a lot about fixed-income investing and usually like to focus on investment-grade corp. Bonds.

But when I look at my investment portfolio and the changes that have taken place over the past few years, I think it's important to comment about interest rates.

Following the 'benchmark' bonds, issued by the federal government, that are used for bank to bank lending; following the medium and long-term 'benchmark' government bonds; and following the popular GIC rates is critical in becoming educated in the Canadian bond market.

If you visit http://money.cnn.com/markets/bondcenter/index.html this is an excellent resource for tracking US government issued debt.

 

Look at the "yield curve", this graph plots the various maturities according to their current market yield.

 

Two important facts:

1. The volume of bonds (government and corporate) that are exchanged on a day to day basis is roughly 10x greater than the value of the volume of cash exchanging hands via the stock markets of the world
   
2. Because there are so many different types of issues and different maturities of bonds from each individual issuer, it is uncertain and unlikely that individual bond issues will be traded every day. This is the 'liquidity risk' people refer to when holding bonds, when interest rates (or the price of your bond) fluctuate and they hope to sell their bonds in order to capitalize, only to find that selling their bonds is difficult.
   

Because of these two facts, it's possible to think of the bond market as a kind of ocean cruise-liner (please refrain from Titanic analogies), which parallels the vitality of the overall economy. When investors the world over have confidence in the economy, the government or bonds in general, it typically drives up the price of all bonds and when the government is encouraging growth, it typically lowers interest rates to encourage lending and ultimately lead consumers to avoid putting their money into savings. Governments can be like the captain, ordering to speed up or slow down the ship- lower interest rates typically encourages growth, higher interest rates encourage saving money and taking it out of the economy to curb inflation.

In the previously described situation, the world before the economic meltdown was fairly reflective of my description. After the meltdown, a flight to safety and the lowering of benchmark rates for intra-bank lending has created the perfect storm. Captain Bernanke has ordered all men to the coal furnaces; fire the engines, full steam ahead! Benchmark interest rates of all maturities have plummeted to the lowest point in history.

This is important for me, because when I moved my money into fixed income, I temporarily placed a lot of it in GICs. The strategy is simple: Most advisors recommend, and a common misconception is, that it's to your advantage to be fully invested at all times.

Conversely, the way the corporate bond market works, it's actually best to buy in increments (part of the reason laddering your portfolio so that 10% of your portfolio value is freed up each year for reinvestment). So as I moved out of equities and income trusts and into the fixed income market, 1 year GICs- cashable after 30s days without penalty- are an ideal holding point for my investments if I'm not sure what to be looking for right away.

Due to giving my attention to my own search for alternative investments and the way things worked out with the economic meltdown, I've ended up holding onto the majority of my GICs, I started holding cash at 3% and the last time I purchased any (in September of 2008) the yield was about 1.4%. Now that the Federal Reserve systems around the world have gone to work, the yield for a similar GIC is now literally 0%. It's getting close to the point where you have to pay for a GIC to hold your money....

This is a problem for me as the GICs will be due in September. Fortunately, I believe the credit markets have not collapsed and this has turned into the greatest time to purchase corporate bonds in recent history.

The moral of the story is what I will call the DNAGS dynamic multi-sector wealth factor.

DNAGS stands for DO NOTHING AND GO SLOWLY. The secret of wealthy people who have managed to preserve and grow their wealth is their staying power. Sure, it's important to be confident, aggressive and pursue opportunities as they arise. What is equally important is staying conservative and using a conservative philosophy to avoid being overly-committed or jumping in too early into an investment before verifying it's soundness (this has the consequence of typically looking for moderate total average yield- with the bonus of enhanced security and confidence in your investments).

So as it is, I have about 4 months until my last GIC is due, month by month, I've been moving out of GICs (starting with those which yield about 1-1.4%) and into corporate and some provincial bonds.

So far, I've been able to take money that was earning about 1% and turn it into investment-grade bonds (no maturity longer than 6 years, so far) that are yielding about 6%

This is at least a full percentage point (or 100 basis points) better than the corporate bond ETFs available in Canada. I paid my advisor an average one-time commission of 1% of the purchase price.

Microsoft now a defensive play?

As an additional sign that the credit markets have not collapsed, the biggest and most historical software company of them all is offering its first debt issue.

This is an excellent example of the opportunities and frustrations that retail bond customers face.

http://www.financialpost.com/news-sectors/story.html?id=1585202

 

You read this article in the morning, and as the defensive investor the idea springs to your mind:

 

"I've always wanted to get a bit of the action from the Microsoft business, but the stock has done horribly these past few years and I'm too conservative, even with my speculative investments, to ever purchase common equity in the company I will likely use every day for the rest of my life."

"The currency risk was always too much to deal with to make the stock an attractive investment after the tech Bubble burst"

"Now that they have issued so many billions of dollars in bonds, I can grab an AAA-rated investment that yields interest of a full percent above federal bond rates of similar maturity, that's a good deal!"

"I should be able to call my broker, or I can use my discount brokerage to purchase some units... oh joy!"

 

So here is the sad reality, why some people are turned off from the Canadian bond market, and what you should do as the DIY Canadian investor.

 

1. When Microsoft issues this debt, they have already arranged for ALL of the billions of dollars to be purchased the moment it is issued.
   
2. This works the same way that underwriters work for IPOs. A very large financial institution (or a group of financial institutions) will put up the entire cash amount up front to Microsoft, who then has an additional 2 billion dollars of capital to play with. Microsoft is then responsible for paying the interest on this capital and returning the full amount on maturity
   
3. Once the major financial institution(s) have the bond issues in their possession, they will create a secondary market for them.
   
4. First, they will sell the bonds (with a slight mark-up to pay for overhead and sales commission) to institutional investors (these investors include pension funds, insurance companies, government investment funds, even smaller financial institutions).
   
5. Once the institutional investors have had their fill (the big boys eat the meat, the little guys get the scraps) they will retain the left-over bonds for you, the retail investor.
   
6. By the time you get to purchase these bonds, if you ever do, the mark-up, and fluctuation in price could reduce the spread above a treasury note of similar length to zero.
   

What does all this mean?

It means that if you follow the news about debt issues, you are likely to be disappointed. What is more important is following trends in interest rates (which typically reveals where in an economic cycle you find yourself). Specific companies are not the primary focus of the bond investor- assets, debts, revenue and expenses are the primary concern of the savvy bond investor.

The FP article is interesting because Microsoft has never had to issue bonds (maybe they're starting to run out of money) and the article points to the resiliency of the investment-grade corporate debt market throughout the financial crisis (this strength has been widely overlooked, I do my best to change that).

But this story is very little help if you are trying to establish your diversified bond portfolio. If you lack this insight into the bond market in Canada, your first reaction is probably disappointment

The bigger picture is that when the corporate bond market grows (with the highest-rated corporations, like Microsoft leading the way) it encourages every single competitor to do the same. This has the net result of increasing the yield offered to investors (both institutional and retail) in an attempt to lure more capital.

I asked Hank Cunningham, the sagely author of In Your Best Interest: The Ultimate Guide to the Canadian Bond Market, what the retail investor should do if they missed an opportunity to purchase an attractive yielding bond.

The appropriate response is simple: wait for another investment grade corporation to have a new bond issue. So long as there are investors seeking the reliability and solid return of corporate bonds, there will be investment grade companies that are more than eager to meet that demand.

Checking out the new format as I learn to use office 2007 for the first time in 2 years.

The credit markets are not collapsing, as we had earlier feared.

http://www.theglobeandmail.com/servlet/story/RTGAM.20090507.WBstreetwise20090507073415/WBStory/WBstreetwise/

big time returns... a nice time but not a long time, so have a good time, your stock can't rise everyday.

I've repeated on several occasions that I never keep more than 10% of my own net-worth in the stock market.
I'll just focus on how and why i came to take this attitude and why it's made me enjoy the stock market more even if my exposure is less and to look at equity investments for what they really are (at least through my jaded, hippy-hating eyes).

This view probably started out as an asset mix of around 20% (think pareto's principal- which i don't follow anymore), and from 2005-2008, became more and more conservative. It was mostly because i simply dislike extreme volatility in any aspect of my life where it's not absolutely necessary. Over the past decade the stock market had been booming, but it had also been busting and booming back at a very high rate. I disliked the constant boom and bust so much that i decided to get out of the market. The final sale i made was BMO. I purchased shares at about $62 in July 2006 and sold them in February of 2008 at $57.

at the time i felt like i was taking a beating but just happy to get out.
Everything in my portfolio for the remainder of 2008 was in bonds and GICs (luckily, i was able to buy 1 year GICs, cashable after 30 days, that yield 2.8-3%) Current GIC yields of similar duration are about 0%... I also kept a very small position in a major energy company.

So while i hated the market for what i perceived as volatility. The crashing housing prices in California and Florida and Arizona were in the news, and i was thinking maybe it's time to take the cash and just buy a nice vacation home, and finally be finished with Canadian winters.

I never put two and two together and luckily never bought any property (i had never been offered Mortgage backed-securities or asset-backed commercial paper) and i was just as surprised when the meltdown of October-March crippled the global economy.

That being said, i was also lucky enough to be doing a great deal of reading into macro economics, personal finance and DIY investing at this time. (i was so put off by the stock market, i was wondering if there was any other decent alternative to my bonds- which were earning quite nicely through it all..... the answer btw, so far, is NO).

When i finally rounded out my general investment knowledge by looking at the recent works by Nial Ferguson in "the Ascent of Money" and doing some further background that included Nasim Nicholas Taleb, author of "the Black Swan" among other books on chance and investing, i decided this blog was the next step.

This blog represents my conclusion that the whole notion of diversifying an equity portfolio, that you should balance 50% stocks and 50% bonds or anything similar to this, is a myth.

This blog is my attempt to verify or discredit the belief that the most efficient and safest way for your investments to not go down in value, beat inflation, earn a steady return and provide a fully customizable portfolio for your specific needs is.... BONDS (specifically investment grade corporate, provinical and even real-return government of canada bonds).

If you pay any advisor 1% or more of your capital every year just to manage your money, it is a myth that you need to pay that much just to preserve capital and create growth.

I started this blog with the idea that putting anything more than 10% of your assets in an allocation that does not promise to protect your capital is too risky- investing is about assumptions of what will happen in the future and these assumptions always contain risks we ignore or are unaware of and that is why people lose money when they don't have to.

Im happy that the rebound of march- april has restored an average of 25% people's retirement savings (for those that stayed invested). There are a lot of people who lost over 50% and have little to no chance of ever recovering from the peak, but this is why we call the market volatile and why i'm too scared to put a 1/4 of my money into that arena.

when i do put money in the stock market, i realize it's to my advantage to take more risk. I'm already prepared to take a loss so i want to take the most speculative risks. Do all those crazy trader strategies- buy the companies people are terrified of, buy the companies you like that no one has ever heard of and hedge like a mad man. That's the nature of speculation and it's the form of venture capitalism the stock market provides. If you are prepared for the downside of an unprofitable company, but you like their product and you personally believe in it (like some eco-small-cap-companies, or bio-tech, or whatever) you should enjoy the role of capitalist and your economic vote to increase the resources of whatever belief you attach to your preferred company. your money could, obviously evaporate completely, but when you take only 1% of your net worth and throw it away at a cause (which you had hoped would be profitable) you can also consider it a form of charity and the government does allow a tax credit for the loss if it all goes horribly wrong.

frankly, looking at the corruption and admitted failure to make any meaningful long-term progress from some large and established charities, i think the argument can be made that (specific, highly-speculative) investing in the stock market is an equally charitable form of donation.

buying a bond vs. stock in GE as a medium term investment (about 5 years)

As a Canadian, this dilemma has a serious caveat.
If a Canadian investor wishes to add shares of General Electric Co. to their portfolio they must open a U.S. dollar account and purchase the shares on the NYSE in U.S. currency.
This means that you take the additional currency risk, with respect to the total cash distribution paid out each year, or when you sell all the shares, and convert the money back into Canadian currency (should you choose to do so).
If you want to spend the earnings of your US currency investment inside the states, this isn't a problem
It is still a factor to consider when making an initial purchase (dollar-cost averaging is an applicable strategy that can smooth-out the volatility of currency value, but more transactions also increase the total cost of transaction fees).
If you want to spend the money you earn form your GE shares in Canada you face the additional currency volatility (i.e. if you need money when the value of the Canadian dollar has sunk, it can drastically reduce the buying power of your earnings, hence lower actual cash yield).

taking those factors into account, GE is one of the most diversified, industrial, commercial, media and unfortuantely financial companies in America. The financial hoob-a-joob that took place within that branch of the company has taken the entire corporation to the brink of insolvency.
Fortunately, all major financial institutions in America and around the world are able to borrow money at about zero% and lend it at 5-6%. This is a guaranteed way to keep otherwise bankrupt companies in business during what can be called a mini-depression.

The price of each share was around $25-$35 US ever since it split in 2000. Then in March, when the S&P500 hit 666, it was at about $6.66. Since then, the S&P closed friday at 877 and GE shares were trading at $12.69. The last dividend payment was $0.31 and nobody is sure if it will be maintained or reduced going forward. If you buy the shares on friday, the average yearly cash distribution is (barring a dividend cut) 9.77%.

Can't lie, in the medium term, that is a very, very attractive offer. even if the dividend is cut by 50 or 60%- that's still a good offer, looking at the long-term value of the company (excluding any currency risk).

As an individual investor, look to see if you're willing to go on the roller coaster ride of the future with this company. the value of your capital ($10000-$20000) will be fully put on the line to thrive, survive or decline along with the future prospects for solid revenue growth and the value of the Canadian and US dollars.
If you like what you see, be brave, bold and determined.

Or, if you're just into the idea that instead of taking all the whopping big risks the company has to make for a juicy 9.7% return, you wanted to take an alternate path, providing a great more deal of stability when dealing with the future earning potential of this mammoth and wildly volatile company, avoiding the stock market entirely.

Currently their is a bond issue from GE circulating around most of the retail bond trading desks in Canda. The features of this bond currently are as follows: It matures in june 2014, the original coupon rate was 4.4% and currently is available at 5.3%.
this means that the bond was issued at units of 100 that cost $100 each. your minimum investment is therefore $10000.
But because of all the current global economic uncertainty and decline, investors who sold off their stock (sending the price plummeting an average of 60% from the highs) also sold their bonds, in the belief the company could go bankrupt because of the inherent weakness in the financial arm.
the difference in the sell-off of GE bonds is that the $100 unit price fell to as low as $90 and is currently sitting at around $95 per unit. This means the minimum investment is now $9500, which is why the yield is 5.3% for new investors and still 4.4% for anyone paying $100 per unit.

Also, when the bond matures you will have the additional capital gain. This means your capital will be returned to you in units of 100 that have a value of $100 each. The only reason the cost per unit was reduced was because of investor pessimism. This bond is still A-rated and considered investment grade. The sell-off of the GE Financial bonds was moderate and short compared with the stock. If you invested $9500 originally, $10000 would be returned to you at maturity on top of all the interest payments received before then.
Questions about the future remain, but any bank that can borrow at 0-1% and lend that out at 5-6% is going to make steady money. I also know that my bond payment (guaranteed to be cut only after common shares and Warren Buffets preferred shares) falls in that 5-6% range so it's likely they will be able to make my interest payments untill maturity.

If you feel safe and confident about the company, you press the buy order and the brokerage will transfer the money and you start to receive your payments. You are not dealing with any foreign currency. all of these transactions are available in Canadian dollars.
As the bond investor, if that looks like a good return (about 3% above a similar government of Canada bond) with little to no risk of taking a loss, why take the risk of a big loss just to get the big gain?
money is what you earn, investments are what keep your money safe.

interesting view on canadian banks

http://network.nationalpost.com/np/blogs/tradingdesk/archive/2009/04/30/bank-ppes-ample-cushion-against-rising-loan-losses.aspx