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Live Happy

The Best Ways to Make Your House a Home
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Canadian Cannabis Stocks Simplified

Canadian Cannabis Stocks Simplified

A ‘How-To’ Guide for the Budding Investor
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tagged : investing, stocks
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When the Bubble Bursts

When the Bubble Bursts

Surviving the Canadian Real Estate Crash
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Excerpt

Chapter 1
Canada’s Housing Bubble Defies Gravity

The market for real estate, particularly individual homes, would seem likely to display speculative booms from time to time, since the psychological salience of the price of the places we see every day and the homes we live in must be very high, and because homes are such a popular topic of conversation.
— Robert Shiller, Irrational Exuberance, 2000

One of the earliest uses in recorded history of the word bubble in relation to financial speculation was in reference to the South Sea Bubble — the South Sea Company was a joint-stock company founded in England in 1711. It issued shares to the public in 1719 and in less than a year increased its stock market value ten-fold. A short time later, its stock price had dropped back to close to the original listing price, a crash that reduced the value of the company by 90 percent. Fortunes were made and lost. Despite the huge devaluation in the share price of the company, it continued to exist; indeed, it eventually took over responsibility for the debt of the Government of the United Kingdom.

The Bubble Company, as it was known, copied the Banque Royale, a company that was formed in France in 1716, which was also organized as a joint-stock company and used to finance government debt. Both of these companies were created for the purpose of converting government debt into shares of stock in a listed company. This idea of paying off government debt with shares sounds crazy today, but, at that time, it fired the public imagination and many ordinary people got caught up — speculators would eventually lose their life savings. These two companies and other similar copycat companies became known as the bubble companies. The concept became so popular that the U.K. parliament passed the Bubble Act in 1720 to control them.

Another, more famous, instance of financial insanity and speculative fever was a period known as the tulip bulb mania, which started in Holland in 1634–37. It seems that this mania wasn’t referred to as a bubble, perhaps because of the difficulty for the human tongue in saying “tulip bulb bubble.” Some people, wealthy and poor alike, became besotted with the idea of owning and trading tulip bulbs for financial gain. Bulbs were listed for trading like a stock on one of the earliest stock exchanges, the Amsterdam Exchange. Prices soared to the equivalent of an average person’s life savings for one rare bulb. The fad spread to England and many other countries. Even today, in Holland rare species of tulip bulbs trade at lofty prices, although nothing like the ridiculous values that were common four hundred years ago.

The principal attributes of these activities, whether called bubbles or not, were a degree of excessive speculation, inflated prices, and a subsequent crash, along with widespread public involvement and fascination.

Many writers and historians have tried and failed to make sense of the innumerable instances of inflated values for commodities, stocks, real estate, and other speculative vehicles caused by excessive greed and speculation. Economic theory doesn’t do any better in providing explanations, since bubbles don’t readily allow analysis using advanced mathematics. Modern economic theory avoids the difficulty of understanding bubbles and mania by assuming that all human participants in economic activities are rational at all times under the efficient markets hypothesis. Even Canadian-born economist John Kenneth Galbraith — who discussed many of the most extreme bubbles in A Short History of Financial Euphoria, and provided analysis that does a much better job of explaining economic cycles than do most of his peers and successors — fails to come up with a suitable definition of the bubble phenomenon. Galbraith merely states that they are recurring episodes of collective financial insanity, fuelled by greed, and that they are inevitable.

Given the difficulty of experts who have studied bubbles in detail in coming up with a coherent explanation regarding the origin of bubbles, their nature, or patterns, it’s not surprising that it’s next to impossible for the average person to detect when they are in the grips of a manic episode of excessive speculation. The only defence is to develop a healthy degree of skepticism, an attitude that comes naturally to few people.

One such person is Jeremy Grantham, the founder of the large investment firm GMO, who manages over $120 billion of investments for institutional investors such as pension plans, endowment funds, and companies. I first met him in New York City after he presented at a conference in 2003. He opened his remarks by stating, “I’ve never been wrong.” The room went completely silent as two hundred investment experts and portfolio managers mulled that over. After a very long, awkward pause, he continued, “I’ve been early,” and the room erupted into laughter.

Grantham captured in a very succinct manner the universal difficulty of talking about bubbles and the inevitability of them bursting. Any prognosticator who calls for a crash in a bubble asset invariably looks like a fool for a period of time before eventually, perhaps, being proven right. In the interim, the forecaster predicting the collapse is contradicted by higher and higher prices leading to greater and greater wealth for the bubble participants who ignore the warnings. Inevitably, the public (and clients if the advisor is in the investment business) develops disdain for the person making the unfortunate “early” prediction. As Grantham says in an April 2014 GMO quarterly letter, “the pain will be psychological and will come from looking like an old fuddy-duddy.” However, in the big picture of cycles, those who were forecasting a collapse in the U.S. housing market in 2004 and 2005 were only a year or two early. In real estate, one or two years is a short time. It takes that long sometimes to get a house ready to sell, put it on the market, and wait for the right buyer to offer the right price. Grantham was very early in 2003 with his predictions about a stock market crash, but eventually he was more than right. When the financial crisis hit in 2006, it began with housing, and the next year spread to the financial industry, eventually resulting in the collapse of Bear Stearns, and, in 2008, Lehman Brothers.

Grantham described his research into bubbles. His research showed that “all [ twenty-eight] major bubbles … eventually retreated all the way back to the original trend, the trend that had existed prior to each bubble, a very tough standard indeed.” The definition used for a bubble was any event that was two standard deviations from the mean. Standard deviation is a statistical tool that tells how unusual an event is. Bubbles of that size, according to Grantham, are expected to occur at a frequency of once every forty-four years. The U.S. housing bubble exceeded 3.5 standard deviations from the mean, an event that would be expected to happen very rarely, only once every five thousand years. The U.S. housing bubble started to take shape in 2000, reached one standard deviation about the trend line around 2001, exceeded two standard deviations during 2003, and peaked above three standard deviations in 2005, going to one standard deviation below the mean in 2008. All done in about eight years, a very compact and devastating bubble and bursting that will have repercussions for the United States and the world for decades.

 

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The Real Estate Retirement Plan

The Real Estate Retirement Plan

An Investment and Lifestyle Solution for Canadians
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also available: Paperback
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Excerpt

I’ve been fortunate enough to give hundreds of talks about personal finance, mortgages, and real estate investing across Canada, from teaching MBA students at two of Canada’s top MBA programs to speaking to large groups of “everyday people” at major convention centres. I’ve learned many lessons from these talks, and I believe any speaker will tell you the same thing: as much as we try to add value to our audience members’ lives, we probably receive more from them.
Of all the lessons I’ve learned, I believe the core lesson is about the general psychology of money. It comes down to this: In spite of our best efforts, we fail to think mathematically about money. Instead of calculating income, expenses, taxes, and ROIs, we act emotionally and instinctually. We allow the momentum of past generations to decide our financial future.
I’ve often started talks with a simple question that demonstrates the time value of money. You can play along at home by asking yourself this:
Would you rather have $1 million today or a penny that doubles every day for a month?
Keep in mind that attending a live event is akin to entering into a social contract. You often know that the speaker will try to disorient you, challenge you, and alter your perspective. With this social contract in place, you’d think audience members would expect a challenge question and that the correct answer would be obvious. When a speaker asks such a question, the counterintuitive choice must be the correct one.
But even knowing that I’m asking a challenge question, the audience’s response is typically heavily weighted to the answer that will give them far less money. When I ask them to raise their hands if they would take the $1 million, a large majority puts up their hands. When I ask who would take the penny that doubles every day for a month, the number of hands that go up is a small minority.
I need to stress again that the audience will do this in spite of the fact that it must be obvious I’m presenting a challenge question. It’s a tangible example of how we struggle to think mathematically when it comes to money.
Now, $1 million sounds like so much money compared to a little old penny, but due to the power of compounding interest, that little old penny is worth $5,368,709.12 by day thirty. If you want to consider a thirty-one-day month, it would be worth $10,737,418.24. In both cases, that little old penny has been transformed into a magic seed, and, not unlike a seed, we don’t see its possibilities until it has grown.
The typical audience response is instructive, as this is exactly what happens in the daily financial life of most individuals. Due to a failure to think mathematically, or a misunderstanding of compound interest and the time value of money, we make impulsive decisions that are bad for our finances. If we can’t visualize compound interest and the time value of money even when the example is extreme (doubling daily), what chance do we have with the pedestrian conditions of real-world finance, where a strong return might be only 7 percent over an entire year?
Once you add in market fluctuations that result in paper losses some years and poor decision-making that leads investors to pull out of the markets, you end up with the shaky and often difficult-to-understand reality that most investors face. Because we fail to understand the opportunity cost and time value of money, we continue to make short-term financial decisions. We are willing to give up $10 million for $1 million. Is there any wonder why we struggle to take control of our financial lives?
Our mental models around personal finance are largely broken. Failing to invest early is the greatest of these weaknesses. Business Insider recently told this age-old story graphically using imaginary investors — Bill and Susan.
Susan invests $5,000 each year between the ages of twenty-five and thirty-five, for a total investment of $50,000. As I hope you never would, Susan stops investing at age thirty-five.
Meanwhile, Bill doesn’t start investing at age twenty-five. But he smartens up at age thirty-five and starts investing $5,000 per year (as Susan did for only a decade). Bill decides to make up for his failure to invest early by investing longer than Susan. He invests $5,000 every year between the ages of thirty-five and sixty-five. Overall, he invests $150,000 of initial capital compared to Susan’s $50,000.
But, in spite of investing a third of the initial capital, Susan’s portfolio at sixty-five is significantly larger than Bill’s. Due to the power of compounding and the principle of investing early, Susan has $602,070, while Bill has only $540,741.
But we Canadians are prudent folks, aren’t we? Surely most of us live more like Susan than Bill? Actually, statistics suggest otherwise. The household savings rate in Canada has plummeted in the past few decades from around 20 percent in 1981 to slightly below 5 percent today.2 There are a lot more Bills than Susans. Pun intended.
Bill is probably average. But on the lower side of the average, many people have next to nothing in their retirement accounts. Failing to invest early is the biggest, nastiest risk of all the retirement risks. But who can blame Canadians for not saving early? Life is expensive, and many people simply don’t have any cash left over at the end of the monthly bills. Plus, who wants to live a spartan life without some of the simpler enjoyments, like a family vacation or two every year and a car that doesn’t squeal?
I won’t (yet) talk about Canadians’ tendency to borrow money to purchase expensive liabilities like boats and vacations. But even without these needless expenses, many people don’t have the resources to get started investing young. Hence the savings rates are low. This is the changing nature of our personal finance environment. It sounds bad, and for many it is bad. But, more than anything, it simply represents a change in the marketplace — and Canadians need to adapt.
You can change your approach, however, so that you can take advantage of massive sources of capital that are just sitting there, right now, to be used. Tapping into this “dormant equity” will allow you to overcome this first major hurdle on your way to a successful retirement. It will allow you to invest early and, therefore, profit longer.

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How to Profit from the Next Bull Market
Excerpt

Chapter 1: The Canadian Retirement Landscape

Canadians are living longer due to healthier lifestyles and medical advances that have improved the treatment and control of the leading causes of death — cancer, cardiovascular disease, and stroke. As a result, our retirements are longer than they’ve ever been. Of course, we need to fund our retirements, and we can only do so with either the resources we have accumulated prior to retirement or the funds we have access to through government-assisted programs. If we have not prepared ourselves for our financial future properly, we have only a few options from which to choose: save more while we are working, spend less in retirement, or continue to work longer. Building wealth takes discipline, sacrifice, and hard work.
The alternative to doing so is clear when one considers that, according to a 2015 Fidelity Retirement Survey Report, the top five sources of retirement income for Canadians are the Canada Pension Plan (CPP) and Old Age Security (OAS) at 95 percent, registered retirement savings at 55 percent, non-registered savings at 45 percent, and defined benefit pensions at 35 percent. However, the maximum the combined CPP and OAS payouts are going to provide is approximately $15,000 in annual income, which likely won’t be enough to cover most retirees’ fixed expenses.
If that is true for your particular circumstances and you are serious about increasing your net worth before retiring, or if you simply want to be better informed, then read on! This book is geared toward helping you create wealth for your own financial independence.
The first secret to making money in the stock market is harnessing the power of compounding returns. For example, if you sell a stock short at the beginning of a bear market, the maximum profit potential is a 100 percent return, considering a stock has a lower bound of zero. However, if you buy a stock at the beginning of a bull market, the maximum profit is unlimited, potentially compounding your investment many times over.
When asked what their top financial concern is, about 60 percent of Canadians respond, “Not saving enough for retirement.” Before you determine if you are saving enough, it’s helpful to understand where most Canadians are positioned with respect to their own retirement. Let’s start with a discussion of pensions.

SOURCES OF RETIREMENT INCOME

One thing is for sure: in the current environment of low interest rates, an aging population, and increasing longevity, pre-retirees need to save more if they plan to retire at the customary age of sixty-five. The market value of pension assets in Canada at the end of 2012 was $2.6 trillion. The smallest portion, $213 billion, or less than 10 percent, is held by the CPP and the QPP (Quebec Pension Plan). Employer-administered pension plans control the lion’s share of pension assets, with $1.4 trillion, the majority of which is held in plans for public service workers. The remaining $928 billion is held by individuals in registered retirement savings plans (RRSPs). Despite constant media attention about all the unused contribution room in RRSPs and the frequent criticism of Canadians for their supposed inability to manage their finances for retirement, RRSPs have been the fastest growing of all pension assets. This reflects both increased contributions by Canadians and sufficient rates of return since 2009.
In 2012, just over six million Canadians were members of a registered pension plan. Such plans are divided into two types. Generally speaking, defined benefit plans are funded by the employer and defined contribution plans are contributed to by the employee. In the public service, about 80 percent of workers participate in defined benefit pension plans. This is a sharp contrast to the private sector. There, less than 30 percent of workers have registered pension plans. The “gold standard” defined benefit plans are enjoyed by an even smaller number of private sector workers — just over half of them, or 15 percent overall, are able to participate in defined benefit, employer-sponsored pension plans. The private sector has largely shifted to defined contribution plans as companies have come to understand how much more expensive and riskier defined benefit plans are. After the 2009 financial crisis, firms struggled to make up shortfalls in the funding of their defined benefit pension plans out of profits, precisely when funds were required for working capital. Of course, in the case of government-administered defined benefit plans, the risk is borne by taxpayers, so any deficits are paid for out of tax revenue.
Today, approximately six million Canadians are employed by small- and medium-sized businesses, which may not sponsor any kind of pension plan at all, and almost three million are self-employed. Private sector workers are more likely to change jobs and experience periods of unemployment, resulting in income fluctuations. These workers without defined benefit plans save for retirement using RRSPs, defined contribution plans, tax-free savings accounts (TFSAs), and non-registered (cash) accounts.
Since not all workers belong to an employer-administered pension plan, the self-employed and those who work for employers that don’t offer pension plans must look after their own retirement savings schemes. Being self-employed or not belonging to an employer-administered pension plan does not necessarily condemn you to a life of poverty, but it does stack the odds against you. Nevertheless, Canadians have proven to be resilient, and they have adapted in the absence of an employer-administered pension by increasing the use of other savings vehicles like RRSPs and, more recently, TFSAs.
The shift away from defined benefit pension plans is often interpreted as creating a loss of security for pensioners, but this may not always be the case. Defined benefit plans can go bankrupt, whereas a defined contribution plan’s payout is dependent solely on contributions and investment returns. Also, funding problems for defined benefit plans are not necessarily confined to the private sector. The Quebec Pension Plan is an example of a government-run plan that promises more benefits than current funding can support. This is mainly a result of its exposure to risky assets ahead of the 2009 financial crisis. However, Quebec’s aging population is another problem for the plan. Eventually the QPP will require higher contribution rates or benefit cuts to avoid major changes.
The survival of an employer or the sufficiency of its pension assets is not the only source of uncertainty for pension plans. All such schemes are predicated on calculations about the likely average longevity of the plans’ beneficiaries. Now, longevity risk assumes certain mortality rates, but given that Canadians are living longer due to our health care system and medical advancement, the old assumptions are no longer necessarily valid. Of course, any significant changes to these assumptions could spell trouble.
One way for pension plans to mitigate this risk is to shift from a defined benefit regime to a defined contribution one, which is what many of the plans sponsored by the private sector have been doing. Another way to adjust is to increase the age of eligibility. The Harper Conservatives had planned to change the rules governing Old Age Security payments, which Canadians are now entitled to begin receiving at the age of sixty-five, so that recipients would have to wait until the age of sixty-seven to begin receiving payments. That change was due to take effect starting in 2023, with full implementation by 2029. This hike in the age of eligibility was expected to save the government $11 billion per year. When the Liberals won the federal election in 2015, however, they overturned the roll-back. Good for retirees, bad for deficits.
Pensions and RRSPs are not the whole story, though. The majority of Canadians’ personal assets are held outside pension plans. These assets are equally split between real estate and financial assets other than RRSPs. Most people’s real estate assets don’t extend any further than the principal residence; financial assets, on the other hand, can consist of cash deposits, securities, mutual funds, and other instruments. All of these assets provide potential sources of income for retirees. However, most current Canadian retirees, many of whom own their homes but lack other financial assets, have been reluctant to tap into assets like home equity as a source of retirement income. Younger Canadians seem to be more comfortable with the idea. It is one well worth considering, and I will be discussing the potential benefits of this strategy in more detail later.

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