By Greg Bieber

One of the reasons I believe we advisors were sent into this world, is to prevent the clients we serve from making decisions that result in costly financial mistakes.

What might some of those decisions be? They can take on many forms, such as:

overtrading one’s portfolio,
over borrowing (or borrowing at all) to invest,
trading when one actually thinks they are investing,
over diversifying their holdings (I have seen portfolios with over 30 mutual funds), or over concentrating in one or two particular holdings (Nortel comes immediately to mind for many Canadians),
panicking out of one’s equity investments,
having no plan of any kind,
investing without the aid of a professional financial advisor and/or investing with the aid of a professional financial advisor and ignoring his or her advice which is the same as investing without an advisor.

Do any of these types of mistakes sound familiar to you?

Human behavior, especially in relation to money, appears to be the root cause of these types of activities.

In order to prevent you from being susceptible to these types of behaviors, having a financial advisor you can trust implicitly is, in my view, the most important ingredient to your financial success. While some of you reading this article are “do it yourselfers,” I can only say that doing so increases the odds stacked against you. Sooner or later you are going to be tempted into a very poor decision, one that, if acted upon, you may regret for many years.

The stories you read about in the newspaper such as the stock collapses of the
Bre Xs/Enrons/Nortels of the world, and the whole soap opera drama surrounding their demise, represent aspects of the story that sells newspapers. The real story, which is nowhere to be found is how many investors allowed themselves to own such a large percentage of shares of these companies in their portfolio. They either had an advisor and ignored their advice or were without one completely. 

This past winter, while on vacation, I came across two stories I feel are worth sharing. The first one was brought to my attention while channel surfing when I came upon the Suzie Orman show. She is considered an internationally acclaimed personal financial expert in the United States. During the question period of the show, the caller was inquiring about whether declaring bankruptcy might affect her financially. As Suzie probed her particular situation, she uncovered that this woman and her husband recently bought an $850,000 home which has dropped in value and now is worth $750,000 with, get this, an $810,000 mortgage. This means that it actually has a negative equity value. To add to their financial woes, their credit card debt was $90,000 and their combined household income was about $160,000. Suzie nearly fell off her chair. I actually did. Who gets themselves in a position like that!? A family without the aid of professional financial advisor, that’s who.

The second story occurred while we were being transported to the airport for our return flight home. The driver of our van, a 60-year-old woman from Seattle, had settled in the Arizona area to retire with her RV that was bought with money from her 401K retirement account. It turned out to be the best financial decision of her life. She worked for one company her whole life and her entire nest egg, which she was planning to use to fund her retirement, was comprised solely of shares of that company. Financial disaster struck through corrupt management and the company went broke. She lost everything with the exception of her RV which she purchased before the company went under. I am thinking as she is telling me her story, who allows one to bet their financial retirement on one company!? A family without the aid of professional financial advisor, that’s who. She was 55 when it happened. Today’s retirees are living well into their 80s and 90s; that is a long time for this woman to have to go back to work.

Since my last article in December, the mass media has, and still is, reporting about the housing crisis and looming recession in the United States, the asset backed commercial paper implosion in Canada and now the coming recession in at least Ontario. While all this is going on, the stock market volatility, in both directions (I mention this because for most people volatility goes only one way) at levels last seen some 50 years ago. It never stops. If one is to believe what they are been fed by the mass media on a daily basis, they might be tempted to make a change to their overall long term investment program, in others words, panic out of their equity holdings).

Having a financial advisor whom you can trust implicitly will assist you in navigating through what I refer to as a very necessary, healthy, and normal stock market decline. For the record, these declines tend to occur on average once every five years (at least they have since the Second World War) decline on average approximately 30 per cent and have historically been 13 months in length. Without them, we’d be missing the magnificent rises that follow each of them.

To me, being out of the market is your greatest risk next to being without a financial advisor. Why take the chance?

Insurance for you...what a novelty!
By Greg Bieber

Life insurance is pretty straight forward.

In order for your beneficiaries (or estate) to receive your insurance proceeds you have to die. Forgive me for being the bearer of bad news on this one, but we all go sometime. Having life insurance assists in replacing your income earning power for your loved ones when you are gone or preserves the value of your estate from your pending tax liability or both. In essence, this type of insurance is purchased with others in mind.

That’s all fine for them, but what about you? What happens if you are stricken by a critical illness and you actually continue living? Advances in medicine have either found a way to cure or contain many of the illnesses that used to end our lives. Studies show that we have a much greater chance of suffering from a critical illness before age 75 than dying from it. In fact, the likelihood of surviving a critical illness before 65 is two times greater than dying from it. This is on top of the fact that we are simply living longer in general. Bottom line, our families need money, which is hard to make if we’re sick or dead.

Don’t despair! There is a type of insurance for those who believe that they would benefit from a lump sum payment if they were to be stricken with a critical illness or life-altering disease. It’s called Critical Illness Insurance. In order to receive this payment, you would need to satisfy the 30-day survival period after being diagnosed. If, god forbid, you pass away in that time frame, the premiums paid to date are then returned to your beneficiary and your life insurance (if you have any) will take effect and be paid out.

What kind of illnesses qualify for this insurance benefit? Most insurance companies cover the major ones such as cancer, heart attack and stroke. There are some life altering illnesses that are also covered, such as multiple sclerosis, paralysis, Parkinson’s Disease and blindness. The complete list is too long to write about here, but these are the most commonly claimed.

There are several ways you can purchase this insurance. However, the most popular plans are renewable term and level premiums to age 75. Renewable Critical Illness Insurance is an affordable way to provide coverage for a temporary need, such as paying off a mortgage or loan. Level premiums to age 75 offers a more permanent coverage as level premiums are fixed throughout the life of the contract. You can also include a return of premium feature which means you have all your premiums returned should there be no claims made. Getting your money back on the premiums you have paid on this type of insurance is of course an interesting feature.

We all know someone who is currently experiencing or has had an illness of this nature. Do we really know what kind of emotional or financial toll it takes on them or their family members? A colleague of mine in his early 50’s was diagnosed with Stage Two prostate cancer. While the diagnosis was very serious, with a potential to develop into a more progressive state, it was still at a very treatable stage with a high success rate. Even so, he told me there were many times he stared out the window wondering if he was going to live. Fortunately he had $100,000 of Critical Illness Insurance and in less than three weeks of his diagnosis (and after his 30 day waiting period) he received his benefit payment. Even though he was in good financial health, he found the money to be of comfort during those emotionally difficult times. In the end, he was treated through surgery with complete success. And what did he do with his money? Since there were no restrictions on the use of his benefits, he applied them to defray the cost of one of his children’s education in Europe. He was fortunate. Many others with more severe illnesses use the money for out of country treatment, alternative treatments, home or vehicle alterations, debt repayment or even to take a long put-off family vacation. Thankfully this story had a happy ending. On the flip side….On August 13, 2001, a business acquaintance of mine sent me an emailthat went exactly like this…

Dear Greg,

Do forgive me for writing instead of calling this morning, but I cannot bear to call, it is just too difficult.

I was admitted to the ER last week in terrible pain, and after a number of preliminary tests, have been told I have cancer. It is in a number of parts of my body, thus not an early stage disease.

The next week to 10 days will hopefully bring a detailed and specific diagnosis, and a treatment plan.  Until then, I am in and out of hospital for tests and consultations, and unable to work.

Which brings me to the next point: Once I have a diagnosis and treatment plan, I will want to discuss options with you regarding my work for you. It is premature for us to discuss that now, as I have very little information with which to work. I cannot tell you how much I value both the work I do with you and our professional relationship. My health, indeed my very survival, comes first.

As soon as I have any significant information to share I will do as soon as I can.

Thank you for your understanding.

Nellie (real name withheld)

I know how I felt reading the email. I can only imagine what Nellie must have been going through writing it.

To make a fairly long story short, we reconnected in the fall when her cancer was in remission and had lunch. We talked at length about what she was going through and about our resuming our business relationship. Up until this point she was focused on getting better and thinking about going back to work was the farthest thing from her mind. Rightly so. However as a business owner, without her working, no income was being generated. She was living off and possibly depleting her investments. Being the curious financial advisor that I am, I did ask if she had ever heard about Critical Illness Insurance. “Funny you ask,” she said, “because my advisor mentioned it to me during our annual review earlier in the year and even left behind a brochure for me to read. I just threw it on the dining room table and paid no attention to it. I just thought that stuff happens to other people.” A very common response to insurance in general, I replied.

We resumed our business relationship again up until the end of February of the next year. This was followed by an unusual several week gap in our contact. I soon learned why. On March 26, 2002, I received an email; she had passed way…seven months after her initial diagnosis. We had lost one of the good ones.

Back to the point of the article. I will never know if receiving a lump sum of money would have saved this wonderful woman or even bought her more time. I do know that without it, we will never know. It did, however, give my colleague some additional emotional comfort even though he was in relatively good financial shape.

As to the thought it will never happen to me, read this startling statistic. In the 1970s, one in five people had a lifetime probability of developing cancer. Today, 1 in 2.3 Canadian men and 1 in 2.6 Canadian women are expected to develop cancer over their lifetime.* Yes, you read that right. That other person it always happens to might someday be you.

It’s no coincidence sales of Critical Illness Insurance have increased dramatically. Corporate benefit plans are even beginning to carry them. The downside to its popularity is that insurance companies might begin to rethink the diseases they cover (reduce them) and the premiums they charge (increase them).

So if I were you, I’d take a good hard look at integrating a Critical Illness policy into your overall financial plan unless you already have one. Your respective advisor will no doubt be able to assist you with understanding the options, costs and ultimately the appropriate fit for you.

Your quality of life may depend on it.

*Canadian Cancer Statistics 2007, published by the Public Health Agency of Canada, Statistics Canada and cancer agencies.

The Canadian dollar... what we can really learn from it?
By Greg Bieber

Any time I receive a telephone call from my mother, who is a neophyte on financial matters or on an investment topic, I know the mass media must be giving it considerable attention. I was right. In this case it was the Canadian dollar. I asked her what she was so excited about to which she replied “it has been over thirty years since the two currencies were at parity.” I quickly corrected her grammar and said “Mom you mean par.” “Yes, parity,” she replied. What’s a son to do?

The media coverage was thorough. For about a week it was hard to go anywhere without getting bombarded from the mass media - newspaper, radio, Internet and TV - letting us know our dollar is equal in value with the Greenback. I know they are simply doing their job, yet experience has taught me that mass media coverage generally comes without perspective or wisdom.

So I started to think “just exactly what can us as investors learn from this historic attention grabber of the week?”

Before I address the answer to that question in more detail, I’d like to review some of the more visible facts related to our dollars staggering four and a half year ascent. I do think we can all agree its rise is a reflection of a strong economy and a weak US dollar. It’s great for snowbirds and bad for manufacturers who export; ideal for investors who recently invested outside of Canada, bad, at least for now, for those who did so when our dollar was notably lower. You get the idea. 

Yet what really caught my attention in seeking an answer to my question were my mother’s words - thirty years. And what is so special about thirty years you ask? Lots actually! This relates to a topic that is far more important to you than the value of our dollar: the length of time you may be spending in your retiring years. The last time the Canadian dollar was par with the US currency until now is a neatly packaged set of symbolic retirement years.

To clarify, by retirement I mean someone who only chooses to go work with no financial reason to do so and/or enjoying a lifestyle of their choice from one’s income that is generated from either their pension, their investments or in most cases, the blend of the two.

The days are gone where the previous generation retired at 65 years of age and passed away at 72. Our generation is living longer, healthier, more active lives and requires more capital to fund their retirement than ever before.

According to actuaries, if a couple reaches the age of 65, one of them is projected to live, and at least do so until the age of 92. That’s 27 years beyond the official age of retirement. If you plan appropriately you might be fortunate enough to actually retire earlier, as many are now doing. Take for example my longest retired client who is now 68 years old. He retired when he sold his business in 1991 at age 52 (he recently got dethroned by another of my clients who just packed it in at age 49 years of age)! If he lives past age 84, and there is a good chance he might, he will be a part of a growing population that will be retired longer than they actually worked!

Since the last time Canadian and American dollars traded at par, a great deal has happened. I dare say a great deal more will occur in the next 30 years. So what is so special about this event in itself? Well nothing actually, unless of course you are part of the mass media. It’s an event to cover until the next one comes along. To the long term investor (especially one with a plan), it’s just noise.

To highlight my point, I want to take you on a brief historical journey to highlight some of the noisier events during this period. Understanding history has a way of making you a better investor. Why? Because history has a habit of repeating itself which, in turn, gives you about the most effective window to the future you can have.

As I list them please understand there is no intention on my part to down play these events, especially where human lives were affected. Each one of them on their own, let alone stringing a few of them together, caused some temporary, even some very painful, stock market declines. The key word here though is temporary.

Picture it, it’s the mid 70s…the North American economy was under economic siege with hyperinflation and 20% interest rates. Now to the late 80s…we experienced the single worst day drop in the history of the stock market. The late 80s and early 90s…North America experienced a severe real estate savings and loan crisis, Iraq conflict Part I. Mid-90s … Alan Greenspan’s sudden increase in short interest rates triggered one of the worst bond market declines on record. Late 90s…Asian currency crisis and the unwinding of the Hedge Fund, Long Term Capital management. Turn of the century… technology bubble bursting, second worst stock market decline since the great depression, 9/11, and the never ending Iraq conflict Part II. Today…. the sub prime loan crisis in the U.S.

It seems that whenever one crisis occurs, then comes to an end or at least it runs its course with the media or both, another one is just around the corner ready to take its place.

Yet with all those events, which seem like a distant memory now (when they were actually happening it seemed pretty real at the time), the stock market not only went up in value, but increased substantially. The New York Stock Market, the Dow Jones Industrial Average specifically, which is the most widely followed index on the planet, rose from a value of $997 in November 1976 which was the last time the Canadian and American dollar were of the same value, to $13, 916 at the time of this writing. That’s an 8.90% compound rate of return excluding dividends. Add in the dividends and the number is obviously higher, much higher.

And what did one have to do to experience this kind of return? Basically have a diversified portfolio of professionally managed equities under the guidance of a trusted financial advisor. (See my earlier article Cash, Bonds and Equities, dated September 28, 2006, to see how each asset class percentage is determined). Do I think many people did just that? My best guess is no. For the simple reason investors are now just beginning to experience the benefits of sticking to a plan of holding their equities through good times and bad.

Since that was then and this is now along with knowing what we know today, we can no longer plead ignorance to the benefits of this type of investing. An early and a long well funded retirement is appealing to say the least.

As for me, I can now say I am no longer plugged into making a great deal of changes to my or the portfolios of the families I serve especially on the basis of making decisions on matters that are completely out of our control. It’s both liberating and over the long term, financially rewarding.

I counsel you to do the same.

Why is the market so freaking happy?
Why are our stock market and loonie so happy? Well they’re young, healthy and the envy of their neighbours. But remember, there are two sides to every coin!
By Greg Bieber

I try to make a habit of writing about real financial issues that matter to families. This involves seeking answers to questions like, “How do I create a portfolio that will generate an income that will actually outlive me?” or “How do I put a financial foundation in place in case I die?” or “How much will it cost to send my children or grandchildren to university and how will I pay for it?” I think you get the idea. After finding the answers, the next natural step is to help people put a plan in place to achieve these goals.

Yet, even when I find those answers, there are two entities that are completely out of our control: the Canadian stock market and the dollar. Why am I worried? Both have been rising at either unprecedented highs (the stock market) or reaching 30-year highs (the dollar) with no let up in sight.

Before I elaborate, I want to go on record as saying that I am one of the last people you will ever meet who will talk down a rising market, or even a rising currency for that matter. Additionally, any major short-term movements in the market receive virtually no attention from me and I make a living of counseling families to do and think the same.

I am, however, somewhat perplexed at the consistency of our rising market given, in my view, the pending storm clouds on the horizon and how they will affect you and your investment decisions.

My You’re a Handsome Market
The Canadian stock market has consistently been penetrating record highs for months. You simply have to look at the equity portion of your portfolio to notice that your value has increased quite handsomely. And while the market and your portfolio is rising - as it has for over four straight years without a major pause - one can be forgiven for giving little or no thought to a potential down turn (even if you knew in your gut that it’s overdue).

In the United States there are two risks to the market: inflation and taxes. And because we are so connected with our neighbours to the south, they are in essence risks to our market as well.

The U.S. economy has been on a tear of late. New jobs are being created on a regular basis and unemployment is being reduced to a bare bones number (which in turn is creating a rise in wages, which in turn is inflationary). It’s very difficult to roll back wages so any increases stay in the system. Moreover, the most valuable asset in a household is a job that brings cash flow and then, in turn, gives birth to spending. And lots of it. No wonder retail sales numbers have been very strong.

Hello Inflation
Add a rising stock (and real estate) market on both sides of the border, and commodity prices at or near historical highs, and you have what we call inflation. You’d think the central banks might view this as a reason to tighten monetary policy and increase interest rates. Yet they remain very accommodative. Let me change that to extremely accommodative. There have been 17 rate increases in the U.S. and there appears to be no economic slowdown on the horizon, which is usually the result of rising interest rates. And the Federal Reserve Board - the entity that is the equivalent to our Bank of Canada - has stayed pat for two years. In my opinion they are delaying the inevitable. The only question of relevance is just how much they will raise rates to wring out inflation.

The Tax Increases Cometh
While this storm cloud is forming on the horizon, there is another one that has been developing for several years – tax increases. Several years ago the republicans put temporary tax reductions in place. If not extended, those will soon expire. This means that Americans will soon be paying more taxes. Since the democrats now control congress, any reading I have done suggests they will let these tax cuts expire. This amounts to an approximate $900 billion tax increase - the largest in history. And what do tax increases bring along? Slower growth, increased unemployment, reduced savings and spending as well as slower job growth.

This will have a profound effect on the U.S. stock market, and I dare say ours as well. Markets are cyclical in nature and a rising market is always followed by a declining one. It’s impossible to have one without the other. A coin has two sides. I just want you to be aware of this financially, emotionally and psychologically.

As for our currency, after reaching an all time low of $0.6192 on January 21, 2002, it recently reached a 30-year high of $0.9278 on May 25, 2007. The magnitude and pace of the rise has been dramatic to say the least. Now all the talk is about parity with the U.S. dollar. This increase and any further increases will be certain to curtail any investment returns with any U.S. dollar denominated investments, unless of course their market rise keeps pace or even does better than our dollar.

This begs the question: Should you sell American stocks/mutual funds/third party managers and redeploy the money back in Canadian dollar denominated investments? While the temptation may be great, I say no. Diversification still remains the hallmark for portfolios that stand the test of time and if you are a long-term investor, by definition time is on your side. In the end, you will be glad you did.

TO ASK OR NOT TO ASK... THAT IS THE QUESTION
By Greg Bieber

Each year, my wife and I sit down to discuss our overall financial situation, in particular the more meaningful elements of our financial plan. During this time, I remove the hat I wear as a husband and father and replace it with that of a financial advisor. With a toddler running around the house and another on the way, this year’s meeting was going to be different. My wife knows, from our past discussions, that we are in solid financial shape. Yet I sense she wants these updates to focus on providing some assurance that if anything were to happen to me, that she and our children would be alright, financially speaking. 

We first blocked an hour of time one Sunday afternoon. Scheduling the meeting has always increased the probability of the meeting actually occurring. We met in my home office and I approached it as if I was actually going to a client meeting.

The meeting began and she was all business: “Greg, now that we have a family, I have some specific questions to ask you. Just exactly what will happen to us if you didn’t wake up tomorrow?” I assured her I have both individual and group life insurance, which will allow her to continue with the lifestyle to which she has become accustomed. Comforted by the answer, she then asked, “What might happen to our family if you became critically ill or suffered some disability and were unable to work?” I reassure her that I have critical illness policy that pays out its benefits if I live beyond thirty days if I experience, god forbid, a heart attack, stroke, cancer or some other form of illness the policy covers. As for the second part of her question, I also tell her I have individual and group disability insurance for as much coverage as we are allowed to receive. She nods with approval.

Next question: “Have you any idea what it will cost for our daughter Sofia to attend university and have you a plan in place to make this a reality?” With Tim Cestnick’s Winning the Education Savings Game book at my finger tips, I immediately thumbed to the appendix and located the costs for a four year education with room and board. I inform her it comes to approximately $119,000, some sixteen years from now. “And the plan to get there?” I tell her we have established a RESP and the first contribution is made. Then she reminds me of our pending addition to the family. I tell that we will set up a family RESP to take into consideration all our children.

She continues: “Have you considered when and how you plan to retire? I understand people are living longer and may need money for up to thirty years after they retire. Were you aware of that?” Yes, I said, I have established a proposed retirement date with a plan to accumulate a pool of capital to hopefully generate an income that will outlive us in today’s dollars, inflation adjusted. I continued by telling her at our age we have enough time, with the monthly deposits we are contributing, to achieve our financial goals. Based on what I have read, people are in fact living longer healthier lives and require money to do so because I see it every day in my profession. We must also consider that if they are living longer unhealthy lives, they will needmoney, perhaps more than if they were healthy. “That’s going to be a challenge for some people,” she said out of the blue. I asked why. She responded by saying she is aware of some people our age financially supporting their parents. Then she asks, “Do you think any of them thought they might be assisting their parents financially during their lives?” I remained silent as I felt no response was required since the answer was obvious. The thought did occur to me that having one’s children look after their parents might be considered the bitterest kind of financial defeat of all.

“Do you suppose it’s important for parents in general to assist their children and grandchildren financially, either when they are alive or in the form of a legacy?” In a word, yes. I shared with her that I hear from many parents, with whom I work, that they would rather gift their children money when they need it and see them experience the benefit of that gift. I also hear from grandparents how they have a desire to assist their grandchildren with their post secondary education. They know they can remove at least some of the financial burden from their grandkids and parents knowing the education costs involved.

“You mentioned to me that you advise families to give back financially to the community both when they are alive and when they pass on. In what ways are we set up to provide a meaningful legacy for the community upon our demise?” I said we would require a more dedicated discussion on this before we commit part of our estate to the community and adjust our wills accordingly.

Comforted, our annual meeting was adjourned. It took less than thirty minutes. It was clear that all my wife really wanted to know was that she, and our children, are protected from the financial consequences of death, critical illness, and long term disability; that we had a plan to provide the best education our future money could buy for our daughter and her future sibling(s); that we also had a plan to ensure we become financially self sufficient in our retirement years and we were able to make a meaningful contribution to the community in which we live after we are gone.

The questions she asked me were in essence dealing with real life issues. I also paid close attention to the questions she did not ask. It was clear that her focus was on matters within our control—how much life insurance we get—as opposed to what we can’t control—the stock market-.

That said, my message to you is to ask yourself and your loved ones the same or similar questions and see what answers you learn. I can assure it will uncover, on one hand, the areas of your financial plan that requires attention and, on the other, aspects that are in good shape. As someone once said to me years ago, “When you have a plan, time becomes your friend. When you are without a plan, time becomes your enemy.”

I challenge you in the year ahead go out and make time your friend.

BONDS NOT BOND.
CASH, BONDS OR EQUITIES: WHERE TO INVEST YOUR MONEY AND WHY.
By Greg Bieber

There are three types of asset classes into which you can place your money: cash, bonds and equities. While it may be easy to differentiate one asset class from another, determining which asset class to invest in, and how much of your money to allocate towards each, can be a challenge. I have seen many investors’ portfolios constructed without the understanding of the reasons behind their choices. Not having the basic understanding of why you are placing your money in each asset class could be a contributing factor in why you are falling short of your financial goals. Hopefully this article will help you determine what percentage you invest in each asset class and why.

CASH

First, let us consider cash. This is where you would have your money in a savings/chequing account, Treasury bill, money market fund or a bond with less than one year left on its maturity. These all allow you to access your money virtually on a moments notice. The recommended purpose of holding cash is for emergencies, to cover off any temporary unemployment or to provide a financial bridge until your long term disability insurance begins to pay out. Financial planning manuals suggest having at least three months (after tax income) in cash. My recommendation is that it be anywhere from three months to two years depending on one’s age; the older a person is the longer the time frame. As for historical returns, cash has returned approximately 3%* which makes it a poor long-term investment.

BONDS

Next are bonds. This is where you loan your money to a government or corporation and the issuer guarantees the return on principle at a future date and pays you interest during the time it’s held. In my experience, investors have tended to primarily buy and hold bonds for the perceived safety they offer, for the emotional comfort that they get from being free from the ups and downs of the stock market, or for income. I don’t think that any of these are primary reasons to acquire bonds. Bonds, in my view, are best owned for the purpose of making available a specific sum of capital that you may anticipate wanting inside a five year time period, even though you can buy bonds for up to thirty years in duration. The idea is to time your bonds to mature when you will most likely need the money: when you are planning to buy a new car, a cottage or a home renovation. Historically, rates of returns on bonds have been approximately 5.5 %* which makes them a sub par asset class for long term investing, at best.

EQUITIES

The last asset class is equities. These are common shares of publicly traded companies that can be individually owned or professionally managed. I fully recognize that a home, cottage and other type of real estate fit this asset class, however, for the purpose of the article publicly traded companies will be the form of equities discussed. As an asset class equities have returned over 10%*, which makes it the superior asset class to invest in.

WHAT NEXT?

With this information, how do you determine what amount you place in each asset class? It really boils down to a process of elimination. You identify the amounts you wish to allocate to the first two categories and what is left over simply goes into equities.

TWO THOUGHTS YOU MAY FIND

You may find at least two thoughts come to mind when determining your allocation. The first is how bonds are recommended primarily for future sums of capital as opposed to income or safety. My guess is most of the investing public will think just the opposite and their portfolio may reflect so, meaning they will hold a certain percentage of bonds for income and/or comfort regardless of what rate of return they pay. Second, if this process is followed, the likelihood of an investor having the largest percentage of their portfolio in equities will be very high regardless of their age.
First, because inflation and taxes erode the purchasing power of bonds over time, bonds by definition become, in my view, a poor financial investment. Yes I agree, they are popular and allow one to sleep better at night, at least on the short term. Yet it is a mistake to ignore bonds historical rates of return. Investors who have a very large percentage in bonds may wake up one day in their later years wondering why their money no longer has the same purchasing power it once did. As one of my industry colleagues adeptly put it, the only sane test of an asset class’s safety is to the extent to which it preserves or even enhances ones purchasing power. Bonds have so far failed in this area. It is important to note that while I am providing you a point of view that may challenge the conventional wisdom of owning bonds, please keep in mind there are investors that do have different approaches and objectives based on ones level of sophistication and net worth. In other words they may be perfectly fine owning bonds for reasons other than what is outlined in this article.
Second, because we are living longer and having more active lives with each successive generation, we will require more money to preserve the lifestyle to which we have become accustomed. I know people who have being retired longer than they actually worked! I have found that as investors grow older they tend to invest more conservatively. By that I mean their risk tolerance for equities seems to decrease and their desire to inherently own more bonds in their portfolio increases. This occurs at precisely the time when, in my view, they need to hold a much higher percentage of equities in their portfolio than they are most likely emotionally comfortable. Again this approach may differ for a certain percentage of investors given their level of sophistication, net worth and objectives.

ANSWER THIS QUESTION

Answer this question: When it comes time to withdraw money from your overall portfolio, do you wish to attempt to recover 5.5%* a year during your retirement for say the next thirty years from an asset class that has had a historical return of 5.5%* or is it safer to attempt to receive 5.5% a year from an asset class that has had a historical return of over 10%*?

With this awareness, choosing how much you allocate your portfolio to each respective asset class may determine whether your money and the income it derives for your retirement outlives you or you outlive it. Personally, I like the former outcome.

*These percentages represent the compounded annual return from January 1, 1926 to December 31, 2003 before inflation. Source - Stocks, Bonds, Bills and Inflation 2004 Yearbook, 2004 Ibbotson Associates Inc.

NEW FINANCIAL COLUMN

Every quarter, Greg Bieber of Richardson Partners Financial Limited will be talking about how best to spend, save and invest your money in a regular financial column.

ABOUT GREG BIEBER
Greg Bieber is an Investment Advisor and First Vice President with Richardson Partners Financial Limited. He has been in the industry for almost two decades and has been interviewed for television, radio and print. He has also written articles for the Area News and is now providing Winnipeg Men and Winnipeg Women magazines with a quarterly online financial column.

PAUSE OR NO PAUSE

On May 9th the U.S. Federal Reserve increased their Fed funds rate—which is the equivalent to our Bank of Canada rate—to 5%. This marked their 16th straight increase, which began in June 2004 when U.S. short term interest rates were at their lowest level of 1% (yes 1%).

For the purpose of providing a brief history on how the rates reached this point, allow me to take you back to the headlines at, or just after, the turn of this century. We had endured the second worst stock market crash on record from 2000-2002, an economic recession, calamitous terrorism primarily in the form of 9/11, and corporate and accounting scandals, which rattled investor confidence. In response, now retired U.S. Federal Reserve Chairman Alan Greenspan and its governors took an assertive stand and ratcheted down U.S. short term interest rates from 6.5% to a mind boggling 1% in two and half years, from January 2000 to June 2003.

While lowering the rates appeared to be the correct response at that time, there may now be a danger that the Fed lowered them too far and for too long. Lowering short term interest rates is considered a monetary policy governments have available to them for the purposes of providing liquidity (ease of credit) to the economy, which will in turn help reignite it. Well reignite it did, on a global level. As a result, the U.S. dollar has been in a free fall, which is inflationary as it makes imported goods more expensive, and commodity prices rise even faster as they continued to break out of a 20 year sleep.

Incredibly, many commodities have either made record levels or multi-year highs in recent months. A good example of this is gold blowing through the $700 an ounce mark, albeit briefly. The American economy has grown by 5.3% the first quarter of this year, business spending is up 16.4% and U.S. unemployment is 4.6%, very close to full employment. Furthermore, the consumer has had to endure a 34% increase of gasoline prices these past three months and have you tried to buy a house lately?

Following the May interest rate increase, Alan Greenspan’s successor, Fed Chairman Ben Bernanke, further indicated the Fed may consider a pause in raising interest rates at this time. He was also quoted as saying “some further policy firming may still be needed” which maybe an indication that further rate hikes may be anticipated for the purpose of ensuring price stability. This current lack of conviction created a level of uncertainty and frustration that resulted in the stock markets cracking for the first time in a few years. And, it also has everyone in the investing world talking inflation again.

Taking a page from Fed Chairman Bernanke’s predecessors, specifically paying attention to their first few months in office, Paul Volker and Alan Greenspan rose to the challenge and dealt with their circumstances with the skill of a surgeon. Volker, you may recall, had hyper inflation coming off the seventies to attend to and Greenspan had the single, worst one-day stock market decline on record with no idea what was to follow. Both orchestrated results beautifully and to some, painfully, through decisive monetary policy.

From my vantage point, while there is no indication inflation is out of control, it also appears it is in no way contained. To that I say, the Fed will be much more effective at breaking its back if it remains committed to raising short term interest rates without a pause. The bad news to this scenario is the markets will most likely dislike this news in the short term. In fact, the markets may dislike either scenario, decisive tightening or pausing on any further rate increases, so it may as well administer the balance of the medicine once and for all. The good news is we are closer to the end of rate increases than the beginning. While all this is playing out, investors may feel anxious as we proceed through this cycle. To that I say, remain steadfast and courageous as it will soon be over.