Personal Finance and Investment
12.16.2010
Austrian Economics
Great post by Mercenary Trader. Great relevant discussion of von Mises "prophecy" for markets as indebtedness climes to near-catastrophic heights.
12.12.2010
12.11.2010
Index Funds and ETFs
Portfolios built around ETFs (exchange traded funds) and Index mutual funds are an inexpensive and tax-efficient alternative to actively-managed mutual funds. This is what is known as a form of passive investing. Holding a portfolio that mirrors or mimics the composition of market indices is commonly known as an indexing investment strategy.
Indices such as the S&P 500 in the US and the S&P TSX 60 in Canada are the benchmarks against which many managers of active equity mutual funds measure their performance on a relative basis.
Active managers believe they can outperform their benchmark, earning “alpha” on their investment ideas. Alpha is the excess risk-adjusted return earned over that of the given benchmark or index. According to the Capital Asset Pricing Model, a portfolio that consistently earns alpha has the same beta (systematic risk) as the benchmark, but the manager’s stock selection choices and ability to time the markets contribute to a better return.
Most managers in North America, approximately 75% historically, have not outperformed their benchmark or index. So passive strategies using allocations of index funds and ETFs are a low-maintenance, low-cost alternative for investors. Fees on index funds and ETFs are lower than actively managed funds because they are simply replicating or tracking an index, which requires much less research and lower turnover of portfolio securities than actively-managed funds.
Building a customized portfolio with ETFs and index funds can be a more cost effective way of earning returns equivalent to many actively managed mutual funds. Low MERs (management expense ratios) and greater tax efficiency are the main things that attract investors to using these products in their portfolios.
Happy investing,
Michael
11.26.2010
Managing Debt and Credit
It's that time of the year again when we all feel a little generous. Today, I am going to touch brieftly on the importance of debt management and explain why credit is very important.
Credit was once defined as "Man's Confidence in Man." Apparently, back in the day, a handshake was all it took to qualify for a loan at your local Financial Instutition but in fact, the definition of credit today is more like "Man's Confidence in Himself." Using credit today means you have confidence in your future ability to pay that debt. Forty years ago, your parents may have paid cash for their homes and their cars, a largely unheard-of event today. If they borrowed money at all, chances are it was from a relative or friend, and not a financial institution.
Today debt and instant credit are part of our everyday lives. The convenience of instant credit, however, has taken its toll. Many individuals use credit cards to spend more than they earn, and a few of these people actually build themselves a debt prison from which some never emerge. On the other hand, those who never use credit can be denied a loan or credit when they have a justifiable need or use for it. Using credit establishes a history of financial responsibility: Until you establish a credit history--you can start at the age of 19, your chances of qualifying for an important loan, such as a mortgage, are greatly reduced.
What is the balance between using credit wisely and staying out of overwhelming debt? Let's look at the facts and some pros and cons.
Debt comes in many forms, and most types help us in our daily lives -- when used responsibly. Most people cannot buy a home without some financial help, and many cannot buy a car (especially a new one) without some sort of financing. The money borrowed to purchase large-ticket items is called installment debt: The debtor pays a portion of the total at regular intervals over a specified period of time. At the end of that time period, the loan with interest is paid off.
Installment debt allows you to purchase items at a competitive interest rate: for example, 5% to 7% for a 30-year home mortgage and 8% or 9% for a car loan. The loan is paid back on an amortizing schedule, monthly payments of a fixed amount that remain constant over the life of the loan. At first, most of the monthly payment consists of interest. In later years, principal begins to be paid down.
Installment debt is easily budgeted and the debt is eliminated on a predetermined date. Even for those who may actually have the cash to purchase the desired item, installment debt can make financial sense if you can earn a higher return (after taxes) on your investment of cash than you must pay on your installment debt.
A revolving line of credit, also called "open-ended credit," is made available to you for use at any time. Examples of revolving credit are credit cards such as Visa, Mastercard, and department store cards. When you apply for one of these cards, you receive a credit limit based on your credit payment history and income. When you use the credit line, you must make monthly minimum payments based on the total balance outstanding that month. Some lines of credit will also have an annual account fee.
While revolving credit is a convenient way to borrow, it can also become an endless pit of minimum payments that barely cover the interest due. Many cards charge annual rates of interest of 18% or higher. As you pay off your debt, the minimum payment is also reduced, thus extending your payoff period and, consequently, the interest you pay. Paying just the minimum due on a $2,000 credit card loan could mean making monthly interest payments for 10 or more years!
Revolving credit, in addition to being convenient, eliminates the need to carry a lot of cash and can help establish you as a creditworthy risk for future loans. The itemized monthly statements also can help you track your expenses. But some people can easily yield to the temptation that the convenience of credit cards offers. Impulse buying, failing to compare costs, and purchasing large items you can't afford are all downfalls brought on by always available purchasing power. Spending more than you earn in any given period is a dangerous practice at best, but doing it over an extended period of time can be financial suicide.
More to come....
Your Finacial Pro, Jorge
Credit was once defined as "Man's Confidence in Man." Apparently, back in the day, a handshake was all it took to qualify for a loan at your local Financial Instutition but in fact, the definition of credit today is more like "Man's Confidence in Himself." Using credit today means you have confidence in your future ability to pay that debt. Forty years ago, your parents may have paid cash for their homes and their cars, a largely unheard-of event today. If they borrowed money at all, chances are it was from a relative or friend, and not a financial institution.
Today debt and instant credit are part of our everyday lives. The convenience of instant credit, however, has taken its toll. Many individuals use credit cards to spend more than they earn, and a few of these people actually build themselves a debt prison from which some never emerge. On the other hand, those who never use credit can be denied a loan or credit when they have a justifiable need or use for it. Using credit establishes a history of financial responsibility: Until you establish a credit history--you can start at the age of 19, your chances of qualifying for an important loan, such as a mortgage, are greatly reduced.
What is the balance between using credit wisely and staying out of overwhelming debt? Let's look at the facts and some pros and cons.
Debt comes in many forms, and most types help us in our daily lives -- when used responsibly. Most people cannot buy a home without some financial help, and many cannot buy a car (especially a new one) without some sort of financing. The money borrowed to purchase large-ticket items is called installment debt: The debtor pays a portion of the total at regular intervals over a specified period of time. At the end of that time period, the loan with interest is paid off.
Installment debt allows you to purchase items at a competitive interest rate: for example, 5% to 7% for a 30-year home mortgage and 8% or 9% for a car loan. The loan is paid back on an amortizing schedule, monthly payments of a fixed amount that remain constant over the life of the loan. At first, most of the monthly payment consists of interest. In later years, principal begins to be paid down.
Installment debt is easily budgeted and the debt is eliminated on a predetermined date. Even for those who may actually have the cash to purchase the desired item, installment debt can make financial sense if you can earn a higher return (after taxes) on your investment of cash than you must pay on your installment debt.
A revolving line of credit, also called "open-ended credit," is made available to you for use at any time. Examples of revolving credit are credit cards such as Visa, Mastercard, and department store cards. When you apply for one of these cards, you receive a credit limit based on your credit payment history and income. When you use the credit line, you must make monthly minimum payments based on the total balance outstanding that month. Some lines of credit will also have an annual account fee.
While revolving credit is a convenient way to borrow, it can also become an endless pit of minimum payments that barely cover the interest due. Many cards charge annual rates of interest of 18% or higher. As you pay off your debt, the minimum payment is also reduced, thus extending your payoff period and, consequently, the interest you pay. Paying just the minimum due on a $2,000 credit card loan could mean making monthly interest payments for 10 or more years!
Revolving credit, in addition to being convenient, eliminates the need to carry a lot of cash and can help establish you as a creditworthy risk for future loans. The itemized monthly statements also can help you track your expenses. But some people can easily yield to the temptation that the convenience of credit cards offers. Impulse buying, failing to compare costs, and purchasing large items you can't afford are all downfalls brought on by always available purchasing power. Spending more than you earn in any given period is a dangerous practice at best, but doing it over an extended period of time can be financial suicide.
More to come....
Your Finacial Pro, Jorge
11.25.2010
Diversification. What is it?
Diversification is an essential tool to reduce risk in your portfolio.
There are two broad categories of risk related to individual securities (stocks, bonds), systematic and non-systematic risk. The first, systematic risk, refers to the volatility associated with the economy at large, macroeconomic risk, the risk of the market. It is the oscillation of market returns throughout the business cycle. This risk is very difficult to diversify away.
Non-systematic risk or specific risk, however, relates to individual stocks, on the micro or firm level. All facets of the given business could be sources of potential risk: business risk, industry risk, supply chain risk and so on. Non-systematic risk what diversification aims to reduce.
Pooling of non-systematic risks through creating a portfolio multiple stocks and bonds is the key. The principle is that you're not putting all your eggs in one basket.
The theory is that this works by holding a portfolio of low-correlated or negatively correlated assets. Correlation is a statistical measurement that identifies the relationship between two variables (stocks or bonds in this case). The relationship in this case measures the extent to which the returns of two given assets move together. If the two assets move together in lock-step, one-for-one, this represents perfect correlation (+1, positive correlation). Uncorrelated assets have no clear relationship, returns vary in a seemingly random manner. Negative correlation would imply that returns between those two assets more in opposite directions.
Diversification seeks to build a portfolio with uncorrelated and negatively correlated assets, in this case stocks and bonds (two assets classes with that are traditionally and historically uncorrelated). We'll assume a 50-50 split between the two. So, for instance, if the stock market was to lose some steam (returns are negative), bond prices would rise (thus positive return). This would have the effect of softening the losses from equities, providing more consistent levels of returns over the long-run.
So, in summary, to reduce risk and volatility, diversification is key.
Happy Investing,
Michael
Happy Investing,
Michael
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