Author: Mr. Cheap

I made some recent purchases during the volatility in the stock markets. Being quite new to stock investing, I feel like a bit of a “green recruit” being tested in the first skirmishes of a war. I think in “A Random Walk Down Wall Street” they talk about investing on paper (not actually buying the stocks, just tracking an imaginary portfolio) is like a virgin reading about sex. The real experience is different.

Losing money isn’t fun. At the end of the dot-com bubble, I lost about 75% of what I’d invested ($15K of a $20K investment). As bizarre as it may seem (you might not believe this if you’ve been reading my blog for a while), I’m actually not all that motivated by money and I pretty well just shrugged my shoulders and carried on with my life. a couple of years ago I finally sold my position (it hadn’t done anything since) and just recently got around to re-thinking about the stock market and getting into it again.

I *really* wish I could have put that $20K into Canadian dividends 7 years ago, but such is life.

Most people don’t seem to react this way. Losing 75% of their money would make them freak out in a major way (like jumping out of a window). I’ve always followed the advice “don’t invest what you can’t afford to lose”, which is maybe what lets me be a bit more detached.

Losing 5-10% recently was nothing. More then anything I worried about missing the bottom, which as I mentioned yesterday I may have done with NA. I guess this makes me more greedy then fearful :-). If the market dropped enough to trigger a margin call, as I mentioned yesterday (say 20%), I *HOPE* that I’d respond by paying the call and transferring in more cash and buying more.

Buying on margin was scarier than I expected. My $28K margin debt is the second largest debt I’ve ever had (my $95K mortgage is the largest). With both of these debts, the things they were used to buy (the condo and the stocks) are still there and still worth money. Its *NOT* the same as $28K credit card debt. I’m not losing sleep over either debt (which I tend to be a worrier, so I think that means I’m very comfortable with them).

With both the BMO and the NA, I’m comfortable with the businesses. Every time the prices drops 5% from the lowest price I bought at, it seems to me that they’re worth buying more of (if it was worth X, its should definitely be worth 95%of X). I’m confident these are secure, strong companies that will be around for the long term (or at worst, would be acquired for a healthy portion of what I’ve paid). I felt the same way when I signed on the dotted line to purchase my condo, and that’s worked out well so far.

I was talking to a friend recently and made reference to the real rate of investment return and had the thought that it would be a very useful concept for anyone who hadn’t encountered it before. Basically the real rate of return is the annual rate of return on an investment minus inflation.

For example, stocks apparently average around a 10% return over a long period. With 3% inflation, we’d say the real return is 7% (10% cash in your pocket minus 3% lost to inflation). If you’re happy about the 5% you recently got on a GIC, the real return on it would be 2%.

You might ask, “Why do I care what the real return is? The money I get is cash in my pocket!” Great question. You care because you won’t get the cash until a later date. The real return tells you what that money will be worth in TODAY’S DOLLARS at that later date. Its easier to calculate your return in future dollars, but it can be hard to shift gears and realize a dollar is worth less in the future than now.

Suzy Orman (among others) loves to tell people how much they’ll have when they retire if they save $X amount. Say you inherit $5,000, invest it an index fund returning an average of 10%. When you retire in 30 years, you’ll have $87,247.01 (5000*(1.10)^30) they say and you’re suitably impressed. What is $87K worth 30 years from now though? Given that a movie will probably cost $25 bucks, it wouldn’t go as far as $87K would today.

A comparable investment would have a real return of $38,061.28 (5000*(1.10-0.03)^30). This is $38K which would buy $38K worth of goods today (so basically after 30 years the $5K investment will give you enough to live a pretty respectable lifestyle for a couple of years, enough to buy two nice cars or enough to take a number of pretty deluxe vacations – about 7 times the buying power of the $5K today).

I like to do all my investment projections in real returns (as Bernstein recommends). This lets you factor inflation into your plans, yet still understand at a glance what sort of buying power your money will have.

You can use all your current numbers for expenses, and if you’re comparing them to the real return of your investments you don’t have to do anything else. For example, my current living expenses are around $1200 / month. If I’m working with real returns, I can use this as my living expenses when I’m 65 and it will still be valid (I can compare expenses in today’s dollars with returns in todays’ dollars). Otherwise I’d have to adjust my expenses for inflation to compare it to future dollars.

E.g. my $1,200 expenses would be $2,912.71 (1200*(1.03)^30) 30 years from now (after inflation). The $87,247.01 above would pay for my living expenses for 29.95 months (87247.01/2912.71). The real return would cover my expenses for 31.72 months (38,061.28/1200). Basically the same results (living expenses for 2.5 years), but much easier to calculate. The difference is due to rounding errors and the fact that 1.07*1.03 ~= 1.10 (but not exactly). No one can tell you exactly what the market returns or inflation will be over the next 30 years so all these predictions are far from certain (and a slight difference between the numbers isn’t a big deal – these AREN’T precise calculations).

Clear as mud? If anyone thinks they can explain this better than I have, feel free to take a shot at it in the comments or link to better explanations (I won’t be offended 🙂 ).

As anyone following the markets has seen, they’ve been jumping around the last while, mostly moving downwards. The stocks I bought are down ~$1,600 (~4%) from when I bought. My father has his sympathetic face on when I talked to him about this, but I’m happy and wish they’d dropped further.

With real estate or stocks, the only time the price really matters is when you’re buying or you’re selling. If you’re buying, low prices are good. If you’re selling, they’re bad. With real estate I buy for the income stream of rent. With stocks I’ve been buying for the income stream of dividends. When I start bulking up my RRSP, one strategy I’m looking at is index funds, which I’ll buy in order to sell after I’m 65.

In “Four Pillars” Bernstein (or it *might* be random walk – the problem with reading a bunch of personal finance books right after another is that they blur together) repeats a few times that a market crash is great for a young person and bad for an old person. A booming market is the reverse.

Ben Stein wrote an interesting article about how massive an over-reaction to the sub-prime problems the current downturn is and how he feels this is a massive buying opportunity (after reading the article I was wishing I had more cash to put into the market – I really need to get working again 😉 ).

Since the stock market is a “secondary market” (people buying and selling ownership of companies, with the money and ownership involved not really affecting the companies in any significant way), the income stream (dividends) aren’t affected by the stock price. With a lower price, the dividend yield increases, and the income stream becomes more affordable. A massive crash would be the same thing on a larger scale. Bring it on!

I was asked last year what I had been buying during the stock market meltdown. I had been saving the bulk of my margin for just such a buying opportunity, so I definitely went shopping.

I previously posted my stock position as of the end of July. Since then, on margin, I’ve put another $15K into the market (two $5K buys of BMO and $5K of NA). I regretted purchasing RUS almost immediately after the purchase (somehow I didn’t realize it was a cyclical), so even though its down a lot I haven’t extended my position in it). It was up $200 after I bought it and realized it didn’t meet my criteria, so maybe I should have sold… Hindsight is 20/20. I feel like I over-bought Rothmans, and in some ways I worry that it might be riskier than banks (they haven’t banned banking in public places yet). At one point my portfolio was 1/2 ROC (and I basically said at that point “enough”).

On a monthly basis, this gives me a “cashflow” of -$5.42 (so my passive income has become passive debt 😉 ) $32.64 (stupid addition!). I was tempted to pick up another $5K of NA, and actually put in an order for it at $53.38 (2 hours after it had been that price), but its just been moving up since then so I missed out.

My hope is that the dividends will pay the interest charges mostly, and if one or two of the dividends gets raised, pretty quickly it’ll start paying down the debt. If there was a massive drop (to the point where my margin debt reached 70% of the value of my securities – if my stocks dropped 18% from their current value) I would have to pay a margin call (add money to the account to prevent them selling off my securities), which I’d be willing & able to do (I have $10K cash right now, and a $20K LOC). The other risk is if none of the dividends are raised, or if RUS cuts its dividend, eventually I’ll have to transfer money into the account to pay off what would become the mounting debt. I am aware of this risk and accept it. The other risk is if interest rates shoot up, E*Trade’s margin debt interest rate is based on prime, so it would increase as well. I would just start paying it down more aggressively in this situation.

Since I can deduct the interest charges (as investment expenses) and the dividends are tax preferred, I’m expecting the tax savings will more then make up for the $4 / month.

While there are some risks, and my passive income has gone down a bit, I think this is a rationale attempt to take advantage of what I hope was an irrational dip in the market. If all of these companies went bankrupt, I could afford the $163 / month payments (and you’d read me grumbling about it for some time 😉 ).

I realize also that I am very focused on banks (long term I’d love to add in some solid dividends from companies in an unrelated sectors such as Loblaws and an Energy stock and a partially unrelated insurance and investment company). Furthermore I realize I may be over-focusing on high-yielding dividend stocks rather then stocks with high dividend GROWTH. Right now I like the money in the bank and being able to have a foundation I can count on rather then buying for (less certain) future gains. As long as the dividends keep up with inflation (3% annual growth, which would be considered VERY meager), I’m content.

So there I am :-). It doesn’t really matter, but the current value of my securities is $48.8K (down $750 from what I paid for them) and I’ve received $72.60 in dividends so far (from ROC). I’m expecting my next dividend to come at the end of the month from BMO.