Archive for December 2, 2009

| December 30, 2009
No comments

How share ownership should work

One investment choice, among many options, is share ownership. With the advent of mutual funds and ETFs, some investors may not understand what share ownership represents. In order to explain it, let’s explore a simple example.

Let’s imagine a young person who starts a business. For this example, we’ll assume that it’s a simple business, with a single  input and a single output. When a young man starts a coffee shop, it requires start-up capital. The value of the business is equivalent to its assets. When the man, who is owner, employer and employee, starts building relationships, increasing the value of his brand and developing recurring revenue, the value of the business increases. The value is based on the ability of the company to produce income.

What happens when the young man wants to expand to a second location? He can approach the bank for a loan, or he can sell bonds, which is essentially a non-bank loan. He will need to pay back the capital at a set date, and pay interest on a specific schedule. Let’s say that the second location is successful and he wants to open five new locations. Suppose either the bank won’t lend the money, or the interest payment schedule is not realistic. Another alternative for raising money is to sell shares.

Shares represent ownership in the company. In the previous example, the owner could use all the income, after paying interest and saving for principal repayment, for his own personal income (salary). When he divides ownership in the business, with shareholders, each owner has a proportional claim on the profits of the business. In a given year, the owner will pay loan interest, set aside money for loan repayment, pay salaries and reinvest in the business. The remaining profit, after taxes, can be paid to owners as a dividend.

The owner no longer works as an employee and has had to hire employees to run all the additional stores. A time may come when the owner no longer wants to work as the employer. Hiring and firing and managing the employees, the assets and the procedures may be outside of this man’s competence. He can hire a manager to run his company for him. This frees the owner from day-to-day management of the company, and may allow him to focus on other strategic activities, such as developing new markets, building relationships with suppliers and communicating his vision to stakeholders (owners and lenders). At this point, he is called the president. The manager is referred to as the CEO.

In order to ensure that the CEO is running the company for the benefit of the owners, the president can put together a board of directors. This divides the work between more people and allows for more input and complementing points of view. For example, the board will discuss the long-term vision of the company, review the financial statements  (via the audit committee), determine appropriate income for the managers (the compensation committee), set a dividend policy, and use their connections to advance the interests of the company. Board members are sometimes paid a fee for their services. The purpose of the board of directors is to ensure that the interests of the owners are advanced.

Once a year, the company holds an AGM (annual general meeting) for shareholders to gather. They have an opportunity to hear their managers report to them and to ask their questions of management. The directors are nominated and voted on, and business may be brought before the shareholders for voting. There is little difference between a privately-held or publicly held company. The main difference is that a public company’s shares trade on an exchange, which makes it easy to buy and sell shares. Most exchanges require that the financial statements of the company be filed publicly, which makes the information easily accessible.

Buying stock means sharing ownership of a corporation. It gives the shareholder a right to future profits. It also confers rights to attend the AGM, nominate and vote for directors. The value of the stock will fluctuate, depending on expectations of future profit. If the company is public, the shares are easily tradable on an exchange. The shareholder should have directors that ensure satisfactory performance by management and shareholders should take an interest in the health of their company.

Category: Opinion | Tags:
| December 23, 2009
No comments

Book mention: Shell Shocked

I can’t call it a book review, because I didn’t read Shell Shocked: How Canadians Can Invest After The Collapse, by John Stephenson. I only got part way through the introduction before I put it down in disgust. I’ll explain what I found objectionable about the book, but I expect everyone will choose for themselves whether or not to pick it up.

It started with a bad impression. I am a financial advisor, so I receive a great deal of unwanted email (spam). I’ve gotten to the point that I hate spam and I will refuse, on principle, to work with groups that send me unsolicited messages. J.Wiley, the publisher, sent me two spam emails about this book. I think they were expecting me to buy it and hoping that I would buy in bulk as a gift for clients. That underlines the fact that they were doing it with their own interests in mind. I consciously made an exception to my “boycott spammers” rule, because I was curious about a book that my clients might end up reading and asking me to comment on. A client asked for my thoughts about The Great Depression Ahead, by Harry Dent. I got it from the library and my wife read a little of it, but there were so many things wrong with the arguments that he laid out, that I refused to waste time on it.

With Shell Shocked, I read the introduction. The author was not off to a good start. He began as a manager at the ill-fated Enron. He says that something felt “not quite right,” but the bankruptcy caught him by surprise. Then he became a portfolio manager, and the market crash of 2008 caught him by surprise. In all fairness, most people were caught off-guard by these two events. It’s normal to be surprised by world-changing events because they cannot, by definition, be predicted. (If they could, they wouldn’t be world-changing.) But this is coming from an author who claims to be predicting the future according to the sub-title: How Canadians can invest after the collapse.

One red flag doesn’t cause me to put down a book, only to be much more critical of the arguments and how they are presented. For example, I read Insure Your Investments Against Losses: Strategies for investors who can’t stomach losing their hard-earned cash, by Robert Goldin. I believe that the author is irresponsible for developing unrealistic expectations by presenting ideas that are unworkable in the real world. His examples are fictitious and are not grounded in reality. People who try to follow his advice (who are hopefully few in number) are in for a huge disappointment (and probably financial loss).

It was bad enough that Shell Shocked was published in 2009, during the market crash. I am not familiar with publishing timelines, but that didn’t leave the author much time at all to write and revise his text, then have researchers corroborate his research. Maybe he didn’t do any research. A passage in the introduction gives that exact impression. The author points out that now is a great time to find investment opportunities. But he tries to back up the point by stating that the Chinese character for crisis is made up of “danger” and “opportunity”. Wait, what do Chinese characters have to do with the stock market?

Maybe the author was drawing on the deep well of ancient Chinese wisdom. After all, they did invent paper money. But let’s remember that they didn’t invent the stock market, so that doesn’t hold. Further, the Chinese stock market crashed worse than the markets in North America during 2008 and 2009. But before we even consider that, it turns out that the Chinese word “crisis” (weiji) can’t be broken down into component syllables. That would be like taking the English word “mankind” and breaking it down into “man” and “kind”, then coming to the conclusion that all men are kind. Further, “ji” only means opportunity when paired with another syllable. The Chinese have never considered “crisis” to be a pairing of “danger” and “opportunity”, since it’s a neologism. It’s much more likely that some public speaker or business book author thought it sounded catchy and started this myth. You can find more information here: http://pinyin.info/chinese/crisis.html.

The above referenced website is the first result when searching Google for “Chinese crisis opportunity”. It’s really not that hard to find, but authors neglect to question their assumptions all too often. And if the author of Shell Shocked bought into this myth so easily, what other myths does he believe unquestioningly? My answer was that I refused to read the book to find out.

To be fair, I agree with the conclusion that is presented on the dust jacket of the book. Canada is a great place to invest. It’s not without troubles, but we have some great companies and great resources within our own borders. Another popular view is that Canada will benefit from increasing trade with China. As long as our relations with China remain friendly and they continue to need the raw materials and the business knowledge that we have, in order to increase their economic activity, our economy will benefit. You don’t have to read a book based on flawed assumptions to agree.

Category: Uncategorized |
| December 16, 2009
One comment

Working effectively with an advisor

Not everyone needs an advisor. If you know how much to put toward debt repayment, how much you need to save, and how to invest it, you can go it alone. But if you have no interest in doing the planning and the math, or in making product choices, you may be well served by hiring a professional advisor.

A common mistake is to think, essentially, the more the merrier. Working with multiple advisors inevitably leads to conflicting advice. Further, since no advisor knows your whole situation, the advice they give may not even be appropriate. Choose one and consolidate. The most important point is that you find an advisor you can trust. If there is trust, you can follow the advice, knowing it’s in your best interest. You can also keep your affairs simple.

Working with a good advisor requires being able to identify one, preferably in the first hour that you meet with him or her. The following are some characteristics that should help you determine the quality and professionalism of an advisor.

A good advisor will take a holistic view. This means that they won’t dispense investment advice before fully understanding your cash flow and your goals. They won’t focus solely on one product, such as insurance, as a solution to all your needs. They will probably ask many questions and have you provide as much information as possible about your finances before they even formulate a plan. It is simply not effective to manage your finances based on generalised rules of thumb. What may be appropriate for most people might not even apply in your situation.

The meaning of professional, to me, is to always work in the best interest of the client. Your advisor should be willing to take as long as necessary to help you understand what he or she is recommending, and why. They should also answer all of your questions, to your full satisfaction. A good advisor is willing to explain how they are paid and should have no hesitation in explaining why their method of payment is best for clients. They will probably already be successful, so you shouldn’t ever feel any pressure from them to commit to a strategy or product that you are unsure of. Before hiring an advisor, it may be helpful to attend an event with other clients, and ask them about their experiences with the advisor. (Keep in mind that unhappy clients probably won’t attend events.)

Both the advisor and client are adults, entering into a mutually-beneficial business relationship. In order to make the relationship successful, the following responsibilities rest on both the  advisor and the client. Ensure that there is consistent and regular communication. If your advisor hasn’t phoned you in six months, consider calling them. There’s no harm in asking them to set a meeting with you to review your progress, or just asking them to review your situation and contact you back with any advice they may have. If you are saving and investing, three of four review meetings a year might be helpful. If you are retired and spending, just one meeting per year may be adequate. You also both need to be accountable for promised actions. If your advisor has recommended completing a task, such as renewing a mortgage, executing a will or even completing a home inventory, that advice is worthless to you if you don’t follow it. They should ask you about whether or not you kept your commitment. By the same token, if they promise to call you to set an appointment, prepare paperwork or send you documentation, you should make a note and expect them to follow through.

Part of working effectively with an advisor is being a good client. It is important to take an interest in your affairs. After all, it’s your future that’s being built, and no one is more interested in your success than you are. If your advisor feels that their advice is unappreciated, either because it’s not followed or it’s constantly questions, they will probably hesitate to continue advising the client. Having said that, ask any questions as they arise. It is helpful, for both parties, to air questions that help clarify what is being discussed. This helps you feel confident that the advice is appropriate and helps the advisor to know that you understand.

Questioning the validity of advice or second guessing the suggestions or intent of the advisor is counter-productive to a healthy relationship. If you find yourself doing this, chances are that there is little trust. If you are the type of person who doesn’t trust anyone, you will probably be more successful managing your affairs on your own. If you simply don’t trust your advisor, there is nothing to stop you from looking for a more trustworthy advisor in the meantime.

There are two main keys to having an effective working relationship with an advisor. You must both take equal responsibility for the relationship. Clearly communicate what is important to you, and how you would like to work together. Then, follow the advice that’s given. Take the actions that are suggested. It requires that both the client and the advisor act as mature, responsible adults.

Category: Uncategorized | Tags:
| December 9, 2009
No comments

Great Advice

I’ve gotten a lot of advice in my time. Sometimes it’s irritating, but it’s always a sign that people care. As soon as people give up on you, they stop trying to help you improve. However, there is more than one way to give advice.

Is there such a thing as bad advice? I don’t think there is, when it comes from someone who is sincerely trying to help. A sales pitch, however, can sometimes be confused with advice. As long as the salesperson has their own interest at heart, or is willing to pitch a product or service, regardless of whether or not it makes sense for you, they are not giving you advice. Most people react poorly to a sales pitch and quickly try to disengage, which is often the proper response.

How do we recognise good advice? Good advice generally starts with someone telling you: “You should…” They are usually offering an idea that you hadn’t considered. Even better, the person giving the advice should ask some questions first. The better they understand you and your specific situation, the more appropriate their advice will be. In fact, if they start in on the advice without asking any questions, chances are that it will feel like a sales pitch.

In the vein of asking questions, great advice often starts: “What can you do…?” I truly believe that most people have the answers to their problems within themselves. In fact, I have found that some people, either from pride or ego, will reject all advice. Not to mention that people will rarely become as invested in the ideas of others as they are in their own ideas. After asking questions to better understand you and your situation, someone who gives great advice will help pinpoint the area that needs to be addressed and ask you how you will address that area. They may continue to question possible outcomes or potential pitfalls you may see. They will try to lead you to the answer, without thrusting it on to you.

An example from health care may be enlightening. If you were to visit your doctor for a physical exam, what would he or she say to you? Mine might recommend playing more sports or eating less sugar. What the doctor doesn’t know, though, is that there’s no way I am going to start playing sports or eating less sugar. It’s just not a part of my lifestyle. It’s good advice, but it doesn’t fit me. Great advice might be: what can you do to be more active? I don’t know if splashing around a pool with my kids counts, but that’s something that I am willing to do and isn’t too much of a stretch. I am also willing to increase the exercise I do inside my own home. How could I improve my diet? I could eat more fresh fruit in place of sugary junk. It’s still sugar, but it’s better for me. Heck, I’ve just gotten great advice without even having to visit my doctor.

Great financial advice would be similar. How can you reduce your debt? What could you do to increase your savings? What steps can you take to make your (retirement?) goal more realistic? I suspect that most of the answers will come from within you, if only because you know what changes you are willing to make.The benefit of working with a professional (like the doctor, in my example), is to give feedback on the effectiveness of your ideas and to follow up with you, at your next meeting, on your follow-through.

While good advice offers ideas, which may be useful, you need to judge them for relevance to your situation. Great advice, however, asks questions. The more questions you are asked, the more likely it is that the answers you find will be appropriate to you and your situation.

Category: Uncategorized | Tags:
| December 2, 2009
No comments

Risk management: What’s the worst that could happen?

We face risks each day of our lives. Most of us avoid thinking about risks, because they are either to numerous or too remote to worry about. It seems common, in fact, to waste energy worrying about things that will never happen. That is not to say that we should never plan for negative outcomes. The approach I recommend is to “hope for the best, but plan for the worst.” In other words, manage your risks.

The term “risk management” is used different ways in different industries. In banking, it means: what is the most we could lose in a given timeframe? In corporate finance, it means: how much could a change in fortunes at the other company affect our balance sheet? In financial planning, it usually means: an insurance pitch. Risk management is at least as much art as it is science. The US banking industry found this out when their faulty science led to the credit crisis during 2008. Possibly the most effective way to manage risk is to think of all the risks you face, then decide how you will address each one.

There are four possibilities when deciding how to address risks that you face. You can either accept the risk, reduce the risk, insure the risk, or avoid the risk. Let me offer a couple examples of each. Some of the risks I accept include: getting food poisoning at a restaurant, a helicopter crashing on me as I walk to work, or losing my job. Some of the risks I try to reduce are: injury in a car accident (by wearing a seatbelt and driving a car with airbags), drowning while boating (by wearing a lifejacket), and having my house broken into (by locking doors). Some of the risks that I insure include: dying before retirement (with life insurance), being unable to work (with disability insurance), and losing my house or belongings in a fire (with home insurance). Some risks I avoid altogether are: losing money in a casino, being hit by a car while riding a motorcycle and any drug-related risks.

The worst things that could happen to derail your financial plan are specific to you, and different people, even when facing the same risk, may react differently. The following are some suggestions to consider. Put into place your own solutions, and you will have peace of mind, which allows you to focus on more meaningful activities.

We will all die one day, so the risk of death is actually certain. You may, one day, be ready for death, but what happens if you die too soon? If no one is dependent on you, you can accept the risk. If your family depends on your income, you can buy life insurance to replace the income. When you are financially prepared to retire, you no longer need insurance to replace your income. If your business depends on you, you could prepare a clear succession plan. If a foundation depends on you, you could set up a trust with a clear indenture. Most of these issues are referred to as “estate planning.”

The chances of suffering a disability are greater than dying prematurely. You may be able to rely on family or friends to care for you during a disability. Some people prefer to be independent, or already have family who depend on them, so they buy disability insurance to create income. Debt often becomes the greatest burden for people who are unable to work, so keeping debt under control is one way to reduce this risk.

It’s probably safe to say that no one who gets married, plans to divorce, but it happens to almost half of all couples. Some problems that might follow a divorce include splitting illiquid assets, increased child care costs or travel costs, spousal and child support payments, and legal costs. Besides that, estate planning issues need to be reviewed, such as inheritance and guardianship. Further, if one spouse stayed out of the workforce to raise children, that person may be at a disadvantage when returning to work. Some of these issues can be addressed with a prenuptial agreement, others with the separation agreement. Sometimes, using a divorce counsellor or arbiter instead of a lawyer can save cost and improve the agreement.

What ideas do you have for dealing with the loss of your job? What if you were held legally liable for someone’s injury or loss? Would you be prepared in the case of a natural disaster or a war? I hope never to have to deal with these issues, but it may be helpful to have a plan.

The last risk I will address is market loss. This is a sure risk for anyone who invests in stock market-related investments, either ETFs, mutual funds or individual stocks. Many people feel that they’ve lost money when the market value of their account decreases. You could avoid this risk by not investing in stocks, but you will also miss out on the growth and dividends of stocks. To be fair, bonds have often returned as much as stocks, and term deposits did better in the early 1980s. You could reduce your risk by investing only a portion in stocks or by owning a market-neutral hedge fund. You could try to insure your risk by owning segregated funds, principal protected notes or options; these types of insurance each have a cost. Or you could accept the risk. Accepting the risk means not selling in panic when the market value falls and not buying in euphoria when the market surges ahead. Not everyone has the constitution to accept the risk of a market loss, but if you understand investing, accepting this risk can be profitable.

We are each faced with many risks in our life. The way we choose to respond depends on our individual personality and outlook. It’s beneficial to consider the risks that you face and choose whether you will avoid them, reduce them, insure them or accept them. If you will reduce or accept the risk, have a plan on how you will deal with it. Then, inform your family or anyone who depends on your or upon whom you may depend, so that everyone can react appropriately in a difficult situation.

Category: Uncategorized | Tags: