Vincent Cheung

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Friday, November 24, 2006

Random money talk

Had a conversation with a friend about money, b/c my credit card bill was $980 this month, and that's without having a girlfriend to pay for! Not sure what my typical bill is, but it's probably closer to $200ish, but the inflated amount is due to my recent discovery of shopping as well as buying concert tickets. Oh, and then my other credit card was like $750, but Mommy and Daddy pay for that one (groceries and other necessities as well as my flight back to Winnipeg for the holidays). They want to pay for it, so who am I to say no? They also pay my tuition and housing. My parents figure that they continue to pay for my older sister's housing, since she still lives at home, so then they pay for mine. I guess they want to provide for me as long as I'm still in school, despite the fact that I can support myself.

My friend said that that was great and that she'd want to do that for her kids as long as they know the value of money and don't take advantage of it. I save like 90% of the money I make and have done so since I was probably 13 (when I started working at my parents' store). So, I would say that I'm pretty financially responsible. I don't make any conscious effort to restrict my spending, it just happens naturally b/c I don't want/need to buy stuff or I don't think it's worth it. I'm frugal. That's the Chinese in me. But, I sometimes splurge :p

This brings me to a conversation I had with a different friend, asking me what to do with extra money that he had. I obviously don't just keep my savings in a bank account. That would be dumb. Most of my money is in GICs (guaranteed investment certificates, called a certificate of deposit, or CD, in the US) and mutual funds. A GIC is like giving a loan to a bank. They take your money for a specified period of time and they give you interest (4, maybe 5%), higher than what a savings account would give you. The interest rate is fixed before hand and is "guaranteed". That's the safest investment. If you need the money before the time is up, you can often get it, but pay a penalty, eg. no interest, or very low interest. There's this strategy called laddering, where you split your money up and invest it in spaced out GICs so that one of the GICs matures each year and then you reinvest for a long time period for the best interest rate, but still get the advantage that some money matures each year if you want, but more importantly, it mitigates fluctuations in interest rates (they change). It doesn't take much to get a GIC, some places, like PC, I don't think there's a minimum amount, and others it would be like $500 or $1000. It's a good idea that if you know you have a bit of money that you don't need for a year, to at least put it in a GIC.

Mutual funds have risk, but can lead to much greater returns. These are more for long investments b/c over the long term, they are better than GICs and saving accounts (so far I've been getting ~10%/year). I'm no expert at this. I just started with mutual funds about 3 years ago. There are many different mutual funds and some work different in terms of the charges. The one thing I know is that diversity is important. Don't put all your eggs in one basket. In one sector tanks, eg. technology, then having money also in say, natural resources, helps to mitigate the damage. One strategy I use is dollar cost averaging, where I automatically have my bank account transfer some money into my mutual fund every week. The idea here is that if you were to make a single large investment, you are not guaranteed that you will buy at a good rate. It is better to spread it out, and even if the market goes down, you will be investing, meaning that you will "buy low", with the eventual hope that it goes back up :)

Bonds are also talked about a lot, but I don't do much of this directly. Most of my investment in bonds is indirectly through mutual funds, though I have one Canada Savings Bond.

Stocks I don't do. I can't be bothered to figure out which companies to directly invest it. I let the mutual funds do that. Though I should've bought Google stock...

So, they say that for someone around my age, that I should have something like 60% in mutual funds and then the rest in bonds, GICs, and saving accounts. I don't have this ratio yet, but with my constant investment in mutual funds, it is slowly getting there.

One other class of investment that I've been looking into recently and is really interesting from a social and economic perspective and has the potential to flip the whole banking industry on its head is person-to-person loans. Banks make money by taking your money and lending it out to others. They charge others interest for the loan, and they pay you a little bit of interest for your savings account. The rest they keep for profit and to make up for loans that are not paid off. This person-to-person loan thing is a means to directly loan money to people, cutting out the bank as a middle man. The idea is that borrowers get a better rate than from the bank, and lenders get more interest than from the bank.

Prosper is a site that does just this. It's like Ebay for loans. Borrowers post that they want to borrow money. Lenders then auction to supply money to the borrower. It's a pretty sophisticated site and it's legit (they gave a talk at Google when I was there). They do the same credit checks that a bank does and if you default on a loan, it pays the same penalty as if you default on a bank loan. It's cool to read the stories people have for the reason they need money, their current financial situation, etc. The strategy here is like with anything else. Diversify. Don't give all your money to one person b/c if he/she defaults on the loan, you are screwed. The site has an automated system where you can tell it to spread you money out across people that have a certain credit level, a minimum interest rate, and several other factors. There are risks. People will default on their loans. The site has stats to tell you how often people of certain credit level default, etc. And you adjust your interest rate accordingly, eg. if you assume that 1% of people with a B credit level default, and you want an interest rate of 12%, then you only lend out if you can get 13% interest. I take it from a completely objective view. I use the automated system to determine where my money goes and I give just the minimum amount to each person ($50). I do like to read the stories of the loans that I am investing in. I lend money to a girl who works for a photo production company in Miami and wants to consolidate her credit card debt. I'm also helping a guy buy an engagement ring (good luck! <-- not said in a sarcastic tone). Sure beats looking at numbers and watching if the ticker goes up or down.

I think it's a fascinating idea and I'm just trying it out with a bit of money right now to see how it goes. It's only for the States though. I managed to get an account b/c of my US bank accounts. One motivating factor for me is that I don't have any mutual funds for my US savings. I'm just starting to get some CDs, but it's not that easy, at least with the banks I'm with. Unlike in Canada, where you can do it online very easily at most banks without any physical paper work. I looked into getting mutual funds, but it was a bit of a headache to get it started and I didn't like how they charged you for it. Next time I find myself in the States, I will open up an ING account and get their mutual funds, as they seem to work the same way as the ones for the Canadian version of ING. Ya, so without any investments with risk, I decided to look into this person-to-person investing. My aim with this is to get at least 12% interest, which is way better than GICs (5% at best). So far I'm +$0.85!!! But it's only been maybe 2 weeks.

The whole microcredit thing that's been in the news recently is really cool as well, where instead of just giving money to people to buy food and necessities, you give them a small loan of money to buy tools to make bread baskets to sell. If they pay off the loan, that's bonus, b/c then you have that money to lend to others. If not, then oh well, that's no worse than just giving the money away for free. It's pretty cool b/c you can help to kick start the economy in impoverished areas and help them out for relatively cheap b/c you get some of the money back. And if they are successful, you can even make a profit, but that's not the point :p. You should then use that profit to help more people! (By the way, microcredit is like a new form of donation, that has up to this point, mostly been done by countries and very wealthy individuals)

Anyways, save as much as you can and make it "work for you". Start small and work your way up as you become more knowledgeable in investments. Diversify. Max out your RRSP contributions (or 401K in the US). Pay off your credit cards fully each month (the interest on cards are retarded). Get a card that gives you rewards (mine from Citibank gives me 1% back in cash).

Ya, so that's my money rant. Do not take any of this as investment advice. Consult your financial advisor before making any financial decisions.


Mike Perrow said...

Hey nice post. Makes me sad about the amount I didn't save/invest over the last six months :-(

Just thought I'd chime in about Dollar Cost Averaging. It's been shown time and again to be a poor investment strategy. It's a common misconception that's thrown around in a lot of pop-investment books. Check your own wikipedia link even ;-)

The reason that DCA performs poorly is primarily due to the fact that typical investment options (stocks, mutual funds, etc.) tend to go up a lot more than they go down, and so by trading off getting your money in earlier for getting an averaged-over-time average buy price, you usually lose out.

Vince said...

True, depending how the market is doing as well.

On the other hand, consider this. Scenario 1, you invest $x at time 0, and then $y at time 1. Scenario 2, you invest $x at time 0 and $y regularly spread out between time 0 and time 1. I argue that scenario 2 is better since you would on average buy lower in the time between time 0 and time 1, than if you just invested all the money at time 1. I argue for dollar cost averaging for situations like this (with the same argument that mutual funds, etc. tend to go up and investing earlier is better). And this is my current situation. I don't want to invest all my money right away, but gradually want to build it up (as I have more savings to do so) and it seems like it would be better to regularly invest as opposed to say, investing lump sums on a yearly basis.

If however, you have a large sum that you want to invest right away, it may be better to just invest it all in one go. Or it may be better to just invest a part of it, and then do dollar cost averaging with the rest. The other thing is that when the money is not in the mutual fund, it should still be getting interest in a savings account or GIC or something...

Anonymous said...

Just attempted to post but didn't work - sorry if this comes out twice.

If you want to try dabbling in stocks, try buying a "safe" stock like a bank (i.e. CIBC or Royal). I got into buying stocks about 2 years ago and have done alright. It's kinda cool to watch the stock market to see how the stocks you own are doing. Plus, dividends deposited directly into your account are a nice bonus. But then again, I'm no expert.

Vince said...

Ya, if mess up the captcha (the word verification thingy-ma-bob), it doesn't really tell you that you got it wrong, it just doesn't say that you got it right. I would want it in big red letters saying something like "You dumb illiterate user, learn to read!!!" (damn it, it just happened to me, good thing I have gotten into the habit of checking if my comment was posted)

So how do you buy your stocks? Through some sort of agency or something? I just really don't know how to start. What kind of fees do they charge? Do you think you beat the mutual funds? Investing in "safe" stocks are fine, but the returns may not be all that stellar, and then add on the fees, and the returns may not be all that great... Plus the whole part of having to spend time investigating stocks and tracking them, etc. But I would like to at least invest a bit of money in stocks to play around and learn more about it.

That's how I started with mutual funds. Just invest a little to start to see what it's like and then as I got more comfortable and gained confidence in it, I invested more.

Anonymous said...

I bought my stocks through an online Canadian company called eNorthern. I believe it costs $24 to make a transaction. I think if you do it through an actual broker, it would be more expensive. eNorthern sends you a monthly statement and they do have customer service reps to talk to. As for returns, so far, they are beating my rate of return on my mutual funds. I did kinda what you did with your mutual funds, I started with a little then bought a bit more.

Anonymous said...

4, maybe 5 percent? In your CD (equivalent)? Hm. I'm getting 5.3% in my checking account. Well, it's a money market account, but I get free checking up to three checks a month, which is all I need. Reimbursed ATM fees and plenty of other nice benefits, too. Internet banks are cool like that. Not sure what the options are in Canada, but is good for checking out the options in the US, anyway.

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