Saving, Investing and Other Parting Thoughts: Mayers
It’s time to go. I have a few things to do before it’s too late.
I’ve spent most of the past 30 years as a financial journalist. Along the way, I’ve seen two deep recessions and some smaller ones, four big market crashes and too many lurches to count. Eight prime ministers have come and gone.
Each crash was followed by a strong recovery and each recession by renewed economic growth. The lesson is that better things usually lie ahead.
In the 1980s, at the beginning of my career, there was too much inflation. Now there’s not enough. Interest rates were at an extreme high, now they’re at an extreme low. Small investors were deeply distrustful of stock markets. That remains so. Public finances were heading the wrong way and they still are.
Despite this, Canada is the envy of the world. We have the things societies need to succeed — progressive and inclusive social views, the impartial rule of law, vast natural and human resources, a sophisticated banking and financial system, excellent public education.
Our federal finances, though far from perfect, are the envy of the developed world. This is a far cry from 1992 when the Wall Street Journal called us that other Third World country on the U.S. border. In that atmosphere, Liberal finance minister Paul Martin made tough choices that have created our relative comfort today. Hopefully, the lessons aren’t forgotten.
But there’s change in the air. The notion that perpetual deficits are good is back. It is based on the idea that it’s not the absolute amount of money you owe, but the amount relative to your income, in this case the value of the economy.
This sleight of hand allows governments to run deficits forever as long as the borrowing is lessthan some percentage of gross domestic product (GDP). Of course, you can keep changing that number to suit your spending needs.
Expect more economic experimentation because the old levers aren’t working. Eight-plus years of ever lower interest rates has created ballooning personal and public debt. Look no farther than house prices, stock market valuations and ever longer lines of credit.
These distortions can go on for a long time. And the trigger that ends them is often something nobody saw coming.
This new thinking includes an unwillingness to let the normal course of the business cycle work. The way it used to work is that the economy accelerates and expands, overheats, contracts and accelerates again.
Now we want it pain-free. Just the upside. This is being done by the manipulation of interest rates to stimulate consumption. This not only steals growth from the future, but digs an ever deeper hole. When the next recession arrives, which it will, there will be no room to reduce rates. The downturn will be much greater and recovery will take that much longer. It’s the paradox of the low interest rate trap.
When it comes to personal finances there have been a few recurring themes. I must thank readers for their questions over the years. Finding the answers helped make me a better saver and smarter investor.
Here are some parting thoughts:
Do not be afraid to invest. Stock market investments helps companies grow, which creates jobs, which creates prosperity.
It is not risk-free, but your risk can be reduced to an acceptable level. For safety look no further than the places where you shop, bank, buy groceries, cellphone services and the Internet. Think Canada’s biggest manufacturers and electrical and gas utilities companies. These companies are the bedrock of our economy and grow with it over time.
Their dividends will give you 3 or 4 per cent annually — plus a tax break — compared with a bank savings account yielding half of one per cent. You get a stream of rising dividends and an increase in the share price over time.
Invest in a way that keeps your fees low. Don’t give your profits way.
Related: 15 rules from a great investing mind
Be patient: We live in a time where patience is measured in the milliseconds it takes to load a web page. Investments are not like that. They take time to mature and time is your friend.
If you buy shares of companies with sound businesses, that have a history of profitability, that dominate their industries and pay dividends in good time and bad, you will succeed.
If you use dividend reinvestment plans which allow you to take the dividends as shares rather than cash, you will accelerate the gains.
Power of compounding: If you are patient then time will allow your investments to grow. Albert Einstein called compound interest one of the most powerful forces in the universe, because it accelerates the accumulation of wealth.
The Rule of 72 shows how this works. It is an approximate way to figure out how long an investment takes to double. The rule divides the interest rate into 72.
- 131 years is how long it takes $1,000 to double in the ‘high interest’ savings account at my bank yielding 0.55 per cent (72 divided by 0.55).
- 32 years is how long it takes $1,000 in a 5-year GIC, paid annually at 2.27 per cent, to double.
- 17 years is how long $1,000 reinvested in dividends of the Big 5 banks takes to double. The five averaged together have a dividend yield of 4.2 per cent. Along the way their share prices will likely double too.
You cannot come out ahead any other way at current interest rates.
If you cannot accept risk then fixed income is where your money should go. But understand that after inflation it is worth less every year even if you steer clear of the Big Five and go to the discount banks who offer a bit more.
Have a plan: Nobody sets out on a road trip without a destination. It should be the same with personal finances. That way you don’t end up in Chicago when you drive to Orlando.
If you have a plan, are patient and let compounding work for you, you can do it. You don’t need to buy complicated investments or swing for the fence to find the next Apple or Google.
Related: How to build a simple plan.
In fact, don’t buy anything that can’t be explained in one sentence. Avoid in-the-news companies. Expectations are high and they often make the news when their advantage has peaked.
Don’t invest because the advisor pitches it as a way to avoid taxes. The Canada Revenue Agency hates those deals and works extra hard to close them.
If it seems too good to be true it is. Ask yourself how an investment can return a “guaranteed-to-be-safe” 6 or 8 per cent in a 2 per cent environment. It can’t.
How to pay for this? Six years ago I wrote that personal finance can be summed up in one sentence: Spend less than you make and save the rest.
The rest becomes your investments, which over time, if you’re patient and have a plan, will pay off.