Budgeting - The Foundation of Financial Success

The very foundation of every good financial plan is a cash flow plan, or budget. Budgets are actually fairly simple to create, but require that the budgeter is honest with themselves. Aye, there's the rub. As it turns out, most people would much rather not investigate the truths in their spending habits, as it is in those truths that their personal demons lie...

Some don't want to admit they spend that much money on "entertainment", others spend too much on shoes or other clothing items, some aren't interested in facing the fact that the interest costs on their short term debt are higher than what they allot themselves for food.

Yes, these are unfortunate issues. In fact, the lack of will to look plainly at their spending habits is the number one reason most people spend their entire lives playing catch up, rather than enjoying the fruits of their labours.

See now why it's useful to have a coach? Often I have spent time going over the budget specifics with clients of mine in order to assist them in getting smart with their cash flow. I once saved a family $1700 per month in unnecessary cash flow expenditures just by rearranging their debt. That's big money. Imagine what benefits you might find just by spending the time to investigate where all the money goes.....

How many of those monthly transactions that occur automatically out of your bank account are necessary? How many of those transactions can you even say for certain that you know what they are? Don't you think that it might be important to know where your money goes?

Now, why again can't you save an additional $50 or $100 per month?

So, the question becomes, what's the process? Well, the first thing to do is to begin documenting every transaction that you make. One of the often discovered side benefits of this particular activity is that, when you're actually forced to write down your purchases ALL THE TIME, it can sometimes change your decisions and curb some of those unnecessary impulse purchases.

Then, you need to start posting those purchases to individual expense categories, such as rent/mortgage, utilities, groceries, fast food and snacks, liquor, cigarettes, gasoline, bus passes, vehicular maintenance, car lease or purchase payment, subscriptions, insurance, savings, etc. You get the drift.

At the end of a couple of months, you'll see some clear patterns emerging in terms of each expenditure category. Here is where you need to actually spend some time thinking about what's really important. Ask yourself the following questions: Is this item important enough to my future goals to require this percentage of my income? Is this item more important than that item?

You need to start to prioritize. Again, this is where it can be useful to have a coach to whom you make yourself accountable. The simple fact is, most people will not go all the way through this process, as they're simply too weak to be honest with themselves.

How about you?

Once you've been through the thought process and considered your spending habits and patterns, once you've spent the time prioritizing the categories, you can begin to allocate your future funds to the individual categories. This, my friend, is your cash flow plan.

The next step is to stick to the budget. Again, useful to have a coach here to keep you honest. Nonetheless, however, there's simply no chance that you're going to be successful unless you monitor your expenditures, and stick to the amounts you've budgeted. This goes back to building good habits.

If you are able to create an honest budget predicated on genuine numbers and thoughtful consideration of your life goals, and then have the discipline to stick to that budget, you are on your way to executing your very own financial plan, and will very likely find considerably more financial success than most others out there. You can do it if you really want it.

But it does help to have a coach.

I'd be really interested to see comments below from readers who have spent the time to do a proper budget, and how that has been valuable to them. Thanks for your time and feedback!

What is a Mutual Fund?

One of the primary reasons I got into this business in the first place was that I had identified that there were a lot of people out there who were investing money using mutual funds, though they didn't really understand what a mutual fund is or how it works. This troubled me deeply, as I felt very uncomfortable with the idea of so many people trusting so much money to a system they understood very little about. As I learned more about financial markets and how they worked, I came to understand that a great deal of financial anguish on the part of individual investors was the result of a poor understanding of the behaviour of their investments. As such, I decided that my life's work would be to educate, advise, and assist regular folks in making wise investment decisions.

So, what is a mutual fund?

The simple answer is that a mutual fund is a pool of investors' money, managed by a professional money manager. The manager will usually have a team of people working for them, including analysts, traders, and other professionals. The manager's job is to grow that pool of money by making wise investment choices.

An mutual fund will usually have a specific mandate, which means that they will choose their investments based upon the "mission" of the fund. First and foremost, the fund will either be an "equity" fund or a "fixed income" fund. An equity fund will buy stocks of publicly traded companies. A fixed income fund will usually purchase bonds and other types of debt securities. Generally speaking, equity funds are considered to be "riskier" or more volatile than fixed income funds.

Equity mutual funds will usually have a geographic mandate, which means that they'll only invest in a certain geographical region such as Canada, Europe, US, Asia, etc. Sometimes they will have a sector mandate, meaning that they'll concentrate on a certain economic sector such as materials, retail, infrastructure, financial companies, etc. They may also choose to invest in companies based upon their size.

Usually, an equity mutual fund will also have a certain investment philosophy as well. They will seek out companies based upon a value approach, or a growth approach. The value approach seeks to identify companies that are trading at a price less than a professionally calculated "intrinsic" value, usually based upon their financial performance and the value of their assets. The growth approach seeks to identify companies which have the potential to grow at a rate superior to their peers, based upon a particular competitive edge in their market.

What does all this mean to you? Well, the fact that mutual funds have these investment mandates means that you're able to build a diversified portfolio of investments. You're able to own different funds that represent different sectors of the economy, and that represent different geographies. This is important, because these different sectors and regions experience different economic conditions and circumstances. By spreading your money around a bit, you reduce the risk that the value of your portfolio will experience wild swings up and down. Of course, its the wild down swings that we're trying to avoid.

Something else to note: it costs you money to own a mutual fund. The cost of owning the fund will be reflected in the Management Expense Ratio (MER), which is expressed as an annual percentage of the fund's total assets. This amount may be anywhere between 1 and 5% per year, or more sometimes. These days, average MERs tend to run in the neighbourhood of 2 - 3%. The thing to remember about the MER is that the fund's performance is reported to you NET of the MER, which means that if the fund reports that it returned 8% last year and had an MER of 2%, it actually returned 10% but kept back 2% for expenses, thereby passing along a net gain of 8% to the investors.

Mutual funds are an affordable and reliable way for the passive, every day investor to participate in equity and fixed income investing. Because direct investing in stocks and bonds is expensive and requires a great deal of very specific knowledge, mutual funds can provide opportunities to grow your pool of money, helping you to plan for prosperous future.

Mortgage Insurance - Why Using Individually Owned Insurance is the Right Answer.

On February 6th, 2008 the CBC show Marketplace provided a most valuable bit of public awareness to an issue that, up until then, was not widely understood. The issue is that of mortgage insurance. Namely, pitfalls of bank owned creditor insurance versus the value of having individually owned life insurance. The complete episode can be found here on the CBC website. I'd suggest you watch it when you have a moment. It's worth seeing if you currently have or plan to get a mortgage.

Let me begin with some brief explanations.

When you get a mortgage, it's generally considered to be advisable that you have some life insurance to cover the value of the mortgage in the event of death. For example, if you have a family you may wish for them to be able to stay in the family home in the event of your death.

Usually, when you get a mortgage, the mortgage officer or broker will offer you the opportunity to insure the mortgage. The product that they are offering is bank owned creditor insurance. The insurance is paid for by you, and owned by the bank. In the event of your death, the mortgage is subsequently paid off. Well, that's the general idea, anyway.

There are a number of problems with the bank owned creditor insurance. Of them, the most worrisome is that they are not underwritten until time of claim. What this means is that the contract essentially states that, provided that you are insurable without ANY additional risk considerations, they will honour the insurance contract AFTER they have had a chance to do a thorough investigation AT THE TIME OF CLAIM. However, because there are very, very few cases that meet those criteria, many claims get denied. This is because many common illnesses and sicknesses for which you have been treated warrant further investigation, which is an additional risk consideration.

The point is not that you were a riskier case, the point is that everything needed to be disclosed. Where this thing tends to go off the rails is that, when answering the brief questionnaire presented by the mortgage agent, people tend to think in terms of "serious issues" rather than answering the question fully and completely, and are not coached adequately on how to answer the questions by the mortgage agent. The mortgage agent, by the way, is not a licensed insurance professional, and therefore does not have the necessary training with regard to insurance law, practices, procedures, or documentation. Have a look at the first question in the questionnaire. How would you answer that question? What if you didn't actually read it, but rather had it read out loud to you, word for word, at conversational speed? Would you answer it "no"?

Let me ask you another question. Have you been to the doctor at all, for any reason in the last two years? If so, you should have answered yes to that first question.

The sad thing is that many, many people answer "no". As such, they are denied claims because they are considered to have answered fraudulently. At claim time, the underwriters have access to ALL of your medical records in order to determine whether or not you meet the claim criteria. And the real issue here is that the mortgage agent or broker bears no liability for having done a shoddy job of the application. They are not held accountable.

Contrast this with a licensed life broker who IS held accountable for doing shoddy work. The licensed life broker or agent can be fined, or lose their license for not acting in their client's best interest at ALL TIMES.

The long and the short of it is that you would have a better measure of protection if you were to have a product that was underwritten at the time of application. In this circumstance, the insurance company does an investigation into your insurability prior to offering you a contract of insurance. However, once offered the contract, provided that you have not lied on the application, the insurance company MUST NECESSARILY pay out the claim at time of death.

Herein lies the difference: with mortgage (creditor) insurance, they decide whether or not to pay you at the time of claim. With individually owned insurance underwritten at application time, the insurance company determines how much to charge you in return for a promise to pay at time of claim.

Of the two, the individually owned insurance provides better knowledge that the financial risk has been managed.

Have a look at all of the information regarding this issue on the Marketplace site. There is a table that further details the difference between the two types of coverage, and a slough of comments from the public regarding the issue. It's a valuable read.

Speak to your financial advisor. This is important stuff.

Get Off the Bandwagon! Mind the Oil!

This week I met with a mutual fund wholesaler from a very well known and reputable firm. Alas, he was imploring us, as advisors, to have faith in a couple of their very well known and historically popular funds, though recent performance has been nearly the worst it has ever been.

One of the arguments this wholesaler offered was that chasing the winners is rarely a good strategy. With that, I was forced to agree. As this article in the Financial Post so eloquently states:

It appears many advisors are giving clients what they want rather than the tough love they require. Advisors are more informed than typical investors because of how they spend their days, but "that makes them susceptible to being caught up in the latest fad," Mr. Richards says. Even so, he still believes "the vast majority" of investors benefit from dealing with experienced advisors who provide "a second opinion to curb the excesses. A good advisor operates as an emotional anchor."

Well, with that said, let us turn our attention to the subject of oil. Oil is a subject much talked about in a wide variety of circles. In fact, the price of oil has gotten to the point where nearly everyone is somewhat familiar with the current price of a barrel of oil. To me, this is indicative of a serious issue.

This recent article in Fortune details a well considered argument for a future correction in oil prices. I tend to agree with the position.

What's the point? The point is that everyone has been very excited about the profitability of the energy sector for a long time. The price of oil is higher than it has ever been. High enough that consumers are beginning to change their behaviours and other forms of energy supply are starting to come on line, thus reducing demand.

Beware the advisor that has you overweight in energy, or for that matter, overweight in Canada, which is primarily energy and financial stocks. The wise choice is still, as it was always, not to gamble on sectors or trends, and rather to focus on the long term with a well diversified and regularly rebalanced portfolio.