Debt & Frugality

As Didi says in the novel (Findependence Day), “There’s no point climbing the Tower of Wealth when you’re still mired in the basement of debt.” If you owe credit-card debt still charging an usurous 20% per annum, forget about building wealth: focus on eliminating that debt. And once done, focus on paying off your mortgage. As Theo says in the novel, “The foundation of financial independence is a paid-for house.”

10 Business Leaders discuss Role of Budgeting in Debt Reduction

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Image courtesy Featured.com

Exploring the critical role of budgeting in debt reduction and the journey to financial independence, we’ve gathered insights from founders and CEOs among others.

From the disciplined approach of discipline and frugality through budgeting to the strategic perspective of budgeting and debt management for independence, here are the diverse experiences of ten professionals who’ve successfully navigated their finances.

 

 

  • Discipline and Frugality
  • Debt Reduction and Savings
  • A Financial Compass
  • Fiscal Success
  • Navigating Finances
  • Clarity and Control
  • Financial Stability and Empowerment
  • A Roadmap to Financial Freedom
  • Enhanced Financial Control
  • Debt Management for Independence

Discipline and Frugality

Being in a financial crisis is not uncommon for the average person; we have all seen people in our lives suffer under the massive weight of debt and how it subsequently affects our quality of life. To get out of debt, you need to be disciplined and frugal. Following a budget needs to become a regular part of your life so that you can achieve financial freedom sooner rather than later.

When you budget, following a rule like 50/30/20, it helps you manage your income in a way that reduces your debt and allows you to live a fulfilled life while still preparing for any unexpected hiccups in the future.

When you budget following a ratio rule, you need to be flexible with the money allocated for “wants,” i.e., the 30 in the ratio. This means cutting out anything in your life that isn’t necessary—such as buying the extra coffee, eating takeout daily, or subscribing to services that you don’t use.

So, don’t allow yourself to fall into the lifestyle-creep trap. By cutting these non-essentials out, you can funnel the extra money into your essentials and debt repayments—which loosens the burden for you and your future.

That being said, you don’t have to make yourself burnt out from budgeting; it’s okay to treat yourself and splurge a little as a reward for doing well with your financial goals. You just need to know your limits and where to draw the line. — Zach Robbins, Founder, Loanfolk

Debt Reduction and Savings

Budgeting is hugely important for reducing debt and achieving financial independence because it can help you determine how much you can contribute each paycheck toward these goals. For instance, with a budget, you can learn exactly how much you have left over each month after essential expenses, such as rent, groceries, and electricity. Once you have this number, you can allocate a portion of your remaining income to reducing debt and savings.

For me, personally, budgeting helps me realize when I’ve overspent in certain areas and need to rein it in so that I will have enough to put towards savings or debt payoff. — Meredith Lepore, Content Strategist/Editor/Writer, Credello

A Financial Compass

Budgeting plays a crucial role in reducing debt and achieving financial independence. By ensuring you spend within your means, it acts as a financial compass.

For instance, when I faced a mounting credit card debt, which mirrored the national average of around $6,000, budgeting became my lifeline. It wasn’t just about tracking expenses but making conscious choices about spending.

This approach helped me not only clear my debt but also build a savings habit, leading to a more secure financial future. — Tobias Liebsch, Co-Founder, Fintalent.io

Fiscal Success

Budgeting is the financial roadmap to success. As a tech CEO, it’s been my steering wheel on the road to fiscal independence. An example would be when we faced a financial bottleneck. We reevaluated our costs, cutting back on non-essential company perks, and reallocated those funds towards paying down our debt.

Thanks to strategic budgeting, we were debt-free in less than a year. Therefore, proper budgeting isn’t just number-crunching; it’s crucial for cuts, savings, and gains, propelling us toward the land of fiscal freedom. — Abid Salahi, Co-founder & CEO, FinlyWealth

Navigating Finances

The importance of budgeting in the journey toward reducing debt and achieving financial independence cannot be overstated—it’s the financial equivalent of a compass on a voyage across the open sea. Without it, you’re essentially navigating blind, at the mercy of the winds and currents. But with it, you can chart a course to your destination, making informed decisions that keep you on track.

There was a time when my financial situation felt like a sinking ship—credit card debt and personal loans were the water flooding in, and I was desperately bailing it out with a leaky bucket. I realized that if I wanted to reach the shores of financial independence; I needed a better strategy.

That’s when I embraced budgeting with open arms. I started by laying out all my expenses and income, categorizing them with the meticulousness of a librarian. It was eye-opening to see where my money was actually going, rather than where I thought it was going. I discovered leaks in my spending—money trickling away on things that, frankly, weren’t adding much value to my life, like a gym membership I barely used or subscription services that just piled up.

Armed with this knowledge, I began to plug these leaks, reallocating those funds toward paying off my debt. Every dollar saved was like a bucket of water thrown overboard, lightening the load and bringing my ship higher in the water.

But budgeting did more than just help me manage my debt; it empowered me. It transformed my relationship with money from one of anxiety and scarcity to one of control and abundance. Through disciplined budgeting, I was able to pay off my debts significantly faster than I had thought possible. More importantly, it laid the foundation for building savings and investments, guiding me toward the ultimate goal of financial independence.

The journey wasn’t always smooth sailing. There were months when unexpected expenses threw me off course, but because I had a budget, I could adjust my sails and get back on track. Budgeting gave me the flexibility to deal with financial storms without capsizing. — Michael Dion, Chief Finance Nerd, F9 Finance

Clarity and Control

Budgeting is absolutely critical for getting out of debt and achieving financial independence. When I first started trying to pay down my student loans and credit card debt in my early 20s, I felt completely overwhelmed. I was living paycheck to paycheck and had no idea where my money was going each month. Continue Reading…

When Low Rates cause people to do Dumb Things

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Image courtesy Outcome/ShareAlike 3.0 Unported 

By Noah Solomon

Special to Financial Independence Hub

When cash, high quality bonds, and other safe assets offer little yield, investors get caught between a rock and a hard place. They can either (1) accept lower returns and maintain their allocation to safe assets or (2) liquidate safe assets and invest the proceeds in riskier assets such as equities, high yield bonds, private equity, etc.

Using history as a guide, when faced with this dilemma many people choose the second option. This decision initially produces favorable results as the increase in demand for stocks pushes prices up. However, as this reallocation progresses, prices reach levels which are unreasonable from a valuation perspective, and the likely returns from risk assets do not compensate investors for their associated risk. At this juncture, committing additional capital to risk assets becomes akin to picking up pennies in front of a steam roller. For the most part, this narrative is what played out across markets following the global financial crisis of 2008.

Following the global financial crisis, near-zero rates pushed investors to take more risk than they would have in a normal rate environment, which entailed making outsized allocations to stocks and other risk assets.

Unable to bear the thought of receiving negligible returns on safe assets, people continued to pile into risk assets even as their valuations became unsustainable.

Had central banks not begun raising rates aggressively in 2022 to combat inflation, it is entirely possible (and perhaps even likely) that stocks would have continued their ascent, valuations be damned!

Instead, rising rates provided risk assets with some worthy competition for the first time in over a decade, which in turn caused investors to rethink their asset mix and shed equity exposure.

The Equity Risk Premium: A Stocks vs Bond Beauty Contest

The equity risk premium (ERP) can be loosely defined as the enticement which investors receive in exchange for leaving the safety of Uncle Sam to take their chances in the stock market. More specifically it is calculated by subtracting the 10-year Treasury yield from the earnings yield on stocks. For example, if the P/E of the S&P 500 is 20 (i.e. earnings yield of 5%) and the yield on 10-year Treasuries is 3%, the ERP would be 2%.

Historically, stocks tend to produce higher than average returns following elevated ERP levels. Intuitively this makes sense. When valuations are cheap relative to the yields on safe assets, investors are getting well compensated for bearing risk, which tends to portend strong equity markets. Conversely, at times when stock valuations are rich relative to yields on safe assets and investors are getting scantily compensated for taking risk, lower than average returns from stocks have tended to ensue.

Chart courtesy Outcome
  • At the end of 2020, the S&P 500 Index’s PE ratio stood at 20 (i.e. an earnings yield of 5%), which by no means can be considered a bargain. However, stocks were nonetheless rendered attractive by ultra-low rates on cash and high-quality bonds. It’s easy to look good when you have little competition!
  • By the end of 2021, the Index’s PE ratio was above 24 (i.e. an earnings yield of 4.2%). Stocks were even less enticing than valuations suggested, given that 10-year Treasury yields had risen from 0.9% to 1.5%. This set the stage for a decline in both prices and valuations in 2022.
  • From an ERP perspective, 2022’s decline in valuations did not make stocks less stretched vs. bonds. The contraction in multiples (i.e. increase in earnings yield) was more than offset by a rise in bonds yields, thereby causing the ERP to be lower at the end of 2022 than it was at the start of the year.
  • In 2023, the S&P 500’s PE ratio expanded from approx. 18 to 23, which was not accompanied by any significant change in 10-year Treasury yields. By the end of the year, U.S. stock multiples had nearly regained the lofty levels of late 2021, despite the fact that Treasury yields had actually increased by over 2% during the two-year period.
  • In contrast, the relative valuation of Canadian stocks vs. bonds currently lies at levels that are neither high nor low relative to recent history.

 Low Rates: The Growth Stock amphetamine

Growth companies, as the term implies, are those that are projected to have rapidly growing earnings for many years. Whereas an “old economy” stock such as Clorox or General Mills might be expected to grow its profits by 2%-10% per year, a juggernaut like NVIDIA could be expected to double its profits every year for the foreseeable future. Continue Reading…

Why Debt-to-Market-Cap matters more than Debt-to-Equity

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Understanding the Importance of the Debt-to-Market-Cap Ratio in Stock Analysis

Image courtesy TSINetwork.ca

When evaluating stocks, it’s crucial to assess their resilience during economic downturns and their potential for future prosperity. While the commonly used debt/equity ratio offers insights into a company’s financial leverage, it fails to capture certain nuances. In this article, we explore the significance of the debt-to-market-cap ratio in stock analysis and why it surpasses the debt/equity ratio.

By understanding the intricacies of this approach, investors can make more informed decisions and increase their chances of identifying companies poised for long-term success.

I was recently asked why I use debt-to-market-cap in my analyses, which is different from the debt/equity ratio seen in most other reports. My answer is two-fold. In analyzing a stock, you need to form an idea of how much it would get hurt in a recession. To put it another way, how likely it is to survive a business slump and go on to prosper when good times return? To do that, you need to look at a number of factors. These include the interest rate on its debt, how sensitive it is to the economic cycle, its pluses and minuses in relation to competitors, its vulnerability to adverse legal and regulatory decisions, its credit history and current credit rating … and so on.

Analyzing Debt-to-Equity Ratio

Many successful investors start by looking at the debt/equity ratio. This ratio comes in several variations, but the basic idea is that you measure a company’s financial leverage by comparing its debt with its shareholders’ equity. You assume an attractive company can earn a higher return on its total capital than the interest rate it pays on the debt portion of its capital. If so, the excess goes to shareholders’ equity, raising the total return to shareholders.

But leverage works both ways. If the total return falls short of the interest costs, the difference comes out of shareholders’ equity. When a company loses money, it still has to pay the interest and one day settle the debt. Generally, it does so by dipping into shareholders’ equity. In extreme cases, losses wipe out shareholders’ equity, and the stock becomes worthless. Then bondholders and lenders take over the assets to try to get back their investment. A high ratio of debt to equity increases the risk that the company (that is, the shareholders’ equity in the company) won’t survive a business slump.

However, this ratio can mislead because it compares a hard number with a soft one. Debt is usually a hard number. Bonds and other loans generally come with fixed interest rates, fixed terms of repayment and so on. Equity numbers are softer or ‘‘fuzzier.’’ They mostly reflect asset values as they appear on the balance sheet (minus debt, of course). But the balance-sheet figures may be misleading. They may be too high, if the company’s assets have shrunk in value since the company acquired them (that is, lost more value than the company’s accounting shows). In that case, the company may need to correct its balance sheet figures by cutting them or “taking a writedown.”

Or the equity value may be too low if the company’s assets have gained value since the company acquired them. This can happen with real estate, patents and other assets (which we refer to as “hidden assets”).Much of a company’s real value may rest in its “goodwill” — its brands, or the reputation and relationship it has built with customers over the years. This value would only appear on the balance sheet if it was bought rather than built up by the company’s operations.

Analyzing Debt-to-Market-Cap

Efficient market theory also leads us to favour debt-to-market-cap over debt-to-equity. This theory says that it’s impossible to beat the market, because the market is efficient and eventually reflects all information, good or bad. This idea had a lot to do with the creation of index funds. Market cap — the value of all shares the company has outstanding — benefits from the “wisdom of crowds.” Continue Reading…

Navigating Short, Medium, and Long-Duration Fixed Income in 2024

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Image courtesy Harvest ETFs

By Ambrose O’Callaghan, Harvest ETFs

(Sponsor Content)

Fixed-income securities are financial instruments that have defined terms between a borrower, or issuer, and a lender, or investor. Bonds are typically issued by a government, corporation, federal agency, or other organization. These financial instruments are released so that the issuing institution can raise capital. The borrower agrees to pay interest on the debt security in exchange for the capital that is raised.

The maturity refers to the date when a bond’s principal is paid with interest to the investor. In the modern era, interest rates tend to fluctuate over long periods of time. Because of this, shorter-duration bonds have predictable rates. The longer investors go down the maturity spectrum, the more volatility they will have to contend with in the realm of interest rates.

On January 16, 2024, Harvest ETFs unveiled its full fixed income suite. That means investors will have access to ETFs on the full maturity spectrum: short, intermediate, and long-duration bonds.

In this piece, I want to explore the qualities, benefits, and potential drawbacks of short-term, medium-term, and long-term bonds. Let’s dive in.

The two types of short-term bonds for investors chasing security

Short-term fixed income tends to refer to maturities that are less than three years. In the realm of short-term fixed income, we should talk about the relationship between money market and short-term bonds.

Money market securities are issued by governments, financial institutions, and large corporations as promises to repay debts, generally, in one year or less. These fixed-income vehicles are considered very secure because of their short maturities and extremely secure when issued by trusted issuers, like the U.S. and Canadian. federal governments. They are often targeted during periods of high volatility. Predictably, money market securities offer lower returns when compared to their higher-duration counterparts due to the liquidity of the money market.

Short-term bonds do have a lot in common with money market securities. A bond is issued by a government or corporate entity as a promise to pay back the principal and interest to the investor. When you purchase a bond, you provide the issuer a loan for a set duration. Like money market securities, short-term bonds typically offer predictable, low-risk income.

The Harvest Canadian T-Bill ETF (TBIL:TSX) , a money market fund, was launched on January 16, 2024. This ETF is designed as a low-risk cash vehicle that pays competitive interest income that comes from investing in Treasury Billds (“T-Bills”) issued by the Government of Canada. It provides a simple and straightforward solution for investors who want to hold a percentage of their portfolio in a cash proxy.

Medium-term bonds and their influence on the broader market

When we are talking about intermediate-term bonds, we are typically talking about fixed income vehicles in the 4-10 year maturity range. Indeed, the yield on a 10-year Treasury is often used by analysts as a benchmark that guides other interest rate measures, like mortgage rates. Moreover, as yields increase on intermediate-term bonds so too will the interest rates on longer duration bonds.

Recently, Harvest ETFs portfolio manager, Mike Dragosits, sat down to explore the maturity spectrum and our two new ETFs. You can watch his expert commentary here.

US Treasuries avoided an annual loss in 2023 as bonds rallied in the fourth quarter. These gains were powered by expectations that the US Federal Reserve (the “Fed”) was done with its interest rate tightening cycle. The prevailing wisdom in the investing community is that the Fed will look to pursue at least a handful of rate cuts in 2024. Continue Reading…

MoneySense Retired Money: Should GICs be the bedrock of Canadian retirement portfolios?

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My latest MoneySense Retired Money column, just published, looks at the role Guaranteed Investment Certificates (GICs) should play in the retirement portfolios of Canadians. You can find the full column by going to MoneySense.ca and clicking on the highlighted headline: Are GICs a no-brainer for retirees? 

(If link doesn’t work try this: the latest Retired Money column.)

Now that you can find GICs paying 5% or so (1-year GICs at least), there is an argument they could be the bedrock of the fixed-income portfolios, especially now that the world is embroiled in two major conflicts: Ukraine and Israel/Gaza. Should this embolden China to invade Taiwan, you’re starting to see more talk about a more global conflict, up to an including the much-feared World War 3.

Of course, trying to time the market — especially in relation to catastrophes like global war and armageddon — generally proves to be a mug’s game, so we certainly maintain just as much exposure to the equity side of our portfolios.

I don’t think retirees need to apologize for sheltering between 40 and 60% of their portfolios in such safe guaranteed vehicles. Certainly, my wife and I are glad that the lion’s share of our fixed-income investments have been in GICs rather than money-losing bond ETFs: the latter, and Asset Allocation ETFs with heavy bond exposure, were as most are aware, badly hit in 2022. But not GICs; thanks to a prescient financial advisor we have long used (he used to be quoted but now he’s semi-retired chooses to be anonymous), we had in recent years been sheltering that portion of our RRSPs and TFSAs in laddered 2-year GICs. Since rates have soared in 2023, we have gradually been reinvesting our GICs into 5-year GICs, albeit still laddered.

The MoneySense column describes a recent survey by the site about “Bad Money advice,” which touched in part on GICs. Almost 900 readers were polled about what financial trends they had “bought into” at some point. The list included AI, crypto, meme stocks, side hustles, tech and Magnificent 7 stocks and GICs. Perhaps it speaks well of our readers that the single most-cited response was the 49% who said “none of the above.” The next most cited was the 16% who cited a “heavier allocation to GICs.” You can read the full overview here but I did find a couple of other findings to be worthy of note for the retirees and would-be retirees who read this column: Not surprisingly, tech stocks (FANG, MAMAA. etc. were the first runnerup to GICs, receiving 13.24% of the responses. Not far behind were the 10.55% who plumped for crypto and NFTs (Non-fungible tokens). AI was cited by 3.7%: less than I might have predicted; and meme stocks were only 2.81%.

As I said to executive editor Lisa Hannam in her insightful article on the 50 worst pieces of financial advice, GICs are at the opposite end of the spectrum from such dubious investments as meme stocks and crypto. (I’d put Tech stocks and A.I. in the middle).

GICs won’t grow Wealth for younger investors, aren’t tax-efficient in non-registered accounts

The GIC column passes on the thoughts of several influential financial advisors. One is Allan Small, a Toronto-based advisor who occasionally writes MoneySense’s popular weekly Making Sense of the Markets column. He is among GIC skeptics. He told me his problem with GIC is that they “don’t grow wealth. They can act as a parking lot for money for some people but over time there have been very few years in which people have made money with GICs, factoring in inflation and taxation.” Continue Reading…