Building Wealth

For the first 30 or so years of working, saving and investing, you’ll be first in the mode of getting out of the hole (paying down debt), and then building your net worth (that’s wealth accumulation.). But don’t forget, wealth accumulation isn’t the ultimate goal. Decumulation is! (a separate category here at the Hub).

Stock Valuations: Are the lunatics running the asylum?

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By Noah Solomon

Special to the Financial Independence Hub

The Buffett indicator is a simple ratio that compares the market capitalization of the U.S. stock market to its GDP. Buffett himself warns that if this ratio reaches 200%, “you are playing with fire.” At its current level of approximately 234%, this indicator is higher than it has ever been, including at the peak of the dot-com bubble in the early 2000s.

The cyclically adjusted price/earnings (CAPE) ratio is a well-known metric invented by economist and Nobel Laureate Robert Shiller. The S&P 500 Index’s CAPE ratio currently stands at 36.6, which is higher than 98% of monthly readings since 1881, and more than double its 140-year average.

To be fair, the current nosebleed levels of the Buffett indicator and the CAPE ratio can be partially explained by today’s record low interest rates. Furthermore, equity markets have become increasingly dominated by technology-driven and/or software-as-a-service (SaaS) companies with above average profitability. This shift may render current valuations less comparable to those of the distant past.

Regardless of the valuation metrics you use or whichever “this time it’s different” adjustments you make, stocks today range anywhere from somewhat expensive to obscenely overvalued.

What Did You Think Was Gonna Happen? Money Makes the Mare Run

Since 2008, financial markets have benefited from an unprecedented period of low-interest rates. When the pandemic began to ravage the globe in early 2020, the Fed cut interest rates to near zero and began pumping hundreds of billions of dollars into financial markets. By purchasing Treasury bonds and government-backed mortgages, the Fed has continued to inject approximately $120 billion into the economy each month.

Leaving interest rates at levels below inflation for an extended period is like putting a giant hose in the ground – water will come up somewhere. In the case of monetary stimulus, the “water” manifests itself in rising asset prices. According to legendary investor Marty Zweig:

“In the stock market, as with horse racing, money makes the mare go. Monetary conditions exert an enormous influence on stock prices. Indeed, the monetary climate – primarily the trend in interest rates and Federal Reserve policy – is the dominant factor in determining the stock market’s major direction.”

In today’s markets, you don’t have to look very hard to find strong evidence of Zweig’s theory, which explains why stock markets were making fresh highs during successive outbreaks of Covid-19 and spiking unemployment. It also explains why approximately two thirds of stock returns over the past decade are attributable to multiple expansion rather than earnings growth.

Those who think that the huge gains in everything from stocks to art to cryptocurrencies to real estate over the past 12 years are solely the result of economic growth and corporate ingenuity should avoid anyone selling GameStop options! The market’s dependence on low rates cannot be overestimated. Interest rates giveth and taketh away. Should the central banks succeed (or over succeed) in getting the inflation genie out of its bottle, equities could be in for a nasty ride.

Stretching A Rubber Band Until It Snaps

Extreme valuations are only one of the features that have historically accompanied asset bubbles and subsequent busts. Another harbinger of future misery has been accelerating gains. Prior to both the tech-wreck of the early 2000s and the global financial crisis of 2008, market returns had shifted from normal to worryingly unsustainable. Accelerating gains can be thought of as a rubber band that is being stretched further and further. The more you stretch the band, the greater the likelihood that it will snap.

As the following chart demonstrates, average equity market returns have been accelerating to the point where they are at their highest levels in five years.

Are the Lunatics Running the Asylum?

Excessive speculation is another common ingredient in the recipe of historical bubbles. Whereas it’s never precisely clear what percentage of market activity is driven by short-term speculators (i.e., gamblers) as opposed to long-term investors, there are some clear signs that the lunatics are at least helping to manage (and possibly running) the asylum.

Short-Dated Call Options: A Canary in the Coal Mine?

If you think information may surface that will cause people to recognize that a company is worth much more than its current value, then you would either purchase its shares or buy long-dated call options. By contrast, short-dated call options represent speculation in its purest form. Buyers of five-day options have no reasonable expectation that meaningful new information will emerge over that period – they are simply gambling. Continue Reading…

Millennials want to FIRE at age 50

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By Mark Seed, MyOwnAdvisor

Special to the Financial Independence Hub

Whether you agree with the FIRE (Financial Independence, Retire Early) movement or not – it’s a big thing.

Personally, I’m a huge believer in clear goals. If FIRE at age 50 is your goal, go for it.

Goals can be positive, purposeful and motivating. I think goals are great because they force you into choices.

Pursuing financial Independence is a choice.

That said, I’ve learned to let go a bit. Spend a bit. Relax a bit. Enjoy things just a bit more. 

In case you missed it, some people can work too hard, too long and save too much for retirement.

Make FI a goal but not life’s final destination

I make financial goals like these every year to help me/us stay focused on our choices.

Whether you are in your 20s, 30s, 40s or 50s aspiring for some form of earlier retirement than most – if that’s your choice – just consider what you’ll do with your time when you get there. FI is a great goal, just don’t make it a final destination.

Millennial FIRE at age 50 case study

I’ve been fortunate to receive emails from dozens, if not hundreds of readers in recent years asking me what it takes to build a 7-figure portfolio, can I retire with X amount of money, and what would a world of living off dividends and distributions could be like.

Well, I will tell you my goal to live off dividends and distributions remains alive and well!

I will continue to answer those questions from readers as much as possible – so keep them coming.

But given those questions, I figured I’d share yet another case study for a reader/lurker on my site.

Before we get to that new case study, a reminder you can check out these previous posts about folks striving to retire or semi-retire earlier than most AND what that takes:

Here is one proven path to retirement ignoring any 4% rule.

Karla and Toby are 54 and 56. Can they retire soon with $1.2 million in the bank and no company pensions?

Mike and Julie want to spend $50,000 per year in retirement starting in their 50s…how much do they need?

This 50-something couple wants to FIRE at 52. How much can they spend?

Millennials want to FIRE at age 50 – can they do it?

A reader of the site emailed me to discuss their early retirement dreams. Let’s look at their case study and find out what it takes to FIRE at age 50.

Here is their profile and what they told me:

  • Judy (F), and Shane (M), aged 35.
  • Judy is currently pregnant, and they are expecting their first child later this year.
  • They live in Kingston, ON.
  • They both work full-time for now.

“Mark, can we FIRE at 50?” If so, “what will our assets look like at age 50 assuming we try and max out contributions to our TFSAs at minimum every single year?”

To help answer these questions, I once again enlisted some help. Welcome back Owen Winkelmolen (no affiliation) who is a fee-for-service financial planner (QAFP) and founder of PlanEasy.ca. Owen specializes in budgeting, cashflow, taxes & benefits, and retirement planning – working with both individuals and young families to help them with comprehensive financial plans from today to age 100.

Owen, thoughts for Judy and Shane?

Thanks Mark and glad to be back on your site. I love these case studies!

First, before we share the results, let’s provide some inputs and background data for context. Based on their information to you, we’ve included this information below in their projections with some assumptions as well:

  • Judy works full-time, for now, making a solid $95,000 per year as engineer with performance bonus opportunities at work of up to 15% (although the latter is never expected).
  • Shane is an HVAC mechanic making up to $80,000 per year.
  • They have a sizeable mortgage: $350,000. They hope to have it paid off in 10 years and as of now, with a child on the way, they have no plans to move.
  • For the most part, they’ve been quite smart – owning both cars/vehicles. They plan to replace Shane’s truck in another 5-7 years so they have established a “car fund”. They have $15,000 saved up already!
  • They’ve read your site Mark (about your emergency fund and have gone well beyond that with a child on the way) and keep about $25,000 in cash as an emergency fund. 

Mark to Owen: we did it – why we have an emergency fund.

  • They’ve worked hard and investing wisely. Mark told me they have about $100,000 invested inside each of their TFSAs – contributions are now maxed out since they’ve been contributing to their TFSAs since account inception.
  • RRSPs are not yet maxed out – there is only so much money to go around. Judy has an RRSP value of $110,000; Shane about $90,000.
  • They have also told Mark they intend to start contributing to a Registered Education Savings Plan (RESP) in the coming years for their child.
  • Neither Judy nor Shane have any workplace pension.

We’re going to make a few assumptions based on the information they also provided:

  • That their home has a value of $500,000 now and they will pay off the mortgage as planned as best they can.
  • Their interest rate is about 2.3%, with payments estimated to be about $2,200 per month.
  • They have no other debt – no credit cards, nothing.
  • We’re not sure if they plan to have other children so we won’t make any assumptions there!
  • We’ll also assume Judy sticks to her plan and stays at home for a bit but will return to work/work form home after about 6 months have passed. Shane also wants to be at home a bit. For daycare, they are lucky, they told Mark they have some help!

Owen: here is what the FIRE at 50 math says!

Judy and Shane have done an excellent job setting themselves up for financial independence and early retirement. Their plan is very robust and includes lots of flexibility. That flexibility will allow them to choose to spend more in the future and find a better balance between saving and spending or retire earlier than they planned. Continue Reading…

What can we learn by scrutinizing Warren Buffett’s portfolio?

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By Ian Duncan MacDonald

Special to the Financial Independence Hub

Warren Buffett has a reputation of being the most successful stock market investor ever.  What companies does he invest in? What do these stocks have in common? What can we learn by looking at his portfolio?

Once every quarter large holding companies like Berkshire Hathaway are required to disclose what stocks they hold. There  are 31 stocks in the Berkshire portfolio.  The value of the ten largest stocks of these 31 make up almost 90% of the portfolio’s total value.  One stock, Apple, makes up 40% of it . The other nine of the top ten stocks have values for Berkshire ranging from Bank of America worth 44 billion dollars  down to .$4 billion dollars invested in DaVita Inc.

Are all these 10 stocks headquartered in the United States?  No

Do they all make profits?  They do but the profits, as reflected in their operating margins, are not remarkable.

Do they all pay dividends?

Are they all paying dividends? No. Are those that do pay dividends paying remarkably high dividends? No.  Two of the 10 pay no dividends and 5 pay dividends of less than 1%.

Do they all trade millions of shares ever day?  No.  While six of them do have daily trading volumes exceeding a  million, one of them only trades fewer than 100,000 shares in a day.

Have the ten all increased their share prices since Berkshire Hathaway acquired them?  No.

Would any of them be considered to be a speculative investment?  Yes.

Do many of the share prices, as reflected in their Price-to-Earnings ratios and book values, appear to be inflated?  Yes,

Stocks that can grow steadily, not dramatically

There are 14,000 North American stocks that Berkshire could invest in. Many stocks could provide a better dividend income, and many have much greater potential for share price growth than these 10 stocks.  However, what most of these 14,000 lack is “survivability.” Buffett seeks stocks that he can depend on to produce reliable profits from their established, loyal customer bases for decades.  These are stocks that can grow steadily, not dramatically.

Berkshire Hathaway has invested 249 billion dollars in the following 10 companies [all US$]:

American Express Company (AXP) with $24 billion invested.

Apple Inc (AAPL) with $114 billion invested.

Bank of America Corp (BAC) with $44 billion invested.

BYD Co. Ltd (BYDDF) with $5 billion invested.

Coca-Cola Co (KO) with $22 billion invested

DaVita Inc (DVA) with $4 billion invested

Kraft Heinz Co ( KHC) with $14 billion invested

Moody’s Corporation (MCO) with $8 billion invested

US Bancorp (USB) with $9 billion invested.

Verizon Communications Inc (VZ) with $9 billion invested.

The wisdom of Buffet’s buy and hold investment strategy is reflected in some remarkable share price gains over the last 20 years:

American Express in 2001 could be purchased for $35.46 and is now trading at $157.95.

Apple is even more remarkable: in 2001 the share price was 33 cents. It is now at $126.90. Like most of these stocks, there have been some share price declines: Bank of America could be bought in 2001 for $29.20.  It can now be bought for $47.05  However, in 2006 it was at its highest price of $53.85.  In 2017 it was only $22.41.  There are many bank stocks whose share prices have had better gains than Bank of America and paid dividends more than double Bank of America’s 1.71% dividend yield.

BYD Company Limited is an unusual stock for this portfolio.  Berkshire has invested almost $5 billion in it. It is a Chinese electric vehicle manufacturer.  Fewer than 100,000 shares are being traded daily, which is small when compared to  the 15,935,074 Verizon Communications shares traded daily or the 11,915,739 Coca-Cola Shares. With a Price-to-Earnings ration of 97.5x the current $42.05 share price for BYD appears to be inflated.  In 2017 its share price was $5.95. This is barely above penny stock status. Its current operating margin of 4.14% would be typical of a speculative investment. This is one of the two foreign stocks among the 31 stocks in Berkshire’s portfolio.

Isn’t it interesting that Buffett invests in BYD instead of Tesla?  Could the contracts BYD is signing with long established car manufacturers to get them into electric vehicles be the attraction? Competition is fast approaching Tesla.

Coca-Cola has provided Berkshire with a solid investment foundation for decades.  Coke is the kind of established brand leader you expect Berkshire to invest in.  In 4 years, its share price has grown by $9.00. In 20 years, it has grown by $22.  Its dividend yield of 3.07% is the second highest of the 10 stocks (only Verizon paying 4.44% is paying a higher yield). Coke’s operating margin of 27.48% was the third highest after Moody Corporation and US Bancorp.

DaVita Inc. is another stock that arouses curiosity as to how it ended up in the top 10 of the Berkshire investments  It provides kidney dialysis services through hundreds of sites in 9 countries. Even though its share price has grown nicely, only one analyst currently recommends it as a buy In 2001 the share price was $7.15, by 2017 it was up to $77.32 and it is now at $120.94. DaVita pays no dividends.

Is there a pending increased need for dialysis services that the rest of the world is ignorant of? Perhaps Buffett just sees DaVita as a steady, profitable, growing stock with an ever increasing potential as the population ages?

Kraft Heinz Company is more typical of the big name, stable, reliable stocks that Buffett favors. However, the current price of $44.15 is significantly below what he paid for it a few years ago.  It is also well below the $99.20 it reached in 2017. Does the Price-to-Earnings ratio of 124.0x indicate that the current  price is greatly inflated?  The operating margin of 3.26% seems leave no room for a dividend these days. There was a 55 cent dividend paid in 2015.  What long term potential does Buffett see for Kraft Heinz?

Moody Corporation is the most profitable of the ten companies.  Its operating margin of 46.63% is much higher than Berkshire Hathaway’s 6% operating margin. Moody’s is a long-established leader in the financial risk information industry. With a small dividend yield of 0.75% the profits are not being paid to shareholders.  Four years ago, the share price was $118.45.  The current price is $332.85. This is a winner for Mr. Buffett.

US Bancorp did not have the highest dividend yield nor was it the highest priced stock nor did it have the highest operating margin, but its financial figures were good in all areas.  It scored a 70, which was the best score of the ten stocks.  The highest score I have ever calculated was 78.  The lowest score was 8.  I personally avoid investing in stocks scoring less than 50. The scoring system was designed to identify the best high dividend paying stocks with the potential to realize ever increasing share prices (The stock scoring software is emailed buyers of my investment books when requested).

Verizon Communications is the second highest scoring stock. Its dividend yield of 4.44% was the highest of the 10 stocks.  Like Moody, it also had good financial figures. It is another example of the solid, well established businesses Buffet wants in his portfolio.

The following are the 10 stocks sorted in descending order by desirability score:

  • US Bancorp – 70
  • Verizon Communications – 66
  • Bank of America Corp – 65
  • American Express – 62
  • Coca-Cola – 60
  • Apple Inc – 58
  • Moody’s Corp – 56
  • DaVita Inc – 51
  • Kraft Heinz – 43
  • BYD Company – 38

You will notice that these top 10 stocks do not include industries negatively impacted by the COVID-19 pandemic and recession, such as hotel chains, cruise lines or air lines. As well, Steel mills, mining companies, oil companies, construction companies or other industries whose fortunes often rise and fall on world price fluctuations have no presence. However, financial organizations like US Bancorp, Bank of America Corp, American express and Moody’s are well represented in the top 10.

The following are the other 21 companies appearing in the Berkshire portfolio of 31 stocks:

AbbVie Inc (ABBV)

Amazon.com, Inc (AMZN)

Aon PLC (AON)

Axalta Coating Systems Ltd (AXTA)

Bank of New York Mellon Corp (BK)

Biogen Inc (BIIB)

Bristol-Myers Squibb Co (BMY)

Charter Communications Inc (CHTR)

Chevron Corporation (CVX)

General Motors Company (GM)

Globe Life Inc (GL)

Itochu Corporation (ITOCF)

Johnson & Johnson (JNJ)

Kroger Co (KR)

Liberty Global PLC Class A (LBTYA)

Liberty Global PLC Class C (LBTYK)

Liberty Latin America Ltd Class A (LILA)

Liberty Latin America Ltd Class C (LILAK)

Liberty Sirius XM Group Series A (LSXMA)

Liberty Sirius XM Group Series C (LSXMK)

Marsh & McLennan Companies Inc (MMC)

Mastercard Inc (MA)

Merk & Co Inc (MRK)

Mondelez International (MDLZ)

Procter & Gamble Co (PG)

Restoration Hardware Holdings Inc. (RH)

Sirius XM Holdings Inc (SIR)

Snowflake Inc (SNOW)

SPDR S&P ETF Trust (SPY)

StoneCo Ltd (STNE)

Store Capital Corp (STOR)

Teva Pharmaceutical Industries Ltd (TEVA)

T-Mobile Us Inc (TMUS)

United Parcel Service Inc (UPS)

Vanguard 500 Index Fund ETF (VOO)

Verisign Inc. (VRSN)

Visa Inc (V)

Wells Fargo & Co (WFC)

If your objective is to build a financially strong portfolio that will endure and grow for decades, then choosing the kind of stocks that Warren Buffett chooses would be a proven, effective strategy.  In my last investment book, ”Safer Better Dividend Investing,” the highest dividend paying stocks in the USA (and Canada) were scored and sorted in descending order.  These charts would help you find outstanding stocks to add to your portfolio.

You do not need hundreds of stocks in your portfolio. The number of stocks Berkshire invests in is thirty-one.  My recommendation is always twenty. This gives you an easily manageable number of stocks while providing safe diversification. Unlike Warren Buffett, you do not have billions to invest but a carefully chosen portfolio can, in time, provide you with generous reliable income and eventual financial independence.

After graduating from McMaster University, with $100 left in his pocket (but no student debt), Ian Duncan MacDonald hitch hiked home to Sudbury to work four months as a labourer in International Nickel’s smelter. In four months, he had saved enough to seek his fortune in the big city.

In Toronto, he was immediately hired by Dun & Bradstreet as a credit reporter. While he had expected to be a reporter for the rest of his life, D&B had other plans. Within four years, he was General Manager of their Marketing Services Division. Three years later, at the age of 28, he was responsible for the sales, marketing and advertising for all three divisions of the company.

At 32, he left D&B to build Screening Systems International Ltd, for a large conglomerate, which led to his interest in collections.  Moving to Creditel of Canada Ltd. he became  Senior Vice President. Subsequently bought by Equifax, he remained there until his retirement in 2005. In anticipation of his retirement he incorporated Informus Inc. to sell his art, his publications and consulting services (www.informus.ca.) 

His investment books “Income and Wealth from Self-Directed Investing” and “Safer Better Dividend Investing” provide a detailed system, scored charts of all high dividend stocks traded on the NYSE, NASDAQ and TSX, plus stock scoring software. They arm someone who has never invested with the knowledge and tools  they need to successfully and safely generate income and wealth for the rest of their lives

  

 

3 tips to House Flipping success for Seniors

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By Jim McKinley

Special to the Financial Independence Hub

If you’ve been looking forward to trying something new in retirement, flipping houses might be the ticket. If you want to be a successful house flipper, follow these steps from Financial Independence Hub to get your business off on the right foot.

1.) Figure out Funding

Funding for house flipping generally comes from two places: investors or hard money loans. Each way has its benefits and drawbacks.

Investors can be a great option because you are bringing someone into the business who wants it to succeed. The money investors give you can also be used more freely than funds from a loan. Auctions, for instance, are an excellent place to pick up homes for cheap, but they often require cash. Most loans won’t cover auction purchases, so investors are an excellent way to open up the world of foreclosed auction homes for you.

The downside to investors is that because they also have an investment in the business, you might have less freedom than you would if you were on your own. Their opinions become as weighty as yours, and you may have to bend to their will when your opinions differ on what to do because they have the money.

Hard money loans are another option for business financing. Instead of basing their approval on you, lenders consider the potential value of the house after repair, called the ARV. If approved, they’ll give you not just the purchase money for the house but what you’ll need to flip it, too, and if the loan goes south, they can get their money back by selling the property. The main drawback to these loans is steep interest.

2.) Know what to look for

The ideal house for flipping is located in an up-and-coming neighborhood, meaning young families and professionals are looking to buy there. It’s located on a good street with low crime and is near nice schools.

According to HGTV, the best houses have areas that can be improved immensely simply by painting. They have solid builds with an attractive layout and unique pieces that give them character. Although it can be tempting to choose homes that could use extreme renovations, those kinds of fixes can take significant time. It’s important to remember that every month you spend working on the house is time that you’re losing money through your loan or paying bills to keep the house up and running. Continue Reading…

Tax rates likely to rise: what to do about it

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By Eva Khabas

Special to the Financial Independence Hub 

The Covid pandemic has led to unprecedented government spending with a deficit that has reached record heights.

Sooner or later someone has to pay for this and that usually means the taxpayer. Don’t look now but when you start your tax planning it’s probably best to assume that tax rates are going up in Canada.

However, even before Covid the federal government was talking about increasing the capital gains tax.

Capital gains inclusion rate could go back up to 75%

Currently, only 50% of capital gains are, in fact, taxable but this was not always the case. In fact, from 1990 to 1999 75% of capital gains were subject to tax! It’s logical to assume that tax revenues will be increased through a higher capital gains portion that is taxable, since capital gains are perceived as ‘passive’ income from investments. In theory, this means taxes should be generated by wealthier taxpayers.

Loss of Principal Residence exemption?

Also, the big fear of every Canadian is that government will remove the principal-residency exemption. Currently, taxpayers can sell their primary residence at a gain and not pay any taxes.  Many taxpayers rely on the appreciation in value of their homes as their main source of retirement income. The impact of making gains on principal residency taxable would be devastating to many, if not most, Canadians.

Before discussing what to do about all this, let’s make sure we understand what capital gains are, how they are different from your other income, and when these gains become taxable.

So, what exactly is capital gain? In a nutshell it’s the growth in the value of an asset being held for investment purposes, so that asset is not for resale. A long-term holding period would indicate that the gain is capital. Currently, only half of the capital gain is taxable, while most other income is fully taxed.

In most cases the capital gain is subject to tax when the asset is sold, but there are also times when you may have to report capital gains without an actual sale occurring. For example, at the time of death there is the deemed or assumed sale of all assets, with any capital gains included in the tax return of the deceased. This would, of course, affect beneficiaries.

It’s important to note that increases in personal tax rates will also result in you paying more tax on capital gains. This is because the tax rate on capital gains is applied at the same tax rates in Canada as on employment and other income. In addition, reporting a higher overall total income would also result in more tax because a higher income puts you in the top tax bracket.

Defence # 1: Timing

So, now we see that many tax-reducing strategies primarily revolve around two things – 1) timing, and 2) reducing your taxable income. First, let’s look at timing.

If you have higher overall income from various sources in 2021, and expect lower taxable income for 2022, consider disposing of the asset(s) in 2022 wherever possible so the gain attracts a lower marginal tax rate for you.

You can also use time to advantage by deferring the cash outflow – the tax you pay to the government – and disposing the assets early in the year. Your tax bill is due April 30th of the following year, so if you sell the capital asset in January of 2022 you still have 15 months until tax must be paid on that.

Staggering gains over multiple years

Now, let’s assume you have a large capital gain. How can you stagger that gain over several years? One strategy is to defer cash receipts from the sale over multiple years. The Canadian Income Tax Act allows you to spread that gain over five years (and in some cases over ten years), provided you receive proceeds from the sale over a number of years. For example, if you receive 20% of the proceeds in 2021, you only need to include 20% of the gain in your taxable income as it can be spread over five years.

RRSPs and TFSAs

All these strategies are of a short-term nature. If the assets are disposed of in the long term, consider holding them inside your RRSP. You don’t have to declare those assets as income until you make a withdrawal. Likewise, you can use your TFSA so some of the gains are not subject to tax at all. Either way, your tax advisor can help determine if assets can be transferred to your RRSP or TFSA. Continue Reading…