Month: February 2021

Debt is not Wine!

Time is good for wine, but it’s very bad for debt.

Blue Lobster

Though it should be obvious to everyone, I’m going to say it again. Debt is not wine.

Hear me now! Time makes debt get worse. This is not a secret. Nor should it come as a surprise. The longer you keep it, the worse it gets. And there is no limit to how big a debt can get.

You know how they say that fine wine gets better with time? Debt is the complete opposite. Debt get WORSE over time. Due to the impact of compounding interest, all of your debts will get bigger the longer you keep them around.

Gangrene gets worse with time too, but only so much. Eventually, flesh that is infected with gangrene is removed. Gangrene has an end life. Debt is worse than gangrene because it can go on indefinitely. For those in the cheap seats who insist on pedantic accuracy, it is true that both gangrene and debt end when the host/debtor dies. However, I’d like to see you get rid of debt (and gangrene) before you shuffle off this mortal coil.

Debt gets worse over time.

Time is the ally of the creditor and the enemy of the debtor. When you borrow money, you’re a debtor and you’re obligated to repay both the amount your borrow and the interest on that debt. Think of the interest rate as the price you pay to borrow money. You might need $1,000 to fix your vehicle. If you borrow money, the creditor is going to charge you interest. For simplicity’s sake, let’s assume you borrow $1,000 for 1 year at a rate of 5% per year. At the end of the year, you have to repay $1,050 to your creditor.

And if you can’t repay your creditor, the interest rate of 5% continues to compound that debt. At the end of the second year, you’ll owe your creditor $1,102.50 (=$1,050 x 5%). At the end of the third year, you’ll owe your creditor $1,157.63 (=$1,102.50 x 5%). And the amount of money owed just keeps going up until the debt is paid.

Take a look at your credit card statement. How much interest is being charged on your credit card balance when you don’t pay the full balance every month?

So there’s two factors impacting the growth of your debt: time and interest rate. You know how when you invest your month, you want a really high rate of return so that your investments grow really big, really fast? Your creditor feels the same way about the debt you owe them. I can assure you that your creditor does a happy dance when you take out an 8% car loan, or a 19.99% credit card loan. The higher the interest rate you pay, the better rate of return your creditor is getting.

Do yourself a favor. Take a pen and a piece of paper and physically write out how much interest is charged annually on your current credit card balance if you let your monthly balance roll over each month. Now add on another year’s worth of interest. For good measure, keep doing this calculation for 10-15 years. The resultant number should make you slight nauseous.

Take a look at this list of facts about credit cards in Canada. Two years ago, the average credit card debt was $4,240. And since this is an average, there are some people with much higher balances! Plug the average number into the compounding calculator of your choice and watch the numbers jump, year over year… I feel sorry for the person who doesn’t have the high income to wipe out this kind of debt in a month or two. High interest debt can balloon very, very quickly.

Wine ages well. Debt…not so much.

Again, debt is not wine. Here’s another simple way to tell the difference between the two. Seeing the end of one makes you sad, but ridding yourself of the other will bring you financial contentment.

When my wine is all gone empty, I’m sad – even if it wasn’t a great bottle of wine. Yet when my debts are all paid off, I do a little happy dance and smile brightly for the rest of the day.

Do what you need to do to get rid of debt. Maybe you give up cable and other streaming services for 12 months? Trust me when I tell you that they will always re-start your subscription. Cook at home a little more often than you normally do. You can continue to get take-out or delivery, but just get them one or two days less each week.

The time will pass anyway. Pay off your debts and start investing your money so that you can pursue your heart’s truest desire. Once your money is going towards your investments instead of towards paying off debts, then time will be working for you instead of against you. And wouldn’t that be a really, really good thing?

Retirement is coming, one way or another.

What the eyes don’t see, the heart won’t grieve…

Anonymous Online Poster

No matter how you look at it, retirement is coming.

And if you’re fortunate, you’ll get to pick when you retire. Should Life have other plans for you, then retirement may arrive unexpectedly. Either way, retirement is in your future. One of the best things you can do for Future You is to start saving today.

This year, the contribution deadline for the Registered Retirement Savings Plan is March 1, 2021. In other words, if you put money into your RRSP on or before March 1, 2021, then you will get a tax deduction that can be used against any taxes that you owe for the 2020 tax year.

Here’s a handy-dandy little chart to show you the maximum amount of money that you can put into your RRSP this year.

What’s that? You say that you don’t have $27,830 lying around to make this year’s contribution?

Do you have $1?

Fear not, Gentle Reader. The numbers listed on the chart are the maximum contribution limits. In an ideal world, you would have no trouble at all socking away this much money.

If you’re not one of the Very Fortunate Ones who can easily plunk $27,830 into your RRSP without batting an eye, then fret not. You will do what you can until you can do better. It’s really not more complicated than that.

If you can afford $1 per day, that’s $365 per year. It’s not a lot but it’s a whole lot more than nothing. If you don’t start saving this tiny daily amount, then I can assure you that you’ll regret your decision. Retiring solely on social benefits will not be comfortable.

At $5 per day, you’re looking at $1,825 per year. That’s not too shabby, but it’s also not the cat’s pyjamas. It means one less snack per day, or one less fancy coffee. (Hat tip to David Bach, who is the author of The Automatic Millionaire. This is one the first books that put yours truly on my current financial path.) Save a few calories – use your kitchen to save some money – throw that money into your RRSP and let it grow over the years.

Kick it up to $10 per day and wow! Now, you’re contributing several thousand dollars in a year. In a lot of places, $10 each day is less than you’d spend on parking your car at work. It’s less than getting a burger, fries and a drink at a fast food place. It’s not a whole lot of money, but it can certainly get you to the retirement you want if you consistently put it to good use. If you don’t believe me, check out what Mr. Money Mustache has to say about the $10 bill.

Pick your per diem.

I trust you see a pattern. By implementing a per diem for your RRSP, and setting up an automatic money transfer, you’ll be improving the chances that you’ll have a financially comfortable retirement.

Whatever amount works for your budget, that’s the amount that you should be sending to your RRSP. Before you even ask, $0 per day is not at all an appropriate amount to be saving.

Once siphoned from your daily chequing account and into your RRSP, your money will grow tax-free until withdrawn. How large will it grow? That’s up to you and/or your financial advisor.

In the interests of transparency, I will tell you that my portfolio is invested in exchange-traded funds with Vanguard Canada and iShares. I’ve gone to a fee only advisor for advice, but I do my own research and make my own investment decisions. I’m currently putting my money into equity products, after having spent 9.5 years investing solely in dividend ETFs. I’m a staunch buy-and-hold investor. That means I don’t sell after I buy. I buy what I believe to be good investments and then I just leave them alone for years and years and years. I still have the bank stocks that my parents bought for me when I was a baby…and I haven’t been a baby for a very long time!

You owe it to yourself to spend some time learning about investing your money. Save your money via automatic money transfers. Invest your money in equity products. Learn, learn, learn – as much as you can! There are books, blogs, YouTube, and people who all have information to share. Then repeat the process. Save – invest – learn – repeat!

Do not procrastinate.

Every day that you don’t open your RRSP and invest your money is a missed opportunity to grow your money in a tax-free environment. This is important because money grows faster when it is not taxed. To be very clear, money grows on a tax-deferred basis in an RRSP and you will pay taxes on the money when your withdraw it. However, if all goes well, retirement is a long way away and your money will grow into a giant pile. While you won’t be happy to pay taxes, regard that tax debt as evidence that you’re not going to be poor in your retirement. Poor people don’t pay taxes. You don’t want to be poor in your retirement.

I digress. Retirement is coming, one way or another. If you’re procrastinating about opening and/or funding your RRSP, then stop! Today’s technology means you can open and fund your RRSP from your hand-computer. You no longer need to go to a branch or talk to a human to complete these functions.

Time waits for no one. Take the steps you need to take so that you can put as much as you possibly can into your RRSP. This is a fundament step that you need to take to better your chances of having a financially comfortable dotage and being able to handle whatever financial challenges come your way when you and your income part ways.

Shorting a Stock – the Simple Basics

A major stock market event occurred during the week of January 25, 2021. The current lore is that a group of humble retail investors put a serious hurt on the hedge fund experts who had shorted GameStop stock. As a result of the online amateurs banding together to drive up the stock price, the hedge funds lost billions of dollars.

I’m discussing it in today’s post because I found it both riveting and exceptionally educational. January 24, 2021 was the week that hedge funds bled billions of dollars because of a little thing called a short squeeze.

(In my humble opinion, the stock market events of January 2021 were far more enlightening than the predictable plunging of stock market values in February/March of 2020 due to the COVID-19 pandemic.)

At its most basic, this is how you short a stock:

Let’s say you ask to borrow your sister’s skirt. She says yes, but she needs it back in 4 weeks. You take the skirt and sell it to someone else for $100. Now, you have money in your hand but you owe your sister a skirt. You find a skirt identical to the one you borrowed, and it’s priced at $45 so you buy it. In 4 weeks, you’ve returned the skirt to your sister and you’re $55 richer.

Now, go back to the last paragraph and change the word “skirt” to “stock” and the word “sister/she” to “brokerage house”.

You now understand the rudimentary principles behind making money by shorting stocks.

Got it? Good. Let’s move on.

Why would anyone do this?

Why? You’re kidding me with that question, right?

They would short a stock for the same reason that they do anything in the stock market – to make money. To short a stock is to gamble that its price is going to decline between the time you borrow the stock to sell and the time you buy it back to return to the lender.

In the case of GameStop, the hedge funds borrowed the stock and sold it when it was around $10/share. They wanted the price to go down so that they could buy it back at a lower price. Once they’d bought it back at the lower price, they would have returned the stock to the lender and kept the monies earned. They would’ve had derived their profit from the difference between the sell price and the lower purchase price.

That was the plan anyway…

What is a short squeeze? 

The short squeeze happens when the price of the stock (skirt) doesn’t go down. Instead it goes up. And since there is no limit to the stock’s price, the person holding the short can get squeezed pretty severely if the price doesn’t stop rising.

Remember, the stock (skirt) must be returned to the brokerage house (sister) in 4 weeks. So you might need to pay more than the original $100 to buy the same stock (skirt) from someone else.

During the week of January 25, 2021, very sophisticated hedge funds got caught in a short squeeze instigated by amateur investors who belonged to a sub-account on Reddit called WallStreetBets. The retail investors started buying stock in GameStop, thereby driving up demand for the stock. In-demand stocks have rising prices, which is exactly the outcome that the hedge funds did not want. Remember – in order for the hedge funds to make money on their short-bet, the price of GameStop stock had to keep going down.

After selling the borrowed stock for $10/share, the last thing the hedge funds wanted to do was to buy back the stock at $11 per share, $50 per share, or $400 per share. For every penny that the stock rose, they were losing buckets and buckets of money.

Don’t Try This At Home

Shorting stocks is not for amateurs. Yes, some of the retail investors in GameStop have made money. The ones who got in early, way back in 2019 when this started. The early investors would have bought at prices that were far lower than they are today. Those early birds would have profited handsomely this week if they sold at the GameStop stock price rose above $300/share.

Even the Ontario Teachers Pension Plan wisely took advantage of the opportunity to divest itself of its shares in the company which owned the malls where GameStop were located and earned $638 million dollars for its members.

Hedge fund managers who had invested in shorts when the stock price was less than $10 had essentially wagered that the stock price would go down further. The plan would have been to buy more stock at the new, lower price and keep the difference after returning the stock to the brokerage house.

This is not what happened. 

By buying the stock, the amateurs drove the stock price up and way past $10. As more investors bought more stock, the price increased tremendously.*** The hedge funds still had to “cover their short”, which means they had to meet the deadline for the return of the stock they had borrowed and sold at the price of $10. In order to meet those deadlines, they had to buy stock at the much-higher price thereby losing billions in the process.

Absolutely fascinating to watch…

Shorting a stock is a risky stock market move. The risk lies in the fact that there is no limit to how high the price of the shorted stock can go. In other words, there is no way to accurately predict just how much money can be lost if the stock price doesn’t go down.

And as the events of late January demonstrated, even the experts can get financially walloped if things don’t go according to plan.

*** At the time of writing this post, the stock in question had hit a high of $469.42USD!