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The Flip Side of Rate Cuts

Yesterday the US Federal Reserve did what the markets expected it to do and cut their target rate by 50 basis points (0.5%). The markets appeared to accept the news fairly well and rallied a little bit after the announcement but then fell off a little towards the close. On this side of the border the Bank of Canada cut their target rate last week by 25 basis points and in their comments they left the door open for another 25 basis point cut early in 2009. The big 5 banks in Canada have all dropped their prime rate to 4% now, only 0.25% away from the lowest prime rate I can remember this decade.

So that's all well and good, it now costs less to borrow money and that should help to stimulate some investment if the credit freeze thaws out which it looks like it could be. But what has happened to savers? This morning I took a look at the interest rate on our PC Financial Interest Plus Savings Account. When we opened that account about a year and a half ago the interest rate was over 4% if I recall correctly. Now the interest rate on that account is down to 3.05%. I wondered what other high interest savings accounts were paying so I took a quick little tour around the online banking sites that came to the top of my head. There appears to be a fairly large range of interest rates available out there for high interest savings accounts. Here is what I found:

PC Financial Interest Plus Savings Account: 2% on balances under $1000, 3.05% on balances $1000.01 and up. Plus they have a deal on right now for any new money deposited into an account before November 30 will get a 3.75% interest rate deposited into the account in December.

ING Direct Investment Savings Account: 3% with no minimum balances. They also have a deal where you can open an early Tax Free Savings Account and they will pay you double the interest between now and the end of the year which for will more than cover the cost of the taxes owed on the interest generated in the two months left before the account gets automatically converted to a real TFSA in January. ING also has some pretty good GIC rates if you are willing to lock your cash in for a specific time frame (1-5 years with rates going up as the locked in time gets longer).

HSBC Direct Savings Account
: 3% on all balances (unless you have more than a million in the account ;) ) but there is an ad on their site saying that the great rates will only last until October 31. I don't know if I believe that (since 3% isn't really a great rate compared to the competition) but maybe they will change rates over the weekend or on Monday.

ICICI Bank HISAVE Savings Account: 3.4% on all balances.

(Have I missed any of the big high interest accounts? Let me know in the comments.)

So for anyone looking to park some cash in an account that will pay more interest than a checking account for either short to medium term spending or while they wait for the markets to calm down a little bit there are options out there. I am actually a little bit surprised that the interest rates on these accounts have held up so well. In the last month the Bank of Canada has cut rates 75 basis points and the big 5 Canadian banks have cut their prime rate by the same amount (albeit reluctantly). Maybe we will see these interest rates come down a little bit in the new year or maybe their aren't enough people with enough cash in these accounts for the banks to risk the public backlash by cutting rates.
category: Personal Finance posted on Thursday October 30, 2008 at 09:22:35 by: 0xCC

A Case Against Market Timing

The recent activities in the market have caused some people to question the "Buy and Hold" strategy. Of course it is easy to look back today and say that buying almost any stock anytime before Labour Day was a short-term mistake. The extreme inverse of a "Buy and Hold" strategy is a market timing strategy. Attempting to buy stocks or an index/ETF at a relative bottom and then trying to sell at a relative high. The problem with a market timing type of strategy is that it is very easy to be very wrong and either be in the market on an unexpected downturn or be out of the market on a strong rally.

Yesterday was a classic example of a quick, strong rally. In the morning there was some indication that it was going to be a strong day but in order to be able to take advantage of the upside a market timer would have had to bought into the market on Monday when the market was in a foul mood. On Monday the Dow closed at 8175.77 and on Tuesday it closed at 9065.12 a 10.8% jump in one day. The S&P 500 closed on Monday at 848.92 and closed on Tuesday at 940.51, a 10.7% jump in one day. The TSX 300 closed on Monday at 8537.34 and closed on Tuesday at 9151.63 a 7.1% jump in one day. If (and that could be a big if) the markets have already seen their bottom and we continue to move up from here missing the move that the market made on Tuesday will mean that a market timer would have missed out on a very nice one day return.

I have heard it said that after a correction like we have had over the last couple of months the market makes the majority of its gains during the recovery in less than 15 trading days. We could have seen one of those days yesterday? Were you in the market or out of it? Will you be in the market for the next 'recovery' day?
category: Personal Finance posted on Wednesday October 29, 2008 at 10:27:17 by: 0xCC

I'm Going To Try REALLY Hard Today...

...to ignore the markets. At least for the first couple of hours. It looks like it is going to be a really wild ride when the markets open. The Asian markets took a beating today and that sell-off is getting ready to make its way over the Atlantic.

Are we going to see new lows today? Maybe.

Does a sell-off like this right now make sense? I have no idea.

Why would the markets sell off like this now? We've been making some pretty good progress in setting up a little bit of a base over the last couple of weeks. Some Asian companies (Toyota, Samsung and Sony) apparently made some worrying comments about their outlook. Egads, you mean we may actually be facing some slower economic activity in the coming quarters? Well, nothing to do but sell!

I want to ignore the markets at least for this morning because I think that the markets this morning are like a 2 year old throwing a tantrum. I could very easily be wrong and the moves that the market makes today are justified but I have a feeling that for the gutsy this morning could be a good buying opportunity. Time will tell but while we wait we are in for a wild rile.

Those with a weak stomach may want to look away for a little while. I'm going to be trying to do just that.
category: Finance posted on Friday October 24, 2008 at 09:08:52 by: 0xCC

The Banks Are Back In Line

The Bank of Canada surprised everyone a little bit on Tuesday by only cutting the overnight target rate by 25 basis points (0.25%) and the Canadian banks took their time announcing cuts to their prime rates but by 6:00pm all the banks had announced cuts to their prime rate. The interesting thing about those announcements is that some banks (TD for example) actually cut their prime rate by more than the 25 basis points that the Bank of Canada cut the overnight target rate. This was because they didn't match the 50 basis point cut that the Bank of Canada had made in the previous week. Suddenly, after the CMHC announced it was going to buy up to $25 billion worth of insured mortgages TD claims that its cost of capital had gone down and that they are now able to offer customers the lower interest rate. In other words the other banks weren't willing to stay at the 4.35% prime rate and had moved to 4.25%. When the Bank of Canada announced the 25 basis point rate cut this week all the other banks lowered their prime rate to 4% so TD really didn't have too much choice so they also lowered their prime rate to 4%.

Now that prime is at 4% this raises some interesting circumstances. Looking at the big 5 banks right now they all have dividend yields north of 4%. So it is possible to get a secured line of credit with an interest rate of 4% (that is variable so it can change at any time) and take cash out of that to invest in a bank or two or three. The interest you pay on the line of credit is tax deductible and the dividends generated by the banks would more than pay for the interest plus dividends generate a dividend tax credit so the taxes generated by the dividends are less than the tax deduction generated by the interest paid on the line of credit.

Of course this is leveraged investing and there are a lot of things that could go wrong. If interest rates go up (which they will eventually) a whole chain reaction of events will make things very sticky. As interest rates go up the variable interest rate on the line of credit will also go up so suddenly the dividends won't cover the interest payments anymore. The next thing that will happen is the stock price of the banks will probably also go down because the market will demand a higher yield from the stocks (yield = dividend paid/stock price so if the dividend paid stays constant the only way to increase the yield is to decrease the stock price). So the end result is that not only are the dividends not covering the interest payments anymore but the market value of the stocks wouldn't cover the cash originally borrowed from the line of credit. I think it is very likely that in the next 2-3 years we are going to be in a situation where inflation starts to creep up and as soon as the central banks are comfortable with the state of the economy they are going to start cranking up the interest rates to get inflation back under control. So in the end this could end up being a very, very dangerous strategy. However, I do believe that if the leveraging aspect is taken out of the equation (i.e. if some one has some cash available to invest) this could be a very good time to be buying stocks in a couple Canadian banks (and I would stay away from the ones that have a yield higher than 5.5% right now because if you look at how far they are from their lows you have an idea of how far they could fall again).

We haven't seen the prime rate this low for a few years and I think the lowest I remember ever seeing it in the last decade is 3.75% which we just might see before the spring. Interesting times we are in...
category: Finance posted on Thursday October 23, 2008 at 10:48:34 by: 0xCC

Bright Fall Morning

I've been meaning to do some style updates on this site specifically related to pictures. Hopefully this will motivate me to do that.

Box Car

It was a nice crisp fall morning so I went out and took a bunch of pictures. This is one of them that I just did some minor colour adjustments to.

I found a couple of new blogs today that have managed to eat up a bunch of my time. an open [sketch]book which I found via Andrea Joseph's Sketchblog which has some pretty amazing sketches in it.
category: Photos posted on Wednesday October 22, 2008 at 16:01:10 by: 0xCC

Last Week Had Some Good Returns

While I'm not comfortable saying we have seen the bottom in the markets yet (although it is possible) our portfolio saw some pretty good returns last week. Our combined portfolio returned around 10% last week which is pretty remarkable. One whole year's worth of return in one week. We are still down around 23% so far this year but compared to the TSE's 30% decline year to date (13833.05 on Dec 31, 2007 vs. 9562.49 on Friday), the S&P 500's 35% decline (1468.36 on Dec 31, 2007 vs. 940.55 on Friday) and the Dow's 33% decline (13264.82 on Dec 31, 2007 vs. 8852.22 on Friday) having a 23% decline doesn't seem too bad.

I believe there are some pretty good deals in the market right now for long-term investors. Having said that I think the next 12-24 months may be very rocky and it is very possible we will see the same level of volatility we have seen in the past couple of weeks continue for the foreseeable future. I wonder if investors will get used to this sort of volatility and maybe even a little bit desensitized to it. Having a 8%-10% increase in a portfolio in one week is a little bit extreme but so was the 15%-16% decrease we saw a couple of weeks ago.

So my question is, if some one is willing to put a little bit of money to work for them and perhaps borrow a little bit of money to do it is it possible to get a reasonable return with a specific strategy? I may just have to run through some examples just for fun...
category: Personal Finance posted on Monday October 20, 2008 at 09:06:53 by: 0xCC

More Interest Rate Shinanigins

Well, the interest rate shinanigins continued late last week. After a coordinated move around the world by central banks to cut interest rates by 0.5% in the middle of the week the Canadian banks decided to only pass a 0.25% cut along to consumers. Late last week the Canadian Federal government announced that they would be injecting $25 billion into the mortgage market by agreeing to buy mortgages through the Canada Housing and Mortgage Corporation (CMHC).

On the heels of the announcement of that plan the interest rate battle began. TD Canada Trust was the first bank to announce it would lower its prime rate 0.15% to 4.35% CIBC followed shortly after also announcing a 0.15% cut to 4.35%. Scotiabank was the first bank to announce that it would lower its prime rate a full 0.25% to 4.25% effectively giving Canadians the full 0.5% cut the Bank of Canada announced earlier in the week. Soon after the Bank of Montreal and Royal Bank followed suit. So now we have two of the big five banks with prime rates at 4.35% and three banks with 4.25% prime rates. I'm not sure how long this difference can last but it will be interesting to watch what happens over the next couple of weeks.

The next interest rate announcement from the Bank of Canada is in a week on October 21. Was that 0.5% cut all they planned on doing or will they cut a little bit more? If they don't cut next week will they announce a cut at the net planned interest rate announcement in December? It will be interesting to watch what happens and how the banks respond.

Finally, don't forget to vote today! You have until at least 7:00pm to do it. If you live in the Pacific time zone, polls close at 7:00, in the Mountain time zone they close at 7:30, Central time zone polls close at 8:30, Eastern time zone polls close at 9:30 and in Newfoundland/Atlantic time zones the polls close at 8:30 (all closing times are local times).
category: Finance posted on Tuesday October 14, 2008 at 15:52:20 by: 0xCC

The Tax Free Savings Account

There have been a couple of ripples in the news related to the new Tax Free Savings Account (TFSA) which becomes available to Canadians in January 2009. First ING Direct announced an account you can open now that will be converted to a TFSA in January and they will pay you double the interest for 2008 so they will more than cover the taxes for most people. Now Scotiabank has announced that they are offering pre-registration for a TFSA. Now that Scotia Bank has jumped on the TFSA pre-announcement bandwagon it should only be a matter of days before the other big banks have their own pre-announcements.

If you are going to do any non-registered investing or saving in 2009 you would be silly to not have a TFSA. If you are paying any income tax at all the first $5000 you save outside of an RSP in 2009 should be in a TFSA. That includes emergency funds, saving for a down payment, saving for a wedding, non-registered investing and anything else you might be saving some cash for should go into a TFSA. Every Canadian over 18 years of age needs to open a TFSA in 2009. Unfortunately I would be willing to bet that the participation rate for TFSAs is going to be only slightly better than the participation rate of RSPs which I think is well under 50% of eligible people.

The thing about the TFSA is that with the current market conditions they are coming at almost the perfect time. I believe that as bad as things are right now that in the next 3-5 years there will be one or maybe even two 12 month periods where the market will return in excess of 20% (look at 2003 for an example), even higher than that if you include dividends. If you are willing to take the risk of using the TFSA to invest in the markets you could have a very nice overall return 5 years from now that will have accumulated tax-free.

Even if you aren't comfortable with investing in the markets at the very least you should be able to get a 2.5%-3% close to risk-free (and tax-free) return on your money in a TFSA. If you currently have an emergency fund, a savings account for a down payment, or for a wedding, or for a car, or for that European vacation you are planning to take in 2010, there is no reason for not taking $5,000 (per individual, $10,000 for a couple) out of that emergency fund and putting in a TFSA that could be giving you exactly the same interest rate as the account the original cash was in.

Do not put opening a TFSA account off. Over the next couple of weeks I expect that all of the major Canadian banks and the majority of the online banks (like PC Financial, ING Direct and HSBC) will be offering some way to make sure you have a TFSA account by early January 2009. If you currently have any cash in any account that you are saving you owe it to yourself to open a TFSA and put as much as you can afford into that account up to the maximum of $5,000. Before we get into the whole holiday rush season (which is coming up pretty fast) I think all the banks will be offering some sort of pre-registration for a TFSA and you will have no excuse for not having a TFSA in early January.
category: Personal Finance posted on Friday October 10, 2008 at 09:28:12 by: 0xCC

Interest Rate Shinanigins

Well it seems like some fallout from the US credit crisis has finally spilled over the border for Canadian borrowers (of course for investors it spilled over a long time ago). On Monday TD announced that home equity lines of credit and variable rate mortgages would increase from prime to prime +1%. I am a TD Canada Trust customer and I have a home equity line of credit with them. When I read that press release I was concerned that the rate on our home equity line of credit would jump from the 4.75% prime rate to 5.75% so I checked our account on-line. The interest rate was still set at 4.75%. Interesting.

Yesterday in a coordinated effort with central banks around the world the Bank of Canada lowered overnight rates in a coordinated effort with central banks around the world by 50 basis points or 0.5%. Usually this results in a lowering of the prime rate by the big 5 Canadian banks of the same amount. In the last 8-12 months or so the big banks have been reluctant to pass on the rate reduction to consumers through the lowering of their prime rate. In fact, during the last Bank of Canada rate reduction there seemed to be a little bit of a game of chicken going on where the banks waited until the end of the day to announce interest rate reductions after the Bank of Canada changed their target overnight rate the the regular time of 9:00 am.

So the banks also seemed reluctant yesterday to lower their interest rates. The interest rate announcement came fairly early in the morning (I can't remember the exact time but I am pretty sure it was before 9:00 am) and the first bank to announce a reduction in their prime rate was TD but it didn't make the announcement until around 1:00 pm and it only reduced the prime rate by 0.25%, not the full 0.5% the Bank of Canada reduced their target rate by. When I look at my home equity line of credit interest rate today it is still set at 4.75% but if you add together all of these changes to the prime rate and variable interest rate policy it should be at 4.75% + 1% - 0.25% = 5.5%. Interesting.

What is the Bank of Canada target rate anyway? Well, according to the Bank of Canada, it is the middle of a range that the bank wants to see the average of the rates for overnight lending between banks to happen at. So what motivation do the banks have to lend to each other at the target rate? Well, the Bank of Canada sets up a range that is 0.5% wide with the target rate in the middle of the range. The Bank of Canada will lend money to banks at the top end of the range (or the target rate + 0.25%) and it will pay interest on deposits at the bottom end of the range (or target rate - 0.25%). So if a bank wants to try to charge or pay an interest rate outside of the range the other banks can just go to the Bank of Canada to get a better interest rate. There is no motivation for a bank to try to charge outside the target range, they won't be able to get anyone else to accept those rates.
category: Finance posted on Thursday October 09, 2008 at 11:27:03 by: 0xCC

What is your worst case scenario?

Well it looks like even with the bail out package being approved in the US the markets are still in a tailspin. When will the markets bottom? I have no idea and anyone that says that they do is just taking a wild guess. So what happens if the markets decide that it might be a good idea to bump the 1929 markets into second place for largest market decline? What impact would that have on your portfolio and your life?

First of all I believe that a market like that should have almost zero impact on your day to day life because anything that is invested in the market should be cash that you don't need for at least 3 years, preferably at least 5 years. If you are in a situation where this isn't true well I hope you are learning a good lesson here. The other thing that may get you in to a little bit of trouble is if you are using margin or are leveraged in any way (using a line of credit for example). I am currently guilty of using leverage but I know I can ride out this market unless margin rules change on me (which isn't out of the realm of possibility).

So what is the worst case for me? I have been investing for income for the last 3-4 years and I have invested mostly in companies that have a long history of paying dividends and increasing those dividends at a rate that nicely beats inflation. So I think the worst case for me is that dividends don't increase over the next 2-3 years. If that happens and we lose another 20% of market value before a slow recovery starts then I will still be in an ok position from a portfolio standpoint.

What else could happen? Well, we could go into a long global recession that starts impacting jobs. What could be the worst case there? We could have no earned income coming into our household which would mean that our cash reserves would last approximately 10 months before we would have to start dipping into cash in our RSP accounts which would last another 2-3 months. After that we could sell off the investments we have with a financial adviser that account for a little less than 30% of our total portfolio and use that to pay off the mortgage. At that point we would need to come up with about $1500/month to be able to continue running the house in 'survival mode'. If the markets only dropped 20% from where they are right now and had stayed there over the something like 2 years (one year to lose jobs and another year to burn through cash reserves) it would have taken to get to the point where we were selling investments to pay off the mortgage our remaining investments would keep us going in survival mode for at least 8 years, probably closer to 10 or 12 years. We could extend that a little bit by selling the house and moving to a smaller house but it is hard to say how much equity we could pull out of the house at that point because I assume that the housing market would have taken a pretty big hit. We could also sell at least one car which could give us around 6 more months of cash.

So for me that is the worst case scenario and that would require the economy to be a total and complete train wreck the likes of which haven't been seen in the last 100 years. It would require the loss of both our jobs, no available government support and a total lack of income for 10-15 years. However if that were to happen we would be in a pretty bad situation. We would be both pushing 50 with our only asset being our house. Which isn't totally brutal but isn't a great position to be in and would probably mean that we would have to work until well past 65 in order to be able to retire.

I don't expect to see anything close to that worst case scenario. In fact, I wouldn't be surprised to see a nice January effect in 2009 and some sort of stabilization through the spring of 2009 (but I don't expect to see any substantial recovery other than in January). However, I think that the worst isn't over yet and we could very easily see the markets down 20% from here before we start to see some recovery. Tax loss selling over the next 2-3 months is going to be hard on the markets but that just means that there should be some cash waiting to get into the markets in January.

What is your worst case scenario? If the markets can't pull out of this decline for 2-3 years (which isn't too far off from what happened in the 2000 correction) will you be able to not touch your portfolio even if you lose your main source of income for the majority of those 2-3 years?
category: Personal Finance posted on Monday October 06, 2008 at 10:34:41 by: 0xCC

How to ruin a good cup of coffee

I made myself a great cup of coffee this morning. It was probably the best cup of coffee I've had in over a month. Just the right balance of body and flavour without being too bitter or overpowering. Short of having roasted the beans myself it was pretty close to the best cup of coffee I think I could make. It was so good I went to get another cup from the pot but it was too late, I had already ruined the rest of the pot.

Normally I only make one cup of coffee in the morning. It is a big cup, probably 500ml (around 16oz I think) but I only make one. This morning M asked me to make some extra coffee because she wanted to bring some to some one later in the day. Ok fine, I can do that. Pull out the coffee maker that I don't normally use. How much coffee? How much water? How much does that thermos that M wants to take hold? Did I put too much coffee in the filter basket? Not enough water? Ok, add some more water but take a cup out of the pot first so there would be enough room to hold the extra water I just added. Yes, that is a good cup of coffee.

After doing some work I go back to the kitchen and remember that I actually had a pot of coffee brewing. Fill up the thermos that M wants to take and still have a good portion of coffee left. Pour myself another cup and... Too watered down now, barely more flavour than a cup of coffee from that Canadian institution.

Oh well, back to making a single cup tomorrow.
category: General posted on Friday October 03, 2008 at 10:27:18 by: 0xCC