Archive for the ‘Investor Education’ Category
Monday, February 22nd, 2010 |
When we apply for a mortgage we should always have some idea as to how much we can afford to borrow, and our capacity to repay the mortgage. Knowing how much we can afford is vitally important because nobody would like to lose their house or investment property to foreclosure. When we ask ourselves the question of ‘how much can I borrow for a mortgage’ it will be highly dependant on two major factors:
1.) The interest rate charged on the mortgage
2.) The amortization, or length, of the mortgage.
When it comes to lenders or banks deciding upon the amount and rate of the mortgage loan, they will certainly look into the financial background of the borrower.
Lenders are typically looking to satisfy themselves of the Three C’s of credit – Including the capacity to repay the loan, along with the credit history and the character of the individual. These factors can be determined initially by looking at the credit score, and secondly by calculating several ratios before the determination of how much credit they can grant to the borrower.
The Real Cost of A Mortgage
When one decides to buy a house, there are several payments that must be paid on time in addition to the actual mortgage payment. These other payments should always be included when we ask ourselves the question ‘How much can I borrow for a mortgage’?
Such additional payments consist of home owners insurance, property tax and home owners association fees. When these are all added to the mortgage payment, they comprise a more realistic cost of home ownership. In addition, add this to your other anticipated monthly expenses and this is one of the ways to estimate how much you can really afford when you apply for a mortgage.
Private Mortgage Insurance – PMI
This might be another expense that could alter how much mortgage we can afford. Private mortgage insurance, also known as PMI; is an additional cost that must be added if you are not able to afford 20% of the homes price paid as a down payment. In such a case, you will need to purchase private mortgage insurance in order to protect the bank’s investment in your high ratio mortgage.
Front-End Ratio
The front and ratio is the comparison between the monthly mortgage cost-which includes insurance, real estate taxes, private monthly insurance with your total monthly income. Generally mortgage costs are given to make up between 26% to 29% of your monthly income, in this case your monthly maximum repayment amount would be $840. This is another analysis you can use in answering the How much I can borrow for a mortgage question.
Back-end Ratio
When your total income is compared with your total debt payments, this is called back end ratio. This, more comprehensive, ratio includes credit card debt and college loans, and any other debt you have. It can make a total of up to 33 to 40% of your income.
For example, if your bank sets 35% as the limit, and you have a monthly income of $3000. In this case your total debt paid in a month would be $1,050. If you pay $400 as a monthly student loan, you would then have a maximum of $650 left from your income which can be used to repay the mortgage loan.
Credit Score
If you have a good credit score, the banks may increase the limit of the above ratio calculations because your history of repayment cements the bank’s faith in your credibility. Once the ration is determined, all the aforementioned characteristics and calculations help both the borrower and lender in deciding how much credit is really affordable for the borrow.
As you can see, answering the question ‘How much can I borrow for a mortgage’ is not as easy as we might think. There are many variables that lenders take into consideration and we must fully understand those variables in order to determine how much mortgage we can really afford. It’s just not as easy as some online mortgage calculators would have you believe!
For more information on Mortgages, check out my Mortgage Survival Guide For the First Time Homebuyer!
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Monday, January 11th, 2010 |
The latest issue of Consumer Reports magazine features an article that looks at why infomercials(and the legend of Billy Mays) are so popular. These ads are carefully scripted to set-off a chemical in your brain called dopamine that typically leads to irrational, compulsive decision-making. This dopamine “high” only lasts for 5-6 minutes, hence the reason so many of infomercials tell viewers to “act now”.
What’s interesting is that dopamine has also been identified by researchers in the field of neuroeconomics (which combines neuroscience, economics, and psychology to study how people make financial decisions) as the cause for imprudent, short-sighted investment decisions.
Not surprisingly, dopamine tends to be released in the brain more frequently when market volatility increases. This is precisely why it’s so important for investors to always make rational, long-term investment decisions based on facts and strategies, not emotion.
Investing Facts
With that in mind, to kick off your week I thought it would be helpful to provide you with a few market facts you might find useful:
- 2009 was the 22nd best year ever for the S&P 500 Index going back 128 years (as far back as data is available). The index however, is still 29% off its 2007 high.
- Despite rising over 30% last year, the S&P/TSX Composite Index is still about 18% below the high water mark it set in July 2007.
- Last year, the MSCI World Index rose 27% in US$ – its biggest annual gain since 2003 and proof that diversifying globally is still an important investment strategy.
- After peaking in November 2008, the VIX index – a closely watched measure of stock market volatility – fell 75% in 2009, a record annual drop.
- After an outstanding 2008, U.S. government bonds ended 2009 with their worst one-year performance in three decades. Despite this, and an improving environment for stocks, flows into mutual funds in the US are still running at five to one in favour of fixed-income assets over equity markets.
Although infomercials and investments are worlds apart, consumers and investors alike, need to make rational decisions based on facts and their long-term needs. For investors, a key success factor is having a well developed investment strategy, complete with rules in place. With a strategy, like investing in dividend growth stocks, you can turn to your stock selection strategy rather than Tony Little or Vince Offer - my personal favourite.
Slap Chop anyone?
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Friday, October 23rd, 2009 |
The following is a case presented to support why we should continue to see an upward investment trend in commodities and how this positive long-term trend is due largely to the supply and demand imbalances that persist in industries that produce commodities.
In addition, the market turmoil of the past two years caused new financings of commodity exploration and development projects to become next to non-existent, so these imbalances have been exacerbated.
Ultimately, the message is the supply / demand imbalance has created a recipe for longer-term commodity price strength. It appears all the ingredients are in place for this longer-term secular theme to play out.
Using oil as an example, here are some points to consider:
- If China and India per capita consumption grows to levels similar to Mexico’s current consumption, global demand would increase by over 36 million barrels per day. This would require the equivalent of three more Saudi Arabia’s to meet this demand.
- Future oil demand will come from developing countries. For example looking at global energy demand from 2005 through 2030, it is projected that OECD (Organisation for Economic Co-operation and Development) countries will show a 19% increase while Non-OECD countries will show an 85% increase.
- Supply constraints support ‘higher for longer’ prices in oil.
- Oil reserve decline rates are getting higher, and the costs of getting oil out of the ground are increasing (the oil sands being a good example of this).
- Even if large-scale investment resumed immediately there is a time lag before commodities can get to market, so this makes it very likely that we will see most commodity prices go higher in time.
An argument against commodities in the long-run requires a belief that the U.S. economy will implode, China and India will not grow, and the wealth effect caused by the growing middle classes in developing economies around the world will not occur.
In my humble opinion, it would be a large stretch to see all of the aforementioned scenarios not play out.
Posted in Investor Education | 3 Comments »
Friday, June 5th, 2009 |
Sometimes you come across a chart or graph that takes an abstract idea and makes it very tangible or real. The chart below from U.S. banking giant JP Morgan strikes me as one of those pithy but powerful statements, speaking to the level of emotion that’s driven investor behaviour over the past year and which is still a big factor today.
We are accustomed to thinking of asset allocation in the context of individual portfolios, but the snapshot below looks at investor’s current allocation to stocks, bonds and cash on a global basis and compares today’s situation with historic norms.
The chart shows that the world’s allocation to equity investments is at the lowest level in 20 years, with fixed income picking up the bulk of the weighting and cash also representing a significantly higher weighting relative to equities. In short, investors the world over are underweight equities relative to the long-term historic average and significantly so.
Clearly, the chart above shows that over the past year, many investors around the world have gravitated towards “safer” asset classes, namely cash and fixed income. But, over time, this is likely not an effective investment strategy. By contrast, professional money managers use asset allocation models built on fundamental investment theory and research to achieve their investment objectives. These tools take emotion out of the equation.
It is important to note that no asset strategy will be ideal during all market conditions, it is the managemetn of emotions and the use of rationale thought and research that will help you understand the market.
Many investors say they recognize that they can’t participate in a market recovery if they’re sitting on the sidelines yet the chart above suggests that for most, their fears get in the way of making disciplined, rational decisions. Most people need some exposure to equities in order to achieve their long-term financial goals.
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Wednesday, May 20th, 2009 |
Since the credit crisis began in August 2007, experts have agreed that there is no magic bullet solution. The general view is that world economies will eventually recover but the healing process will take time. Along those lines, here is REAL data that represents REAL steps in the right direction.
Here are two recent examples:
- Global credit markets continue to thaw as government cash injections and interest rate cuts kick in. Last Friday, the London interbank offered rate (Libor) – the interest rate banks charge each other for loans – fell the most in eight weeks to 0.85% for three-month U.S. dollar loans. Libor, which determines rates on everything from car loans to mortgages, peaked at 4.82% at the height of the financial crisis last October. Last Friday’s fall in three-month Libor was the 33rd consecutive day of declines – the longest stretch dating back to January 2008.
- Last Friday also marked the 10th consecutive day of gains for the Baltic Dry Index, which tracks ocean shipping rates for commodities. This was the longest advance in three months and the index hadn’t been that high since last October. The index is followed by economists since it can provide insight into the level of demand for raw materials in global markets.
Whether it’s banks starting to lend again, demand for raw materials picking up around the world, improved housing affordability in the US or the fact that the stock market rally since March 9th is now the largest and second-longest rally in the past 18 months, it seems step by step the pieces required for recovery are falling into place (albeit baby steps).
That said, the recovery path could still look like “one step forward, two steps back” for a while as we were reminded last week by weaker than expected April retail sales in the US and soft Q1 manufacturing sales data in Canada.
However, we can see that the LIBOR rate, the key indicator for credit movement, has decreased drastically. By all economic measures, this is a great sign for business and as such, a good sign for investors!
Posted in Investor Education | 5 Comments »
Tuesday, March 17th, 2009 |
Yes, we all know that past performance is not an indication of future returns. However, the only information that we have to make decisions on investing is from the past. Therefore, this information is better than no information at all.
Some Important Stats on Stocks
Here are some current relevant statistics for those who want to know if they should be investing in stocks right now:
- 30, 19 – Since 1950, the average U.S. bear market has lasted about 13 months and on average, has declined 28%. At the end of February, we were 18 months into the current downturn and U.S. stocks were off by more than 50% from their October 2007 peaks. On average, when bear markets end the return on U.S. stocks 12 months later has been about 30% and investment losses through previous bear markets were typically restored an average of 19 months thereafter (although it’s important to keep in mind that the breadth of the current decline has been worse than the average).
- 80, 16 -When the S&P 500 is trading below fair value and inflation is at or below its long term historical average of 4.2% (conditions that exist today), the return on stocks is positive more than 80% of the time. The average one year return during these periods is about 16% versus an average loss of 7% during instances where returns were negative (less than 20% of the time).
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30 – On North American exchanges, more than 30% of stocks are currently trading below book value.
What These Statistics Mean
No, these statistics are not the be all and end all of investing. Nor are they to be used as a roadmap for your own investing decisions. However, they are useful in illustrating the fact that bear markets end just as our last bull market ended.
The climb will not be as drastic or sharp as the fall, but there will eventually be another bull market and stocks are surely closer to a bottom now than they are to a top.
Posted in Investor Education | 2 Comments »
Thursday, January 15th, 2009 |
Over the past few months many investors have been questioning their methods of building wealth for the future. With the markets being more volatile than at any time in history, there is no doubt that many people simply feel like running for the exits.
With that in mind, here are three questions that many investors are asking along with answers based on historical statistical evidence.
Why am I still investing in the U.S.?
The message that history has taught us is a simple one. Analysis shows that in the past, when the S&P 500 was trading below fair value and inflation was less than 4.2% which is certainly the case today, there is an 83.3% chance of achieving a positive return.
All the signs and tools that we have to work with indicate that coming out of this crisis there will be significant upside in the U.S. equity market.
How can I keep investing when the economy is in the tank?
This one is easy, stock markets are leading indicators and as such stock markets will likely recover before the ensuing economic recovery. While it is impossible to identify when these recoveries will begin, missing out on the sharp returns that often occur in the early stages of a stock market recovery, is a mistake that investors make very frequently.
How am I ever going to bounce back?
We must remind ourselves that, as a long term investor, it is important to continue to follow the forward looking strategy that was implemented before they felt the emotional pressure of daily market volatility. A very compelling fact to reference is the asymmetrical nature of bull markets vs. bear markets.
The average bull market gain of 79% far outweighs the average bear market decline of 28%. And the length of the average bull market is 34 months long vs. the length of the average bear market of only 11 months.
While these questions are not intended to completely sooth anyone’s concerns about the health of thier portfolio, it is always nice to know what history has shown. Even though history cannot predict the future, it is the best information that we have to qualify our decisions with.
Posted in Investor Education | 3 Comments »
Thursday, December 4th, 2008 |
As an investor, you come up with an overall approach to meet your objectives and then bring in the stocks, bond, real estate etc. to your portfolio to execute the plan. Of course you expect that there will be frustrations along the way – just like we can’t control the weather, we can’t control the markets. But, if you are willing to put up with the frustrations, by the end of your investment time horizon, you should be able to enjoy the retirement you’ve always dreamed of.
Historical Statistics
Anyone investing for a long time should expect markets to go down sooner or later, but the long-term trend has always been up. In 183 years of equity markets in the U.S. performance was positive 70% of the time and negative only 30% of the time. Years like the one 2008 is shaping up to be are extremely rare. In fact, the only complete calendar year that lost over 40% was 1931. Conversely, the market improved by more than 40% ten times.
The chart below shows the frequency of positive and negative calendar year returns in the U.S.
There are two key messages to take away from this chart:
- The market performance of 2008 is well outside the norm. Looking at history, it seems unreasonable to expect such negative returns to keep recurring.
- Investors often focus on average returns, but the long-term experience of the market is very different from the average. The average U.S. equity calendar year return is approximately 8%, but in any given calendar year there’s less than a 25% chance of a return in the range of 0 to 10%. Returns outside that range should be expected – both positive and negative.
Additionally, what you can’t see in the chart is that four of the five best years (over 50% return) occurred immediately following a negative year.
With 2008 being the worst calendar year in recorded history for equity returns, do you think that the possibility is increased for history to repeat itself with 2009 rebounding with a potential 50%+ return? While we have history as a guide, only time will tell if these statistics will hold true in the future.
Posted in Investor Education | 5 Comments »
