Personal Finance 101

Economics 101: A Fiscal Policy Dilemma

Wednesday, July 16th, 2008

How Long Will Economic Recovery Take?

As troubling as these times look, we all assume that eventually things will change and the economy will once again be robust, financial markets will stabilize, and commodity prices will revert to the mean.

In the mean time, however, many financial pundits are taking their best guess as to how long the recovery process will take. We are constantly barraged in the media with a mixed bag of opinions, all of which are given without request mind you, and all trying to influence government policy makers to either reign in pricing or make borrowing money easier.

Will We See Stagflation?

The puzzling duo of slow growth and high inflation is extremely troubling for policy makers because combating one ailment only serves to exacerbate the other. A true economic Catch-22 if you will. It is widely thought that the central banks will leave the overnight rate unchanged until year end as a tightened credit policy may send the economy into a severe downward spiral.

The current state of affairs has even the most seasoned economists scratching their heads:

“That’s the dilemma that rapidly rising high oil prices create for central banks everywhere. It boxes them in,” said Douglas Porter, deputy chief economist with BMO Capital Markets.

“It has the nasty side-effects of crimping growth and driving up inflation. This is like a mini-version of what central banks faced in the 1970s when oil prices spiked.”

The era that Porter speaks of was marked by what has since been termed stagflation - a persistent period of economic stagnation and high inflation.

The Numbers Tell The Story

In uncertain times like these, it is even more prudent to look at the hard data to provide the “real” truth behind the economy. The following are sets of numbers that help us to understand the effect that skyrocketing energy prices are having on consumers:

• Consumer Prices were ups 1.1% last month - The largest monthly increase in over 25 years!
• Energy prices are up 6.6% since last month.
• Inflation adjusted average weekly wages dropped 0.9% last month. This was the largest drop in wages since 1984.
• Consumer inflation is up 5% over the last year - The highest since 1991.
• Airline prices were up 4.5% in June - The biggest one-month jump since early 2000.
• Vegetable prices were up 6.1% in June - The largest monthly increase in three years.

What Can Investors Do?

In any inflationary environment the common practice says to keep existing outflows down, skip new large expenses, and increase your emergency savings. I would like to personally add that we should continue to invest in equity markets as long as we have time on our side (7-10 years).

Increase emergency funds and review life and health insurance.

The 3-6 months’ worth of expenses that advisors suggest we keep stashed away in liquid assets such as fixed deposits or a high interest savings account could be increased.

Life and health insurance should be reviewed and could be topped up with low-cost term insurance if necessary. Shop around for no-obligation insurance quotes. InsureMe.com offers quotes on all types of insurance and are very competitive.

Prepay your mortgage.

As mortgage and interest rates may climb higher, prepaying your loans will give you a guaranteed return on your investment equal to the interest rate on the loan. Moreover, no single investment option is likely provide guaranteed returns greater than the rate of interest on your mortgage. In addition, the psychological satisfaction of reducing your overall debt can trump any financial return. This is especially true for the conservative investor.

If you are concerned about rates increasing, you might want to lock in the interest rate on your mortgage with a fixed rate loan. If you have a good credit score, banks will likely really want your business as lending regulations are tightening. This would be a good opportunity to have a service like LendingTree.com working for you to get the best rate.

Continue to invest in stocks.

The only opportunity that we have to combat inflation is to investing in equity. Carry on with your stock investment strategy and take advantage of buying opportunities in great dividend growth stocks. For the moderately conservative investor, seek out large cap stocks that are trading at least 30% off of their 52-week high and have stable earnings as they are likely to rebound first.

If you want to pick up stocks, invest in stages and go for value dividend growth buys. If your time horizon allows, a great buying opportunity may be upon us. Remember, history is on your side.

Diversify in precious metals.

While Gold and Silver are at high prices, some advisors still recommend that you invest 5-10 per cent of your portfolio in gold exchange-traded funds and gold mutual funds. Their reasoning for this suggestion is that, historically speaking, periods of high inflation result in a surge in gold prices.

What are your plans for this economy?  Are you buying, selling, or staying the course?

Posted in Investment News | No Comments »

Student Loan Reduction Strategies

Tuesday, March 4th, 2008

It appears that I shocked a few people when I wrote about my thoughts on maxing out your student loans to get every penny that you can. Of course, there are the same arguments about other kinds of debt as well. I have received my fair share of email regarding my advice on the use of debt.

Debt is a Tool.

It is that simple.

Loans, mortgages, credit cards etc. These are all tools that, if used correctly, can not only help you manage your cash flow but increase your wealth as well. Yes, debt can be terrible if you can’t control it, but it can also be your best friend if managed correctly.
I already talked to you about the power of using a mortgage as leverage to build wealth and why lenders are more eager to hand out money when it is backed by an asset such as real estate versus consumer debt - like a car loan!

Why is This Article Titled “Student Loan Strategies”?

Well, as mentioned in the previous article on student loans, the student loan is some of the easiest money (debt) that we can obtain as average individuals. It is even easier to obtain than a mortgage because you are not required to prove that you have an established income. The debt is backed by your future earnings - how’s that for pressure!

Anyway, as we get back to the moral of the story and we understand how we can leverage our student loan money so we might graduate without a negative net worth, there is a way to combine the above strategies in order to profit while getting your degree.

Kiss The Dorms Good Bye!

This strategy is directed toward the parents of children who are on their way to college. So, if you are a college student, or about to be one get your parents on the phone!

To the parents…

Your child will have to live somewhere and either you or they will have to foot the bill regardless of where they hang their hat, so why not profit from it?

The strategy is to purchase a house with as many bedrooms and bathrooms as possible in a location that is as close as possible to the university. Yes, you will be renting this house out - but your child will be managing the rental.

College rentals can be unique and very profitable in that it is possible in this situation to rent “by the room”. While most residential real estate rents by the unit or the house, the college market will allow increased returns by renting by the room.

An Example

A 4 bedroom home that would normally rent for say $1000/month as a unit can often be rented by the room in the college market for between $350 and $450/month per room. As you can see the potential for profit is much higher and the potential for your child graduating without a mountain of debt it also greater.

This strategy requires more management as you must collect rent from each person separately instead of collecting one check from the entire house. If you trust your child and they are responsible, this should not be a huge issue as they will be living there to manage the property.

This will also help your child to learn to better manage finances and learn business skills such as management, marketing and basic accounting.

The Benefits

Ideally, the monthly profits (cash flow) from the roommates can cover expenses, repairs, vacancies etc. or may be used to have your child live, essentially, for free!

However, the best part about this strategy is that over the course of the 4-5 years that your child is in college, you will be gaining equity in the home courtesy of your child’s college roommates. This equity can be crystallized by selling the home when the child graduates and using the equity to pay off the student loans for example.

If you have a steady income and a good credit score, buying a house for your child to live in while going to college is typically a sound strategy.

If you don’t know if you have good credit or not, you can check out your credit score for free at Experian.

The Kicker

If you have more than one child that attends the same university, this strategy can have a compounding effect as the younger ones enter school and the rooms continue to be rented out, your equity grows and grows.

If you are fortunate enough to realize a substantial capital gain along with your home equity, you executed this strategy exactly as my good friend and his parents did when I attended college. I only wish my parents and I could have undertaken this strategy instead of paying off someone else’s house!

I hope you enjoyed this example and are able to benefit from it. I share this with you, not because I profited from it, but because I was a victim of it! If it helps your child start their professional life without the same $40,000 in student loan debt that I had, then it has been worth the time to write this article.

Stay tuned later this week when I will tell you a story about what I learned from falling victim to this strategy and how it catapulted my net worth right out of college!

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