Sep 162014
 

A series of stress tests can help you sleep at night worry free :) A stress test is designed to determine if you have the ability to deal with a financial crisis if things go pear-shaped. It makes the impact of unlikely, but plausible events measurable and transparent, so you can see exactly if you should be worried or not about your financial situation.

A stress test is like an alternative solution to an emergency fund, but there are some differences.

Emergency funds are great, but they lack tangibility. The popular rule of thumb is for people to have enough cash in their emergency funds to “cover six months’ worth of essential expenses,” writes personal finance guru Gail Vaz-Oxlade on her blog. I’ve heard other professionals say this as well. It’s good advice, and these knowledgeable gurus are not wrong. But six months is quite an arbitrary time period :| Why not four months or nine months? An emergency fund is a good start to financial security, but perhaps it’s not quite enough to give you the complete peace of mind that you deserve. This is where stress testing your finances can come in handy.

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A stress test will categorize all your risks, quantify them, and tell you exactly how much money you should keep on hand, and more importantly, why. It removes all traces of uncertainty and doubt from an objective point of view and offers you a strong sense of financial stability :D It’s also flexible and is accommodating based on your changing financial needs. For example if you renovate your kitchen a stress test can help you determine a budget and solutions in case of complications or unexpected overhead costs. A stress test will also show you warnings in the changing economy, like potentially rising mortgage rates, so you can prepare for it.

Having $15,000 or 6 months worth of expenses in an emergency fund doesn’t tell you why that amount is important, or exactly how that money would be used in a real life situation. You can’t do anything with an emergency fund except wait for an emergency to happen. But a stress test allows you to be proactive instead of reactive. If you have proper auto insurance and know that the most expensive out of pocket cost is $2,000 to fix your car in the unfortunate event that it gets damaged, then a stress test will help you maintain at least $2,000 of cash or available credit at all times, so you don’t have to constantly worry about it ;)

But it’s not about one or the other. A stress test can be used as an emergency fund, or you can incorporate an emergency fund inside a stress test :)

Below are six stress tests that I have made for myself. You can use them as reference/template to create your own. Because stress tests are so granular and custom in nature, everyone’s will be different.

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Aug 012014
 

There’s a saying that younger people should invest more in equities (stocks) and older people should buy more bonds. Some like to use the “100 minus your age” rule to determine asset allocation. Start with the number 100 and subtract your age. The resulting figure is the percentage you should allocate to equities, and the rest should be invested in bonds. For example a 30 year old investor could have the following portfolio:

70% = Vanguard Total World Stock Index Fund Investor Shares (VTWSX)
30% = Vanguard Total Bond Market ETF (BND)

This simple yet balanced portfolio should benefit from the long term growth of the U.S. and global markets, while providing fixed income stability :) But should everyone follow this rule of thumb? Probably not. Age should not determine our asset allocation. Consider the following situations.

Economic Situation:

U.S. government 10-year bonds today only pay about 2.5% interest a year. But ten years ago they were paying twice as much. This means in order to achieve an adequate return on a fixed income portfolio today we would have to mix in higher risk investments such as non-investment grade bonds and mortgage backed securities. However at some point the risks will not be worth the expected returns. So in a low interest rate environment it may be prudent to lower our exposure to bonds, and stock up on more equities instead, at least until interest rates move higher.

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Three decades ago those 10-year government issued bonds were paying 15% interest a year due to a more robust economy and higher interest rates. In that kind of situation we want to be overweight in bonds because the 15% annual return is virtually risk free since it’s guaranteed by the U.S. federal government :D

Personal Situation:

If a young person in his late twenties has $50,000 in savings, what should he invest in? We see questions like this on Reddit all the time, but it’s impossible to give a categorical answer without knowing the individual’s personal situation. If he plans to buy a home in a couple of years using his savings as a down payment then he should probably avoid risky investments and be 100% in bonds. On the other hand if he has no plans to purchase a big ticket item, and he works for a State university that offers a generous fixed income retirement plan, then he should probably invest most of his own savings into growth stocks.

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Jun 142014
 

Canadian comedian and actor Jim Carrey gave a moving commencement address to a class of 2014 last month. In his speech he describes how people often make seemingly practical choices that are actually based on fear, and how this can turn into a costly mistake. It’s true for many aspects of life, including personal finance. What I want is to become financially independent. But what I fear is making the wrong decision and losing all my money. So I have to let my love of freedom overcome my fear of failure.

Jim encourages us to ask the universe for things that seem out of reach. It’s amazing what we can receive if we simply ask for it. Last year I hoped my investments would perform well. The universe granted my wish and the stock markets returned over 20% in 2013. I also wished to receive more dividends and boom! Many companies I own have increased their dividend distributions over the last year, including Apple, Target, Enbridge, Disney, McDonalds, Chevron, and Scotia Bank. The universe rewards those who are proactive and optimistic :D

This is why I buy stocks despite their volatility. Why I buy real estate and land despite pundits saying the property bubble will burst at any moment. Why I invest in gold and silver even though many would argue precious metals are not even real investments. I will gladly face all the risks because I’m not afraid to ask the universe for what I really want ;)

Jim’s dad taught us that even if we make conservative financial choices, we can still fail. So we might as well take a chance on our dreams, even if it means exposing ourselves to more risk. I think this is great advice for many people who are too conservative with their financial decisions. We only live once after all. We can’t let fear paralyze and prevent us from turning our goals into realities. And for dads all around the world, happy Father’s Day :)

A longer version of Jim’s speech can be found here.

 

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Random Useless Fact:

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Jun 082014
 

From shady snake oil salesmen to the proverbial Nigerian prince, there is no shortage of fraudsters in the world trying to swindle people out of their money. You might think scams only happen to other people. You know better than to fall for phishing scams or multi-layered marketing products that don’t work. But despite best efforts even the most careful, conservative investors can still get tricked.

 

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A retired couple in Ontario Canada sold their home and received $268,000 from the proceeds. They wanted to invest in something short term and gave the entire amount to an investment company, MJF Financial Consultants. The couple was very explicit that they will need this money in the near future and did not want to risk losing any of the principle. The company told them to not worry.

Well unfortunately the money-grubbing clod of a salesman forged the couple’s signature, and gambled their $268,000 in risky stocks. When the couple asked for the money back, the investment firm had lost $80,000 of their money.

We had trusted him to make the right choices for us.” – Don, the husband.

A government investigation has found the company committed forgery and acted inappropriately, and it should reimburse the $80,000 back to the couple. However, this recommendation is non-binding, meaning the company doesn’t have to if they don’t want to. Welcome to Canada, where punishment for white collar crime is often just a slap on the wrist :P Unfortunately the couple may never see their $80,000 ever again :(

I never had any health problems prior to this. I am now on two heart meds, five times a day. I am furious.” – Elaine, the wife.

Being the victim of fraud and misrepresentation is often harder to avoid. There’s no way to tell for certain which mutual fund dealer will decide to fake a client’s signature, or commit embezzlement or other financial crimes.

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May 272014
 

Life is short so it’s important to take periodic breaks from our busy lives, sit back, and enjoy the present moment :) Listening to music is a great way to unwind. Here’s some ambient background music composed by David Wise of RARE/Nintendo fame. Enjoy!

Studies have shown that people who are more giving also live happier lives! Money shouldn’t be a means to an end. But it can help us to live in the moment and give our lives more meaning. Perhaps the most meaningful life is one that’s shared with others :)

Warning: Incoming feels. Keep a spare tissue handy.

When 26 year old maintenance inspector, Chris Price, was told he had terminal lung and liver cancer and didn’t have long to live, he decided to dedicate the remaining time he had left to make all his girlfriend’s dreams come true. He proposed to her (Ceri) and they were wed last August, with Ceri’s four children as the guests of honour :)

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Soon after, Chris surprised his new wife and his stepchildren with a trip to Disneyland in Paris.

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He even flew with Ceri to New York for a romantic weekend of sightseeing and shopping. He bought her a pair of boots for $800, and a $1,500 handbag.

He knew I had fancied a pair of Louboutin boots but they were way too expensive for me to ever afford them. But Chris bought them for me and got me an even more expensive Mulberry handbag.” ~Ceri

As a final gesture of endearment Chris booked a Las Vegas getaway for Ceri’s birthday.

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