Building Wealth with Low interest Rates

It's possible to build wealth in a low interest environment. Here's how.

When most of us read about interest rates, our minds race to our mortgages.

Last week we weighed the pros and cons of refinancing and examined how beneficial a low interest rate environment is when it comes to our mortgages.

Most people already know how important interest rates are to their mortgage. That link gets a little fuzzier when it comes to their investment portfolios. Can you build wealth in a low interest rate environment?

First some background. The Bank of Canada's benchmark lending rate stands at 0.50 per cent. That's the lowest in history. For the record, most consumers won't be able to borrow at that rate. It is the target rate on overnight loans between commercial banks.

What's important to remember is that the lower the benchmark rate, the lower your rate will be. And rates could fall further. The Bank of Canada could take rates to 0.25 per cent when it meets again on April 21.

What does all this mean to your portfolio? The cost of borrowing money has never been lower. Essentially, it means money is on sale.

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Discount brokerage margin rates on Canadian debit balances are between 2.50-3.75 per cent. That's attractive to many investors when you consider the S&P/TSX Composite Index has averaged a total return of 7.65 per cent over the last 25 years. And that's despite the recent declines!

Borrowing to invest can make sense - it can magnify potential gains. For example, say you had $5,000 to invest in a security that cost $50. You could buy 100 shares. If the share price rises to $75 you'll make a tidy profit of $2,500.

Now, let's say you used 50 per cent margin. That is, used $5,000 of your own money, and $5,000 in borrowed money to invest $10,000. You could now buy 200 shares. If the share price went up to $75, your gain would be $5000.

But you need to understand the risk. Borrowing to invest can also magnify potential losses.

In the example above, if the stock price falls, you'll suffer double the loss. If you bought 100 shares at $50 with cash, and the stock price fell to $25, your initial investment of $5,000 would be worth $2,500. Ouch. But what if you invested $10,000 using a 50 per cent margin? Your loss would be $5000. Double ouch.

You can see why research is important. Learn as much as you can about the investment, the borrowing facility and your own cash flow before you borrow to invest.

Time is something to consider as well. Given the higher risk, ensure you have enough time to actively monitor your investments. Investors can't be lax when buying on margin.

Another reason why time is important: the longer you hold an investment on margin, the higher your break-even cost. After all, the interest clock is ticking. Factor in the interest cost in your decision making. It's the one variable that is often overlooked.

It goes without saying that you should diversify your portfolio and avoid concentrated positions in a few stocks, or industries.

Borrowing to invest has a tax advantage. As a general rule, a portion of the interest cost is tax deductible to the extent there is a reasonable expectation of profit.

Opening a margin account isn't your only option. You could consider a line of credit. Borrowing from a secured line of credit will provide a lower interest rate in many instances.

Remember to use margin prudently and keep some cash in your account to meet any margin call. It is the responsibility of the investor and/or advisor to fully understand the investment and risk level before borrowing to invest.

You need to ask yourself if leverage is part of your financial goal. Talk to your advisor if this strategy is suitable and fits in with your overall financial strategy. And be sure to understand the margin rules and your firm's policies by carefully reading your margin agreement and disclosure statement.

The other way interest rates affect your portfolio is through interest rate sensitive stocks. Usually companies with high debt loads, such as utilities, are more sensitive to interest rates because of the higher cost of borrowing and them being considered as income plays for their dividends.

Lower interest rates generally make them more attractive. Automakers and homebuilders tend to benefit from lower rates since it's cheaper for customers to purchase their products.

Finally mortgage companies and banks are in the business of lending money. So, when interest rates go down, the cost of the money they borrow for lending purposes goes down too. Some of this saving is passed on to their customers, who may be more likely to borrow.

That takes care of the equity side of your portfolio, but what about the fixed income segment? With one year GICs currently yielding 1.25 per cent and three year GICs yielding 2.75 per cent, income seekers are right to be worried about how the low rate environment is affecting their lifestyle.

I would consider including high quality investment grade corporate bonds to help pick up some additional yield. On average, Canadian corporate bonds are yielding 4.50 per cent for a three year maturity.

It's more than possible to build wealth in a low interest environment if you focus on the right sectors, asset classes and use your margin account prudently.


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How to save $10,000 in 2009 & Manage your Budget : Save & Get Rich

How to save $10,000 in 2009 & Manage your Budget : Save & Get Rich

If you were hoping for a list of small tweaks you could make in your spending to save $10,000 a year, sorry.The reality is that $10,000 is a lot of money. And saving big money usually means making big changes in the areas where we spend the most, such as:Housing.Transportation.Food.

Many people balk at chopping these basic expenses, notes Vicki Robin, a founder of the simple-living movement and co-author of the landmark book "Your Money or Your Life," first published in 1992 and recently reissued in a new edition.But those willing to entertain alternatives often find they can cut their expenses dramatically. Surveys of those who tried the nine-step "Your Money or Your Life" program -- which teaches people how to achieve financial independence by reordering their spending priorities -- found that participants trimmed their spending, on average, by 25%, Robin said.The following are ways people have found to substantially reduce their costs to live, move and eat. Perhaps some will inspire you.Saving on shelter On average, one-third of the money Americans spend goes to housing costs. Trimming that bill can reap significant savings. Some ideas:Rent for less. Smart Spending blogger Donna Freedman gets reduced rent in exchange for managing a small apartment complex. Others alternate stays in short-term or inexpensive rentals with housesitting or caretaking gigs.Patricia Walker, 64, typically gets paid $5 to $12 a day to housesit in the Mexican retiree mecca of Ajijic. That's more than enough to pay the $160 monthly rent on a tiny casita she uses between housesitting gigs."This is an area where there are a lot of wealthy Americans and Canadians, and when they travel they don't want to leave their homes alone," said Walker, a former Californian who blogs about her life in Mexico. "Right now I'm getting paid to live in a mansion, with a maid three days a week and a gardener, and they pay for everything." Walker said she finds her housesitting jobs through word of mouth. People looking for longer-term stints can subscribe to The Caretaker Gazette for $29.95 a year.Move. Downsizing to a smaller house or a less-expensive area can dramatically improve your financial prospects. Anne Crawford, 49, sold her home in Northern California after two decades there and paid $93,000 cash for a small house in her hometown of Omaha, Neb. The move not only freed her of a mortgage but allowed her to pay off her other debts and supplement her savings.Share. Having roommates may feel like something you should outgrow, but plenty of people decide the savings more than make up for the loss of privacy. For years, Robin and a crew of roommates shared a large Seattle home that also served as headquarters for her New Road Map Foundation.More recently, a family that Robin knows decided to offer a room to someone who provided both part-time child care and lawn care. That arrangement essentially turned unused space into a big savings for the family's budget.Rethink your car The federal government's latest Consumer Expenditure Survey indicated that the average household spent $8,758 a year supporting an average of two cars. But you can easily spend more than that on a single car in an area where insurance costs are high. Research firm Runzheimer International estimated a 2009 midsize sedan would set its owners back $8,764 to $13,200 a year, depending on where the family lived.

Clearly, not owning a car, or owning one car fewer, can save you a bundle if you can pull it off. Some alternatives:Car sharing. If you live in an area served by the car-sharing service Zipcar, you can pay an annual fee and hourly charges to have access to a number of vehicles parked around your town. If you live in other areas, renting a car occasionally and using public transportation the rest of the time can make sense.Carpooling. If you must own a car, try to make it a "site of production" rather than just a "site of consumption," as Robin puts it. That means using it to make money, or at least be reimbursed for some of your costs, such as by carpooling."What people chip in for gas often exceeds what you had to pay to fill up the car," Robin said.Car maximizing. You can save more than a quarter-million dollars over your adult life simply by owning cars for 10 years instead of five. You can save even more if you buy those cars used. Read "Make your car last 250,000 miles" for tips on how to keep your vehicle running smoothly longer.

Eat for less You can trim an out-of-control food bill substantially by eating out less and making more meals from scratch. Combining coupons with weekly sales can chop an additional 25% or more from your bill.

Being vegetarians, as Oregon residents Sandy Aldridge and Dale Lugenbehl are, can save you a bundle as well, since meat is relatively expensive.But Aldridge and Lugenbehl take it a step further by growing most of the food they eat. Instead of spending more than $500 a month on food, which is average for two-person households, the couple spend "less than $30 a month, sometimes considerably less," Aldridge said.

Aldridge acknowledges that tending a garden and processing the produce can be a lot of work, but she finds it preferable to running back and forth to a grocery store. Also, the couple don't grow their own just for financial reasons, but as a way of lessening their environmental impact."Because we grow things organically, we don't use any chemical pesticides or fertilizers. It also eliminates transportation of the produce," Aldridge said. "You really can't get anymore bio-regional than picking things from your backyard." What they don't grow, they "purchase in serious bulk -- 25- and 50-pound sacks of grains and beans, 5-pound sacks of nuts," Aldridge said. "That packaging, for the most part, is compostable, so we just return it to the soil."OK, now for the tweaks Not inspired yet? Then consider these 10 ways to save at least $1,000 a year:Put $4,000 more into your 401(k) plan. If you're in the 25% federal tax bracket, you'll reduce your tax bill by at least $1,000 (more if you also pay state and/or city income taxes).Contribute to a flexible spending account. Your workplace probably offers these accounts, which allow you to put aside pretax money to pay medical or child care expenses. Not only do your contributions escape income tax (which range from 15% to 35% on the federal level), but you also don't pay Social Security or Medicare taxes, saving you an additional 7.2%. If you're in the 25% federal bracket, a $3,105 contribution will save you at least $1,000 in taxes. You just have to be sure to use the money by the end of the plan's year; otherwise, you forfeit whatever's left in your account.Stop smoking. Quitting a pack-a-day habit will save nearly $1,500 if you pay $4 per pack.Join the 21st century. Plenty of 20-somethings know the truth: You don't need a cable TV subscription or a land phone line, as long as you've got a broadband Internet connection. Many TV shows are available for free, either on network sites such as CBS.com or at MSN TV or Hulu.com. And there are plenty of ways to make phone calls for less, including via Skype, Vonage and MagicJack, which costs $40 for a whole year. If you're spending more than $84 a month on your TV and phone, dropping both could save you $1,000 a year.Do your own nail care. Even at the cheap places, a weekly manicure/pedicure will set you back more than $20, plus tip.Drink (tap) water. The alternatives cost you. If you drink one bottle of soda (at $1.25 each), and your weekly consumption includes a latte ($4), an alcoholic beverage ($6) and a case of bottled water ($5), you can save more than $1,200 by drinking plain tap water, even considering the $30 you blow on a purifying pitcher.Stop driving like a maniac. Driving the speed limit and avoiding aggressive moves, such as fast accelerations and slamming on the brakes, can improve your fuel economy by a combined average of 42%, according to Edmunds.com. That means savings of more than $1,000 for someone who drives 20,000 miles a year, gets 20 miles to the gallon and pays an average $2.50 a gallon.Pay off your credit cards. If you carry a $10,000 balance, you're probably paying at least $1,000 in unnecessary interest (assuming the current 11% average interest rate).Rethink date night. Dinner ($40, easy) and a movie ($14 for two tickets) once a week sets you back $2,800 a year. If you're paying a baby sitter, add $2,000 more or so to the tab. You can chop the bill in half just by going out every other week. Another way to save: alternating baby-sitting with another family.

Cut your clothing bill in half. The average household spent $1,881 on clothing in 2007; the tab for a family of four was $2,859. Some of that was doubtless necessary spending to replace outgrown shoes and worn-out jeans. But if your closet is already chock-full and you're still adding to it, you might want to call a timeout on clothing purchases.

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How to Make Money With Rates at Zero?

Treasury bonds don't offer much in the way of income anymore. Here are some better ways for investors to profit in 2009.

Federal Reserve Chairman Ben Bernanke may eventually be hailed as an economic Santa Claus if the Fed's dramatic rate cut helps bring an end to this recession.

But if you're an investor relying on a fixed income, Bernanke is The Grinch Who Stole Your Yield. Now that interest rates are effectively at zero, you won't get much from owning Treasurys. The U.S. 10-year note sports a puny yield of 2.19%, for example.

With many experts predicting rocky times through 2009, it's more important than ever for investors to own stocks and bonds that offer decent yields and a margin of safety.

One way to do that is with stocks that pay dividends. Many blue-chip stocks have yields well north of 5%, companies such as AT&T (Sure, some of these so-called "widow and orphan" stocks may not seem terribly exciting. But you know what? Earning 5% with a boring blue chip is better than losing all your money with Bernie Madoff.

"Many investors are concerned the market may be flat for many years. We feel that's unlikely, but even if that were the case, earning a 5% yield might not be that bad," said Steve Neimeth, manager of the SunAmerica Value fund. "Even if the market is flat for two to three years, investors could get paid to wait for a recovery."

Neimeth, who owns Verizon, Pfizer and AT&T in his fund, also likes food giant Kraft (KFT), which yields about 4.3%.

Of course, it's always worth asking if a dividend-paying company is financially healthy enough to keep paying out.

Bank stocks' high yields looked attractive earlier this year, but many institutions have since slashed their dividends - some near a penny per share - because of the credit crunch.

And one fund manager said that any bank asking the Treasury Department for capital is irresponsible if it continues paying dividends.

"Banks should not be paying any dividends if they are going to the government for money," said Don Wordell, manager of the RidgeWorth Mid-Cap Value fund.

Instead, Wordell said he's focusing on technology companies that he believes are healthy enough to keep paying their dividends. Two of his top holdings are Intersil (ISIL), a semiconductor company with a 5% yield and no debt, and Harris Corp (HRS)., which makes radio communications equipment and has a yield of 2.2%

Paul Alan Davis, co-manager of the Schwab Dividend Equity fund, sees good opportunities in the beaten-down energy sector, including natural gas company Williams Companies (WMB) and oil firms Chevron (CVX), Exxon Mobil (XOM) and Occidental Petroleum (OXY). These stocks all pay yields ranging from about 2% to 3.3%.

These yields may not sound that lucrative, but Davis said it's more important to focus on companies with the potential to grow their dividends, not just those with super-high yields. After all, the yield is the dividend divided by the stock price, so an extremely high yield could actually be a warning sign.

Don't Ignore Bonds

Dividend-paying stocks aren't the only way for investors to profit from a steady income stream. Sabur Moini, manager of the Payden High Income fund, has found plenty of opportunities in the world of high-yield corporate bonds.

Yes, many high-yield bonds are inherently risky. But Moini said there are values now because the market is pricing in higher default rates than he thinks are likely next year.

"Clearly we are in a recession and 2009 won't be good," he said. "But a number of companies that raised money in 2005 and 2006 are fine and won't have to refinance or have debt coming in due in the next year."

The key, Moini said, is to focus on companies in defensive industries that generate strong cash flow.

"The bonds we own have attractive yields and the companies will be around for the next few years. We are staying away from autos, homebuilders and more cyclical companies," he said.

Some of Moini's top investments are high-yield bonds of cable company Cablevision (CVC), satellite TV firm DirecTV (DTV), hospital operator HCA, which was taken private in 2006, and privately held California supermarket chain Stater Brothers. The bonds for all four companies yield more than 10%

Jeffrey Saut, chief investment strategist for Raymond James Financial, said he's looking more closely at high-yield investments and finding the best values in funds that invest in municipal bonds.

Even though the credit crisis has many state and local governments dealing with major budget problems, Saut said the pessimism in the muni bond world is overdone.

"Unless all municipalities go bankrupt, there are some funds trading at big discounts with the potential for stock-like returns," he said.

Three funds he recommends are the Nuveen Insured Dividend Advantage Municipal (NVG) fund, which yields about 7.5%, the BlackRock MuniHoldings Insured Fund II (MUE), which yields almost 8%, and the Lord Abbett Bond Debenture fund, which yields nearly 9%.

Rob Arnott, chairman of Research Affiliates, a Newport Beach, Calif.-based money management firm with about $30 billion in assets under management, agreed that investors should look to bonds for bargains.

He said that while the stock market is probably accurately factoring in the likelihood of a long recession, bond investors are much gloomier and are pricing in another Great Depression.

"The out-of-mainstream parts of the bond market are wildly attractive. Why would anyone hold cash yielding zero when they can get double-digit yields?" asked Arnott, whose firm is the subadviser for the PIMCO All Asset fund.