When I stepped out of the house at 6 am today, I gasped. It was 13 degrees!! (In American-speak, that’s 55 degrees.) The day before, it was 22 headed to 30 degrees (or 86). Welcome to the dying days of summer. (Insert pained expression.) That’s the bad news.
The good news is that it’s time to get back to working on your financial goals at full-speed! And since I’m on a mission this year to help more women invest – more, sooner, faster – I’m going to be talking about investing at this month’s Women’s Money Group meeting and I’m going to spend the month ahead breaking down different aspects of investing into simple, understandable chunks.
The financial planning industry, as a whole, wants you to believe that investing is a terribly complex, difficult business best left to the “experts”. Let’s get real – it’s not rocket science!! You can absolutely understand it perfectly well and do it yourself if you choose to. So forget the scare tactics, turn off the financial porn coming at you from business news channels, ignore ubiquitous hot stock tips, and let’s drill down to the fundamentals.
Let’s start at the very beginning…. (My apologies, in advance, if you now have Julie Andrews’ voice wedged in your brain.)
You have some extra money. You decide that it’s high time it earned its keep because you shouldn’t be the only one working. That’s no fun. Even when your work is fun, it’s not amusing to watch your money slacking off. You determine that it’s time to treat your money like the employee-at-your-service that it should be and you look for places, people, or things to invest in.
Here’s the deal: Regardless what you select, investing boils down to two options:
As you might expect, each one comes with pros and cons. In this two-part series, I’ll take a look at the differences. Today, we’ll tackle lending.
The idea with lending is that you invest money for a fixed period of time, called the term, and receive a (typically) guaranteed amount of interest. The obvious pro with this kind of investing is that you know what your return will be and, in some cases, it’s guaranteed. In other words, there’s little(ish) uncertainty or risk. The downside is that it typically doesn’t pay as well to be a lender compared with ownership.
Here are some examples:
Savings accounts – Each one of us became a lender fairly early in life when we opened one. When we deposit our money in a savings account, we are in fact lending our money to the bank, which in turn uses our funds for other investments, such as mortgages. In return, the bank pays us (ridiculously small amounts of) interest on our money.
I like John Robertson’s example of inflation in his book The Value of Simple:
“If you have some money and you just hold on to it for a period of time, like putting it under your mattress, it ends up buying less in the future. For instance, the $100 in your sock drawer bought 100 sticks of gum when you put it there last year, but now might only buy 97 sticks. Inflation acts like a negative return on your money.“
Guaranteed Investment Certificates – Loans made to a bank or a trust company for a fixed, usually short period of time ranging from several months to five years (though longer terms are available). The interest rate is guaranteed. For my American readers, think Certificates of Deposit.
Treasury Bills – These are considered to be the safest investment of all since they consist of loans made to the government, either the federal government or provincial governments in Canada. Both Canadian and American T-Bills are backed by solid, stable countries that aren’t going bust any time soon, therefore you can be certain of getting your capital back with interest. In Canada, T-Bills tend to be short-term loans of one year or less.
First and Second Mortgages – Say what? Aren’t mortgages something that only bank-like lenders offer? No. There are a ton of investors out there (I’m one of them) who lend their money to people for the purchase of real estate. These are called Private Lenders. The Lender (i.e. you) does the due diligence, usually in conjunction with a mortgage broker, and determines the suitability of a borrower. Once the borrower is approved, the lender’s lawyer draws up a mortgage contract, just like a bank, and the debt is registered on title as protection for the loan.
As you might imagine, the rates for private mortgages are considerably higher than those offered by a bank. So why, then, would people looking to buy real estate go this route? There are many potential reasons for this:
The amount you make as a first and second mortgage holder depends on the amount you request. The Golden Rule applies: He/She with the money makes the rules. Typically, the rates for a first mortgage range from 6% – 9%, and the rates for second mortgages range from 8% – 15%.
There’s more interest to be made as a mortgage lender, but there’s more risk that comes with it too. Before you say “Giddy up!” on these types of investments, ensure that you know what you’re doing. Having a mortgage broker tell you it’s a great deal doesn’t count. Not even close.
Bonds – These are loans to a corporation or a government, that have been set up in a way that they can be traded before they come due. The terms typically range from less than three years (short-term) to more than ten years (long-term).
There you have it – an overview of the first basic type of investing: lending money. In my next blog post, I’ll tackle ownership.
Any questions? Reach out.