Believe it or not, one in six Canadians will eventually go bankrupt.
There are just over 26 million adult Canadians, and in a typical year between 120,000 and 150,000 Canadians file a consumer proposal or declare bankruptcy, so dividing filings into population shows that over the next 30 years, assuming rates don't increase, one in six Canadians will become insolvent.
Think about that: if you are riding an elevator with six random Canadians, it's likely that one of those people has or will declare bankruptcy at some point in their lives.
Why do we have such a high bankruptcy rate? The answer is simple: debt.
We are encouraged by the government, banks, and retailers to use debt to finance consumption. According to Statistics Canada, the average Canadian has debt equal to 163.7 per cent of their disposable income. In simple terms, if you earn $20,000 (after tax) in a year, you have $32,800 in debt.
Is that a problem? Should we be worried about this?
If you are a bank lending money, high debt levels are great. Banks are earning record profits, so as long as we keep borrowing and paying our debts, the banks and credit card companies are very happy.
If you are a borrower, easy access to credit is also great, as long as you can service your payments. Debt allows us to buy a bigger house, drive a newer car, and buy fancy new electronic products. Debt creates jobs. What's not to like?
With low interest rates our average debt service ratio is at record lows. In 1990 Canadians used over 11 per cent of their disposable income to pay interest on their debt; today we only need 7 per cent of our income to pay interest. All is good.
Or is it? If we are able to handle our debt because interest rates are low, why will one in six Canadians go bankrupt? In my experience, there are two main reasons for bankruptcy even when times are good:
First, while TransUnion just reported that the average Canadian has more than $27,000 in debt, the average person filing bankruptcy owes over $60,000, not including their mortgage. You can handle a small amount of debt, but if it gets out of control, watch out.
Second, you can only pay your debts if you have an income. If you get laid off, or get sick and can't work, your ability to service your debt is gone.
I advise everyone I meet to "stress test" your finances, and ask yourself whether or not you can handle a shock to your financial system. Here are some easy questions to ask:
- Are you spending more than you earn?
- Do you have an emergency fund?
- Are you already over-extended?
All of these are indicators of how well you can weather a change in circumstances. If you are living paycheque to paycheque now, or can't survive a rate increase or loss of income, you may become one of the one in six Canadians who go bankrupt if you suffer reduced income, so now is the time to start reducing debt.
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The experts CBC News spoke to were unanimous on the need for a plan that takes volatility into account. "I meet so many people who don't have an investment plan - who won't have an intentional allocation to bonds, stocks, cash," says Edmonton-based financial educator Jim Yih. Having a plan is one of the best ways to increase your probability of investment success in the long run, he says. "It's hard not to pay attention to the swings," Yih acknowledges. But having an overall investment strategy and target asset mix makes it easier to avoid being caught up in the emotions of a plunging market. Sticking to that plan, of course, is a critical part of coping during the big slides.
Yih also says investors would be well advised to figure out their risk capacity - how much risk they need to take to reach their goals. This is not the same as the usual risk tolerance measures financial companies use, which he says "test how much risk you want to take." In addition to a financial plan, some advisers we talked to mentioned the importance of having an investment policy statement (IPS). This document determines how investment decisions are made. "The IPS gives you your rules for managing your investments, and when you believe in your rules, you will be better able to manage your response to wild market swings," says Warren MacKenzie, CEO of Weigh House Investor Services. But he notes that an IPS still isn't offered by many financial advisers, so you may have to hunt around. David Chilton, author of The Wealthy Barber Returns, points out that people often think they can handle a lot of volatility - in other words, a lot of risk. That is, until the market actually undergoes a severe correction. "Figuring out how much volatility you can stomach ahead of actually experiencing that volatility is an inexact process," he writes. "For most of us, it's less than we think."
Is the investing concept of "buy and hold" through thick and thin really dead? Some advisers think it's time to at least revisit this familiar maxim. "Buy and hold is a great strategy if you are in a bull market," Warren MacKenzie says. "But if we're in a secular bear market - and I believe we are - buy and hold is the worst strategy." Now is the time to hire a professional manager who can buy and sell to take advantage of that volatility, MacKenzie says. "You must realize that to be a successful investor, you have to buy when the news is bad and when other investors are selling," he adds. Look at volatility as an opportunity to make money, MacKenzie says, because most people sell when the market drops and buy when it's near the top. Hiring someone to carry out your buying and selling also allows that third party to be the sober second thought your first impulse to panic needs - someone who isn't as emotionally involved with your money as you are.
Some advisers aren't quite willing to entirely write off the buy and hold philosophy, but do agree that market dips can uncover good quality stocks that have gone on sale. "Volatility can represent a buying opportunity if the fundamentals are sound and the price has dropped," says Cherith Cayford, a principal with Victoria-based CMG Financial Education. Cayford isn't ready to declare buy and hold dead just yet. "It still makes sense for quality blue chip investments." But she adds that it's vital to have cash available for those market opportunities that dips can produce. The buying doesn't have to be an all-or-nothing process, either. Instead of biting off more than you may be able to chew, you can nibble - investing a portion of your cash when the investment drops to an attractive level.
There are plenty of other investments that historically don't tend to move as dramatically as the stock market as a whole. So don't be surprised if your adviser suggests an increased allocation to alternative products or asset classes to reduce the riskiness of your portfolio. Government bonds, for instance, tend to be much less volatile than equities. But be aware that even long-term government bonds aren't yielding much these days. Utilities, telecoms and real estate investment trusts (REITs) are all less volatile than the dominant TSX sectors of energy companies and financials, while still paying reasonably high dividends. Preferred shares also fall into this category.
For some investors who can't escape the daily litany of depressing economic stories, some advisers suggest that turning a blind eye to the latest swings may be the best coping strategy. "Headlines can certainly be disconcerting," admits Marc Lamontagne. "You have to focus on your long-term goals." "In some cases, I have recommended clients stop opening their quarterly statements." This is, he points out, not a good long-term strategy for people who don't have a professional managing their investments. These days, the do-it-yourselfers need to pay even more attention.
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