If you want a set sum at retirement, you have ways to guarantee the money will be there. You pay a premium for this security, but you might sleep better at night

In the midst of the ongoing financial crisis, what was once good advice for investors seems outdated. That advice has usually been to diversify. Have stocks and bonds, some life insurance and maybe some real estate and commodities. Farmers and ranchers are in the commodity business and tend to own their land. That’s pretty good diversification.

All this diversification does not guarantee that in a market driven by falling commodity prices, most of the asset classes, which are supposed to be independent of each other, will not all crumble together.

There is a solution, however, in setting up a process that does for stocks what bonds customarily have. That’s a guarantee of value at given times. It works fairly easily. By using one of four methods that puts a time value on any investment, it is possible to be sure that no investment will be in a negative position at the time you want to draw on money.

THE STRIP BOND TRICK

The first and most basic way to guarantee an investment is to use strip bonds. It underlies every other way of providing portfolio insurance. Assume that you want a sum of money in 2026, 18 years from now, but you want to be sure that you sustain no investment losses. Assume that the total amount of money available for investment is $100,000. So you buy a strip bond, which is just a bond coupon or residual (the face value certificate) with a due date in 2026. At 4.0 per cent, which you can get on a Government of Canada bond strip, that 18-year coupon will cost you about $50,000. In 2026, that $50,000 will have doubled into $100,000. No matter what else you do with the other $50,000 (out of the original $100,000), you cannot have less than $100,000 at 2026.

If you put the other $50,000 into a good bunch of stocks that appreciated at, say six per cent per year, you would have $150,000 from the stocks and the original $50,000, which will have doubled to $100,000. Your total assets are now $250,000 from this investment. You have converted a sum of money at risk into a bond with an assured redemption value. The process leaves you exposed to inflation and to taxation if the strip is held outside of an RRSP, for every year’s interest accrual is taxable. Inside the RRSP, interest is not taxed until it is paid out as a distribution.

PRINCIPAL PROTECTED NOTES

You can get a similar result by going to a chartered bank and buying a principal protected note (PPN). They come in a bewildering variety of choices. Typically, you can get participation in some index, such as the TSX 60 (the top 60 stocks on the TSX ranked by market capitalization) or the U. S. S&P50 Composite or the Morgan Stanley Capital International index that tracks stocks in 30 countries.

A PPN will allow you to get up to a specified level of appreciation in the index you choose. For gains over that amount, you get nothing. If the TSX 60 has fallen below its level when you bought the note at the time of maturity, you get what you paid in. The deal is favourable to the bank, for it gets everything over the annual appreciation limit by investing your money. To protect themselves from downside loss, the bank buys bonds or options on future money, which is much the same thing. You can do the same thing with strip bonds and take all of the upside gain. The bank only offers a packaged solution.

PPNs are far from risk free. They look like guaranteed investment certificates, but they are not insured by the Canada Deposit Insurance Corporation. In the U. S., investors who bought PPNs from Lehman Bros., the failed New York investment bank, have to line up with other creditors for their money. The gain limits and the invisible charges that banks make for gluing these things together make them a risky alternative to the strip bond trick.

SEGREGATED FUNDS

Segregated funds are sold by life insurance companies for an average charge of 0.75 per cent more per year for management than underlying mutual funds charge. For that surcharge, the life insurance company guarantees to return not less than your original investment if you hold for fund for 10 years. If the average fee is 2.4 per cent and the seg fund pushes that fee up to 3.15 per cent, then over 10 years, your fees will be a third of what you put in — that’s counting some compounding. This is a huge amount to pay for an event — a fund being down after a decade compared to its original cost — that rarely happens. Of course, it can happen and it is happening these days. On top of the return of capital guarantee, the investor gets substantial protection from creditor claims. Finally, the return of capital provision is valid if the investor dies. Then the original capital cost of the plan is available to investor’s spouse in a spousal trust or to the estate.

LIFE INSURANCE

Finally, the investor can buy endowment life insurance to provide a known value with a lump of money that is invested in stocks or anything else. The way it works is to use endowment policy to convert to cash at a definite date. It is much the same technique as the strip bond trick. You take a theoretical sum, use part to pay for life insurance premiums and invest the rest. At a defined date, you get your payoff, which will be the

Have you been kicking tires or scanning classified ads lately looking for a used tractor? Purchasing a used machine can make some good economic sense. For decades, car experts have been touting the advantages of buying used to avoid the depreciation involved with a new purchase. Used tractors are no different. It’s possible to get a good used tractor with the options you need for thousands less than a new one. That is, of course, if you can find one.

Of course there are risks involved when buying used. “Buyer beware” is the phrase that sums them all up. You’ll find some real gems out there waiting for a new home. But some are ticking time bombs when it comes to future breakdowns, mainly because previous owners mistreated them. Inadequate maintenance and abuse can haunt a machine for a long time.

So a careful inspection is in order before signing a cheque. Make sure you’ve done all you can to ensure that a new-to-you tractor will treat you right. To help you pick a winner, here are a few tips put together with help from Mike Bevans, project manager with the Alberta AgTech Centre and former engineer at John Deere.

KNOW THE RIGHT PRICE

Make sure you don’t pay too much. You can find estimated values in books such as Iron Solutions (But a thorough look through all the advertisements you can find will give you a good idea of the prices sellers are currently asking for comparable tractors.

Once you’ve found something you’re interested in, begin your inspection of it by surveying its overall appearance. Does it look beat up or like it just rolled off the assembly line? “That will give you an indication of the kind of life the tractor’s had,” says Bevans. Is the sheet metal straight or dented and rusty? Are the tires checked and paint faded from exposure to sunlight — indicating it spent most of its life outside?

Careful owners usually keep their machines looking as good as they run. Unfortunately, so do the careless ones.

Look for dirt and oil build up which indicates leaks. The engine, SCVs and PTO seal are all places to check for this problem. While you’re looking at the PTO, examine the shaft to see if it’s damaged or twisted from being engaged under load at high RPMs.

Check the engine oil before you start it. Is the oil level where it should be? All diesels burn some oil, but a low level could indicate excessive use or lack of maintenance.

LOOK AT THE SMOKE

Be sure the owner doesn’t “warm it up for you” before you get there. You want to see the engine start cold. How quickly does it fire? Lots of cranking could indicate a compression problem. Expect to see a little white smoke until the engine gets up to temperature. That is from a misfire condition that usually occurs in cold diesels. “It’s typically a temperature related problem,” says Bevans. If the smoke persists, check the engine temperature gauge to see if the thermostat is maintaining the proper engine temperature.

Blue smoke is not good. That indicates excessive oil consumption, and you’ll have your hands inside that engine to fix a problem before too long. You shouldn’t see black smoke from an idling diesel — or at any time on newer engines with electronic, common-rail injector systems. Black smoke on newer tractors suggests insufficient air intake or other fuel system problems.

Also on older tractors, check the engine mounting bolts for signs that they have worked loose and not been re-torqued soon enough. That can cause damage to the frame and engine block, which can be a pretty costly repair if the wear is severe. Check the front axle mounting points for the same problem. You would likely be able to see wear signs around the heads of the bolts if that problem had occurred.

If the tractor has a loader attached, ask the owner if the loader was removed when it was used for fieldwork. A tractor bouncing across fields can cause excess wear at the loader pin joints. Lift the loader arms a few times to see how the hydraulic pump performs. If you hear whining from the pump or if the loader chatters, there’s a pump problem.

In the midst of the ongoing financial crisis, what was once good advice for investors seems outdated. That advice has usually been to diversify. Have stocks and bonds, some life insurance and maybe some real estate and commodities. Farmers and ranchers are in the commodity business and tend to own their land. That’s pretty good diversification.

All this diversification does not guarantee that in a market driven by falling commodity prices, most of the asset classes, which are supposed to be independent of each other, will not all crumble together.

There is a solution, however, in setting up a process that does for stocks what bonds customarily have. That’s a guarantee of value at given times. It works fairly easily. By using one of four methods that puts a time value on any investment, it is possible to be sure that no investment will be in a negative position at the time you want to draw on money.

THE STRIP BOND TRICK

The first and most basic way to guarantee an investment is to use strip bonds. It underlies every other way of providing portfolio insurance. Assume that you want a sum of money in 2026, 18 years from now, but you want to be sure that you sustain no investment losses. Assume that the total amount of money available for investment is $100,000. So you buy a strip bond, which is just a bond coupon or residual (the face value certificate) with a due date in 2026. At 4.0 per cent, which you can get on a Government of Canada bond strip, that 18-year coupon will cost you about $50,000. In 2026, that $50,000 will have doubled into $100,000. No matter what else you do with the other $50,000 (out of the original $100,000), you cannot have less than $100,000 at 2026.

If you put the other $50,000 into a good bunch of stocks that appreciated at, say six per cent per year, you would have $150,000 from the stocks and the original $50,000, which will have doubled to $100,000. Your total assets are now $250,000 from this investment. You have converted a sum of money at risk into a bond with an assured redemption value. The process leaves you exposed to inflation and to taxation if the strip is held outside of an RRSP, for every year’s interest accrual is taxable. Inside the RRSP, interest is not taxed until it is paid out as a distribution.

PRINCIPAL PROTECTED NOTES

You can get a similar result by going to a chartered bank and buying a principal protected note (PPN). They come in a bewildering variety of choices. Typically, you can get participation in some index, such as the TSX 60 (the top 60 stocks on the TSX ranked by market capitalization) or the U. S. S&P50 Composite or the Morgan Stanley Capital International index that tracks stocks in 30 countries.

A PPN will allow you to get up to a specified level of appreciation in the index you choose. For gains over that amount, you get nothing. If the TSX 60 has fallen below its level when you bought the note at the time of maturity, you get what you paid in. The deal is favourable to the bank, for it gets everything over the annual appreciation limit by investing your money. To protect themselves from downside loss, the bank buys bonds or options on future money, which is much the same thing. You can do the same thing with strip bonds and take all of the upside gain. The bank only offers a packaged solution.

PPNs are far from risk free. They look like guaranteed investment certificates, but they are not insured by the Canada Deposit Insurance Corporation. In the U. S., investors who bought PPNs from Lehman Bros., the failed New York investment bank, have to line up with other creditors for their money. The gain limits and the invisible charges that banks make for gluing these things together make them a risky alternative to the strip bond trick.

SEGREGATED FUNDS

Segregated funds are sold by life insurance companies for an average charge of 0.75 per cent more per year for management than underlying mutual funds charge. For that surcharge, the life insurance company guarantees to return not less than your original investment if you hold for fund for 10 years. If the average fee is 2.4 per cent and the seg fund pushes that fee up to 3.15 per cent, then over 10 years, your fees will be a third of what you put in — that’s counting some compounding. This is a huge amount to pay for an event — a fund being down after a decade compared to its original cost — that rarely happens. Of course, it can happen and it is happening these days. On top of the return of capital guarantee, the investor gets substantial protection from creditor claims. Finally, the return of capital provision is valid if the investor dies. Then the original capital cost of the plan is available to investor’s spouse in a spousal trust or to the estate.

LIFE INSURANCE

Finally, the investor can buy endowment life insurance to provide a known value with a lump of money that is invested in stocks or anything else. The way it works is to use endowment policy to convert to cash at a definite date. It is much the same technique as the strip bond trick. You take a theoretical sum, use part to pay for life insurance premiums and invest the rest. At a defined date, you get your payoff, which will be the

About the author

Columnist

Andrew Allentuck’s book, “Cherished Fortune: Build Your Portfolio Like Your Own Business,” written with co-author Benoit Poliquin, was recently published by Dundurn Press.

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