OtOoI Glossary

Glossary of Important Stuff


Bond – a fixed income financial instrument that may be purchased from a company, or government, that provides steady income at a pre-determined rate of return.

Capital – AKA principal, capital is the initial investment, or money that you save or invest.

Compound Interest – the concept that money earned with interest is added to the bottom line, increasing, or compounding the effect of interest over time.

Inflation – the incessant climb of the cost of living, and the continual erosion of every dollar’s buying power, due to the effects of Demand-Pull (higher demand drives up prices) and Cost-Push (higher costs of doing business are passed on to the consumer).

Dividend – a share of earnings paid by a company that is treated differently with regards to taxation; one may receive dividends from shares owned, or as chosen form of income from one’s own small business.

Dividend Re-Investment Plan (DRIP) – a financial tool for re-investing dividends paid to a shareholder back into the company.

Diversification – increasing variability in the types of industries or sectors represented within one’s portfolio to reduce the impact of a single sector’s, or single company’s poor performance.

Exchange Traded Fund (ETF) – a financial instrument managed by an investment company that pools the capital of investors to purchase equity in many companies in order to deliver diversification, reduce volatility, and generate returns at the aggregate of the chosen market.

Guaranteed Investment Certificate (GIC) – a financial instrument that generates a set rate of return annually, over a defined investment period, and guarantees the return of capital in addition to the interest.

Investment Horizon – measured in years, the period of time between now and when one will need the money one has invested.

Management Expense Ratio (MER) – a key figure in the analysis of ETFs and Mutual funds, expressed as a percentage percentage, it is the cost of managing the fund (trading fees, salary of employees, overhead) divided by the value of total cash managed. The MER is typically less for ETFs and more for Mutual Funds.

Mutual Fund – a financial instrument managed by an investment company that pools the capital of investors to purchase equity in companies, hoping to deliver diversification and returns greater than that of the market in which it invests (due to expert analysis and investment).

Principal – the amount of money contributed by the investor, to their portfolio.

Rate of Return (ROR) – reported in percentage, the gain or loss on an investment over a specified period of time. Can be useful as a measure of a specific equity’s performance, a fund’s performance, or one’s overall portfolio’s performance.

Registered Retirement Savings Plan (RRSP) – a retirement savings vehicle that is protected by tax treaty, and allows one to defer taxes paid on income until retirement. The annual contribution is limited by annual salary.

Risk – the chance that an investment’s actual return will be less than the expected return, and may actually be total loss of original investment.

Risk Tolerance – Risk tolerance is an important factor for one to understand about oneself before starting to invest. Questionnaires are available on the web, here, and here.

S&P 500 Index – Standard & Poor’s index of the top 500 companies traded on the NYSE and the Nasdaq.

S&P/TSX Composite – Standard & Poor’s index of the largest companies by market capitalization on the Toronto Stock Exchange, representing 70% of the market value of companies traded on the TSX.

Tax-Free Savings Account (TFSA) – a savings vehicle that allows one to grow investments tax-free, as money withdrawn from a TFSA is not taxable. The annual contribution is limited by the Canada Revenue Agency.

Volatility – a measure of the variability in returns on an investment, fund, or portfolio, from day-to-day or year-to-year, where higher volatility means a higher standard deviation to returns. Volatility is distinct from risk (as above), although it is related to the risk of uncertainty in the size of changes of an investments value.

Yield – expressed as a percentage, the income return on an investment, compared to its cost to the investor.

Glossary of Bonus Stuff


NB: These terms are not offered in alphabetical order, as you often must understand the prior term to grasp the next. You may find these terms useful in evaluating the performance of individual companies, with the majority of these terms being reported on typical free financial websites (like Google Finance, or Globe Investor). Don’t worry, I still barely understand them. Hence, bonus shit.

Adjusted Cost Basis (ACB) – the cost of every investment purchased, as an average; the ACB may go up if a share is purchased twice (or more), first at a lower price, and then at a higher price. Most investors use a spreadsheet to keep track of this, as it becomes important for declaration of Capital Gains or Losses at tax time.

Capital Gains – when an investor sells an equity, ETF, or mutual fund, any money that is gained is a realized gain, is considered income, and is therefore eligible for taxation (unless it is within a TFSA or RRSP). One may also claim a capital loss for selling at a loss. Additionally, due to the constant buying and selling of equity within ETFs and mutual funds, investors in these funds may be subject to capital gains on these actions.

Price/Earnings (PE) Ratio – the price of a company’s share divided by its declared earnings; gives an approximation of how much an investor is willing to pay every dollar earned by the company, and can be useful in identifying overvalued or undervalued companies within an industry.

Forward Price/Earnings (Forward PE) Ratio – the price of a company’s share today, divided by its expected earnings; gives an approximation of earnings growth, as a falling Forward PE suggests an increase in earnings.

Price/Earnings to Growth (PEG) Ratio – the price of a company’s share divided by its declared earnings, and divided by the growth rate of its earnings over a set period of time; can give a clearer picture of a company’s health than the PE ratio. A PEG ratio of less than 1 is, as a rule of thumb, desirable, though it varies from industry to industry.

Price/Book Ratio – the price of a company’s share divided by its book value, otherwise known as its total assets less its intangible assets and liabilities; it gives an approximation of a company’s value relative to its worth.

Operating Margin – expressed as a percentage, the operating margin is the operating income (the amount of money generated by operations, less cost of operations), divided by the net sales; it gives an approximation of a company’s efficiency at turning sales into bottom line profit. A higher operating margin indicates a company that is better at turning every dollar earned in sales, into profit.

Market Capitalization – an expression of the size of a company in dollar terms; calculated by multiplying the number of outstanding shares by its share price.

Dividend Yield – expressed as a percentage, the annual yield of dividend income only on each share; calculated by dividing the annual dividend per share by the share price.

Dividend-Ex Date – the last day a person must own a share in order to be eligible for the company’s announced dividend. To receive the dividend, you must purchase the share the day before the ex-dividend date to be eligible as trades are finished at end of day.

Dividend Pay Date – the day on which dividends are disbursed.

Beta – a numerical quantification of a stock’s volatility, in comparison to the market, where a value of 1.0 suggests the stock’s price typically moves with the market (price rising as the market rises, and falling as the market falls); a high beta indicates higher volatility (e.g.: most tech stocks), while a low beta indicates lower volatility (e.g.: most utilities).

Debt-to-Equity Ratio (D/E Ratio) – a measure of a company’s leverage (operations financed using debt), and is calculated by dividing the amount of total liabilities (or debt) by total equity (or assets); a high D/E ratio indicates that a company is financing much of its operations with borrowed money, which may be helpful for growth, but is not a good business model in the long term.

Penny Stocks – a stock worth less than $1, is typically more risky and more volatile, as numerically small fluctuations in price can lead to large percentage changes in holding value.

Initial Public Offering – a private company chooses to go public, important people decide how much the company is worth, and investors buy shares.

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OtOoI Ch. 5: Investment Strategies

OtOoI Ch. 5: Investment Strategies

We’ve covered a lot of ground to get to this point. We’ve learned about why we need to invest, which prompted us to learn more about the environment in which we invest (and the financial instruments we can use to do so), the mindset we need to have when investing, and what sorts of accounts we can put our money into.

Now that you have funded your investment accounts with hard earned savings (and plan to keep funding it with ongoing savings, right?!), it’s time to decide how you want to deploy that money to beat inflation.

Today, we’ll talk about investing with:

  1. Financial Advisors
  2. Conservative Investing
  3. Index Investing
  4. Value Investing
  5. Growth Investing
  6. Income Investing
  7. Short Selling

WARNING: This is another dense chapter, but reads like Twilight. Enjoy!

Financial Advisor

I’m not going to bother with too much explanation on this one. A financial advisor can be had at most financial institutions (your big box banks, as well as smaller investment brokerages).

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Figure 17. This is Brian; he’s trustworthy, and his job is to make you money, but not before he takes his cut for doing so. His wife and kids send you their regards!

There are many kinds of financial advisors, and they offer various services, from financial planning to portfolio management. They can be helpful in that they are typically certified*, and therefore know the business of investing.

Finding a financial advisor can be the most hands off investment strategy, as you simply provide the money, and an explanation of your plans, goals, and risk tolerance (usually determined by an interview and questionnaire). The planner does the rest.

They may utilize different investment strategies and philosophies to manage your portfolio, partially based on the answers to the questionnaire, and also based on your direction or preferences (if you have any of them).

Another major factor in what they may offer you is the bias they derive from their desire to make money for themselves.

Financial advisors work on many different models. Some work on salary and commission. They may receive incentives from mutual fund companies for selling you mutual funds; they may charge a percentage of your profits for the year or charge a percentage of your portfolio for managing it; others charge a flat fee for every trade they make (requiring your permission) on your behalf.

It’s important to remember that certain models of compensation for your financial advisor are better for you, and may be different based on your investment strategy. If you want someone who is more hands off, but still would like their advice and oversight, maybe paying them a flat fee for every trade would be better. If you want to be more hands off, you might find that paying them a percentage of your profits incentivizes them to produce superior results.

Ultimately, remembering that while their job is to make you richer, their ulterior goal is to make themselves richer. Understanding how your advisor is compensated is important to understanding how they work for you, the products they offer you, and the advice they give you.

*Do your homework and make sure they are. Key word would be ‘fiduciary’.

Conservative Investing

Buy bonds and GICs. Low risk, low returns.

I don’t mean to make this sound boring, but it is. Conservative investing can be safe, and in all honesty, it probably isn’t why you are reading this book.

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Figure 18Zzzz.

What I would like to offer you is that conservative investing should, and likely will, factor into your financial and retirement plan at some point. Why?

Because eventually our long term investment horizon becomes shorter (that’s how time works people), and our risk tolerance goes down.

While we may find that having the major proportion of our portfolio dedicated to equity (the higher risk stock market) in our youth, that proportion should diminish as we approach the time when we need to preserve our capital to draw on.

A general rule of thumb is that the percentage of your portfolio allocated to equities should be 100 minus your age. You can therefore imagine that as you age, you shift more of your holdings into safer, lower-risk bonds. You may of course, manipulate this rule to your desire, based on your perceived risk tolerance.

Doing this is a hedge against stock market volatility, which becomes more of an issue when you actually have a need to access your savings in your retirement.

Example: Calvin and Jim are both 60 years old, and have both been investing for their retirement. They both have portfolios worth $1,000,000. Calvin follows the “100-age” rule for equity allocation, while Jim has been more cavalier with his investments and left his entire portfolio in equity. The year is 2008 and the stock market dives 40%.

Calvin’s portfolio has 60% bonds and 40% equities. Due to the stock market drop, Calvin’s equities are now worth 24%. His portfolio has dropped 16%, and is now worth $840,000. Jim’s portfolio is 100% equities. His portfolio drops 40%, and is now worth $600,000.

When each withdraws $30,000 for their annual salary, Calvin withdraws 3.5% of his portfolio, while Jim withdraws 5%. The stock market rebound is dampened for Jim.

Conservative investing can, and should be a part of your retirement plan, but how you employ it is up to you, your goals, and your risk tolerance.

Index Investing

This is perhaps the second most (if not the most) hands off investment strategy. It is aptly named, Couch Potato Investing. So what is it?

The philosophy is based off of the Efficient Market Hypothesis. This is the idea that the market is smarter than your mutual fund money manager; that stock prices are generally fairly priced, and therefore, it is next to gambling to try and beat the market with stock picking. It holds the idea that over time, the nature of the global economy is that it gets bigger, and therefore, if you own a stake in the companies that participate in it (in fact, own a fraction of a stake in an enormous number of those companies), your investment will grow with the economy.

world in hands
Figure 19. Hold the world’s markets in your hands, or in your portfolio. Or both.

The practical way that this is done is by purchasing index-tracking ETFs. As mentioned in the section on funds, ETFs are the chosen vehicle because of the objective evidence that the majority of mutual funds do not outperform the index and yet charge higher fees. Index-tracking ETFs, by definition, perform on par with the market. If the market grows by 8%, so does your portfolio (minus fees).

Typically, you can find a combination of ETFs that track indexes in various markets (for example, tracking the S&P TSX, the S&P500, and then funds tracking international or developing markets). You will apply a certain percentage of your portfolio to each ETF. This way, you are giving yourself Super-Duper™ diversification, because not only are you diversified within a single market, but you are diversified within different global economies. If the Canadian market is taking a pounding, and the American market is booming, your portfolio remains relatively stable.

If you want to set it and forget it, this may be the strategy for you. Your portfolio will need to be rebalanced at least once per year to maintain the appropriate allocations to your various ETFs. This ensures you do not become overbalanced in any one market, preserving your beloved diversification.

Example: Harriet is a Canadian Couch Potato with $40,000 in her TFSA. She has an assertive approach to ETF investing through ETF provider Vanguard, with 25% of her portfolio in Canadian Bonds (VAB), 25% in Canadian stock (VCN), and 50% in the international stock market (including U.S., excluding Canada; VXC).

The year is 2017 and the Canadian market has tanked 10%, while the global market has rallied 5%. VCN is therefore now worth $9,000, (25% of $40,000 is $10,000, less 10%) while VXC is now worth $21,000 (50% of  $40,000 is $20,000, plus 5%).

At year end, she sells some VXC (at 52.5% of her portfolio) and buys some VCN (at 22.5% of her portfolio) to rebalance back to 50% and 25% respectively.

You can learn more about index investing, including model portfolios at The Canadian Couch Potato website.

Stock Picking

Stock picking is probably the investment strategy that you immediately picture when you think about the stock market. You are a genius, watching the markets, assessing individual companies, buying a stake in them when they are undervalued, and then getting out after they surge in price to double your investment.

Some people have had success doing this. It is associated with a great deal of risk, as it usually entails buying a stock that is discounted with the hopes that the stock price will rebound. The difficulty with stock picking is that opportunities can be created by the emotional lability of the investing populace, but one can also be burned by this emotional lability. Buying stock, especially those below $5-10 a share (or worse, below $1) have the highest potential for enormous gains (because a $0.10 rise in stock value is a far more significant on 400 $1 shares than a $0.10 rise on 10 $40 shares; $40/10% profit vs. $1/0.25% profit). For the same reason, they have the highest potential for enormous losses.

There are many strategies within the realm of stock picking, some more risky (and more akin to gambling) than others. These strategies can also be employed effectively for business ownership, or going ‘long’ on stocks rather than speculating in fickle markets. I will outline some of these stock picking strategies here.

1. Value Investing

This involves assessing a company’s fundamentals (revenues, expenditures, earnings, liabilities, book value) and determining the actual value of a company’s stock. This inherent ‘value’ may be based on strong earnings, or a great dividend, or a strong base of tangible assets. The value is then compared to the actual price, and the investor makes a judgment as to whether the stock is under- or over-valued. 

Essentially, a value investor relies on the idea that a company has some rational value, but that the price is set by irrational investors. By trying to be as rational as possible (investing based on fundamentals, or evidence), the investor can capitalize on opportunities when investor sentiment undervalues a company with strong underlying value.

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Figure 20. Warren Buffett is a classic example of a value investor. He buys companies with strong fundamentals, and holds them.

This can be a successful strategy, but relies on the irrationality of the market to find opportunities, and also requires a good deal of numbers work to identify where value is. Additionally, the strategy is contradicted by the Efficient Market Hypothesis (essentially the basis of index investing), that markets are efficient and therefore the price of most companies in the market are fairly priced based on their value.

There are shortcuts for value investing, like looking at P/B ratios to identify companies with strong concrete value compared to their price, or PE ratios to identify those companies that have higher earnings compared to their price. These ratios can change based on a number of different variables, and therefore it is usually recommended to  look a little closer at the numbers behind them.

Example: Hi, Inc (HI). is a wireless telecommunications company. The average P/E ratio in the sector is 25, but due to the entry of a competitor into HI’s key operating region, investors are concerned about the company’s long term prospects, driving down share prices and discounting them to a P/E ratio of 15.

Despite concerns over reduced profits due to increased competition, the regulatory environment remains favourable for HI, and projected earnings remain solid even in the context of increased competition. There is value in HI due to these strong fundamentals, and the stock can be had at a bargain relative to the industry average P/E.

2. Growth Investing

Again, this strategy requires looking at the fundamentals of a company, but from a different perspective. The growth investor identifies companies that have a trend of earnings growth due to expanding market share, good products, and efficient management. 

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Figure 21. Thomas Rowe Price is considered the father of growth investing.

These companies may be priced fairly, or even highly now (based on their current earnings), but are underpriced today in relation to the long term, as they are companies that will grow (increasing their earnings), and therefore increase their value.

The assessment of a company’s capacity for growth starts with a look back at it’s historical growth, and then an appraisal of the company’s projected growth for the next five years. These projected growth figures are established by analysts, and the data behind their projections should be carefully considered within the context of the company itself, and the industry in which it operates.

Another important factor to consider is whether the company’s management efficiently control costs, allowing growing profits to translate to higher bottom line earnings (this is called profit margin**), as well as its efficiency in generating profits from its underlying equity (this is called the Return on Equity***).

Growth companies rarely pay dividends as their goal is to retain profits for re-investment in the firm, allowing it to grow that much faster.

The rule of thumb for effective growth investing is to invest in companies that will double in size within five years, which predicates a 15% annual growth rate in the company. This is the growth rate you will be looking for in the analysts’ predictions.

The downside, of course, is that the predictions are just that: predictions. You cannot be sure that the company you have chosen will double in value in the next five years,  otherwise all of us would be growth investors and all of us would be very rich.

Example: Jimmy’s Coffee (JMY) has an IPO, resulting in shares priced at $30. Annual earnings are currently $2 per share, giving JMY a P/E ratio of 15.0, which is considered a fair ratio in the coffee market.  With this newly invested capital, Jimmy’s management initiates a plan of rapid expansion. Analysts predict growth in earnings of 15% per year.

In five years, sales have doubled and costs have been quartered by astute management and economies of scale. As such, earnings have tripled to $6 per share. Given a fair P/E ratio of 15, each share is now worth $90, and has also tripled in five years. This company is an outstanding growth company and you are very satisfied with yourself for seeing its potential.

This strategy also falls prey to the efficient market hypothesis; that growth is a desirable trait and therefore the current market price reflects potential for growth. An example would be Tesla Motors, which is highly valued despite negative earnings because of obvious growth potential in the long term.

**A company with a high profit margin produces more profit (net income) as it has fewer costs to eat away at the company’s gross revenue. It is a more efficient company at translating pre-cost income into post-cost earnings.

***A company with a higher R.O.E. produces more profit with less equity (money invested). It is a more efficient company at turning invested money into net income, meaning a higher percentage of every dollar invested produces profit.

3. Income Investing

Income investing stands in stark contrast to growth investing, in that it typically involves purchasing companies that are well established in their fields, with fewer opportunities for growth, but steady earnings and solid business. For mature companies, there is a decreased capacity for growth, leading to diminishing returns for each dollar pumped back into the company. Instead, they pay dividends to their shareholders out of the earnings.

The key consideration in income investing is the dividend yield, which is a figure that immediately tells you how much of a dividend you can expect for your dollar invested.

Example: Royal Bank of Canada (RY) costs $70 per share, and pays an annual dividend of $3 per share. $3/$70 is 4.28% dividend yield. For every dollar invested, RY pays you 4.28 cents, which you may take as profit, or apply towards the purchase of more shares (see below).

It is very simple to find dividend information on any financial website, but the dividend yield is not the be-all and end-all of income investing, as the investor must assess the sustainability of the dividend’s payment, which comes from the company’s profits. A key figure to consider in its sustainability is the dividend pay ratio, which is a measure of the yearly dividend per share divided by the earnings per share (EPS). A company with yearly dividend per share higher than earnings per share is not sustainable forever (though it is possible as the dividend can be paid out of the company’s cash savings; this strategy is often employed to avoid dividend cuts when a solid company is going through a rough patch).

Income investing is not any less risky than the other investing strategies, though risk can be mitigated by considering which companies you are purchasing. As mentioned above, many of these companies are large, well established, strong companies that are unlikely to go under, and therefore reduce your risk for loss of capital. They are, however, still susceptible to market volatility.

A benefit of Canadian dividend paying companies is that for Canadian investors, the dividends are tax preferred. You will pay a lower tax rate on dividends from Canadian companies than from American or international companies.

Ultimately, this can be a solid way of investing, with lower risk (due to the reliability of the companies), and returns that are simple to predict (each company typically announces its yield, so you can know exactly how much money will be coming in each year from your holdings), while appreciation in stock value is another consideration.

One final note for income investing is the consideration of dividend growth. A company that is able to increase its dividend yearly signals a strong company with strong fundamentals. Dividend growth is a hedge against the impacts of inflation, and also adds value to the stock; companies that grow their dividends are more highly valued, and therefore also grow in price. Assessing a company’s dividend growth is a key component in picking any stock for an income portfolio, and historical dividend growth can be found online. In a way, this blends the concept of growth investing with income investing.

Dividend Reinvestment

An added feature for dividend paying stocks is that many of these companies offer what is called a Dividend Re-Investment Plan (DRIP).

A DRIP is an offer by the company to pay the owed dividend partially in cash and partially in stock. The company will often incentivize this process by offering some discount on the stock, as it allows them to keep more of their cash on hand for expanded operations. Every stock purchased with a DRIP increases your next dividend payment, as you will have more shares paying dividends. This grows the output of your portfolio, along with the overall value of the portfolio (because you have more shares!).

Example: Toronto Dominion (TD) shares cost $50, and pay a quarterly dividend of $0.50 (annual dividend yield of 4%). TD offers a DRIP giving you a 2% discount on shares purchased through the DRIP.

Your portfolio holds 200 shares in TD, giving you a quarterly dividend of $100. This purchases you 2 new shares of TD ($98, at $49 each, a discount of 2%), along with a $2 deposit for the remaining cash owed. Your next quarterly dividend will be $101 (two new shares paying $0.50 per quarter).

The other added benefit of a DRIP is you expand your holdings in the company without being subject to trading fees (anywhere from $7.99 and up per trade), allowing you to grow your portfolio while minimizing costs for You, Inc. Your portfolio becomes a self-growing machine, as the profits it generates grows the contents of your portfolio, not just the value of each share.

Finally, when you retire, or at any time for that matter, you can cancel your DRIP and start withdrawing the dividends as income… hence, income investing.

4. Short Selling

Short selling is an investment strategy based on pessimism. It is a way to make a quick buck, and can be extremely risky. The reason that it is a fast way to make money is because it is literally the practice of holding a stock for a short period of time, or shorting the stock (whereas most investors using the above strategies are ‘long investors’).

The short seller ‘borrows’ stock from a brokerage and sells it at a certain price, then buys the stock back after a drop in the stock’s market price. The difference in the price between where it was sold on the short, and then purchased back at a lower price, is the profit from the short sale.

Example: Dairy Queen (DQ) shares are priced at $20. The short seller believes that shares of DQ are over valued, and are due for a correction.

The short seller borrows 500 shares of DQ stock from their broker at a cost of $10,000. While borrowed, the short seller services the loan of stock with cash payment.

DQ declares a drop in its quarterly earnings prompting a selloff that drives share prices down to $15, at which point the short seller buys back 500 shares at a cost of $7,500 to cover their stock loan to the brokerage, taking a profit of $2,500.

If this is confusing to you, don’t do it.

Conclusion

The approaches listed above are only four in a huge array of others, some variations on those I’ve outlined, others combinations of the above, and others based on completely different philosophies.

Within your portfolio, you can choose to pick some stocks based on value, others based on growth, others based on income, and others based on anything else you find to be intriguing.

You may occasionally be able to find stocks that are a good value and also have promising dividend growth. This is the approach I typically use; looking for solid companies that are discounted on the year (usually around its 52 week low), that have a history of rewarding their shareholders with growing dividends. I then establish a DRIP for each, and watch my portfolio grow without the tether of fees.

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Figure 21. Build your own retirement savings machine.

This approach is ideal for the person who is investing large lump sums (for example, topping up a TFSA contribution, or investing a tax return or bonus) as you can cut down on expenses by minimizing your trades. Additionally, it requires minimal oversight as it entails buying and holding strong companies for long periods of time. It is a portfolio growing machine, as over time, my stake in each company increases, increasing my dividends, which increases my portfolio’s capacity for self-reinvestment. In retirement, I plan to cancel my DRIPs and draw on the dividends my portfolio generates as quarterly income. This strategy may not be perfect for you. For me, as a busy medical professional, it is ideal as it lends itself to hands off, lower-risk investing, in my opinion. Despite this, it still affords me oversight and control (which I obviously value).

The underlying philosophy is that of business ownership; I provide equity for the companies I involve myself with to carry out their operations, and they reward me with steady profits in cold, hard cash.

Today, we concluded our 5-part series on investing as a means of saving for retirement. We discussed more hands-off investing (financial advisor-driven, conservative, index investing), and more active investing (value, growth, income) strategies. There are many other ways of investing, but I hope that you now have the tools to explore them yourself!

What I would encourage you to do is look for different techniques that work for you, philosophically, and based on risk tolerance. Your portfolio can, and should be a growing and changing entity. Don’t be afraid to start small and learn by trial and error. The beauty of starting early is that you have lots of time to make good on your mistakes.

There is a whole world of finance for you to discover, and I hope I have equipped you with the basic tools to understand and keep learning. Refer to the following glossaries (published tomorrow) for a review of some of the key terms presented in this series.

Keep your eyes out for features in the future on other aspects of finance pertinent to young professionals (incorporation, tax planning, mortgages, etc.). I hope that you have found this series useful, and am happy to answer any questions you may have. 

And to your future self, Happy Retirement! And of course,

Happy Living,

JRM

OtOoI Ch. 4: Where to Save

OtOoI Ch. 4: Where to Save

Last week we outlined how to get to know your investing self, and explored a basic philosophy to get through investing without losing all of your hair. We talked about investment horizonapproaching investing with a minimum of emotion, and the idea of being a business owner.

Today, we will talk about where to put your money when you decide it is time to start saving for retirement. This will be from a uniquely Canadian perspective, as we discuss the various accounts available only in Canada. Some principles, however, are universal.

Emergency Fund

An important thing to consider is what you need your money for. Obviously you need to save for your retirement. You want to do that, otherwise you wouldn’t be reading this book. But there are other things to save for:

      • A downpayment on a home
      • An engagement ring
      • That 2015 Ford Mustang
      • Etc.

The point is, there are things that you need to save for where you plan to use that money sooner than twenty-five years. Sooner, even, than the next five years! I’ll  reiterate this again.

Any money that you will need in the next 5 years should NOT be in the stock market.

You don’t want that money to be at a five-year low when you need it.

But if it is at a five-year low, you can just delay getting a house, or buying the ring, or riding around town in that sick whip of yours. Right?

But what about things that can’t wait? A car accident? Rent and food when you lose your job? These are things we can’t predict will happen, and we need to be prepared for them. So the first thing I would recommend to you is this:

You need an emergency fund.

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Figure 13. Better to have a clear emergency exit than to watch your house burn down around you because of bad timing.

This fund should be equal to whatever your monthly salary is (because you’re clearly getting by on that), multiplied by at least three months, or longer if you wish to be more conservative. This money should be liquid (ideally cash), and therefore not in the stock market. Sure, that money is depreciating at the rate of inflation, but a 2% chunk out of your savings each year is better than the 15% (or 20%, or 50%, or 5%) chunk you would lose if you had to liquidate equities at an inopportune time.

Once your emergency fund is established, you can start saving for your retirement, and all those other things you want. So, the next question is, where to save? You have a few options.

Savings Account

Exactly what it sounds like. This is your run-of-the-mill savings account at your chosen bank. You won’t get much of a return (in fact, none, due to the effects of inflation), but your money is generally considered safe. Stick your emergency fund here.

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Figure 14. Stick it in the vault.

Registered Retirement Savings Plan (RRSP)

A Registered Retirement Savings Plan is one of the best ways to save for retirement. From within an RRSP, you may hold cash, purchase bonds, GICs, funds, or equities. As a result, you can tailor your RRSP portfolio to your desired level of risk and investment philosophy/strategy.

You may have multiple RRSPs, but your contributions to the RRSP are dictated by the Canada Revenue Agency (CRA) based on your income. This is because registration of the RSP makes it a tax-preferred account (see end of this section). When you make contributions to an RRSP, you are reducing your effective income by the amount you have contributed. This is because you plan to withdraw the money from an RRSP as income in your retirement (at which point you would be taxed on it), and therefore it would be unfair to tax you on the money twice.

The reason that this is beneficial is because you may be able to make contributions to an RRSP that lowers your income into a lower tax bracket, thereby reducing the total amount of income tax you pay for that year. At the very least, you will lower your income such that you pay less tax (because you made less money).

Over the year, you will pay tax on each paycheque based on an estimate of your annual income. The end result of an RRSP contribution, however, is that at tax filing time, your annual income will be effectively lower. You will have overpaid on income tax and will therefore receive a nice tax return, which you can then invest!

Example: Calvin earns $97,000 per year as an electrical engineer. The CRA deducts taxes from each paycheque in the appropriate amount (Calvin’s income lands him in the third tax bracket, at 26%, which begins at $90,000, we will simplify to 25% for this example).

He pays 15% on his first $45,000, 20% on the amount between $45,000 and $90,000, and 25% on the amount over $90,000. As a result, he pays  $6,750 + $9,000 + $1,750 = $17,500.

This year, Calvin contributes $7,000 to his RRSP, lowering his effective income to $90,000. As a result, he is not required to pay 25% on that $7,000, and receives a tax return of $1,750, which he happily invests.

Another benefit to RRSPs is that companies often offer RRSP contribution top-ups to their employees. For every dollar an employee contributes, the company will, up to a point, match the contribution. For example, they may match 20% of your contribution up to $2,000 per year. You could contribute $10,000, and they would contribute $2,000 on your behalf, for a total contribution of $12,000. A 20% annual return! If you have this opportunity, maximize on it!

A final important benefit to RRSPs is that up to $25,000 in the fund can be used, tax-free, to buy or build a home (Home Buyer’s Plan, or HBP), as long as you pay it back within fifteen years. This is a great way to save for a down payment as it is cutting down on your tax burden in your young, good earning years (effectively increasing the amount you can save).

However, there are a few important caveats to RRSPs:

    1. You must be on payroll (not just earning dividends) in order to allow RRSP contributions (the CRA will set your annual deduction limit). This may be a factor to consider for entrepreneurs and small business owners who choose to pay their salary via company dividends.
    2. You will eventually pay tax on the money withdrawn in your retirement. The key there is that you will only withdraw as much as you need, which is often less in retirement (no kids, mortgage paid down, etc.), and therefore you will be in a lower tax bracket. The income you earned in your prime is taxed at a lower bracket in retirement, with the added benefit of reducing your tax load in those prime years.
    3. The amount you can contribute each year is set by the CRA. Check with them to find out how much you are allowed to contribute, or you may over-contribute.

For other tax reasons, an RRSP can be converted into a Registered Retirement Income Fund (RRIF), which gives you more flexible access to your retirement savings. The CRA automatically converts all RRSPs to RRIFs when you turn 71, but you may convert earlier than this.

A final note; registered is essentially a reference to the wide recognition of an account’s tax preference by countries other than Canada.

For example, an RRSP earning money from American investments is not taxed by the United States, because of the account’s registered status under our free trade agreements. This makes RRSPs an excellent container for any investing you may do in American equities.

Another example of a registered account is a Registered Education Savings Plan (RESP) as discussed in the previous chapter.

As a general rule, if an account is referred to as “Registered,” it suggests some level of tax protection.

Tax-Free Savings Account

The Tax-Free Savings Account (TFSA) is the preferred retirement savings vehicle for Canadians. So what is it?

It is a savings account, much like an RRSP, in which you can stash cash, or buy bonds/GICs, funds, or equities. You may have multiple TFSAs with different institutions (for example, a cash TFSA and an investment TFSA), but you are limited by the total amount that you can contribute each year, which is set by the Canada Revenue Agency.

TFSAs were first introduced in 2009, and in the first four years, one could contribute $5,000 per year to their TFSA. In 2013, and 2014, (and again, now in 2016), the annual limit was $5,500, and in 2015, it was a glorious $10,000. This means that if you do not currently have a TFSA, and were 18 before 2009, you have room to contribute $46,500 into a TFSA.

So why is it the preferred vehicle for retirement savings?

Again, it is a tax-preferred account (it’s in the name) like an RRSP, but its tax treatment is different from RRSPs, in that it is the inverse. Money that you contribute to the TFSA has been taxed (in that you earned it and it will be taxed in that year), but after that money enters the TFSA, it will never be taxed again by the CRA.

Example: Calvin earns $97,000 per year as an electrical engineer. He has significant cash savings, and after reading these posts, decides to invest it all in a TFSA.

He invests $46,500 into an investment TFSA, maxing out his contribution room. He deploys the cash into various investment strategies (see Chapter 5) and manages a conservative 6% annual return over the next 25 years, adding the max ($5,500) each year to his TFSA.

When he retires after 25 years, he has contributed a whopping $184,000 of his after-tax income, but due to the power of time and compound interest, his TFSA portfolio is now worth over $511,000. He has made $327,000, tax-free, which he can draw on to fund his retirement, with no impact on his tax bill. He uses these funds to top up the income he is paid out of his RRSP.

This is how Calvin affords medical travel insurance for his frequent trips to Orlando, in his infirmity.

Screen Shot 2016-08-10 at 5.01.51 PM
Figure 15. Calvin’s TFSA growing over 25 years of investing.

What this means is that you can withdraw from your TFSA to top up your income now, or in retirement (I recommend the latter), and you will not be taxed on it.

calvin golf.jpg
Figure 16. Feels good to have a few extra dollars that the tax man can’t touch. Good work Calvin!

This tax preference makes it a perfect vehicle for long term investing because any interest that you earn over the years will be money you have made without a single penny being taxed. 

A major benefit to the TFSA account is that it’s contents can be liquidated and withdrawn at any time for any reason.

The major drawback to this is that the withdrawn money cannot be re-deposited immediately, and instead, the amount withdrawn is added to the contribution room for the following year.

Example: Calvin withdraws $3,000 from his TFSA in 2015. Now he has to wait until 2016 to deposit that withdrawn money back into the TFSA, therefore, he deposits $8,500 ($5,500 + $3,000) in 2016.

Another thing to consider with TFSAs is that they are not recognized as Tax-Free in any jurisdiction other than Canada (note: it does not have “Registered” in the name). Therefore, any appreciation or dividends you receive from assets invested in non-Canadian companies may be subject to withholding taxes from the country of the company’s origin (for example, the United States).

A common misconception is that a TFSA is purely associated with a financial institution. A TFSA can, indeed, be opened at any respectable financial institution, but the amount that can be deposited is set by the Canada Revenue Agency. It is first and foremost, a tax shelter.

In other words, you can have as many TFSAs as you want, at as many different banks as you want, you are only limited by your contribution limit.

Cash Investing Account

Wow, you’ve maxed out your RRSP and TFSA contributions and you still have more to save? Good work!

Open up a cash investing account and start buying bonds/GICs, funds, and/or equities. Your money will still hopefully outperform inflation, but as this account is not tax-preferred you will receive an income statement from your financial institution at tax time, indicating how much you have earned, and how it contributes to your annual income (which will increase your tax bill).

You will take income on interest, capital gains*, and dividend payments**.

Conversely, you can also declare capital losses***, which work against your income and can actually lower your tax bill. Selling at a loss is not usually recommended, but in some cases, it may be beneficial (getting off of a sinking ship? Feeling that your portfolio is overweighted in a certain equity?). Consider carefully.

Capital Gains: purchase a stock at $10 and sell it at $20, you have a $10 capital gain. Note, gains are only taxed when they are realized (meaning you need to sell that stock to be taxed on it, otherwise it is only a paper gain).

**Canadian dividends are taxed more favourably by the CRA than international dividends (it’s complicated, but comes down to the fact that dividends are paid from a company’s earnings, which for Canadian companies, have already been subjected to Canadian taxes, and therefore, should not be taxed fully twice).

***Capital Losses: purchase a stock at $20 and sell it at $10, you have a $10 capital loss.

Today, we talked about the various containers into which you can deposit your hard-earned savings and hopefully invest them for a comfortable (or extravagant) retirement.

We covered:

  1. The importance of an emergency fund.
  2. Basic savings accounts.
  3. Registered Retirement Savings Accounts
  4. Tax Free Savings Accounts
  5. Cash Investing Accounts

Our five-part series on investing for retirement concludes with Chapter 5 next Friday as we explore some of the various investing strategies and philosophies used. 

Happy living,

JRM

OtOoI Ch. 3: Preparing Your Mind to Invest

OtOoI Ch. 3: Preparing Your Mind to Invest

One week ago, you fought your way through the most difficult chapter in this 5-part series. We discussed the environment we invest in, and the various investment vehicles that are available to us, including:

  1. The Stock Market = The Investing Environment
  2. Stocks/Equities = The Classic, The Standard, The Foundation
  3. Fixed Income/Securities (such as Bonds, GICs) = The Geller
  4. Funds (Mutual, and Exchange Traded) = The Team

Now that we understand the basics, I’d like to take a moment to explore more about how we invest, from a psychological standpoint. Before you put your money in the ring, you need to have a better understanding of who you are as an investor.

There are many reasons to invest. You may want to invest to make a quick buck (this is called gambling).

Perhaps more prudently, you may want to invest to get a better return on your savings than a traditional savings account, or to accumulate wealth for your retirement.

Ultimately, investing can lead to irrational, and very costly decisions if you do not have the correct mindset to invest.

Investing is inherently risky. You are putting your money on the line in an environment fully exposed to market forces. In a single day, you could make a fortune, or lose a fortune. If you are afraid of risk, perhaps you are happier with your money stashed away in a savings account, but remember that even with savings, there is risk—risk that inflation will eat away at your hard work.

galaxy
Figure 11. Where do you fit in the world of investing?

The amount of risk you expose yourself to is dependent on what you invest in, and what you invest in is therefore heavily dependent on your answers to the five questions below. Additionally, risk tolerance questionnaires are available online to give you an idea about how much risk you can tolerate, or how you should allocate your asset classes in your portfolio based on your risk tolerance.

Higher risk investments are defined as having a higher risk of losing significant amounts in your portfolio, but are associated with higher returns. This is why you can make more on the stock market than by investing in low-yield bonds.

An important aside is that there is a difference between risk and volatility. A risky stock is not more or less volatile than a ‘safe’ stock. Volatility comes from market forces and investor sentiment. Risk comes from a company’s business practices, and the actual environment in which the company operates. A company that has steady returns in heavily regulated markets, like a utility company, is far less risky than a startup healthcare company in a competitive sector. Yet, each is exposed to market volatility.

In order to decide how you want to invest, you need to ask yourself the following questions:

    1. What am I investing for?
    2. How much risk am I able to handle on a financial level?
    3. How much risk am I able to stomach on an emotional level?
    4. How much volatility am I able to stomach on an emotional level?
    5. Do I want to put in a lot of work to invest, or a little?

So, let’s begin this exercise in understanding our own investment philosophy with an analysis of our investment horizon.

Investment Horizon

Determining what your investment horizon is, is the first thing you need to do, and answers the first two questions we have above.

Are you investing to save money for a down payment on a house in the next 5 years? Are you investing for your child’s future education? Are you investing for your own retirement?

There are many reasons to want to save, and therefore, to invest, but the time until that money is needed is the most important factor. A general rule is:

Any money that you will need in the next 5 years should not be in the stock market.

Why?

Because stock markets are volatile, and while volatility is not typically a bad thing in long term investment horizons, it is when you need access to your money now. Your portfolio’s value can go up and down with market volatility all it wants if you don’t need that money for 25 years, but if you need your investment for a down payment on a house in 5 years, what do you do if your portfolio happens to be down 20% when you need it?

Your investment horizon is of the utmost importance in deciding what you will invest in. Imagine a typical portfolio, which may contain some percentage of stocks and some percentage of bonds. The percentage allocated to fixed income should be higher in accounts holding money needed in the near future. A good example of this would be investing in a Registered Education Savings Plan (RESP)* for your child’s education.

Example: Jim deposits $2,000 into an RESP for his newborn son, JJ’s education, with plans to contribute an extra $1,000 per year. He chooses to invest in a mix of market tracking index ETFs, and bonds.

For the first 10 years of JJ’s life, Jim has an allocation of 90% ETF and 10% bonds, as he can tolerate the volatility and risk associated with stock market exposure. The money is not needed for another 8 years.

Over the next 8 years, Jim gradually shifts the allocation within JJ’s RESP, eventually achieving 90% bonds and only 10% in ETF by the time JJ turns 18 and decides to go to university. Jim has effectively managed risk, and minimized volatility, ensuring that when JJ needs it, the RESP portfolio will not be at a 20 year low due to stock market overexposure.

*Bonus note: RESPs are a great way to save for your child’s education, as the Canadian government will match 20% of your annual contribution of up to $2,500 (called a Canadian Education Savings Grant, or CESG), bringing your total annual contribution to $3,000 with a cost of $2,500. You’ll be hard pressed to find any other investment vehicle with a guaranteed 20% return.

Mindset

If you’re going to be able to sleep at night, I find it helpful to remind yourself of one important fact, and to take on two particular frames of thinking.

First, the important fact: investing for retirement, by definition, requires a long term perspective. It is the definition of a long term investment horizon. Saving and investing for a long term horizon is going to involve exposure to risk and volatility, but the beauty of a long term horizon is that there are more years ahead to make back money you may lose on a month to month, or year to year basis.

What this means, is that when the market starts to fail (for whatever reason), remember the length of time you have ahead of you and keep calm. A dip in prices is not the time to sell**, in fact, it may very well be the worst time to sell. A loss on paper is only a real loss if you choose to realize the loss by selling.

**Unless we’re talking about stock in a company that is clearly going out of business (eg. Nortel or Enron), but this is why we diversify: to reduce systemic risk.

In fact, a dip in the market may be the very time to be bold, to increase your stake if you’ve got a chance. Why? Because, a dip in the market is frequently an emotional response to some terrifying news. This may create some great opportunities to get stocks at a great value, and that terrifying news will be but a blip twenty-five years down the line. These opportunities are only possible when you take emotion out of the mix, which can be difficult, but is made easier looking at your decisions from a viewpoint in a galaxy far, far, away. 

One of the greatest investors and philanthropists of our time subscribes to this mindset when he says:

“Be fearful when others are greedy, and greedy when others are fearful.”

– Warren Buffett

Now, for two frames of thinking that I believe will serve you well in your future.

First, don’t be dogmatic. Be flexible. Learn constantly. Don’t listen to your cousin Tommy as your sole source of investment advice. In fact, don’t listen solely to me as your source of investment advice. If your chosen strategy isn’t working for you, don’t hold onto it for dear life: FIND A NEW STRATEGY.

Read. Talk to others, and find out what is working for them. Do your research and adapt. The market is constantly changing, so you can’t expect a single investing approach to work perfectly over that long period of time between now and your retirement.

Remember rule number one: make your dollars work for you. Sit down at least once a year and figure out where you can trim the fat, and how to whip that portfolio into a well oiled machine.

Water bear, SEM
Figure 12. Be the tardigrade of the investing world-always capable of adapting-and cute… in a creepy way.

Second, don’t be a speculator; be a business owner. The first business you own is YOU, Inc. Your business is in the industry of savvy investing. As the CEO of YOU, Inc., you are responsible to the shareholders (you, your family). Find ways to cut back on expenses (lower MER, or eliminate them altogether?), increase efficiencies (find the appropriate amount of time to manage your investments, or even hire someone else to do it for you?), and drive higher revenues (with intelligent investments and patience).

The second business you own, and in fact, the multiple businesses you own, are those you choose to take a stake in with your investments. The moment you purchase a share in a company, you are tied to it. If you hope to make it a short term relationship, with ideas of (hopefully) turning a quick profit, you are a speculator. If you hope to cultivate a long term relationship with a company that has solid earnings and rewards those who make those solid earnings possible, then you are a business owner. I recommend the latter of those two for a long term investment strategy with an eye towards retirement savings.

One last word of advice: there is no better time to invest than today. It’s not a question of timing the market, but rather, a question of time in the market.

To summarize today, we discussed:

  1. Five important questions to ask yourself before investing.
  2. How to understand Investment Horizon, and its impact on your investment behaviours.
  3. A mindset of prudence, and minimizing on emotion, to help you sleep at night when your money is on the line.
  4. To think of yourself as a business owner, first of YOU, Inc., and second, of the businesses you take a stake in.

Check back next Friday for Chapter 4 of On the Origin of Investing, where I will address where to save; the various containers in which you can stash your cash (hint: that Ziploc bag under your mattress won’t cut it).

Happy living,

JRM

OtOoI Ch. 2: Fine, I’ll Invest. What Do I Need to Know?

OtOoI Ch. 2: Fine, I’ll Invest. What Do I Need to Know?

Last week, I outlined three important rules that govern basic finances, and used those rules to justify why you need to invest. Those rules are:

  1. Make every dollar work for you.
  2. Inflation will erode the buying power of every dollar you save.
  3. Time is your best friend in fighting inflation, as it allows you to harness the power of compound interest. 

The fact that you’ve come back to read part 2 of On the Origin of Investing, suggests I’ve successfully convinced you that you need to start saving for retirement, and start thinking about investing. Welcome to the party!

I’m sorry to say, however, that the last chapter may have been the easy part for both you and I. We had a bit of math to crunch (and that’s the foundation of everything we’re doing), but in order to invest, we actually need to understand the environment in which we are investing.

This will be the most dense chapter in this series, but it truly is essential to be familiar with this terminology if you’re going to be able to follow the final three parts in this series.

So… let’s do this!

The environment we are investing in is not your community. It is not your current circumstances. It is not even the economy. The environment we are investing in is the whole world, and everything that happens within it has an impact on what happens to the dollars we deploy.

We have to concern ourself with markets. Supply and demand. What do people want to buy and how can we make money off of it? Where do we find value? What kind of an impact is the new CEO going to have, or a new government, or the next big startup?

What is a stock market? What does it mean when I buy a stock? What’s a penny stock? What’s a blue chip stock? What else can I invest in?

I hope to answer all of these questions, and more, in the coming pages as we discuss The Stock Market, Equities, Fixed Income, and Funds.

The Stock Market(s)

The stock markets, and there are many, are a physical location where stocks are bought and sold (what’s a stock? see the next section).

meat-market-1
Figure 6. Stocks are bought and sold on the stock market.

The Toronto Stock Exchange  (TSX), the New York Stock Exchange (NYSE), the London Stock Exchange (LSE), the Frankfurt Stock Exchange (FWB), and the Shanghai Stock Exchange (SSE). Each of these is a store, where stock brokers take orders to buy and sell shares in companies that are listed on that particular stock exchange. 

For example, in the TSX, shares in Bell Canada (BCE-T) trade at volumes of over 1 million shares per day (they also sell on the NYSE at BCE-N). Shares in Apple Inc. are traded on the NYSE (AAPL-Q) at volumes of over 60 million shares per day.

By definition, these companies are publicly traded (as in, there is no one family or person who owns the company outright), and therefore can be purchased by anyone with the money to do so.

While understanding that these are simply the physical places where stocks are bought and sold (hence, a market), you may be more interested in traditional measures of the performance of these markets.

In order to understand how each of these markets is doing, we look at stock market indices.

Stock market indices track the overall performance of companies listed within the specific stock exchange. It’s the Cole’s Notes summary of how each company on the exchange did for the day, rather than having to read every single chapter (a report on each company). Some of these indices are more broad, while others narrow down to specific sectors of a country’s economy.

You may have heard of the S&P/TSX Composite Index, the TSX Venture, the S&P 500, the Dow Jones Industrial Average (DJIA), the Nikkei 225, the Hang Seng Index. What these indices try to capture is the overall strength of an economy, or at least, the value of the companies within that index.

S&P TSX Composite
Figure 7. The S&P/TSX Composite Index since inception. That big dip in 2009? You guessed it! The Great Recession.

For example, the S&P/TSX Composite Index, (S&P, by the way, is short for Standard & Poor’s), follows the price of the largest companies on the TSX, by market capitalization*, and represents approximately 70% of the total market capitalization of companies traded on the TSX. The S&P 500 represents the 500 largest companies being traded in the NYSE or the NASDAQ (another major American stock exchange).

*Also abbreviated as market cap, it indicates how much a company is worth, based on price, and multiplied by the number of shares the company has issued. A higher market cap means a company is worth more.

As a result, each index is essentially a snap shot of the day’s market activity.

Because indices are an easy way to communicate, in broad strokes, about the overall progress in the economy, you will often see these indices reported on your favourite news station during the financial segment. Now you’ll know what they’re talking about!

We’ll come back to indices later when we talk about funds.

Equities

Let’s cut to the chase. I keep talking about stocks, shares, equities. All of these mean essentially the same thing.

An equity (or a share, or a stock) is a fraction of a company’s worth that is sold on the stock market. By buying a share in the company, you are a shareholder, and are literally becoming a co-owner in the company (one of thousands, in most cases). Being a co-owner in a business comes with risk and reward.

The risks are obvious; if the company you own performs poorly, or goes out of business, then the value of your ownership takes a significant cut. The value may even be wiped out completely.

The benefits, however, are also tantalizing. As a co-owner, you are entitled to profits generated by the company. These profits may come in the form of dividend** payments, or they may come in the form of increased company valuation (which makes each share worth a little more, and therefore makes you some money).

**Dividends are monthly, quarterly, or yearly disbursements of CASH to shareholders of a company, and represent a portion of the profits generated by the company.

There are many factors that go into the valuation of a stock, but what is important to remember is that a stock is a commodity. It is subject to SUPPLY and DEMAND

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Figure 8. Demand draws the Wal-Martians. Supply makes them fight!

Therefore, if demand for a stock rises because a company is performing particularly well, the value of each stock increases to satisfy the demand.

If a company is doing poorly, the demand may go down, and the supply may go up (as shareholders may be eager to get off the sinking ship, and put their shares up for sale). These things in combination will cause the value of each stock to decrease.

The law of supply and demand is ultimately what dictates the value of a share, but what actually creates demand? What actually creates value?

Let’s start from the ground up, literally.

A company you own a share in is a living, breathing entity. It exists. As a result, there is tangible value in a company. This tangible value, at its simplest level, is how much money the company is worth without any business operations. The properties owned, the computers inside those properties, the heavy equipment, and factories. All of these things have concrete value because they are concrete things, and therefore make up a portion of the stock’s price. This portion is called the book value***.

***I’m sorry I have to do this, but book value has two meanings.

First, as above, the company’s tangible assets.

Second, in the realm of personal finance, the book value is how much an individual paid for a stock, or stocks (the price in your accounting book), which is helpful in determining the performance of your investments.

However, when we purchase a company, we aren’t only purchasing its assets, we are purchasing the work of the people employed, and the potential for growth in the company. In this, there is intangible value, because we can’t sell off our employees at the end of the day, and we can’t be sure how the company will grow.

Still, we appreciate talented engineers, convincing salespeople, and intelligent management, all of whom work towards growing the company. We’re willing to pay for these things because these things are what make the business run, and generate increasing profits. Therefore, we pay a little (or a lot) more for the stock based on what we think that business is worth. This is called market value, because the market decides what that intangible value is worth.

Market value and book value creates an important ratio in evaluating a company: it’s Price/Book (P/B) ratio. A low P/B ratio suggests that the price of a stock is well backed by its tangible assets. A higher P/B ratio suggests that the company’s stock price has more to do with the company’s intangible assets (like potential for profit growth, and creative management). A company with a low P/B ratio is not necessarily better or worse than a company with a high P/B ratio, but it is helpful to know what you are paying for.

Example: Fortis Inc (FTS), a utility company offers 250 million shares in it’s company at a value of $40 per share. This values the company at $10 billion dollars.

FTS generating stations, offices, and conduction equipment, versus their minor commercial debt has an estimated worth of $5 billion dollars.

This means that shares of FTS have a P/B ratio of 2.0 (10/5), and that investors believe the possibility for profit growth is high enough to justify a stock price twice that of its book value.

Another key ratio in understanding the position of a stock is its Price/Earnings (PE) ratio. Similarly to the P/B ratio, the PE ratio is calculated by dividing a share’s price by its annual earnings per share (EPS). It tells you how many dollars an investor is willing to pay for each dollar earned by the company. The reason that this is helpful is because it helps you to understand how highly valued a company is by investors. Given two companies with identical earnings, a higher PE ratio suggests that a company’s shares are highly valued because investors are willing to pay more for each dollar made,  than a company with a lower PE ratio.

Example: Bank of Nova Scotia (BNS) and Bell Canada Enterprises Inc. (BCE) both have a share price of $50.

BNS earns $5 per share, giving BNS a PE ratio of 10 (50/5=10).

BCE earns $2.50 per share, giving BCE a PE ratio of 20 (50/2.50=20).

This means that investors are willing to pay twice as much for every dollar earned by BCE than they would for BNS, which may mean BCE is overvalued, or it may mean that investors see more potential for earnings growth in BCE, giving it higher value.

The difficulty with stocks, and you may be starting to recognize this, is that our investments are heavily tied to investor sentiment. Many people buy and sell on the stock market without really knowing why they are buying and selling. It may be a tip from a friend, or a news headline might scare investors about an impending sell off. We, as humans, are extremely emotional, especially when it comes to losing and gaining money (in the next chapter, we’ll talk more about the mindset necessary for successful investing).

What this means is that our investments can be wiped out when sentiment turns the wrong way. Of course, our investments can balloon if we get on early before investor sentiment becomes rosy. Stocks are inherently volatile as a result of emotional buying and selling. Owning stock is often likened to riding a roller coaster, but there are good ways and bad ways of riding a roller coaster, which we’ll talk about more in Chapter 5, on investment strategies.

Blue Chip Stock: a giant company with a solid reputation, usually with dependable earnings, often paying dividends.

Penny Stock: a common stock valued at less than $1 per share, therefore minor fluctuations in price have enormous impact on holdings; highly volatile and speculative.

Fixed Income (Securities)

What would Ross Geller, of Friends,  do with his lottery winnings?

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Figure 9. Ross Geller espouses the low risk, low reward nature of bonds.

So what is a bond?

It is a type of fixed income investment known as a debt investment.  When an investor purchases a bond, they are actually loaning their money to a specific entity, like the government, with the assurance that the loan will be paid back after a set period of time (on the maturity date), and over the time that the loan is maturing, the investor is paid a set interest rate. As a result, the bond holder receives a fixed income in compensation for loaning the entity money for operations.

There are two main benefits to bonds, and one important thing to keep in mind.

    1. Loaning money to an entity like a country is very low risk as countries are probably the most reliable debtors in the world (not many countries go bankrupt), and therefore, bonds can be a very low risk way of investing your money.
    2. Bonds generate fixed annual income, so you can have a reliable and predictable amount of cash flow from these investments, which are particularly useful for those who are retired.

The important thing to keep in mind is that bonds are purchased for a set value and produce a set return (yield). This return is constant for the life of the bond (eg. a 10-year bond), but the bond’s effective interest rate fluctuates with the value of the bond.

As a result, if interest rates on savings accounts go up, the relative value of that bond decreases because the money invested in the bond would have a higher yield in a different bond with a higher interest rate. Similarly, if interest rates go down, the value of that bond goes up because the interest rate on the older bonds are even more valuable in a low interest rate environment.

Example: A Canada Premium Bond is purchased for $10 and returns $0.20 annually ($0.20/$10 = 0.02 = 2% yield), while interest on savings accounts are 1%. If savings interest rates rise to 4%, demand for the bond will fall, and the value of the bond will decrease until it’s effective yield is greater than 4%, so less than $5 ($0.20/$5 = 4%).

The cumulative effect of this is that the value of bonds move inversely with interest rates. The higher the interest rate set by an entity (company, country, etc.), the lower the demand for older bonds set at lower interest rates. Therefore  the value of that old bond is lower because your money can be better deployed elsewhere.

In Canada, another form of fixed income, low-risk investment, is a Guaranteed Investment Certificate (GIC). Similar to bonds, they are loans to the government for a set period of time, with the promise of repayment of the principal, with interest on the maturity date, which is set at 1 year or more.

GICs are very low risk (guaranteed to be paid back on investments up to $100,000), with even less volatility than bonds due to stable prices, and are also favourably taxed in Canada. They fall prey to the same problems as bonds, with diminishing returns (due to opportunity cost), if interest rates rise. The big difference, however, is that your capital is guaranteed to be preserved.

Example: $1,000 invested in a 5-year GIC at 3% is returned as $1,159.27 (3% annually, compounded annually over 5 years).

Fixed income can, and often should be a component of a stable investment portfolio due to their low risk. Of course, with lower risk, there is typically lower return. In the setting of market instability, however, it may be helpful to your portfolio’s overall health to have some of your investments in more stable investments.

A commonly stated rule is The Age Rule: your portfolio should hold fixed income in the same percentage as your age (eg. a 20-year old’s portfolio would hold 20% bonds/GICs and 80% other vehicles such as equities or funds). By no means is this rule hard and fast.

A Brief Aside: Diversification

Diversification is an investment strategy that involves spreading your dollars around among various, different investments. The theory behind this approach is that if you invest in multiple sectors, if one sector is performing poorly, the negative effects of that performance on your portfolio will be minimized by average or better returns in better performing sectors of the economy.

A general rule with diversification is that you must own at least twenty stocks to be adequately diversified in equities.

Example: You invest $10,000, putting $5,000 in Canadian banks, $3,000 in Canadian energy companies, and $2 000 in Canadian manufacturing companies.

The latest news causes a 10% drop in the value of your bank stocks. Meanwhile, energy companies surge 10% and manufacturing holds steady with no gain on the day.

Your portfolio is now $4,500 in banks, $3,300 in energy, and still $2,000 in manufacturing for a total of $9,800. This is a 2% drop, compared with a 10% drop if you had invested only in banks. Diversification has reduced your portfolio’s volatility.

Funds

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Figure 10. Funds help you invest as part of a team.

Funds are a very popular, hands off way to invest. You can think of funds as a sort of team sport, where you work together with other investors. A financial company offers their services to manage the fund, which involves buying shares in companies on the stock market, or buying bonds. The money to purchase these shares or bonds comes from investors like you. A whole lot of investors like you. As a result, these financial companies are able to buy a whole lot of shares in a whole lot of companies, which creates… you guessed it…

DIVERSIFICATION.

You buy shares in the fund, where each share represents a fraction of all of the companies held in the fund. When companies in the fund do poorly, the value of the fund goes down, and when companies in the fund do well, the value of the fund goes up.

Meanwhile, the head honchos managing the fund charge a fee to manage the giant portfolio you have all bought into, with the intent that their management will make all of you a whole lot more money. The fee they charge is called a Management Expense Ratio (MER) and is expressed as a percentage. It represents the operating expenses of the fund as a percentage of the total value of the assets it is managing. 

Example: The Great Canadian Mutual Fund (GCF) manages $100 million dollars in assets, and has an annual operating expense of $2,000,000 (Bay Street “geniuses” take a high salary and trading isn’t free). This makes the MER 2.0%.

There are two kinds of funds that you can purchase, which I will compare and contrast below.

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In either case, investing with funds is a more hands off experience, but this comes with a cost in the form of the MER.

The current trend in fund investing is shifting away from Mutual Funds to Exchange Traded Funds. This is due to ETF’s lower MER, as percentage point differences in expenses can make a big difference when they are COMPOUNDED over the life of the investment.

Additionally, research has suggested that despite the active management of mutual funds, the majority of them do not outperform the market as they advertise. In fact, a study by Standard & Poor’s has indicated that over a 5 year period, only 22% of Canadian equity-based mutual funds, and only 12% of American equity-based mutual funds actually outperformed the market in which they exist. This is in contrast to ETF index funds which, by definition, usually perform on par with the market.

We will talk more about funds in Chapter 5.

Wow. That was a lot. But we made it. You now understand the fundamentals of the environment we invest in:

  1. We invest in the global stock market governed by supply and demand.
  2. Basically, we can invest in stocks/equities, fixed income, and funds, each having its own pros and cons.

Stay tuned next Friday for Chapter 3, where we will discuss an approach to deciding how to invest, and the mindset needed to feel comfortable putting your money into the market.

Happy living,

JRM

OtOoI Ch. 1: Why You Should Invest

OtOoI Ch. 1: Why You Should Invest

Welcome to the first instalment of On the Origin of Investing, a 5-part series on what I’ve learned about saving for retirement effectively (hint: investing is involved). Yesterday, I told you that I am not promising to make you the next Wolf of Wall Street or our generation’s Warren Buffett. What I’m promising is to give you the tools to start planning for financial success and independence in retirement.

In this series, we’re not really talking about penny stocks, initial public offerings, and Wall Street lunches with Matthew McConaughey, so you may be asking yourself: why should I invest?

We invest to prepare for retirement.

Retirement seems like a long way off for most of you. Many of you are still in school, or are only just getting started in your careers. The idea of preparing for retirement, which may be 30, 40, or even 50 years down the road for you, may seem a little strange, but thinking about retirement, and starting to prepare for it now, is of the utmost importance.

Why?

When you retire, you are no longer working. Shocking, I know, but that also means the amount of money coming in is going to be far less than in your working years.

There is good news. As a Canadian, you will contribute to the Canada Pension Plan (or CPP) throughout your career. The average monthly benefit after age 65 is currently just shy of $630 a month, for a whopping $7,560 a year. Generous, I know, but even with this lavish pension, you might have to cut back on those trips down south you’ve been planning.

Now before we get too doom and gloom, at 65 you will also be eligible for Old Age Security (OAS) which currently has an average monthly benefit of $570, for another $6,840 annually. This certainly helps, but we’re still talking about an annual income well below the poverty line, and this may be a difficult adjustment after what were probably your most lucrative years in employment just prior to retirement.

If you were lucky enough in your career to be able to contribute to a pension plan with your employer, things will look a little more rosy (especially if you work for the government!).

Of course, there is only one real reason for this: you are being forced to start saving for retirement early!

But, what if you don’t have a pension plan at your work? What if your employer doesn’t offer it (which is becoming more and more common in the modern age of contract work)! Or maybe you’re self-employed! What’s an entrepreneur to do?

Start. Saving. Early.

Retirement is not as far away as it seems, and we can’t rely on the government to put a roof over our heads, food on our table, and tickets for flights to Miami in our hands.

Now, I’ve managed to tell you why you need to save, but not why you need to invest. To explain this, I’d like to explore three simple rules to justify investment.

The First Rule

If you’ve ever read Terry Goodkind’s epic fantasy series, The Sword of Truth, you would know that the Wizard’s First Rule is that “people are stupid.” I’m going to challenge you not to be stupid, or rather, not to work stupid. You need to work smart.

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Figure 2. Our diplomas mean a lot less these days. Better work REAL smart.

Therefore, the first rule of retirement planning is to make every dollar work for you.

Every dollar you make needs to be earmarked for something. Your dollar works for you by keeping a roof over your head which, in turn, makes it possible to keep working and earning more money. Same goes for the food you buy and the gas in your car.

However, if you budget well (and by God, you need a budget!), there are going to be some dollars left over at the end of the month that you are not making work. Or at least, you are not making them work as hard as they should be.

For example, you may be putting your money in your bank’s savings account where they are accruing interest at a rate of 0.05% (at your major bank, in a no-fee savings account), to a whopping 2.25% (at your discount bank, on a promotion). Your money is working, but it’s not working smart, and it’s not working hard.

It’s your job to whip those dollars into shape, because savings at those rates are not going to cut it, primarily because of the second rule.

The second rule is practically a law of nature, at least in our world, and explains why savings accounts do not work for retirement.

Rule Numéro Duo

Inflation. I don’t want to call it a rule, because it is more of a fact of life. Let’s just say it is not something that you have to follow, but rather something you must always keep in mind. Inflation will dictate how much the money that you save now is worth when you retire.

Inflation is the natural process by which goods increase in price, and therefore, inflation decreases the purchasing power of your dollar. As you can see in the graph below, inflation has been relatively steady for the past two decades, with prices usually rising by approximately 1-2% per year. This is why a loaf of bread cost 5 cents in the 1950s, and costs $2.99 (or more, I see you with your fancy artisan whole wheat round) today.

Screen Shot 2016-08-04 at 5.08.15 PM
Figure 3. The historical rate of inflation in Canada, from 1950-2015.

This is also why using a savings account to accumulate money for your retirement is not going to work. Using an average (and sustainable) paid savings account at a major bank, your money will appreciate approximately 0.1% per year. Meanwhile, the price of that Starbucks latté you buy every Monday (and Tuesday, Wednesday, Thursday, and Friday) is going to rise approximately 1% per year.

Let’s use an example to illustrate how inflation works.

Say in 1990, you stashed $20,000 away in your savings account. In its first year, at 0.5% interest (much higher than what you’ll get today), it is going to appreciate by $100.23, and you’ll be left with $20,100.23. Extrapolating this forward, down a 25 year time to retirement, your initial $20,000 will become $22,662.38. Not bad for doing nothing! You’ve made $2,662.38 in 25 years thanks to the power of time and compound interest (see the third rule). It’s 2015 and you can buy that base model Ford Mustang you’ve had your eye on.

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Figure 4. Mmmmmmmm.

But there’s a catch.

Over the same period of time, due to inflation, every one of those dollars in your bank account is now worth a whole lot less. In the period between 1990 and 2015, inflation’s cumulative 25 year rate was 58.8%! This means that something that cost $1 in 1990 now costs nearly $1.59. Your brand new Ford Mustang cost $20,500 in 1990, but a brand new Mustang in 2015 costs $32,554. I guess you won’t be getting that dank whip after all.

You’ve been bested by the effects of time and a crappy interest rate*.

These are the devastating effects of inflation, and are the primary reason why you must invest if you want to maintain your buying power into retirement.

*Interest rates are not always as low as they are now, and there have been times in history when interest on savings accounts have managed to outstrip inflation. It is important to remember that the Bank of Canada sets interest rates, and the banks will typically offer interest on savings well below this, in order to leave room for them to profit. Shitty right? Wrong, because that can be our profit too.

Third Rule

Time is your best friend. I know the idea is a little strange, given that time just kicked your ass back to 1991, and given enough of a leash, time will literally kill you, but trust me, time can be real friendly if we follow rule number one, which was?

Make every dollar work for you!

Come on, keep up.

In order to beat the devastating effects of inflation, you’re going to need a better way of saving, because savings accounts aren’t going to cut it.

When you make every dollar work hard, you CAN achieve a rate of return that beats inflation. All you need to beat inflation is a measly 1-2%, but we can do much better than that if we have the right mindset, and make our money work smart.

If you can, at the very least, match inflation, every dollar you stash away will at least be able to buy you the same things you buy today. If you can do better than inflation, your wealth will grow with the power of compound interest. Compound interest is the reason why time is your best friend.

So, what is compound  interest?

It is the interest you earn on interest. If you are earning a very conservative 4% interest per year, your actual gain becomes much higher than this with time.

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Figure 5. The effect of compound interest, depending on frequency of compounding. Graph created by Jelson25.

4% in your first year becomes 4.16% in your second year (0.16% is interest on the 4% interest you made in your first year), becomes 4.49% in your third, and 8.02% in your tenth. This is because you are earning interest on interest, which makes your actual return relative to your investment, a little bit higher with each compounding period.

A $20,000 investment, with no further contributions, and annual returns of 4.0%, becomes $54,275.30 after 25 years. You have made $34,275.30 in interest alone (more than the value of that 2015 Ford Mustang you wanted). The sooner you start to invest, the sooner you can harness the power of compound interest for yourself.

So, if a savings account isn’t going to cut it, how do we get this kind of return?

We invest.

Keep your eye out for Chapter 2, next Friday, where we will discuss the various financial instruments available for investing.

Happy living,

JRM

Intro: On the Origin of Investing, Or What I Learned about Money, Investing and Saving for Retirement

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It’s been nearly two years since I wrote something for my blog. This makes me a bad blogger, but I suppose it has come at the expense of being a better person. Over the past two years, I’ve done a lot.

For those of you who have enjoyed my writing, my time spent NOT blogging has been spent writing. I wrote (and cameo’d in) a musical to raise money for the Canadian Cancer Society, I wrote for The Droopy Lid, UofT’s Medical Humour Newspaper, I wrote a short story about medicine in a dystopian future, and of course I worked on the sequel to Waking Woods. Quick update: I’m well over half way done Rising Ruins, the second book in The Courser & Wallace Chronicles. I know it has been a long wait, but I promise that it will be worth it!

For those of you who know I am studying medicine, my time spent NOT blogging has been spent studying and practicing medicine. It’s more than a full time job. Over the past two years, I’ve transformed from the bright-eyed first year medical student into a fourth year (almost) medical student. I have a better grasp on what it means to be a doctor, I have a collection of powerful memories formed with my colleagues and my patients, and I have a better idea of where I might end up in my professional career.

Finally, for those of you who have been a part of my life in a real way, my time spent NOT blogging has been time spent with you. Strengthening my relationship with the most important woman in my life, nurturing old friendships, and building new ones. The past two years have been a wonderful, productive, mind-expanding ones.

One of my endeavours over the past two years, when I haven’t been studying or writing, or spending time with friends and family, is learning about investing in a serious way. Over my three years in medical school, I’ve heard a lot about financial planning, about taxes, incorporation, and entrepreneurship. I’ve heard a lot of worries from my classmates and friends about what all of it means and how it applies to them.

And I don’t blame anybody for worrying. The countless headaches I’ve brought on myself trying to understand the basics are a testament to that. I’ve come a long way, but in finance, just as in medicine, there is always more to discover and more to learn. As a side project, I have begun to collate some of the things I’ve learned about finances and investing from the perspective of a young person facing an increasingly complex economic environment.

First will be a 5-part series on saving for retirement (because, as I hope to prove to you, saving for retirement is one of our first jobs). To bastardize a hero of mine, Charles Darwin, I call it On the Origin of Investing. This is an apt name, as the stock and financials market may be one of the best real-time representations of survival of the fittest by natural selection.

So, without further ado…

On the Origin of Investing

Welcome to On the Origin of Investing, a no-nonsense, back to basics compilation of what you need to know to get started in investing (and as always, the option to learn a little bit more).

This series is a collection of the things I’ve learned about finance and investing, with a particular bent towards its purposes for retirement savings.

No, I’m not trying to sell you on anything. I’m not going to promise that you will find great success because you’ve read this. I’m not going to make you into the next Wolf of Wall Street, nor are you likely to become Warren Buffett Jr. (though we’ll try to get close). Finally, I’m not going to tell you how to invest, I’m going to tell you what you need to know to get started on your own.

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Figure 1. Throw away your dreams of being the next Wolf of Wall Street, but don’t throw away your dollars.

 

This series is not about learning how to be a stock market maven, or how to become a millionaire in three easy steps (because if we can only get you to a million, we’re in trouble… see rule 2 in the coming post). What I will promise you, however, is that I’m going to try to make learning finance fun for the average person (like you! don’t worry, you’re still very special and unique), by distilling out the most important things, and injecting a bit of humour into a field that engenders anxiety in approximately 102% of people.

A new part will be published every Friday (for light weekend reading, of course) for the next 5 weeks. More series on other financial topics pertinent to medical (or non-medical) professionals and young people in general will follow.

As you read, please feel free to ask questions, or make requests to talk more about certain topics.

Happy living,

JRM

Days 25, 26, 27 – Heidelberg Hide-Aways

Days 25, 26, 27 – Heidelberg Hide-Aways

My apologies for the long delay in posting this, but, better late than never, I suppose. Some of the details may be a little foggy, as a result.

Our trip from Munich to Heidelberg was rather uneventful, though it was delayed by approximately half an hour (so much for German punctuality). The end result was us running from the train station in Heidelberg to meet the student we were renting an apartment from.

We made it to the apartment a few minutes late, and were welcomed by Nikolas, who explained how the rental would work, and gave us a thorough explanation of what to see, do, and eat in Heidelberg. After he left, Cara and I took a walk through Old Town Heidelberg to get our bearings. We eyed a few of the landmarks and checked out a number of the stores.

One store in particular is the Knosel Chocolaterie, a store famous for their ‘Student’s Kisses’ chocolates. The store is still owned and operated by the Knosel family, whose chocolates were a hit as gifts from the male students of the University of Heidelberg to the various women in their lives.

Knosel Chocolaterie in Heidelberg, Germany.
Knosel Chocolaterie in Heidelberg, Germany.

It should be noted that Heidelberg is built around the university, which is the oldest in Germany, and is responsible for much of the city’s history. The university was founded at the bequest of a German king who decided that Germany needed a university to make progress in the sciences. It is home to many famous scientists and Nobel laureates, and was also the site at which Robert Bunsen invented the Bunsen burner. The university also has an interesting history through the last century as it was subject to a great deal of controversy and reform during the rise and fall of Nazi Germany.

The Old Bridge, with a view of Heidelberg Castle in the background.
The Old Bridge, with a view of Heidelberg Castle in the background.

After picking up some chocolate kisses in the Knosel shop, Cara and I wandered across the Old Bridge to the other side of the river, and sat down on the riverbank to read as we worked up an appetite for dinner. A short time later, we went back into Old Town and found a schnitzel restaurant called The Heidelberger Schnitzelhaus, that Nikolas had recommended to us. The place boasted over 100 kinds of schnitzel. For those of you who don’t know, schnitzel is basically pork that has been pounded flat, breaded, and then pan fried in butter to a crispy consistency. It is then traditionally topped with things to make it different. This place had over 100 different formulations to make your schnitzel something special. Mine was covered in bacon and onions in a creamy sauce, while Cara had a red wine sauce with mushrooms in it. Both were delicious and the meal was extremely filling.

We were tired from the day of travel, and all the walking, so we made our way back to the apartment and turned in for the night.

The next day was Cara’s birthday, and Cara had made a request to visit Heidelberg Castle, and do a hike up the Philosopher’s Walk (or Philosphenweg), which was a popular path frequented by philosophers and artists (including Goethe and Mark Twain).

The Fat Tower of Heidelberg Castle, destroyed when lightning ignited the gun powder stored within.
The Fat Tower of Heidelberg Castle, destroyed when lightning ignited the gun powder stored within.

We started with a trip to the castle, where we got an audio guide to narrate our exploration. The castle was once a dominating and imposing feature on the hill overlooking Heidelberg, and was in various states of use and operation as the residence of German kings, and a primary defensive bastion. Over the years, the castle fell into disuse, was ransacked, and destroyed by war and fire. More time had the castle being partially reclaimed by nature, which had the unintentional effect of making the ruin all the more romantic and striking. The stone walls and battlements crumbling over the centuries and crawling with vines made it a favourite place for both Goethe and Mark Twain as well. Inside the castle, which is better maintained, we visited the wine cellar, which contained the Great Wine Barrel. This barrel was used as a tithing vessel to which wine makers of the region delivered their taxes. It held over 223,000L of wine (of all kinds, so you can imagine it was not very good), and was the main source of drinking fluid for the castle. There is an old legend that the court jester, Perkeo, was a famous alcoholic (even receiving his name, Perkeo for responding to the question “More wine?” with “por que, non?” or, “why not?”) who died after being convinced to drink the castle’s water.

The 223,000L Great Barrel in the lower levels of the Heidelberg Castle.
The 223,000L Great Barrel in the lower levels of the Heidelberg Castle.

After the castle, we made our way across the river to the Philosphenweg. The path we took was much longer and actually led us to the top of a 300m mountain overlooking Heidelberg. The first thing we found was the ruin of St. Stephenskloster, which has a restored tower that we were allowed to climb to the top of, and which gave a great view of Heidelberg and it’s castle.

The view from the tower at St. Stephenskloster. You can see Old Town, the Old Bridge, and Heidelberg Castle.
The view from the tower at St. Stephenskloster. You can see Old Town and Heidelberg Castle.

The actual tower, which, clearly, has been restored.
The actual tower, which, clearly, has been restored.

We then continued on to find a Nazi amphitheatre, a chilling experience to say the least.

Looking down on the stage of the Nazi Amphitheatre. It is disturbing to imagine the place filled with supporters sporting swastikas.
Looking down on the stage of the Nazi Amphitheatre. It is disturbing to imagine the place filled with supporters sporting swastikas.

We then climbed to the very peak where we found St. Michaelskloster, which was an even larger abbey, with the rooms all labelled, and two towers, which we could climb to properly appreciate the ruins and the view.

The ruins of St. Michaelskloster. I imagine the central tree as being much smaller in year's past, when it would have been completely surrounded by stone walls that have since yielded to the test of time... even as the tree perseveres in the face of the same.
The ruins of St. Michaelskloster. I imagine the central tree as being much smaller in year’s past, when it would have been completely surrounded by stone walls that have since yielded to the test of time… even as the tree perseveres in the face of the same.

A long walk back down the mountain and through Old Town brought us back to the apartment for a well deserved shower. We then walked back into Old Town to enjoy some Thai food (which was good, but the service was extremely slow). We finished off the night with dessert at Cafe Knosel (just up the street from the chocolaterie), and then headed home after a long day of walking (over 25km).

Our last day in Heidelberg was a rainy one, and was spent doing a bit of souvenir shopping, and seeing some of the museums in Heidelberg. We visited the Heidelberg University Museum, the Karzer Student Prison (where students were incarcerated by the university for their many misdeeds and pranks; they were allowed to attend class while in prison, but otherwise were forced to remain in their cells).

A cell in the Karzer Student Prison. Students passed the time by graffitiing the walls. A favourite technique was to emulate the student's profile.
A cell in the Karzer Student Prison. Students passed the time by graffitiing the walls. A favourite technique was to emulate the student’s profile.

We relaxed in the afternoon with some reading, and found our way to a beer house and hotel recommended by Nikolas as a good place to eat. We shared a salad and Ox Topside (which is basically a boiled beef dish; good, but not spectacular), and I enjoyed one of my favourite beers of the whole trip (the Kulturbraueri Seasonal Brew… not sure what it was exactly, but it was delightfully hoppy, but also a full bodied amber ale. VERY GOOD). On our walk home, we picked up dessert at a shop. This dessert was a Schneeball (Snowball), which is basically pastry, rolled up into a ball, and covered with sugar, or other toppings. We got a cinnamon sugar one (gee, I wonder who chose that one… CARA) and took it home to eat with some fresh strawberries (which are way better in Germany than in NA). We were in for our longest train ride of the trip the next day, so we called it an early night and eagerly anticipated the trip to Berlin.

On the riverbank during the Golden Hour on our last night in Heidelberg.
On the riverbank during the Golden Hour on our last night in Heidelberg.

Days 21, 22, 23, 24 – Much in Muenchen

It seems that we have been dogged by rain every day since leaving Italy. After nearly 20 hot days in Italy, I would be lying if I said I was not looking forward to a hopefully cooler Germany. Unfortunately, so far, we’ve experienced mostly cool temperatures (maybe I’m picky?) and a good amount of atmospheric lubrication to make it just that much colder.

All of this being said, our three and a half days in Munich were very enjoyable, and packed with many of the things that made Munich a city I very much wanted to visit. We had periods of wonderful weather, and even when it was cooler, I managed to remind myself that in one way, it was precisely what I’d been asking for while sweating at a standstill in Italy.

A sculpture erected in front of the Maintenance Building in Dachau. It is an amalgamation of barbed wire and emaciated bodies. Chilling.
A sculpture erected in front of the Maintenance Building in Dachau. It is an amalgamation of barbed wire and emaciated bodies. Chilling.

On our first day in Munich, or Muenchen in the original German (or Deutsch in the original… oh forget it), Cara and I made the joint decision to make a pilgrimage to Dachau (one of the worst concentration camps during the Nazi era) in the afternoon. The weather forecast was threatening rain, which we deemed appropriate given the solemn content of what was to be our afternoon, so we packed our rain jackets and hopped on the train.

On our arrival in Dachau, we found a sign that indicated the route from the train station to the concentration camp was marked by signs that narrated the way. It was a solemn 3km walk as Cara and I retraced the footsteps of those persecuted by the Nazis, walking along the same streets that thousands of Jews, political enemies, asocials, homosexuals, Roma, and many others were beaten and herded, many towards their deaths. We walked under an overcast and threatening sky and reflected on the evil humankind is capable of.

Almost, as if to welcome us for our visit in spite of the impending rain, the clouds opened up to reveal a blue sky and warm sun as we terminated the Path of Remembrance at the memorial’s entrance. We walked through the gates, which promised the famous “Work Brings Freedom,” and began to explore the site.

Much of what we saw, Cara and I knew about previously (thanks Canadian public school system), but we still learned knew things, and took a lot away from the visit. Dachau began operation in 1933 as the Nazis took power. Over the course of its operation into 1945, Dachau saw more than 200,000 prisoners cycle through the system. Some few, mostly in its early years, were released. Many tens of thousands died of abuse, malnutrition, disease, overwork, and execution.

We started in the bunker, which was the camp’s prison. There, we learned of abuses, torture, and terrible conditions. We explored the reproductions of the camp’s cramped living quarters (originally built to house 6000 prisoners, at its peak Dachau housed over 50000). We visited the Crematorium, where the bodies of the dead were disposed of. Hauntingly, we walked through the ‘shower’ room and observed the literal killing machine of the gas chambers, which led directly into the room where the furnaces operated. It was truly sickening to imagine the people who could take part in such a thing. Impossible to imagine those who could dream it up.

We left that place and visited the religious memorials at the far end of the site. Then walked slowly down the main camp road, where the foundations of the over 40 camp barracks buildings still stood.

With time running out, we walked through the permanent museum in the maintenance building and learned about the situation and environment that led to Hitler’s rise to power, what precipitated the use of the concentration camps, and how the Nazis were able to deceive the entire world about what was actually happening in them.

Unfortunately, we ran out of time before we could finish the museum, and so we, unlike so many others, were able to walk freely through the gates with a more whole—a more concrete understanding of what happened 70-80 years ago. We also emerged with the hope that such experiences, if had by enough people, will prevent such atrocities from ever happening again.

We walked back along the Path of Remembrance back to the train and sat quietly on our way back to the hostel.

1L of beer. Because Germany.
1L of beer. Because Germany.

Cara and I found dinner at a nearby restaurant where we shared two kinds of sausage (currywurst and white sausages) as well as fries and sauerkraut. I also had my first German beer (1L!) and Cara had the same kind (but only 0.5L). The food was delicious and it was a good way to get in a meal of real German food (actually… Bavarian food; anything that you think of as being typically German, like sausages and beer and schnitzel are actually a product of the Bavarian region, which only became a part of unified Germany in the 20th century).

The next day, Cara and I slept in a wee bit and then took the train from Munich to Fuessen. Why? To visit a really cool castle: Neuschwanstein (pronounced Ny-Sh-vawn-stine). Built by King Ludwig II of Bavaria in the late 1800’s, it was designed to be a sort of medieval fairy tale castle (in fact, it served as inspiration for Sleeping Beauty’s castle). Though it was never finished (he was removed from power due to some level of supposed insanity, and died young shortly thereafter), the castle is complete in many areas, and open to the public for tours.

The view of Neuschwanstein Castle from the Marienbrucke.
The view of Neuschwanstein Castle from the Marienbrucke.

Cara and I started the visit with an hour and a half in line to buy tickets for the guided tour (the only way you can see the inside of the castle), then waited for our tour by doing some hikes around the area. There is another very nice castle called Hohenschwangau Castle which we visited but did not enter. We also did a significant hike up to the Marienbrucke, a bridge that was also constructed by Ludwig II, which crosses a gorge and gives great views of a waterfall and of Neuschwanstein castle. It is a great place for pictures, though I found myself doubting, at times, the integrity of the bridge, what with the hundreds of tourists on it jockeying for photos.

The view of the Marienbrucke from Neuschwanstein Castle.
The view of the Marienbrucke from Neuschwanstein Castle.

After finding the view, it was nearly time for our tour, so we walked down to the castle and appreciated it from the outside, as well as exploring its courtyard. Our turn finally came and we entered the castle, starting up a spiral staircase. We explored the throne room, Ludwig’s bedroom, his reading room, servant’s quarters, and the kitchen, among other things. The interior was grand, and truly fairytale like. I think it was a highlight of the trip for Cara, as she loves seeing palaces as they were intended to be lived in (ie: correctly furnished, as opposed to being converted into a regular museum).

After a confusing and convoluted train ride home that got us back late, I stopped for a doner (sort of like a gyro or donair) that is a very popular fast food in Germany, and then we went back to the hostel to plan for the next day.

The Antiquarium inside Munich's Residenz.
The Antiquarium inside Munich’s Residenz.

Continuing in the grain of Cara’s desire to see palaces, we visited the Munich Residenz in the morning. The Residenz was the seat of government and palace of the Bavarian Imperial (and then Royal) family, the Wittlesbach’s. This place was largely destroyed during the allied bombings of WWII, but has been extensively reconstructed and restored. It is both a museum, and a properly furnished palace. We were able to visit rooms associated with governance, as well as the many rooms that were occupied by the rulers of Bavaria as they rose from the position of Dukes in the Holy Roman Empire, to Emperors, and then finally to the Kings of Bavaria (after allying with Napoleon Bonaparte, who basically put an end to the mighty Holy Roman Empire). We also got to explore the Residenz treasury, which contained many precious pieces of jewellry, crowns, gems, sculptures, religious relics, and the like.

The Beer Barrel Room in the Hofbrauhaus.
The Beer Barrel Room in the Hofbrauhaus.

After the Residenz, we enjoyed a walking tour of the Old Town with a guide. He gave us insights on many of the structures we visited, as well as many local legends, and history. We learned about the Beer Hall Putsch, Hitler’s first (and failed) attempt at revolution in the 1920s, we learned about devastation during WWII and rebuilding, and we learned about the other 800 years of history in Munich, which covered the founding (Muenchen is a reference to the Monk’s monastery by which the first settlers put down roots), through its association with the Holy Roman Empire (Munich is often considered the most northern Roman city), and then its rise to greatness as the seat of the Bavarian royalty prior to German unification. I’m won’t bother to tell you too much about the things we saw, but will list them briefly. We started at the Glockenspiel, which has the dubious honour of being Europe’s 2nd most overrated tourist attraction. We then visited the Frauenkirche, the emblem of Munich, and a church that was supposedly built with the help of the Devil. We visited the Odeonsplatz, the great square where Hitler delivered many of his speeches, and we visited the Residenz (again, where we were able to learn more about the kings of Bavaria). We visited the Hofbrauhaus (the Royal Beer Hall, the most famous beer hall in Munich, home to a storied history all begun because the Catholic king of Bavaria did not like drinking the Protestant-made beer of Northern Germany). We visited Sankt Jakob’s church, which was destroyed and rebuilt countless times over the course of its history, and is associated with the Miracle Stein (to make a long story short, the church’s cross blew down during a storm, and a slightly drunk Municher from a nearby beer garden volunteered to set it right, but in the process, dropped his family stein from the church’s roof; despite a fall of hundreds of feet, it did not break, and is now considered a relic… only in Germany!).

Munich's Hofgarten.
Munich’s Hofgarten.

After the tour, Cara and I took a walk through the Royal Garden, and up to the English Garden.

Nothing stops Munich's surfboarders from getting their fix in the middle of the city.
Nothing stops Munich’s surfboarders from getting their fix in the middle of the city.

We watched the famous Munich surfers, who ride the standing waves on one of the rivers. Very cool to watch, and it looks very fun. After this, we strolled through the garden, thankful that the rain for the day was holding off. We stuck our feet in the river (it was cold, but very welcome as we had been walking all day), did some reading in the park, and then went to the Chinese Tower Beer Garden. Cara and I shared a roasted pork knuckle, Bavarian meatloaf, country potatoes. I had a half litre of Hofbrau (royal beer) and Cara had a radler (a mix of lemonade and beer), which she enjoyed.

The Chinese Tower Beer Garden.
The Chinese Tower Beer Garden.

Then it started to rain. We took shelter under the traditional beer garden chestnut trees until the rain let up a bit, then walked back to the hostel. There, we met some of our hostel mates and went to another beer garden nearby the hostel for some more beer, from Augustiner Brauhaus, a mostly local brewery which is also the oldest brewery in Munich. I had a half litre Augustiner Weissbier (wheat beer) and Cara (accidentally) got a 1L radler. While she liked that one more, it was too much, and I ended up having to finish it for her. While our hostel mates moved onto another bar, we went back to the hostel and got to sleep, with an early morning the next day.

The next morning, Cara and I got a metro pass for the day and took the tram out to Schloss Nymphenburg. This was yet another palace that Cara’s research said we had to see. The Schloss Nymphenburg was initially constructed as the summer residence of the Bavarian royals, but was quickly expanded to form, basically, a small town that served the royal family and the court, during the summer months of May to September. Included with the enormous palace is an enormous garden which evolved over the years from a French style (more man made, more architecture, more manicured, etc.) to an English style (more wild and natural). As a result, there is an interesting mix of French architectural features with what seems to be a mostly natural park. Did I mention that it is ENORMOUS?

The view of Schloss Nymphenburg from the end of the canal within the palace's English Garden.
The view of Schloss Nymphenburg from the end of the canal within the palace’s English Garden.

Anyway, we went into the palace and again, were able to appreciate the enormity and grandness of it. We visited the royal apartments, we saw the Hall of Beauties (a room bedecked with over 30 painted portraits commissioned by King Ludwig I (grandfather to King Ludwig II) to document female beauty. Interestingly, his daughter in-law is one of the women featured in the paintings (though we are unsure of whether she was married to his son yet, or not).

After the palace, we visited the Sleigh and Carriages museum where we saw many rich carriages and… er… sleighs. Neat to see. I was hoping to see some royal automobiles, but there were none, unfortunately. This was a short visit, and then we went into the park.

Our first stop in the park was Amalienberg, a hunting lodge which was designed by a key court designer, Philip Cuvilier (sp?), a master of the Rococo style. The place was pretty cool. I won’t say much beyond that. Next, we visited Badenberg, which was a hunting lodge for the King, and includes the oldest indoor pool of the modern era. This was pretty neat to see.

We walked through a bit more of the park, stopped to enjoy our packed lunch, and then made our way slowly out of the park.

Our next stop was BMW Welt (Deutsch for World), one of the highlights on my itinerary. This is an enormous modern complex that serves as tourist attraction and information centre for everything Bavarian Motor Works (and its subsidiaries, Mini and Rolls Royce). I’m a huge BMW fan, and Cara is a huge Mini fan (how I convinced her to go). We got to check out cars that are way too expensive for us, got to sit in them, imagine, dream, and then get out slowly and sadly.

Nearby is the BMW factory and museum. We didn’t know you could get a factory tour, so we missed out on that, but we went into the BMW Museum, which is another very modern building that takes you through the history of BMW, with its start as an airplane engine manufacturer during WWI all the way through to its modern works as a design and efficiency pioneer. We saw some of the very first vehicles produced by BMW, including its cars and motorcycles, saw race cars, some of its most famous lines (like the M, motorsport line), and some interesting concept cars. Altogether, it was a very cool experience. It also rained quite a bit, so we were glad to be indoors.

We sat around in BMW Welt (they have some nice sitting areas) to read, while the rain died down and we worked up an appetite for dinner. I’d heard of a good Mexican place near the English Garden called Condesa, so when we felt the pull for dinner, we hopped on the underground and headed that way. When we arrived, we saw that the menu was entirely in German, and the occupants of the tables were all locals. In my books, this is always a good sign. We managed to order quite easily because the cashier spoke good English. I enjoyed a pork burrito (Castor style, which includes pineapple), and Cara enjoyed a chicken burrito. I would call it one of the best burritos I’ve had (close second to Burrito Jax in Halifax), so if you’re ever in Munich and hankering for some Mexican, I’d recommend Condesa.

That was more than enough for us, so we confusedly navigated our way through the underground system, stopped in Marienplatz to do some souvenir shopping, and then got back to the hostel. We got invited out by our hostel mates again, but this time, we turned them down in favour of packing and getting an early night (we were both pretty exhausted, but yes, I suppose we’re a little lame).

And so, that was the end of our Munich experience. Now we’re on the train to Heidelberg, which is running uncharacteristically late. It’s Cara’s birthday tomorrow (the 1st of August), and the weather forecast says it will be a nice one, so we’ll have to make the best of it!

Check back for an update in a few days, after we’ve done Heidelberg. Auf wiedersehn!

Day 20 – Insights (and Outsights) in Innsbruck

Day 20 – Insights (and Outsights) in Innsbruck
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The Inn River, looking towards the Nordketten.

I should start by saying that until only a few weeks before we left, Cara and I had no intention of stopping in Austria. It was a side note on our journey from Italy to Germany. A beautiful side-note, I suppose, but I was more than happy to simply enjoy the scenery as our train worked its way through the Central Alps (I say, as I type under artificial light on the train; we’ve been in a tunnel for a few minutes) like the little engine that could. The plan made sense until we realized that we had to include Austria in our Select Eurail Pass. Well then, we had to make a stop in Austria, and it seemed that Innsbruck made the most sense.

Innsbruck is a quaint city of approximately 120,000 extremely fit mountain people. It is situated in the Inn valley between the Nordketten mountains and the Central Alps, and is named after the Inn River which runs through it. Innsbruck played host to two Olympic Winter Games (in the 60’s and 70’s), and as the ever industrious Austrians were wont to do, made extensive use of the infrastructure from the ’64 Olympics in preparing for those in ’76, and have continued to make ample use of the facilities (hosting annual alpine ski competitions, transforming the Olympic stadium into a sports and concert venue, and the Olympic village into budget housing). We only had one full day in Innsbruck (with 2 nights booked in our 600 year old hotel), so Cara and I wanted to make the most of it.

We started early with a trip up the Nordketten mountains by funicular (a sort of very steep train), and the Nordkettenbahnen (a sort of gondola) which took us from city level, at approximately 570m above sea level, up to approximately 2800m at the peak of Hafelekar. The air was a little thin up there, and Cara and I were both huffing and puffing by the time we reached the very peak (a ten minute hike from the bahnen station). Even with that, the air felt so clean and fresh, it seemed as though the lung cancer we’d likely initiated in the land of mopeds and vaporettos was quickly reversed. In Italy, we saw many beautiful buildings. We visited historic sites, and appreciated the toil of man. On Hafelekar, we paid homage to nature. Its immensity and its wonder. We stood on the peak and looked over Innsbruck, we stared into the distance at mountains even taller than the one on which we stood. I’m struck now, in reflection, that I’ve been to the Alps and stood upon them, before doing the same in our own Canadian Rockies. This is something I am now moreso motivated to do.

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The view from Hafelekar.

Cara and I explored and hiked the various trails snaking along the peaks and faces of the range and savoured every molecule of mountain air we could manage. I even yodelled and listened as my voice (my voice!) echoed off mountain walls and through valleys kilometers away, and found its way back to my ears behind me. We took many photos and honestly, went slowly as we didn’t want to leave. This, on its own, was worth the visit to Innsbruck.

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The view of Innsbruck from Seegrube with a pretzel and a delicious dark beer.

We made our way down to Seegrube, which was the station approximately 2/3s (probably close to 2km above sea level) of the way up the mountain, and sat down to look over Innsbruck one last time. I enjoyed an Austrian beer (don’t worry, it was past noon) and a pretzel, and Cara savoured an ice cold Coke. We then hopped back on the bahnen and left that place, which, seemed so close to the sky.

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The Golden Roof. That’s pretty much it. One of the must-sees in Innsbruck, apparently.

The afternoon consisted of sightseeing at the various landmarks and historical sights of Innsbruck. We used the Sightseeing Bus to get around, which was useful as it rained for the entire evening. Perhaps this was lucky, as it was clear and beautiful for our entire trip up the mountain, but it also put a certain damper on our afternoon touring.

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The Christ to which the statue of Emperor Maximilien I prays to eternally in the Hofkirche.

First, we visited Hofkirche (the Imperial Church), where the Tomb of Emperor Maximilian I (though not his body) is housed. His tomb was not complete at the time of his death, and although his heirs saw to the completion of the monument, they did not wish to disturb his body at its initial resting place.

We next visited a Tirolean (Tirol is the region of Austria in which Innsbruck is) Museum where we saw many pieces of history and got to go inside reconstructed historical rooms (which was really cool).

We then paid a visit to Bergisel (the Olympic ski jump; we were able to go to the top and see what the skiers see before they push off. Believe it or not, the path of the jump points directly towards an ancient cemetery… I don’t know about you, but I would find that very unnerving to jump towards). Ambras Castle closed out our day. We had intended to visit the Swarovski Cristelwallten (Crystal World), which is a garden and cavern filled with spectacular natural crystals. It is described as a chamber of glittering dreams. Unfortunately, everything touristy in Innsbruck closes at 5, and we simply ran out of time. Cara and I both decided we would like to do another visit to Austria in the future, to do Innsbruck properly, and also visit Vienna and Salzburg. Who knows, maybe we could also do some skiing in the Alps (if we go during the winter).

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View from the Bergisel Ski jump.

Anyway, that’s enough of an update on our short, but excellent stay in Austria. If ever you are passing through Innsbruck, it is worthwhile to schedule a few (3-4 hours) to go up the Nordketten. It truly is breathtaking, and was the definite highlight of the stop.

We’re on the train to Munich now. We’ll watch as the mountains melt away and we descend into our first German stop. Check back in a few days, or follow the blog, to see what we get up to there!

Until next time, auf wiedersehen!