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What to do with a $10k windfall

This weekend the National Post published a Jonathan Chevreau article in which many financial gurus discussed how to spend a $10k windfall. We each got a line or two but I've posted my full recomendation below.

My first recommendation is to use the $10k to pay off any debt the investor may have. This includes credit cards, car loans, the mortgage, margin loans, etc.

If there is anything left, I'd be sure that the investors has an adequate emergency reserve equivalent to at least 3 months of salary. The emergency fund should be kept in a separate high interest account from ING Direct or PC Financial and used only in an emergency.

Most people will have used the entire windfall by this point. If any is left over I'd suggest saving about $1k to spend on Christmas gifts and holiday cheer.

I would also suggest that the investor spend the remainder of the windfall over the course of the next year. Go on a holiday, buy a TV, etc. Just be sure to avoid more debt. In other words, just spend it.

No, I've not gone off my rocker, but I don't think many investors will be successful in the next decade. Certainly not as successful as they have been in recent times.

Consider investing in 30-year government of Canada bonds which yield about 5.8%. Now include tax and inflation. With a 40% tax rate the 5.8% return drops to 3.5% which is close to the 3% inflation rate. So, after-tax and inflation such an investor will earn about 0.5% on their money. Not very inspiring. Now consider that with a few thousand to invest most investors will turn to savings bonds which yield much less than 5.8% and are very likely a losing proposition. If CSBs aren't good then perhaps a bond fund. However, even the solid PH&N bond fund charges a MER of 0.58% which makes a positive real return unlikely. As a result, if an investor has no debt and a strong emergency reserve then it doesn't make much sense to buy bonds at this time.

Ok, how about stocks? Here we are in even more hot water and I refer to Mr. Buffett's words:

"Let me summarize what I've been saying about the stock market: I think it's very hard to come up with a persuasive case that equities will over the next 17 years perform anything like -- anything like -- they've performed in the past 17. If I had to pick the most probable return, from appreciation and dividends combined, that investors in aggregate--repeat, aggregate--would earn in a world of constant interest rates, 2% inflation, and those ever hurtful frictional costs, it would be 6%. If you strip out the inflation component from this nominal return (which you would need to do however inflation fluctuates), that's 4% in real terms. And if 4% is wrong, I believe that the percentage is just as likely to be less as more."

-- Warren Buffett (Fortune Nov 99)

So, Warren comes in at 6% with 2% inflation. Now consider buying a low cost index fund that charges a MER of, say, 0.5%. A 6% return becomes 5.5% after MER, then 4.4% after tax and 2.4% after inflation. Not great. Do you really want to deprive yourself of spending fun for a measly 2% return? After all, no one is getting any younger....

Ok, say that the investor has no debt, a good emergency fund and spends more than they want. Most normal investors will have fallen out of the pack by now, but for argument sake let's say we have the full $10k to invest.

I'd put it all into a high interest savings account and wait until later on this fall. Since the markets have declined significantly this year I expect that tax loss selling will be particularly intense. The late fall has been a great time to pick up bruised stocks. Here I'd be particularly interested in those with debt-to-equity ratios of less than 1, earnings yields of more than 10% and a long history of operation.

I notice that your editors have been screaming for a good stock for today!

If pressed, I'd suggest using a simplified version of Ben Graham's defensive approach. Here I demand the following characteristics of a stock:

P/E Ratio <= 15
P/Book Ratio <= 1.5
Book Value >= 0.01
Current Ratio >= 2
5 Yr Earnings Growth >= 15%
5 Yr Dividend Growth >= 0%
5 Yr P/E Low >= 0.01
1 Yr Revenue >= $400 Million

With the help of the fine screener at I found the following U.S. candidates:

Name              Symbol P/E  P/B  Debt/Equity Current Ratio
M.D.C. Holdings   MDC    5.0  1.13     0.31      2.5
Domtar Inc        DTC    9.7  1.26     0.57      2
Pulte Homes       PHM    5.9  1.29     0.65      2.5
Haverty Furniture HVT    11   1.3      0.76      2.6
Tredegar Corp     TG     9.0  1.44     0.52      2.6
Thor Industries   THO    11   1.45     0.00      2.7
Aaron Rents, Inc. RNT    12.7 1.47     0.46      11.2

Each investor will want to do their own due diligence on these picks. For instance, investors should not buy stock in their employer just in case they are fired.

Given the small sum I suggest picking one stock and putting what is left of the $10k into it or splitting it into 2 and allotting two $5k chunks to different stocks.

I should note that I hold none of these stocks myself but have mentioned MDC as a buy to my readers. I am eyeing MDC as a potential purchase for later in the fall.

I would also say that if the investor is not comfortable with a value style then it would be wise for them to look elsewhere. Frequent style switching is dangerous to one's wealth and a nearly perfect way to buy high and sell low.
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