Saturday, July 16, 2016

Short Takes: Trailing Commissions, Spooking Index Investors, and more

I’m losing track of the days while on vacation, so I’m a day late with my short takes. Here are my posts for the past two weeks:

Possible Ban on Trailing Commissions

No Fear: Tales of a Change Agent

Home-Buying Dreams

Here are some short takes and some weekend reading:

Tom Bradley clearly explains the issues at stake in the battle over banning mutual fund trailing commissions.

Dan Bortolotti offers a cynic’s guide to spooking index investors. He gets important messages across and he’s funny.

The Reformed Broker has a story about fund companies whose employees sue to not have to eat their own cooking in their retirement plans. It’s funny and sad at the same time.

Preet Banerjee’s video explains why 0% financing on a car might actually be more expensive than paying interest on a car loan from another lender.

Canadian Couch Potato and Justin Bender have updated their excellent paper on foreign withholding taxes to take into account recent ETF changes. Fortunately for me, holding U.S.-listed ETFs for foreign stocks in an RRSP still gets their thumbs up.

Mr. Money Mustache has some practical ideas for making big changes in your life to free up time and money.

Million Dollar Journey answers some questions about the Smith Manoeuvre. This is a risky strategy only suitable for a minority of investors. You need to have high risk tolerance and the ability to handle the details correctly to maintain tax deductibility.

Boomer and Echo wrote an open letter to air miles to complain about some nasty tricks that devalue the miles. I have a tough time getting too excited because I expect all such programs to devalue their points or miles once there is a large outstanding balance.

Big Cajun Man discusses his four best investments. It may not be what you’re expecting.

My Own Advisor says your net worth is misleading if you include assets you have no plan of selling or fail to take into account taxes.

Thursday, July 14, 2016

Home-Buying Dreams

I’ve written several times about the benefits of renting in Canada’s high-priced housing market (see here, here, and here). What I hear back from many young people is some version of the following:

But owning a home is one of my dreams. I want to have children and raise them in a house, not some apartment.

This is quite understandable. I bought my current home to suit my children’s needs. We’re near a school and have a nice big yard they played in when they were younger. I can certainly understand why my sons and their peers want the same thing for themselves and their own families.

Unfortunately, today’s house prices are much higher relative to incomes than they were when I was starting out. For many young people today, stretching to buy the house of their dreams is a bad idea financially.

Does this mean the dream of owning a house is dead? Absolutely not. The path may be different from what it was for me and possibly more difficult, but there is still a way.

The first thing to realize is that Rome wasn’t built in a day. Most of my peers rented apartments for a few years before they bought a home. My own path involved renting apartments, then renting a row house before I bought my first house.

The key while in the renting phase is to save money. Owning a home comes with property taxes and significant upkeep and repair costs. Renters should be able to build savings while they rent.

Another thing to realize is that renting doesn’t necessarily mean living in an apartment. While it makes sense to start out with cheaper rents, it’s certainly possible to rent row houses or even a detached home once your income can support the rental cost.

If housing prices remain high for some time, millennials my end up renting longer than my peer group did, but that could change. For anyone who rents and builds savings, a housing crash could be the perfect opportunity to jump into home ownership. But you have to be saving a down payment to be able to take advantage of lower house prices.

There is nothing wrong with building a career and savings while renting progressively nicer places to live. You might even choose to rent a nice place to raise children. There is no need to put off having a family because you want to own a home first. The important barriers are income and savings, not home ownership. At some point while building a good life based on renting, you may benefit from a housing crash and jump into buying a home.

It’s hard to imagine how housing prices can keep climbing as fast as they have been. Who could afford to buy homes at double today’s prices? I know that sounds dangerously close to making a prediction, but we’ve had many cases of house prices dropping in the past, and there is no reason to believe it won’t happen in the future.

Monday, July 11, 2016

No Fear: Tales of a Change Agent

Having worked at Nortel years ago, I was interested enough to read Tim Dempsey’s book, No Fear: Tales of a Change Agent, mainly for its alternative title, or Why I Couldn’t Fix Nortel Networks! I was hoping to get more insight into the causes of Nortel’s demise. Too many other accounts focus on Nortel’s final years when little could have been done to save the company. I was hoping for more insight into what went on in the final years of the tech bubble ending about the year 2000.

Unfortunately, the book only makes passing references to the excesses of that period when Nortel made a number of choices to please analysts and keep its stock rising. Nortel hired indiscriminately to meet growth expectations and describe itself as having “over 90,000 employees worldwide.” It also grew through numerous acquisitions. But likely the most damaging activity came from trying to meet revenue and profit expectations. Nortel built billions of dollars’ worth of telecom equipment and shipped it to “customers” who had little expectation of ever paying for it. This gave apparent immediate profits but ultimately led to enormous financial losses from which the company never recovered.

This book is primarily about Dempsey’s career in human resources at Nortel. He believes that Nortel’s “colossal collapse” came because he “was unable to effectively change the leadership system.” I doubt that a better management style would have saved the company. The top level of the company made conscious decisions to boost the stock in the short term to the detriment of Nortel’s long-term health.

In the Preface, Dempsey describes Nortel in September of 2000 as “soaring” with “$30 billion in sales.” Unfortunately, in later restatements, Nortel admitted to losing tens of billions of dollars in the early 2000s. All was not how it seemed before the bubble burst.

In discussing poor acquisitions, Dempsey explains that “an HR exec did some research on specific acquisitions that we made and discovered that we had never met the business case of a single one.” But I bet the stock price went up anyway.

At a Nortel executive leadership forum in 2000, “a long-term career Nortel employee ... gets up and expounds ‘The market’s not as big as marketing says it is; I don’t believe the numbers.’ ... he was no longer seen as a ‘team player.’” Sadly, being a team player in this case means helping to prop up the stock price by not pointing out obvious truths.

At one point Dempsey describes a conversation between a business unit CFO and a corporate executive. The CFO wanted approval for a “deal that would land a big order if we were willing to finance the whole package.” The word “finance” in this context is a euphemism for shipping equipment to a customer who would never pay and pretending the “deal” is profitable. Dempsey explains: “financing of deals led to a lot of pain. We need top line growth, so we find someone who is willing to take our money to buy our equipment, thereby driving up our forecasts and, at the time, our stock price. Many of these customers did not have established business models or track records, and some were never able to pay off these bills.”

At one point Dempsey refers to “accounting mishaps.” This is a very generous way to describe false financial statements. It may not be possible to prove anything about Nortel’s intent at the time, but it is naive to think that these were just inadvertent mistakes.

For anyone who has ever played buzzword bingo, one particular sentence in the book sticks out: “we led many projects, seeking numerous objectives, hopefully synergistically and reinforcing in a systemic way, to steer us to some tipping point that would make the change inevitable.” This sentence is a good reminder that the book is primarily a story of Dempsey’s career in HR and only small parts are directly related to Nortel’s business activities.

As the tech bubble inflated and the value of stock options held by executives grew astronomically, Nortel did what was necessary to keep its stock price rising. It hired recklessly, made acquisitions, and built billions of dollars’ worth of telecom equipment and sent it to “customers” who would never be able to pay for it. Dempsey thinks the problem was leadership style and other commentators think the important mistakes were made in Nortel’s later years. Why do we need to search for subtle problems within Nortel when its actions during the tech bubble were more than enough to destroy the company?

Tuesday, July 5, 2016

Possible Ban on Trailing Commissions in Canada

The Canadian Securities Administrators (CSA) has issued a proposal to ban mutual fund embedded commissions. This would force financial advisors to charge their clients directly instead of getting commissions from the mutual funds that hold their clients’ investments. Whether this makes sense depends on how we view the mutual fund industry.

There are two extreme narratives that characterize the fund industry in Canada. Which one you think is closer to the mark will likely decide whether you support CSA’s proposed changes.

Narrative 1: Financial advisors are hard-working professionals who must be paid for the initial work they do for their clients and must be paid a lesser amount each year for their ongoing work helping their clients. Paying the advisors out of client assets within mutual funds is just a convenient way to complete the transaction with a minimum of hassle for clients.

Narrative 2: Mutual funds that pay trailing commissions know that investors are clueless about costs and have conspired with advisors to increase fees to punishing levels and split the spoils. The embedded commission model is designed to keep investors in the dark.

Obviously, there is some truth in both narratives. But which one dominates? As the latest changes to the Client Relationship Model (known as CRM2) come into full effect, no doubt reality will be pushed somewhat away from Narrative 2, but how much? Is CRM2 enough or do we need to ban embedded commissions entirely?

My own opinion is that there is too much truth in narrative 2. There are certainly some good pockets within Canada’s mutual fund industry, but banning embedded commissions is needed. If it happens, it will cause big changes.

Thursday, June 30, 2016

Short Takes: Autistic Adults, Criticizing Banks, and more

Have a great Canada Day! With Canada Day landing on Friday, I’m giving my short takes a day early. Here are my posts for the past two weeks:

Visa Response to Walmart Unconvincing

Misbehaving: The Making of Behavioral Economics


A Wealth of Common Sense

Here are some short takes and some weekend reading:

Big Cajun Man looks at solutions to the problem of how to keep making financial decisions for an autistic family member who becomes an adult. Hint: the solution is not a power of attorney.

Tom Bradley at Steadyhand observes that few people in the financial industry are in a position to be critical of our banks, but he would like to see the much lower costs that are surely possible due to their massive scale. I’ve long thought that the best hope for lower costs will be a never-ending stream of banking start-ups (such as ING/Tangerine, PC Bank, EQ Bank, etc.). As the big banks buy each start-up, it just encourages more start-ups to give it a try. If enough enter the market, the big banks won’t be able to keep fees sky high by buying them all.

Canadian Couch Potato looks at the trade-offs between holding cheap U.S. ETFs directly versus the convenience of holding a more expensive Canadian ETF that invests in the U.S. ETFs.

Kerry Taylor has a very interesting take on the cost of getting married. She says the average wedding cost in Canada is about $27,000, but you can get married for as little as $427 in Toronto. “Shelling out an additional $26,573 does nothing to get you hitched.” So, don’t blame high costs on getting married. Getting married is cheap; it’s the party you indulge in that’s expensive.

Preet Banerjee interviews Randy Cass, CEO of robo-advisor Nest Wealth, in his latest podcast. Nest Wealth charges its customers a flat monthly fee instead of a percentage of their savings.

My Own Advisor discusses the crossover point where your savings produce enough income to cover your expenses. I think about this quite a bit and I find it difficult to decide how much safety margin to build into my expected expenses. I’ve built in allocations for infrequent purchases like a new roof, car, furnace, and air conditioner. But it’s hard to give up a steady pay cheque when I know there’s a chance I might need more money than I think.

Boomer and Echo looks at the right way to calculate your net worth. I think it depends on what you plan to do with the information.