Friday, October 31, 2014

Short Takes: Crowdfunding Tax Issues, Index Investing Choices, and more

I wrote one post this week revealing my asset allocation and my reasoning behind it:

My Asset Allocation

Here are some short takes and some weekend reading:

The Blunt Bean Counter looks into the tax implications of crowdfunding.

Potato looks at a wide range of choices for implementing a passive index investing plan. He rates them by simplicity and costs.

Gail Vaz-Oxlade describes a life without the secret debt that comes from overspending on cars and vacations as “living in the light.” I like it.

Colleen Jaconetti at Vanguard coins the term “rebalaphobia,” the fear of rebalancing your portfolio. I think this is quite common.

Big Cajun Man reports that TD Waterhouse has made it easier to make transactions in their RDSP accounts.

My Own Advisor reviews the book The Empowered Investor.

Million Dollar Journey shows how to figure out where your hydro dollars are going.

Tuesday, October 28, 2014

My Asset Allocation

I’ve resisted discussing my asset allocation for some time, but now is finally the time to describe it and the reasons behind it. I’m not holding it out as a model portfolio; I believe it’s suitable for me and not necessarily anyone else. With that warning, enjoy the discussion and feel free to ask questions or take some pot-shots.

The main reason why I haven’t discussed my asset allocation in detail before now is that I don’t want readers to treat it like a model portfolio and follow it blindly. Everyone’s situation is different. The need for variation in asset allocation from one investor to the next usually isn’t huge, but there is no one-size-fits-all portfolio.

A secondary reason for keeping my asset allocation to myself is that I can’t be sure I’ll never change it. For example, I recently made the minor change of switching from an ETF of small-cap stocks to an ETF of small-cap value stocks. I don’t have any plans to change my current allocation, but I may think differently in the future.

All Stocks

To start with, my portfolio is 100% allocated to stocks. This means that my returns are more volatile than portfolios containing some bonds and real estate. I don’t recommend 100% stocks for everyone, but I believe it works for my situation.

I have a fully paid-for house and have no debts of any kind. I get job offers fairly regularly, so I’m not overly concerned about the continuity of my pay cheque. I also have a cash buffer that bounces around between 3 and 6 months of my family’s spending. This stable base makes it reasonable to handle the volatility of stocks.

On the emotional side, I handled the tech crash in the early 2000s and the financial crisis of 2008-2009 without any panic selling or sleepless nights. So, I’m confident I don’t need the security of a lower-volatility portfolio.

I’m also prepared to adjust my retirement date based on stock market performance. Before retiring, I’ll certainly sell a sizeable block of stocks and hold the proceeds in safe investments like cash or GICs. If it seems like a bad time to be selling stocks, I’ll just keep working until I can sell some stocks. It’s true that many people have a retirement date forced upon them for health or other reasons, but I expect to have enough savings to cover my expenses indefinitely before I reach age 65.

The Allocation

To decide on an allocation among Canadian, U.S., and international stocks, a starting point is the percentages of the world stock market capitalization each represents. According to a Harvard blog, Canada and the U.S. have 4% and 40% of the world’s stock market capitalization, respectively. So, we have

4% Canada, 40% U.S., 56% international

However, I live in Canada, and while it doesn’t make sense to have too much of a home country bias, my spending is correlated with the fate of Canadian companies. So, I chose to bump up my Canadian allocation to 30%. There’s nothing magical about this figure; it just seems about right. Leaving the other two categories in roughly the same proportion gives us

30% Canada, 30% U.S., 40% international

I spend a good chunk of my time in the U.S., so for the same reason I increased my allocation to Canada, I increased my allocation to the U.S. to 45%. Again, there isn’t much to justify this exact figure; it just seems about right. This gives

30% Canada, 45% U.S., 25% international

Choosing ETFs

There are a number of ETFs that cover my 3 allocation categories. I use low-cost index ETFs for each category. For Canadian stocks I chose Vanguard Canada’s VCN. There are several other possibilities, but I like that VCN includes some smaller-capitalization stocks and more stocks than many other ETFs. I also like Vanguard.

For the U.S. and international allocations, I decided to go with ETFs from the U.S. rather than Canada. This has the advantage that the MERs are lower than they are with Canadian ETFs, but a disadvantage is that I have to do currency exchanges between Canadian and U.S. dollars. Fortunately, Norbert’s Gambit is a clever way to reduce currency exchange costs.

For international stocks, I went with Vanguard’s VXUS. This ETF covers the entire world other than the U.S. It does include a little bit from Canada. So, my actual allocation to Canada is more like 31% than 30%.

I chose to use my U.S. allocation to get some added exposure to small-cap stocks and value stocks. So, my U.S. allocation is split between VTI and VBR, both from Vanguard. VTI holds an index of all U.S. stocks. VBR holds all U.S. small-cap value stocks.

Here is the final allocation to index ETFs:

30% VCN
25% VTI
20% VBR
25% VXUS

There is nothing magical about these exact percentages. The key thing is to stick to them. It’s far too easy to see one ETF shoot up in price and suddenly decide to increase your allocation there. It’s better to mechanically rebalance back to your chosen percentages occasionally.

Complications

Having only 4 ETFs may seem overly simple and that there is room for finer slicing and dicing of categories. However, there are always added complications when you try to use an asset allocation in real life. It’s better to start with something simple.

One complication I have is that my wife and I have 9 accounts. Why not consolidate some of them you may ask? I can’t. My wife and I each have one RRSP, one TFSA, one LIRA, and one non-registered account. The ninth account is her spousal RRSP. I treat the 9 accounts as a single portfolio, which simplifies things somewhat, but handling this many accounts adds some complication.

Another complication is that I keep as much of my VTI, VBR, and VXUS in RRSP accounts as possible. This is because the U.S. imposes a dividend withholding tax on stocks held in our TFSAs and non-registered accounts. Following this rule sometimes forces me to make extra trades when I’m rebalancing the portfolio.

I have a group RRSP at work that I joined to get the company matching contributions. The MERs of the funds offered are extremely high, and my lowest cost option among stock funds is a Canadian index fund. So, I treat it as part of the 30% allocation to Canada.

My wife and I still hold some Berkshire Hathaway stock that has significant unrealized capital gains, so I’m not inclined to sell until it’s convenient from a tax perspective. For now, I treat it as part of my U.S. allocation which reduces the amount of VTI and VBR we hold.

There are other complications, but you get the idea; it’s best to start with a simple allocation.

MERs

A particularly good feature of my allocation is its low cost. Here are the MERs:

VCN 0.05%
VTI 0.05%
VBR 0.09%
VXUS 0.14%

Blended Portfolio MER: 0.08%

This is a very low yearly cost, and you may wonder what would be the big deal if it were 0.25%, or 0.5%, or higher. Because your investments grow for a very long time, it’s best to think of costs over a much longer time than just one year. These costs aren’t just charged on new money; the same money gets hit year after year. So, the costs build up.

I use what I call the MERQ (Management Expense Ratio per Quarter century). Thinking about costs over 25 years gives a better perspective. My portfolio’s blended MERQ works out to 2.0%. This means that every dollar I save that stays in my portfolio for 25 years grows to 2% less than it would have without MER costs. But for an MER of 0.5%, the MERQ is a much more painful 12%.

MERs aren’t the only portfolio costs. There are trading commissions, bid-ask spreads, trading costs within the fund, currency exchange spreads, and dividend withholding taxes to consider. Be sure to account for all costs when choosing among portfolio options. In my case, my portfolio is large enough that the MERs and international withholding taxes within VXUS dominate the other costs.

Conclusion

So there you have it. I have a fairly simple, low-cost portfolio of index ETFs. It suits me, but your mileage may vary.

Friday, October 24, 2014

Short Takes: PRPPs, Sticking with a Plan, and more

Here are my posts for this week:

Stock Market Momentum

The 4-Hour Workweek

Here are some short takes and some weekend reading:

Preet Banerjee explains why he thinks that PRPPs don’t offer enough to make them attractive compared to TFSAs, RRSPs, and group RRSPs.

Canadian Couch Potato offers three specific reasons why you should stick with your asset allocation plan in the face of recent stock volatility.

The Blunt Bean Counter highlights the huge gap in income tax levels between Alberta and Ontario on incomes above $150,000. So far Ontario has kept the top marginal rate a hair under the psychological barrier of 50%. Their game seems to be to lower the income that gets hit with higher rates. If they ever do go over 50%, it should make some people rethink where they want to live or how hard they want to work.

Big Cajun Man managed to finally stop paying for AOL. I didn’t even know that AOL was still around. I used to joke that I belonged to their CD of the month plan. I still use some of their CDs as coasters.

My Own Advisor runs through the basics of PRPPs, but finds that they don’t add much to existing plans without being mandatory.

Wednesday, October 22, 2014

The 4-Hour Workweek

I had heard so many different things about Timothy Ferriss’s book, The 4-Hour Workweek, that I thought it couldn’t possibly cover all the subject areas. But I was wrong. Ferriss gives step-by-step instructions for changing many different aspects of your life all unified under the theme of “escape 9-5, live anywhere, and join the new rich.”

The main themes of the book are getting past fear of change, eliminating time waste, creating a low maintenance business, getting agreement to work for your current employer remotely, mini-retirements, and living in other parts of the world. Some of these themes may seem familiar, but Ferriss’s detailed strategies for completing these goals make this book unique. Few readers will attempt everything they read about in this book, but almost all readers will find some useful information for improving their lives.

The type of reader who will get the most out of this book is the 9-to-5 cubicle-dweller who yearns for a different life. We get some insight into Ferriss’s personality when he says that we shouldn’t be trying to figure out what we want or setting goals; we should be seeking excitement. He goes on to say that “boredom is the enemy, not some abstract ‘failure.’”

The discussion of taking mini-retirements instead of short vacations seems compelling, but I think it is only likely to be helpful for talented people who can find a new job or career fairly easily. I can see the concept of mini-retirement being used as an excuse not to look for a new job by someone who loses a job and can’t really afford to sit around.

A quote from Dave Barry sums up feeling s about meetings among fed-up office workers: “Meetings are an addictive highly self-indulgent activity that corporations and other organizations habitually engage in only because they cannot actually masturbate.”

Another quote from Robert Frost that will resonate among cubicle-haters: “By working faithfully eight hours a day, you may eventually get to be a boss and work twelve hours a day.”

Continuing with this theme, Ferriss writes “Most people aren’t lucky enough to get fired and die a slow spiritual death over 30-40 years of tolerating the mediocre.”

We get some encouragement to take a chance from a Colin Wilson quote: “The average man is a conformist, accepting miseries and disasters with the stoicism of a cow standing in the rain.”

One area where Ferriss’s ideas and mine differ is with investing. He chooses to own only fixed income investments and stocks of companies he is able to influence through angel investing. I’d rather just own every stock in the world and focus on other things.

The author emphasises the importance of not letting email chew up too much of your time. He says to check it only a couple of times per day, or even better a couple of times per week. He makes a good point about avoiding work email on the weekend: “Is your weekend really free if you find a crisis in the inbox Saturday morning that you can’t address until Monday morning?”

I can’t do this book justice in explaining how thorough Ferriss’s prescription is for transforming your life. No doubt most readers will not choose to follow Ferriss’s path exactly, but he does a great job of giving the tools necessary to change the things you want to change.

Monday, October 20, 2014

Stock Market Momentum

People tend to think of the stock market as something that moves up and down like an airplane. There are problems with this way of thinking that cause investors to make poor choices.

If the stock market really were like an airplane, it would have momentum that makes it difficult for the market to change direction from rising to falling or vice-versa. The truth is that prices can change on a dime because they are determined by the bid and ask prices of traders who can change their minds in an instant. There is a technical concept of momentum in stock prices, but it isn’t the same as momentum in physics; there is no physical object that must be slowed down and turned in the other direction.

The problem with a false analogy like the airplane is that it creates the illusion that if markets move in one direction a few days in a row, they are almost certain to continue that way for a while. But this isn’t true for stocks.

The recent downtrend in stock prices has many commentators saying that we are “in a correction.” But all we can say with any certainty is that we have had a correction. It may or may not continue. Saying that we are in a correction implies that falling prices will continue over the short term, which is far from certain.

The wiring of our brains makes humans very good as finding patterns. The trouble is that we sometimes see patterns that aren’t there. Stock prices over the short term are largely random. If you think you see a pattern, blame your brain.