Friday, January 30, 2009

Short Takes: Federal Budget Edition

1. Many bloggers gave summaries of what they saw as the important parts of the budget:

2009 Budget and Investors (by Larry MacDonald)
Notes from Budget 2009 (by Canadian Capitalist)
A Budget for All (at Canadian Personal Finance)
So what do you think of the budget? (by Ellen Roseman)
Federal Budget 2009: Personal Opinion and Highlights (at Million Dollar Journey)

2. Larry MacDonald brings us stories from the budget lock-up. Journalists in the lock-up get to see the budget early, but cannot leave or communicate with the outside world until the budget is released to the public.

3. Ellen Roseman brings us the story of Toronto Dominion bank introducing a new $35 inactivity fee on unsecured lines of credit that are unused for a year. I guess you pay whether you borrow or not.

4. Preet is giving away 4 books this week. You have until 11:59 pm Friday to comment on one of the 4 posts below to enter the draws.

Findependence Day by Jonathan Chevreau
No Hype! The Straight Goods on Investing Your Money by Gail Bebee
New Rules of Retirement by Warren MacKenzie and Ken Hawkins
RRSPs by Preet Banerjee

5. How old are you in credit years? This is a little quiz (that doesn’t seem to lead to a sales pitch) that I found through a post at Clever Dude Finances & Life. After 8 quick questions, you’re told your “credit age.” It doesn’t mean much, but it is amusing. Apparently, my credit age is 45, but would have been 52 if I had any debts.

Thursday, January 29, 2009

Overcharging for Mortgage Insurance?

The latest federal budget promised to “propose new measures to ensure that Canadian consumers are charged no more for mortgage insurance than the true cost of obtaining that insurance.”

When your down payment on a house is less than 20% of the purchase price, you normally have to pay for insurance provided by the Canada Mortgage and Housing Corporation (CMHC). If you default on your mortgage, CMHC covers the bank’s losses.

Like many items in the budget document, the meaning here is not entirely clear. My best guess is that the budget seeks to stop lenders from unreasonably marking up the cost of insurance provided by CMHC. CMHC provides a table of rates that makes it easy enough to check what you should be paying, but maybe few people actually bother to check.

It never occurred to me that banks would do anything but add the exact amount of the CMHC premium to the mortgage principal. But, I guess that isn’t a very good way to run a business. Adding service charges are a core competency of banks.

Another possible interpretation of the budget language is that the government intends to overhaul the CMHC premiums, but this seems unlikely.

Are there any readers out there with direct experience with being overcharged for CMHC mortgage insurance?

Wednesday, January 28, 2009

Federal Budget Promises New Credit Card Regulations

Along with income tax breaks and massive government spending, yesterday’s federal budget promises to “enhance consumer protection by limiting [credit card] business practices that are not beneficial to consumers.” Unfortunately, the budget is vague on what changes will be made.

Here are some of the promises:

1. clear summary information on application forms and contracts
2. clear and timely advance notice of changes in rates and fees
3. minimum grace period on new purchases made with a credit card
4. improved debt collection practices

The budget doesn’t contain much more detail than this. The third point about requiring a minimum grace period on new purchases could be interesting depending on what it means. The “grace period” is the time when no interest is charged on new purchases.

My credit card agreement tells me that I get a grace period only if I paid my bill in full last month and pay it in full this month. The grace period extends from an item’s date of purchase until the payment due date on my credit card bill. I guess not all credit card agreements are as reasonable as mine and the government feels the need to guarantee some minimum grace period.

Another interpretation of this minimum grace period promise is that it will apply to all purchases regardless of whether you pay your bill in full or not. If this is right, then even if you carry a balance, your purchases wouldn’t accrue interest for some minimum number of days. Don’t get too excited, though. In a quick poll of some friends, nobody thought that this was likely the right interpretation of the budget language.

So, we’re left with the vague feeling that something will be done to make credit cards better for consumers. I hope this is true. But, don’t look for big reductions in interest payments. If government rules were to cut too deeply into credit card profits, banks would cancel many people’s cards because the risk of default would be too great for the reduced reward.

Tuesday, January 27, 2009

Bell Wants Me Back, Again

I’ve explained before that Bell technicians were unable to make their internet service work on my telephone line. In a case of the left hand not knowing what the right hand is doing, Bell continues trying to win me back as a customer.

The latest letter from Bell offers me internet service for only $17.95/month (in giant font). I suppose that would be a bargain if the service could be made to work, but I find the weasel wording around the giant numbers amusing.

In front of the giant 17 is the word “from” written sideways in tiny font. This isn’t too surprising. The cheapest service costs $17.95.month, but higher levels of service cost more. There is also a tiny superscript “2” indicating that there is a footnote with additional information somewhere. However, I don’t see any notes on the page.

A quick flip of the page shows about 130 words in 3 lines of text with characters less than a sixteenth of an inch tall all jammed into the bottom of an otherwise blank page. Nice. Fortunately, my eyes are still better than 20/20. Amusingly, there is more than enough room at the bottom of the front side of this letter for these microscopic notes.

Note 2 informs me that the rate is actually $27.95, but I’m getting a $5 discount for having a Bell telephone and another $5 discount that will go away after a year. But that’s not all. I’ll have to pay an extra $2/month for modem rental, and the $17.95 entitles me to only “2 GB/mo”.

Being a techie, I know what 2 GB (Gigabytes) means. The average person won’t know that a teenager using YouTube will burn through 2 GB very quickly. And I’ll be charged $2.50 for each addition GB. It’s not unusual for my family to use 30 GB in a month. So, I’d be hit with about $70 in additional charges. Of course there would be taxes on all this as well.

So, I guess internet service from Bell for only $17.95/month just isn’t in the cards for me, even if it could be made to work on my telephone line.

Monday, January 26, 2009

Another Way to Build Your Own Market-Linked GIC

A reader made an interesting observation about last week’s post on building your own market-linked GIC with stock options. Econstudent noted that using call options, you lose out on the stock’s dividends. So, let’s build an investment with principal protection that doesn’t lose out on the dividends.

Recall that our earlier strategy was to invest most of our $100,000 in a 3-year GIC that matured to a value of $100,000, and used the left over money to buy call options on the TSX 60 stock index. This fully protected the initial principal, and gave some upside if the TSX 60 rose over the 3 years.

Another approach is to actually buy the TSX 60 in the form of the exchange-traded fund XIU with most of the $100,000. Then buy long-term put options on XIU, and invest any cash left over in a GIC. The put options provide principal protection in case stocks drop, and you get to collect dividends during the three years you own XIU shares.

The dividend rate on XIU is about 4.8% right now, which is fairly high. In theory, all the prices of call and put options on XIU should take into account dividends. Sure enough, when I tried constructing portfolios with this alternative method that seems to have the advantage of capturing XIU dividends, I couldn’t do any better than I did with the first call option method.

It seems that put option prices are very high right now. For example, XIU closed at $13.04 on Friday, and the cost of a March 2011 put option struck at $12 is $3.15. XIU would have to drop below $8.85 in a little over 2 years for this put option to be profitable. This is more than a 30% drop. With option prices this high, it’s hard to do well building your own market-linked GIC.

Friday, January 23, 2009

Short Takes: Undeserved Bonuses and Layoffs

1. Larry MacDonald brings us the story of billions of dollars in bonuses for Merrill Lynch staff in a year where they have so far reported over $14 billion in losses. I could use a bailout to pay bonuses to myself, family, and friends as well.

2. Canadian Capitalist has some sage advice for tough times. Many people find it hard to be realistic about the possibility of being laid off. The prospect is just too horrible to imagine. But, it’s important to cut spending before being laid off to build a cash safety net.

3. Canadian Financial DIY explodes some myths about asset allocation. The oft quoted “asset allocation accounts for 90% of portfolio returns” makes little sense.

4. Frugal Trader finds the silver lining in the current recession.

5. Preet makes a strong financial case for owning a basic car and renting a fancy one occasionally when you want to impress.

6. The Big Cajun Man sees that leverage is tempting right now, but isn’t interested in taking the risk.

7. Happily, this blog has been released from Google’s doghouse. I guess a human finally looked at my content and decided that this is a real blog. Search engine hits are ramping up again as well. It looks like I’m back in business!

Thursday, January 22, 2009

Analyzing Market-Linked GICs

A risk-averse friend was asking me about market-linked GICs as a possible investment. He believes this is a good time to own stocks, but wants protection against losing any money. Market-linked GICs seem to be a good fit, and so I decided to take a closer look.

The particular GIC my friend mentioned was Royal Bank’s 3-year GIC linked to the TSX 60 index (details explained here). The basic idea is that if the TSX 60 goes up after 3 years, you get a return, and if it goes down, you get your principal back with no return.

However, if the TSX 60 goes up over the 3 years, you don’t get the full return. For example, if the TSX 60 goes up 50%, your $100,000 GIC won’t grow to $150,000. If it worked this way, it would be the same as owning the TSX 60 stocks with a side promise to give you back your full $100,000 if the index goes down. Banks aren’t in the habit of giving out free lunches like this.

Enter the “participation factor,” or PF. The bank actually promises you a percentage of the TSX 60 return. So, if your PF is 60%, and the TSX 60 goes up 50%, your return on $100,000 is 60% of the $50,000 increase in the index, or $30,000. Your $100,000 would grow to $130,000.

A minor complication in all this is that the GIC return is not based on the TSX 60 value at the end of 3 years, but on the average value over the last year of the 3 years. This reduces volatility somewhat, but also reduces the expected return.

Unfortunately, I couldn’t find any information about what PF percentage is being offered by the Royal Bank right now. They say the PF is “set at the time the deposit is purchased based on our assessment of market conditions.” The PF is the critical factor in determining whether this GIC is a good investment or not.

You’d think that this would be the end of the analysis, but not so! We can estimate a fair PF using a technique for building your own principal-protected notes described by Preet a year ago.

Start by buying a CDIC-insured GIC that will be worth $100,000 when it comes due in 3 years. The best rate I was able to find was 4.1%. If we put $88,644 into this GIC, we’ll get $100,000 out after 3 years. This takes care of the guaranteed protection of principal. Now we get to play with the left over $11,356 from our original $100,000 to invest.

We’ll put the remaining money into stock options on the TSX 60. As I write this, the TSX 60 is at 1287. We’d like to buy options struck at 1287, but the Montreal exchange only offers call options expiring in March of 2011 on the TSX 60 (ticker: VIU) stuck at 1200 and 1400. This is a little sooner than Royal Bank’s market-linked GIC which bases return on the average price over the final year (Jan. to Dec. 2011). We’ll buy the options struck at 1400. So, we’ll only get the return on the TSX 60 above 1400, instead of 1287.

As I write this, VIU options struck at 1400 have a bid of $210 and an ask of $260. That’s a huge spread, but let’s assume that we can’t do any better than the ask price. Our $11,356 would buy 43 contracts priced at $260, with $176 left over. Part of this would be eaten up by the trading commission.

With the TSX 60 at 1287, these 43 contracts represent the upside on just over $55,000 worth of the TSX 60 index. This is an effective participation factor of 55% of the original $100,000. However, we only get the upside above 1400, and our options expire a little sooner than Royal Bank’s market-linked GIC. So, if the Royal bank is offering a PF less than about 50%, we think we can do better.

I’m not actually a big fan of principal protection. I think the cost of this protection is too high. But for investors who want this protection, it’s important to evaluate whether your market-linked GIC is a good deal or not. If anyone can do better than I have at building a market-linked GIC equivalent to maximize the effective PF, I’d be pleased to hear about it.

Wednesday, January 21, 2009

Mortgages get Cheaper

The Bank of Canada dropped its interest rate by half a point to 1%, and the banks dropped their prime rates by the same amount to 3%. The banks have been criticized for not passing on lower interest rates to consumers, but they have this time. In some cases, mortgage rates have dropped by more than half a point.

It’s interesting that in the aftermath of a financial crash brought on by too easy credit, particularly in the US, the fix is to make credit easier to get. I’m not saying that I disagree with this policy; it just seems a little ironic.

Eventually we will pull out of recession, and it will be interesting to see how close we get back to the way things were. In theory, banks should have learnt some lessons and should maintain higher standards for lending money than they had before the crash. But, they face considerable pressure to loosen their purse strings right now.

I’d like to think that lending policies in the future will be sane, but we may see lending standards deteriorate over time building up to another crash. Preventing another such crash probably requires changes in banking regulations, but there is little appetite for such regulations now that we are in recession.

If we do have another orgy of derivatives and packaged debts, I hope Warren Buffett will be around to warn us again. I might take action based on his warnings the next time.

Tuesday, January 20, 2009

Watching Stock Prices

At a party recently, I listened to two people talking about stocks, or more accurately, talking about stock prices. This is harmless enough, but it became evident that these people owned some of these stocks and knew almost nothing of the finances of the underlying businesses.

To too many investors who make direct investment in individual stocks, “due diligence” means little other than looking at stock price charts. Watching stock prices is like watching the score of a football game and ignoring the game on the field. Leading by 3 points with 10 seconds left in the game sounds great until you look at the field and see the other team on the verge of scoring a touchdown.

For the investor with little interest in evaluating businesses, low-cost index ETFs are a great way to go after the long-term returns available from stocks.

Monday, January 19, 2009

QuickTax Responds to Audit Defence Questions

Last week I wrote about QuickTax’s Audit Defence product where for $40 you get the services of a tax specialist if you get audited by Canada Revenue Agency. Some readers and I had questions about how Audit Defence would work, and Geoff at QuickTax replied with some answers:

“Audit Defence, which is already a popular offering with Intuit’s US TurboTax customers, is designed to offer our Canadian QuickTax customers peace of mind. An independent research firm reported that 20 per cent of Canadians are fearful of an audit. While that might not be you or me, it’s a sizeable part of our population.

“Audit Defence for the 2008 tax year can be purchased directly within QuickTax, and will be available from February onward. Should the QuickTax user be audited or subjected to a CRA review for this tax year, Audit Defence provides full-service representation by a third-party tax specialist. They will review documentation and correspondence, provide counsel, schedule and attend appointments, and help make the audit as painless as possible. While many CRA post-assessments take place over the phone, some are conducted in person. The Audit Defence service covers you in either case. As you note, it’s not available in Quebec, but it is available everywhere else in the country, whether you’re in a big city or a small town. If you were to hire a tax professional yourself to help you through an audit, it could certainly cost you quite a bit more.

“As I noted, Audit Defence is designed as a peace of mind offering, but consider the time savings component of having a professional help prepare you and support you during your meetings with the CRA. From my personal perspective, the free hours I’d lose preparing my information or the time I’d take off work are worth significantly more than the sticker price.”

The critical factors in deciding whether to buy Audit Defence are

1. The probability that you will get audited by CRA.

2. The value of the tax specialist’s help to you if you get audited.

Your chances of getting audited by CRA depend greatly on your situation. My finances are pretty simple, and I’m not concerned about getting audited. Your situation may be different.

The value of a tax specialist’s services depends greatly on how much work this tax specialist will do for you. The first wave of Audit Defence customers will provide some information on this. The third-party tax specialists themselves may be a good source of information on this point as well. Are they given any particular limits on how much time they can spend? Is there an upper bound on how much they get paid by QuickTax? Does the customer have any recourse if he is unhappy with the level of service?

As with any type of insurance, customers have to make a leap of faith that they will be protected in the event of an audit. QuickTax begins with a strong reputation in the software tax preparation business. Some happy first customers for Audit Defence would go a long way toward helping the next set of customers make that leap of faith.

Friday, January 16, 2009

Short Takes: Mutual Fund Shame, Garth Turner, and a National Securities Regulator

1. Preet put together 15 years of mutual fund indices compared to their benchmarks. The string of mostly negative percentages is a stinging indictment of the mutual fund industry.

2. This week brought us another amusing review of Garth Turner’s latest book, this time by James Daw. “Turner tells us to buy chickens to raise, buy several seasons worth of seeds to hoard in your safe and buy a gun to shoot squirrels for food.” Great stuff.

3. There were differing opinions on the current effort to set up a national securities regulator in Canada. On the pro side are Canadian Financial DIY and Gail Bebee who believe it will benefit investors. On the con side is the Money Grubbing Lawyer (the web page with this article has disappeared since the time of writing) who believes that the current system works well and gives a detailed legal argument that forcing a national securities regulator on the provinces is unconstitutional.

4. Canadian Capitalist dug up the buried history of a new actively-managed ETF. Apparently, the Horizon AlphaPro Managed S&P/TSX 60 ETF was a mutual fund in a previous life (under two different names) and didn’t fare well against its benchmark.

5. Big Cajun Man tells the story of getting his severance package from Nortel, and feeling guilty that former coworkers who got laid off later won’t get theirs because of Nortel’s bankruptcy.

6. This blog is still partway in Google’s doghouse. I’m still waiting for the situation to be reviewed by an actual human at Google. Here are a couple of the lies a Google bot tells me each week when I have to renew my request for a review: “We'll take a look at your blog and unlock it in less than two business days,” and “someone will look over your blog and respond [by email].” In the mean time, my posts don’t seem to be picked up by any search engines. I’m tempted to make the jump away from Blogspot, but have little interest in the IT aspect of blogging; Blogspot allows me to focus on the content.

Thursday, January 15, 2009

Is Nortel a Victim of the Global Financial Crisis?

Some would paint Nortel as a company that was on the verge of making a big turn around, but was blindsided by the financial crisis. If only the credit markets were in better shape, Nortel wouldn’t have been forced into bankruptcy.

There is some truth to this point of view, but not much. To draw an analogy, when a very old and weak man gets the flu or pneumonia and dies, we can say that he would not have died if he hadn’t become sick. But he was in such a weakened state that any added sickness would end his life. This is how it is with Nortel.

As a shareholder myself, I used to hold out hope for Nortel to recover, but it’s important to be realistic. To see how weak Nortel had become, you just have to look at its earnings history. I dug through old Nortel annual reports and tried to resolve all the inconsistencies from the earnings restatements to produce this history:

Nortel Earnings ($ millions)

2008 (first 3 quarters): -3664
2007: -957
2006: +28
2005: -2610
2004: -247
2003: +276
2002: -3064
2001: -25,720
2000: -3470
1999: -351
1998: -569
1997: +812
1996: +619
1995: +469
1994: +404

Results up to 1997 looked good, and then the wheels fell off. Over these nearly 15 years, Nortel’s net loss is a little over $38 billion! Nortel’s business has been terrible for more than a decade. To say that the credit crisis caused Nortel’s problems is highly misleading.

After the bankruptcy filing, Nortel’s share price dropped to 12 cents (Canadian). Taking into account the reverse share split, this is down 10,000 times from its peak! This is a truly low point for Nortel investors.

Wednesday, January 14, 2009

Questionable Sports Charity Scheme

Little League Baseball Canada is the latest sports organization to have its charitable status revoked because it participated in a tax-shelter program set up by Parklane Financial Group, according to Paul Waldie of the Globe and Mail.

Investors who donate $2400 to a fund that pays royalties to sports organizations could get back $10,000 in tax receipts. For an investor in a 40% income tax bracket, this leads to a $1600 profit.

It’s possible that the people running the sports organizations weren’t aware of the details of the arrangement and how fishy it looks. After all, their focus is on sports rather than finance. But, it’s hard to understand how an individual making a donation and ultimately turning a profit could be unaware that something is wrong.

Tuesday, January 13, 2009

QuickTax Offers Audit Defence

QuickTax was widely criticized last year for limiting customers to filing only two tax returns per copy. They have fixed this problem for the 2008 tax year by now allowing eight returns per copy. However, the most interesting new QuickTax feature this year is Audit Defence.

If you’re worried about being audited by the Canada Revenue Agency, for an extra $40 you can get “full-service representation by a tax specialist – not just support or tips.” Of course, you pay this up front before you know whether you’ll be audited or not. This is essentially a form of insurance.

This new service has some restrictions. It’s not available to Quebec residents or users of QuickTax Business Incorporated, and it doesn’t cover GST/HST reviews or “detailed financial audits,” whatever that means.

The biggest question mark is whether the service will actually be helpful to taxpayers who get audited. Many of us know at least one person who found out the hard way that extended warranties on consumer electronics are a waste of money because it is so hard to collect on the warranty. It will be interesting to see what customer experience will be like with Audit Defence.

Monday, January 12, 2009

Silver Lining for Job Loss

Job losses continue for middle-aged workers who have put in many years with their employer and had planned to stay until retirement. The loss of savings caused by the big drop in stock prices during 2008 only adds to the stress felt by people now losing their jobs. There is a small silver lining, though.

Many laid-off workers receive severance packages including several months’ pay as well as a payout of the accrued value in their pension plans. They need some of this money to live on while searching for a new job, but a big chunk of this money can often be saved for retirement.

All this means that laid-off workers find themselves suddenly with a pile of cash to invest in some way. The currently low stock market prices make an interesting place to invest this money. There is no guarantee in the stock market just as there are no guarantees in life, but lower prices increase the chance of good returns in the future.

It would be interesting to know what choices laid-off workers are making when it comes to investing their newly-found retirement money. Some possibilities include leaving it in the company pension plan, buying an annuity, and investing it in some combination of stocks and bonds.

My choice for money I won’t need for 3 years is to put it 100% into stocks. This option is all the more attractive with today’s low stock prices, but may be a difficult choice for someone who has just lost his job and is feeling very insecure.

For those who have the courage to take advantage of fire-sale prices in stocks, I hope that future returns prove to be a silver lining slightly offsetting the painful life disruption of job loss.

Friday, January 9, 2009

Short Takes: Mortgage Interest Deductions, Garth Turner, and Monthly Payments

1. Rob Carrick reports that the Supreme Court has ruled against the Lipson’s in the mortgage-interest deduction case. The Lipsons were using what could be called a very aggressive version of the Smith manoeuvre.

2. Kelly McParland’s review of Garth Turner’s latest book is hilarious (sadly, the web page with the review has disappeared since the time of writing). I have a hard time throwing away books; it just feels wrong. I made an exception for one of Turner’s books several years ago.

3. BluntMoney has some blunt words about thinking in terms of monthly payments. I particularly liked the advice about cars.

Thursday, January 8, 2009

Money for Nothing

The book Money for Nothing: One Man’s Journey Through the Dark Side of Lottery Millions is Edward Ugel’s story of his life as a salesman buying lottery annuities. Ugel tells entertaining stories that expose the character flaws of not only the lottery winners, but also the salespeople (including himself) who chase these winners.

To understand the business Ugel was in, you first have to know that often big lottery prizes are paid out over time like an annuity. So, a prize advertised as $5 million may actually be $250,000 per year over 20 years.

For the entrepreneur who understands how people react to winning a lottery, these annuities create a business opportunity. To see this, let’s imagine a couple, Frank and Ann Beck, who win $250,000 per year for 20 years. In January of the first year they get their money and buy a big house, planning to make the mortgage payments with future years’ lottery payments.

Then Frank’s deadbeat brother moves in with them, and several other family members and friends come by with their hands out. The Becks aren’t too good with numbers, and by July, they are out of money and starting to borrow. When they get their next payment in the second year, they climb out of debt, but have little left over.

By mid-way through the third year, the Becks have debts piling up and are getting nervous. They are also very embarrassed to be in this situation. After all, they won $5 million. Now, along comes Edward Ugel to solve their problems. He offers to buy their remaining 17 lottery payments for a lump sum right now.

The Beck’s aren’t sophisticated people and don’t realize that the amount offered to buy the annuity is too low. They just see an end to their problems and accept. Ugel makes another huge commission.

It’s not just the lottery winners who have character flaws that cost them money. Ugel and many of his fellow salespeople had gambling problems; he liked video poker, slot machines, and other forms of gambling.

Overall, this is an entertaining book that exposes the human weaknesses of average people who win lotteries and the people like Ugel who preyed on them.

Wednesday, January 7, 2009

Moving Closer to a Planned Economy, Comrade

Governments are starting to do scary things with the auto and financial sectors. As Terence Corcoran of the National Post points out, there are risks in the auto bailouts (the web page with this article has disappeared since the time of writing).

Our current financial mess was caused by banks lending money to people who couldn’t pay it back. It’s ironic that governments are now pressuring banks to lend money to individuals more liberally. The thinking seems to be that banks should lend money to people who are poor credit risks so that they can buy bad cars. That should solve our problems.

The only way I can see for the banks and car companies to be run any worse would be to have the government taking an active role. Any step toward a planned economy is a bad step.

The role of government in the economy should be to set the rules, enforce the rules, and reign in market participants who wield too much power. If the government wants to encourage greener cars, it should do this by creating tax incentives. By propping up the big three car companies directly, the government is making life more difficult for new aspiring car companies. These companies exist and are much more likely to produce green cars than the big three automakers.

The basic problem with the big three automakers has little to do with the recent financial bubble. They make bad cars. Asian car companies make much better cars. It’s that simple.

General Motors, Ford, and Chrysler are too bloated and uncompetitive for it to be realistic to save all their employees’ jobs. Parts of each (or all of one) should go, but that is unlikely to happen. Much more likely is for us to step closer to a government-planned economy.

Tuesday, January 6, 2009

What to Look Out for with TFSAs

The Tax-Free Savings Account (TFSA) is a reality in Canada now that we’re in 2009, and there are some questions that you should have answered before opening a TFSA. Costs of a TFSA can offset its tax advantages.

The TFSA differs from an RRSP in that contributions cannot be deducted from your income. On the plus side, all growth in a TFSA (interest, dividends, capital gains) are tax-free and can be withdrawn tax-free.

Before leaping in and opening a TFSA at your bank, it pays to think of the bank’s motives. Banks are in the business of making money. How will they make money from your TFSA? Here are two big areas:

1. Fees

2. Interest rate spreads on cash and fixed income investments.

The TFSA is new territory for banks. You can bet that they have put considerable effort into deciding the best way to make money from TFSAs. Here are some possible approaches:

1. Offer TFSAs with similar terms and fees as RRSPs.

2. Offer TFSAs with better terms and lower fees than other accounts and try to grab major market share.

3. Try to set a new standard for higher fees and new types of fees.

Not all banks will take the same approach initially. Before opening your account, you should understand what fees you will be charged and what restrictions you will have to live with:

1. Are there fees for making deposits? (Probably not.)

2. Are there fees for making withdrawals? What about if you make many withdrawals in one year?

3. Are there account maintenance fees? (Probably for low balances, but how can the balance be high if we’re limited to a $5000 contribution this year?)

4. What interest rate is paid on cash? Is it lower than for other types of accounts like RRSPs and savings accounts?

5. What rate is paid on fixed-income investments like GICs? Is it lower than the rate paid on GICs outside the TFSA? This is a tricky one to answer because you can almost always negotiate a higher rate than the advertised rate.

6. For self-directed TFSAs, are you restricted to a limited set of investments? If all you’re allowed to buy are high-MER mutual funds, then you will be locked into paying very high fees.

7. Are there fees for transferring assets to another TFSA?

8. Are there fees for closing down a TFSA?

9. Are there any other types of fees that I’m not imaginative enough to think of?

If you’re planning to open a TFSA for emergency cash or a GIC, you can probably get these questions answered to your satisfaction fairly quickly. However, the range of possible new fees for self-directed TFSAs is broader. I plan to wait a while and let others run into the problem areas. Life can be fun on the bleeding edge, but I’d rather watch from a safe distance and avoid the spray.

Monday, January 5, 2009

Silly Headline about CEO Compensation

Outrageous CEO compensation is a serious problem. Many CEOs manage to create incentive structures for themselves that make them rich even while investors lose money. I’m usually happy to see media reports that shine the light on this issue, but a recent article is so silly that it distracts from the real issue.

On the weekend, I read the following headline: CEOs beat employee's annual wage in 4 minutes, study shows by Eric Beauchesne (the web page with this article has disappeared since the time of writing). This sounds fishy. Only 4 minutes? I know these CEOs make a lot of money, but this is crazy.

Before reading the article, I did some simple mental calculations. Let’s say the employee makes $40k/year. If the CEO makes this much in 4 minutes, that’s $10k/minute, or $600k/hour. Based on a 40-hour week, that’s $24M/week, or about $1.25 billion per year! I doubt that very many CEOs are paid his much.

Beauchesne’s article contained enough statistics that I was able to figure out that the average of the 100 highest paid CEOs in Canada make $40,237 (the average worker’s yearly pay) in a day plus 4 minutes and not in just 4 minutes. This is based on average CEO pay of $10,408,054 per year.

In fairness to Beauchesne, he probably didn’t write the silly headline, and he did quote the report from the Canadian Centre for Policy Alternatives accurately. It turns out that the report itself was misleading. A casual reader of the report would definitely be left with the impression that CEOs need only 4 minutes to make the average worker’s yearly pay.

Unfortunately, too many people don’t understand the differences among millions, billions, and trillions. Once the numbers get this big, they start to sound the same to the mathematically-challenged. It should have taken only a minute with a calculator to confirm that the newspaper headline was silly, but nobody managed to catch this. Lost in this farce is the need to properly align the interests of CEOs and shareholders.

Friday, January 2, 2009

Short Takes: Mexico Wins, QuickTax, and TFSAs

It’s been another quiet week on the blogs, but there were a few interesting articles:

1. Larry MacDonald gathered the 2008 returns of the major stock markets in the world. I’ll spoil the ending: Mexico won with a return of -21.6%. As Larry says, mattresses outperformed in 2008.

2. Canadian Capitalist is happier with QuickTax this year. You can now file up to 8 returns, and the advertising is clearer about what you get with the “enhanced” versions.

3. Scott Adams of Dilbert fame explains that the life of a billionaire isn’t always what you think it might be.

4. Preet speculates about the possible motives of investment managers who give free advice on television.

5. Big Cajun Man recounts his experience setting up a TFSA. He’s trying to work around some fees that caught him off guard.

6. Most stock pickers only talk about their success stories, but FrugalTrader admits to some unlucky timing in his latest Smith Manoeuvre update.

7. This blog continues to be held in the doghouse by Google software. I still have to fill out one of those annoying CAPTCHAs to post an article. Google bots promise that an actual human will examine the situation within a few days, but it has been weeks. Sigh. Hopefully, the bots won’t just summarily wipe me out.

Thursday, January 1, 2009

Happy New Year!

Here’s to celebrating the start of 2009 and not thinking about money for just one day!