Friday, July 30, 2010

Short Takes: Buying Tax Losses, Mortgage Pre-Payment Rules before Discharge, and more

1. Larry MacDonald described a scheme to eliminate your income taxes by buying tax losses from companies. Canadian Capitalist isn’t in a hurry to try it. I wouldn’t try this myself for fear that it would be disallowed for some reason, but it is interesting.

2. Canadian Mortgage Trends has some good advice about pre-paying a mortgage before discharging it.

3. Preet argues that when it comes to measuring the performance of mutual fund managers as stock-pickers, the index is too high a standard. His focus is on the manager’s stock-picking ability rather than whether the mutual fund in question is a good investment.

4. Canadian Financial DIY reviews the new taxwiki.ca.

5. The Money Gardener almost went for a clever approach to extended warranties at Sears.

6. Big Cajun Man got a good rant going about troubles with his PC MasterCard.

7. Million Dollar Journey addresses the question of whether students should contribute to an RRSP.

8. Money Smarts had an uplifting post about how work kills a piece of his soul every day. I’ve had days like that. I think my soul regenerates, though.

Thursday, July 29, 2010

Why is “Free” So Irresistible?

For some reason we overvalue things that are free. My wife jokes that she chose her university program based on the fact that they gave each new student a free T-shirt. We seem to be willing to do quite a lot to get something for free.

Anticipating a free bag or other trinket at the end of the year keeps me doing volunteer work. A bottle of liquor with an attached sample-sized bottle of some other drink seems much more appealing than some other bottle without a “free” sample even though the first bottle is more expensive.

I recently made a poor choice because I couldn’t turn down a free lunch. The owner of the building I work in offered tenants a free lunch. This lunch consisted of hot dogs, warmed up pre-cooked hamburgers, coleslaw, and fries. I was nauseous the rest of the day and even had trouble sleeping that night. The worst part of it was that I knew this would happen and I ate it anyway.

I’m interested in hearing of other stories of free things that would have been better to have turned down. Even better would be to show me how to avoid the next stomach-churning free lunch.

Wednesday, July 28, 2010

Mastercard Updates Rules

Mastercard has updated its Cardholder agreement to make it consistent with the new credit card regulations from the Canadian federal government. However, many of these changes don’t take effect until 2010 September 1.

Here are the highlights:

Credit Limit

You must provide your consent before your credit limit is increased.

End to Double-Cycle Billing

You won’t be charged interest on new purchases if you pay your bill in full even if you didn’t pay it in full the previous month.

Cancellation of Card

Your card can be canceled if you have no activity for 9 consecutive months.

The first two changes are definitely customer-friendly. To compensate, we can expect some combination of higher credit card interest rates, lower credit limits, and higher credit-worthiness to acquire a credit card. Banks and credit card companies are in this business to make money, and we have to expect them to shed unprofitable customers.

Tuesday, July 27, 2010

A Proposed Smooth Billing Plan for Utilities

The typical equal billing plan has customers pay exactly the same amount each month for gas or other utilities. If the utility gets the estimated consumption wrong, customers face a large correction at the end of the year. Many Enbridge customers are unhappy about the recent large end of year bills they received to make up for monthly payments that were too low.

One way to avoid this problem is to use a smooth billing plan of the type I’ll describe. This plan allows for modest changes in the amount billed each month to correct for poor initial consumption estimates. This smooth billing plan has the side benefit that consumers can see with each bill whether their consumption is rising or falling. Without this feedback, consumers are encouraged to increase consumption.

Suppose that your estimated consumption of natural gas is as follows:

Jul: $30
Aug: $30
Sep: $60
Oct: $80
Nov: $100
Dec: $180
Jan: $220
Feb: $190
Mar: $140
Apr: $100
May: $40
Jun: $30

These numbers are cooked to work out to an average of $100 per month. One way to do the billing is to charge exactly $100 each month and correct any estimation error at the end. But what happens if consumption is actually 25% higher than the estimate? In this case, the final bill has $300 added to it for a total of $400.

Another approach is to adjust the bill by small amounts each month to correct for estimation errors. If actual consumption for July is $42 ($12 over the estimate), this is split evenly over the 12 months, and the July bill is $101. If August’s consumption is under the estimate, the difference is divided by the 11 remaining months and the bill goes down by a small amount.

With this approach, even if consumption is consistently 25% higher than the estimate, the gas bills will start at $100 and rise steadily to $163 in the final month. The total amount billed over the year exactly matches consumption, and there is no $400 shock in the last month.

This approach gives the consumer a fairly smooth bill, but does have enough change each month to alert the consumer to unexpected increases or decreases in consumption. This feedback encourages adjusting usage habits to conserve energy.

Monday, July 26, 2010

Equal Billing Plans Encourage Increased Consumption

Utilities often offer some sort of equal billing plan that allows customers to pay fixed payments each month. This requires the utility to guess each customer’s consumption for the year. Any estimation error gets corrected at the end of the billing year. But, what effect does equal billing have on consumption?

Ellen Roseman reported that natural gas utility Enbridge underestimated customer consumption over the past year by a wide margin. This has led to a predictable outcry from customers unhappy with the large bill they received to cover actual gas consumption. Lost in the discussion of whether Enbridge should have done a better job is the negative effects of equal billing (called the Budget Billing Plan by Enbridge).

In general, people like predictability in the costs they face. It’s easier to plan exactly how much money will be left out of every pay cheque if all monthly costs stay constant. However, for many people, once a monthly amount is set, the mental link between consumption and having to pay for that consumption is severed.

It becomes far too easy to nudge the thermostat up another degree in the winter if you won’t have to pay the added cost until the next summer. When monthly billing is based on actual consumption, the delay from setting the thermostat to seeing the higher cost is only a month or less. The shorter this delay is, the better most people are able to control their consumption.

The hue and cry over the large Enbridge bills is evidence of consumers’ ignorance of their gas costs. If these people had faced unpleasantly high bills sooner, some may have chosen to reduce their use of natural gas sooner.

Friday, July 23, 2010

Short Takes: iShares Sleight of Hand on Fees, Mutual Fund Disclosure Changes, and more

1. Rob Carrick reports that the new owner of iShares is making the tricky move of publicizing Management fees rather than the complete Management Expense Ratio (MER).

2. Preet isn’t too happy with the direction taken by proposed new point of sale mutual fund disclosures.

3. Larry MacDonald thinks the flood of new commodities investors may be causing commodity returns to become more correlated with stock returns.

4. Larry Swedroe has some amusing things to say about the value of interest rate forecasts. I’ll give you a hint – he doesn’t believe that anyone can accurately forecast interest rates.

5. Financial Highway has a useful list of 10 things to know about renter’s insurance.

6. Canadian Capitalist has a survey of commodity indices that may help if you’re thinking of investing in commodities.

7. Thicken My Wallet takes a look at what different types of lawyer services should cost.

8. Big Cajun Man muses about what it would take to lower his mortgage debt by $10,000 in a year.

9. Frugal Trader explains the different kinds of insurance, part 1 and part 2.

10. Money Smarts has a story of having to evict an old lady for her own good.

Thursday, July 22, 2010

Does Buying a House Make You More Financially Responsible?

The Wealthy Boomer did a piece on the financial habits of homeowners and non-homeowners. The piece quotes from a survey that concludes that homeowners are more financially fit. This study is reasonable as far as it goes, but the conclusions confuse correlation with causation.

Among Canadians who own a home, 65% pay off their credit card balances each month compared to only 48% of non-homeowners. This and other statistics leads Genworth Financial president and COO Peter Vukanovich to conclude that “homeownership helps people focus on their financial situation and get their fiscal house in order.” The idea is that buying a home somehow makes you better at managing your money.

This last part is a theory based on the correlation uncovered by the study. Another theory is that people who cannot manage their money well are less likely to buy homes. Personally, I find this theory more plausible. Maybe there is some truth to both theories, but the statistics do not prove either one.

This whole business is like examining the height of basketball players and concluding that you can grow taller if you start playing basketball. In this case it is quite obvious that causation goes in the other direction; people who are tall are more likely to be drawn to playing basketball.

This problem with the conclusions of studies comes up very frequently. The next time you read about a study, try looking for unjustified leaps to convenient conclusions.

Wednesday, July 21, 2010

Protecting Yourself from Interest Rate Increases

There is no shortage of speculation on what will happen with interest rates. Some commentators predict sharp increases and others predict stable rates. Maybe there are some who predict that interest rates will drop a little. Many borrowers listen to these predictions trying to decide whether they have to do anything about their growing debts. This way of thinking is dangerous.

Just because a convincing forecaster says that interest rates will not rise, we should not ignore dangerous debt levels. Debtors should look at the range of possibilities rather than listen to experts make precise predictions. The truth is that nobody knows for sure what will happen with interest rates.

The best rate I was able to find for a 1-year closed mortgage is 2.64%. In three years, this rate could easily be anywhere in the range 2% to 8% or higher. Borrowers should ask themselves what will happen to them if rates rise steadily to 8% in the next 3 years. Will finances be a little tight or will they go bankrupt?

It is the range of possibilities that matters, not the most convincing prediction.

Tuesday, July 20, 2010

Commodity Futures not the same as Commodities

Recently, Canadian Capitalist asked whether Canadians should add commodities to their portfolios. On the surface, I couldn’t understand why a hunk of copper would be expected to perform as well as the stock market. However, when we say “commodities”, we are actually referring to commodity futures. (No doubt Canadian Capitalist understands this well.) Futures differ from the commodities themselves in important ways.

There is no reason to believe that commodity futures will give the same returns as the commodities themselves. When we buy a copper future, the price will reflect not only the current price of copper, but also the uncertainty in the future value of copper. Like any other derivative, commodity futures have time value.

If an investor buys a one-year copper future, sells it a year later, and buys another one-year copper future, there is no reason to believe that the sale price of the first future will match the purchase price of the second future. However, actual copper will maintain constant value during the few seconds the investor was making the futures trades.

I’m convinced that owning commodities directly is unlikely to beat investing in the stock market. After all, we keep getting better at growing things and digging things out of the ground more cheaply. A possible exception is commodities that are being exhausted, like oil.

However, commodity futures could easily perform very differently from the commodities themselves. The price of a future will reflect a risk premium. The more perceived risk, the greater the expected return. None of this proves that commodities futures are a good investment, but it is possible.

Monday, July 19, 2010

Smooth Consumption over a Lifetime

For many people income levels over their lifetimes can be very uneven. Younger people tend to earn less per year than middle-aged workers, jobs are sometimes lost, and many women and some men take time off to raise children. There can also be windfalls such as inheritances or lottery winnings. Despite this unevenness in income, it is possible to smooth out yearly spending with appropriate saving and borrowing. However, is targeting smooth consumption a good idea?

I first encountered the idea of smooth consumption in Moshe Milevsky’s book Your Money Milestones. I’m not prepared to give a full review yet, but the idea of smooth consumption is worth some thought on its own.

Milevsky introduces the idea with an idealized example. Suppose you are 25 and know for certain that you’ll make $25,000 per year for 10 years, $100,000 per year for 20 years, and then $25,000 per year for 30 years and then die. If we ignore taxes, inflation, and interest, your total lifetime earnings will be $3 million or $50,000 per year over your remaining 60 years of life.

By borrowing in your early years, saving in your high-income years, and spending your savings later in life, you can smooth out your spending to exactly $50,000 per year. Milevsky says that “the correct way of thinking about savings rates is as the output of a financial plan that seeks to smooth consumption.”

However, things look different when we take into account interest on debt and returns on savings. Suppose that the income levels are actually in constant dollars (meaning that they increase with inflation). Suppose further that interest on debt and savings is 3% above inflation each year. How does this change the picture? Taking into account interest, it turns out that you can spend $55,000 each year and will run out of money after 60 years.

Now, what happens if you don’t start spending $55,000 per year right away? Suppose that you start spending $30,000 per year and increase this by $2500 per year until you reach some maximum and hold it steady for the rest of your life. In this case, the maximum yearly spending is $61,900 per year and your average yearly spending over the 60 years is $58,200 per year.

By delaying peak spending when you’re young you can increase the total amount you can spend over your lifetime. This illustrates the benefit of saving. This idea can be taken too far by scrimping all your life only to die while sitting on a mountain of money, but a reasonable amount of frugality while you are young can pay big dividends later in life.

Milevsky’s message of smoothing consumption is a very good idea for people who receive windfalls. Highly-paid athletes would be very smart to save heavily during their earning years. The situation is different when considering going into debt. The idea of smoothing consumption by spending heavily when you have a low income can be overdone. Borrowing for sensible things when you’re young like an education or a house can make sense, but spending twice your income while making $25,000 per year is crazy.

Sadly, good advice is often taken by the wrong people. Spendthrift young people may take Milevsky’s advice and overspend, and miserly people may take my approach and save every penny for a rainy day that never comes. On the whole, though, I think more young people need a message of saving than need a message to spend more.

Friday, July 16, 2010

Short Takes: Retirement Savings, Eco Fees, and more

Larry MacDonald reports on a study that says 80% of Canadians’ save enough that their consumption will drop by less than 10% upon retiring. This contrasts sharply with the near hysterical cry to save baby boomers from starvation when they retire. My guess is that the truth is somewhere in between.

Preet takes a stand and declares that eco fees are a tax despite what Stewardship Ontario says.

Canadian Capitalist reviews a new Canadian equal-weighted index ETF.

Bill Mann reports that the plug-in Prius is coming to Canada.

Big Cajun Man got a rant going on the subject of pet health insurance.

Financial Highway lists 9 things your insurance agent won’t tell you. I must say that I’ve found it challenging to learn how the insurance industry works. I wish I’d seen this list a decade ago.

Thicken My Wallet has some advice for people stuck in McJobs.

Frugal Trader debates whether to start paying off his Smith Manoeuvre investment loan now that his mortgage is paid off.

Thursday, July 15, 2010

The Myth of Visible Sales Taxes

One of the justifications for applying the GST and HST at the cash register is that this makes it a visible sales tax. Unfortunately, it is this very feature that makes this tax invisible at the most critical time: when consumers make purchasing decisions.

Canadians are becoming increasingly accustomed to seeing added charges on top of advertised prices. Eco fees just add to standard HST or GST plus provincial sales tax. Things are worse if you want to fly; the number of added charges on flight costs is almost uncountable.

An unfortunate side effect of this trend is that we don’t know what the final price of an item will be even knowing the advertised price. This makes it difficult to make sound purchasing decisions. By adding these charges later to make them visible, they become invisible when we make the decision of whether to buy.

There is some justification for applying sales taxes after the fact because not all customers must pay GST or HST. For example, online retailers must routinely calculate different sales tax depending on where the purchaser lives. Another justification is that these sales taxes are a fixed percentage that people tend to understand reasonably well.

Eco fees are a very different matter. The amounts vary wildly. There is no reason why eco fees shouldn’t be just included in advertised prices. If retailers want to make eco fees more visible, then they can include a mention of the eco fee amount along with the advertised price that includes this fee.

If this trend continues too far, then advertised prices will bear no resemblance to the all-in price the consumer must pay. (This has already happened with cars and airline flights.) I would prefer to see all-in pricing as is common in much of Europe.

Wednesday, July 14, 2010

Skeptical Investing

John Lawrence Reynolds pulls no punches in his book The Skeptical Investor: How to Grow and Protect Your Retirement Savings. He rips through the investment industry, fraudsters, and poor investment vehicles. Overall, the book is useful for novice investors, but they may find themselves cowering under a bed before reaching the last page.

The main focus of the book is what investors should not do. Less focus is placed on what investors should do, but this makes some sense. There is only one best path and many bad paths. Reynolds explains what is wrong with the bad paths in easy to understand compelling terms.

About mutual funds he says “Canadian mutual fund expenses charged to those who entrust the fund with their money are outrageously and indefensibly high.” Reynolds thinks that a fee-based approach where investors pay a fixed percentage of their assets rather than paying commissions and MERs makes more sense.

“Nearly 5% of Canadians have been victims of investment fraud at some point in their lives.” This surprised me greatly. Could this really be true of over a million people? Reynolds devotes an entire chapter to an interesting discussion of different types of investing fraud.

A common theme in the book is that investors must be protected from huge drops in stock prices like what happened in 2008 and 2009. Many times Reynolds tears apart financial advisors for not protecting their clients from stock market crashes. At first I thought he meant that advisors should have seen the crash coming, but he never explicitly says what the advisors should have done to protect their clients.

The book goes through various methods of protecting principal, but finds them all lacking. Principal-protected notes, segregated mutual, and lifecycle funds have high fees built in. The risk of default with high-yield bonds is too high. Put options are too complicated for most investors to understand. Good financial advisors who can protect their clients are available only to those with 7-figure portfolios. Asset allocation does not prevent losses.

Wolves await the small-guy investor behind every door. What does the author suggest we do? In the end he advises a fairly conservative asset allocation where your percentage in fixed-income matches your age up until about age 80 when you should buy an annuity. This is a little too conservative for me, but most investors will make worse choices than this.

Overall this book is useful for explaining the many pitfalls awaiting the unwary investor. The criticisms of the investment industry are mostly deserved. The exception is the implication that financial advisors can somehow protect clients from losses. Of course, investors who view financial advertising can be forgiven if they believe that they were promised protection from losses.

Tuesday, July 13, 2010

Measuring Portfolio Returns

On the surface, measuring your portfolio’s return and comparing it to some index seems like it should be easy: take the final value, divide by the starting value, and compare. However, there can be a number of complications. This is my attempt to evaluate my investing performance.

Over the years I’ve done many approximate calculations to assess my stock-picking ability. A few months ago I met with Preet Banerjee of Where Does All My Money Go? fame, and he asked me how my stock picking results compared to index returns. This innocent question left me stammering because I knew I had only approximated the answer. Without taking into account all factors, I couldn’t be sure.

I fired my financial advisors and started investing on my own roughly the middle of 1998. I completed a nearly full transition to index investing roughly the middle of 2010. So, the period of interest for measuring my stock-picking results is this span of 12 years.

However, I did not start with one lump sum of money. I made literally hundreds of deposits and withdrawals to and from 9 different trading accounts. Figuring out a rate of return over these 12 years requires an Internal Rate of Return (IRR) calculation. (There are cases where IRR does not work well, but that is not the case here as it turns out.)

There were two different ways to go with this calculation:

1. Track all the account withdrawals and deposits.

2. Track all the stock-related transactions such as trades, commissions, fees, dividends, and income tax payments.

I decided to go with approach 2 because I want to focus on stock-picking results and not mix in results from cash, bonds, and other non-stock investments. Here are some statistics from the large spreadsheet I generated:

– 144 months
– 88 stock purchases
– 91 stock sales
– 398 dividend payments
– Many commissions and fees that I lumped together each month

Also included on the spreadsheet were all the income taxes I paid on capital gains. I did not include taxes paid on dividends because these taxes would have to be paid on index dividends as well. This gives an apples-to-apples comparison between my return and index returns when the index returns include dividends but not income taxes.

A minor quibble is that the index approach would have a bigger built-in capital gain (or at least a smaller capital loss). It’s hard to value the accumulated capital loss my portfolio generated that I am able to carry forward. This difference puts my return at a disadvantage compared to indexing, but I’m just going to ignore it because the combination of available RRSP and TFSA room makes it unlikely that I will ever use up all of this accumulated capital loss.

(Some readers may wonder how a fairly successful portfolio could build up a large capital loss. The answer is related to technical differences in the ways that stock gains and stock option gains are taxed.)

I performed the IRR calculation with no thanks to Excel because it seems to need transactions equally-spaced in time for the built-in IRR function. I also calculated the stock index returns for Canada and the US for the period from 1998 July 1 to 2010 July 1:

Me: 9.6% per year (my portfolio accounting for capital gains taxes)
Canada: 5.9% per year (S&P TSX Composite total return)
US: -1.6% per year (S&P 500 total return measured in Canadian dollars)

So, I beat the index by a decent margin. Is this edge statistically significant? Am I some sort of stock-picking savant? Hardly. Let’s try a little sensitivity analysis.

For many years I held stock in the company I worked for and this continued long after I stopped working for them. I obtained most of this stock through stock options. So as not to throw off the calculations, I treated the options as though I purchased them at the value they had when I was first allowed to exercise them. Over the years I exercised the options and sold the resulting stock in bits and pieces. At the end, the remaining shares were nearly worthless.

What happens to my returns if we eliminate my 3 biggest stock sales one at a time? I recalculated my compound average return assuming that these trades never happened and that I held the shares until the same day I got rid of all the other remaining nearly worthless shares. Here goes:

Return without biggest sale: 2.6% per year
Return without 2 biggest sales: -1.0% per year
Return without 3 biggest sales: -2.4% per year

My results on this stock completely swamped all other stock trades I made. The employer shares I sold early gave phenomenal gains and the ones I held to the end gave dreadful losses.

In the end I don’t really know if I’m any good at stock picking, but I doubt it. I’m content with my decision to switch to mostly indexing, and I’m happy to have been lucky for 12 years.

Monday, July 12, 2010

Can Poker Save Your Portfolio?

A fairly common investing personality I see among my high-tech colleagues is the investor who needs action. While most investors tend to be overly conservative, action junkies need risk to make things interesting. Those who need some risk are likely better off finding some avenue other than investing for finding action.

When the topic comes to investing and I mention buy-and-hold indexing, others often complain that this is too boring for them; they prefer to make big bets on hot stocks. However, when I press for details of their results, invariably their incomes prop up their portfolios rather than the other way around.

How can investors like this save their portfolios from themselves? Maybe one possibility is to find risk elsewhere and keep the investing boring. I don’t think of myself as an action junkie, but I guess I have at least a small risk-seeking streak. I enjoy a few poker games each year. A typical game will see me ahead or behind less than $100. This is much better than betting the farm on a high-tech start-up and losing $100,000.

Unfortunately, there are pitfalls with this approach as well. I know a few people who play far too much poker and play badly enough to lose money consistently. Further, a couple of them take unreasonably big gambles with their investing as well.

So, playing a little poker works for me but not for everyone. I’d be interested in hearing from others who have found an effective outlet for their gambling instinct to keep them away from losing their savings.

Friday, July 9, 2010

Short Takes: Bad Stock Predictions, Sickly Dogs of the Dow, and more

1. Larry Swedroe holds Fortune Magazine’s nose in their year 2000 list of “stocks to last the decade”. It’s important (and funny) to check up on these silly predictions that seemed smart at the time. The most amusing two entries were Enron and Nortel.

2. Remember the “Dogs of the Dow” dividend yield approach to beating the market? Preet reports that it has underperformed the market for the last 15 years. Trying to follow the latest trend is a great way to avoid the problem of having too much money. On the other hand, Larry MacDonald reports that the Canadian version is still beating the market.

3. Potato provides details on his belief that we’re in a housing bubble.

4. Canadian Capitalist looks at competing one-liners for and against do-it-yourself investing.

5. Big Cajun Man pulls out a math word with his third lemma of money.

6. Mike at Money Smarts has a great list of resources to check before agreeing to rent an apartment. It has been a while since I rented, but I do remember moving into a terrible building for a year. The owner had the renters assigned to different floors by race, and that isn’t even on my top 5 list of complaints about him. Number one was a forged cheque on my bank account.

7. Ed Rempel tries to defend active investment managers, but gets ripped apart by commenters.

8. Financial Highway predicts how credit card companies will react to new rules designed to protect consumers. This is a good example of unintended consequences.

Thursday, July 8, 2010

Time-of-Use Electricity Pricing and Economic Incentives

Time-of-use electricity pricing has made it to my area. Electricity rates on weekends and overnight are about half of the cost during peak hours. This creates an economic incentive for people to shift electricity use to off-peak hours.

In principle, this approach makes sense. People respond to incentives. According to the mailing I received, I can save 17 cents by setting my dishwasher to run overnight instead of running during peak hours. This isn’t enough to get me to change my behaviour much, but it is likely to get some people to change, and this will help to smooth out demand.

A more cynical view is that this form of pricing is just more complicated and will ultimately lead to higher electricity prices without the average person being able to figure out as easily that prices have risen. Although the initial changes appear to be revenue-neutral, the groundwork has been set to make it easier to raise prices without as much complaint.

Wednesday, July 7, 2010

Relief by Indexing

My transition from being an active stock-picker to investing in low-cost index ETFs is mostly complete, and I’d have to say that it has been a relief. While I enjoy thinking about investing topics, having to track a basket of stocks can be a chore when I’d rather be doing something else.

I used to own between 10 and 20 individual stocks at any one time, and it takes time to keep up with them. For many investors, “keeping up with stocks” means watching their prices. However, to have any hope of success, stock pickers have to do much more than just stare at price graphs. They need to read company information and try to sniff out signs of changes in the odds of future company success. And they have to do this better than other investors.

To reduce my burden I could have tried to find a financial advisor and hand over my money, but then I'd be left worrying whether I’d chosen the right advisor. Overall, I expect better performance from indexing than from an advisor because of the lower fees.

I haven’t completely sworn off individual stocks, though. I still own some Bank of Montreal (BMO) and Berkshire Hathaway (BRK). (Disclaimer: I do not recommend any particular individual investments. Buyer beware.) I'm hoping that tracking just two companies will be manageable and enjoyable. They also represent only a small fraction of my portfolio and are quite stable companies (not that that is any guarantee: think Nortel). I may yet decide to eliminate individual stocks altogether.

I don’t consider these two stocks to represent “play money”. I don’t believe in wasting a fraction of my money on poor investments. If I didn’t believe that these two companies would perform well, I’d sell them.

I’m looking forward to simpler income tax returns and the knowledge that my returns will roughly match the widely-reported stock indexes whether I watch my investments or ignore them.

Tuesday, July 6, 2010

Parkinson’s Law

“Work expands so as to fill the time available for its completion.” This familiar law is the first sentence of the book Parkinson’s Law and Other Studies in Administration, written by C. Northcote Parkinson, and published by The Riverside Press in 1957. This book is an absolute gem. It combines wit and humour to explain how human nature and self-interest drive the forces of administration.

Parkinson explains how the administrative part of an organization will grow regardless of whether the rest of the organization is growing or shrinking. Administrative growth is independent of the total amount of work that must be done.

This explains why the organizational charts I’ve seen of city government show a majority of workers doing administration and a minority actually doing the work the city is paid by taxpayers to do. Sadly, the numerous administrative workers aren’t just idle, though. As Parkinson explains, they create work for each other so that all workers are very busy, but the output of the entire administration is minimal.

In the second chapter, Parkinson explains why reasoned argument is a waste of time when trying to sway a committee vote. Efforts are best spent trying to sway the votes of clueless committee members. I learned this the hard way after many years of doing work on standards bodies.

Another of Parkinson’s laws is the Law of Triviality: “The time spent on any item of the agenda will be in inverse proportion to the sum involved.” This law arises from the fact that people focus on the things they can understand. A good modern example is the focus on the cost of the G-20 summit fake lake as opposed to the overall summit cost which was about 20,000 times higher. The overall summit costs are complicated, but everyone can understand a fake lake even though its cost is trivial.

Parkinson has numerous examples to support his claim that organizations move into perfectly planned buildings only after their important work is complete. After entering this perfect building, the organization begins to decline. Modern examples include many tech companies that moved into new headquarters just as the tech bubble burst.

One particularly funny chapter showed how to find the important people at a cocktail party. Although much of the analysis is meant to be funny rather than completely accurate, many of Parkinson’s claims about the nature of parties ring very true. Sadly, it seems that I am not an important person.

A running theme through the book is the comic mock arrogance of the author. Like many of the jokes, it likely contains at least some truth. At one point in a discussion of trying to save an organization riddled with incompetence, the author notes that it may require “the services of the greatest living authority: Parkinson himself.”

This book is only 113 pages long with not much text on each page and is well worth a read if only for its humour. For those in a position to change the administration of an organization, this book could be a valuable guide.

Monday, July 5, 2010

HST and Contractors

With Ontario and BC making the jump to the Harmonized Sales Tax (HST), we’re bombarded with negative stories about paying more in sales taxes. However, the reality isn’t all bad. What is missed is that often the provincial sales tax (PST) used to be charged more than once on the same item. In these cases the HST is actually less than the combination of GST and PST. I’ll illustrate this with a simple contractor example and give you something to look out for on your next contractor bill.

Let’s look at an example using Ontario percentages (5% GST, 8% PST, and 13% HST). Suppose that you hire a contractor to do some work that involves $1000 worth of parts or materials that were subject to GST and PST before and HST now. After July 1, here is the accounting:

– contractor pays $1000 + HST = $1130 for the parts
– contractor collects HST on the entire job from you
– contractor gets back the $130 HST he paid on the parts in the form of an input credit

This way, the HST is only charged once on the whole job rather than added twice to the parts. This means that if the contractor’s parts charge is intended to reflect his actual cost, your bill should have just $1000 for parts (and one big HST amount calculated on the total bill). If the parts charge is $1130 with an additional HST amount charged on the total, then the HST is being charged on the parts twice, and the contractor is pocketing the extra $130.

No doubt some contractors will just put $1130 on the bill and pocket the extra money. Many contractors mark up the parts they use by even more than this. How this is handled will be determined by the competitiveness of the industry. If it is competitive, then some other contractor will do his billing differently or lower his labour price or make some other change that reflects his lower HST costs.

Under the old PST system, resellers often couldn’t recover the PST they paid on the components they bought. This means that the final price of some goods contained more than 8% PST. There were layers of PST hidden from the consumer.

Now, when your contractor presents you with a bill, you can ask whether the parts and materials charges contain the HST the contractor paid for them. If so, then the contractor is essentially marking up these costs.