Friday, August 30, 2013

Short Takes: Recommending ETFs, Financial Advisor Standards, and more

Canadian Couch Potato reports on an effort to allow mutual fund advisors to recommend ETFs. If this happens, I suspect that initially most mutual fund advisors would only recommend ETFs when they would lose the client otherwise. But, over time, this may lead to positive changes. If ETFs come to dominate, either advisors will have to figure out how to charge their clients directly for advice (a good outcome), or ETFs will have to start making direct payments to advisors (a bad outcome).

Preet Banerjee says it’s time to toughen the standards for being able to call yourself a financial advisor.

Retire Happy Blog wants you to try the 7-day spending challenge and implores you to “Stop buying crap!”

Big Cajun Man has some scary two-sentence financial horror stories from his readers.

Million Dollar Journey updated his advice on how to invest small amounts each month. Personally, I think it makes more sense to just save cash for a couple of months before investing. But some people are a little impatient.

My Own Advisor admits to some “dumbass” financial moves.

Monday, August 26, 2013

Winning the Loser’s Game

Long-time readers of this blog may recognize that this post title has appeared here before. That’s because I’m reviewing the sixth edition of Charles D. Ellis’s excellent investing book Winning the Loser’s Game, and I reviewed the fifth edition a few years back. I was pleased to reread the familiar parts and see the new material written in Ellis’s clear and convincing style.

The main message of this book is that trying to beat the market is a loser’s game because “professional investors are so talented, numerous, and so dedicated to their work that as a group they make it very difficult for any one of their number—and virtually impossible for amateur investors—to do significantly better than others, particularly in the long run.”

Some accuse mutual fund managers of being unable to beat their benchmarks because of various failings such as having a short-term focus. Ellis says that the real reason mutual fund managers can’t get an edge is because they and other professional investors are all so talented that there aren’t enough poor traders to exploit. Because “institutions do over 95 percent of all exchange trades,” there aren’t enough amateur investors to exploit either.

I won’t repeat the material from my review of the fifth edition except to say that of the two typos I found in the fifth edition, only one was corrected. Table 17.1 on page 142 of the sixth edition still has inflation percentages ranging from 2% to 6% when they should range from 3% to 7%.

In one of the new chapters for the sixth edition, Ellis has an interesting take on how we measure management fees. “When stated as a percentage of assets, average fees do look low.” But “investors already own their assets.” Fees should be expressed as a percentage of “incremental returns over the market index.” Viewed this way, typical fees “are over 100%.” This means that fees exceed the value that mutual funds provide.

This is definitely a book I wish I’d read back when I was just starting out as an investor. Perhaps I could have avoided some expensive mistakes. I highly recommend that thoughtful investors give this book a read.

Friday, August 23, 2013

Short Takes: New Vanguard ETFs, Commission-Free ETFs, and more

My posts for this week:

Playing the Winner’s Game

Currency Exchange at BMO Investorline

Here are my short takes and some weekend reading:

Canadian Couch Potato reviews the latest crop of Canadian ETFs from Vanguard. VCN looks quite interesting as an alternative to Vanguard’s VCE or the iShares XIU for those investors who want to add exposure to mid- and small-cap Canadian stocks.

Million Dollar Journey shows young investors just starting out where to find commission-free ETFs.

Canadian Mortgage Trends tells the story of a credit union unwilling to eat mortgage brokers’ commissions; the mortgage rate it advertises directly to the public is lower than the rate it offers to clients of mortgage brokers.

My Own Advisor explains why dividends matter to him. I think the most important reason why dividends matter is somewhat self-fulfilling. If dividends matter to you and they help you stick with your plan and not sell near a market bottom, then dividend investing can be good for you.

Preet Banerjee explains the First-Time Donor’s Super Credit that can boost the tax deduction you get on your charitable donations.

Big Cajun Man recounts all the information he had to dig up to help his daughters fill out student loan forms.

Wednesday, August 21, 2013

Currency Exchange at BMO Investorline

Currency exchange is typically a lot more expensive than many people realize. Paying somewhere close to 1% for each exchange may not sound like much, but if you switch back and forth between Canadian and U.S. stocks over the years, you’re paying this cost on the same capital multiple times. Your total cost over decades could easily grow to over 10% of your savings.

One method of saving on exchanging Canadian and U.S. dollars, called the Norbert Gambit, involves using an equity that trades in both Canadian and U.S. dollars. You simply buy the equity in one currency and sell it in the other currency. Instead of paying hidden fees baked into your broker’s exchange rates, you pay two trading commissions and bid-ask spreads.

Because my employer pays me in Canadian dollars, my new savings are in Canadian dollars, and I occasionally need to exchange some of them for U.S. dollars to maintain my desired asset allocation in my overall portfolio. I recently did this again at BMO Investorline, and the process is becoming (somewhat) smooth.

I began by selling ETFs denominated in Canadian dollars. A minute later I used the resulting Canadian cash to buy DLR, which is an ETF that trades in Toronto in both Canadian dollars (as DLR) and in U.S. dollars (as DLR.U). The next step is to sell DLR.U. Unfortunately, you can’t do this online with Investorline. However, you can call up an Investorline representative to sell the DLR as DLR.U.

When I called Investorline, I had to explain what I was doing to the representative, but after she put me on hold for a minute, she came back with a full understanding of what I wanted. She cheerfully sold the DLR.U for me (charging only the US$9.95 commission that applies to online trades). A minute later I went back to my online account to buy a U.S. ETF with the U.S. dollar proceeds.

The whole process was wrapped up in about 15 minutes with no need to wait the 3 days for trades to settle. The slowest part of the process is calling up the broker.

One amusing part of the call was when the Investorline representative started to explain that since I was exchanging more than $75,000, I could have called them to do the exchange for me at a special rate. She then did the calculation to see how many U.S. dollars I could have got using this method. I laughed when it turned out that I saved about $200 compared to their special rate. My savings were even larger compared to the rate I would have got doing the exchange through my online account.

Whenever you exchange currency and want to know what it will cost, take half the losses on a round-trip exchange (i.e., Canadian dollars to U.S. dollars and back again). This works whether you do the exchange yourself online, ask for a special rate, or use the Norbert gambit.

For the online cost, go to the foreign exchange page, type in the starting amount (with the action “sell”) and see how much you would get in the other currency (without executing the exchange). Then type in this new amount (in the new currency) and see how much you’d get back in the first currency. The difference between the starting and ending amounts is the “round-trip” cost. Divide this by 2 to get the one-way cost.

Using my online account, I found the following currency conversion costs:

On C$100,000: one-way cost is C$575 (0.57%)
On C$10,000: one-way cost is C$152 (1.52%)

For the Norbert gambit, the calculation takes a little longer but works roughly the same way. Start with the Canadian dollar amount, deduct the trading commission, calculate how many DLR units you can buy at the ask price, see how many U.S dollars you can get by selling at the DLR.U bid price, and deduct the trading commission. Then do the whole thing in reverse. Finally, divide the round-trip loss by 2 to get the one-way cost.

For the Norbert gambit (based on $9.95 trading commissions and DLR price quotes as I write this):

On C$100,000: one-way cost is C$217 (0.22%)
On C$10,000: one-way cost is C$40 (0.40%)

So the savings are $358 on $100,000, and $112 on $10,000. This is enough to justify an awkward phone call to your broker.

The reaction I get from some people is disbelief that it should be so hard to get a fair exchange rate. I have two reactions to this: 1) the Norbert gambit is still unreasonably expensive, and 2) you can always go the easy route by letting your broker do the exchange and pay hundreds of dollars more.

Monday, August 19, 2013

Playing the Winner’s Game

Larry Swedroe now has a Canadian Version of his book Think, Act, and Invest Like Warren Buffett, created with the help of PWL Capital. The Canadian Version is called Playing the Winner’s Game. This excellent book is now more relevant to Canadian readers.

Much of my review of the U.S. version of the book still applies. After all, sound investment principles are much the same no matter where you live. The main difference with the new book is that examples are based on Canadian investments. In the main set of example portfolios, Canadian stocks are used and real estate is used in place of commodities.

There are still a couple of places where U.S.-specific advice was not updated in the Canadian version. There are references to U.S. social security and long-term capital gains taxes (we don’t have different tax rates on long- and short-term capital gains in Canada).

This is a great book to get solid investing advice without much technical discussion. And now it is even better for Canadians.

Friday, August 16, 2013

Short Takes: Returns on Options, Arguing Against Indexing, and more

This week I compared dividend investing to index investing:

Dividend Investing Advantages and Disadvantages

Here are my short takes and some weekend reading:

Larry Swedroe explains how call options have historically been poor investments and that writing covered calls is no prize either.

Canadian Couch Potato offers a tongue-in-cheek guide for mutual fund salespeople to argue against index investing.

Tom Bradley at Steadyhand gives some interesting perspective on real estate by comparing today’s low interest rates and high prices to a time in the past when prices were low but interest rates were very high.

Canadian Capitalist shows how to get access to High-Interest Savings Accounts (HISAs) through discount brokers.

Big Cajun Man warns the young about lifestyle creep.

My Own Advisor updates us on his progress to building passive income with dividends.

Wednesday, August 14, 2013

Dividend Investing Advantages and Disadvantages

Frugal Trader at Million Dollar Journey wrote a thoughtful post titled 5 Advantages of the Dividend Investing Strategy that caught my attention. He believes that both index investing and dividend investing are good strategies. I’m not sure if he intended his 5 advantages of dividend investing to be advantages when compared to index investing, but I’ll take them this way below.

Let’s examine each of these 5 advantages:

1. Produces a Passive Income Stream for Life, and with Raises!

Dividend stocks certainly produce passive income that tends to rise over time. However, indexing does the same thing. Dividend stocks produce bigger dividends, but indexes tend to produce bigger capital gains. So, I’d say that this advantage applies equally to both dividend investing and index investing.

2. Encourages Buying and Holding for the Long Term

I suspect that this is where dividend investing has an edge over index investing, at least for some investors. No matter how you invest, it’s important to stick with your plan rather than sell low when you get scared or buy high when you get overconfident. Some index investors have a tendency to change their asset allocations at the wrong times (selling low and buying high). The dividend investors I know seem to do well at sticking with their plans when the stock market gets volatile.

3. Helps Create a Market Bottom

I think this is really just a short-term concern. Over the long run, if a company’s earnings can’t support the dividend that it pays, then the company will eventually cut the dividend. For as long as investors believe the dividend won’t be cut, the stock price will be held up somewhat, but this can last only so long. Over the long run, stock prices are driven by company earnings whether the company pays a dividend or not.

4. Dividends are Tax Efficient

This depends on the investor. For the investor in the accumulation phase of life, growing capital gains in index ETFs in a taxable account is more tax efficient than dividend stocks because almost all taxes are deferred until the stock is sold. Over the long run, the dividend investor will pay more total taxes than the index investor will pay.

However, things change when the investor is actually living on the dividends. In this case, if the investor is index investing, he or she will be spending a combination of dividends and capital gains. Which approach is better depends on income level. For high incomes (in Ontario, over about $90,000 per year), capital gains taxes are lower than dividend taxes. When someone’s income is so low that they collect the GIS, capital gains are better than dividends as well. But for the bulk of Canadians who will be between these two extremes in retirement, dividends are more tax efficient.

5. Reduces Risk of Selling at Market Bottom for Capital

This is true, but it ignores another effect which is that companies who maintain their dividends at market bottom are pulling money out of the business during tough times. These are times when businesses are usually better off retaining earnings, either because earnings are down or because excess cash can be used to buy cheap assets. Pulling money out of a company in the form of dividends in a bad economy is damaging even if you can’t see a change in the number of shares you own.


Overall, both dividend investing and index investing have a lot to offer. Sticking with either for the long term is likely to work out well. Indexing has an edge in terms of diversification and taxes during investors’ accumulation phase. Dividend investing has an edge in sticking with the plan through tough times and with taxes during retirement. For myself, the advantages of indexing are more compelling, but your mileage may vary.

Friday, August 9, 2013

Short Takes: Illusory Bond Losses, Attacks on Indexing, and more

Here are my posts for this week:

9000% Per Day!

Ratios to Rate Your Personal Finances

Here are my short takes and some weekend reading:

Canadian Couch Potato explains why losses in your bond fund may be just an illusion.

Preet Banerjee defends index investing against flawed attacks.

Retire Happy Blog says “settling your estate is not an honour. It is work.” See this post for a good checklist of executor duties organized by when you have to do them.

Big Cajun Man is running an interesting contest to win some Quicken software. I might try this sort of contest myself sometime.

My Own Advisor is considering making fewer extra lump sum payments on his mortgage so he can invest more. Perhaps a middle-of-the road approach makes sense. Instead of making extra mortgage payments to pay it off in 8 years, try 10 years.

Thursday, August 8, 2013

Ratios to Rate Your Personal Finances

Don at My Dollar Plan wrote a post about 4 ratios to rate your personal finances. I thought I’d see how our family finances fare in this test and maybe learn something new. For each ratio, Don gives a recommended minimum or maximum level. Here goes.

Liquidity Ratio = Liquid Assets / Monthly Expenses

Our family comes in at 6.2 months right now, but this figure varies over time from about 4 to 8 months. I usually let cash sit in trading accounts until it builds up to about $5000, at which point I buy some ETF that’s below its target allocation in our family portfolio. The amounts in each account vary over time, but the total of all these amounts has some stability.

We almost always have less than the 10 months of living expenses that Don recommends. I’m not too concerned because I have a large line of credit available and could also sell off some ETFs in non-RRSP accounts if necessary.

Savings Ratio = Savings / After-Tax Income

Don actually had gross income in the denominator, but I don’t see why your savings ratio should be penalized for paying taxes. Remember to count only the after-tax portion of any RRSP contributions.

My family comes in with a very healthy 61% savings rate. Don recommends saving 20% of your gross income. Let’s call this 25% to 30% of your net income. I’m pleased to be saving double this amount and look forward to full financial independence.

Housing Expense Ratio = Homeowner’s Expenses / After-Tax Income

Don recommends housing expenses of no more than 20% to 25% of net income. My family is at a comfortable 10%.

Non-Mortgage Debt Ratio = Non-Mortgage Debt Payments / After-Tax Income

This is where it gets embarrassing for me. My wife had to replace her car recently and we paid for it on our line of credit. We’ll have this paid off very soon, but a debt is a debt. We plan to pay far more than the minimum 2% each month, but using the minimum payment, our non-mortgage debt ratio is 0.3%, well below Don’s maximum of 15%. Because we have no mortgage, our total debt ratio is also 0.3%.

So that’s it. We’re doing fine everywhere except possibly with our liquidity. How do your finances stack up?

Wednesday, August 7, 2013

9000% Per Day!

Google does a good job of filtering spam comments out of Blogger, but I still have to delete several per day. Some of these spam commenters are clever and include key words from the post they are commenting on. However, a recent spammer’s pathetic effort just made me laugh:
“Fast Return Investment-9000% after 24 hours.”
With all the warnings we see about being wary of offers that are too good to be true, I’d hope that nobody would get caught by something this ridiculous. But let’s daydream a little. What if we could roll over an investment to make a 9000% return compounded each day. Starting with one dollar, let’s see how our wealth would grow:

After 7 days: The dollar would grow to over $50 trillion! We’d be able to pay off the U.S. national debt with plenty left to spare.

After 15 days: Our wealth would be roughly equal to a block of gold the mass of the Earth.

After 41 days: We’d have about a dollar for every electron in the known universe.

I pity any person who gets taken in by such nonsense.

Friday, August 2, 2013

Short Takes: Index Portfolio Outperformance, U.S. Dollar RRSPs, and more

This week I explained a hidden cost of trying to mimic an index with a subset of stocks:

Building Your Own Index with Individual Stocks

Here are my short takes and some weekend reading:

Canadian Couch Potato explains research showing that portfolios of index funds tend to outperform portfolios of actively managed funds. The gap is bigger than when you just compare individual funds.

Canadian Capitalist created a spreadsheet to help you estimate how much it costs to have an RRSP with a brokerage that doesn’t permit you to hold U.S. dollars.

Financial Crooks tells the story of replacing a rented hot water heater with one that was purchased.

My Own Advisor reviews Ellen Roseman’s book, Fight Back.

Big Cajun Man asks whether draining the old bottle of fabric softener into the new bottle is thrifty, frugal, or cheap. I have a different answer because I’m allergic to the stuff. It’s even cheaper to just use white vinegar in place of fabric softener.