Friday, December 31, 2010

Year-End Prediction and Videos

For the last post of 2010 I thought I’d make a safe prediction and point to a couple of good financial videos.

Prediction: In 2011, blogs and other media will be filled with reasons for why current conditions for different asset classes are different this time, but they will be wrong. The best ways to approach investing over the long term will continue to be the best ways into the future.

In his latest newsletter, Ken Kivenko included a couple of interesting videos. The first is a short funny video about mutual funds and the second is a clear explanation of what you’re up against when trying to beat the market.

Have a fun and safe New Year’s Eve.

Thursday, December 30, 2010

An Explanation of Insurance Company Squeamishness about Home Businesses

In response to yesterday’s post about difficulties insuring home businesses, Sue Waterman, President of Intercon Insurance Services Limited in Vancouver, was kind enough to send a clear explanation. The following are her (lightly edited) remarks.

As you’ve discovered, with a few very limited exceptions homeowners’ policies normally exclude home based businesses, though some simple arts and crafts type businesses can be added for a small additional premium. But professionals of any kind consulting from home are a challenge.

As professionals they’re liable for the work they do and defending professional liability claims in today’s legal climate is seriously expensive even if you win (think $50,000 to $100,000 and much more if it goes to court). So they need professional liability or Errors and Omissions insurance – which given the size of legal defence costs is, not surprisingly, also expensive. But my experience over the years has been that many retired or part time professionals simply can’t afford or don’t want to pay the premium required to properly insure themselves, which leaves them operating uninsured.

When a claim is eventually made against them, their defence counsel immediately sends it in to their homeowners insurer because that’s the only policy they have, and that insurer then incurs serious defence costs to prove that it wasn’t really insuring an engineer or lawyer’s professional liability worth thousands of dollars as part of a $500 or $600 homeowners policy.

So homeowners insurers now take the not totally unreasonable position that unless there is professional liability in place they don’t want to provide homeowners coverage to professionals.

An additional wrinkle is that many professionals have also set up personal service corporations for tax reasons, and anyone operating through a corporate entity should as a bare minimum be carrying commercial general liability as well as professional liability insurance.

That no-one called you back to explain this is unforgiveable though and on behalf of my industry I apologise - if you ever have any property and liability insurance questions I’ll be happy to try to help.

And for the record, no insurer has ever offered to send me on an exotic vacation (though when I push them for lower premiums for my clients they have occasionally suggested other places I could go) and they charge me to play in their golf tournaments and expect me to buy lunch.

The part of this that surprises me is that professional liability claims made against home insurance companies aren’t immediately laughed out of court by judges. Given that they aren’t, it makes perfect sense that insurance companies treat home-based professionals like the plague.

For the record, when I was trying to replace my house insurance and no broker would call me back, I only mentioned that I was looking for home insurance in most of the messages I left. They didn’t even know about my consulting work. Something big must have been going on at the time to busy out all the insurance brokers.

Wednesday, December 29, 2010

Insurance Broker Conflict of Interest

According to the Globe and Mail, insurance brokers receive lavish vacations and other perks from insurance companies. My own brief encounter with insurance brokers didn’t reveal any conflicts of interest, but it did leave a bad taste in my mouth.

Continuing yesterday’s story of my home insurance company dropping me, my next step was to try to find another insurance company to take me on. I decided to try an insurance broker and called a few. None answered the phone. I left messages and when I didn’t get a call back by the next day, I called a few others.

In all I called 15 insurance brokers. Only one had a human answer the phone to take a message. After I left a second message with one broker, I got a call back from a guy who took some information, promised to call back again, but never did. The entire experience was baffling. Something big must have been happening in the industry at that time.

Tuesday, December 28, 2010

House Insurance for Home-Based Businesses

People who run small businesses out of their homes often mistakenly think that their home insurance policies cover their business activities. As explained by Miranda at Financial Highway this is usually not the case. My own experience with home insurance was much worse than the picture Miranda paints.

I used to run a one-man consulting business. The only things I needed for the business were a computer, some space in my files for papers, and some desk space. I never even had any clients in my home. Even so, I thought it would be best to contact my insurance company to make sure I was properly covered. I also inquired about professional liability insurance for my business dealings.

The insurance company took all the information, went away for a long time, and finally came back to say that they wouldn’t offer me professional liability insurance and further they were dropping me for home insurance! They didn’t care that I had nothing in my home that would matter to my business if it were destroyed.

The only explanation I was able to extract was that if I had some bad business dealings, a client might try to sue the insurance company. Why one of my clients would try to sue my home insurance company is beyond me.

All this might make people with home businesses think that they had better not tell their home insurance company about the business. However, if something big happens such as the house burning down, the insurance company will investigate looking for reasons to deny the claim. Finding a home-based business would be a great reason for denying a claim.

Monday, December 27, 2010

Changes to Stock Option Taxation Finally Official

Back in March the Conservative government announced some changes to the way that stock options are taxed. One of these changes brought relief for those who had to pay taxes on phantom income. Unfortunately, these new rules did not become law until Bill C-47 received Royal Assent December 15.

Canada Revenue Agency (CRA) was quick to come out with a form to allow people to elect to pay a penalty tax instead of paying tax on the phantom income. This form has the catchy name Election for Special Relief for Tax Deferral Election on Employee Security Options. This whole business is quite complicated. If you’re affected, you may want to get some professional tax advice.

Friday, December 24, 2010

A Holiday Thank You

It’s been a quiet week and instead of my usual roundup I’ll say thank you to my readers and a special thank you to my wife for all the work she does at this time of year. My shopping responsibilities for Christmas are minimal. What I do is better called buying than shopping. Once I thought through what I wanted to get and where I’d get each item, shopping took me just under 2 hours including time for a haircut. As you may have guessed, my wife does most of the Christmas shopping.

Thursday, December 23, 2010

It’s Not Rocket Science

Tom Bradley at Steadyhand has an excellent book out called It’s Not Rocket Science (available free here). It is a collection of 34 of Bradley’s articles over the past five years. Each article approaches an investing topic in an easy-to-understand style contrasting sharply with the common industry message that investing is hard and that people should be afraid.

Compared to the rest of the mutual fund industry, Steadyhand takes a very different approach to active investing and this shows through in Bradley’s writing. There are too many good themes is the book to mention them all, but I’ll pick three.


Over the long term “stocks will beat bonds, and bonds will beat cash.” This may not be true for one year or even five years, but my investing approach is based on the expectation that S>B>C.

Insured Investment Products

We’d all prefer not to lose money, but “too often buyers believe that someone else is paying for the insurance guarantees. Wrong. There is no new source of return being invented.” The cost of insurance guarantees comes out of your returns.


“Security selection is the highest quality alpha you can get.” I’ve personally given up on seeking alpha (which means trying to beat market indexes), but I believe that some stock pickers are capable of choosing outperforming stocks consistently enough to expect to beat the index over the long term. Other approaches like market timing or trying to guess future interest rates seem like a loser’s game.

Whether you are an index investor or an active investor, the lessons in Bradley’s articles are worth learning.

Wednesday, December 22, 2010

Lenient Border Guards

At this time of year many Canadians head to the U.S. in search of bargains for Christmas presents. Taking a bite out of the savings are travel costs and duties when you return. However, border guards don’t always make you pay.

My cousin was telling me about a woman who returned from a trip recently having bought $900 worth of items, including the obligatory bottle of booze. She declared the full $900 and even though her exemption limit was only $400 for having been gone 48 hours, she was sent on her way without having to pay any duties.

This happened to me once, although I was only over my limit by a small amount. Not being an experienced U.S. shopper, I’m curious about how common it is for border guards to not make people over their limit pay duties.

Are there any experienced U.S. shoppers who can comment on how often border guards forgive duties and for what types of dollar amounts?

Tuesday, December 21, 2010

Stress-Testing a Retirement Plan

It’s easy to make a plan for spending retirement savings that looks good on paper. But there are many unknowns when it comes to investing. A little bad luck in the first few years of retirement can sink your plan.

Proper stress-testing of a retirement plan is the main theme of Jim Otar’s book Unveiling the Retirement Myth. Instead of testing a plan with average return figures for stocks, bonds, and other asset classes, Otar simulates retirement plans using actual market data since 1900. These simulations check the results when a virtual copy of you retires in each year to see what happens.

Suppose you have a $1 million nest egg and plan to withdraw $50,000 rising with inflation each year. If you assume your investment returns will be 5% above inflation each year then the $1 million will last forever. But this is unrealistic. Returns vary unpredictably. This retirement plan that looks so great shrivels up when Otar’s analysis shows how often you’d run out of money before age 90.

As I explained in an earlier post, I have concerns about the way that Otar reduces dividends in actual historical returns before using them, but the basic idea of checking a retirement plan against historical data is useful.

According to Otar, those who create a single projection of a retirement savings balance aren’t necessarily naive: “most of these plans are produced for only one reason: to sell dreams. Many financial planners do that, many stockbrokers do that, mutual funds do that, hedge funds do that, many pension managers do that.” I guess it’s hard to sell a financial plan to a client if it shows a 25% chance of the client eating cat food.

Monday, December 20, 2010

Jim Otar on Safe Withdrawal Rates in Retirement

Trying to figure out how much money you can safely withdraw from an investment portfolio each year is challenging. Some use rules of thumb such as 4%, but the real answer must depend on the types of investments and total fees and commissions paid each year. Jim Otar has studied this problem extensively, but has a questionable built-in assumption.

Otar’s book, Unveiling the Retirement Myth, contains a near endless supply of worked examples where Otar checks the likelihood of running out of money in retirement based on real historical rates of return over the last 100+ years.

Readers are told to “ignore any retirement plan that includes a forecast” but implicit in Otar’s analyses is the assumption that the future will look like the past – plus a twist. The author replaces historical dividend returns with roughly the current dividend level: 2%. Otar says that using historical dividend yields “creates an artificially higher degree of outperformance compared to prevailing dividend yields.”

If this is true, then isn’t it also misleading to use historical bond returns when currently bond yields are very low? And isn’t it overly pessimistic to use historical inflation figures when inflation is low right now? This handicapping of stock returns affects almost every worked example in the book.

Some might suggest that it makes sense to handicap stocks somewhat because they are risky. The problem is that the author ends up handicapping stock returns doubly. First Otar removes most of the dividends from stock returns and then he analyzes the volatility of these lowered returns to recommend even lower allocations to stocks in retirement portfolios.

It’s no wonder that Otar recommends “never allocate more than 50% of your assets to equities in any portfolio, ever.” Another consequence of the reduced dividend assumption is the conclusion that the percentages of stocks and bonds in a portfolio doesn’t seem to affect how long it takes to run out of money. Yet another is that it makes various types of annuities including the variable types with guaranteed minimum withdrawals look better than they are.

The approach Otar takes to analyzing portfolio longevity in the first half of the book is very interesting. I’d like to see it done using more reasonable return assumptions. Chapters 21 to 26 about seeking positive alpha are mostly an exercise in data mining. Overall, I’m glad I read the book for some useful ways of thinking about retirement, but I disagree with many of the conclusions.

Friday, December 17, 2010

Short Takes: Anti-Competitive Credit-Card Companies and more

The Competition Bureau is going after Visa and MasterCard for anti-competitive practices. At issue is rules they impose on vendors that drive up costs for everyone regardless of whether they pay with a credit card or not. The responses from Visa and MasterCard accusing retailers of trying to pass costs onto consumers are mostly nonsense. All costs get passed to consumers eventually. The best way to benefit consumers is to lower total costs. Allowing consumers to pay less when they use a cheaper form of payment is the right approach.

Potato got caught by a Pharma Plus location that doesn’t honour their parent company’s offers.

Money Smarts is on a quest to eliminate all paper bills and statements.

Big Cajun Man is tired of answering the same investor profile questions over and over again.

Financial Highway reviewed Gary Kaminsky’s book Smarter than the Street and seemed to like it more than I did.

Thursday, December 16, 2010

Index Investing is a Statement about Personal Limitations

There is no shortage of lively debate about the merits of passive index investing versus active stock picking. Much of the discussion stems from one side misunderstanding the other. After reflection, I’m convinced that my choice to invest passively in index ETFs is fundamentally a statement about my own limitations.

I don’t doubt that there are stock pickers who outperform due to skill rather than luck. It seems clear enough that Warren Buffett did this throughout his career, although it's not clear whether he can continue to outperform in the future given the huge 12-figure sum he is trying to grow.

I don’t try to pick individual stocks because I don’t believe that I can beat the index consistently after costs. Proponents of active investing would be quick to point out that I can just find someone who can outperform at stock picking and invest in this money manager’s fund.

This brings me to my next limitation: I don’t believe that I can figure out which money managers will outperform. There are a few people in the active investing world I admire such as Tom Bradley at Steadyhand. However, I don’t know if they have an above-average chance to outperform. This is a statement about my limitations and not a statement about Steadyhand. Their approach to investing seems sensible and I like the way they control fees, but I still don’t know how likely they are to outperform indexes.

Maybe it isn’t even necessary to pick winning money managers. Maybe I can just find a financial advisor who can pick winning money managers for me. As you might guess at this point, I have a third limitation. I don’t believe that I can figure out which advisors can pick winning money managers.

All this sounds very weak. Am I just lacking in confidence? Those who know me well know that I have no shortage of confidence. I spent several years working with financial advisors, and then several more years picking my own stocks. My conclusion is that it is a very difficult game and I can’t do it well enough to overcome the costs of these approaches.

To those who believe they can pick winning stocks or pick winning money managers or pick advisors who can pick winning money managers I say that the vast majority of you are wrong. This doesn’t mean that you are all wrong. Maybe some are right. But I can’t tell which ones. The fact that most people whose money is actively invested will get returns below index returns is just simple math. Rather than restate the explanation of this fact, I’ll just point to William F. Sharpe’s explanation.

So for those convinced that they have skill at picking stocks, money managers, or advisors, you can pity the thundering herd of those who cannot. But know that I think the odds are strong that you are actually running along with the rest of us.

Wednesday, December 15, 2010

How to Replicate the Performance of Dynamic Funds

Dynamic Funds have 7 mutual funds that have beaten their respective stock index benchmarks over the past 10 years despite sky-high MERs. Jonathan Chevreau suggests that this is reason for index fund proponents to eat crow (the web page containing this article has disappeared since the time of writing). Canadian Capitalist did an excellent job of explaining the problem of identifying outperforming mutual funds before they outperform. I won’t repeat their arguments. But I will show how to replicate the performance of Dynamic Funds with a dead-simple strategy.

Let’s say that we run a mutual fund company that wishes to charge a 4% MER. (Why water-ski behind a small yacht when it could be a big yacht?) But we also want 7 of our funds to outperform the S&P TSX index over the next 10 years. This sounds like a tall order, but it’s actually quite easy.

To begin with we’ll create 112 (7x16) mutual funds in our family. The reason for this number will become apparent later. We’ll invest each one in the S&P TSX index and collect our 4% MER each year. The only thing left to add is some bets.

Initially, we’ll pair off the funds into 56 pairs. Suppose that funds A and B are paired. Fund A will enter into a derivative contract and fund B will take the opposite side of the same derivative contract. We’ll stop the betting when one fund is up 25% and the other is down 25%. The type of derivative doesn’t really matter and it doesn’t matter whether fund A or B comes out ahead.

Once the betting is complete, all the funds will have returns with three components: the stock market return, the 4% per year MER loss, and +/- 25% from the derivative betting (56 winning funds with +25% and 56 losers with -25%).

Next we match the 56 winning funds in pairs and repeat the betting process for another round. The losers from the first round won’t do any further betting. When this round ends we’ll have 28 funds that have won twice and have had two 25% bumps in return.

You guessed it. We will then have another round of betting using the double winners to give 14 triple-winners. A fourth rounds gives 7 quadruple-winners. All 112 funds will get the index return less the 4% MER each year and then plus or minus the results of the betting. Note that all this betting could be spread fairly smoothly across 10 years so that the 25% bumps wouldn’t necessarily be very visible. Here are the resulting per-year returns for the funds over a decade relative to the S&P TSX index:

7 funds: +5.0%
7 funds: -0.2%
14 funds: -2.4%
28 funds: -4.5%
56 funds: -6.6%

Even after paying the huge 4% MER, 7 of the funds outperformed the index by 5% per year for a decade! We collected this high MER for a decade and all we had to do was invest all the money in an index and trade some derivatives. We never had to worry about which stocks or derivatives might perform best. As a bonus we are left with 7 funds that we can tout as long-term stars.

The reader may object that while we’re left with 7 star funds, there were also 105 underperformers. Dynamic has about 100 funds with only 7 showing outperformance. So, my scenario mirrors Dynamic’s case quite well.

I have no idea how Dynamic Funds achieved their results, but we see that my strategy can achieve similar results with no skill at all.

Tuesday, December 14, 2010

Does Paying Yourself First and Blowing the Rest Work?

Rob Carrick asked this question as a subtitle to an interview with Kerry Taylor about budgeting. The question is whether a viable alternative to budgeting is to take a percentage off the top of your income for savings and just spend all the rest. The unsatisfying short answer is “it depends”.

I have no doubt that Carrick can make this approach work for him; he has proven many times over that he’s very financially savvy. Less sophisticated people can easily get themselves into trouble. These people might misunderstand “pay yourself first and blow the rest” to mean that as long as they set aside 10% of their pay cheques for long-term savings they can do whatever else they want.

Building savings won’t help much if you build up lines of credit, car loans, and credit-card debt even faster. When the various debts grow large enough that your finances reach a breaking point, you’ll be forced to pay off the debts with the supposed long-term savings.

So, paying yourself first and blowing the rest can work with the caveat that you can’t build up debt at the same time. However, this can be tricky to measure. If you get a car loan, you’ve actually spent much more than a single pay cheque (at least for most of us). Does this break the rule about how you’re allowed to “blow the rest” or is it okay as long as you pay off the car loan over a reasonable period of time without building up other debts? In real life it can be difficult to decide if you’re really living within your means or you’re spending your future. This is easy to figure out for extreme cases but borderline cases are more difficult.

I’m a believer in paying yourself first, and realistically, few people will consistently follow a budget. But when you’re blowing the rest of your pay cheque, make sure you’re not consistently spending more than what is left after taking savings off the top.

Monday, December 13, 2010

The Limits of Retirement Calculators

Figuring out how much money you need to save for retirement isn’t easy. It’s no wonder that so many people turn to experts for help. For the do-it-yourself crowd there are online retirement calculators to help. Unfortunately, the precise answers we get from most of these calculators just give us the illusion of certainty.

For fun I imagined my 25-year old self using one of these calculators. A quick online search for retirement calculators landed me at Mackenzie’s RRSP Calculator. This calculator is a common type where you punch in some numbers including assumptions about inflation and returns and the calculator gives unrealistically precise answers about how much you need to save.

So now I’ll conjure up the 25-year old me to answer the calculator’s questions:

Current value of RRSP

That’s an easy one: $0.

Current RRSP contributions

I haven’t really started yet, but let’s say that I start saving $100 per month.

Years to retirement and number of years for funds to last

I can’t imagine being 65 and having worked all my life. Let’s say I retire at 55 and the money has to last 40 years.

Income required in today’s dollars

I’d like to have a comfortable retirement. On top of CPP and old age security, let’s say I’ll need $40,000 per year from my RRSP.

Rate of return

I hear plenty of people talk about making 20% or more on their stocks each year. I’d better be more conservative and just assume 15%.

Inflation rate

All the reports I hear say that inflation is around 2%.

That was easy. Now click on “Next” to see what we get. Mackenzie’s calculator comes back with a few numbers in addition to the following message:

“Congratulations! Your savings plan will provide sufficient assets to meet your needs through retirement.”

Great news! It turns out that my $100 per month savings are enough to retire comfortably at 55. My savings plan is right on target.

Of course this is all nonsense. The most important element of this “savings plan” is its hopelessly unrealistic return expectations. I assumed that I’d make about 13% above inflation each year for the rest of my life. This won’t happen. Based on these same assumptions, saving $1000 per month would allow me to retire at age 38. This is just silly.

The lesson here is to be wary of any tool that gives the illusion of precision. Decisions about retirement planning are inherently fuzzy because future returns and inflation are not known. To use these calculators correctly, you have to make conservative assumptions about investment returns.

An entirely different way to think about retirement is to invest as much as you can in the best way you can and be somewhat flexible about your retirement age and retirement income.

Friday, December 10, 2010

Short Takes: Hidden iTunes Charges and more

Many parents keep their young children quiet for a while by letting them play games on their iPhones and iPads. They may want to rethink these diversions after reading about kids who managed to rack up triple-digit iTunes charges. This trap even caught parents who tried to make sure that their kids wouldn’t have access to the ability to purchase game tokens.

Big Cajun Man finds an analogy between the latest Bank of Canada interest rate decision and a funny story about a tattoo.

Canadian Financial DIY explains how income taxes increase the effect of inflation on investment returns.

Money Smarts looks into why investors tend to fill their TFSAs with just cash and GICs.

Thursday, December 9, 2010

Meir Statman’s Top 10 Investing Errors Hit Home

I’m not a big fan of top 10 lists, but I highly recommend reading Meir Statman’s top 10 list of errors average investors make. Statman hits the ball out of the park. I can see my own tendencies in every one of the errors. I might go so far as to say that investors should reread this list just before making any trades.

Even easier than seeing your own errors is seeing these mistakes in other people’s behaviour. However, I try to avoid pointing them out to all but my closest friends and family. Few will thank you for criticism and only those closest to you will forgive you and maybe even thank you (much later).

Wednesday, December 8, 2010

Interac e-Transfer Security

Interac is renaming its email money transfer to Interac e-Transfer in part because people can now send or receive money with mobile phones as well as their computers. This is a potentially convenient way to send money, but it brings up the obvious question of how safe it is to send money by email or with a mobile phone. The answer is partly encouraging.

Interac attempts to allay security concerns as follows:
“The sender’s financial institution and the recipient's financial institution transfer funds using established and secure banking procedures. Personal or financial information, such as address, phone number and bank account information, is not shared and remains private.”
So the sender doesn’t need to know the banking details of the receiver, and the money is actually transferred using traditional secure banking procedures. This seems to close the door on any problems, but there is one potential security hole.

When we pay bills online, we choose one of our accounts as the source of the money and some institution’s account to receive the money. With e-Transfer, you choose an account as a source of the funds, but the receiver gets to choose the destination account. For security, the sender chooses an answer to a personal security question such as “what is your favourite city?” and the receiver must enter the correct answer.

So, if someone else intercepts the email and can guess the answer to the security question, this person could receive the money. I don’t see this as a big threat for modest sums, but I'd be concerned about sending large sums of money this way. I did not investigate the fees that are charged for this type of transaction.

Tuesday, December 7, 2010

Christmas Toy Scrooge

My company’s HR department is encouraging employees to take part in a program to buy toys for less fortunate children. My only problem with it is the requirement that all toys be purchased new. My own experience with my family over the years tells me that there is a huge glut of perfectly good slightly used toys available.

My family have thrown out thousands of toys, many of which were still new-looking, but we simply couldn’t find anyone who wanted them. They couldn’t be sold at garage sales or even given away at these sales. We often threw them away just to create room in our home. From what I saw of friends’ homes, they could have improved their lives by throwing away more toys.

This whole charity effort has the feel of something designed to pump up toy sales. I have no idea if this is really the case, but adding to the glut of toys choking the homes of families rubs me the wrong way.

I would prefer to see needy children paired up with some of the almost new but unwanted toys in wealthier homes. This would require volunteers to inspect toys and clean them, but this is something I’d have an easier time throwing myself into enthusiastically.

Monday, December 6, 2010

Smarter than the Street

Gary Kaminsky was a successful money manager and is now co-host of the CNBC show Strategy Session. His new book Smarter than the Street lays out an ambitious goal of teaching readers to do what he did:

“We did it constructing a specific strategy and adhering to that strategy, regardless of the investing climate. It is a strategy that almost anyone can learn. One of the primary goals of this book is to reveal this strategy, step by step, to individual investors.”

Kaminsky makes big promises in the Introduction that go largely unfulfilled in the rest of the book. The “specific strategy” turns out to be quite vague and relies heavily on gut feel. A large block of the book is devoted to advising investors to read company annual reports, look for big changes, and pay attention to how companies use excess cash. How to use this information to pick stocks is left unstated except for some examples.

Some parts of the book are more specific, such as the recommendation to own between 15 and 30 stocks. The difficult part is figuring out which stocks to own, but the book isn’t much help on this point despite the claim that “as you have seen in the last several chapters, I have some very specific rules for buying stocks.”

The section on deciding when to sell a stock is a little more concrete. Kaminsky describes how to look for changes in the economic environment, industry outlook, company fundamentals, management strategy, and stock valuation. Once again, though, the sell decision comes down to gut feel.

The book has a few points that were good. The author is down on trading too much and in particular day trading. He describes market timing as a “failed technique” and recommends choosing stocks with the expectation of holding them for 2 to 5 years. As for what money to invest, he says “you should not invest any money that you will need back within a three-year period.”

On analysts who produce price targets for stocks, the author says that they are “wasting my time, their time, and your time.” He calls these price targets “another by-product of the Wall Street marketing machine.”

On a couple of points, Kaminsky seems to be self-contradictory. Averaging down is bad, but “adding to a winning position when the stock is priced at a more reasonable level” is good. Buying on dips is bad, but going against the herd is good.

The author completely loses his way with a couple of blackjack analogies. He says “buying stocks because over the long term they always go up is like saying, ‘I’m going to play blackjack every day because ultimately I’ll have to have a winning hand.’” Long-term investors don’t buy stocks because they know they will have one good month or year, but because the total returns over a long period of time have been positive. The opposite is true with blackjack where over the long term players lose money.

Kaminsky believes that to invest successfully, you have to think about how other investors will react to news. He tries to explain this with a blackjack analogy where he claims that when other players at a table are playing foolishly, it lowers your chances of beating the dealer. This is nonsense. I don’t trust the analytical ability of anyone who can’t get this right.

Kaminsky justifies the need to beat the index with a detailed prediction that we will have another “lost decade” for stocks. I have no idea whether stocks will be flat for the next decade and I don’t believe he knows either. Given that so many money managers have lost money over the last decade, the author appeals to the reader’s ego: “surely you believe that you can do better.” I can also do worse, ... and don’t call me Shirley.

Friday, December 3, 2010

Short Takes: A Cheap but Still Expensive Mutual Fund and more

Rob Carrick profiles a mutual fund company that pinches pennies to the point where they take pens and paper from hotel conference rooms. Being careful with investor money should be applauded, but their MER is still about 2.2% on assets of $1.5 billion. This means that expenses are about $33 million per year. Maybe I’m not very imaginative, but I don’t know how they could spend this much money if they won’t even buy pens.

Big Cajun Man gives his take on gifts you should never give your kids. I thought the best one was avoiding giving them something you always wanted. Times change. Your dreams aren’t your kids’ dreams.

Financial Highway gives step-by-step procedures for disputing problems with your credit report.

Money Smarts explains the requirements to qualify for four financial advisor designations.

Thursday, December 2, 2010

Taking it Easy on Financial Advisors

I received an email comment on yesterday’s post that ended with
“Thanks for the insight. And please take it easy on Investment Advisors ... some of us are genuinely trying to improve the lives of our clients.”
The funny thing is that I do believe that some (probably most) financial advisors genuinely try to help their clients. So how can I believe this given my many past remarks on this subject? Let me explain starting with an analogy.

The company I work for has a few direct competitors. The work my colleagues and I do is designed to increase our market share which means taking market share away from our competitors. If we succeed in making more desirable products, then our competitors will shrink and possibly even fail. This would cause people to lose their jobs.

Few workers think in these terms, but the truth is that their efforts are aimed at destroying other people's jobs. Of course this is the nature of capitalism and it serves us well, but I don't really like to think in terms of taking away someone else’s job. As a matter of fact, if I saw a direct connection between some action on my part and a particular person losing his job, I might not be able to bring myself to do it. This is likely true of most of my colleagues as well. Yet we all work feverishly to destroy other people’s jobs anyway.

The same type of situation exists with many financial advisors. They work within a system designed to extract a large percentage of their clients’ savings each year, yet they individually genuinely want to help their clients. In my opinion the problem is the system that most advisors work within, not the financial advisors themselves.

On a personal level, I have a close friend who tried his hand at selling mutual funds for a few years. I can guarantee that he really did want to help people. He is always ready to pitch in when someone in our circle of friends needs help. But the net effect of his efforts as a financial advisor was to move people into segregated funds that charge MERs of over 3% each year. I have a hard time calling this “help” regardless of his intent.

I’ll leave it up to financial advisors to decide whether this feels like me taking it easy on them or if it feels like more of the same.

Wednesday, December 1, 2010

Addressing a Shortage of Competent Financial Advice

Canada has no shortage of financial advisors, but some investors complain that it is hard to find an advisor who isn’t just a mutual fund salesperson. No doubt good advisors exist, but perhaps they are in short supply because of the requirements to get a designation.

Mike Holman described the requirements to get 4 different designation levels. The requirements for the top two levels caught my eye. In addition to having to pass exams, becoming a Certified Financial Planner (CFP) requires “two years of direct financial planning experience,” and becoming a Chartered Financial Analyst requires “four years of related investment experience.”

Why not make the testing more stringent and reduce the time component? The answer is that these rules are designed to protect those who already have the designations from competent competitors. With these time requirements it’s almost impossible to hold these designations for part-time work no matter the competence of the candidate.

This criticism can be made of most professional designations in other fields as well. It is very common for entry to professions to involve requirements that keep out anyone who isn’t 100% personally committed to working in the profession no matter how good they are at the work. In this case the side effect is investors facing an apparent shortage of fee-only financial advice.

Tuesday, November 30, 2010

The Right Mindset for Trading Equities

For many people it’s almost impossible not to have opinions about stocks. Even those who use a low-cost indexing approach to investing like me find themselves with a strong opinion about a company’s prospects from time to time. For those who commit real money to their opinions, I have a suggested mindset for trading.

Imagine an office building with 1000 people working away on clusters of the latest powerful computers. The workers are former physicists. String theory wasn’t challenging enough for them and they went looking for greater mathematical challenges. Now they are all working together developing advanced trading strategies.

The next time you trade an equity imagine these former physicists being on the other side of the trade selling whatever you’re buying or buying whatever you’re selling. I’m not saying this just to scare readers; this is a fairly accurate depiction of the trading universe.

I’m a believer in owning equities and taking some investment risks, but trading frequently against multiple armies of former physicists is dangerous. I prefer investment strategies that require very little trading.

Monday, November 29, 2010

The Easiest Way to Invest

Readers of investing blogs tend to be those who enjoy spending time thinking and talking about investing. However, most people would rather talk about foot fungus than investing. These people see investing as a necessary evil and want to handle it in the easiest possible way.

It seems like a no-brainer that the easiest way to invest is to hand your money over to a financial advisor and just do whatever he or she says. Even if we ignore the high cost of paying the typical advisor, I’m not convinced that the answer is this obvious.

The term “DIY investor” conjures up images of a group of people boring their spouses at a party with endless talk of whether Apple or Google stock will go up or down. But it doesn’t have to be this way. An investment portfolio can be just about as simple as a bank account.

For example, an investor could just divide investment funds into thirds: one-third for a Canadian stock index, another for a U.S. stock index, and the last for a bond index. New money goes into whichever is lowest, and withdrawals come from whichever is highest. This may not be optimal, but it is dead simple, requires no paying attention to the financial media, and is likely to outperform investments recommended by the typical advisor.

I contend that the strategy I described is actually easier than having a financial advisor invest your money for you. I’d rather just do what I want to do with my money than have to talk to an advisor for all transactions. The main barrier for the “uninterested investor” is to gain enough knowledge to be able to ignore other input and just stick to a simple plan through thick and thin.

There is room for financial experts in people’s lives, but keep in mind that the typical person whom we call a financial advisor is not an expert. They just tell you which mutual funds to buy and do the buying for you. If you need complex legal, tax, or insurance advice, you need to find an expert. The same would be true whether you buy your own ETFs or let someone buy mutual funds for you.

With a modest amount of effort to gain some investing knowledge initially, investors can make their investing lives even easier with a simple DIY approach than they can by just handing their money over to someone else.

Friday, November 26, 2010

Short Takes: Geo-Arbitrage and more

Financial Highway gives the top three places to live and practice geo-arbitrage, which means living someone warm and inexpensive and making money from a western country while working remotely.

Frugal Trader at Million Dollar Journey managed to pay off his mortgage in under 3 years.

Big Cajun Man is contemplating re-gifting within the family, which means some hand-me-downs for his young son.

Thursday, November 25, 2010

Huge Pay on the Reserve

The National Post reports that a politician in Glooscap First Nation in Nova Scotia is paid $978,468 per year. This is very high, but sounds much worse when considering that the reserve has only 300 members. It gets worse, though. Apparently only 87 members actually live in the community.

With a little math these numbers lead to a suggestion that would probably help these 87 people greatly. Perhaps we could get rid of the politician and divide the pay equally among the residents. This works out to $11,246 per person per year. I’m guessing that these people would be better off with the money than whatever service the politician provides.

Wednesday, November 24, 2010

A Useful Cell Phone Feature

Many people are unhappy with the size of their cell phone bills but imagine the shock a Quebec woman got when she was charged $47,000! Her story had a happy ending, but many others whose stories don’t make the news aren’t so lucky.

From an informal poll of a few friends it seems that getting hit with an unexpectedly high cell phone bill is quite common. Maybe they’re not as high as $47,000, but they are higher than anticipated. This happens often enough that it seems to be part of the business plan of cell phone providers.

A useful feature to protect cell phone users would be a monthly cap. If I expect my usual cell phone bill to be $100, I might volunteer for a feature where my service gets shut off if my monthly bill hits say $500. The idea is that this would be an immediate cut-off so that my bill could never exceed $500. This would only happen if I were being hit with some expensive charge that I didn’t understand in advance.

Some people wouldn’t want such a feature, but I think many would like it. Cell phone providers are unlikely to offer it unless forced to, but I can dream of a world where consumers are protected from random massive bills.

Tuesday, November 23, 2010

XPF – New iShares North American Preferred Stock Index ETF

Preferred shares are tempting for fixed income investors mainly because they pay higher returns than many other fixed-income investments. These higher returns come with the inevitable higher risks. BlackRock has helped to spread the risk by coming out with a new exchange-traded fund called XPF that tracks the S&P/TSX North American Preferred Stock Index.

The downside is the cost. The management fee is 0.45%, which is fairly high for an index ETF. The HST adds a little more: 0.03%. Then there is the currency hedging. Half the fund is invested in U.S. preferred shares and the currency exposure is hedged back to Canadian dollars. Such hedging usually seems to cause tracking errors in fund returns.

Another thing to consider is that while XPF has 120 underlying holdings, they are from a relatively small number of companies. For example, I counted 18 holdings of various Royal Bank preferred shares. Presumably, if there is risk of default on one Royal Bank preferred share, then they are all at risk.

For an investor who is only interested in the Canadian part of the ETF, a potential alternative investing strategy is to choose a few preferred shares from different companies and buy them directly. The limited universe of preferred shares means that XPF has limited diversification value over holding the preferred shares directly.

On the other hand, it certainly is more convenient to just buy XPF. Investors should likely be driven by costs here. An investor who works out the costs of XPF and the do-it-yourself approach for the anticipated size of investment can decide whether the annual additional costs of XPF are worth the convenience.

Monday, November 22, 2010

Confusion over General Motors Stock

With much fanfare, the new GM Company had an initial public offering (IPO) last week. Sadly, some shareholders of the old General Motors Corporation think that their old shares will be converted into the new GM shares that closed Friday at US$34.26 per share. This will not happen.

The old GM Corporation was renamed to the Motors Liquidation Company as part of its bankruptcy process. All the old GM stock was renamed MTLQQ. These shares closed on Friday at 18.46 U.S. cents per share.

The Motors Liquidation Company sold its assets to the new GM Company. The ultimate value of the MTLQQ will be decided after the bickering among old GM’s creditors is done. This value is likely to be very low and will have nothing to do with the shares in the new GM Company.

So, in a couple of steps, General Motors Corporation has restored its name to the same initials. However, the old one was “Corporation” and the new one is “Company”. In the shuffle, the old shareholders are left with very little.

Don’t get me wrong, though. I think it’s appropriate for shareholders to lose everything when a company goes bankrupt. I just think it’s sad when naive shareholders hold out hope of getting their money back when it won’t happen.

Friday, November 19, 2010

Short Takes: Math Skills Correlate with Wealth and more

New research suggests a strong correlation between math skills and wealth. Other skills such as a good memory had far weaker correlation with wealth.

Money Smarts reviews CIBC Investor’s Edge Discount Brokerage.

Big Cajun Man runs the numbers on taking the bus versus driving to work. Despite the fact that the numbers strongly favour the bus, he explains why he continues to drive.

Thursday, November 18, 2010

No-PIN Debit Cards – No Thanks

Bill Mann reports that No-PIN debit cards will be coming to Canada this summer. You’ll be able to wave these cards in front of a reader without having to insert them or enter a PIN or sign a slip of paper. My personal take on this is that I don’t want any part of it.

I only use my debit card for accessing bank machines or to identify myself within a branch of my bank. I think of it as a bank card rather than a debit card and prefer not to give retailers access to my bank accounts. If my debit card were stolen, I certainly wouldn’t want the thief to be able to drain my bank accounts by making purchases. If I ever need to use my bank card as a debit card, I would prefer to have to enter a PIN.

I realize that others think differently on this issue and that’s fine: to each his own. However, I would want the option of having a card that cannot be used as a PINless debit card.

Some may say, “just don’t use it to buy anything,” but this doesn’t address my objection. I don’t want anyone else to be able to use my card without a PIN. If I never use it without a PIN this does nothing to prevent a thief who gets hold of my card from using it without needing to know the PIN.

Banks have plans to permit PINless transactions only if they are under $100. They also plan to occasionally require PIN entry particularly if there have been many transactions. This limits the pain somewhat, but not enough for me. A thief could easily run up thousands of dollars in charges. I have no interest in arguing with a bank over which charges are legitimate and whether I notified them quickly enough or protected my card well enough.

I understand the motivation for this “innovation”. Paying with a debit card is usually much slower than paying with cash. Retailers (and customers waiting in line) would love to speed up the payment process. The banks like it because it will increase the number of transactions people make with debit cards. Faster payments will make it more practical to use debit cards for smaller payments.

I’m just not interested in getting on this train. I don’t buy things very often and I don’t mind punching in my PIN or signing for purchases. For many people, bank statements are a blur of numbers (mostly debit purchases) to be ignored except possibly for the current account balance. However, I still check every entry on my account statements against my records and I do find errors from time to time.

Wednesday, November 17, 2010

Is There a Point to Diversification?

A friend I’ll call Jake was analyzing his investments and posed the following question (lightly edited):
I’ve got a standard mix of ETFs, including XIC, XIN, XSP, XBB, and XRB, each with a target percentage of my portfolio and a plan to rebalance when things get out of whack. I plotted the value of my portfolio against the TSX. Guess what? All three lines are almost identical. The correlation isn’t perfect, but close enough over any time period.

So what has my “diversification” and “balancing” bought me (aside from extra transaction fees)? Are markets so tightly interconnected as to make “diversification” impossible/meaningless? When was the last time you saw the S&P go one way but the DOW and/or NASDAQ go the other? Is there any advantage to carving off a chunk of cash and investing in a sector or part of the world? Logic says yes, but the results say no.

I won’t give up on my diversification just yet, but if I was giving advice to a newbie it might be “buy XIC and some bonds and diversify later (much later!).”
Jake has a point that the world’s stock markets are highly correlated. The fact that including some fixed-income investments in the mix has made little difference is a coincidence that won’t continue indefinitely. However, the interconnectedness of our world usually makes different stock markets move together.

The short answer to the value of diversification is the protection it gives from extreme events. Stock markets tend to move together when all is running smoothly, but there is always the possibility of major events that affect one part of the world more than others. I’d hate to have my investments concentrated in one sector or country and have that country experience some severe crisis.

As for the advice to a newbie, I don’t see anything wrong with starting out with just one or two ETFs while the portfolio is small. What is the value in having $2000 diversified among a half-dozen ETFs? There is nothing wrong with buying one ETF with the first $2000 and then buying some other ETF six months later with another $2000 that has been saved. Another direction for small portfolios is low-cost index mutual funds.

Tuesday, November 16, 2010

Negotiating a Line of Credit Interest Rate

Commentators frequently recommend that people negotiate the interest rate on their mortgages, lines of credit, GICs, and other loans and investments. But not much is usually said about how to go about such negotiations. I don’t have all the answers, but I did recently negotiate for a better interest rate on a line of credit. The process surprised me in a few ways.

I have an unsecured line of credit that has been mostly dormant for 17 years. A recent temporary need for money led me to use it and find out that the interest rate I’m being charged is prime+4.5%. After a quick poll of friends, it seemed that I could certainly do better. I decided to do what I could to reduce this interest rate as quickly and easily as I could.

I figured the easiest way to proceed would be to simply call the bank’s general phone number and provide an update on the 17-year old information they have about me. Surely it would be obvious that my financial circumstances warrant a lower interest rate.

Unfortunately, the call didn’t go at all as I planned. The call centre person said he couldn’t just reduce my interest rate. I’d have to apply for a new LOC which would involve a credit check. This last bit of information was conveyed with a tone implying that having your credit checked is a fate worse than death. To avoid such calamity I should go to my bank branch where they might be able to help.

The next day I called my branch, made it through the telephone menu system, and somehow ended up talking to someone at a call centre in another city. I tried my first approach again, but was assured that getting a lower interest rate was some sort of impossible goal without first talking to someone at my branch.

The call centre connected me to my branch where a bank employee assured me that we couldn’t handle this over the phone and I’d have to make an appointment to visit a specialist at the branch. After insisting that a delay of more than 2 weeks was unreasonable, I got a Saturday afternoon appointment.

My wife and I arrived on Saturday armed with every piece of paper we could think of that might be needed. In the first 30 seconds of the meeting the bank representative told us that she was prepared to use her discretion to give us a 1% interest rate reduction. My first thought was that surely this could have been handled over the phone, but I bit my tongue.

The bank representative also said that this 1% reduction was all anyone at the branch had the authority to offer. My first two attempts at asking who did have the authority to authorize a bigger reduction met with a stream of words that ended with repeating that 1% was all the branch could offer.

I can see where many people would have given up at this point. It seemed impossible to get anyone with some authority to actually look at our financial situation and make a sensible determination of an appropriate interest rate for our LOC. I decided not to be put off and insisted that the bank must employ someone with the authority to set a reasonable interest rate and that I wanted to deal with this person.

The representative went off to talk to a superior for quite a while and returned to announce that she could take our information and send it in to some sort of centre where they would take into account our “entire banking relationship” and determine an interest rate. This finally brought us to the point where she took our personal financial information.

At this point the most surprising part of this story happened: she didn’t want to know my income! She took all kinds of information about assets and liabilities, but even after I brought it up, she still didn’t want to know my income. This didn’t give me any confidence that the bank would make a sensible choice of interest rate.

When the promised date for an answer came and went, I started leaving messages. A few days later the bank representative finally told me that my LOC interest rate would be lowered to their base rate, which is prime+3%. That still doesn’t seem great, but taking off 1.5% helps. The term “base” is amusing; it clearly implies that I’m getting the very best rate possible, which seems unlikely. At least I’m not paying more than this so-called base rate.

After all this, my lesson is that the bank’s approach wasn’t so much to say no as it was to avoid answering the question. Their strategy was to put me off and hope that I would give up. In a sense they have partially succeeded because I probably won’t bother to go to one of their competitors looking for a lower interest rate.

Monday, November 15, 2010

If Stocks Go to Zero...

Too often I hear people talking about disaster scenarios where they protect their savings with gold or some other supposedly safe investment in case stocks go to zero. Do these people understand what it would take for stocks to be wiped out completely?

For a stock to go to zero, the business must be wiped out. For a broad stock index to go to zero, all the businesses making up this index must be wiped out. Just imagine it: no internet service providers, no telephone company, no cell phone network operators, no cable companies, and no grocery stores.

Without internet connectivity, telephone, cell phones, or food, exactly what would we buy with our chunks of gold? I certainly wouldn’t trade a can of beans for a bar of gold in such a desperate situation.

No doubt the remedies governments are using to deal with recent financial crises will have negative financial effects down the road, but I have a hard time seeing how the average person can protect himself from a widespread disaster.

Friday, November 12, 2010

Short Takes: Online Broker Rankings, Banks Crying Wolf, and more

Globe and Mail’s online broker rankings are out with Qtrade taking top spot again.

Tom Bradley says that the big banks are crying wolf with their customers as the banks transition into sales organizations.

Million Dollar Journey looks at whether people with defined-benefit pensions should save in TFSAs or RRSPs.

Big Cajun Man reports that Canadians now have over a trillion dollars in mortgages.

MoneyNing shows that telecommuting won’t save you quite as much money as some claim.

Thursday, November 11, 2010

Remembrance Day – Going Beyond Symbolic Gestures

Poppies and “Support Our Troops” bumper stickers are common symbolic gestures of support for our armed forces and veterans, but many veterans could benefit from more tangible support.

Recently, Canadian veterans demonstrated on Parliament Hill over the belief that their disability compensation and pension benefits aren’t adequate. In particular, they say that soldiers wounded in Afghanistan get less money than older veterans got.

I haven’t investigated these claims enough to decide if I think they are true. But anyone who feels strongly enough about supporting our troops should consider checking into these claims. If you decide they have merit, call or write your MP and tell him or her what you think. You will be doing more for veterans than any bumper sticker can do.

Wednesday, November 10, 2010

Prying Bankers Think They Know You

A Wall Street Journal article New Ways Banks Are Spying on You lists the many new types of information that banks collect about their customers to make lending decisions. Banks look at rent, utility payments, estimated house value, and other information. One of the things they do with this information is estimate people’s income to check the income they claim on credit card and loan applications.

Setting aside the privacy concerns, what if you live a lifestyle that doesn’t match the banks’ models? Maybe you have an average income, but their analysis leads them to think you have a low income. A bank that trusts their software more than they trust their customers may reject your application because they think you lied.

As more of the intelligence in the business of banking gets coded into software, the people working in banking will become less likely to understand the limitations of this software. Despite the fact that I work in high-tech, I fear the day when the best answer you’ll get for why you were rejected for a loan is “the computer said no.”

Tuesday, November 9, 2010

What Does “Pre-Approved” Mean?

House shoppers get a lot of comfort from having a pre-approved mortgage. Knowing how much a bank will lend you removes one big worry from the process of finding the right home. In this context, “pre-approved” means that the bank took your relevant personal details and determined how much they would lend you. However, when it comes to credit card offers from the very same banks, “pre-approved” seems to mean something completely different.

According to [a resource no longer available online], when it comes to credit card offers, “pre-approved” means “not yet approved” as opposed to “approved in advance”.

When yet another pre-approved credit card offer from RBC arrived in the mail, I decided to check just how pre-approved I really was. A footnote from the heading on RBC’s offer pointed me to some fine print on the back that explained what they mean by “pre-approved”:

“This pre-approved offer is based on the credit and financially related information the Royal Bank of Canada has about you.”

This certainly implies that I was approved in advance. A quick look at the application tends to support this interpretation; the only information RBC asked me to provide is

– Telephone numbers
– Birth date
– Employment Income
– Mortgage or rent payment

The application explains that my personal income must be more than $60,000 or my family income must be more than $100,000. So, I'm obviously not fully pre-approved. But the lack of any further questions implies at least a partial level of pre-approval.

To test this, I went to the RBC web site to check out the application that just anyone would have to fill in. The only additional questions on this application beyond the ones above were

– Years at current address
– Years with current employer

They don’t seem to care about assets and liabilities beyond house and mortgage. So, beyond what RBC was able to figure out from my address, it seems that my pre-approved status has little meaning. It would be nice to force banks to use the term “pre-approved” consistently between mortgages and credit cards, but this is likely too much to ask when it comes to marketing.

Monday, November 8, 2010

Bell’s Generous Offer

Bell has an offer for its customers: a $100 credit toward a new Bell TV subscription or a new cell phone. This sounds like a generous promotion until you read the body of the letter and fine print on the back.

As a long-time monopoly, Bell was regulated by the CRTC and one of the things Bell was directed to do was to set aside some of the money it collected from its customers for “future use”. CRTC has now decided that this money should be returned to customers.

Bell’s letter states that the rebate amount “could be up to $67 per home phone line”. However, “as an alternative” Bell is offering the $100 coupon. While it may not be obvious, the phrase “as an alternative” means that if you take the $100 offer you give up your right to the $67 rebate. The last line of the fine print on the back of the page is much more direct:

“By taking advantage of this offer, you will not be eligible for any other offers specific to this program, or the rebate cheque mandated by the CRTC.”

Leaving aside the question of whether customers are adequately warned that taking the coupon means they won’t get the $67, one has to question whether this is a good deal. The offer is obviously a bad deal for people who don’t want a new Bell TV subscription or a new cell phone, but what about people who do want one of these things?

The fine print states that the $100 cannot be combined with any other available offers. So, its real value is less than $100 when other offers are available, which seems to be almost all the time. Even if I wanted a new Bell service I’d be inclined to take my $67 in real money and turn down this $100 in “marketing” money.

Friday, November 5, 2010

Short Takes: Unclear Mutual Fund Statements and more

Scott Ronalds reported some results from the latest DALBAR study of the statements that mutual fund companies send to their clients. Apparently, 68% of reports don’t even include the client’s overall rate of return and few show the fees clients pay. The few “statements that do show fees present them in an unclear way.”

Canadian Tax Resource explains the differences among setting up your business as a sole proprietorship, a partnership, and a corporation.

Preet Banerjee takes a look at the conditions under which fundamental indexing will outperform capitalization-weighted indexing.

Money Smarts explains the different ways that financial advisors get paid. If you don’t know how your advisor is being paid, there is a good chance that you’re paying too much.

Big Cajun Man explains that when it comes to banking, everything is negotiable.

Million Dollar Journey explains preferred stocks. See part 2 as well.

Financial Highway has some useful information about credit card solicitations.

Thursday, November 4, 2010

Disagreeable Financial Advisors

Most times in life we seek to spend time with people we like and who agree with our views on major topics. However, this may not be a good strategy when it comes to financial advisors as Jason Zweig explains.

Here is a rough transcript of a common exchange I have with people about their financial advisors:

Me: “Are you happy with your financial advisor?”

Reply: “Yes, he’s a really great guy.”

Me: “Is he handling your money well?”

Reply: “Uh, I don’t really understand that stuff very well. But he’s really a good guy.”

A sign of a good salesperson is being likeable. Things aren’t much different with financial advisors. The advisors who are hungry for business do well by agreeing with whatever the client says, even if the client thinks he want to manage his money in a way that isn’t likely to perform well.

This brings me to a potential strategy for choosing a financial advisor. Seek out an advisor who disagrees with you. The theory is that such an advisor is more likely to be looking out for your interests even if it might cost him some business.

I don’t know if finding a disagreeable financial advisor is the best strategy, but it certainly makes sense to be wary of those who agree with you too much.

Wednesday, November 3, 2010

Gold’s Amazing Decade

Over the past decade, the price of gold has risen from about US$270 to US$1358 per ounce. This is a staggering average compound gain of 17.5% per year. Human nature compels us to imagine this trend continuing, but such high prices should make us wary, not bullish.

If we cast our view back to before the most recent decade, gold actually lost value. For the 20 years ending 10 years ago, gold lost an average of 4% per year! This isn’t an after-inflation figure. If we take into account inflation, gold lost much more value than this.

The tough thing about valuing gold is that it has almost no inherent value. Stocks correspond to businesses that have profits, losses, and dividends. We can at least measure the price of stocks relative to the earnings of these businesses. In the case of gold, how do we measure value?

Of course, currencies have a similar problem. Why do we value dollars? The short answer is that governments act in a manner designed to stabilize the value of currencies.

Between the current high price of gold and a lack of confidence in the desire of world powers to maintain the value of gold, I’m not interested in it as an investment.

Tuesday, November 2, 2010

TFSAs are another Tool for Balancing Assets between Spouses

The tax advantages of balancing assets between spouses aren’t as great as they used to be, but there is still some advantage to shifting assets (legally) from one spouse to another. For example, a couple can reduce their income taxes if taxable dividends are attributed to the lower income spouse.

To this end, my wife and I have been trying to increase her financial assets at the expense of mine. The main tool for doing this has been for all family expenses to be paid out of my income. She saves all money that comes into her hands.

Under the TFSA rules, one spouse can contribute to the other’s TFSA without the resulting income being attributed back to the contributor. This is explained clearly a few paragraphs into this CRA page on TFSAs.

So, I can fill up my wife’s TFSA from my non-registered account and she can leave her money in her non-registered account. This reduces the amount of taxable passive income I receive and increases hers.

Fortunately, new rules on income splitting with pension income and RRIFs make asset balancing between spouses less important, but there is still an advantage to balancing non-registered assets.

Monday, November 1, 2010

Lottery Fever and What to do with the Money

With the Lotto Max jackpot reaching $50 million for Friday’s draw, tongues were wagging. Most of my co-workers claim they don’t buy tickets even when the jackpot becomes huge. In a few cases the stated reason is not wanting to have to manage all that money.

It’s certainly true that most lottery winners seem to manage their money poorly. There is no shortage of rags to riches and back to rags stories. So, what would be a good way to handle the money from a $50 million win?

I may not have the best answer, but here is one answer. I would open two discount brokerage accounts and designate one of them the “tax” account. Both the tax and non-tax accounts would get $25 million. Each would hold the same mix of ETFs. One possible mix is equal dollar amounts of each of the following:

XIU, ZCN – Canadian stocks
XBB, ZAG – Canadian bonds
XSP, ZDM – U.S. and international stocks

The idea here is to have the following types of diversity in case of problems:

– 2 separate brokerages
– 2 separate ETF companies (iShares and BMO)
– stocks and bonds (the lower expected returns of bonds vs. stocks is of little concern with so much capital)

At the current dividend yields, the average yield of this portfolio is 2.68%. Every 3 months each brokerage account would get about $167,500.

My simple rule at this point is that I can spend (or waste) the cash that enters the non-tax account in any way I wish. If I feel generous, I can give chunks of it away. The cash that arrives in the tax account is for paying income taxes. At the end of the year anything left over in the tax account that wasn’t needed for paying income taxes becomes free for spending.

The only remaining rule is to avoid ever signing papers that promise future payments. If some friend begs for $250,000, the answer would be that he’ll have to wait until my account accumulates that much. If I want to buy a house, I have to “save up” for it. By never eating into capital or signing papers promising future payments, the money should last indefinitely.

Friday, October 29, 2010

Short Takes: Discount Brokerage Comparison, Red-Tagged Furnaces, and more

Money Smarts came out with a thorough comparison of Canadian discount brokerages. There are two handy tables for easy comparison along with detailed notes on each brokerage. The column that concerns me the most is Forex fees.

Ellen Roseman finds a number of consumers complaining that their furnaces were “red-tagged” by technicians to boost sales of new furnaces. If these claims are true then homeowners need to be very careful about who they choose to clean and inspect their furnaces.

Big Cajun Man says that TD Canada Trust plans to open branches on Sundays and asks whether this service is really needed. My take is that it doesn’t matter whether it is needed; what matters is whether it is wanted and profitable.

Financial Highway looks at the wisdom or folly of using retirement funds to pay for your kids’ education.

Million Dollar Journey gives us a look inside a demi-millionaire’s wallet.

Thursday, October 28, 2010

Interest Rates on Old Lines of Credit

I have a 17-year old line of credit that has seen very little use. I have it “just in case”. A recent temporary need for money led me to use it instead of selling investments, but I never actually checked on the interest rate. The rate turns out to be prime+4.5%. Ouch.

I’m not exactly up on appropriate interest rates for unsecured lines of credit since the credit crisis, but this seems a little high. Perhaps the problem is that the bank is determining the interest rate partially on 17-year old information I gave them when I opened the line of credit. Or maybe they are just hoping that I won’t notice.

Either way, I’ll be off to the bank to try to get a better rate soon. Anyone else who has an old line of credit but hasn’t looked at the interest rate lately might do well to check it and possibly try to get it lowered.

Wednesday, October 27, 2010

Inherent Value of Businesses

A recent study of currency-hedged foreign equity funds by Raymond KerzĂ©rho provides some explanations for why these funds tend to perform worse than we expect. This reduced performance is called “tracking error”. I believe this is related to the fact that businesses have inherent value independent of currencies.

Canadian Capitalist gave a good overview of this report, but I want to focus in on just one source of tracking error.

One major reason why currency-hedged U.S. stock funds perform below expectations is that the value of the U.S. dollar and the value of U.S. stocks tend to move in opposite directions. For technical reasons with the way these currency-hedged funds operate, this negative correlation gives rise to tracking error.

The idea that stocks and currencies tend to move in opposite directions makes perfect sense if you start from the point of view that businesses have inherent value that is at least partially independent of currency. When the U.S. dollar moves up or down, is there any reason to believe that the inherent value of Walmart has changed?

If Walmart maintains its inherent value, but the U.S. dollar goes down, it makes perfect sense that the value of Walmart measured in U.S. dollars would go up. Of course, stock values are not completely independent of currency fluctuations, but it makes sense that U.S. stock funds will tend to continue to move in the opposite direction of the U.S. dollar.

Tuesday, October 26, 2010

Thinking of Investing in China? Don’t Ignore the Past

Many people are inclined to think that the rise of China’s stock markets is happening for the first time. This isn’t true. As Jason Zweig explains, China has had temporarily successful stock markets a few times in the last 150 years.

Personally, I consider the risk of the communist party choosing to just shut down their stock markets too great to make any serious investment with my money in China. Bulls will explain why maintaining markets is in the communist party’s interests, but who is to say that the small number of people who run the country will behave rationally? And who is to say that the communist party is even competent to run a capitalist economy?

Zweig’s warnings are more nuanced than mine, but I’m content to avoid investments I don’t understand.

Monday, October 25, 2010

Number One DIY Investing Cost: Currency Conversion?

After a quick look through old brokerage statements, it seems that my number one cost is not commissions or spreads but currency-conversion charges. These charges are mostly hidden, but they are very real. I’m a little under the weather and haven’t actually studied the numbers carefully, but I plan to.

Canadian Capitalist posted two ideas for avoiding currency conversion charges on U.S. dividends. These are good ideas, but the longer-term answer is to pressure discount brokerages to do two things:

1. Allow investors to hold U.S. dollars in RRSPs. A few do this already.

2. Start charging more reasonable currency conversion percentages. The high percentages used to make sense when banks actually had to handle cash, but for electronic transactions, banks could easily make a profit charging one-tenth of what they charge now.

Feel free to give your brokerage a hard time about this.

Saturday, October 23, 2010

And the RESP Book Winner is ...

Gene K. wins the draw for a copy of Mike Holman’s RESP Book (see my review here). Thank you to everyone who entered the draw.

Friday, October 22, 2010

Short Takes: Real-Return Bonds and more

Million Dollar Journey explains real-return bonds.

Money Smarts defends mutual fund DSCs (Deferred Service Charges). I’m not convinced, but I do see his point that they could be worse.

Big Cajun Man sums up his experiences with RESPs now that he has actually made a withdrawal.

Financial Highway has 10 ways to lower your insurance costs, but they were initially all listed as #1. I guess anything that saves money has high priority.

Thursday, October 21, 2010

RESP as a Weapon!

A big part of the work I do professionally involves thinking about how to get around security measures and how to use things for unintended purposes. An idea related to RESPs came to mind.

As I often do, I’ll explain my idea in story form:

Ken is a well-to-do homeowner who recently had new neighbours Ted and Alice move in next door. Ken is an RESP expert and the subject came up the first time he spoke to Ted. Ted and Alice saw the benefits of an RESP and they opened one for their baby daughter Emily with some advice from Ken.

The relationship between the neighbours later soured. Their squabbling escalated to the point where they were calling bylaw officers on each other for minor breaches of local ordinances.

In a spiteful mood, Ken concocted a little plan. He opened an RESP in Emily’s name and deposited the lifetime maximum of $50,000 in a single deposit. Ted and Alice hadn’t made a deposit in their RESP yet and now they would never be able to. Anything over the lifetime $50,000 limit gets hit with a 1% per month penalty tax.

Ken planned to leave the money in the RESP for 30 years and then withdraw it and pay tax on the gains. Of course, Ken had no intention of using the money for Emily’s education.

Ken will have to pay an extra 20% tax penalty on the gains when he withdraws the money but this will be partially offset by 30 years of tax-free growth. Because Ken has maxed out his RRSP and TFSA room, the RESP tax shelter is welcome. The extra 20% tax is just the price of revenge.

The question here is whether this could work. Ken would need to get Emily’s Social Insurance Number. The details of my story make it plausible that he would have seen Emily’s SIN when helping Ted and Alice open their RESP. Because Ken has no intention of applying for government RESP grant money, he avoids the need for other documentation about Emily.

Could this work? I’m hoping that the answer is no, but I see nothing in the RESP rules that prevents it. It may not work for certain institutions that offer RESPs, but Ken only has to find one where it will work.

Wednesday, October 20, 2010

Modest Investment Returns are Better than They Appear

We frequently hear that investors need to lower their expectations about investment returns. Experts say that it just isn’t realistic to expect double-digit average returns over the next decade or more. However, if we put the focus where it belongs on real returns, the future looks brighter.

The latest expert to counsel lowered expectations is TD Bank's Chief Economist Don Drummond. Drummond suggests realistic expectations are 2% inflation, 6% to 7% returns for stocks, and 3% to 4% returns for bonds.

These predictions are presented as very modest returns when, in fact, they are quite good. The important thing is to focus on real returns, which are returns after subtracting out inflation. Real returns of 1% to 2% for bonds and 4% to 5% for stocks are nothing to dismiss. I would happily accept this result.

Investors get themselves into trouble when they focus on nominal returns, which are returns without subtracting out inflation. Let’s look the decade starting in 1972 as an example. The TSX Composite index had an average gain of 11.7% per year. This may sound much better than 6% to 7%, but we must account for inflation. During this decade inflation was very high. The average real return on the TSX Composite during this period was only 2.2% per year. I’d rather have 4% or 5% real returns.

While an investment of $100,000 in the TSX in 1972 grew to $303,000 ten years later, its purchasing power grew to only $124,000. What’s worse is that an investor who had to pay say 20% taxes on the yearly gains actually lost purchasing power over this period.

Put another way, an investor who spent the gains each year thinking he was preserving his capital would have seen the purchasing power of his $100,000 in 1972 drop to only $41,000 a decade later.

I’m sure that Don Drummond and Canadian Capitalist understand all this very well, but they also know that the majority of investors tend to focus solely on nominal returns. Investors need to stop moaning about low nominal returns and start focusing on real returns.

Tuesday, October 19, 2010

Book Giveaway: The RESP Book

Who knew that RESPs had so many rules! Mike Holman clearly explains all the ins and outs of RESPs in his book The RESP Book: The Complete Guide to Registered Education Savings Plans for Canadians. The book is only 118 pages long – the author tends to get to the point quickly.

Holman has graciously offered an extra copy of the book as a giveaway for my readers. To enter, just send an email to the contact email address in the upper right corner of my blog with the subject “Book”. Readers who subscribe to my feed will have to click through to my web site. Another benefit of going to my site when reading a post is to see the comments other readers leave on that post. All entries received before noon on Saturday, October 23 will be considered for the draw. I reserve the right to eliminate entries that I judge to be outside the spirit of the contest.

Holman covers the full range of RESP topics: contributions, grants, withdrawals, opening an account, and basic investing information. The author isn’t just a promoter, though; he also lists reasons why some people shouldn’t open RESPs.

One part of the book that struck me as amusing was the subsection titled “RESPs for adults are a waste of time.” What do you really think, Mike? This is as strong an opinion as the author expresses, though. Holman has opinions about which approaches are better than others, but they are expressed in a fair and balanced way.

Here are a couple of questions that came to mind while reading this book:

1. If two or more people open RESPs for the same child and they collectively go over the $50,000 lifetime contribution limit, which RESP gets hit with the 1% per month tax penalty?

2. RESP contents are divided into contributions and accumulated income. Accumulated income consists of government grant money and investment gains. When I start withdrawing RESP money for a child in university, my preference is to withdraw grant money first, then investment gains, and lastly contributions. The reason for this order is in case the child quits school, the grant money must be returned to the government and the investment gains will be taxed. When withdrawing accumulated income, can I request that it be entirely grant money at first, or is this restricted in some way?

In conclusion, I recommend this book to anyone planning to open an RESP. It is likely to be useful to those who already have RESPs as well.

Monday, October 18, 2010

Chasing GIC Returns

I’ve recently been trying to help an elderly GIC investor get the best possible returns on her money. While investigating different options, I discovered that the institutions offering the best rates aren’t accessible from BMO Investorline.

BMO Investorline allows investors to hold GICs from banks other than BMO in an Investorline account. They offer 15 different choices with 3-year GIC rates up to 2.3% and 5-year GIC rates up to 2.95%. As long as they are all covered by CDIC, it’s not clear why anyone wouldn’t just choose the highest rate available.

However, a Google search on “GIC rates” turned up 3-year GIC rates up to 3% and 5-year GIC rates up to 3.45%. This is a gap of 0.7% and 0.5% from the best rates available through Investorline.

In every case, the rates in the Investorline list were as good as or better than the rates shown in the search. It’s just that Investorline didn’t offer GICs from the institutions with the best rates.

Here is a list of the institutions that offered 3-year GIC rates better than the best available through Investorline:


This raises the question of why Investorline doesn’t offer GICs from these institutions. Are they covered by CDIC? Maybe they don’t offer Investorline a commission for bringing in business. Maybe some of these institutions consider GICs to be loss-leaders to bring in other business and they’re not interested if the customer is essentially retained by Investorline.

My search continues for some way to get good GIC rates from different banks without having to open separate accounts with each bank.

Friday, October 15, 2010

Short Takes: Credit Card Arbitrage, Overdraft Fees, and more

My Dollar Plan has an update on Madison’s amazing credit card arbitrage strategy. She borrows a 6-figure sum at a cost that is lower than the interest rate she can get in a savings account. Beware: there are many potentially costly traps for the unwary with this game.

Big Cajun Man has a few choice words for anyone (including himself) who complains about bank overdraft fees.

Money Smarts finds some problems with the free online financial advice service Matthew McGrath promises to address Mike’s concerns.

Financial Highway explains that friends and family are a significant risk for identity fraud.

My Own Advisor tells the story of Grace Groner, a heroine for dividend investors.

Thursday, October 14, 2010

The Futility of Mutual Fund Disclosures

According a 30-year veteran in the Canadian mutual fund industry, typical Canadian investors are either “not capable of grasping” or simply “refuse to believe” how MERs work.

Identified as commenter “MDB” on Ellen Roseman’s blog, this industry insider goes on to explain that mutual fund investors lose “60-80% of their total lifetime return because of MERs.” However, when he attempts to explain this problem to clients, they “glaze over, not wanting to understand this issue. If everyone they knew invested in mutual funds, that made it okay with them.”

Some of MDB’s clients believed “that a regulated product sold by a licensed broker could do no harm.” When MDB spoke to investors from other brokerages, “despite the prospectus in hand, they thought I was misleading them in order to discredit their advisor.” They would look MDB in the eye and say they were not charged MERs.

When a seasoned veteran can’t even convince investors that they pay MERs, the prospect of improving things with better mutual fund disclosure seems completely futile.

Existing mutual fund disclosure does help some investors, but maybe fewer than I originally thought based on MDB’s comments. Better disclosure would help more investors, which is a step in the right direction even if it doesn’t reach the majority of investors.

I’m more convinced than ever that disclosures must be expressed in dollars. If I were about to invest $250,000 of my savings with an advisor who recommends some DSC funds with a 2.5% MER, I should have to sign a sheet of paper with something like the following on it:

First year fees you pay: $6250.00
Estimated first decade fees you pay: $62,500.00

Early withdrawal fees you may pay:
1st year: $13,750.00
2nd year: $13,750.00
3rd year: $12,500.00
4th year: $11,250.00
5th year: $10,000.00
6th year: $ 7,500.00
7th year: $ 3,750.00

If someone reads and understands this information and then decides whether or not an advisor’s help is worth the money, then disclosure has served its purpose. However, if MDB’s experience is any indication, even this level of disclosure may not reach many investors.

Wednesday, October 13, 2010

A Microsoft Story

In my earlier investing days I tended to make investing decisions based on short compelling stories about stocks. Some of these stories I got from others and some I created myself. These thoughts still rattle around in my head, but I no longer act on them. Consider the following story about Microsoft:

Computer speeds are not growing the way they once did. It used to be that we could count on the speed of computers to double every year or two, but no more. A result of this fact is that consumers have less pressure to replace their computers as quickly as they once did. Microsoft makes money by selling a new copy of their operating system with new computers. Fewer sales of new computers will reduce Microsoft’s sales. In addition, dropping computer prices reduces the price Microsoft can charge for their operating systems. The end result is a bleak future for Microsoft stock.

Let me begin by saying that I don’t know whether the premise of this story is correct. Even if the premise is correct, the conclusion may be wrong for other reasons. One could certainly concoct many other stories related to Microsoft stock that focus on their business in different ways. Some of these stories would be bullish and other bearish.

My real point is to illustrate the kind of reasoning that used to drive my investing behaviour. From listening to others who invest in individual stocks, I find that their reasoning for liking or not liking given stocks tends to boil down to a short story like the one above. I used to check a company's financials as well, but in the end my investing choices were usually driven by these short stories.

I’d be interested in finding out whether my story above actually affects anyone’s thinking about Microsoft stock. However, I have undermined the study by admitting that I don’t believe it myself. (I don’t believe it is wrong, either. I just don’t know.) I’ve also undermined my story’s impact by calling it a story rather than a “stock analysis”. I also failed to include a bunch of pointless charts of recent stock performance that might lend greater credibility to the story.

If I have any talent at creating such stories maybe I have a future as a stock “analyst”. It’s more important to sound compelling than it is to have a record of correct predictions.

Tuesday, October 12, 2010

Lotteries Appeal to the Poorest in Poor Countries Too

A couple in my extended family decided to leave Canada’s cold a little over a decade ago and headed off to the island of Roatan, the largest Bay Island of the Honduras. I’ll call them Bob and Jill. The two of them regularly see a mix of wealthy foreigners and very poor locals. Recently, lotteries hit the island in a big way. The results are tragically predictable.

Tickets for the twice-daily draws sell for somewhere close to 25 Canadian cents each. Bob and Jill do a lot of volunteer work with the locals providing some jobs and helping children with education both by financing it and tutoring them. The excitement among the poorest locals over the lottery looks very similar to our experience.

Bob and Jill try to explain that it is a waste of money, but the typical reaction from lottery players is “but I’m going to win so much money.” It is only the locals who are better off financially who seem able to see the new lotteries for what they are: a big waste of money.

It seems that even in a country that is very poor by our standards, the poorest of the poor find some spare money to waste on lottery tickets.