Friday, January 29, 2010

Short Takes: Not so Post-Dated Cheques and more

1. Canadian Financial DIY digs into bank practices and Canadian Payments Association rules to discover that post-dating a cheque doesn’t guarantee that it won’t be cashed right away.

2. Murray Dobbin thinks that Canada’s housing bubble will burst. Some of the remarks seem politically motivated, but he offers ample statistical support for his arguments.

3. Big Cajun Man finds that promised delivery dates for clothes dryers at Home Depot aren’t as firm as he had hoped.

4. Larry MacDonald makes use of the insurance component of his segregated mutual fund.

5. Preet explores the question of whether Warren Buffett is skilled or just lucky.

6. Have you ever wondered how mortgage brokers get paid? Canadian Mortgage Trends gives some insight with recent changes to mortgage broker compensation.

7. Ellen Roseman finds that not all customers who complain deserve her help.

Thursday, January 28, 2010

Many Bank Fees Should be Considered Interest Charges

PBS aired a very interesting story called The Card Game that takes a look at bank practices that exploit people when they start to have money problems. The story explained some of the more unpleasant practices and debated whether they should be stopped. Another concern was how they could be stopped without undermining free enterprise.

One of the slimier practices described was overdraft fees on debit cards. In the example given, a consumer doesn’t realize that his bank account balance is low and goes about his business for a month making debit purchases. The bank then takes all the debit transactions, reorders them from biggest to smallest so that the account is drained on the first few transactions, and then charges a $35 fee on each overdraft transaction. So, a $5 coffee becomes a $40 coffee.

This is a very nasty practice clearly designed to severely punish the unwary. There is no reason to believe that the bank’s exposure to a potentially bad loan is any different if the consumer makes one $50 debit charge instead of ten $5 charges. Yet the overdraft fees are $350 in the latter case instead of only $35.

I think the answer here is to declare (by law) that the overdraft fees are a form of interest and that interest should be capped at some usurious level, such as a nominal 60% per year (5% per month). This would permit the bank to charge 5% interest on overdrafts each month, but this would amount to only 25 cents on a $5 coffee each month rather than a one-time fee of $35.

The same idea could be applied to exceeding the credit limit on a credit card. If the fee for going over your credit limit were declared a form of interest, then it wouldn’t be possible to hit consumers with excessive over-limit fees each month. The fees would have to be proportional to the extent of the excess debt.

I’m not suggesting that we let debtors off the hook. I just want the punishment (in the form of charges) to fit the crime. It makes no sense to offer “overdraft protection” and then charge $35 for $5 of overdraft. This is a 700% penalty.

It can be a difficult challenge to determine which charges are legitimate fees and which are really just a form of interest charges. When a bank has legitimate costs resulting from some consumer’s action (such as bouncing a cheque), it makes sense to charge a fee that shouldn’t be considered interest. However, overdraft fees seem to me to be obviously just a form of interest.

I would like to see legislators in both Canada and the U.S. define what is considered interest more broadly and set some interest rate ceiling, such as a nominal 60% per year.

Wednesday, January 27, 2010

Do Car Ads Prove that People Want to be Fooled?

Recently I combed through some ad fine print to show that some cars were more expensive than the ads made them seem. Yet another car ad reveals more of the same and I’m starting to wonder whether people are genuinely being fooled or whether they want to be fooled.

This time I was looking at an ad for GM cars. The top car showed the price $16,498 in large font. However, the fine print says that the MSRP of the actual car pictured is $19,925. I can’t tell if that is before or after some “cash credits”. Here are a few more fun bits in the fine print:

“Dealers are free to set individual prices.”

“Insurance, license, PPSA, administration fees, and applicable taxes are not included.”

“At some dealers, the vehicles in this advertisement are only available with additional features of
glass etching (up to $424),
locking wheel nuts (up to $150),
nitrogen in tires (up to $399),
GM tire protection plan (up to $220),
mud flaps (up to $120),
box liner (up to $325),
Walk Away insurance (up to $389) and/or Drive Green program ($199) which have additional costs.”

All this is baffling enough that I have no idea of the car’s real price other than I’m pretty sure it’s more than $16,498.

One of the previous car ads had twice-a-month pricing, but GM does this one better with bi-weekly pricing. Instead of advertising payments based on 12 payments per year or 24 payments per year, GM uses 26 payments per year. I bet that daily deductions from by bank account would be pretty small.

To be fair, some people would appreciate payments synchronized with their pay cheques if they are living with almost no cash buffer. However, it seems that this car will cost more than the $105 every two weeks shown in the ad.

This brings me to the question of whether people are actually fooled by all this nonsense of showing prices that don’t include all costs. No doubt some are, but I’m guessing that many people want to be fooled.

Men know that women use make-up to artificially improve their appearance, but most men I know approve of being fooled in this way. Similarly, when people start to get excited about owning a particular car, they may be happy to pretend that the price is lower than it really is, particularly if it helps to win over an unconvinced spouse.

For Canadians wishing to approach car purchasing rationally, I recommend the yearly Lemon-Aid series of books for both new and used vehicles. I have no connection to these books or their author Phil Edmonston other than having used them several times before buying a car. They are available in the public libraries I’ve checked. I’m not aware of any better source of unbiased information about cars.

Tuesday, January 26, 2010

Gold is not the Answer in Case of Major Instability

Gold bugs often say that it’s important to own gold because it is something real that will retain its value even if runaway inflation devalues cash. I don’t spend much time planning for the breakdown of society, but recent events in Haiti can cause us to think about what we should own that will retain some value when everything else is becoming worthless.

In the face of extreme societal breakdown, nothing can really retain much value, but for lesser calamities, some things are better than others. It’s certainly true that poor fiscal management by governments combined with demographic changes, depletion of natural resources, and natural disasters could cause major instability leading to very high inflation.

However, I don’t see gold as the answer. It has little inherent value. In the face of food shortages, why would anyone trade some food for gold? It’s true that money only has value because we all agree it has value. But the same is true of gold. If things get bad enough, we could just as easily lose confidence in gold as we could lose confidence in money.

So, what could hold its value when everything else is becoming worthless? One possibility is real estate. As long as society continues to respect land titles, real estate should have some value.

The best answer I can think of is a stock index. Owning a small slice of thousands of companies across North America (or the whole world) is a good way to protect against calamity. I would rather own a slice of all business than a few pounds of gold.

I see little point in planning for the worst possible disasters, because almost all things will become worthless other than air, water, food, and shelter, and it would be difficult to control any of these things in great abundance. For lesser calamities, I’d rather own stock index units than gold.

Monday, January 25, 2010

RRSP vs. TFSA: Foreign Dividend Taxes

Many experts have commented on the relative merits of RRSPs and TFSAs for Canadian investors. Once people realize that TFSAs aren’t just for cash or GICs, they realize that they have to choose between RRSPs and TFSAs for their long-term retirement savings in all its forms: stocks, bonds, real estate, etc.

The main consideration in this choice is tax rates. If your marginal tax rate while working is higher than it will be when you retire, then RRSPs look good. Some lower income Canadians will see their effective marginal tax rates increase because of the claw-back of the GIS and other government programs.

Another lesser, but still significant consideration is taxes on foreign dividends. The U.S. in particular has a tax treaty with Canada so that dividends from U.S. companies have no tax withheld when Canadians hold the stock in RRSPs. When U.S. stock is held in a regular taxable account, the standard withholding tax on dividends is 15%. Unfortunately, this 15% withholding tax applies to TFSA assets as well.

Let’s take the example of a 30-year old investor, Neil, who wants to invest a slice of his retirement savings in a U.S. stock index ETF. Let’s suppose that this investment will be held until Neil is about half-way into retirement, say about 45 years, and that all dividends will be reinvested.

If the dividend yield over those 45 years is 3%, then holding the ETF units in his TFSA will only give Neil a 2.55% yield (15% less). His RRSP would get the entire 3%. For one year, the difference is small, but over 45 years, the TFSA would have 18% fewer ETF units than the RRSP would have.

So, when the time horizon is long, foreign dividend tax considerations are important for choosing between RRSPs and TFSAs.

Friday, January 22, 2010

Short Takes: Unrealistic Expectations for Stocks and more

1. Jason Zweig finds that people have unrealistic expectations about stock market returns. The more things change, the more they stay the same.

2. Both Preet and Patrick shared their takes on the efficient market hypothesis. I’ve struggled with this one myself, and I’m stilling mulling over their ideas.

3. Larry MacDonald explores Milevsky’s idea that homeowners need to own more bonds. I’ll need more convincing on this one.

4. Potato lowered the stress level on a move by getting a library to take a donation of many of his unwanted books.

5. Big Cajun Man runs into some unexpected costs during a hospital visit.

Thursday, January 21, 2010

Should You Save in RRSPs or Not?

“Is it better to just invest and pay your taxes now or is it better to invest through RRSPs? Or are they about the same return?”

This question came from a reader, Dan, who I met when I spoke to the Ottawa Share Club.

Most people focus on the immediate tax refund from making RRSP contributions, but this is really just a tax deferral. You will have to pay these taxes when you eventually withdraw the money. If your tax rate is lower when you withdraw the money, you end up saving on taxes, but this is not the primary advantage of RRSPs.

By deferring taxes you get the benefit of having the returns on your savings compound tax-free. If you invest in a regular taxable account and pay the taxes owing each year, you lose out on much of the compounding. An example will illustrate this nicely.


Rhonda is 25 years old. She plans to open an RRSP and contribute $10,000 this year and increase this amount by inflation each year for a total of 40 years. This year she’ll get a $4000 tax refund making the net cost to her this year $6000.

Thomas is also 25 years old. He plans to open a taxable investment account and deposit $6000 this year and increase this amount by inflation each year for a total of 40 years. Thomas plans to pay any investment taxes owing out of his savings each year so that his net cost will be the same as Rhonda’s net cost.

Both investors will retire at age 65 and withdraw a fixed after-tax amount each year (rising with inflation) that will exhaust their savings after 25 years.

The question is: who will get the larger retirement income? To answer this, we’ll have to make a series of assumptions.


Taxes: To isolate the benefits of compounding in RRSPs, we will assume that both investors have constant tax rates throughout their lives: 40% on regular income, 20% on capital gains, and 13% on dividends.

Inflation: 3%

Returns: Both investors have a mix of stocks and bonds that earn 7% per year (4% capital gains, 2% dividends, and 1% interest).

Turnover: Both investors change 20% of their investments each year. This doesn’t affect Rhonda much, but it causes Thomas to pay some capital gains taxes each year.


The costs to both investors are the same, and if both approaches were equally good, then we would expect both Rhonda and Thomas to have the same income in retirement. But that’s not how it works out. After fighting with Excel for a while, here are the results:

Yearly after-tax income in retirement in today’s dollars:

Rhonda: $35,074
Thomas: $22,861

This is a big difference that we can attribute to the power of tax-free compounding. Any advantage due to having a lower tax rate in retirement would be extra.

The main message is that if you have a long investing horizon, RRSPs can give a big advantage. Tax-Free Savings Accounts (TFSAs) have this advantage as well.

Wednesday, January 20, 2010

The Assault on Public Service Pensions Begins

The inevitable assault on public service pensions appears to be underway. Many have assumed that the problems of private pension plans would not carry over to public pensions, but this is just wishful thinking. Just because governments can borrow hundreds of billions of dollars to cover promised pension payments doesn’t mean that they are willing to do so.

Superficially, the problems of both public and private sector pensions are similar. Too little money has been saved to cover future promises. If that money isn’t made up, then something has to give. If a plate has ten cookies, and ten people have been promised three cookies each, we may not know who will get their cookies, but we can be sure that not everyone will get all three.

An important difference between public and private sector pension plans is that the government has greater scope to lie to themselves about the real costs of future pension obligations. As explained in the C.D. Howe Institute’s backgrounder The Startling Fair-Value Cost of Federal Government Pensions, government plan valuations “often use aggressive assumptions about future returns on investments in their discount rates for liabilities.” This makes future costs look smaller than they really are.

I have no idea whether the current government is serious about dealing with this problem now. It’s always easier to leave huge problems like this to future governments. But we will have to face this issue at some point.

There are a number of ways of dealing with this issue:

1. Run huge deficits for many years to pay pensions with borrowed money.

2. Reduce benefits somehow, such as tinkering with the inflation indexing, or something more drastic like switching to a defined contribution plan.

3. Make plan participants pay a larger share of their salaries to save in the pension plan.

In the fullness of time, the government may do all three to some degree.

Tuesday, January 19, 2010

Realistic Retirement Expectations

According to the most recent RBC retirement poll, only 25% of Canadians expect to have enough retirement income to realize their dreams. The message isn’t very subtle as we head into RRSP season: contribute more to your RRSP.

It’s important to remember that this is a poll of what people think will happen, not an expert’s prediction. The poll says more about people’s expectations than it says about what will really happen.

It would be nice to live in a world where everyone got to realize their dreams, but life doesn’t always work out the way we want. I see the results of this poll as a sign that Canadians’ expectations are more realistic than what I remember from the tech boom.

A decade ago we didn’t realize it, but we were coming to the end of a huge bull run in the stock market. The TSX Composite had returned a compound average 16.4% from 1993 to 1999 inclusive. People talked seriously about extravagant retirement plans that started with

“Assuming I can make 15% to 20% per year on my retirement savings ...”

The craziest part was that nobody laughed at these unrealistic expectations. People took the inflated stock prices as a given and expected them to continue rising at an unprecedented pace throughout their retirements. Sadly, stocks were destined to drop sharply, particularly technology stocks.

It’s no fun to keep adding another year or two to how much longer you’ll have to work, or to lower the amount you expect to be able to spend each year. However, it’s better to be realistic than it is to jump into retirement and run out of money.

Monday, January 18, 2010

Average Yearly Stock Return of 98% for 40 Years

Statistics can be very useful objective data to guide decisions. However, they can also be used to mislead. For example, did you know that the TSX Composite index of Canadian stocks has averaged a 98% return per year for the last 40 years?

One of the useful data sources that Canadian Capitalist pointed to is a spreadsheet of total returns of different asset classes maintained by Norbert Schlenker of Libra Investments. Using the total returns on TSX Composite stocks back to 1970, we find that $1 at the start of 1970 grew to $40.23 by the end of 2009. This a 3923% increase over 40 years, or 98.1% per year.

I can hear a chorus of “just a minute – that’s not how you calculate yearly returns.” Of course, I agree. We shouldn’t just take the total return and divide by the number of years. However, a motivated debater could probably find creative ways to justify this calculation and muddy the waters nicely. For example, 98.1% really is the correct percentage when TSX Composite returns are viewed in terms of simple interest rather than compound interest.

The most reasonable way to get the average yearly return is to find the percentage that compounds for 40 years to give the same total return. In this case, the answer is 9.68% per year. This is called the average compound return.

In this particular case it’s easy to see that the first calculation is misleading because the final answer is so ridiculous. A more subtle way to make returns look better than they are is to take all the yearly returns, add them up, and divide by 40. This gives an answer of 11.12% per year. However, if you started with one dollar and made this return every year, you’d end up with $67.87, which is much more than the $40.23 produced by the TSX Composite.

These different ways of calculating average returns aren’t necessarily right or wrong. It all depends on what you use them for. The problem is that people with a particular axe to grind will choose the calculation that helps support their argument rather than the one that makes most sense in the given context. This is how statistics can become misleading.

In most cases, the compound return method gives the most meaningful answer. Unfortunately, the calculations are a little more difficult for the less mathematically inclined.

Friday, January 15, 2010

Short Takes: US Mortgage Solution, Walk-In Clinics, and More

1. It seems wrong to just walk away from debts. What if your house value drops to $200,000, but you owe $300,000 on your mortgage? Should you just walk away? Laws in Canada make this difficult, but US law is different. Roger Lowenstein argues that Americans whose mortgages are under water should just walk away. Banks make decisions purely based on profit and loss calculations; why shouldn’t homeowners do this as well? By doing the “moral” thing, homeowners are putting themselves at a disadvantage in their dealings with banks.

2. Larry MacDonald is concerned about the direction Canada’s medical system is heading as doctors tend to work in clinics with increasing profit motive.

3. Canadian Financial DIY offers a drastic solution for keeping people away from fraudulent investing schemes.

4. Big Cajun Man makes a case for de-cluttering your financial records.

5. Frugal Trader sets some aggressive financial goals for 2010.

6. Preet puts on his professor persona to explain a new competitor to the Fama French Three Factor Model of investment returns.

Thursday, January 14, 2010

Advertising Fine Print Comedy

On successive days my local newspaper carried full page ads from car companies. Ordinarily, I don’t notice ads in newspapers much, but the volume of fine print caught my eye. And of course, we all know that the bad news is in the fine print.

A Ford ad had about 1500 words of fine print! That would cover about 5 pages in the Stephen King book I pulled randomly from my bookshelf. A Hyundai ad had about 600 words of fine print running sideways down the length of the ad.

In a fit of masochism, I decided to read the fine print just to see how bad the news was. I’ll spare you the details and leap straight to the funniest parts.

The top of the Hyundai ad featured a car whose price (in huge red font) is $9999 with 0% financing. However, fine print revealed the following information about the car pictured beside this seemingly too-good-to-be-true price:

Price of car in picture:
plus a $1495 delivery and destination charge
plus “registration, insurance, license fees, and applicable taxes”.

So it seems that this $9999 car will actually cost over $20,000. Nice.

The funniest part of the Ford ad was to list “twice a month” payments. So, they divided the monthly payments by 2 before printing them in huge blue font. In that spirit, I’d like to offer $20 bills for $15.*

* Must pay twice.

Fine print is rarely good news, but at least it can be amusing.

Wednesday, January 13, 2010

Taking Financial Risks is in the Genes

Researchers have found a link between attitudes towards long shot financial risks and a specific gene. We tend to like paying a small price for a long shot at a big gain such as in a lottery. At the same time, we tend to prefer paying a small price to avoid taking a chance on a big loss, which explains insurance. The researchers found that how much we like going for big gains and avoiding big losses is linked to a gene called monoamine oxidase A (MAOA).

It turns out that those with a more active version of this gene are more likely to enjoy lotteries and less likely to want insurance than those with the less active version of the gene. To overstate the results, we have two kinds of people:

1. Long shot gamblers who aren’t worried that their houses will burn down.

2. Non-gamblers who buy the $75 extended warranty on a $300 television.

An interesting question is whether many people are able to overcome their perceptions and emotions to make rational decisions. I see this as similar to the perception tricks where you’re asked which line in a diagram is longer. Your brain tells you that one line looks longer, but a ruler tells you that they are both the same length. We accept that they are the same length, but one continues to look longer anyway.

For some reason almost everyone comes to the correct conclusion about the line lengths, but fewer people seem about to accept rational analyses of lotteries and insurance. In these cases, emotions and perceptions often prevail.

Thanks to a friend who pointed me to this research, but probably prefers not to be named.

Tuesday, January 12, 2010

Hospital User Fees

Canada has socialized medicine that covers a wide range of medical needs. We usually say that these services are “free” to Canadians. Of course, by “free” we mean that all costs are shifted to taxpayers. However, many hospital patients and even visitors get hit with a form of user fees.

These fees come in the form of parking costs. In a recent evening trip to my local hospital, I was charged $14 for parking from about 6:30 pm to 10:30 pm. This isn’t a lot of money, but it is much more than the going rate for evening parking in this area.

I could have taken the bus if I wanted to avoid paying for parking, but the last thing I was thinking about while heading to the hospital was a few dollars. I suspect this is true of most others who go to the hospital. So, hospitals are mostly free to charge what they want for parking. Hospital parking rates in my area having been rising much faster than inflation for several years.

Parking fees aren’t likely to ever be officially considered a hospital user fee, but from a practical point of view, they amount to user fees. It would be interesting to see what effect parking rates have on the number of hospital visits. Do some people put off a trip to the hospital because they don’t want to pay for parking? I can guess what the official answer would be, but I’d like to know the real answer.

Monday, January 11, 2010

Misleading Stock-Picker Performance Statistics

Lately I’ve seen several ads and web sites touting the records of different stock-pickers and their systems. One thing the proud claims had in common was that they didn’t count all of the picks for reporting performance figures. This can give misleading results as I’ll show with an example.

Two stock pickers, Amy and Bill, made one pick each day for the past 10 years. They held their picks for the day and moved the resulting money to another pick the next trading day. After examining their records, we find the following results:

Amy: 99% of her picks resulted in a cumulative outperformance of the S&P TSX index by 327%!

Bill: 99% of his picks resulted in a cumulative underperformance of the S&P TSX index by 70%.

It seems apparent that Amy is a great stock picker and Bill should find another job. Amy’s record appears so strong over 10 years that she could easily sell access to her picks through a newsletter.

If you’re suspecting some sort of catch, you’re right. Both Amy and Bill just bought the S&P TSX index and left their money there for the full 10 years. The way that I reported their results was highly misleading, but accurate.

After eliminating the worst 25 days, the returns really are 327% higher. Of course, Amy just matched the index, but her best 99% of days led to huge outperformance. Similarly, Bill matched the index too, but after eliminating his best 25 days, his results look very poor.

To be fair, none of the ads and web sites I saw abused the statistics this badly. If they had, then the reported results would have seemed too incredible. Instead they abused the statistics just enough to make the results seem very good, but still believable.

Friday, January 8, 2010

Short Takes: EI Information Leak and more

1. Don’t tell the Big Cajun Man when EI premiums stop coming off your pay cheque. He’ll use that to figure out how much you make.

2. Larry MacDonald reports on the possible end to trailer fees.

3. Canadian Mortgage Trends warns not to just accept the interest rate offered in a mortgage renewal letter. One homeowner was offered a 5-year fixed rate 1.3% higher than the rate advertised on the same bank’s web site.

4. Tom Bradley at SteadyHand points out a logical inconsistency in a Kraft public statement about the battle involving Warren Buffett over the attempted takeover of Cadbury.

5. Frugal Trader rates his performance on his 2009 financial goals including a goal to pay down his mortgage by $20,000 more than the regular payments. He managed to exceed this goal!

6. Preet says that the new Google phone isn’t going to revolutionize the cell phone market.

Thursday, January 7, 2010

Perverse Incentives for Hedge Fund Managers

While mutual funds usually just charge a fixed percentage management fee, such as 2% of assets under management, hedge funds add a “performance fee”. One of the supposed benefits of paying a hedge fund manager more if the fund performs well is that it aligns the manager’s interests with the investors’ interests. However, in reality, their interests are actually very poorly aligned.

Consider the hypothetical Hyper-Uber-Growth Engine (HUGE) fund. It has a typical “2 and 20” arrangement where management fees are 2% of assets under management plus 20% of any profits above a threshold return of 4%. So, the manager gets 2% plus one-fifth of any returns above 4%.

To model the amount of risk a hedge fund manager is willing to take, HUGE is run in the following unusual way. The assets are invested in some conservative way throughout the year, and on the last day of the year, the manager takes some fraction of the fund to Las Vegas and bets it all at the roulette wheel on red.

The odds are 18/38 that a red number will come up (fund investors win), and 20/38 that the result will be black or zero or double-zero (fund investors lose). Obviously, this is a bad bet from the fund investors’ point of view, but it is the HUGE manager who gets to decide whether to place the bet and how much to wager.

As of the last day of 2009, HUGE had made a 4% gain on its mix of investments and had $100 million in assets. This amount includes the HUGE manager’s entire personal assets of $1 million. The fact that the HUGE manager has all of his personal fortune in the hedge fund can only increase the alignment of his interests and those of the investors, but as we’ll see it won’t help much.

A $1000 Bet

Suppose that the manager decides to bet only $1000. From the investors’ point of view, either the fund will lose $1000, or it will gain $800 (after removing the 20% performance fee). Taking into account the roulette probabilities, the investors’ expected loss on this bet is $147.

The manager’s personal wealth is 1% of the fund. So, the bet will cause him to lose $10 or win $8. But that’s not the end of the story for the manager. If he wins the roulette bet he will also get the $200 performance fee. In total he has a 20/38 chance of losing $10 and an 18/38 chance of winning $208. His expected gain works out to $93.

So, this is a bad bet for investors, but a very good bet for the manager. If the manager chooses to bet $10 million of investor money, his personal wealth of $1 million will either drop to $900,000 or it will rise to $3,080,000. This is a great bet for him, but investors will either lose 10% with probability 20/38 or gain 8% with probability 18/38. Investors’ expected loss is 1.47% of the fund.


Of course no hedge fund would be run the way that this hypothetical fund is run with the roulette betting. But this example does illustrate why hedge fund managers have a strong incentive to take big chances with investor money, even if those chances have a negative expectation.

Wednesday, January 6, 2010

More Pointless Frugality

Those of us whose home position is to be frugal need to examine our behaviour sometimes to see if it makes sense, such as when I decided that mouse traps are disposable. This time I look at humidifier pads.

I have the type of humidifier that attaches to the furnace and forces air to flow through a water-soaked pad. This pad seems to be made mostly of metal and a residue from the evaporated water builds up over time.

For many years I didn’t realize that it was normal to buy replacement pads. I thought the pad was an integral part of the humidifier and I struggled to find ways to clean it. What seemed to work best was soaking it in CLR.

Worried that maybe it wasn’t really getting cleaned properly, I decided to see if the pad could be replaced. On my first attempt at a big-box store, I learned not to call it a humidifier grill. They didn’t have those and I shouldn’t waste this very important employee’s time.

Fortunately, I persisted and found that humidifier pads are a standard replacement item and are quite cheap ($9.99 for my model). This isn’t much more than the cost of a bottle of CLR ($8.69).

This little story is as much about ignorance as thrift, but I’ll call my $1.30 plus tax savings in previous cleanings the result of pointless frugality. For such modest savings, I had to do the work to soak the pad, and then get a result that may not have been as clean as a new pad.

From now on I’ll happily buy new humidifier pads for the extra buck and a half it will cost.

Tuesday, January 5, 2010

Deferred Sales Charges Penalize Regular Savers

Larry MacDonald sparked a spirited debate over how Deferred Sales Charges (DSCs) on mutual funds are calculated. The debate centered on how an investor who makes regular monthly contributions to a mutual fund is affected by DSCs. However, even if DSCs are calculated in a way more favourable to the client, they can be surprisingly high even for loyal investors.

Consider the case of a hypothetical investor Tara who made regular monthly contributions to the Investor Group Canadian Equity Fund C for 10 years. She then had a sudden need for the money and withdrew the full amount. How much will she pay in DSCs?

The debate is whether Tara will pay DSCs on the full amount based on the date of her most recent contribution, or whether the DSC will be calculated for each contribution separately. The language in the fund’s simplified prospectus seems to imply that the date of purchase of each fund unit is tracked separately for calculating the DSC. Based on the following schedule, the first 3 years of contributions would have no DSCs, and the more recent contributions would be charged a sliding scale of DSCs.

During first 2 years: 5.5%
During 3rd year: 5.0%
During 4th year: 4.5%
During 5th year: 4.0%
During 6th year: 3.0%
During 7th year: 1.5%
More than 7 years: 0%

At first glance, it seems that Tara will be charged much less than the 5.5% DSC that would apply if the fees were calculated based on the date of her last contribution. However, the DSC is not as much smaller as I thought it would be.

To simplify the analysis, we’ll assume that Tara bought a fixed number of units each month rather than investing a fixed dollar amount. This won’t affect the conclusion much.

Tara’s DSCs will be calculated as two years at 5.5%, one year at each of the other percentages in the table, and three years of no DSCs. This averages out to 2.9%, which is more than half of what she would have been charged if she were a manic investor who invested a lump sum yesterday and withdrew it today.

This fund’s MER is 2.85% and the total MER fees Tara paid over the 10 years works out to about 13%. Tara has been a loyal client who has paid substantial MER fees, and she is now being hit with DSCs of 2.9%. This seems more like an opportunistic fee grab rather than a fair charge for fickle investors who jump from fund to fund.

Monday, January 4, 2010

Common Knowledge about Stocks

It’s common knowledge that 2009 was a terrible year in the stock market. But a quick look at the numbers shows that an investor in the TSX composite index using the iShares capped ETF (ticker XIC) with reinvested dividends would have made 33.5%! That’s a great gain.

Just a minute, some readers would say. People are lumping in the losses in late 2008 as well when they say that stocks have performed poorly. Fair enough. Taking 2008 and 2009 together, XIC with reinvested dividends lost 5.6% per year. This isn’t exactly devastating, but it’s no fun either.

What about an investor who made regular dollar-cost averaged investments of new money in XIC over the past two years? This new money that was invested for between zero and two years would have actually made a gain of 13.5%.

These actual figures contrast sharply with the despair felt by investors through the depths of the paper losses in March 2009. It’s clear that those who stuck to a long-term plan either lost little or actually made money, and those who sold out during the stock price lows were the ones hurt the most.

Friday, January 1, 2010

Short Takes: New Year’s Edition

Happy New Year! Despite the reduced number of articles written over the holidays, I still found a few interesting things to read.

1. Many people advocate a “core and explore” approach to investing. This amounts to setting a solid core of investments plus a smaller amount of “play” money. When the advice comes from a financial advisor, it amounts to a core of index investments plus some explore money for active management. Larry Swedroe explains the evidence supporting this approach and then demolishes it in part 1 and part 2 of his article.

2. Preet went looking for Olympic hockey tickets to the men’s gold medal game. The price is unbelievable!

3. Big Cajun Man put together a carnival of money stories with a boxing theme.