With the exception of Questrade, most brokerages in Canada don’t permit investors to hold U.S. dollars in their RRSP accounts. This may not seem like a big deal until you check out the currency conversion costs when trading U.S. securities. A solution to this problem is called “washing” the trades. I recently did this and thought it might be useful to describe exactly how it is done at my discount brokerage.
Before going any further, it’s important to know that “washing trades” means something completely different from “wash trading”. Wash trading is an illegal activity where someone simultaneously buys and sells a stock to drive up trading volume and give the appearance of something big about to happen. Washing trades is a brokerage service that means eliminating currency conversion costs.
I got my trades washed recently as I continued my transition from owning individual stocks to owning index ETFs. I wanted to sell several U.S. stocks and buy a U.S. index ETF in my RRSP. Without doing anything special, the following would have been the sequence of events for me:
– Place the order to sell U.S. stocks
– The order is executed and U.S. dollars arrive in my RRSP
– U.S. dollars get converted to Canadian dollars at CDN$1.0035 per U.S. dollar
– Place an order to buy the U.S. index ETF units
– Canadian dollars get converted to U.S. dollars at CDN$1.021 per U.S. dollar
– The buy order is executed
Note the pointless conversions in the middle from U.S. dollars to Canadian dollars and back again. This would have cost me 1.7% of my money if I hadn’t had BMO Investorline wash the trades. At Investorline, they actually call this “exchange rate matching” because they just make the two exchange rates equal rather than actually eliminating the currency conversions.
The exact method of exchange rate matching depends on whether the total number of U.S. dollars involved in your buy orders is more or less than the total number of U.S. dollars in your sell orders. This determines whether you are a net buyer or net seller. If you are a net buyer, then the sell order exchange rates get changed to be equal to the buy order rates. If you are a net seller, then the buy order exchange rates get changed to be equal to the sell order rates. Either way the portions of the trades that match up in total U.S. dollars don’t cause any losses. The excess U.S. dollars created or consumed are exchanged at the correct rate that favours the brokerage.
A restriction on wash trading is that it only applies to trades within a single day. So, if you sell U.S. securities one day and buy other U.S. securities the next day at Investorline, you’ll get hit with the full currency conversion costs.
Another restriction is that you have to ask for exchange rate matching with a phone call between 3:15 and 4:30 pm. Apparently, the day’s exchange rates get set around 3:15. I tend to be a little paranoid about these things and place the call before 3:30.
There is no good reason why washing trades couldn’t be done automatically without any phone call, except that BMO makes more money if you don’t make the call. There is also no good reason why the call has to be placed between 3:15 and 4:30. Surely I should be able to call at noon to say “when the rates get set, please wash my trades.” Again, BMO makes more money if I trade in the morning and forget to call later.
So, it is possible to avoid currency conversion costs, but you have to follow the silly rules. This is yet another of life’s taxes on the unwary.
Wednesday, March 31, 2010
Tuesday, March 30, 2010
Cheap Natural Gas
My wife observed that our most recent natural gas charge was $48.11 compared to $255.94 a year ago. That’s huge difference. I started thinking about the causes of this drop, but it wasn’t until I investigated further that I discovered the dominant reasons.
The cause I was hoping for was the new furnace I had put in. No doubt this high-efficiency furnace helped, but not that much. The other obvious cause was the mild weather we’ve been having. Again, this helped, but isn’t enough to account for the big drop.
The first thing I noticed when comparing the details in the bills was that the charges are based on “estimated readings”. Over the years I’ve often found these estimates to be wildly inaccurate.
I almost stopped comparing the most recent bill to the year-old bill at this point when I saw the per-cubic-meter charge on the most recent bill was 12.9 cents. This seemed low compared to the last time I noted this figure. Sure enough, a year ago natural gas cost me 29.2 cents per cubic meter. That’s a drop of 56% in one year!
This has to be galling for people who have been tricked into paying premium rates on fixed-price contracts. These low prices may not last, but I’m happy to ride the roller-coaster of gas prices instead of paying a premium to lock in gas rates for a few years.
The cause I was hoping for was the new furnace I had put in. No doubt this high-efficiency furnace helped, but not that much. The other obvious cause was the mild weather we’ve been having. Again, this helped, but isn’t enough to account for the big drop.
The first thing I noticed when comparing the details in the bills was that the charges are based on “estimated readings”. Over the years I’ve often found these estimates to be wildly inaccurate.
I almost stopped comparing the most recent bill to the year-old bill at this point when I saw the per-cubic-meter charge on the most recent bill was 12.9 cents. This seemed low compared to the last time I noted this figure. Sure enough, a year ago natural gas cost me 29.2 cents per cubic meter. That’s a drop of 56% in one year!
This has to be galling for people who have been tricked into paying premium rates on fixed-price contracts. These low prices may not last, but I’m happy to ride the roller-coaster of gas prices instead of paying a premium to lock in gas rates for a few years.
Monday, March 29, 2010
Splitting Pay Between Accounts
I recently started a new job with a smallish company. After taking the job, one of the questions I asked the human resources person who showed me around on the first day was whether I could split my pay between two different banks accounts. I thought that maybe a small company might not be set up to handle this, but they can. I noticed I felt relieved. Such a small thing makes a difference in my marriage.
My wife and I have had various periods of time when both of us earned an income, only one of us did, and times when neither of us earned income. One constant we maintained through all this is that all money belongs to both of us. Just because at a given time only one of us had an income didn’t mean that spouse controlled the money.
We prefer to maintain separate bank accounts. Neither one of us wants misunderstandings or mistakes to lead to bounced cheques and other headaches. This means that I need to send some of my pay over to my wife’s bank account.
One solution to this problem would be for her to ask me for money whenever she runs low. But in the past, this has been a problem for us. It just feels too much like begging. It’s much better to have the money just arrive automatically. This approach actually makes a tangible difference in our happiness.
My wife and I have had various periods of time when both of us earned an income, only one of us did, and times when neither of us earned income. One constant we maintained through all this is that all money belongs to both of us. Just because at a given time only one of us had an income didn’t mean that spouse controlled the money.
We prefer to maintain separate bank accounts. Neither one of us wants misunderstandings or mistakes to lead to bounced cheques and other headaches. This means that I need to send some of my pay over to my wife’s bank account.
One solution to this problem would be for her to ask me for money whenever she runs low. But in the past, this has been a problem for us. It just feels too much like begging. It’s much better to have the money just arrive automatically. This approach actually makes a tangible difference in our happiness.
Friday, March 26, 2010
Short Takes: Index Tracking and more
1. Preet lists some reasons you may not have thought of why your index fund may not exactly track its index.
2. Frugal Trader lays out his RESP asset allocation strategy. The interesting thing to me is the transition points. When the date comes to shift money from stocks to bonds, will he do it mechanically on the exact date specified, or will he try to time the trades? These choices are always more complicated in real life than on a chart.
3. Big Cajun Man has found a sign of a very bad day for an investor.
4. Tom Bradley wonders who is buying Kevin O’Leary’s new mutual funds? This is one case where it doesn’t pay to get in early.
2. Frugal Trader lays out his RESP asset allocation strategy. The interesting thing to me is the transition points. When the date comes to shift money from stocks to bonds, will he do it mechanically on the exact date specified, or will he try to time the trades? These choices are always more complicated in real life than on a chart.
3. Big Cajun Man has found a sign of a very bad day for an investor.
4. Tom Bradley wonders who is buying Kevin O’Leary’s new mutual funds? This is one case where it doesn’t pay to get in early.
Thursday, March 25, 2010
Misalignment of Interests on Wall Street
I saw an interview on the Daily Show recently where the guest claimed that leading up to the recent credit crisis, people on Wall Street “fooled themselves”. While this may be true, I think the dominant driver was the self-interest of people at the expense of their companies.
To illustrate what I mean, imagine that you play a game each day on your company’s behalf where you toss 4 dice and your company collects a million dollars if they don’t come up all 1s. If they do come up all 1s, your company must pay $5 billion.
The expected payoff of each roll is a $2.86 million loss, a terrible deal for the company. But, what happens if you play anyway? For a few years you make a million dollars for your company each day. All this apparent profit seems wonderful. The company pays you, your colleagues, and management big fat bonuses for generating so much “profit”.
This continues until the fateful day when the worst happens and the company goes bust having to come up with $5 billion. From your point of view, though, this has been wonderful. You’ve collected a lifetime of income in bonuses in a few years and can retire comfortably.
People on Wall Street were blinded to the risks their companies were taking on, but this blindness may have less to do with ignorance than it had to do with greed.
To illustrate what I mean, imagine that you play a game each day on your company’s behalf where you toss 4 dice and your company collects a million dollars if they don’t come up all 1s. If they do come up all 1s, your company must pay $5 billion.
The expected payoff of each roll is a $2.86 million loss, a terrible deal for the company. But, what happens if you play anyway? For a few years you make a million dollars for your company each day. All this apparent profit seems wonderful. The company pays you, your colleagues, and management big fat bonuses for generating so much “profit”.
This continues until the fateful day when the worst happens and the company goes bust having to come up with $5 billion. From your point of view, though, this has been wonderful. You’ve collected a lifetime of income in bonuses in a few years and can retire comfortably.
People on Wall Street were blinded to the risks their companies were taking on, but this blindness may have less to do with ignorance than it had to do with greed.
Wednesday, March 24, 2010
Evaluate This Portfolio
A reader I’ll call Jim is looking for feedback on his portfolio. Jim is 50 years old and has no company pension plan. Here is the breakdown Jim sent:
RRSPs
$10,000 S&P/TSX 60 (purchased this year, due 2015) at BMO
$7000 term deposit 1.75% at BMO
$81,000 mutual funds at National Bank Financial, including
– Fidelity Northstar Class B (FID210)
– Vengrowth Investment D (VEN662)
– BMOG Asian Growth and Income M FL (GGF620)
– Sentry Select Canadian Income Class FL (NCE517)
– Vengrowth II Investment D (VEN679)
– MacKenzie Cundill Recovery FL (MFC742)
– Manulife Growth Opportunities FL (EPL588)
– Vengrowth I Investment D (VEN669)
– Sprott Canadian Equity Fund SR A FL (SPR001)
– Synergy Canadian CC FL (CIG6103)
$2000 GIC at 4.5% due 2011 at Bank of N.S.
$13,000 Bonds averaging 4.9% at Great West Life (60% company match)
$18,000 stocks at National Bank Financial
$28,000 term deposits (mutual funds) due 2013 (4000) and 2024 (24000) bonds at National Bank Financial
TFSA
$5000 cash at BMO
Taxable Accounts
$53,000 8 Drip stocks
$1600 Other stocks
Total: $218,600
The good news is that Jim has more savings than most people. However, this portfolio reminds me a little of mine before I finally fired the financial advisors I had worked with. Jim has assets all over the place.
The biggest chunk of money is in mutual funds at National Bank Financial. I only looked up a few of them, but the MERs were high (between 2% and 3%). The first Vengrowth Fund seemed to have a 10% up front commission! The primary purpose of these mutual funds seems to be to generate fees.
This portfolio has a lot of duplication. The various funds no doubt cover many of the same stocks. It can feel like diversification to own many mutual funds, but this can just obscure what you really have.
My personal preference is to own low-cost index ETFs or funds rather than actively-managed mutual funds. I’m actually getting out of the business of picking individual stocks, but it is possible for knowledgeable investors to create an appropriately-diversified portfolio of individual stocks. I just think it’s easier to use index ETFs.
I’d be interested in hearing what readers think of Jim’s portfolio.
RRSPs
$10,000 S&P/TSX 60 (purchased this year, due 2015) at BMO
$7000 term deposit 1.75% at BMO
$81,000 mutual funds at National Bank Financial, including
– Fidelity Northstar Class B (FID210)
– Vengrowth Investment D (VEN662)
– BMOG Asian Growth and Income M FL (GGF620)
– Sentry Select Canadian Income Class FL (NCE517)
– Vengrowth II Investment D (VEN679)
– MacKenzie Cundill Recovery FL (MFC742)
– Manulife Growth Opportunities FL (EPL588)
– Vengrowth I Investment D (VEN669)
– Sprott Canadian Equity Fund SR A FL (SPR001)
– Synergy Canadian CC FL (CIG6103)
$2000 GIC at 4.5% due 2011 at Bank of N.S.
$13,000 Bonds averaging 4.9% at Great West Life (60% company match)
$18,000 stocks at National Bank Financial
$28,000 term deposits (mutual funds) due 2013 (4000) and 2024 (24000) bonds at National Bank Financial
TFSA
$5000 cash at BMO
Taxable Accounts
$53,000 8 Drip stocks
$1600 Other stocks
Total: $218,600
The good news is that Jim has more savings than most people. However, this portfolio reminds me a little of mine before I finally fired the financial advisors I had worked with. Jim has assets all over the place.
The biggest chunk of money is in mutual funds at National Bank Financial. I only looked up a few of them, but the MERs were high (between 2% and 3%). The first Vengrowth Fund seemed to have a 10% up front commission! The primary purpose of these mutual funds seems to be to generate fees.
This portfolio has a lot of duplication. The various funds no doubt cover many of the same stocks. It can feel like diversification to own many mutual funds, but this can just obscure what you really have.
My personal preference is to own low-cost index ETFs or funds rather than actively-managed mutual funds. I’m actually getting out of the business of picking individual stocks, but it is possible for knowledgeable investors to create an appropriately-diversified portfolio of individual stocks. I just think it’s easier to use index ETFs.
I’d be interested in hearing what readers think of Jim’s portfolio.
Tuesday, March 23, 2010
SuperCycles
According to economist Arun Motianey, author of SuperCycles, a SuperCycle is a wave of boom and bust spread over an extended period of time. He argues that the attempts by government policy-makers to stabilize prices are actually the cause of these boom and bust cycles.
Although this book may be intended for a general audience, it was a difficult read for a non-economist like me. It is always hard to tell in these situations if the problem is with the reader or writer, but many parts were lost on me. However, I did come away with some understanding.
Motianey looks through financial history and finds repeated patterns of a cycle. They begin with governments achieving price stability through policies such as the Gold Exchange Standard. This is followed by a collapse in commodity prices which causes a mismatch between prices of inputs (commodities) and outputs (finished goods). This leads to excess investment chasing the available profits, excess credit satisfying the demand from manufacturers, and then excess capacity. This situation cannot continue indefinitely, and the result is a bust.
One particularly interesting part was a table that broke out investment returns since 1929 in the U.S. by periods of high or low GDP growth and high or low inflation:
Real Yearly Returns Since 1929
It seems that stocks like anything other than low GDP growth with high inflation, bonds and T-bills like low inflation, and commodities like high inflation.
Instead of the usual book giveaway I often run, the publisher, McGraw-Hill, has decided to run their own. While I don’t use your email addresses for any other purposes, the McGraw-Hill Privacy Statement says “We may also make your contact information available to other divisions of the McGraw-Hill family of companies or to other reputable business information companies, so that they can inform you about other products and services that may interest you.”
Although this book may be intended for a general audience, it was a difficult read for a non-economist like me. It is always hard to tell in these situations if the problem is with the reader or writer, but many parts were lost on me. However, I did come away with some understanding.
Motianey looks through financial history and finds repeated patterns of a cycle. They begin with governments achieving price stability through policies such as the Gold Exchange Standard. This is followed by a collapse in commodity prices which causes a mismatch between prices of inputs (commodities) and outputs (finished goods). This leads to excess investment chasing the available profits, excess credit satisfying the demand from manufacturers, and then excess capacity. This situation cannot continue indefinitely, and the result is a bust.
One particularly interesting part was a table that broke out investment returns since 1929 in the U.S. by periods of high or low GDP growth and high or low inflation:
Real Yearly Returns Since 1929
Equities | Bonds | T-bills | Commodities | |
Low GDP growth, low inflation | 14.0% | 9.3% | 2.9% | 0.4% |
High GDP growth, low inflation | 10.6% | 5.2% | 1.3% | -0.8% |
High GDP growth, high inflation | 8.4% | -1.4% | -1.0% | 21.7% |
Low GDP growth, high inflation | -1.9% | -5.0% | -1.7% | 13.7% |
It seems that stocks like anything other than low GDP growth with high inflation, bonds and T-bills like low inflation, and commodities like high inflation.
Instead of the usual book giveaway I often run, the publisher, McGraw-Hill, has decided to run their own. While I don’t use your email addresses for any other purposes, the McGraw-Hill Privacy Statement says “We may also make your contact information available to other divisions of the McGraw-Hill family of companies or to other reputable business information companies, so that they can inform you about other products and services that may interest you.”
Monday, March 22, 2010
The Value of Your Life
This essay is decidedly less concrete than my usual output. It was sparked by an interesting discussion with some friends including the Big Cajun Man.
We tend to think that our lives have infinite value to us. However, I’m going to argue that your life has a finite value to you and that this value can be quantified is various unsettling ways. I’m not just talking about the value others put on your life, but the value you place on it yourself.
We can see this finite valuation from our choice to engage in risky behaviour such as driving a car. According to the Wall Street Journal, the odds of dying in a motor vehicle accident sometime in your life (presumably at the end) are about 1 in 84. This would be some sort of average U.S. figure, and the real figure for you would depend on where you live, how much you drive, how you drive, etc. The main point is that your figure is some probability larger than zero.
Unless you have an unusual home or hobbies, driving a car is more dangerous than sitting in your home. So, choosing to drive is usually a voluntary choice to trade some increased risk of death for whatever benefit comes from traveling from one place to another in your car.
However, if your life has infinite value, then this increased risk of death has infinite cost. If the benefit from your car trip is finite, then you’ve made a bad choice.
Now I’m not arguing that driving a car or any other risky behaviour is irrational. What I am arguing is that it is inconsistent with a belief that we assign infinite value to our lives. Risky behaviour is sometimes justified if the benefit that it brings is worth more than the lost value due to the increased risk of death. This is true because the value of a life is finite, even to the person in question.
An apparent counter-argument is that it is rational for people to do just about anything to avoid an otherwise certain death. There is no amount of money you could pay someone to get them to stay in a burning building.
However, this doesn’t mean that people value their lives infinitely. What could anyone possibly do with a stack of money in the few minutes before burning up? In this situation, the money has no value. This is equivalent to “I’ll give you nothing if you stay and burn.”
However, things change if there is only a chance of death. Suppose you were offered a million dollars to roll a pair of dice, and you’d get the money if they don’t come up snake-eyes, but you die if they do both come up 1s. I certainly wouldn’t take this deal, and I suspect few people would take it.
What if we made it three dice so that the odds of dying are now 1 in 216? Still no takers? How about 4 dice? As we keep adding dice, the odds of having them all come up 1s will eventually drop below the chances of dying from some other cause while tossing the dice. At some number of dice it would become rational to take the offer, toss the dice, and walk away with the million dollars (assuming that we’re satisfied that the dice are fair and the game isn’t somehow rigged). Your life has a finite value to you, even measured in dollars.
If you live for 30,000 days (about 82 years), the value of your life is the sum total of the value you extract from each of these 30,000 days. If some event manages to steal the value of one of these days from you and the lost day is a typical day for you, then your loss is about one part in 30,000 as bad as if you had died in infancy.
The inescapable conclusion is that we don’t attach infinite value to our own lives.
We tend to think that our lives have infinite value to us. However, I’m going to argue that your life has a finite value to you and that this value can be quantified is various unsettling ways. I’m not just talking about the value others put on your life, but the value you place on it yourself.
We can see this finite valuation from our choice to engage in risky behaviour such as driving a car. According to the Wall Street Journal, the odds of dying in a motor vehicle accident sometime in your life (presumably at the end) are about 1 in 84. This would be some sort of average U.S. figure, and the real figure for you would depend on where you live, how much you drive, how you drive, etc. The main point is that your figure is some probability larger than zero.
Unless you have an unusual home or hobbies, driving a car is more dangerous than sitting in your home. So, choosing to drive is usually a voluntary choice to trade some increased risk of death for whatever benefit comes from traveling from one place to another in your car.
However, if your life has infinite value, then this increased risk of death has infinite cost. If the benefit from your car trip is finite, then you’ve made a bad choice.
Now I’m not arguing that driving a car or any other risky behaviour is irrational. What I am arguing is that it is inconsistent with a belief that we assign infinite value to our lives. Risky behaviour is sometimes justified if the benefit that it brings is worth more than the lost value due to the increased risk of death. This is true because the value of a life is finite, even to the person in question.
An apparent counter-argument is that it is rational for people to do just about anything to avoid an otherwise certain death. There is no amount of money you could pay someone to get them to stay in a burning building.
However, this doesn’t mean that people value their lives infinitely. What could anyone possibly do with a stack of money in the few minutes before burning up? In this situation, the money has no value. This is equivalent to “I’ll give you nothing if you stay and burn.”
However, things change if there is only a chance of death. Suppose you were offered a million dollars to roll a pair of dice, and you’d get the money if they don’t come up snake-eyes, but you die if they do both come up 1s. I certainly wouldn’t take this deal, and I suspect few people would take it.
What if we made it three dice so that the odds of dying are now 1 in 216? Still no takers? How about 4 dice? As we keep adding dice, the odds of having them all come up 1s will eventually drop below the chances of dying from some other cause while tossing the dice. At some number of dice it would become rational to take the offer, toss the dice, and walk away with the million dollars (assuming that we’re satisfied that the dice are fair and the game isn’t somehow rigged). Your life has a finite value to you, even measured in dollars.
If you live for 30,000 days (about 82 years), the value of your life is the sum total of the value you extract from each of these 30,000 days. If some event manages to steal the value of one of these days from you and the lost day is a typical day for you, then your loss is about one part in 30,000 as bad as if you had died in infancy.
The inescapable conclusion is that we don’t attach infinite value to our own lives.
Friday, March 19, 2010
Short Takes: Disability Tax Credt and more
1. Larry MacDonald reports that the Disability Tax Credit is often overlooked. In one case, a woman with inner-ear problems got a $48,000 income tax refund by re-filing past years’ income tax returns using the Disability Tax Credit.
2. Big Cajun Man proposes a new property tax model. I’d like to pay less tax too, but I’m not holding my breath.
3. Million Dollar Journey has CFP Brian Poncelet explaining how annuities work.
4. Preet looks at the option of having a higher car insurance deductible to lower the premiums.
5. Potato sees the trend toward younger people buying homes as a sign of the end of Canada’s housing bubble.
2. Big Cajun Man proposes a new property tax model. I’d like to pay less tax too, but I’m not holding my breath.
3. Million Dollar Journey has CFP Brian Poncelet explaining how annuities work.
4. Preet looks at the option of having a higher car insurance deductible to lower the premiums.
5. Potato sees the trend toward younger people buying homes as a sign of the end of Canada’s housing bubble.
Thursday, March 18, 2010
Enthusiasm: The Double-Edged Sword
Without enthusiasm, we wouldn’t start anything new. It’s very easy to plod along doing the same thing every day, and it takes some enthusiasm to make a change. On the other hand, too much enthusiasm can cause problems as well. We can see this in personal finances and other areas of our lives.
Take exercise as an example. It takes enthusiasm to get over the hurdle to get started. But too much excitement has its own problems. Those who start a new workout regimen talk as though they invented it, they spend money needlessly on the latest workout clothes, and they overdo things at the start and hurt themselves. Too much enthusiasm often leads to disillusionment and quitting.
Dieting is another good example. Getting excited enough to eat better is a good thing, but too often I hear people decide to make big changes they can’t sustain: “I’m going to skip breakfast and have only salad for lunch.” Big changes like this often lead to extreme hunger and overeating and guilt later on. Modest shifts to healthier foods and increased exercise are often a better path than radical changes made by over-enthusiastic people.
When it comes to finances, people sometimes decide that the time has finally come to really attack their debt by, say, increasing their debt repayments by $1000 per month. This is great if it is possible, but if that doesn’t leave enough money for basic shelter, food, and clothing, then these people are just setting themselves up for failure. Budgets must be realistic.
People who move along at an even keel have an advantage over manic-depressive types in this regard. Instead of alternating high enthusiasm and failure, try the slow and steady approach with modest enthusiasm.
Take exercise as an example. It takes enthusiasm to get over the hurdle to get started. But too much excitement has its own problems. Those who start a new workout regimen talk as though they invented it, they spend money needlessly on the latest workout clothes, and they overdo things at the start and hurt themselves. Too much enthusiasm often leads to disillusionment and quitting.
Dieting is another good example. Getting excited enough to eat better is a good thing, but too often I hear people decide to make big changes they can’t sustain: “I’m going to skip breakfast and have only salad for lunch.” Big changes like this often lead to extreme hunger and overeating and guilt later on. Modest shifts to healthier foods and increased exercise are often a better path than radical changes made by over-enthusiastic people.
When it comes to finances, people sometimes decide that the time has finally come to really attack their debt by, say, increasing their debt repayments by $1000 per month. This is great if it is possible, but if that doesn’t leave enough money for basic shelter, food, and clothing, then these people are just setting themselves up for failure. Budgets must be realistic.
People who move along at an even keel have an advantage over manic-depressive types in this regard. Instead of alternating high enthusiasm and failure, try the slow and steady approach with modest enthusiasm.
Wednesday, March 17, 2010
Voluntary Online Payment Models
A while back, Canadian Financial DIY reported on a new model for voluntary payments for online content called Flattr. The basic idea of Flattr is that users take a monthly fixed amount of money and spread it around in equal shares to the various web sites they choose to “flattr”. A question I have is whether this is really any better than directly soliciting contributions.
I decided to put my money where my mouth is, or is that your money where my mouth is? In any case, I’ve added a button at the top right of the blog page for direct voluntary payments. (Since the time of writing, I've removed this button.) I’ve decided to keep the content part of my blog entries free of paid content, affiliate programs, etc., and just make direct voluntary payments possible. I prefer to maintain a clear boundary between content and advertising on my blog.
It turns out that Paypal makes it easy to set up a payment button like this, but the simplest approach uses a button labeled “Donate”. This sounds too much like a charitable contribution to me. I decided to go with “$upport this blog!” to make it clear that contributions are not charity, but are encouragement to me to continue investigating financial matters and writing about them.
Whether this direct payment method is better for users than Flattr probably depends on the user. Flattr makes it easier to spread a little money around to a lot of web sites. However, direct payments are probably easier for users who only want to make occasional contributions and not be bothered with committing to payments every month.
In any case, once Flattr matures and publishes figures on the distribution of money directed to various content creators, I can compare my numbers to theirs.
I decided to put my money where my mouth is, or is that your money where my mouth is? In any case, I’ve added a button at the top right of the blog page for direct voluntary payments. (Since the time of writing, I've removed this button.) I’ve decided to keep the content part of my blog entries free of paid content, affiliate programs, etc., and just make direct voluntary payments possible. I prefer to maintain a clear boundary between content and advertising on my blog.
It turns out that Paypal makes it easy to set up a payment button like this, but the simplest approach uses a button labeled “Donate”. This sounds too much like a charitable contribution to me. I decided to go with “$upport this blog!” to make it clear that contributions are not charity, but are encouragement to me to continue investigating financial matters and writing about them.
Whether this direct payment method is better for users than Flattr probably depends on the user. Flattr makes it easier to spread a little money around to a lot of web sites. However, direct payments are probably easier for users who only want to make occasional contributions and not be bothered with committing to payments every month.
In any case, once Flattr matures and publishes figures on the distribution of money directed to various content creators, I can compare my numbers to theirs.
Tuesday, March 16, 2010
Hot Water Heater: Rent vs. Buy
Two Saturdays ago, I got up to find that hot water was shooting out the top of my hot water heater. This forced my hand on the decision of whether to replace my 20-year old hot water heater with another rental from Direct Energy or buy one.
In the face of water gushing onto my basement floor, I took the following steps:
1. Panic. This is best limited to a few seconds during which you don’t move.
2. Shut off main water supply to the house. Every adult and teenager in the house should know where this is, and it should be kept clear.
3. Clean up the water. A plastic dustpan worked great for scooping up the water off the cement floor that pooled away from the drain.
4. Call a friend who knows how to do just about any kind of work around a house and is often available on short notice. This step could be tricky if you don’t have the right friends. I do my best to be helpful to my friends, and they tend to reciprocate when I’m in need.
5. Buy and install a new water heater.
I had been planning to buy a new water heater for some time because the old one produced a lot of rusty hot water, and the $15.21 (including tax) I pay in rental fees each month irritates me. My punishment for procrastinating was the somewhat flooded basement.
I went for the longest warranty (12 years) at Home Depot, and the new water heater cost $711 (including sales taxes). At $15.21 per month, the new heater will pay for itself in 47 months, or about 4 years. This analysis leaves out a few factors:
1. Water heater rental costs go up over time. In fact, my rental cost had just increased by about 11%.
2. The water heater purchase had to be paid up front, but monthly rental costs are in the future.
3. Any repairs would be covered on a rental. The exact coverage on my 12-year warranty is uncertain. You never really know what costs are covered (such as parts and labour) until you try to make a warranty claim.
Factors 1 and 2 roughly offset each other, but the potential need for repairs changes the equation. Let’s say that if my new heater is problem-free for at least 4 years, then I will come out ahead. If not, then it will take longer to get to the break-even point. However, I’m confident that I’ll come out ahead in the long run.
In the face of water gushing onto my basement floor, I took the following steps:
1. Panic. This is best limited to a few seconds during which you don’t move.
2. Shut off main water supply to the house. Every adult and teenager in the house should know where this is, and it should be kept clear.
3. Clean up the water. A plastic dustpan worked great for scooping up the water off the cement floor that pooled away from the drain.
4. Call a friend who knows how to do just about any kind of work around a house and is often available on short notice. This step could be tricky if you don’t have the right friends. I do my best to be helpful to my friends, and they tend to reciprocate when I’m in need.
5. Buy and install a new water heater.
I had been planning to buy a new water heater for some time because the old one produced a lot of rusty hot water, and the $15.21 (including tax) I pay in rental fees each month irritates me. My punishment for procrastinating was the somewhat flooded basement.
I went for the longest warranty (12 years) at Home Depot, and the new water heater cost $711 (including sales taxes). At $15.21 per month, the new heater will pay for itself in 47 months, or about 4 years. This analysis leaves out a few factors:
1. Water heater rental costs go up over time. In fact, my rental cost had just increased by about 11%.
2. The water heater purchase had to be paid up front, but monthly rental costs are in the future.
3. Any repairs would be covered on a rental. The exact coverage on my 12-year warranty is uncertain. You never really know what costs are covered (such as parts and labour) until you try to make a warranty claim.
Factors 1 and 2 roughly offset each other, but the potential need for repairs changes the equation. Let’s say that if my new heater is problem-free for at least 4 years, then I will come out ahead. If not, then it will take longer to get to the break-even point. However, I’m confident that I’ll come out ahead in the long run.
Monday, March 15, 2010
Is Your Financial Advisor a Yes-Man?
Investors have a tendency to abandon their financial plans in extreme market conditions. In the midst of a stock price bubble, investors tend to overweight in stocks at high prices, and after a stock market crash, investors tend to underweight stocks at low prices.
A common argument in favour of financial advice is that since people make emotional decisions to buy high and sell low, they need financial advisors. The first part of this argument makes sense; people do make these mistakes. However, who says that financial advisors steer investors away from these mistakes?
CNN Money Fortune reported on research showing that financial planners tend to be yes-men who reinforce the bad investment behaviours of their clients. This suggests that using an advisor is no guarantee that you’ll make better choices.
So, investors who wish to avoid making emotional investing mistakes seem to have two choices:
1. Learn to control your emotions enough to make rational investing choices, even when everyone around you is making mistakes.
2. Find one of the apparent minority of financial advisors who will actually help protect you from emotional investing mistakes.
I try to use the first solution. It seems to me that if you’re able to judge whether an advisor is keeping your emotions in check, then you probably have already figured out how to control them on your own. Another approach is to just pick an advisor you like and hope that you’ve lucked into one of the good ones, but I don’t recommend this.
A common argument in favour of financial advice is that since people make emotional decisions to buy high and sell low, they need financial advisors. The first part of this argument makes sense; people do make these mistakes. However, who says that financial advisors steer investors away from these mistakes?
CNN Money Fortune reported on research showing that financial planners tend to be yes-men who reinforce the bad investment behaviours of their clients. This suggests that using an advisor is no guarantee that you’ll make better choices.
So, investors who wish to avoid making emotional investing mistakes seem to have two choices:
1. Learn to control your emotions enough to make rational investing choices, even when everyone around you is making mistakes.
2. Find one of the apparent minority of financial advisors who will actually help protect you from emotional investing mistakes.
I try to use the first solution. It seems to me that if you’re able to judge whether an advisor is keeping your emotions in check, then you probably have already figured out how to control them on your own. Another approach is to just pick an advisor you like and hope that you’ve lucked into one of the good ones, but I don’t recommend this.
Saturday, March 13, 2010
QuickTax Online Winners
Congratulations, Richard and Rajesh on winning QuickTax online codes in our random draw. The winners have been contacted by email. Thanks once again to QuickTax for providing the prizes.
Thank you to everyone who entered the draw.
Thank you to everyone who entered the draw.
Friday, March 12, 2010
Short Takes: Canadian Dollar Predictions and more
1. CIBC predicted that the Canadian dollar will rise in value. It seems that we rarely see predictions that the Canadian dollar will go down. However, the Canadian dollar has gone down as much as it has gone up relative to the US dollar over the decades. The disproportionate number of predictions of a rising Canadian dollar are just a form of cheerleading with little predictive value. But, it feels good to believe that our dollar is rising.
2. Where Does All My Money Go? features a series on bankruptcy written by someone actually going through bankruptcy.
3. Larry MacDonald reports that ETF providers are eyeing the segregated fund market. Reducing segregated fund MERs to reasonable levels would be a welcome change.
4. Larry Swedroe explains that emerging markets with high GDP growth tend not to give high investments gains.
2. Where Does All My Money Go? features a series on bankruptcy written by someone actually going through bankruptcy.
3. Larry MacDonald reports that ETF providers are eyeing the segregated fund market. Reducing segregated fund MERs to reasonable levels would be a welcome change.
4. Larry Swedroe explains that emerging markets with high GDP growth tend not to give high investments gains.
Thursday, March 11, 2010
Some Family Success
Google's Blogger system has a handy feature where posts spontaneously revert to draft status preventing them from being posted. This is what happened today. This bug has existed for several months, and after much experimenting I'm convinced that user error is not a factor.
In place of today's original topic (which I'll save for another time), I'll tell you about my recent experience traveling with my son's high school basketball team to the provincial championships.
Hotel room: $484
Meals: $280
Gasoline: $141
Water bottles for players during games: $12
Gold medal: Priceless!
In place of today's original topic (which I'll save for another time), I'll tell you about my recent experience traveling with my son's high school basketball team to the provincial championships.
Hotel room: $484
Meals: $280
Gasoline: $141
Water bottles for players during games: $12
Gold medal: Priceless!
Wednesday, March 10, 2010
The Investor’s Manifesto
William J. Bernstein doesn’t mince words in his book The Investor’s Manifesto: Preparing for Prosperity, Armageddon, and everything in Between. The style is very direct which makes it easy to read and understand. Bernstein has strong opinions about investing and he makes sense.
The main focus of the book is how to save and invest in preparation for retirement. Bernstein has tough love for the majority of individual investors who make serious mistakes that cost money, and has harsh words for the financial industry that takes advantage of people. The main advice is to find the right balance of low-cost index funds, and he gives a number of example portfolios. He also has some detailed advice on how to teach children to manage money well.
Here are a few parts of the book that caught my eye:
The Masses
“I have come to the sad conclusion that only a tiny minority [of investors] will ever succeed in managing their money even tolerably well.” I would add that this is true even with the help of a typical financial advisor. Bernstein believes that the two biggest problems are overconfidence and overemphasis on recent history.
The Investment Industry
“Be wary of the investment industry. People do not seek employment in investment banks, brokerage houses, and mutual fund companies with the same motivations as those who choose to work in fire departments or elementary schools. ... If rigorous precautions are not taken, the financial services industry will strip investors of their wealth faster than they can say ‘Bernie Madoff.’”
“If you act on the assumption that every broker, insurance salesman, mutual fund salesperson, and financial advisor you encounter is a hardened criminal, you will do just fine.”
Gordon Equation
Bernstein claims that the best estimator for real returns in the stock market is the Gordon equation which just adds the dividend rate to the real rate of increase of dividends. This certainly makes sense because it is essentially measuring business performance.
Renting vs. Buying a House
Bernstein’s rule of thumb is that if a house costs more than 150 times what it would cost to rent it monthly, you’re better off renting. “I have found that this is one of the fastest ways known to man of darkening a realtor’s face.”
Active Management
A table of costs of actively-managed mutual funds including expense ratio, commissions, bid/ask spread, and impact costs, gives totals of 2.2% for large cap funds, 4.1% for small cap funds, and 9.0% for emerging markets. Among “active mutual fund managers ... few can surmount these hurdles in the long run.”
Commodities
Bernstein believes that commodities are just the “asset class du jour” and that future returns will be “certainly much lower than they have been in the past.”
Emotions
“Nothing is more likely to make you poor than your emotions; nothing is more likely to save your finances than learning how to use cool, dispassionate reason to hold these emotions in check.”
Rebalancing
Rebalancing in really bad years “will mean pouring large amounts into falling equities, when your friends and family are running around like decapitated poultry.”
Bernstein recommends periodic rebalancing and doesn’t like threshold rebalancing. His main reason seems to be that it can lead to frequent trading when markets are volatile. This doesn’t make sense to me. If the thresholds are wide enough, then when high volatility leads to trading, you are making lots of money selling high and buying low. Trading costs are easy to take when the trades are profitable, which they must be when using threshold rebalancing with sufficiently wide thresholds.
Mutual Fund Companies
“Do not invest with any mutual fund family that is owned by a publicly traded parent company.” Bernstein says that the profit imperative of publicly traded companies will drive them to fleece investors.
Spending Rate in Retirement
Bernstein’s advice on what percentage of your starting portfolio (adjusted for inflation) you can spend each year is more conservative than most:
2%: secure as possible
3%: probably safe
4%: taking risks
5%: you had better like cat food
Of course, these percentages depend on how you invest. The percentages are much different for a low-cost investor compared to another investor who pays 2.5% MERs.
Conclusion
Bernstein is clearly very smart and his analysis and advice is usually spot on. Any investor who chooses to stray from Bernstein’s advice should think carefully about exactly why his advice doesn’t apply. I definitely recommend this book to investors.
The main focus of the book is how to save and invest in preparation for retirement. Bernstein has tough love for the majority of individual investors who make serious mistakes that cost money, and has harsh words for the financial industry that takes advantage of people. The main advice is to find the right balance of low-cost index funds, and he gives a number of example portfolios. He also has some detailed advice on how to teach children to manage money well.
Here are a few parts of the book that caught my eye:
The Masses
“I have come to the sad conclusion that only a tiny minority [of investors] will ever succeed in managing their money even tolerably well.” I would add that this is true even with the help of a typical financial advisor. Bernstein believes that the two biggest problems are overconfidence and overemphasis on recent history.
The Investment Industry
“Be wary of the investment industry. People do not seek employment in investment banks, brokerage houses, and mutual fund companies with the same motivations as those who choose to work in fire departments or elementary schools. ... If rigorous precautions are not taken, the financial services industry will strip investors of their wealth faster than they can say ‘Bernie Madoff.’”
“If you act on the assumption that every broker, insurance salesman, mutual fund salesperson, and financial advisor you encounter is a hardened criminal, you will do just fine.”
Gordon Equation
Bernstein claims that the best estimator for real returns in the stock market is the Gordon equation which just adds the dividend rate to the real rate of increase of dividends. This certainly makes sense because it is essentially measuring business performance.
Renting vs. Buying a House
Bernstein’s rule of thumb is that if a house costs more than 150 times what it would cost to rent it monthly, you’re better off renting. “I have found that this is one of the fastest ways known to man of darkening a realtor’s face.”
Active Management
A table of costs of actively-managed mutual funds including expense ratio, commissions, bid/ask spread, and impact costs, gives totals of 2.2% for large cap funds, 4.1% for small cap funds, and 9.0% for emerging markets. Among “active mutual fund managers ... few can surmount these hurdles in the long run.”
Commodities
Bernstein believes that commodities are just the “asset class du jour” and that future returns will be “certainly much lower than they have been in the past.”
Emotions
“Nothing is more likely to make you poor than your emotions; nothing is more likely to save your finances than learning how to use cool, dispassionate reason to hold these emotions in check.”
Rebalancing
Rebalancing in really bad years “will mean pouring large amounts into falling equities, when your friends and family are running around like decapitated poultry.”
Bernstein recommends periodic rebalancing and doesn’t like threshold rebalancing. His main reason seems to be that it can lead to frequent trading when markets are volatile. This doesn’t make sense to me. If the thresholds are wide enough, then when high volatility leads to trading, you are making lots of money selling high and buying low. Trading costs are easy to take when the trades are profitable, which they must be when using threshold rebalancing with sufficiently wide thresholds.
Mutual Fund Companies
“Do not invest with any mutual fund family that is owned by a publicly traded parent company.” Bernstein says that the profit imperative of publicly traded companies will drive them to fleece investors.
Spending Rate in Retirement
Bernstein’s advice on what percentage of your starting portfolio (adjusted for inflation) you can spend each year is more conservative than most:
2%: secure as possible
3%: probably safe
4%: taking risks
5%: you had better like cat food
Of course, these percentages depend on how you invest. The percentages are much different for a low-cost investor compared to another investor who pays 2.5% MERs.
Conclusion
Bernstein is clearly very smart and his analysis and advice is usually spot on. Any investor who chooses to stray from Bernstein’s advice should think carefully about exactly why his advice doesn’t apply. I definitely recommend this book to investors.
Tuesday, March 9, 2010
QuickTax Giveaway
The makers of QuickTax were kind enough to offer two access codes for any online version of QuickTax as a giveaway for my readers. To enter the draw, send an email with the subject “QuickTax” to the address in the top right corner of this blog. Entries must be received before Saturday at noon, eastern. The winner will be chosen at random among the entries and contacted by email. I won’t use the email addresses for any other purpose.
To regular users of QuickTax Standard, the most visible change is in the EasyStep interview process where the software asks an extensive set of questions to determine exactly what information you’ll need to enter. These questions were all asked up front for 2009, and it felt a little like an inquisition. But overall I liked answering these questions all together at the beginning of the process. My wife said that it gave her more confidence that we would remember to enter everything we needed.
I’ve used QuickTax for several years now and find it useful. It’s hard to get excited about filing your income tax return, but QuickTax hasn’t added to the pain.
Good luck in the giveaway.
To regular users of QuickTax Standard, the most visible change is in the EasyStep interview process where the software asks an extensive set of questions to determine exactly what information you’ll need to enter. These questions were all asked up front for 2009, and it felt a little like an inquisition. But overall I liked answering these questions all together at the beginning of the process. My wife said that it gave her more confidence that we would remember to enter everything we needed.
I’ve used QuickTax for several years now and find it useful. It’s hard to get excited about filing your income tax return, but QuickTax hasn’t added to the pain.
Good luck in the giveaway.
Monday, March 8, 2010
Short Takes: New Budget Edition
You’re getting this edition of short takes on a Monday because the big news in the budget about stock option trap relief that appeared on Friday.
1. Larry MacDonald highlighted the parts of the budget Canadians care about most in a MoneySense article.
2. The Tax Guy focused on the tax-related elements of the new budget.
3. Preet interviewed Michael Moore!
4. Canadian Financial DIY brings us researchers who believe that we could have predicted Bernie Madoff’s fraud before the fact. Great! Let’s use their methods to find the currently ongoing financial frauds.
5. Wow! Big Cajun Man seems to put a lot of effort into doing his income taxes.
6. Million Dollar Journey explores the dangers of co-signing for your child.
7. If you’re like me, you wonder what impact the new mortgage rules will have. Here is CIBC economist, Ben Tal’s answer at Canadian Mortgage Trends.
1. Larry MacDonald highlighted the parts of the budget Canadians care about most in a MoneySense article.
2. The Tax Guy focused on the tax-related elements of the new budget.
3. Preet interviewed Michael Moore!
4. Canadian Financial DIY brings us researchers who believe that we could have predicted Bernie Madoff’s fraud before the fact. Great! Let’s use their methods to find the currently ongoing financial frauds.
5. Wow! Big Cajun Man seems to put a lot of effort into doing his income taxes.
6. Million Dollar Journey explores the dangers of co-signing for your child.
7. If you’re like me, you wonder what impact the new mortgage rules will have. Here is CIBC economist, Ben Tal’s answer at Canadian Mortgage Trends.
Friday, March 5, 2010
Budget Brings Big News for Stock Option Victims
The usual Friday feature of short takes will have to wait until Monday because the 2010 budget appears to have a provision to finally help people caught in a stock option trap. I’m in this situation along with people I used to work with at both Entrust and Nortel.
Canadians generally think of stock options as financial lottery tickets given to CEOs and other company bigwigs to make them rich. There is a lot of truth to this. But during the technology boom in the late 1990s, even working level employees often received a few stock options not realizing their potential for financial harm.
When stocks rise and employee stock options become valuable, we usually say that so-and-so “cashed in his options” and now the jerk is rich. However, this glosses over the fact that it is really a two-step process. For example, a Nortel employee first had to exercise the stock option by paying its strike price. Then the employee received Nortel shares and could sell them in the stock market for a higher price than the option strike price.
This sounds a lot like many scams where you’re promised great riches if you just send in a small fee now. With scams, there are no real great riches to come later. Unfortunately, that’s the way it worked out for some people as we’ll see.
Exercising stock options and selling the resulting shares are often done all on the same day so that it is like a single transaction. But, for various reasons, some employees choose to pay the option strike price but then hold onto the shares, sometimes for years.
The problem comes if the share price is high when the option is exercised, but drops before the shares are sold. Canada Revenue Agency (CRA) expects people to pay taxes on the paper gain from when the shares were high. For employees of Entrust and Nortel, the income tax owing usually far exceeds the pittance they get when they sell their shares. The Nigerian prince didn’t come through with the promised fortune, and CRA still wants their cut of the fortune anyway.
Minister Flaherty has ridden to the rescue with a compromise of sorts. As long as Canadians are willing to forfeit the proceeds from the sale of the shares in the form of a special tax, it appears that they won’t have to pay tax on the huge paper gain. I say “it appears” because I base this on my own (possibly flawed) interpretation of pages 357 and 358 of the 2010 budget document:
Canadians generally think of stock options as financial lottery tickets given to CEOs and other company bigwigs to make them rich. There is a lot of truth to this. But during the technology boom in the late 1990s, even working level employees often received a few stock options not realizing their potential for financial harm.
When stocks rise and employee stock options become valuable, we usually say that so-and-so “cashed in his options” and now the jerk is rich. However, this glosses over the fact that it is really a two-step process. For example, a Nortel employee first had to exercise the stock option by paying its strike price. Then the employee received Nortel shares and could sell them in the stock market for a higher price than the option strike price.
This sounds a lot like many scams where you’re promised great riches if you just send in a small fee now. With scams, there are no real great riches to come later. Unfortunately, that’s the way it worked out for some people as we’ll see.
Exercising stock options and selling the resulting shares are often done all on the same day so that it is like a single transaction. But, for various reasons, some employees choose to pay the option strike price but then hold onto the shares, sometimes for years.
The problem comes if the share price is high when the option is exercised, but drops before the shares are sold. Canada Revenue Agency (CRA) expects people to pay taxes on the paper gain from when the shares were high. For employees of Entrust and Nortel, the income tax owing usually far exceeds the pittance they get when they sell their shares. The Nigerian prince didn’t come through with the promised fortune, and CRA still wants their cut of the fortune anyway.
Minister Flaherty has ridden to the rescue with a compromise of sorts. As long as Canadians are willing to forfeit the proceeds from the sale of the shares in the form of a special tax, it appears that they won’t have to pay tax on the huge paper gain. I say “it appears” because I base this on my own (possibly flawed) interpretation of pages 357 and 358 of the 2010 budget document:
“In any year in which a taxpayer is required to include in income a qualifying deferred stock option benefit, the taxpayer may elect to pay a special tax for the year equal to the taxpayer’s proceeds of disposition, if any, from the sale or other disposition of the optioned securities. Where such an election is made:A big area of uncertainty is how taxpayers can make this election to pay the special tax and how they subsequently fill out their tax forms. It appears that this election can be made even if the shares were sold before 2010:
– the taxpayer will be able to claim an offsetting deduction equal to the amount of the stock option benefit; and
– an amount equal to half of the lesser of the stock option benefit and the capital loss on the optioned securities will be included in the taxpayer’s income as a taxable capital gain. That gain may be offset by the allowable capital loss on the optioned securities, provided this loss has not been otherwise used.”
“Individuals who disposed of their optioned securities before 2010 will have to make an election for this special treatment on or before their filing-due date for the 2010 taxation year (generally April 30, 2011).”I’m certainly hoping that I can make this election before filing my 2009 taxes. This provision will save me more than the amount of my first mortgage. I don’t want to have to come up with this money by the end of April and hope to get it back later somehow.
Thursday, March 4, 2010
Bank of Montreal Exceeds Expectations – I Got Lucky
Bank of Montreal’s (ticker: BMO) first quarter results exceeded analyst expectations. Starting from the depths of the market crash about a year ago, its stock has roughly doubled. In one way, my investment in BMO says good things about my investing temperament, but in another way, I was just plain lucky.
I owned BMO before the market crash, and bought more a few times while the stock price was low. The ability to ignore doomsday predictions and invest in an asset whose price is low is an important skill for investors.
However, the fact that I happened to lock in on BMO for a big bet and ride its ascent is mostly just luck. Fortunately for me, the recent good news about BMO business performance means that my bet isn’t likely to go south too soon. As much as I’d like to believe that I have some great stock-picking skill, I don’t believe I do. BMO could just as easily have continued drifting down in price for all I knew at the time I invested.
For this reason, I plan to continue my slow but steady transition from owning individual stocks to owning low-cost index ETFs. In the future, I plan to show my composure by adding new money to whichever ETF has had the worst recent performance rather than choosing an individual stock that has been hammered.
I owned BMO before the market crash, and bought more a few times while the stock price was low. The ability to ignore doomsday predictions and invest in an asset whose price is low is an important skill for investors.
However, the fact that I happened to lock in on BMO for a big bet and ride its ascent is mostly just luck. Fortunately for me, the recent good news about BMO business performance means that my bet isn’t likely to go south too soon. As much as I’d like to believe that I have some great stock-picking skill, I don’t believe I do. BMO could just as easily have continued drifting down in price for all I knew at the time I invested.
For this reason, I plan to continue my slow but steady transition from owning individual stocks to owning low-cost index ETFs. In the future, I plan to show my composure by adding new money to whichever ETF has had the worst recent performance rather than choosing an individual stock that has been hammered.
Wednesday, March 3, 2010
The Right Model for Financial Advice?
I recently received a request from a reader to sit down to look at his financial situation. I get these from time to time, but I’m not comfortable acting as an untrained financial advisor, and I’m not even sure whether it is legal. But, it got me thinking about what model makes sense for financial advisors.
The dominant model that exists right now is based on hidden commissions from the products sold to clients. This works well for many financial advisors, but few clients would be happy about it if they understood how much they were paying and how much better their investments could perform with less expensive products.
If I felt the need to get advice, the model that would make most sense to me is something close to what is often called “fee-only”. However, I would only be looking to pay an advisor for the time he spends talking to me. I wouldn’t be interested in paying for several extra hours of the advisor’s time to produce a written plan for me.
I could envision bringing in documents containing all my financial details and talking to an expert for a couple of hours to get his opinion of what should be changed. Then I would go away and handle the changes myself. Every so often I would come back for another hour to discuss further updates.
For this model to work, the advisor would have to charge a high hourly rate. Perhaps $200 to $400 per hour would make sense depending on the advisor’s skill level. Even 3 hours at $400 per hour would be much cheaper than mutual fund MERs for portfolios over $100,000.
Are there any readers who have used an advisor on this type of basis? Was the advisor helpful or did he use the face-to-face time to pitch an arrangement that would get him more money? Did you follow up on the advice or was the cost of the meeting wasted?
The dominant model that exists right now is based on hidden commissions from the products sold to clients. This works well for many financial advisors, but few clients would be happy about it if they understood how much they were paying and how much better their investments could perform with less expensive products.
If I felt the need to get advice, the model that would make most sense to me is something close to what is often called “fee-only”. However, I would only be looking to pay an advisor for the time he spends talking to me. I wouldn’t be interested in paying for several extra hours of the advisor’s time to produce a written plan for me.
I could envision bringing in documents containing all my financial details and talking to an expert for a couple of hours to get his opinion of what should be changed. Then I would go away and handle the changes myself. Every so often I would come back for another hour to discuss further updates.
For this model to work, the advisor would have to charge a high hourly rate. Perhaps $200 to $400 per hour would make sense depending on the advisor’s skill level. Even 3 hours at $400 per hour would be much cheaper than mutual fund MERs for portfolios over $100,000.
Are there any readers who have used an advisor on this type of basis? Was the advisor helpful or did he use the face-to-face time to pitch an arrangement that would get him more money? Did you follow up on the advice or was the cost of the meeting wasted?
Tuesday, March 2, 2010
Overpaying for “Free” Life Insurance
Many employers provide free life insurance to employees as part of their benefits package. Unfortunately for the employee, the premium paid by the company is a taxable benefit. In some cases the taxes owing can actually be more than what it would cost to buy the life insurance.
I encountered this situation years ago when the tax rules changed making company-paid life insurance a taxable benefit. My company paid $1.68 per year for each $1000 of life insurance coverage. This amount had to be added to my income.
At the prevailing marginal income tax rates, I paid taxes of $0.83 per $1000 of coverage. Perversely, I could buy life insurance cheaper than this. Although the cost wasn’t huge, I tried to decline the company life insurance on principle. A confused human resources person checked into it for me and came back saying that I couldn’t decline the insurance.
At the time I tried to explain the situation to some colleagues, but it became obvious that few believed that what I was saying could be true and none cared. So, my little revolution was stopped in its tracks. I’d be interested to hear from anyone who tries this comparison for his own situation. Do you pay more in taxes for free group life insurance than it would cost to pay the premium on your individual plan?
I encountered this situation years ago when the tax rules changed making company-paid life insurance a taxable benefit. My company paid $1.68 per year for each $1000 of life insurance coverage. This amount had to be added to my income.
At the prevailing marginal income tax rates, I paid taxes of $0.83 per $1000 of coverage. Perversely, I could buy life insurance cheaper than this. Although the cost wasn’t huge, I tried to decline the company life insurance on principle. A confused human resources person checked into it for me and came back saying that I couldn’t decline the insurance.
At the time I tried to explain the situation to some colleagues, but it became obvious that few believed that what I was saying could be true and none cared. So, my little revolution was stopped in its tracks. I’d be interested to hear from anyone who tries this comparison for his own situation. Do you pay more in taxes for free group life insurance than it would cost to pay the premium on your individual plan?
Monday, March 1, 2010
Buffett’s Latest Wisdom
Warren Buffett’s eagerly anticipated 2009 letter to shareholders of Berkshire Hathaway arrived on the weekend. For long-time fans, this letter doesn’t disappoint. It contains more of his priceless wisdom expressed clearly and wrapped in humour. Here are some examples.
Not relying on being too-big-to-fail
In a jab at reckless banks, Buffett says “We will never become dependent on the kindness of strangers. Too-big-to-fail is not a fallback position at Berkshire. Instead, we will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity.”
Berkshire maintains cash reserves similar to the emergency funds we’re all supposed to have for ourselves. The main difference is the size of the emergency fund: “The $20 billion-plus of cash equivalent assets that we customarily hold is earning a pittance at present. But we sleep well.”
Housing recovery
Buffett seems optimistic about the future of the U.S. housing market saying “within a year or so residential housing problems should largely be behind us, the exceptions being only high-value houses and those in certain localities where overbuilding was particularly egregious.”
Investing climate “ideal”
“We’ve put a lot of money to work during the chaos of the last two years. It’s been an ideal period for investors: A climate of fear is their best friend. Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance.”
CEO misbehaviour
“The CEOs and directors of the failed companies ... have largely gone unscathed. ... If their institutions and the country are harmed by their recklessness, they should pay a heavy price – one not reimbursable by the companies they’ve damaged nor by insurance. CEOs and, in many cases, directors have long benefited from oversized financial carrots; some meaningful sticks now need to be part of their employment picture as well.”
Accepting payments to take on enormous risks seems profitable until something goes wrong. During this period of apparent profitability, CEOs and their underlings collected obscene bonuses on the illusory profits. Without some change to the way CEOs are compensated, they have every incentive to do more of the same.
Berkshire Hathaway undervalued
Buffett wasn’t happy about issuing stock as part of the takeover of Burlington Northern Santa Fe because “Charlie and I believed (Berkshire shares) to be worth more than their market value.” Don’t be too quick to run out and buy Berkshire stock on this apparent recommendation. At the time class A shares traded for US$98,750 each, but as of Friday’s close they trade for US$119,800, a 21% increase.
Justifying poor investment choices
Buffett told an interesting story about a bank he owned stock in long ago that made a dumb acquisition. In a justification reminiscent of a recent blog post on justifying poor investments when they are small, the bank managers said “We need to show that we are in the hunt. Besides, it’s only a small deal.”
Buffet’s business partner, Charlie Munger, had a priceless reaction: “Are we supposed to applaud because the dog that fouls our lawn is a Chihuahua rather than a Saint Bernard?”
Not relying on being too-big-to-fail
In a jab at reckless banks, Buffett says “We will never become dependent on the kindness of strangers. Too-big-to-fail is not a fallback position at Berkshire. Instead, we will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity.”
Berkshire maintains cash reserves similar to the emergency funds we’re all supposed to have for ourselves. The main difference is the size of the emergency fund: “The $20 billion-plus of cash equivalent assets that we customarily hold is earning a pittance at present. But we sleep well.”
Housing recovery
Buffett seems optimistic about the future of the U.S. housing market saying “within a year or so residential housing problems should largely be behind us, the exceptions being only high-value houses and those in certain localities where overbuilding was particularly egregious.”
Investing climate “ideal”
“We’ve put a lot of money to work during the chaos of the last two years. It’s been an ideal period for investors: A climate of fear is their best friend. Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance.”
CEO misbehaviour
“The CEOs and directors of the failed companies ... have largely gone unscathed. ... If their institutions and the country are harmed by their recklessness, they should pay a heavy price – one not reimbursable by the companies they’ve damaged nor by insurance. CEOs and, in many cases, directors have long benefited from oversized financial carrots; some meaningful sticks now need to be part of their employment picture as well.”
Accepting payments to take on enormous risks seems profitable until something goes wrong. During this period of apparent profitability, CEOs and their underlings collected obscene bonuses on the illusory profits. Without some change to the way CEOs are compensated, they have every incentive to do more of the same.
Berkshire Hathaway undervalued
Buffett wasn’t happy about issuing stock as part of the takeover of Burlington Northern Santa Fe because “Charlie and I believed (Berkshire shares) to be worth more than their market value.” Don’t be too quick to run out and buy Berkshire stock on this apparent recommendation. At the time class A shares traded for US$98,750 each, but as of Friday’s close they trade for US$119,800, a 21% increase.
Justifying poor investment choices
Buffett told an interesting story about a bank he owned stock in long ago that made a dumb acquisition. In a justification reminiscent of a recent blog post on justifying poor investments when they are small, the bank managers said “We need to show that we are in the hunt. Besides, it’s only a small deal.”
Buffet’s business partner, Charlie Munger, had a priceless reaction: “Are we supposed to applaud because the dog that fouls our lawn is a Chihuahua rather than a Saint Bernard?”
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