Friday, December 31, 2010

Year-End Prediction and Videos

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

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

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

Have a fun and safe New Year’s Eve.

Thursday, December 30, 2010

An Explanation of Insurance Company Squeamishness about Home Businesses

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

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

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

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

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

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

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

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

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

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

Wednesday, December 29, 2010

Insurance Broker Conflict of Interest

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

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

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

Tuesday, December 28, 2010

House Insurance for Home-Based Businesses

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

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

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

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

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

Monday, December 27, 2010

Changes to Stock Option Taxation Finally Official

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

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

Friday, December 24, 2010

A Holiday Thank You

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

Thursday, December 23, 2010

It’s Not Rocket Science

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

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


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

Insured Investment Products

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


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

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

Wednesday, December 22, 2010

Lenient Border Guards

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

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

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

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

Tuesday, December 21, 2010

Stress-Testing a Retirement Plan

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

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

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

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

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

Monday, December 20, 2010

Jim Otar on Safe Withdrawal Rates in Retirement

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

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

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

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

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

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

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

Friday, December 17, 2010

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

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

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

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

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

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

Thursday, December 16, 2010

Index Investing is a Statement about Personal Limitations

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

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

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

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

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

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

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

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

Wednesday, December 15, 2010

How to Replicate the Performance of Dynamic Funds

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

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

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

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

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

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

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

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

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

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

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

Tuesday, December 14, 2010

Does Paying Yourself First and Blowing the Rest Work?

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

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

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

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

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

Monday, December 13, 2010

The Limits of Retirement Calculators

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

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

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

Current value of RRSP

That’s an easy one: $0.

Current RRSP contributions

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

Years to retirement and number of years for funds to last

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

Income required in today’s dollars

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

Rate of return

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

Inflation rate

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

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

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

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

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

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

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

Friday, December 10, 2010

Short Takes: Hidden iTunes Charges and more

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

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

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

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

Thursday, December 9, 2010

Meir Statman’s Top 10 Investing Errors Hit Home

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

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

Wednesday, December 8, 2010

Interac e-Transfer Security

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

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

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

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

Tuesday, December 7, 2010

Christmas Toy Scrooge

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

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

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

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

Monday, December 6, 2010

Smarter than the Street

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

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

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

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

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

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

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

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

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

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

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

Friday, December 3, 2010

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

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

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

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

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

Thursday, December 2, 2010

Taking it Easy on Financial Advisors

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

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

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

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

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

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

Wednesday, December 1, 2010

Addressing a Shortage of Competent Financial Advice

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

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

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

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