Friday, September 30, 2011

Short Takes: Roaming Charges and more

Money Smarts explains how to avoid cell phone roaming charges in the U.S.

Canadian Couch Potato reviews the book The Smartest Portfolio You’ll Ever Own.

Canadian Financial DIY isn’t very impressed with some ETF research by the Investment Funds Institute of Canada.

My Own Advisor explains why he chooses to DRIP (automatically reinvest dividends). I don’t do this because I use dividends to rebalance my portfolio and my transaction costs are low relative to my portfolio size. Your mileage may vary.

Big Cajun Man doesn’t agree with debt counseling advertising that says that your debts aren’t your fault.

Retire Happy Blog makes the case against selling into a bear market.

The Blunt Bean Counter explains some of the family issues that should be considered in your estate plan.

Thursday, September 29, 2011

Low Interest Rates on Savings Compare Well to the Past

People with cash savings and GICs often complain about the low interest rates available today. A Yahoo Finance article (no longer available online) goes so far as to ask what’s the use of saving money? However, the higher interest rates of the past are nowhere near as good as they look.

In 1981, the average short-term government bond rates were about 16%. This looks pretty good compared to a 2% GIC today. However, we should take into account taxes. Assuming a 40% tax rate, these returns drop to 9.6% and 1.2%. The past still looks good. But, what happens if we take into account inflation? The inflation rate in 1981 was 12.5% and the current inflation rate is about 3%. So, savings lost about 3% in 1981 and lose about 2% today.

Comparatively speaking, interest rates on savings today don’t look so bad compared to the past. Savers in 1981 thought they were making money, but they weren’t; they were effectively spending their principal. Perhaps the larger lesson is that short-term cash savings rarely grow in real after tax terms.

Monday, September 26, 2011

Buying on the Dips

Commentators often advise stock investors to “buy on the dips.” Jason Zweig took a detailed look at this advice and came up with the counter-intuitive result that buying on the dips doesn’t work.

This result is a tough sell, though. It just seems obvious that we’re better off buying stock just after a 5% drop than just before. What many investors don’t realize is that this is a false comparison. To be able to buy on a dip, you must have cash available that is designated for stock ownership but isn’t yet invested.

The next thing to consider is that you must keep this money available for as long as it takes to get to the next dip in prices. What if stocks rise 40% before the next 5% dip happens? You’re better off buying at 35% higher prices than 40% higher prices, but buying right at the beginning before the 40% rise is the best option of all here.

The fundamental problem with buying on the dips is the opportunity cost of holding cash that is not getting stock returns. Having cash on the sidelines works well sometimes, but works out poorly more often.

Friday, September 23, 2011

Short Takes: Lottery Tricks of the Mind, Gold Mining Stocks, and more

Big Cajun Man has a clever explanation of why lottery wins seem more likely than they are.

Jason Zweig thinks that while gold may be in a bubble, gold mining stocks seem cheap. He observes that gold miners are only trading at 18 times earnings. However, if gold really is in a bubble, aren’t the profits of the miners inflated? Do we really need the earnings multiple to be inflated as well?

The Blunt Bean Counter runs through the top 20 things he doesn’t understand about income tax. It’s well worth a read to better understand different areas of the tax rules.

Andrew Hallam explains why he gave up stock picking and switched to indexing.

Money Smarts says homeowners should be cheering house prices down if they plan to upgrade to a bigger home.

Larry Swedroe explains why you should take a pass on absolute value funds.

Thursday, September 22, 2011

Different Approach to Explaining Index Investing

The math says that before costs, index investors must get the same returns as the average active investor. But, index investing has lower costs giving the edge to index investors. Because most active trading is done by professional investors, it’s not surprising that the evidence says that after costs indexing will outperform investing with the average professional. But few people understand this. Most people will never believe that they can get better returns than a brilliant professional can. After all, professionals in almost all other fields do better than amateurs.

But what if there was a way to get advice from not one or two, but all professional investors? We could have all the professionals in the world get together and average out their best picks. Most people would be more than happy to follow this collective advice from the best investing minds. But how could we possibly convince all the professionals to get together like this?

Of course we can’t, but this is a trick question. It turns out that the index is the (weighted) average of all professional investors’ best picks. Buying low-cost index funds is like hiring every professional investor in the world, but only paying for a small fraction of one of them.

Tuesday, September 20, 2011

Millionaires Aren’t What They Used to Be

U.S. President Obama’s plan to apply a “Buffett tax” has been widely described as a millionaire tax. But it doesn’t apply to those who have a net worth of a million dollars; it only kicks in for those whose income is a million dollars per year. These are two very different things.

According to Wikipedia and U.S. census information, one out of every 11 U.S. households has a net worth of a million dollars or more. However, only 1 out of every 230 households has $30 million or more, which is closer to the wealth level needed to generate a million dollars in income per year.

Coming back to Canada, many government workers retire with a pension worth more than a million dollars, but I’m sure that most of them would say they aren’t rich. We’re used to thinking of millionaires as wealthy people, but those who have just $1 million in total assets between a house and retirement savings are quite ordinary.

It is very likely that you routinely meet millionaires, but you may not often come across people whose income is a million dollars per year. Most millionaires live in ordinary neighbourhoods, but the truly wealthy can afford to live in better places than the rest of us.

Monday, September 19, 2011

RIM Is Not Dead Yet

News of the big drop in RIM’s profits has many people predicting that RIM will suffer the same fate as Nortel. It’s understandable that Canadians are concerned about the future of a Canadian high-tech success story like RIM after they watched in disbelief as Nortel failed. However, there is a big difference between RIM’s financial results and Nortel’s.

In the past three quarters, RIM’s profits have been $934 million, $695 million, and $329 million. This is a disappointing trend, but keep in mind that they still have profits. Nortel had massive losses over the course of a decade before they finally speared in. There is a big difference between lower profit and negative profit.

To draw an analogy with retirement saving, consider Rick who has added the following amounts to his RRSP over the last three quarters: $9340, $6950, and $3290. By contrast, in 2001 Nora withdrew $257,200! Rick has reason to be concerned about his trend, but Nora is speeding towards a brick wall.

I have no idea what will happen to RIM’s business in the future, but there are no similarities between their finances and Nortel’s finances yet.

Friday, September 16, 2011

Short Takes: Backfill Bias, Commission-Free ETF Trading, and more

Preet Banerjee explains how backfill bias artificially pumps up the average returns reported by mutual funds. I thought survivorship bias, where bad funds get closed and no longer affect the average, was bad enough. Now we find that some funds wait to see if they perform well before retroactively including them in mutual fund averages.

Larry Swedroe shows that Edward Jones’ strong financial results may be bad news for its clients.

The Blunt Bean Counter makes the case that an accountant is often more valuable than a lawyer when you’re in trouble with CRA.

Retire Happy Blog goes through the different events that make it difficult to control when you retire.

Money Smarts works through detailed examples of how to generate estimates of home maintenance costs for your budget.

Big Cajun Man is literally sickened by misuse of the word “literally”.

Million Dollar Journey explains how to calculate a defined-benefit pension’s commuted value.

Tuesday, September 13, 2011

Aligning Interests

When we enter into ventures with others, it's important that our interests are aligned so that we're working toward the same goal. This is true whether you're selling your house or investing your life savings with a financial advisor. Figuring out when intersts are well-aligned can be tricky.

When you sell your house and pay a real estate agent a percentage of the house price, it may seem that your interests are well-aligned, but in reality they are not. One way to look at this situation is that the more you get for your house, the more the real estate agent gets paid. But this is too superficial.

The real estate agent's main concern is her pay per hour worked. Selling your house for an extra $25,000 is much less important to her than selling it quickly. For you, that extra $25,000 makes a big difference. The agent's ethics may keep her working toward your best interests, but her compensation structure pushes her toward making sales fast even if the price is a little low.

The same problem usually exists when investing with an advisor. The advisor gets paid indirectly out of your savings. The returns you get are important to you, but they only make a modest difference to the advisor's pay. However, the situation changes if the advisor invests his own savings along with yours.

This is the situation with Steadyhand funds as Tom Bradley explains. The Steadyhand team have 80% of their assets invested in the same funds as their clients. So if their clients lose money, the team feels the pain as well. (Disclosure: I have no financial connection to Steadyhand, but I like the members of their team that I've met.)

The one area where their interests are not well-aligned with their clients' is the part of the fund costs that make up the Steadyhand team's salaries. This problem exists with all mutual funds I've seen. If these salary costs go up, clients get lower returns, but the fund team gets these costs on their own investments returned to them.

Investors can monitor this potential conflict by keeping an eye on the fund MERs. Happily, Steadyhand funds have low MERs compared to other Canadian mutual funds. For those who prefer not to handle their investments alone, Steadyhand is a solid choice.

Monday, September 12, 2011

The Motley Fool Comes Full Circle

I got to know the Motley Fool web site back in the mid 1990s as a great place to learn about investing in stocks. They taught me about avoiding high MERs and commissions and investing for the long run among many other useful lessons. However, they seem to have lost their way.

The Fool message in the early days was clear: investing in indexes is a great approach, and for those who are willing to put in the work, picking individual stocks can be rewarding as well. They advocated investing for the long-term with low turnover (infrequent trading) to keep costs low and keep the focus on company fundamentals rather than short-term trading.

The Motley Fool was a big part of my attempt to beat the market through stock selection and my ultimate decision to give up on this strategy and buy low-cost index ETFs. I even subscribed to one of their newsletters for a while. Since I cancelled my subscription, I received many “last chances” to come back. In just the past year I’ve received 63 pleading emails to re-subscribe, 61 of which came after a message that started “This is positively our final offer.

Their latest invitation offers me “Rare investments that can make you 3-5 times your money in a single year – without abandoning conservative investment values.

How can I take this stuff seriously? This kind of come-on is exactly the type of thing that sensible web sites warn people to avoid because it is too good to be true.

Given how highly I regarded the Motley Fool in the 1990s, it’s hard to believe how little regard I have for them now.

Friday, September 9, 2011

Short Takes: Fee-Only Advisors and more

Money Smarts explains how to find a fee-only financial advisor. I liked his word of warning. Just because an advisor is fee-only doesn't mean that there is no conflict of interest. The most valuable part of financial advice is the part that is explained to you in person. Fee-only advisors often charge many hours work for preparing several pages of documentation. Documentation is a good thing, but don't over-pay for it.

The Blunt Bean Counter says that when it comes to taxes, beware of any scheme that seems too good to be true.

My Own Advisor runs down his list of favourite Canadian ETFs.

Big Cajun Man isn't too happy with Air Canada's new baggage fees and offers an amusing way around them.

Canadian Couch Potato looks at whether gold is really a hedge against inflation.

Thursday, September 8, 2011

Qualifying for Lower Trading Commissions

Typically, discount brokerages in Canada offer lower trading commissions for investors who have more than $50,000 in their trading accounts. However, there is usually some fine print that can lead to novice investors paying higher commissions than they expect.

A good example is Qtrade’s Commission and Fee Schedule page. It says that online investors with accounts that total at least $50,000 qualify for $9.95 commissions on trades. But a footnote says “You must advise us of these multiple account relationships.”

Just because you know that you have multiple accounts with your RRSP, RESP, and TFSA doesn’t mean that Qtrade knows. In practice, you have to tell them that all your accounts plus your spouse’s accounts should be grouped together. Otherwise, you could be paying $19 per trade instead of $9.95.

I went through this misunderstanding years ago with BMO and recently a colleague overpaid on a few commissions with Qtrade. It pays to read the fine print related to any fees you pay in your trading account.

Wednesday, September 7, 2011


I wont say that I think we’re in a gold bubble because an ounce of gold has lots of room to rise until it trades at historical prices for tulip bulbs or 100 shares of Nortel.

Fundamental analysis points to a high value for gold as well. In addition to its ability to sit around in piles near armed guards, an ounce of gold has many uses:

– paperweight
– ring
– shiny thing
– very small barbell

We have reason to believe that historical fascination in gold will persist. After all, modern inventions like computers and smart phones are in no way more interesting to look at than a shiny piece of gold.

Tuesday, September 6, 2011

Making a Game of Good Finances

There is a new app available that makes a game out of eating well and losing weight. This got me thinking about whether the same could be done for personal finances.

Imagine a game that has access to all your account balances and can assess the state of your finances and whether the latest changes have been a step forward or a step back. Cleverly tying this into game play might provide the kind of incentive many people need to manage their money well.

There are obvious security concerns with giving some app access to your accounts, but I think it is possible in principle to do this safely (possibly with the cooperation of banks). The app would only need account balances; it wouldn’t need the ability to make transactions.

It would probably take several iterations of uninspired versions of such a game to finally get to something that would actually affect people’s behaviour, but I can see the possibility of this working extremely well.

Friday, September 2, 2011

Short Takes: Dividend Taxes, and more

Boomer&Echo have a guest post from the Blunt Bean Counter with a clear explanation of dividend taxation including the what the various boxes on your dividend tax slip mean.

Canadian Financial DIY calls on reporters of index returns to report total returns instead of stock returns without dividends.

Money Smarts explains why he has an emergency fund.

My Own Advisor explains why he drives an 11-year old car. Coincidentally, that’s the age of my car.

Big Cajun Man makes fun of magical healing bracelets with his “Financial Balance Band”.

Thursday, September 1, 2011

Determining Whether Investors Benefit from Stock Buybacks

Recently, Dividend Growth Investor set out to determine whether stock buybacks benefit investors. The unsatisfying answer is that it depends. There is no computation that can be made today to determine whether a current stock buyback will be good for investors.

When a company buys its own stock, they are essentially retiring shares. This means that each remaining share represents a slightly higher percentage of the company, but the company has less cash. If the company is fairly valued, this should be a wash for investors.

However, if the company's stock is undervalued, the increased ownership of each share is a bargain and investors benefit. Conversely, if the company's stock is overvalued, the loss of cash from the share buyback is too great to compensate for the increased ownership represented by each share.

A problem here is that determining whether a stock is overvalued or undervalued depends on knowledge of the future. We can look back at a share buyback from 10 years ago and assess whether it was good for investors, but we can only guess whether today's share buyback will prove to be a good deal. At its core, arguing about the benefits of stock buybacks is the same as arguing about whether a given stock is a buy or a sell.

One thing we can tell from an announced stock buyback is that it is a signal by a company that they think their stock is undervalued. You'd think that if anyone had useful insight into this question, the company itself would. Unfortunately, companies have been accused of announcing a stock buyback to make investors think that the stock is undervalued. Investor reaction may then give the stock an artificial rise allowing insiders to cash in stock options for greater profits.

Another possible motivation for stock buybacks is to cover up share dilution due to issuing stock options to employees. Exercised stock options increase the share count and share buybacks decrease the share count. This can be a big problem for investors if the shares are overvalued, which would likely be the case if employees are exercising options in large numbers.