Monday, April 30, 2012

A Guaranteed Yield of 20%!

Inspired by a reader comment on Canadian Capitalist’s article about covered-call exchange traded funds, I’ve decided to make an offer to select investors. I will guarantee payments each year amounting to 20% of the average daily balance in each investor’s account.

The idea for this investing approach was sparked by the savvy comments of STU L comparing covered call ETFs to regular ETFs:
“I’ll take the income, thank you. The capital gain/loss is unimportant as I’ll hold these stocks indefinitely. 2.25% or +10%? it’s a no brainer decision. I wanted to setup some kind of cash generator portfolio or ATM and these coverd-call ETF’s filled the bill. Everyone gets all weird about the hi yields but have they noticed that more and more companies are bringing out their own call option funds. That says something in itself.”
STU correctly points out that 10% is, in fact, more than 2.25%. STU is also right that many companies are coming out with covered call funds, which means that they must be good for someone.

My thinking is that a 10% yield just isn’t enough. What if you’ve got $120,000 saved and you want to start collecting $2000 per month instead of only $1000? That’s where my investing approach fits the bill.

My approach has tax advantages as well. The payments I make will be a mixture of interest, dividends, capital gains, and capital. But my unique approach will make most of the 20% payments tax-free! Not only will you start collecting twice as much per month compared to covered call ETFs, but you’ll pay a lower tax rate on this yield. If there’s a downside to my approach, I haven’t mentioned it.

Friday, April 27, 2012

Short Takes: Financial Checkup and more

The Blunt Bean Counter has a thorough checklist for your yearly financial checkup.

Big Cajun Man asks whether warning labels on dangerous financial products are likely to scare you away or make you more determined to prove that you’re sophisticated enough to handle them.

Retire Happy Blog explains pension splitting rules. This can save retired couples big money.

Larry MacDonald says that if Warren Buffett thinks the rich should pay more in taxes, perhaps he should pay some extra taxes voluntarily. I’ve never understood this logic. If a football player objects to steroid use in the league, what sense does it make to tell him that he can avoid steroids and the rest of the players can continue as they please?

Thursday, April 26, 2012

Second Look: The Role of a Financial Advisor

Writing this blog has taught me a lot about personal finance and investing. This is one of a series of articles where I argue with my former self by disagreeing with one of my previous articles. Unlike politicians, I’m allowed to change my mind as I learn more from my readers and my own research.

In an article about a survey of investor attitudes toward their advisors, I said
“Portfolio returns should be the main concern of an investor.”
When it comes to a relationship with a financial advisor, I now think that other advice about saving, life planning, and tax planning are very important as well. In my own experience with a couple of financial advisors years ago, I never got anything useful in these other areas (and nothing useful in terms of portfolio returns either).

I still think that people place far too much importance on whether an advisor is likeable and inspires confidence. Good advice should be more important than a nice smile, but this doesn’t seem to be how people are wired.

If we go on the assumption that most advisors can manage to match market returns before fees, the main thing for investors to look for in an advisor is enough useful advice and guidance to justify the fees charged.

On the Positive Side …

Here are a few of my older articles that I still quite like:

I devised a 6/49 lottery strategy that is profitable if you can get access to information on which number combinations have not been chosen.

The market timer breakeven date helps to determine whether market timers have made or lost money.

Beware of geeks bearing formulas.

Dollar-cost averaging myths.

Silence as a negotiation tactic.

A quick way to find some nasty terms in a contract.

A useful way to think about the choice of a mortgage term.

Wednesday, April 25, 2012

New ‘NDP Tax’ in Ontario May Not Generate the Expected Revenues

Dalton McGuinty’s minority government in Ontario has agreed to the NDP’s new 2% tax on income over $500,000 to get the budget passed. However, according to Scott Stinson this “is effectively a tax increase of 3.12% because it will be imposed before a high-income surtax that already exists.” McGuinty expects this new tax to bring in an extra $470 million per year, and I’m reminded of the Laffer curve as a reason why this added revenue may not fully materialize.

It’s important to consider the possible secondary effects of any change. We tend to take for granted that increasing tax rates will produce more revenues, but the simple example of the Laffer curve shows that this isn’t always true. If the tax rate is 0%, tax revenues will be zero. But if the tax rate is 100%, tax revenues will also be zero because nobody would bother to work. So, somewhere between 0% and 100% tax rates, tax revenues stop increasing as the tax rate increases.

Getting back to the new tax increase, the obvious secondary effect is that some high-income Ontarians will leave the province. I have no idea how many will leave, but the number who stop paying taxes in Ontario due to this tax increase will not be zero.

Let’s focus on those whose income is $1 million per year. The new tax aims to collect an additional 3.12% of the amount over $500,000, or $15,600. If a million-dollar earner would have paid $400,000 in income taxes, then having just one of these people leave the province will wipe out the added revenue from $400,000/$15,600 = 26 others who choose to stay. So, the new tax will be revenue-neutral on this group if only about 4% of them choose to leave Ontario.

Trying to pile extra taxes on high earners is a tricky game, especially when they can easily choose to settle in a new province or even a new country.

Tuesday, April 24, 2012

Things You Need to Know about Selling Stocks

In the spirit of My Own Advisor’s post The Top 5 Things You Need to Know about Dividend Paying Stocks, I decided to sing the merits of selling 5% of your stocks each year.  I don't want to pick on My Own Advisor because he's a good guy and many blogs say similar things, but I had to pick some blog to have some fun with.

1. Selling 5% of your stocks each year provides an immediate return.

Even if your stocks subsequently go down in value, you get to keep the cash from selling 5% of your stocks each year.

2. Safety buffer against the worst case scenario.

If the worst happens and the businesses you own go bankrupt, you get to keep the cash from 5% sales in all previous years.

3. The value of that 5% increases over time.

As long as your business is successful and produces more than a 5% yearly increase in share value, each year’s sale will be worth more than it was the previous year.

4. Many businesses have a long history of rising share values.

Several Canadian banks along with BCE have been around since the nineteenth century, and their share values have risen impressively.

I won’t torture you with an attempt to match the fifth point. The main idea is that if a business doesn’t give some of its cash back to shareholders in the form of a dividend, you can always just sell some of the stock. Only a fraction of the sale will be taxable as a capital gain, making this approach more tax-efficient than dividends. I’m not saying that dividend investing is necessarily bad, but many of the trumpeted benefits exist more in our minds than in reality.

Monday, April 23, 2012

Mortgage Savings Nonsense

How many times have you heard something like the following? “On a $250,000 mortgage at 3.5%, if you choose a 20-year amortization instead of 30 years, your payments will only be $328 more per month more and your savings over the life of the mortgage will be $55,675!” This is just well-meaning nonsense.

If there were no such thing as inflation, the figures above would be accurate. But in what universe does is make sense to simply add 2012 dollars to dollars from the year 2042? Even if inflation is only 2.5%, the 2042 dollars will be worth less than half of present day dollars.

To figure out the real savings, you have to take into account inflation. Suppose that over the life of the mortgage, inflation is 2.5%. Then we can take the present value of the 20 or 30 years of monthly payments to figure out the potential savings.

30-year case:

Monthly payment: $1119.09
Present value: $284,281

20-year case: 

Monthly payment: $1446.66
Present value: $273,713

The actual savings from choosing the shorter amortization and higher payments is $10,568. I’d rather have this money in my pocket than give it to a bank, but this is a far cry from the figure of $55,675 when we ignore inflation.

I think the people who quote the fictitious huge savings generally mean well, but the reasons why it is usually a good idea to take a shorter amortization go beyond the modest cash savings. If you take a short amortization, the higher monthly payments will steer you towards a more modest home. And the higher payments will dampen lifestyle inflation. You’ll also have more room to lower payments later if your income drops for some reason.

Friday, April 20, 2012

Short Takes: Money Psychology and more

Where Does All My Money Go? says that successful investing is more about psychology than math. I’d say that it’s about having the right psychology to allow yourself to follow the math. I agree that many who are strong at math still do stupid things with their money.

Big Cajun Man had some fun with a financial fill-in-the-blanks. My contribution: “Stupid people and their money are … not sitting at my poker table often enough.”

The Blunt Bean Counter writes a top-ten list of pet peeves about personal income tax season.

Retire Happy Blog gives an example of how to use a trust to save taxes.

Wednesday, April 18, 2012


At the intersection of economics and sports you’ll find the book Scorecasting: The Hidden Influences Behind How Sports Are Played and Games Are Won, by Tobias J. Moskowitz and L. Jon Wertheim. This book appealed to my analytical side, my sports nut side, and my love of debunking ideas that almost everyone is sure are true. I highly recommend this book to sports fans whether or not they are numbers people.

While this book has little to do with finances other than the obvious financial benefits for professional sports teams if they can figure out how to win, I see a strong parallel between sports and investing. In investing, we have the debate between index investors and those who hope to beat the odds with their stock-picking hunches. In sports we have the debate between those who crunch the numbers to determine the best strategies and those who operate on intuition.

The book begins with “whistle swallowing,” or the tendency for officials to try to avoid the perception that their decisions determine the outcome of a game. In baseball, the authors found that the strike zone is 188 square inches larger when the batter’s count is 3-0 than it is when the count is 0-2. It seems that umpires prefer not to call strikeouts and walks. On 0-2 counts, even pitches right down the middle are called balls 15% of the time. The authors conclude that perhaps batters should swing more on 3-0 counts because the pitch is likely to be called a strike anyway. However, I doubt that this is a good idea; walks are more valuable than most people realize and it makes sense to take a chance on drawing a walk on the 3-1 or 3-2 pitch rather than ground out on the 3-0 pitch.

In U.S. football, it turns out that teams go for it on fourth down far too infrequently. Even teams like the New England Patriots (who go for it much more often than other teams) don’t go for it often enough. This runs so contrary to people’s intuition that you won’t find many who agree with this assessment even after seeing the numbers. And even though going for it may be the right decision, coaches get lambasted when it doesn’t work out. The authors tell the story of the high school football team, Pulaski Academy, that never punts, never returns punts, and on kickoffs attempts on-side kicks or just kicks the ball out of bounds to prevent a return. Pulaski went on to great success.

In basketball, the authors show that sitting out players with foul trouble makes little sense. “Yes, a player may foul out of a game, but benching the player ensures that he’s out of the game.” The authors estimate that NBA coaches give up 0.5 points per game with the flawed strategy of benching star players in foul trouble. One coach gave an explanation of why he would continue to bench players with 5 fouls despite the evidence: “my kids go to school here!” It turns out that coaches feel great pressure to do what the fans expect them to do.

In basketball we often hear that defense wins championships. The authors crunched the numbers and found that, in reality, offense and defense are equally important. However, as any youth basketball coach knows, many players must be motivated to play hard on defense, but need little motivation to play hard on offense. So, declaring that defense wins championships isn’t really about choosing a strategy as it is about demanding that players put forth a full effort at both ends of the floor.

The authors devised a number of clever tests to show that the usual explanations for home-field advantage are mostly nonsense. The real answer is the influence the fans have on officials. This isn’t likely to be a popular answer, but the evidence that officials tend to favour the home team seems undeniable. The use of replay challenges in the NFL has actually reduced home-field advantage because visiting teams have more bad calls against them to get reversed than home teams have. I wonder if the reluctance of MLB to introduce replay challenges has anything to do with the expected reduction in the home-field advantage that fans tend to like.

In a discussion of how teams value draft picks, the book describes a clever experiment I hadn’t heard of before: “a certain economics professor has been known to stuff a wad of cash into an envelope, stating to his students that there is less than $100 inside. The students bid for its contents; without fail, the winning bid far exceeds the actual contents–sometimes even exceeding $100!” It seems that when it comes to bidding, competitive juices often overtake reason.

The authors also mention the classic test for overconfidence: “are you an above-average driver?” Three-quarters of test subjects say they are above average. This test has always bothered me because different people have different notions of what makes a good driver. Some think safety and others think technical skill. I have technical skill at driving, but I may not be safer than average. However, I don’t doubt the conclusion that people tend to be overconfident.

It turns out that icing kickers in the NFL and free-throw shooters in the NBA by calling a timeout makes no difference to the outcome (other than annoying fans).

Most fans believe that players are sometimes hot or cold, but the evidence suggests that there is no such thing as a “hot hand”. One aspect of this conclusion that troubles me is that, in basketball, there is a tendency for players who make a couple of shots in a row to get confident and take increasingly difficult shots. Researchers could control for increased difficulty resulting from longer shots, but may have a harder time controlling for greater defensive pressure or off-balance shots. However, I don’t doubt that people see patterns that aren’t there. Even if momentum exists to a small degree, fans will see it as 10 times bigger than it really is.

The Chicago Cubs’ century-long futility is legendary. The explanation? Fan “attendance is the least sensitive to performance in all of baseball.” It turns out that the owners still make money even if the team loses. “Attendance was more than four times more sensitive to beer prices than to winning or losing.”

I’ll give the last word to Amos Tversky who captured the tendency for people to stick with their intuition instead of believing the evidence: “I’ve been in a thousand arguments over this topic. I’ve won them all, and I’ve convinced no one.”

Tuesday, April 17, 2012

Adjusting Portfolios to Account for Investor Behaviour

We now understand well that investors consistently make certain types of behavioural mistakes, such as selling stocks after the market drops, buying back in when stocks are soaring, and chasing last year’s hot mutual fund. How best to adjust portfolios to deal with these cognitive errors is a subject for debate.

One approach is to take the way an investor feels about gains and losses and construct an asset allocation that maximizes the investor’s perceived net gain. This is the approach taken by Morningstar with their star ratings that bake in an assumed average level of risk aversion. However, this can lead to extremely conservative portfolios, which is not in the best interests of most investors.

The real answer is to evaluate potential asset allocations based on two criteria. The first is how beneficial the allocation would be for the investor (as opposed to how comfortable the investor would be). The second is how likely the investor is to stick with the allocation through thick and thin and how much his returns will suffer when he deviates from the plan.

Let’s consider an example. Suppose that a young nervous investor has little stomach for stock volatility and may not be able to handle more than a 20% stock allocation without bailing at the next big drop in stock prices. A careful analysis of this investor’s financial life might indicate that his stock allocation should be 75% if only he could handle it. Settling for 20% would be a big penalty.

But, suppose that this investor could be distracted by dividends. By choosing ETFs that specialize in dividend-paying stocks and getting the investor to focus on the fairly steady dividend stream from the ETFs, he might be able to stick with a larger allocation to stocks.

The penalty for lack of diversification that comes with specializing in dividend-paying stocks is likely to be much lower than the expected penalty of only allocating 20% of a portfolio to stocks. Both approaches may make the investor equally comfortable, but the dividend approach has much better expected returns and matches the investor’s needs better. Even better would be broad stock index ETFs, but this just isn’t possible for this nervous investor.

The basic idea is to match investors’ needs as best as possible taking into account their behaviours. This is very different from just trying to make investors comfortable.

Monday, April 16, 2012

Second Look: Canadian Homeowners’ Sensitivity to Interest Rates

Writing this blog has taught me a lot about personal finance and investing. This is one of a series of articles where I argue with my former self by disagreeing with one of my previous articles. Unlike politicians, I’m allowed to change my mind as I learn more from my readers and my own research.

I wrote about Warren Buffett’s proposed solution to preventing a repeat of the U.S. housing crisis and in the comments section, I crowed

“I'm proud of the Canadian system and its stricter policies for obtaining a mortgage that has pretty much dampened any housing bubbles that we might have.”

I’m not so sure about this any more. I don’t think we’re headed for a mortgage crisis anywhere close to as bad as what happened in the U.S. a few years ago, but it seems clear now that many Canadians would be in for trouble if interest rates rose by even as little as 2%.

On a $300,000 mortgage amortized over 30 years, 3% interest gives monthly payments of about $1260, but 5% interest leads to $1600 payments. This could easily push some homeowners who are right on the edge into default (or at least force them to sell their homes).

I’m not making any predictions about the extent of the pain we’ll see throughout the economy when interest rates start to rise again, but it won’t be fun for those who are heavily indebted.

On the Positive Side …

Here are a few of my older articles that I still quite like:

Market timing in pictures.

MER: Death by 1000 cuts with pictures!

With some dialogue I show that MERs are the gift that keeps on giving.

A profitable, but potentially very dangerous 6-figure credit card arbitrage scheme.

How lenders juice interest payments by not using real interest rates.

A look at how the steady rise of stock prices gets lost in the noise.

Making large sums of money last requires surprisingly low spending each month.

Improving incentives for real estate agents to better align their interests with the clients’ interests. This one had some good discussion in the comments section.

Lacking a sense of scale can hurt financially.

Thursday, April 12, 2012

No More Market Orders

I used to make most of my stock trades as market orders. This meant that the broker just executed my buy or sell order at the best available price right away. However, I now make limit orders exclusively to avoid getting burned by unusual market conditions.

The exact price on stock trades isn’t as important for buy-and-hold investors as it is for high-speed traders. A few cents per share spread over a decade holding period isn’t a big deal. However, unusual market conditions can lead to surprises.

To use a concrete example, if you place a market order to sell 200 shares of VCE when its spread is $24.87 to $24.88, you expect to get $24.87 per share. However, this is not guaranteed. If there is a sudden change in the market, you could end up getting less. How much less depends on how violently the market shifts.

A simple remedy is to place a limit sell order at, say $24.85. You are still very likely to get $24.87 per share, and you are guaranteed not to get any less than $24.85. The exact price to choose for the limit is the lowest price you are willing to accept if there is a sudden shift in the market.

My excuse for getting into the habit of making market orders is that it used to cost me $25 per market order trade and $29 for a limit order trade. Now that I pay about $10 per trade and there is no extra cost for a limit order, I no longer have any reason for using market orders.

I still sometimes forget to include a limit with my orders, but an article about “hide-not-slide” orders reinforced for me the lengths active traders will go to take money from each other. I can’t say that I fully understand the purpose of these hide-not-slide orders, but they have helped me to remember to protect myself with limit orders.

Wednesday, April 11, 2012

Useless Investing Ideas

I used to read newsletters and blog articles touted as “investing ideas”. The premise seems to be that investors wander around without any idea of where they could put their money, and they just need some ideas. I think these writers are just avoiding making any claims that they think their investing ideas will be profitable.

There are thousands of individual stocks, mutual funds, and ETFs. I could even get a listing of all of them if I was motivated to do so. A smart phone application could pop one up each morning as an investing idea. Why would I need to have someone else give me an investing idea?

Of course, readers are supposed to infer that they are reading good investing ideas, and writers get the benefit of not being held accountable for their ideas if they don’t pan out. This reminds me of weasel-wording that can come up in legal contexts. Instead of saying “the young man who died bungee jumping was suicidal,” a lawyer representing the bungee operator might distance himself from such an accusation by saying “I’d like to suggest that perhaps this wasn’t so much an accident as it was a case of the young man being despondent over a breakup with his former girlfriend.” This is an attempt to deflect blame away from the bungee operator without getting skewered for making a baseless accusation against the victim.

Reading active investing advice is usually a waste of time anyway, but it’s worse if the writer isn’t even claiming that it is good advice. Although I don’t think much of Jim Cramer’s act, at least he makes it clear where he stands on the stocks he discusses. I prefer to see people stand behind their investing ideas.

Tuesday, April 10, 2012

OAS Age Change Debate

To say that some people are unhappy that eligibility for Old Age security (OAS) will be going up from age 65 to 67 is an understatement. Preet Banerjee collected together some of the more reasoned arguments in this debate. I don’t want to pick on Preet because he’s definitely one of the good guys, but I don’t agree with everything he said.

My main concern is with the oft-quoted statistic that OAS and GIS (Guaranteed Income Supplement) payments are currently 2.36% of GDP and are expected to rise to 3.14% of GDP by 2030. Preet says that some see this as a “whopping” increase, it doesn’t really look very whopping at all.

I disagree. GDP (Gross Domestic Product) is the market value of everything produced in the entire country. Just about anything you measure as a percent of GDP (except government debt) is going to look small. Even Bernie Madoff’s fraud was only 0.45% of U.S. yearly GDP. If my cable company tried to convince me to take a full suite of all their top-of-the-line services because it only costs 3% of my pay, I wouldn’t be persuaded.

I definitely agree with Preet when he looks at the main reason in favour of increasing OAS eligibility: “If we did nothing, the average length of retirement would eventually approach the average length of one’s working career.” OAS needs to change over time to reflect changes in our longevity.

Preet asked a final question in reference to the fact that we can defer OAS payments past age 67 in return for higher payments: “As voluntary deferrals earn a premium in benefits, can those of us who got the shaft at least get a premium for our mandatory deferral?” My answer would be that younger people already get a premium in the form of a greater life expectancy which leads to more OAS payments.

I’d like to see automatic OAS reviews that would make eligibility adjustments based on life expectancy. The goal would be to make the lifetime costs per person for OAS stay constant (after adjusting for inflation). Without automating these changes, inaction causes OAS costs to keep rising as life expectancy increases.

Monday, April 9, 2012

Investing is Like Driving on a Punctured Tire

All investment portfolios have leaks. As you drive that metaphorical portfolio, money leaks like air from a punctured tire. You lose money to trading commissions, trading spreads, ETF and mutual fund MERs, income taxes, lack of diversification, and other costs. We can’t eliminate these costs entirely, but we can shrink the size of the hole.

One way to control costs is to trade infrequently. This reduces trading costs and triggers less capital gains tax. For those who embrace the benefits of diversification, Management Expense Ratios (MERs) on exchange-traded funds (ETFs) and mutual funds are a concern. Seemingly low MERs like 2% are actually applied every year, and they add up to big money over many years. To make this clearer, a while back I coined a new 25-year measure called the Management Expense Ratio per Quarter century (MERQ).

To illustrate what the MERQ means, let’s compare the largest Canadian equity fund in Canada to one of the least expensive Canadian equity index ETFs. The RBC Canadian Equity fund controls investor assets of $5.2 billion and charges an MER of 2.05%. This works out to $107 million per year! In contrast, Vanguard’s Canadian Index ETF (VCE) charges an MER of only 0.09% per year.

The corresponding MERQ values work out as follows:

RBC Canadian Equity fund: MERQ 40.1%
Vanguard Canadian Equity Index ETF (VCE): MERQ 2.2%

Suppose that a lump sum investment would have grown to a million dollars in 25 years if the MER charged were zero. After we factor in the MER for these two possible investments, here are their final portfolio values:

RBC Canadian Equity fund: $599,000
Vanguard Canadian Equity Index ETF (VCE): $978,000

It’s hard to believe that a little 2% difference each year could do so much damage, but it does. I’d like to see mutual funds and ETFs start reporting 25-year MERQ figures instead of yearly MERs to make the costs easier for investors to understand. Failing that, reporters who have no interest in hiding these costs from investors can adopt the MERQ as a better measure.

Thursday, April 5, 2012

Short Takes: Underwriting Conflict of Interest and more

Tomorrow is a holiday, so this is a special Thursday edition of Short Takes. Have a great long weekend!

Tom Bradley at Steadyhand doesn’t understand why regulators permitted Scotiabank to underwrite its own stock issue. His disclosure at the end of the piece cracked me up.

The Blunt Bean Counter wades into the debate about whether insiders have an edge in trading stocks they are close to professionally.

Where Does All My Money Go? explains the wash-trading charges against RBC. Preet’s explanation is much clearer than anything I read in newspapers.

Big Cajun Man looks at the budget’s changes to Registered Disability Savings Plans (RDSPs).

Retire Happy Blog takes a look at corporate bonds. Personally, I don’t invest in such bonds and probably won’t in the future except possibly indirectly through a bond index ETF.

Million Dollar Journey explains the Pension Benefits Guarantee Fund.

My Own Advisor seems to be ahead of the game on his 2012 personal financial goals.

Wednesday, April 4, 2012

Millionaire Teacher

Andrew Hallam’s book Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School is a colourful and entertaining guide for novice investors to keep them on the right financial path. However, the ninth rule was a curious departure from the strong message in the rest of the book.

The main thing that separates this book from others that offer similar advice is Hallam’s enthusiasm and vivid analogies, such as when he says that investing while you have credit card debt “makes as much sense as bathing fully clothed in a giant tub of Vaseline and then traveling home on the roof of a bus.” I’m not sure what that means, but it is entertaining.

“Worrying about the immediate future is letting the stock market lead you by the gonads.” Perhaps this explains why women have better investment results than men.

When it comes to spending, you “can’t be average” if you expect to become wealthy. Instead of looking to others’ actions to validate your own poor spending habits, you should think for yourself.

After quoting Warren Buffett and William F. Sharpe, Hallam says that “if a financial adviser tries telling you not to invest in index funds, they’re essentially suggesting that they’re smarter than Warren Buffett and better with money than a Nobel Prize Laureate in Economics. What do you think?” Because of most advisers’ conflict of interest, “asking your adviser how he feels about indexes is going to be a waste of time.”

Hallam is very hard on the financial services industry and financial media, which they mostly deserve. He calls the write-ups on the state of the economy that come with your investment statements “confusing economic drivel.”

On the need to own some bonds, Hallam says “only an irresponsible portfolio would fall 50 percent if the stock market value were cut in half.” I think this depends on the temperament of the investor. I agree that most investors need to use bonds to reduce volatility, but those who can stay calm as stock prices fall can make a different choice with savings they won’t need for many years.

As further evidence of the need for bonds, Hallam compares the Canadian Couch Potato Portfolio (rebalanced Canadian bonds, Canadian stocks, and U.S. stocks) to a portfolio with 100% Canadian stocks from the end of 1975 to the end of 2010. Starting with $100, the Couch Potato ends up with $3493, and Canadian stocks end at $3157. However, this is quite misleading. A 50/50 portfolio in Canadian and U.S stocks would have performed almost exactly as well as the Couch Potato portfolio. Further, bonds performed spectacularly well over most of this time period. I’m all for using bonds to lower volatility to allow investors to stick to their plans when the going gets tough, but there is no reason to expect that a portfolio that includes bonds will outperform an all-stock portfolio in the future.

“Gold is for hoarders expecting to trade glittering bars for stale bread after a financial Armageddon.” That gave me a chuckle.

Rule 9 is titled “the 10% stock-picking solution … if you really can’t help yourself.” This sets a tone that is consistent with the rest of the book, but the body of this chapter is much more enthusiastic about the benefits of stock picking. Hallam goes through all the arguments and techniques for trying to beat the market with individual stocks. A reader could be forgiven for thinking that the previous 8 rules were for chumps and the real way to make money is by using these methods to pick stocks. It isn’t until the final paragraph that Hallam admits that “odds are high that eventually most stock pickers will lose to market-tracking indexes.”

Apart from rule 9 about stock picking which seems oddly out of place, this book is useful for novice investors and is entertaining enough that some of them may actually read most of it.

Tuesday, April 3, 2012

Penny Angst

I decided to poke around online to see what people think of eliminating the penny in Canada. The main thing I learned is that there are many opinionated math-challenged and spelling-challenged people in the world. There are also many people who are very unhappy about dropping the penny. While there may be some good reasons to object to dropping the penny, I didn’t find any.

Let me go through the main arguments that I encountered.

I like saying “a penny for your thoughts.”

Saying this to a sweetheart is still permitted. When we are old enough to be great-grandparents, maybe we can explain to our families the meaning of that funny word “penny” that gets used in so many expressions.

What if retailers all round prices up to the next nickel?

I think this would enrage customers. If some retailer were bold enough to try it, we could shop elsewhere. However, I suspect that almost all retailers will follow the government’s guidelines to round shopping totals ending in 1, 2, 6, and 7 down to the nearest nickel and round totals ending in 3, 4, 8, and 9 up to the nearest nickel.

What if retailers are very clever to choose prices that always round up by 2 cents?

This won’t work if we buy 2 or more things at once because the rounding doesn’t happen until after the prices of all the items are totaled. Retailers may still be clever enough to choose prices that lead to rounding up more often than rounding down. Let’s suppose that retailers manage to average an extra half-cent per transaction due to rounding up more frequently than down. Even if I make 100 cash transactions per month, that’s only 50 cents. Big deal.

Even if the rounding is fair, bad luck might make the rounding go against me.

If the rounding amount is randomly chosen among -2, -1, 0, 1, or 2 cents one hundred times each month, the odds of being up or down by more than $10 after 50 years is less than 1 in 200.

The government is a bunch of thieves.

Even if that were true, keeping the penny wouldn’t help.

If there are some good reasons for keeping the penny, I’d like to hear them.

Monday, April 2, 2012

Simplifying Your Financial Life

Reader JP sent some questions about his leveraged investments and whether he should hold his mortgage in his RRSP. Here is an edited version of his questions:
“Does it make sense to hold my residential mortgage in my RRSP? Given the size of my RRSP and the modest remaining size of my mortgage, I’m really torn about what steps to take. In addition to my RRSP I have after tax investments that I purchased using a secured line of credit, separate from the mortgage, and I claim the interest as investment costs.

On one hand, I have enough that I could simply blow away the mortgage by cashing out the after tax investments. The after tax investments give a nice stream of dividends, but does it make sense to have them and still have the mortgage sitting there?

Do RRSP contributions make any sense now that my wife and I are now both ‘employees’ rather than ‘contractors’ and we still have the mortgage sitting there?”
To start with, I have nowhere near enough information to give JP any specific advice. However, I can discuss how I think about my own finances.

Assuming that JP’s non-registered investments are valuable enough to allow him to pay off both the line of credit and the mortgage, this would seem very tempting to me. I like simplicity and this would definitely simplify JP’s finances. It’s amazing how complex your various accounts can become (RRSP, spousal RRSP, locked-in RRSP, RESP, TFSA, non-registered accounts, etc.). Unless there is a compelling financial reason to add complexity, I err on the side of simplicity.

On the specific question about holding a residential mortgage in an RRSP, this never interested me, but it could be useful in some situations. For example, if JP has a poor credit rating and has to pay a high interest rate on his mortgage, he may prefer to pay that interest to himself (in his RRSP) rather than pay it to someone else. This doesn’t come up very often, though; how many people have enough assets in their RRSPs to pay off their mortgage but have a poor credit rating?

On the question of whether RRSP contributions make sense, there are circumstances where people have so much money in their RRSPs that it makes no sense to add more, but I’m guessing that isn’t the case for JP. When it comes to RRSP contributions and making extra payments on a mortgage, common advice is to do both. With JP and his wife both working and the mortgage being small, you’d think it would be possible to make RRSP contributions and pay off the mortgage aggressively.

Overall, I’d be tempted to simplify by paying off as much debt as possible (without draining RRSPs) and not worry about complicated things like holding a mortgage in an RRSP, but JP’s circumstances may be very different from mine, and he’ll have to decide for himself what to do.