Tuesday, July 31, 2012

Olympic Attendance Costs

I noticed that some of the Olympic events don’t seem to be particularly well attended. I’ve heard officials blaming this on “no shows,” but I wonder if it has more to do with ticket prices.

A quick check of beach volleyball ticket prices revealed that if you want to watch the semi-finals and finals only, the cheapest seats cost a total of 320 Pounds, or about $500. Middling seats would be about $1000 per person and the best seats closer to $2000. Toss in another few other events, and a couple could easily spend a 5-figure sum on tickets.

At these prices, I can certainly see why many people would choose to watch the games on television.

Monday, July 30, 2012

Book Giveaway: The Beginner’s Guide to Saving and Investing for Canadians

A group of Canadian bloggers and an online insurance specialist got together to write The Beginner’s Guide to Saving and Investing for Canadians, edited by Dan Bortolotti. Having followed the authors’ excellent blogs for years now, it’s no surprise that the book is well-written. At only about 100 pages long, the book’s main strength is that it sticks to the big important issues rather than diving too far into minutia. At the bottom of this review, I’ll describe how you can enter a draw to win a copy of the book.

The first chapter, by Krystal Yee, covers budgeting and basic cash-flow planning to get out of debt and create savings. Although quite basic stuff, many Canadians make the kinds of mistakes Yee describes. It’s hard to build a solid financial future while paying interest on credit-card debt.

Jim Yih goes through the alphabet soup of different types of savings accounts (RRSP, RESP, TFSA, etc.). It’s possible to write a complete book on the details associated with each type of account, but Yih sticks to the high-level facts to help you determine which types of savings accounts you should consider.

Ram Balakrishnan covers a more difficult topic for beginners: investing. He recommends passive investing in indexes rather than actively choosing stocks. Balakrishnan does a good job of explaining the low-cost benefits of passive investing, but some beginners will have difficulty following this path. For example, the advice to “look for a discount brokerage [at] the bank where you have your main chequing account” won’t work well for those who don’t know the difference between a discount brokerage and bank branch staff who sell expensive mutual funds. Hopefully, the sample portfolios at the end of the chapter will help beginners see the difference between these low-cost portfolios and the kinds of portfolios that are typically sold to Canadians.

A blogger who goes by the name Frugal Trader wrote a chapter on dividend investing. Many dividend investing enthusiasts are quite rabid, but Frugal Trader gives a balanced view including both advantages and disadvantages of dividend investing. In my opinion, he overstates the tax efficiency of dividends from Canadian corporations, particularly now that Canada has TFSAs. It’s true that dividend taxes are very low if your income is around $40,000, but how many people with incomes this low have used up all their RRSP and TFSA room? For people with higher incomes, capital gains taxes are either about the same or lower than dividend taxes, depending on the province. Overall, I think the benefits of dividend investing are largely emotional, but this can be important. Whatever keeps people on the right track with their savings and investing and sticking to a solid plan is a good thing. Investors who follow Frugal Trader’s low turnover dividend investing plan will get far better investing results than the average Canadian.

Because I know less about insurance than investing, Glenn Cooke’s chapter on buying the right insurance was the most illuminating for me. He covered life and disability insurance in a way that simplified the subject without hiding important information. He makes it clear what types of insurance you may need and what types to avoid.

I found 7 typos in the book, which is a little disappointing for a book only about 100 pages long. However, none of the errors is likely to create confusion for readers. I actually reviewed a digital copy, and perhaps these typos were caught before the book went to print.

Overall, this is an excellent book for the average Canadian who is looking for clarity in the confusing world of personal finance. Understanding the ideas in this book can make the difference between perpetual money problems and having a sound financial future.

To enter the giveaway:

Just send an email with the following things:
– Subject: Book Giveaway
– Answer to the following skill-testing question: (7 x 8) + 6 – 2
– Use the email address listed at the “Contact” link (For those who are reading my feed, you’ll have to click through to my web site to get the email address.)

Another benefit of going to my site when reading a post is to see the comments other readers leave on that post. All entries received before noon Eastern Time on Sunday, August 5th will be considered for the draw. I will make a random draw without favouring any particular entries. I reserve the right to eliminate entries that I judge to be outside the spirit of the contest. Good luck!

Friday, July 27, 2012

Short Takes: Dumping Stocks and more

Rob Carrick talks to author and financial advisor Carl Richards about whether to risk investing in stocks. A good quote: “If you’re going to get out of the market, make it a permanent decision, please.” Richards fears that investors who get out now will climb back in again when stocks are flying again at high prices.

Canadian Couch Potato makes the case that we can’t know whether we are in secular bear or bull markets until they are over.

Big Cajun Man is in full rant mode about so-called “good debt.” I think he has a point. Taking on debt may be the right thing in some cases (think of buying a home or getting an education), but that doesn’t make the debt good. It just means that you’ve paired up a good thing (a home or degree) with a bad thing (a debt).

Million Dollar Journey looks at the tax efficiency of dividend investing through a corporation.

Wednesday, July 25, 2012

Unexpected Anchoring in Charitable Donation Amounts

An effort to boost donation amounts for a charity succeeds, but not in the way we expected. I’ve been involved with Little League Baseball for many years now. Instead of charging admission during tournaments to cover costs, we “pass the hat.” This is where spectators are asked to toss money into a hat that is carried around at one point during each game.

It used to be that many people would just pull a few pennies, nickels, and dimes out of their pockets, which makes for a lot of coin rolling, but doesn’t help the donation total much. Sending young people with a puppy around to carry the hat improves the haul somewhat, but better ideas were needed.

A recent bright idea was to offer a league pin to anyone who donates $5 or more. At first this didn’t seem to help much because few people donated enough to get a pin. But there was a nice secondary effect; the typical donation became $2 instead of a few low denomination coins. Just mentioning $5 had the anchoring effect of dragging people’s donation closer to $5.

One negative effect was that people began to claim that they had bought a pin at a previous game with the implication that they saw no need to contribute again. And once one person says this, others who hear it often say the same thing, including a few people who never actually bought a pin. Overall, though, the pin idea has been very successful. Perhaps we will stumble onto other ways to exploit human tendencies that are well understood in the retailing world.

Friday, July 20, 2012

Short Takes: Impossibly High Yields, Payday Loans, and more

Jason Zweig looks at the incredible appetite investors have for high-yield investments despite the fact that these yields are mostly just a return of investor capital.

Million Dollar Journey explains payday loans and their regulations (but the post has disappeared from the internet). He points out that the typical annual interest rate is 652%. But this is based on “simple interest” which doesn’t exist in the real world. Compounded out, this is about 33500%!

Big Cajun Man implores readers to call their bank’s bluff and jump to a new bank.

Preet Banerjee reports on some recent research into shoppers’ troubles with math.

The Blunt Bean Counter asks whether you’re selfish with your money and financial advice.

Jim Yih has a new book out about guaranteed investments.

Wednesday, July 18, 2012

Marketing Translations

Shoppers are bombarded with messages of sales, specials, and deals. These marketing messages almost always make the deal sound better than it really is. Here are a few common messages along with translations into more neutral language.

Buy one and get the second one at
50% OFF!

Translation: “25% off, but you have to buy two of them.”

We’ll pay the HST!

Translation: “11.5% off.” The HST may be 13%, but taking it off saves only 11.5%.

Fill all 10 spots on your sub card and you get a

Translation: “9% off, but you have to buy 11 subs before this promotion ends.”

Buy with our card and
collect valuable points!

Translation: “Trade dollars for another form of currency called points whose value we control and can devalue with redemption rule changes any time we please.”

None of these deals is necessarily good or bad. They just aren’t as good as they seem at first. Do readers have any more good examples?

Tuesday, July 17, 2012

Covered-Call ETFs Disappoint So Far

Rob Carrick reported that so far cover-call ETF results have been disappointing. Some investors have been surprised by this, but the real surprise is that so many seemed to expect outperformance.

At its core, a covered-call strategy involves owning stocks and selling call options on those stocks. Compared to a strategy of just owning stocks, the difference is obviously the short position in call options. So, for a covered-call strategy to outperform, the excess profits would have to come from the options.

For the options to be profitable, traders would have to consistently trade call options far above their real value. Why would anyone expect this to be the case for such short-term financial instruments?

Even if writing covered calls has no expectation of excess profits, it is reasonable to expect that it will change the volatility of investment returns. But again, I see no reason to expect that we will be left with anything other than the usual relationship between risk and reward: the higher the risk, the greater the expected reward.

Investors who like a covered-call strategy because of the way it changes the volatility characteristics of returns may be making a sensible choice for their situation. But this is very different from expecting outperformance.

Carrick is quite right that “We’ll need a full cycle of stock market ups and downs to properly judge covered call ETFs.” My expectation is that a full stock market cycle will see the covered-call strategy underperform by the costs involved in implementing the strategy. If covered calls prove to be profitable, it would expose a surprising inefficiency in markets.

Monday, July 16, 2012

MERQ as a Better Measure of Fund Costs

Reader B.C. sent the following question about the Management Expense Ratio per Quarter century (MERQ):
I have been reading through some of the old posts on your blog, and came across your idea of the MERQ as a more valuable indicator of management expenses than the MER, and I wholeheartedly agree.

What is not obvious to me though is what equation you are using to calculate the MERQ. Would you be able to provide me with the equation? I'm sure that I am just forgetting some basic math :-)
A fund’s Management Expense Ratio (MER) is the management expenses and certain other fund costs for the year divided by the average assets under management during the year. This is then expressed as a percentage. The problem with this measure is that it gives a low-looking percentage (usually between 0.1% and 3%) that seems harmless. But, this bite out of your savings gets taken out of the same money year after year.

Suppose that Fund A’s expenses lead to year-end assets being 2% lower than they would have been if there were no expenses. This doesn’t sounds so bad, but consider what happens after 2 years. After the first year, 98% of the money stays, and after the second year, only 98% of that remaining money gets to stay again. This means that after 2 years, 98%x98% = 96.04% of the money is still there. Expenses have accumulated and now nearly 4% of the money is gone.

To carry this forward 25 years, we multiply 98% by itself 25 times to get about 60%. This means that 40% of the money is gone after 25 years (an MERQ of 40%). Suddenly, the 2% loss each year seems much more painful.

You may wonder how the fund’s return each year factors into all of this. The answer is that it doesn’t really enter into the calculation. Certainly costs are more palatable when a fund performs well, but for a given MER percentage, fund returns don’t affect what percentage of your money gets consumed in costs. So, if Fund A would have grown your money to a million dollars over 25 years without expenses, the after-expenses figure would be about $600,000. If Fund A performs very poorly and would have grown your money to only $100,000 without expenses, the after-expenses figure would be about $60,000. The 40% MERQ is the same whether returns are good or poor.

For technical reasons related to the way that MER figures are calculated, an MER’s impact on your savings is just slightly less than it would seem because of the compounding effect during the year. Because MERs are negative percentages, compounding actually works in your favour in this case. Here is the formula for calculating MERQ:

MERQ = 1 – e^(–25*MER)

This is easily calculated on a scientific calculator using the e^x or INV ln button.
On a spreadsheet, use 1 – EXP(–25*MER).

It’s not possible to run a fund without any expenses at all, but it certainly pays to keep costs down. A mutual fund with a 2.5% MER has an MERQ of 46.5%, but an ETF with a 0.25% MER has an MERQ of only 6.1%. After 25 years, would you rather have a portfolio of $535,000 or $939,000?

Friday, July 13, 2012

Short Takes: Falling House Prices and more

Rob Carrick looks at the upside of falling house prices.

The Blunt Bean Counter explains the ramifications of a recent ruling by the Tax Court of Canada on what constitutes a “set” when selling personal use property. This could be important if you ever find yourself selling off valuable collectibles.

Canadian Couch Potato announced a new service for do-it-yourself investors to look at their financial plans.

Big Cajun Man sings the praises of slow thinking. I know I make better decisions when I take my time and think things through.

My Own Advisor shares his reasons for owning ETFs.

Million Dollar Journey looks at the pros and cons of rent to own houses.

Preet Banerjee’s latest podcast features a discussion of mobile wallet technology and two ways to save on cellphone roaming charges.

Thursday, July 12, 2012

Discipline vs. Conviction

Jim Yih wrote an interesting article about the importance of discipline over conviction when it comes to financial success. He says “most investors think that investment success comes with conviction or intuition when really the thing that matters most is discipline.”

I agree with Jim, but the problem is that investors who make the most money quickly make their fortunes with conviction and intuition. If a thousand investors each take a wild chance and pour all of their savings into their favourite stock, a few will make a fortune. Of course, most of them will end up with far less than someone who chooses a well-diversified portfolio, but the few lucky ones stand out.

There is a parallel here with lottery tickets. A huge majority of lottery players lose money over their lifetimes. But a lucky few strike it rich, and these lucky people are very visible. It’s obvious that buying lottery tickets is a poor financial move, but it is less obvious that relying on conviction and intuition in investing is also a bad idea for most people.

Lottery advertisers like to tell us that you can’t win if you don’t play. It’s the same with high-risk investing: if you don’t take a big chance, you can’t get rich quickly. But you’re still better off trying to get rich slowly by sticking to boring things like a sensible asset allocation, diversification, low fees, and rebalancing.

Tuesday, July 10, 2012

Fear about Large Sums of Money

There is a curious paralysis that hits people when they are forced to make decisions about large sums of money. Very frequently, they end up making the default choice that involves no action at all. But these same people will throw themselves into decisions about small amounts of money with zeal.

The most frustrating example of this for me occurred in 1994 when the government eliminated the $100,000 lifetime capital gains exemption. The government was allowing people to file an election with their 1994 taxes to treat capital assets as though they were sold so that they could use up some of their capital gains exemption before it disappeared. By doing this, the adjusted cost base of the assets would be higher and less tax would be owing in the future when the assets were sold (or deemed to be sold).

Three elders in my extended family shared ownership in a cottage. I carefully explained all this to them. I even tossed in some emotional stuff: “if you don’t do this, when you pass on the cottage to the next generation, they may have to sell it to cover the taxes owing.” They all seemed to understand what was at stake and the fact that it would cost them nothing right now.

I learned later that none of the three of them ever filed the election. Tens of thousands of dollars were at stake and they did nothing. Yet they continued to squabble over who had paid how much for various trivial cottage repairs.

I saw another example of this odd behaviour when I worked for a small company that was being spun out of a larger company. At an all-hands meeting to discuss all forms of compensation, there were no questions about the biggest parts of compensation: salary and stock options. Even the savings plan generated few questions. The bulk of the discussion was about the dollar limit on eyeglasses coverage in the benefits plan.

It’s no wonder that the bulk of financial advisor time goes into chasing down prospective clients. It must be difficult for advisors to make time for working on financial plans when they have to spend so much time making people face up to big financial decisions.

Monday, July 9, 2012

Stock-Picking Contest vs. My Portfolio

Million Dollar Journey reported on the 6-month point of a stock-picking contest among 10 bloggers. They’ve been doing this for a few years now. I’m not in the contest, but I like to stick my nose in by comparing my actual portfolio results to their stock picks.

The stock-picking results so far range from -26.55% to +13.34% with an average return of -1.5%. My portfolio’s return for the first half of 2012 is +1.9%. If you add my portfolio to the group, I’d be fifth out of 11. So, as usual, my (mostly) index-based portfolio isn’t first or last and is a little above average.

This is what you expect from indexing compared to concentrated portfolios; rarely first or last over short periods of time, but always tending to be a little above average. Over longer periods of time, indexing rises toward the top.

Friday, July 6, 2012

Short Takes: Bleeding Clients, Dismal Financial Predictions, and more

Rob Carrick asks whether an email explaining to investment advisors how to aggressively take more money from their clients is just the product of a rogue sales rep or is standard practice in the industry.

Million Dollar Journey pokes some fun at big predictions that fizzled.

Canadians have, on average, 15 years left on their mortgages. I find this interesting, because 15 years is the longest amortization I’ve ever had, and because I doubled my first payment, my amortization period dropped almost immediately. This shows that I’m quite conservative about debt compared to the average Canadian with a mortgage.

Big Cajun Man anticipates yet another September of spending on his children’s education.

Preet Banerjee announces that he will be the next host of the show Million Dollar Neighbourhood on the Oprah Winfrey Network. Preet’s a good guy and I bet he’ll make this show quite interesting.

Wednesday, July 4, 2012

Exploiting RRSP Tax Confusion

A while back I listened to a pitch designed to get employees at my company to sign up for a group RRSP plan. One of the points the salespeople made that resonated with the audience was that employees could have their entire bonus payment deposited into their RRSP accounts without any withholding tax. Many employees were left with the false impression that this would save them a bundle on their taxes.

To make this more concrete, suppose that employee Megan receives a $20,000 bonus and has a 45% marginal tax rate. Megan will only get to keep $11,000 of her bonus. But if she signs up for this group RRSP, she can deposit the entire $20,000 into her RRSP. It seems like she is able to save $9000.

A first objection to this naive analysis is that Megan could have put the $11,000 after-tax bonus into an RRSP and would later get back $4950. So, Megan only saves $4050 with the group RRSP. However, even this analysis is flawed.

Suppose that Megan has $9000 in other savings. She could use that money plus her after-tax bonus to make a $20,000 RRSP contribution and then get a $9000 tax refund when she files her taxes for the year. This makes it clear that the main benefit of the group RRSP plan is that Megan essentially gets her tax refund right away instead of having to wait until she files her taxes. If Megan doesn’t have $9000 kicking around, then she can borrow the money and pay off the loan when she files her taxes.

Another twist is that Megan could file a T1213 form with CRA so that she would get her $9000 back spread over her remaining pay cheques for the year instead of waiting until tax-filing season.

In the end, the group RRSP doesn’t save Megan $9000. It just saves her a little interest on this amount and saves her some aggravation.