Friday, October 31, 2014

Short Takes: Crowdfunding Tax Issues, Index Investing Choices, and more

I wrote one post this week revealing my asset allocation and my reasoning behind it:

My Asset Allocation

Here are some short takes and some weekend reading:

The Blunt Bean Counter looks into the tax implications of crowdfunding.

Potato looks at a wide range of choices for implementing a passive index investing plan. He rates them by simplicity and costs.

Big Cajun Man reports that TD Waterhouse has made it easier to make transactions in their RDSP accounts.

My Own Advisor reviews the book The Empowered Investor.

Million Dollar Journey shows how to figure out where your hydro dollars are going.

Tuesday, October 28, 2014

My Asset Allocation

I’ve resisted discussing my asset allocation for some time, but now is finally the time to describe it and the reasons behind it. I’m not holding it out as a model portfolio; I believe it’s suitable for me and not necessarily anyone else. With that warning, enjoy the discussion and feel free to ask questions or take some pot-shots.

The main reason why I haven’t discussed my asset allocation in detail before now is that I don’t want readers to treat it like a model portfolio and follow it blindly. Everyone’s situation is different. The need for variation in asset allocation from one investor to the next usually isn’t huge, but there is no one-size-fits-all portfolio.

A secondary reason for keeping my asset allocation to myself is that I can’t be sure I’ll never change it. For example, I recently made the minor change of switching from an ETF of small-cap stocks to an ETF of small-cap value stocks. I don’t have any plans to change my current allocation, but I may think differently in the future.

All Stocks

To start with, my portfolio is 100% allocated to stocks. This means that my returns are more volatile than portfolios containing some bonds and real estate. I don’t recommend 100% stocks for everyone, but I believe it works for my situation.

I have a fully paid-for house and have no debts of any kind. I get job offers fairly regularly, so I’m not overly concerned about the continuity of my pay cheque. I also have a cash buffer that bounces around between 3 and 6 months of my family’s spending. This stable base makes it reasonable to handle the volatility of stocks.

On the emotional side, I handled the tech crash in the early 2000s and the financial crisis of 2008-2009 without any panic selling or sleepless nights. So, I’m confident I don’t need the security of a lower-volatility portfolio.

I’m also prepared to adjust my retirement date based on stock market performance. Before retiring, I’ll certainly sell a sizeable block of stocks and hold the proceeds in safe investments like cash or GICs. If it seems like a bad time to be selling stocks, I’ll just keep working until I can sell some stocks. It’s true that many people have a retirement date forced upon them for health or other reasons, but I expect to have enough savings to cover my expenses indefinitely before I reach age 65.

The Allocation

To decide on an allocation among Canadian, U.S., and international stocks, a starting point is the percentages of the world stock market capitalization each represents. According to a Harvard blog, Canada and the U.S. have 4% and 40% of the world’s stock market capitalization, respectively. So, we have

4% Canada, 40% U.S., 56% international

However, I live in Canada, and while it doesn’t make sense to have too much of a home country bias, my spending is correlated with the fate of Canadian companies. So, I chose to bump up my Canadian allocation to 30%. There’s nothing magical about this figure; it just seems about right. Leaving the other two categories in roughly the same proportion gives us

30% Canada, 30% U.S., 40% international

I spend a good chunk of my time in the U.S., so for the same reason I increased my allocation to Canada, I increased my allocation to the U.S. to 45%. Again, there isn’t much to justify this exact figure; it just seems about right. This gives

30% Canada, 45% U.S., 25% international

Choosing ETFs

There are a number of ETFs that cover my 3 allocation categories. I use low-cost index ETFs for each category. For Canadian stocks I chose Vanguard Canada’s VCN. There are several other possibilities, but I like that VCN includes some smaller-capitalization stocks and more stocks than many other ETFs. I also like Vanguard.

For the U.S. and international allocations, I decided to go with ETFs from the U.S. rather than Canada. This has the advantage that the MERs are lower than they are with Canadian ETFs, but a disadvantage is that I have to do currency exchanges between Canadian and U.S. dollars. Fortunately, Norbert’s Gambit is a clever way to reduce currency exchange costs.

For international stocks, I went with Vanguard’s VXUS. This ETF covers the entire world other than the U.S. It does include a little bit from Canada. So, my actual allocation to Canada is more like 31% than 30%.

I chose to use my U.S. allocation to get some added exposure to small-cap stocks and value stocks. So, my U.S. allocation is split between VTI and VBR, both from Vanguard. VTI holds an index of all U.S. stocks. VBR holds all U.S. small-cap value stocks.

Here is the final allocation to index ETFs:

30% VCN
25% VTI
20% VBR
25% VXUS

There is nothing magical about these exact percentages. The key thing is to stick to them. It’s far too easy to see one ETF shoot up in price and suddenly decide to increase your allocation there. It’s better to mechanically rebalance back to your chosen percentages occasionally.


Having only 4 ETFs may seem overly simple and that there is room for finer slicing and dicing of categories. However, there are always added complications when you try to use an asset allocation in real life. It’s better to start with something simple.

One complication I have is that my wife and I have 9 accounts. Why not consolidate some of them you may ask? I can’t. My wife and I each have one RRSP, one TFSA, one LIRA, and one non-registered account. The ninth account is her spousal RRSP. I treat the 9 accounts as a single portfolio, which simplifies things somewhat, but handling this many accounts adds some complication.

Another complication is that I keep as much of my VTI, VBR, and VXUS in RRSP accounts as possible. This is because the U.S. imposes a dividend withholding tax on stocks held in our TFSAs and non-registered accounts. Following this rule sometimes forces me to make extra trades when I’m rebalancing the portfolio.

I have a group RRSP at work that I joined to get the company matching contributions. The MERs of the funds offered are extremely high, and my lowest cost option among stock funds is a Canadian index fund. So, I treat it as part of the 30% allocation to Canada.

My wife and I still hold some Berkshire Hathaway stock that has significant unrealized capital gains, so I’m not inclined to sell until it’s convenient from a tax perspective. For now, I treat it as part of my U.S. allocation which reduces the amount of VTI and VBR we hold.

There are other complications, but you get the idea; it’s best to start with a simple allocation.


A particularly good feature of my allocation is its low cost. Here are the MERs:

VCN 0.05%
VTI 0.05%
VBR 0.09%
VXUS 0.14%

Blended Portfolio MER: 0.08%

This is a very low yearly cost, and you may wonder what would be the big deal if it were 0.25%, or 0.5%, or higher. Because your investments grow for a very long time, it’s best to think of costs over a much longer time than just one year. These costs aren’t just charged on new money; the same money gets hit year after year. So, the costs build up.

I use what I call the MERQ (Management Expense Ratio per Quarter century). Thinking about costs over 25 years gives a better perspective. My portfolio’s blended MERQ works out to 2.0%. This means that every dollar I save that stays in my portfolio for 25 years grows to 2% less than it would have without MER costs. But for an MER of 0.5%, the MERQ is a much more painful 12%.

MERs aren’t the only portfolio costs. There are trading commissions, bid-ask spreads, trading costs within the fund, currency exchange spreads, and dividend withholding taxes to consider. Be sure to account for all costs when choosing among portfolio options. In my case, my portfolio is large enough that the MERs and international withholding taxes within VXUS dominate the other costs.


So there you have it. I have a fairly simple, low-cost portfolio of index ETFs. It suits me, but your mileage may vary.

Friday, October 24, 2014

Short Takes: Sticking with a Plan and more

Here are my posts for this week:

Stock Market Momentum

The 4-Hour Workweek

Here are some short takes and some weekend reading:

Canadian Couch Potato offers three specific reasons why you should stick with your asset allocation plan in the face of recent stock volatility.

The Blunt Bean Counter highlights the huge gap in income tax levels between Alberta and Ontario on incomes above $150,000. So far Ontario has kept the top marginal rate a hair under the psychological barrier of 50%. Their game seems to be to lower the income that gets hit with higher rates. If they ever do go over 50%, it should make some people rethink where they want to live or how hard they want to work.

Big Cajun Man managed to finally stop paying for AOL. I didn’t even know that AOL was still around. I used to joke that I belonged to their CD of the month plan. I still use some of their CDs as coasters.

My Own Advisor runs through the basics of PRPPs, but finds that they don’t add much to existing plans without being mandatory.

Wednesday, October 22, 2014

The 4-Hour Workweek

I had heard so many different things about Timothy Ferriss’s book, The 4-Hour Workweek, that I thought it couldn’t possibly cover all the subject areas. But I was wrong. Ferriss gives step-by-step instructions for changing many different aspects of your life all unified under the theme of “escape 9-5, live anywhere, and join the new rich.”

The main themes of the book are getting past fear of change, eliminating time waste, creating a low maintenance business, getting agreement to work for your current employer remotely, mini-retirements, and living in other parts of the world. Some of these themes may seem familiar, but Ferriss’s detailed strategies for completing these goals make this book unique. Few readers will attempt everything they read about in this book, but almost all readers will find some useful information for improving their lives.

The type of reader who will get the most out of this book is the 9-to-5 cubicle-dweller who yearns for a different life. We get some insight into Ferriss’s personality when he says that we shouldn’t be trying to figure out what we want or setting goals; we should be seeking excitement. He goes on to say that “boredom is the enemy, not some abstract ‘failure.’”

The discussion of taking mini-retirements instead of short vacations seems compelling, but I think it is only likely to be helpful for talented people who can find a new job or career fairly easily. I can see the concept of mini-retirement being used as an excuse not to look for a new job by someone who loses a job and can’t really afford to sit around.

A quote from Dave Barry sums up feelings about meetings among fed-up office workers: “Meetings are an addictive highly self-indulgent activity that corporations and other organizations habitually engage in only because they cannot actually masturbate.”

Another quote from Robert Frost that will resonate among cubicle-haters: “By working faithfully eight hours a day, you may eventually get to be a boss and work twelve hours a day.”

Continuing with this theme, Ferriss writes “Most people aren’t lucky enough to get fired and die a slow spiritual death over 30-40 years of tolerating the mediocre.”

We get some encouragement to take a chance from a Colin Wilson quote: “The average man is a conformist, accepting miseries and disasters with the stoicism of a cow standing in the rain.”

One area where Ferriss’s ideas and mine differ is with investing. He chooses to own only fixed income investments and stocks of companies he is able to influence through angel investing. I’d rather just own every stock in the world and focus on other things.

The author emphasises the importance of not letting email chew up too much of your time. He says to check it only a couple of times per day, or even better a couple of times per week. He makes a good point about avoiding work email on the weekend: “Is your weekend really free if you find a crisis in the inbox Saturday morning that you can’t address until Monday morning?”

I can’t do this book justice in explaining how thorough Ferriss’s prescription is for transforming your life. No doubt most readers will not choose to follow Ferriss’s path exactly, but he does a great job of giving the tools necessary to change the things you want to change.

Monday, October 20, 2014

Stock Market Momentum

People tend to think of the stock market as something that moves up and down like an airplane. There are problems with this way of thinking that cause investors to make poor choices.

If the stock market really were like an airplane, it would have momentum that makes it difficult for the market to change direction from rising to falling or vice-versa. The truth is that prices can change on a dime because they are determined by the bid and ask prices of traders who can change their minds in an instant. There is a technical concept of momentum in stock prices, but it isn’t the same as momentum in physics; there is no physical object that must be slowed down and turned in the other direction.

The problem with a false analogy like the airplane is that it creates the illusion that if markets move in one direction a few days in a row, they are almost certain to continue that way for a while. But this isn’t true for stocks.

The recent downtrend in stock prices has many commentators saying that we are “in a correction.” But all we can say with any certainty is that we have had a correction. It may or may not continue. Saying that we are in a correction implies that falling prices will continue over the short term, which is far from certain.

The wiring of our brains makes humans very good as finding patterns. The trouble is that we sometimes see patterns that aren’t there. Stock prices over the short term are largely random. If you think you see a pattern, blame your brain.

Friday, October 17, 2014

Short Takes: Robo-Advisors and more

I wrote one post this week reviewing a book that solidified my view that I won’t pay any attention to market predictions:

Clash of the Financial Pundits

Here are some short takes and some weekend reading:

Dan Bortolotti discusses the effect robo-advisors will have on the financial advice industry. He concludes that “To justify their fees, advisers will need to improve the level of personalized planning services they deliver.”

Million Dollar Journey shows where to get help for starting or growing a business.

Big Cajun Man makes his case for allowing couples to split their income. We’ve been getting lots of hints that this is coming but only for couples with young children.

Tuesday, October 14, 2014

Clash of the Financial Pundits

The book Clash of the Financial Pundits by Joshua M. Brown and Jeff Macke promises to tell readers “how the media influences your investment decisions.” For the most part the authors deliver on this promise. In the end this book solidified my view that it’s not worth paying any attention to those who make market predictions, but that’s not what the authors intended as the takeaway for readers.

Much of the book consists of transcripts of interviews with various financial pundits, the most well-known of which is Jim Cramer. While I found these interviews somewhat interesting, the best parts of the book were short chapters 9, 13, 15, and 19, none of which contained interviews.

Chapter 9 explained that the pundits who attract viewers are those who make the most outrageous predictions. “So long as you’ve still got a recognizable name, you’re still in the [punditry] game.” “And being right is irrelevant, so fire away!”

Chapter 13 explains that among pundits “it’s better to be confident than accurate.” Whether you really know what will happen isn’t important. What matters is “acting like you know.” This is “what the public wants anyway.”

Chapter 15 makes the very good point that well-known investment rules contradict each other. It goes on to list 18 pairs of rules that are contradictory. One example is “no one’s ever been wrong taking a profit! But let your profits run and don’t sell your winners.”

Chapter 19 shows how pundits make predictions in ways that allow them an out if the prediction turns out to be incorrect. They “couch their predictions in outrageousness and wackiness” or use “the subtle art of making a suggestion that can later be construed as a prediction” if the prediction turns out to be correct.

The authors try hard to make the case that to “have some hope that your portfolio will help you maintain your purchasing power through decades of retirement” you have to pay some attention to financial media. I’m not convinced. You need to learn about asset allocation and many other things, but you don’t have to listen to anyone who makes market predictions. As Charlie Munger said “Our job is to find a few intelligent things to do, not to keep up with every damn thing in the world.”

I liked a quote from Ben Stein: “I have to say that every time I see anyone make a specific prediction about the future ... I shake my head because those predictions are useless. There’s only one guy whose predictions are incredibly useful; that’s John Bogle.” Bogle is considered the “father of index investing.”

In an exchange between Jeff Macke and Jim Cramer, they agree that their critics should just “take the other side of every trade.” This would be a dream for pundits. Everyone either loves you or hates you, but they all watch you. I think Cramer’s picks are just random and so I don’t pay any attention.

I liked one of Cramer’s quotes: “if you really understand [what you’re talking about] you can make it simple.” This is very true. Those who make things seem complicated often have a poor understanding of what they’re talking about. You need to understand a subject well to be able to explain it clearly.

In the authors’ conclusion they say that “predicting the future consistently cannot actually be done—by anyone” and “that despite this inability to be right all of the time (or even most of the time), there is still value to be gleaned from the words and ideas of the market commentariat class.” I disagree. All evidence is that people who act on ideas to beat the market end up losing to the market, on average. Mechanical strategies with appropriate levels of risk are a better bet than trying to outsmart other traders. What investors often need is an antidote to market pundits. During the 2008-2009 crash, Warren Buffett tried to remind people that the U.S. has a great economy and that the future would be better than the past, despite the then current troubles.

Another frequent justification in this book for the existence of pundits is that people wouldn’t watch a show that just said to buy index funds. This is true. I fully expect financial media to do whatever makes money. But attracting eyeballs isn’t proof that they are a net benefit to the viewers.

Overall, I found this book to be an easy and interesting read. It clearly lays out the techniques financial media use to attract viewers, which I liked. It even suggests that viewers should be very selective about what they watch. But, in my opinion, they still overstate the value of pundits.

Friday, October 10, 2014

Short Takes: Reinventing Finance and more

Here are my posts for this week:

The Alchemy of Finance

“Invest However You’re Most Comfortable”

Here are some short takes and some weekend reading:

Marc Andreessen believes we can improve finance by completely reinventing it. If you think Andreessen is right about this, you may not want to concentrate your portfolio in bank stocks.

Boomer and Echo compares 5 different robo-advisors already operating in Canada or coming to Canada soon.

Mr. Money Mustache teaches how to get rich with science. As usual, he writes very well and makes you think.

Canadian Couch Potato has some interesting examples of how taxes affect ETF performance. Portfolio turnover matters in addition to the mix of dividends, interest, and capital gains.

Big Cajun Man asks whether spousal RRSPs have any use now that we have pension splitting. He got some good ideas in the comments section for how spousal RRSPs are still useful.

My Own Advisor’s latest dividend update drew quite a few comments, mostly from active stock pickers.

Karen Cleveland at Canadian Business has some sensible ideas about what to do when you’re sick. Spoiler: stay home. You think you’re being a hero by going in to work, but others just want you to stay away from them. Another thing to consider is that staying home is doing your part to reduce the virulence of infections. Any infection that causes people to isolate themselves is a genetic failure. Infections are most successful if they’re as virulent as possible without making people stay home.

Thursday, October 9, 2014

“Invest However You’re Most Comfortable”

It sounds wonderfully inclusive to say that everyone can succeed at investing by approaching it in whatever way they’re most comfortable. In reality, this just isn’t true.

One elderly couple I know has been living off GIC interest for many years. Even worse, they’ve just been accepting the interest rates offered by big banks instead of seeking out the best rates. They now have very little left and are forced to live extremely modestly. Given the large nest egg they started with decades ago, they could still be living a middle class lifestyle. But they stuck with what made them comfortable.

I’ve known two people well who tried to make money with stock options. Both lost all the money they devoted to the effort. They didn’t like the idea of making money slowly and went for some big scores. So much for seeking success investing in their own way.

Many of my colleagues over the years have invested their money trading individual stocks. This was particularly true during the tech boom in the late 1990s. It can be tricky to learn people’s true returns because they usually don’t know themselves how they’ve done. They tend to boast about their successes, but you can get them to moan about their losses if you ask right. I’m willing to guess that few of these people managed to do as well as market returns.

I was comfortable with stock-picking for many years. However, if we eliminate the spectacular returns I got on one stock in 1999, my stock-picking record was underwhelming. If I had continued stock-picking with this level of underperformance instead of switching to indexing, by today my portfolio would be smaller by about the value of my house.

It makes so much sense to seek out friends and activities that make us happy and comfortable, but this doesn’t apply to investing. It pays to reason your way through deciding how to invest your life savings.

Wednesday, October 8, 2014

The Alchemy of Finance

One of the books that I’ve often seen respectable financial writers include on their reading list is George Soros’s The Alchemy of Finance: Reading the Mind of the Market. These recommendations along with Soros’s incredible success as an investor were enough to tempt me to read this book. I found it interesting in parts, but seriously doubt that it will help me as an investor.

Soros’s main theme is his idea that people’s collective biases do more than just drive prices; they actually change outcomes. He calls this “reflexivity.” To take a simple example, suppose XYZ Company is overpriced and short-sellers are just waiting for their profits. But then XYZ uses its overpriced stock to buy a fairly valued company, increasing XYZ’s total profits. The market then overvalues this increase in profits, and XYZ makes another acquisition with its over-priced stock.

The high valuation on XYZ is self-fulfilling. XYZ keeps using stock to buy other companies cheaply. The short sellers get burned even though they were right that XYZ’s original business was overvalued. This is an example of self-reinforcing reflexivity. The market’s bias for XYZ was the reason for XYZ’s success. Soros also offered examples of self-defeating reflexivity. Reflexivity “is like shooting at a target when the act of shooting moves the target.”

Soros says that reflexivity is the reason why economic theory based on finding equilibria doesn’t apply in the real world. “Far from being always right, [the market] always incorporates the prevailing bias.” Market bias can change quickly preventing the market from finding equilibrium. “The stock market is generally believed to anticipate recessions: it would be more correct to say that it can help to precipitate them.”

Much of the book focuses on studying and trying to predict macroeconomics. Soros gives a number of interesting insights into why events in the 1980s played out as they did. In fact, Soros made a great deal of money betting on his ideas. However, when I try to apply Soros’s ideas to modern times to see if I have any insights that could be profitable, I draw a complete blank; everything seems uncertain.

The book isn’t without some humour. The dedication: “To Susan, without whom this book would have been ready much sooner.” Another instance: “President Reagan, despite his intellectual limitations ...”

A common prediction at the time was that the amazing rise of Japan as an economic superpower would continue. Soros was not immune. “Japan has already taken over the role of the United States as the major supplier of capital to the rest of the world and it is only a question of time before the yen takes over as the major reserve currency.” It hasn’t worked out that way. “The historic significance of the Crash of 1987 lies in the fact that it marks the transfer of economic and financial power from the United States to Japan.”

Despite the fact that I found much of this book interesting, I doubt that it will help many people become better investors. A possible exception is if it convinces some readers that they can’t be George Soros and should stick to safer ways of investing.

Friday, October 3, 2014

Short Takes: Wall Street Changes People, After-Tax Returns, and more

I wrote one post this week questioning the view that Canada would be so much better off if more of us used financial advisors:

Do Financial Advisors Boost Savings Rates?

Here are some short takes and some weekend reading:

Michael Lewis explains what happens to young people who go to work on Wall Street. I found it a very interesting read. As a lead in to how Wall Street changes people, he says something spot on about writers on the internet: “All occupations have hazards. An occupational hazard of the Internet columnist, for instance, is that he becomes the sort of person who says whatever he thinks will get him the most attention rather than what he thinks is true, so often that he forgets the difference.” Very true.

Canadian Couch Potato provides a detailed analysis of after-tax returns of many popular Canadian ETFs.

Robb Engen at Boomer and Echo examines the behavioural biases that have kept him in the active stock-picking game. It sounds like he’s going through that same process I went through as I went from picking stocks to index investing.

My Own Advisor shares 8 things he’s learned about money. The first one is a shock to most new homeowners: “owning a house is expensive.” When you add maintenance costs on top of property taxes and a mortgage, suddenly renting doesn’t look so bad.

Big Cajun Man shares his experiences with RESPs now that he’s been through it from beginning to end.

Million Dollar Journey has some advice on finding quality tenants for your rental property.

Wednesday, October 1, 2014

Do Financial Advisors Boost Savings Rates?

Recently, The Conference Board of Canada came out with the report Boosting Retirement Readiness and the Economy Through Financial Advice. They conclude that if more people used financial advisors, they would save more money, and the country would benefit over the long term. Unfortunately, it relies on a flawed study.

This new study does not do any original research into the effects of financial advisors; the authors rely on previous work. They acknowledge that advisors do not produce enough extra returns to cover their fees, but that “the real benefit of having an advisor may not be performance-related at all. It may have more to do with engendering beneficial savings behaviour among clients.”

Unfortunately, the authors rely primarily on the 2012 Cirano study Econometric Models on the Value of Advice of a Financial Advisor to justify the claim that financial advisors boost savings. A couple of years ago I pointed out the serious flaws in this study. I’ll briefly summarize.

Advisors seek out clients who already have significant savings. The 2012 study did not control for initial wealth. Advisors tend to drop clients who fail to save enough money over time; these clients don’t generate enough fees to justify the effort of providing them financial advice. The 2012 study did not account for this factor which created survivorship bias in their data.

Based on the flawed 2012 study, The Conference Board simply presumed that if enough people currently not receiving advice began using an advisor, their savings rates would rise by amounts indicated by the 2012 study. Even if we had a solid study showing that advisors encourage higher savings, it is very likely that the amount of increased savings would be far less than indicated by the 2012 study.

There is another source of bias here. Those people who actually have the skills to handle their own money tend not to use advisors. When The Conference Board study presumes that a fraction of people not using an advisor start doing so, this will include some people already managing their money well. If some of these people started paying for advice, their savings would be lower over time due to advisor fees. In my case, if I used a financial advisor, I’d have paid fees over the years adding up to the price of a house.

I have no doubt that most people could use good financial advice. However, the current Canadian model where advisors sell expensive actively-managed mutual funds leads to high costs and minimal real advice. We need a model where people pay for advisors separately from paying for mutual fund management. This will lead to increasing the number of advisors who are more than just mutual fund salespeople.