Tuesday, April 11, 2017

Review: The Four Pillars of Investing

I would strongly recommend anyone serious about investments start their education with this book.  I first read The Four Pillars of Investing (McGraw Hill, 2010) by Dr. William J. Bernstein a few years ago. I reread it recently in preparation for this review. Like any good book, new insights and appreciation emerged on rereading.

The Structure of the Book

The author uses an architecture metaphor, asking what pillars should underpin your investment portfolio. His four pillars are:
  1. Theory of Investing
  2. History of Investing
  3. Psychology of Investing
  4. Business of Investing
I was hesitant to even list these pillars in the review, as they make the book sound heavy and boring.  But it is not that at all! Rather, it is one of the most interesting investing books I have read!

Each of the themes is covered in a number of chapters.  For example, Chapter 3 "The Market is Smarter Than You Are", is his take on the efficient market hypothesis.  As well as providing the statistics to show that most funds will be, on average, well, approximately average, he makes the strong case that you can't pick stocks and you can't time the market successfully in the long term.

I particularly liked the historical depth of the book, not just in the second section but throughout.  He starts off the history section with the statement: "About once every generation, the markets go barking mad." I loved the many historical tidbits I learned, such as that Isaac Newton had big investment losses in the South Sea Bubble, or about the early 'stock exchange' in the coffeehouses of Change Ally. While these examples may be considered trivia, the historical aspects of the book help us place boom and bust, risk and reward, within a long equity history.

The above is not the only clever opening statement.  The psychology section starts "The biggest obstacle to your investment success is staring out at you from your mirror." In chapters 7 and 8 he offers insight on investment emotions, and practical advice on how to reign in investor behaviour issues. It is full of gems like
"...asset classes with the highest future returns tend to be the ones that are currently the most unpopular."
In answer to the question "To whom do I listen?", Dr. Bernstein offers the same advice of many others to tune out the investment noise. He then goes on to summarize with remarkable simplicity and clarity the two aspects  that you may well need guidance with.
  • Your appropriate asset allocation
  • Being self-disciplined in your investments
While the majority of the book is concerned with establishing the four pillars, closing chapters deal with putting it all together (his so-called investment "assembly instruction booklet'). While the specific advice must be placed within the context of the time that the book was revised, now almost 8 years ago, the general theme of using low cost passive index investments, appropriately diversified across different asset classes, remains as true today as when the book was written.

Why I Liked It

I find that too much investment writing tries to jump to just the answers - without first establishing a base to critically evaluate any proposals. This book fills that void.

The book will help you see investments within a long term historical trend, quantitatively establishes the importance of asset allocation, and helps you avoid paying too much for financial services and reign in your own worst tendencies.

The writing style is clear, engaging and, dare I say fun?  The historical tidbits, and statements of principles through analogy and metaphor, make the book feel light, while teaching you some critical investment truths. He wrote the book with that aim – to appeal to an audience that did not embrace mathematics.

In an earlier review of a different book, I mentioned that after reading a book I ask myself the following four questions.
  1. Was my time invested in the book, time well spent?
  2.  Do I have confidence in the validity and balance in the presentation? 
  3. Was I engaged in the book? 
  4. What were the author's motives in writing the book? 
I enthusiastically answer YES to the first three questions.  While any author hopes to have some financial success with a book, I feel that Dr. Bernstein, first and foremost, wants to help individual investors have success and avoid blunders.

The Author's Other Books

The author has been prolific in his investment writing, and you may well be interested in some of his other books. Prior to this book, William Bernstein wrote The Intelligent Asset Allocator, a more mathematically based book than this one.  I have not yet read it personally, but plan to.  It has received high praise from readers.

More recently (published in 2012) his The Investor's Manifesto covers some of the same theoretical underpinnings as The Four Pillars of Investing.  It is richer in mathematical basis, and of course more up to date in the current index investing landscape.  I hope to give it a full review in the not too distant future.

You can get a full list of his investing books on his website, http://www.efficientfrontier.com, including his Investing for Adults series which I have not read.

In case you were wondering about his background, William Bernstein followed work in science into a career as a medical neurologist.  He lives in Portland, Oregon, and for a number of years his efforts are invested in financial theory and history, and investment writing. The Globe and Mail did a nice interview with him that is available here.

Concluding Thoughts

If you are just getting started in investing, this book is the perfect place to start.  It will help you think about the big picture before you start considering advice for specific investment instruments. The book is interesting to read, and provides a solid grounding.  It's not surprising that it has a large number  of positive reviews on Amazon and similar sites.

Especially for Canadian investors, this is not a DIY manual though. After reading the book you will need to go to other information sources (dare we say including our website?)  for help in putting together a specific intelligent portfolio for your investment situation.

If picking up the book used, make sure you get the 2010 edition, and not the 2002 edition.  Both are still available on Amazon.  The 2010 version has a red bar across the top of the cover.

 If you use an eReader, the book is surprisingly inexpensive on Amazon.ca - just CDN$2.61!  I am not sure if it is always this inexpensive, or a limited time sale price, but the book is an incredible deal at this price. The ebook is also available on CloudLibrary, should you have an account through your local public library.

I have no hesitation in placing this book in the top few investment books you should read! Enjoy! As one of the reviews on Amazon commented:
"What sets this book apart from other investing books is the breadth of areas covered, and also the writing style which is both "understandable and entertaining". A highly recommended read for any investor regardless of level."
I agree.  Whether starting out in investing, or if you have been an involved investor for many years, or even if you are a professional financial advisor, you will find real value in this book.

This posting is intended for education only and should not be considered investment advice. The reader is responsible for their own financial decisions.  The writer is not a professional financial planner or investment advisor. For major financial decisions it is always wise to consult skilled professionals. While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Disclosure:  No compensation by any company, organization or individual has been offered, requested or received for writing this column.

Books for Review: I will not promise a positive, or even any, review, but if you wish to submit your investment book for me to consider, contact me rhawkes (at) chignecto.ca. I am particularly interested in Canadian books.


Sunday, April 9, 2017

Do XAW, VXC Represent Global Stock Market ?

Do you know what proportion of the global stock assets are represented by US markets? those in Canada? Europe? China? A surprising number of investors have either vague or out of date answers. This post will provide some data on the global equity space, along with reflections on how that might inform your investing choices.

While most investors exercise some degree of home country bias,  for a variety of good reasons, it makes sense to invest globally. In this posting I propose a simple idea: why not invest in different markets according to the size of those markets?

Some Data

The size of economies is somewhat different from the size of equity markets in those countries, and it is a good question whether we should use stock market or economy size. I will work with stock market valuations in this post.

There are about 60 stock markets globally, and their valuations are shown in a really nice data visualization here. You can get the raw data with the most recent statistics here from the World Federation of Exchanges.

Kim Iskyan wrote an article for Asia Wealth Investing Daily in November, 2016 that provides statistics (taken from Bloomberg) on the sizes and growths of different national stock markets, with a look at the top ten. You can read his report here courtesy of Stansberry Churchouse Research.

Not surprisingly the US stock market is the largest by a significant factor, at 36.3% of the total.   China was second, at 10.1%, followed by Japan at 7.9%, Hong Kong at 6.3% and UK at 4.6%. Canada, followed by France, Germany,  India and Switzerland complete the top ten.

 If we accept the premise of investing globally in proportion to equity assets, about 36% of your equity investments should be in the US, 10% in China (with another 6.5% in Hong Kong),  8% in Japan, about 3% in Canada.

The World It Is A Changing

The article cited earlier points out that a fairly dramatic change in the relative capitalizations of different markets is taking place.  For example, from October 2003 to 2016, the US stock market while increasing in an absolute sense, dropped as a fraction of global stock assets  from 45.2% to 36.3%. The big increases were all in Asia, with China going from 1.5% in 2003 to 10.1% in 2016, Hong Kong from 3.0% to 6.3%,  and India from 0.8% to 2.6%. Stock markets in Europe and Japan all fell as a global percentage. Interestingly the Canadian market, with a slight rise from 2.6% to 2.9%, was the only top 10 'developed' market to show an increase.

 Do XAW and VXC Represent World?

So how would you build an ETF portfolio consisting only of TSX listed ETFs that faithfully represented the entire global equity market. While specialized ETFs representing almost any market now exist, and you could build an ETF portfolio to almost exactly represent the world's equity markets, the MER would be high for so the many specialized products.

Most use ETF products like XAW from iShares or VXC from Vanguard Canada to represent most of the world.  These track different indices, with XAW tracking the MSCI while VXC tracks the FTSE global index.

Both XAW and VXC have excess weight on the US equity market, with XAW at about 54% and VXC at almost 56%, whereas the actual size of the equity markets suggest that only about 36% should be in US equities. Both under represent  emerging markets, with a total emerging market share of 11.5% in XAW and 7.8% in VXC currently. Note that VXC does not include any Canadian equity at all, so you should include at least 3% of your investments in a broad Canadian ETF such as VCN or XIC.

A simple way to make your global equity ETFs more representative of the entire world is to include about 20% of your holdings in XEC or VEE emerging market ETF (even though there are emerging holdings already in the XAW and VXC).  This would reduce the US holdings to about 44%, neareer to the 36.1% of the global equity assets, and similarly for other developed markets.

Another option would be to make up your global holdings using VEF (developed markets except the US, but including Canada), VUN (or some other widely represented US holdings) and XEC (or VEE) for the emerging markets component.  In this way you can adjust your US, other developed and emerging market holdings to the exact amounts you desire. If  Scotia iTRADE is your discount broker, VEF and XEC are both commission free to buy and sell, making this option even more attractive.  If you want to include China as a separate component, ZCH could be used, although remember you do have China represented in XEC or VEE. Also, the number of individual stocks within ZCH is limited.  If you want to add some Canadian home market bias (see below), XIC or VCN (or many others) could be added.

But I Want to Minimize Risk!

While it is natural to look backwards, as the excellent book The 3 Simple Rules if Investing reminds us: only look forward. It is true that volatility has in the past been greater in emerging markets. However, with high developed market equity valuations, unusually low interest rates, and political uncertainty in several developed economies, it can legitimately be asked whether the more governmentally controlled 'emerging'  economies such as China may offer lower future volatility.

Just as passive investors are urged to own all (or really a major part) of a domestic market,  it could be argued that the same principle would argue to hold most of the world equity assets proportionately in a global equity portfolio. 

Why Home Bias?

I'm sure they have been written, but I can't recall reading an investment commentary on the virtue, or lack thereof, of home bias.  This is a topic for a future column, but I considered reasons that you would want to show some home bias in your investments.
  • Your income needs are related to the inflation rate in your home economy, so significant Canadian holdings make sense.
  • As we argued in a post about holding individual stocks, it makes sense to invest in what you best understand, and that for most is the Canadian market.
  • While government intervention is only one of many factors, it does influence the rewards and risks of different types of investments. You will understand the political climate of your own country best.
Only you can decide what amount of home bias you want to have in your investments.  It probably makes sense to have less home bias in your accumulation phase than in retirement when you are withdrawing regularly from your funds.

Concluding Thoughts

Of course there are good reasons to not weight investments only according to the relative size of that countries equity assets.  For example, risk will vary in different countries. Also, average valuations, as expressed by P/E or other measures, may be significantly different in different regions.  Also, we know the North American stock market much better, and that familiarity might help us make better choices.

You should expect more than a rule of thumb about what fraction to be held in Canada, US and internationally based on the situation of ten years ago.  Make sure that your financial advisor discusses international holdings, and in particular emerging economies, in a current, evidence based fashion. If you do decide to have extra North American assets, make sure that it is a deliberate choice.

The international ETF space continues to change, so make sure to investigate the holdings of each ETF with current data before you make any decisions. We will be reviewing emerging market ETFs in a future post.


This posting is intended for education only and should not be considered investment advice. The reader is responsible for their own financial decisions.  The writer is not a financial planner or investment advisor, and reading this column should not be interpreted as obtaining individual financial planning or investment advice. For major financial decisions it is always wise to consult skilled professionals. While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Disclosure:  The author of this column holds the following ETFs mentioned in this article in one or more account I manage: XEC, XIC, VCN, VEF and VXC.  I use Scotia iTRADE discount brokerage services.  No compensation by any company has been offered, requested or received for writing this column.




Friday, April 7, 2017

Developed or Emerging: Classification Systems

Before we can consider in detail the question of how much should be invested in different international markets, and how, it is necessary to be clear on what we mean by terms like emerging and developed. Markets are classified by the major index companies. As an investor it is important to know what index your passive ETF or index mutual fund follows, and which countries are, and are not, included in that index.

MSCI Classification

MSCI (Morgan Stanley Capital International) provides one of the major classification systems used in the index investing world.  They divide equity markets into Developed, Developing and Frontier divisions (there is also a Standalone market index. with national exchanges not included in any of the previous three; this mainly includes very small or very isolated exchanges). You can see the details of which country is in which classification here.

FTSE Classification

The other primary classification system is provided by FTSE (now part of the combined FTSE-Russell). FTSE stands for Financial Times Stock Exchange. They divide markets into Developed, Advanced Emerging, Secondary Emerging and Frontier. You can see current country inclusion in the categories of the FTSE here. Of particular utility is their Matrix of Markets that lists stock markets by country against index segments.  This is a simple way to see if a particular country is in an index based ETF.

Things Change

The indexes are periodically reconsidered - for example FTSE update their list usually in March of each year. The process of deciding if countries should be moved to another category is complex.  Metrics are established for that process, looking at aspects such as transparency, accountability, liquidity and size of the market.  FTSE-Russell explain their process in a white paper available here. In the MSCI classification Pakistan will move from Frontier to Emerging in May 2017.

Should We Be Doing This?

Many have commented that the term emerging economy is obsolete and should be abandoned.  Certainly markets like China and India are rapidly growing and are similar in many ways to the markets in the developed category. While five characteristics are claimed to represent emerging economies and markets, application of these descriptors is difficult.

Also, there is a problem with any category system in that two stock markets with only slight differences might result in inclusion in different indexes. For example, why are Poland and the Czech Republic included in developing, yet those economies are similar in life style, economy and political environment to neighbouring European countries that are in the developed category? There appear to be similar discrepancies in Asia.

But we do need some way to lump together economies and stock markets that share similar characteristics.  One option might be to assign a grade to each stock market on a scale (say 0 to 100) based on how developed it is.  Then we could have indexes that track only markets with a score in a certain range.  While the result might be almost identical to the current system, there would be better transparency of results.

Final Thoughts

The Vanguard ETFs follow the FTSE index, while generally speaking the iShares ETFs follow MSCI. Vanguard have a really nice listing that links ETF products against the index they follow all on one page.

While the country inclusion is pretty similar in the MSCI and the FTSE, there are differences.  For example, FTSE place South Africa in developed, while MSCI do not. The Chinese stock market is divided into A and B categories, historically on the basis of whether foreigners were allowed to invest on that market. How the A Chinese stock markets are handled affects international index funds.

In a future posting I will I discuss the fraction of global equity assets in different markets, and the implications on how we should invest globally.

This posting is intended for education only and should not be considered investment advice. The reader is responsible for their own financial decisions.  The writer is not a professional financial planner or investment advisor. For major financial decisions it is always wise to consult skilled professionals. While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Disclosure:  No compensation by any company, organization or individual has been offered, requested or received for writing this column.





Monday, April 3, 2017

Review: Portfolio First Aid

I picked up a copy of Portfolio First Aid at my local public library, intrigued by the title and impressed by the author team. Micahael Graham, PhD (Economics) was Chairman of the Board at Toronto investment firm Heathbridge Capital Management Ltd. at the time the book was published (2005), and had worked in investment industry for more than 40 years. He currently runs MGIS.  Co-author Bryan Snelson is a Vice-President and Investment Advisor at RBC Wealth Management.

What I Liked

Any investment book is only as good as the quality of the advice it offers. Given the expertise of the authors, one can have confidence in this book. An investment book also needs to be clear and engaging, and I would give this book high marks in both.

The writing is clear and precise.  I liked the use of boxes to draw attention to important points. The titles of these. In both these boxes and in sections titles effectively draw the reader in. By current standards the 2005 book is somewhat lacking in illustrative material, but the black and white visuals and tables explain key ideas effectively.

Perhaps it will not appeal to all readers, but I like how we come to know the authors through commentary throughout the book.  For example, on pg. 8 Michael relates the experience of flying to Winnipeg on Oct. 19, 1987, Black Monday, for a pre-planned meeting with investors. What do you say the day after markets have lost 23% in one day?

I particularly liked Chapter 7 Show Me The Money: Investing for Income. You will find coverage of dividends, real return and corporate bonds, laddered bonds, income trusts, dividend funds, preferred shares and much more.

After I finish reading a nonfiction book I always ask myself these four questions.  One is, was my time invested in the book, time well spent? Do I have confidence in the validity and balance in the presentation? Was I engaged in the book? What were the author's motives in writing the book? To the first three I could confidently answer YES for this book.

With respect to the last question, I suppose any author team always have mixed motivations for a book, but I do feel that in the case of this book there is an authentic desire to contribute to the well being of investors. The authors write in the preface
"There is nothing worse than having to inform an investor that his or her hard-earned savings has been badly mauled-sometimes irreparably"
They feel that with careful analysis and attention to a portfolio the odds of that can be lowered, while retaining reasonable returns.

Not That Book

One of the online reviews of the 2009 version of this book, a very negative review, complains that the book has little specific advice to offer, and emphasizes use of professional advisors more than it should. While I feel that the reviewer has been unfairly harsh, it's true that Chapter 4 You Need Financial Help! and Chapter 5 It's Always About You: Working With Your Advisor assume that the correct choice for most is to work with a financial advisor, rather than DIY investing. Perhaps because of this assumption, as the negative reviewer noted, little in the book that is detailed enough to guide the DIY investor in specific decisions.

I view this book as contributing to understanding the big picture of investing.  A recipe book for DIY investors it is not. Discount brokerage accounts are mentioned on 4 different pages in the 2005 book, but not as a recurring theme.  ETFs find mention on 5 different pages in the book.

That is not to say the book does not get involved. Chapter 9 Running With Scissors: Prescriptions for Managing Risk, for example, covers bond ratings, market risk, interest rate risk, default risk, lost-opportunity risk, purchasing power risk, stop-loss orders, options, calls, short-selling, puts, hedge funds and covered calls. They urge individual investors to avoid many of these, however.

Concluding Thoughts

I liked this book and recommend it to Canadian investors for inclusion in a list of your first 10 investment books. I should point out that I reviewed the 2005 book, but an updated book on the same theme,  by these authors plus Cindy David, CFP. You can get the 2009 book at Amazon.ca in hard or soft cover. You can pick up the 2005 edition from Amazon.ca and independent booksellers and you can probably find it at low cost from used bookstores, or free from a public library.

While no on can predict the future, there are many worrisome signs about the investing landscape these days.  It's a perfect time to consider how you can guard against the catastrophic losses, and this book will help.

Toronto based freelance financial journalist Jade Hemeon wrote the following in his review of the 2005 book on Amazon.ca.
"A useful and entertaining tour of the investment world that hits all the significant ports of call. Written by two veteran financial advisors in a vividly descriptive fashion, it offers sage advice enhanced by personal anecdotes and humor. This book will help investors avoid costly mistakes and develop a strategy that can withstand the drama of shifting market moods."
I could not say it better! Give this book a read, and you will come away with a deeper understanding of the investment world.  But don't expect the book to be a step by step guide to DIY investing, or you will be disappointed.

This posting is intended for education only and should not be considered investment advice. The reader is responsible for their own financial decisions.  The writer is not a professional financial planner or investment advisor. For major financial decisions it is always wise to consult skilled professionals. While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Disclosure:  No compensation by any company, organization or individual has been offered, requested or received for writing this column.

Books for Review: I will not promise a positive, or even any, review, but if you wish to submit your investment book for me to consider, contact me rhawkes (at) chignecto.ca. I am particularly interested in Canadian books.

Sunday, April 2, 2017

Your Plan Starts With Goals

Financial planning experts agree that having a plan is essential, and that it is important to periodically revisit that plan. As with many things in life, it is never too late to start with a financial plan.  My main point in this short post is that your plan should not start money, but rather with your life goals. It works best if your plan is in writing.

Life Goals

Start with the big picture. Each plan will be unique, since each of us is unique, but the following questions may be helpful.

  • Who are the most important people in your life?
  • What in life is most important to you?
  • Who else are you, or might you be, responsible for, and what are their needs?
  • What organizations and causes do you want to support?
  • What are your career aspirations, and what do you need to get there?
  • What age do you hope to retire, and do you see retirement as a partial or full retirement from paid work?
  • What makes you happy?
  • What special needs to do you have?

Getting There

After you have your life goals established, the next step is to make a reasonable series of financial estimates of what you will need to achieve your goal.  For example, if you want to fully retire at a certain age, make reasonable estimates of how much you anticipate needing. Keep in mind that OAS and CPP will get you part way there.  Then use a calculator such as this one from Financial Post to estimate how much you need to contribute each year to meet your goal. 

Other goals will be easier to estimate.  For example, perhaps you want enough for a down payment on a house of a certain price in five years time, or want to build up an emergency fund to cover 9 months of expenses.

Some may be more complex - for example you want to be able to quit your job and start up a business. You need a reasonable business plan not just for startup funds, and income replacement, but also to anticipate possible business losses in early years and a contingency fund.

Not Just One Plan

I think that having multiple parallel plans works best for many of us.  For example, have one retirement plan, another that is a plan for education savings, a plan to work toward a major housing goal,  a plan for helping causes important to you, etc. Clearly the different plans must make sense when taken together with your resources, but it is often simpler to establish the way forward when we view it as a series of parallel paths. Also, I think it is more encouraging to see that progress has been made in meeting some goals, even when we have fallen short on others.

Some argue that multiple plans add complexity, but I think the opposite is true.  It is simpler to look at our financial goals and progress as a series of parts, and then view the big picture as the sum of those parts.

Rebalance Your Life Plan

Just as we are advised to rebalance investments annually, you should revisit the life goal aspects of your plan periodically.  Evaluate whether your goals or circumstances have changed, and make changes to your plan. One advantage of your plan being in writing, even if as simple as a bullet list of items, is that it makes it easy to see whether you are on track, and where changes are needed.  I have never done this personally, but I know of people who set a date, like New Year's, for a formal reconsideration each year, and I think that makes a lot of sense.

Know When To Hold and When To Fold

While plans are important, they can and should be changed. As the Kenny Rogers The Gambler lyrics suggested
"You've got to know when to hold 'em  
Know when to fold 'em"
I think that some of us don't know when to hold them, when to stay firm to goals, even when things seem difficult. But some of us are also too resistant to change goals, even when, deep down, we know we should.

Maybe something that was important to you, is no longer so important.  Perhaps you have new priorities.  Maybe you have changed your mind and want to retire earlier or later. Sometimes conditions require us to change our plans - for example after the market crashes some had to postpone retirement, or make it a partial retirement.

Resources for Developing a Financial Plan

I don't personally like the financial priority and order in some of these processes, but the following are valuable background for developing your financial plan.
  1. WikiHow have a clear and attractive article on developing a financial plan. I particularly like their emphasis on SMART.  Is it Specific, Measurable, Achievable, Rewarding and Timely
  2. The Moneysense Financial Plan Kit is surely one of the most complete guides out there, and well thought out.  They provide a series of Word of PDF documents to help you create a plan in 11 steps.
  3. Although not as prescriptive as the above, the finiki document on Creating a Financial Plan is Canadian with good information on a number of aspects of your plan.
  4. Want to see what an award winning financial plan looks like? See this great Canadian financial plan here.

Closing Thoughts

Life is not about investments.  Investments are tools, nothing more (or less).  They are tools that allow you to care for others, to provide educational opportunities, to feel secure in your retirement, to allow independence, to support organizations and causes important to you.

Whether you want to engage a professional financial planner to assist you with the plan is a matter of personal preference.  If you are making the plan yourself, make sure that you use valid sources to help you with quantitative aspects of your plan.

For many it makes sense to start the life plan goals on your own, but then get a professional financial planner to help estimate how much you will need, and how to get there financially. You can find a CFP® (Certified Financial Planner) in your area here. I would not count on an advisor who has a stake in your investments to help you with a financial plan.

If you do use the services of a professional planner, always keep in mind that it is your plan and you must take ultimate responsibility for your plan.  She or he may help you develop the plan, but never ask (or let) an advisor to make the plan for you.

This posting has considered developing a life plan, and a little bit about the financial needs for that plan.  After that part of your plan is complete, you also need an investment plan, that will guide how to invest your savings consistent with your life plan.  We will cover investment plans in a future post.

Happy planning!

This posting is intended for education only and should not be considered investment advice. The reader is responsible for their own financial decisions.  The writer is not a professional financial planner or investment advisor, and reading this column should not be interpreted as obtaining individual financial planning or investment advice. For major financial decisions it is always wise to consult skilled, impartial professionals. While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.




Saturday, April 1, 2017

You Need a PFA!

A new food store opened in our neighbourhood.  I decided to check it out a number of months ago. As I walked through the doors of the modern palace, sunlight streamed through the windows. It certainly looked nice.

I started toward the first aisle, but was greeted by a very young man in a crisp dark business suit.

"Hello, and welcome to JBFE. Come into my office and we will discuss your food needs" he said, offering me a too firm handshake and a smile.

"I just came to sort of browse the store...." I mumbled.

With self-assured confidence he smoothly declared "I am Mr. Stuart Foodee, PFA, WKWE and I will be your Personal Food Advisor.  Now if you just step into my office, I will help you decide which of our foods are best for you."

I tried a few more objections. but soon I was sitting in his office, the other side of a glass desk, my eyes fixed on a painting of a carrot on the wall, right next to his PFA certificate.  I noted that the date on it was five days ago.

Mr. Foodee smoothly continued... "First, you need to fill out some surveys  before we can design your personal food plan and portfolio."

"My food portfolio? But I just wanted to look around today" I protested.

"Food is very important, literally a matter of life and death. You can't just rush in and buy things. You need a personal food advisor to help you make good choices.  Food is complex, there are literally hundreds of thousands of choices.  We at Elite Foods want to help you navigate those choices, and I am your Personal Food Advisor. Now let's get started, Bobby."

No one had called me Bobby since I was six.

"Now, how many meals a day do you usually eat, Bobby?"

"Uh... 3 I guess" I answered. "Very interesting" he commented.

The list of questions continued....

"Would you rate your food knowledge as novice, intermediate, expert or advanced?" I admitted I was novice.

"Do you prefer environmentally sensitive food choices?" I thought I should say yes.

"What is your monthly salary from all sources?"

I looked at him quizzically and protested "But I just want to maybe buy a few items here."

Mr Foodee did not skip a beat, "We can't help you make good food choices unless you are open with us, Bobby. Look around, you can trust us, we are professionals."

"Now we need to evaluate your food risk." he continued.

"Oh, like how concerned I am about pesticide residues?" I said, for the first time seeing some potential value in this conversation.

"No" my PFA replied "Let me get at your food risk through these questions.  Would you rather have fine delicacies on the first two weeks of the month, if it meant you had to eat less later in the month?"

I mumbled some reply, and he gave me a food risk tolerance score of 71.

Eventually the interview process was over, and Mr. Foodee declared that he was finished. The printer buzzed and he printed out some forms, but I was not allowed to see them.

With relief I turned to finally explore the store, but he firmly blocked the way.  "You don't need to enter the store, in fact we can't let people do that, I mean you need us to decide what your food needs are.  Food is complex."

"If you just sign these three forms, everything will be set up. Oh and we need your credit card and SIN for our records."

"Maybe I will come back, I'm not sure about this." I protested.

"Billy, we are professionals. I am your Personal Food Advisor. We offer hundreds of highly differentiated mutual food services here."

Eventually I signed the forms, and was given some pamphlets on thick glossy card stock. I left, not sure what had just happened.

A week later a courier arrived at my apartment, with a tiny food basket in crisp white lining.  I admit, it did seem exciting.  The custom labels looked nice, although the products really did not seem a good fit for what I liked to eat, at least the ones that I understood.

Also, when I looked at the receipt I was shocked by how expensive everything was. Plus I was charged 3% more for management fees, plus a front end food fee, I guess for the analysis of my needs by my PFA.  There was also a fee because apparently my account was a small one.  And a few other fees.

I went in the next month to cancel the food service, but somehow I got persuaded to instead meet with a Vice President Client Services.  Wow, a VP seeing me on my second visit, they did really care about me!  I admit, it all seemed very professional.

The Vice-President had me do another survey, or maybe it was the same survey over again,and gave me more glossy brochures, and I signed something else. I mean who was I to know about my food needs and all the choices?  I mean food is complex, you know.

Still, a month later, after seeing how much more expensive food was than at my old store, I went in, determined to cancel the service this time. I discovered that I had a DSC.  I had never heard of those before, but I guess they are standard in the food portfolio business. It turns out that if I cancel in less than 7 years I need to pay 6% of my annual food costs to cancel the service.  Food service is complex.

Oh well, those baskets are pretty nice.  And I did get to meet another Vice-President! They seem to have a lot of vice-presidents.

I pretty much just have enough money each month to cover my apartment and the food service, but really that simplifies my life.  No need to choose where to go or what to buy any more.  I can't believe that I used to manage without a Personal Food Advisor. I mean food is complex! It is calming to have  my PFA make all the decisions.

I realize you may have questions, but please ask Mr. Foodee, my PFA.  I lately, have had trouble thinking for myself.  Not sure when that started, a few months ago, I think.

I went to the library the other day to see if I could get a self-help book, but when I asked at the desk for a personal library assistant to select the book that was best for me and sign it out for me, they just sort of looked puzzled and referred me to the reference desk.  I went home without any book, feeling a little sad, but not sure why.

This posting should not be considered professional food advice.



Wednesday, March 29, 2017

Review: Inflation-Proof Your Portfolio

After so many year's of extremely low interest rates and low inflation, too many have been lulled into complacency that will always be the case. When browsing investing books last month I came across Inflation-Proof Your Portfolio by David Voda.  I have recently finished the eBook version available through my local public library (it is also available as a hard back printed book).  Here are my thoughts on the book.

The Main Messages

The key ideas of the book can be simply summarized:
  • Government debt is growing at an alarming rate (the book is written from a USA perspective, but the argument would hold for many countries including Canada).
  • It is argued that hyperinflation will result (not everyone agrees with this, and Jeffrey Dorfman argues that the high debt will keep interest rates low, the exact opposite of premise in this book). 
  • To help protect against hyperinflation 'exchange dollars for real things.'
  • Under hyperinflation remember that a dollar in the future is worth far less than a dollar now.
  • Since not all countries will simultaneously suffer inflation at the same time and rate, diversify across a number of currencies.
  • The final principle expressed in the book is 'prepare for the worst, but expect the best.'
Most experts would agree with some of the advice in the book, such as lock in your mortgage rate at a long term, low fixed rate. Some of the other advice, such as to buy gold and silver coins, mining companies, real estate, and other commodities, is less universally supported by financial writers.

The Good

It is right that we should be wary of increases in inflation and interest rates, and no reader could leave the book without concern about government debt.

The ideas of diversifying across currencies, holding more of your assets in 'real things', and think about the consequences of rapidly rising interest rates all ring true to me.

There is some good general financial advice (although it is often lost within the political hyperbole of the book).

Each chapter ends with a Key Points section.  I wish all financial books used this structure.

The eBook version has live web links to a large number of cited sources in each chapter.  This makes it easy to check out statements.  The quality of referenced material varies somewhat, from reports to articles of various depth.

The Bad

I found David Voda's writing style too alarmist and political in tone for my liking.

That is unfortunate, since, as indicated above, there are positives in the book. We should all be concerned about rising government and personal debt, particularly when that rise is high compared to the GDP change. There is a case for holding a portion of our portfolio in "real" assets to guard against inflation losses, and for some to consider investing outside the stock and bond market in real assets.

The main problem with the book is that despite the title, there is not much directly related to inflation proofing an investment portfolio in the book. Many opportunities to talk about the type of ETFs that are likely to hold up under inflation are missed. In fairness, the book does not claim to be investment advice.
"This book is neither an economic treatise nor specific investment advice."
I wish there had been more depth on actual inflation proofing portfolio ideas, and less political views and coverage of what I consider to be solutions that would appeal to only a few. Interestingly, the author is not a fan of TIPs and other inflation protected bonds, an obvious topic.

The most current edition of the book was published in 2012 by Wiley, and a more up to date treatment of some of the topics might have added to authenticity.

By wandering into areas that, in my humble opinion at least, have little relationship to the topic of the book (such as protecting your Facebook privacy and preparing to live off the grid if society breaks down), the focus of the book is lost.

So Who Wrote This?

I did not consider who had written the book until after I finished reading the book. Interestingly, their is no author biography on Amazon, unusual particularly for a book published by a major publisher like Wiley.  It does show other books by the author, including a couple on snowboarding, one on real estate, and a recent book on debt and financial planning. A bit of digging did find this biography on the Wiley site for the book.
"DAVID VODA is a writer, businessman, and investor currently living in Boulder, Colorado. He has written on business topics for the Los Angeles Times and the New York Times, was a realtor in Palm Springs, California, and buys and sells real estate for his own account. He was a principal in Yes Yes Productions, which produced the award-winning feature, The Secretary. Most recently, he was producer of PJTV's business and economics show, Front Page."
Some of the best investing books have been written by people with varied professional backgrounds, so I would not hold that against the author.  It is not obvious to me how widely read this book is. I was surprised that Amazon.ca had zero reviews of it.  It states that this second edition, published by Wiley, came after a wildly popular self-published first edition.

Final Thoughts

Early in the book, after a rant in favour of non-interventionist governments,  the author writes "But enough about politics."  Unfortunately, he did not follow his own advice in the rest of the book. This book should have had a title like "One Individual's Concern About Government Debt and Inflation."

Overall, I would certainly not place this book in the top 10 (or even the top 25) investment books that you should read. So, if you are just starting out in investing, don't start with this book!

But if looking to explore public finance and interest and inflation rate issues, this may be worth a quick read (it actually does not take long to go through the entire book).  Check if you can get the book at your local library. But read with a critical eye.

This posting is intended for education only and should not be considered investment advice. The reader is responsible for their own financial decisions.  The writer is not a professional financial planner or investment advisor. For major financial decisions it is always wise to consult skilled professionals. While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Disclosure:  No compensation by any company, organization or individual has been offered, requested or received for writing this column.

Books for Review: I will not promise a positive, or even any, review, but if you wish to submit your investment book for me to consider, contact me rhawkes (at) chignecto.ca. I am particularly interested in Canadian books.

Saturday, March 11, 2017

Can We Talk Bonds?

Now that you have some Canadian equity ETF planted in your investment garden, the next step is to add some bonds. Bonds serve as a buffer against volatility, since high quality bonds usually go up in value when equity prices go down (and vice versa). We will start by describing how individual bonds work, although for most of us a bond ETF makes more sense.

Introduction to Bonds

Those of retirement age probably bought Canada Savings Bonds in the past.  You buy a bond with some money, at some point in the future they give you back that money, along with interest along the way.  Bonds work like that. Unless the government or company defaults, your principal (the initial cost) is guaranteed and is returned on the maturity date.  The interest rate is called the coupon in the world of bonds.

Bonds are sold by the Canadian government, the provinces, municipalities, and companies.  We call bonds from companies corporate bonds, while the others are called government bonds (sometimes municipal are split off into their own category). Compared to stocks (equities), most individual bonds are safer, both from absolute loss of principal, and also from deep losses in value.

Bond Ratings

That is not to say that buying a bond is absolutely safe. The investing world have developed ratings for bonds as a measure of how secure they are.  The most widely used bond rating system is done by Standard & Poor.  The most secure bonds, generally offered by national governments, are given a rating of AAA.  Still very secure, but slightly less so, are AA and then A, followed by BBB.  We show these in the following table. Different terms are sometimes used for the different letter categories, but there is general agreement that BBB and above are investment grade. Note that Moodys have a slightly different bond rating system.

I don't like the term "junk" bonds for those rated BB and below.  I think that has a more negative connotation than is appropriate.  Yes, there is a higher risk than with government AAA or AA  bonds, but junk bonds these are often offered by large stable companies and the odds of them not defaulting are good. The reason to purchase bonds in the BBB to B rating is that generally they pay a significantly higher coupon rate in return for the higher risk that you are assuming.

Many discount brokerage firms allow you to purchase individual bonds and hold them in your account. I am most familiar with Scotia iTRADE.  They make it easy to find bond listings according to the type (e.g. corporate), duration, coupon rate and credit quality.  In terms of pricing you pay a commission at purchase of $1 per $1000 in face value, but with a minimum of $24.99 (and a maximum of $250).  For example if you buy bonds worth $20,000 you will pay $20 in commissions, while if you buy $100.000 you will pay $24.99.  Of  course these may well change, so be sure and check current rates if you are considering purchase of individual bonds.

I have never purchased an individual bond from my discount brokerage.  It seems to me that the commission is significant, especially if I consider that I would want to buy a number of different bonds to lessen the impact if one of them did default.  I think unless you are a huge institutional investor it is better to buy a bond ETF.

Bond ETF Choices

The  Freedom Thirty-Five blog has done a really nice job of looking at Canadian bond ETF choices.  As he points out, while cost is important, so is performance. By the way, while on his site, check out his graphic in About Me regarding what others think he does! He points out that there are more than 60 bond ETFs on the TSX, so my analysis below will be highly selective, looking only at broad holdings of primarily investment grade bonds.  We will look at corporate bonds in a future post.

You can purchase bond ETFs with exclusively corporate or government bonds, with long or short durations, or a ladder of purchase dates. You can purchase bonds that will increase in value if interest rates go up (so called real return bonds in Canada, TIPs in US). But in the rest of this column, I am going to narrow the choice to three widely held bond ETFs with reasonable MER values and which hold a mix of government and corporate bonds, mainly of investment quality.

My three choices are shown in the following table. For each I give the name, fees expressed as a MER, the assets held in the fund (e.g. 385M$ means that $385 million dollars are invested in XQB at the time of writing), the average daily volume at the current time (e.g. 65k means about 65000 units of VAB are traded daily), and the spread between bid and ask prices on open orders.  Note that all of these change over time, so if important to you should be checked through a source such as morningstar.ca at the time of investment.
Note that although ZAG has a formal MER of 0.23 based on audited financial statements, its MER currently and going forward will be 0.10. We explain all that here.

I did some searching, both directly from the companies themselves and from third party assessments, and the portfolio holdings reported for the same product seemed slightly inconsistent.  I expect this is due to how bonds with a federal agency that is a crown corporation are reported (is that corporate or government?), and the changes from different reporting periods.  In any case, all three hold a mix of government and corporate, with roughly 60 to 70% government and 40 to 30% corporate.

While any of these are good choices, there are some differences.  As indicated in the table, the effective durations are not quite the same, with XQB slightly shorter duration.  ZAG is a fund of funds, which means that rather than holding a number of individual bonds, as VAB and XQB do, it holds in varying amounts 10 other BMO bond funds.  In this way it is arguably more fully diversified than the other two. While all three are high investment quality, XQB contains nothing below A, while VAB does have just under 10% at BBB.  This helps the investment yield, at only a tiny amount of higher risk.

If you are a Scotia iTRADE account holder, there is an advantage of XQB in that it is on the list of commission free trades.  This means that it is a good choice if you are purchasing your bond ETF in a number of small transactions, which would not be efficient if you needed to pay commissions with each purchase. It is also helpful for annual strategic rebalance, since there is not a commission charged for XQB sale or redemption in an iTRADE account.

There are other broad Canadian ETFs not covered here. iShares XBB has more than $2.3 billion in assets, and has been a mainstay for many years, but with its MER of 0.34% I find it currently uncompetitive. If you desire a swap-based product that does not pay out annual dividends, then HBB (MER of 0.17%) is worthy of consideration.  Many suggest that in the current climate you give up a little bit of return and buy shorter duration ETFs to guard agains interest rate fluctuations. Vanguard VSB would be a good choice (MER 0.11%) as would iShares XSB (although at a higher MER of 0.25%).

Final Thoughts

My final views?  If your discount brokerage is something other than Scotia iTRADE, I would probably choose ZAG.  I like the stability of the "fund of funds" approach, it has a marginally higher yield, and a marginally lower management fee going forward.  The Canadian Couch Potato have currently selected it for bond holdings.  The differences are not enough to move ETFs if already invested in one of the others, however. If you are a Scotia iTRADE customer, I would use XQB.  You will more than make up for the slightly higher MER through saved commission fees.

As with any financial decision, it is always wise to seek qualified investment counsel prior to purchase. The 2017 edition of the Globe and Mail Buyer's Guide to Bond ETFs by Rob Carrick is now out, and is a valuable and comprehensive source of information for Canadian bond ETFs.

The fees are now remarkably low for bond ETFs.  With XQB a Scotia iTrade customer can hold $10000 in bonds, spread across high quality federal, provincial and corporate bonds, and pay only $13 a year in fees, and no commission charges for purchase or redemption.

This posting is intended for education only and should not be considered investment advice. The reader is responsible for their own financial decisions.  The writer is not a financial planner or investment advisor, and reading this column should not be interpreted as obtaining individual financial planning or investment advice. For major financial decisions it is always wise to consult skilled professionals. While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Disclosure:  The author of this column holds the following ETFs mentioned in this article in one or more account: VAB and XQB.  I use Scotia iTRADE discount brokerage services.  No compensation by any company has been offered, requested or received for writing this column.

Corrections and Additions: I added the link to the 2017 Guide to Bond ETFs which was not out at the time of the original article. Following the original posting, I divided this into sections for clarity.






Saturday, March 4, 2017

Some Canada For Your Garden

It's about time we got down to some specifics in terms of what investments to consider for your funds garden. We will start with Canadian equity (stocks). using ETFs as our investment vehicle.

It is generally agreed that Canadian stocks should be a core component of a Canadian portfolio.  For most individual investors, rather than holding those stocks directly, it makes sense to use an ETF.

Another option would be Canadian stock index mutual funds, but that will result in a higher MER.  If you don't want to bother with a discount brokerage account, mutual funds might still be a good option for you. Also, if you are funding your investments in small amounts at a time, mutual funds will avoid the discount brokerage commissions on ETF purchases. We will cover Canadian stock index mutual funds in a future post.

Fortunately, there are a number of great Canadian stock ETFs with very low management expense ratios (MER).  At the time we are writing this (early March 2017) the information on the most popular choices in this category are given in the following table (click on it to make the image easier to read).

The Toronto Stock Exchange (TSX) actually has two branches. the main TSX which with 1561 companies listed, and a venture category for smaller and newer companies, that as of the time of writing, had 2424 listed companies.  You might be surprised by these numbers, since most financial news talks about either the TSX composite, that contains about 250 of the larger companies from the entire TSX, or the TSX 60 which, as the name implies, is the 60 largest companies.  As companies grow, or reduce in net worth, the exact companies on the two lists change slightly from time to time.

Is it better to hold an ETF that tracks the TSX 60 or the TSX composite? The advantage of the TSX 60 is that they are all large, for the most part very stable and well established, companies. This is very much a 'blue chip' list, and most of the companies are household names. It is important to realize that the TSX, and especially the TSX 60, is far from diversified, however.  For example, at the current time the three largest companies are all banks (Royal, Toronto Dominion and Bank of Nova Scotia), and together they account for almost 24% of the entire TSX 60 value!  Even in the broader TSX composite, these three companies represent nearly 18% of the index value.

The main Canadian stock ETFs track either the TSX 60 index or the TSX composite index. From the ETFs shown in the table, VCN, XIC and ZCN track the composite index (or a slight alteration of it), while HXT, VCE and XIU track the TSX 60. As you can see, competition in this investing space has resulted in very low and similar MER of 0.06 on most products (XIU being the exception).

If MER is not a distinguishing characteristic, how do you choose between the ETF options?  The simple answer is that the products are very similar, will yield nearly the same performance, and really you should not worry too much about which to choose.  

There is one significant difference between HXT and the other offerings in the table, however.  All of the others hold the actual TSX stocks. That is, they take the funds invested in the ETF, and then buy proportionately the different stocks in the index.  The down side of this is that when the index changes, the fund will need to do a bit of buying and selling, triggering some capital gains, and for short periods of time drifting very slightly from the index. The plus side, though, is that you really are owning the actual stocks by holding the ETF. 

The HXT product is an example of what is called a swap-based ETF.  Rather than buying the stocks, it gives the money to a bank that agrees to return to HXT the return of the TSX index over the period of time. The process is well explained in this post from the Canadian Couch Potato site (note the MERs have changed in the several years since that post was written, but the explanation of how the swap works is still valid). 

There is an important tax (and income) difference that should be understood as you make the choice between HXT and one of the other Canadian index ETFs.  No dividends are paid by HXT, although they are worked into the appropriate changing price of the ETF.  This means that swap based products are not good choices when you want a regular income stream.  There is a potential tax advantage, though, in that you do not need to pay annual tax on dividends earned. It is important to realize that you will still be taxed, but as a capital gain when you sell your units of HXT. What you are really doing is deferring the tax, and it will appear as a later capital gain rather than as a regular annual dividend. Whether this is a positive or negative will depend on your personal financial situation.  Swap based products are good if your income from other sources is variable, and you can cash in the  HXT units in a tax year when your other income is relatively low.

For any ETF, a consideration is how widely traded the product is.  We have shown (using data from morningstar.ca) the mean daily volume of each ETF.  For example, the mean number of units of HXT that traded in a day were 212000 (we have written this as as 212k, with k meaning thousands, in the table).  We also show the total assets held in each of the ETFs - e.g. ZCN has about 2.4 billion dollars invested in the fund.  Both of these numbers will change over time, so you should check for current values if this information is important to you. These are all pretty widely held, however, and the concerns about specialized ETFs that are only lightly traded do not hold for any of these products.

 I have also included in the table (using morningstar.ca data) the spread between the mean ask price at which the ETF is offered for sale, and the price being bid by someone looking to purchase the ETF.  A smaller spread is desired, since that implies it will be easier to quickly buy or sell the ETF without paying a premium on the transaction. Naturally widely held ETFs with high daily trading volume are generally expected to have a lower spread. The figures here represent a snapshot at the time I am writing this post, and would change from day to day according to overall trading volume and other factors.  By showing patience and using limit orders you can usually get a stock or ETF at a fair price.

Some of these products have been around much longer than others - e.g. iShares XIU entered the Canadian ETF space earlier, as one of the first Canadian ETFs, and that largely accounts for the fact it has much more money in assets.

If you use Scotia iTRADE as your discount brokerage, HXT can be bought and sold without commission.  I believe that QTrade Investor and Virtual Brokers also offer HXT without commission, but check with them to be sure.

Personally I prefer the slightly broader holdings of the composite index. Within that space I see little difference between VCE, XIC and ZCN - I personally use XIC, but that is mainly because I was invested in XIC units before the other two started operation.  I do like for some accounts (e.g. my TFSA) the swap based HXT. Also if I am investing in small amounts. I use HXT since it is commission free in my Scotia iTRADE account.

There are a number of other ETFs that operate in the Canadian equity index space, and we may cover some of them in future posts.  For most investors, however, we feel that one or more of the options shown in the table would well serve your needs.

You should discuss with your investment advisor which of these products are best for you, and have her/him explain in more detail the implications of swap-based vs. directly held ETFs. Your investment advisor can also help you determine how much of your portfolio to hold in Canadian equity ETFs or mutual funds.

Before ending this posting I want to stress how incredibly low the MER are for these products.  You can have $10000 invested across about 250 different companies in the composite TSX index, and your annual fees are $6.00.  That is truly good news for investors!

This posting is intended for education only and should not be considered investment advice. The reader is responsible for their own financial decisions.  The writer is not a financial planner or investment advisor, and reading this column should not be interpreted as obtaining individual financial planning or investment advice. For major financial decisions it is always wise to consult skilled professionals. While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Disclosure:  The author of this column holds the following ETFs mentioned in this article in one or more account: HXT, VCN, and XIC.  I also use Scotia iTRADE discount brokerage services.  No compensation by any company has been offered, requested or received for writing this column.




Friday, March 3, 2017

Should You Buy Only Stocks You Understand?

Like many good questions, the answer to the question posed in the title is yes, but also no.  Let's elaborate.

Before we start, we assume that you have decided to hold some individual stocks in your portfolio, and that is a good choice for your financial situation.  That decision is a whole question in itself, and not a simple one to answer, and we will deal with in a future post.

Perhaps Warren Buffett is the best known proponent of the idea that you should only invest in what you really understand. Indeed number 7 on a list of Buffett investing quotes is "Never invest in a business you cannot understand."  Berkshire Hathaway Inc. invested mainly in big name companies operating in areas that he understood. Also, while others were rushing into technology stocks, Berkshire Hathaway Inc. stayed largely on the side (although recently holdings of Apple have been significantly increased).

It seems obvious that you should really know a company before you invest in that company.  No matter how many balance sheets you examine, how many analyst reports you read, it might be argued that you must understand the field the company operates in to truly understand it at the deepest level. It is only through that knowledge that you can reasonably predict how the company's financial situation is likely to change in coming years. Do you really understand fuel cells at a scientific and engineering level, if not why are you considering buying stocks of Ballard? Do you really know the pharmaceutical industry? If not, why are you considering Valeant?

So let's say you  have extensive work experience and academic background in the banking business.  You understand banks and insurance companies at a deep level.  More than any other area of the stock market, you feel qualified to choose which companies have a bright future, and which not so much. Indeed as Alexander MacDonald has pointed out, if you had invested only in Canadian Banks you would have out performed an other North American sector over the past 25 years.
The problem with that approach, however, is that it totally lacks in diversification, and therefore your investment portfolio is expected to be more volatile. A second possible problem is that you might depend too much on your personal expert viewpoint, and not give sufficient weight to the views of investment analysts. The 2008 financial crisis emphasized this point.

However, it is important to think about diversification across your entire financial holdings.  For example, if you have TFSA, RRSP and unregistered accounts, it is not necessary that each be fully diversified, but rather that in total your holdings are. There may well be tax reasons why your holdings in unregistered are different than in the RRSP.  The fact that TFSA accounts are not part of international tax treaties means that certain types of holdings should not be held there (more on that in a future post).

So back to our question on stocks.  If you do decide to hold a number of stocks in one or a few categories, because that is what you understand well, make sure that you balance that with broad holdings in the rest of your portfolio. Not only should no one stock represent a large part of your portfolio, but also no stock category should be a major part.

Some will work in companies where stocks in the company are either part of your compensation, or offered at an attractive price.  While it makes sense to hold those stocks, make sure that it does not represent all or most of your investment holdings. There is a good article on this topic by Eric Rosenberg here.

What are your thoughts on this topic?  Why not leave a comment?  As always, thanks for reading!

This posting is intended for education only and should not be considered investment advice. The reader is responsible for their own financial decisions.  The writer is not a financial planner or investment advisor, and reading this column should not be interpreted as obtaining individual financial planning or investment advice. For major financial decisions it is always wise to consult skilled professionals. While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Disclosure:  The author of this column has not received any compensation from any financial company for writing this column, and has no association with any company mentioned.  I do hold a small number of individual stocks, but neither of the two mentioned by name in this column.


Thursday, March 2, 2017

We Need More Personal Finance and Investment Education for Youth

A bit over a year ago CBC news ran this story on why children, youth and young adults should be taught personal finance in school and at home.  It is an important point, and one that has received far too little attention.

Most concepts are best learned through a spiral approach. The same topic is encountered at different ages, each time with a higher sophistication. This certainly works in the world of physics.  For example, a physics graduate will learn mathematically sophisticated abstract mechanics ideas in upper level undergraduate courses. But a few years earlier the student encountered Newton's laws in vector form in first year university, and before that the same laws in high school physics in simpler situations. Even earlier the student sees mechanics ideas in a more qualitative fashion in junior high.  At a qualitative level mechanics concepts are encountered even earlier in elementary grades. I talked about force and gravitation and orbits with grade 1 students last month.  As I see in my own grandchildren, children can experience a lot of mechanics in building block towers, rolling objects down inclines, playground equipment, and a number of other forms of play.

Financial education will be most successful if it is similarly encountered with increasing sophistication at different stages in life.  Young children can begin to learn with store and bank play, and a bit later they can be introduced to the concept of saving for something special, and making simple financial decisions. Some families successfully include children in annual family budget meetings or financial choices.  Once students are about to start university, they should have an active role in planning how to finance their post-secondary education.

So what should schools do? The Financial Post had a recent article that looked at how Canadian students in each province are exposed to financial planning ideas. While there are many promising initiatives, as some commenters have pointed out the reality is uneven at best. A key decision is whether financial education should be in stand alone courses, or integrated into other topics in the curriculum, or both.

As well as understanding concepts, such as the value of future money, handling credit responsibly, and building a personal budget, it is essential that students learn about risk and reward, investment options, diversification, and the difference between passive and active investment vehicles.

Various organizations offer resources that can be used by schools and parents for financial education. For example, practicalmoneyskills.ca, an initiative supported by Visa Canada, have games, information, and detailed class lessons with presentation materials and suggested activities on topics in personal finance and to some degree saving and investment.

While some universities offer financial planning as a course open to students in all programs, such courses are not yet widely available. Athabasca University offer by distance education a comprehensive personal financial planning course Finance 322.  It has, in my opinion, a nice balance of topics important to individuals for their personal finances and investments. The most recent version of the course is also approved as part of the Financial Planning Standards Council FPSC Level 1 certification.

The case studies at GetSmarterAboutMoney.ca could be effectively used in junior high, high school or university courses dealing with these topics.  They also have a wealth of linked information on various topics.

Check through the article produced by the Higher Education Control Council of Ontario for a white paper with links to various organizations that have materials to support financial literacy.

In a future column I will be commenting on why the Canadian stock markets are somewhat light in high technology offerings, surprising in a country with high educational achievement and scientists and engineers who are internationally recognized.  As a small part of the solution, I feel that we need to more effectively integrate economic aspects into the science and technology curriculum. A few years ago I taught an undergraduate physics course on energy issues.  As well as the usual physics topics, students collaborated on the financial analysis of wind energy parks, and considered economic and scientific aspects in selecting good energy companies to invest in.

We see in elite athletes, accomplished scientists, distinguished writers, and others, the importance of engaging with a topic early in life.  I think we miss a huge opportunity by not introducing children and young adults, in an appropriate way, to investments. Warren Buffett apparently made his first investment, 3 shares, at age 11. Ideas of financial risk and reward, and the importance of using evidence in making choices, should be taught early and often.







Tuesday, February 28, 2017

When is the MER not what you think it is?

Although I don't follow the model portfolios exactly, I am a big fan of the principles of the Canadian Couch Potato. It has demonstrated the virtue of staying invested in a diversified, low cost, small and easily understood set of broad index funds.  It is called couch potato since you rebalance about every year, but otherwise just leave it alone. The simple couch potato portfolio has had solid performance and limited volatility over the long run, bettering many mutual funds, all with very low fees.

I suspect most readers are already very familiar with the Canadian Couch Potato  but in case you are not, I urge you to regularly consult their website, and to give full consideration to their model portfolios. Recently they have also started a podcast series that I also recommend.

The folks at Canadian Couch Potato have model balanced index portfolios for conservative to aggressive investors. They show how to implement them using ETFs, Tangerine investment funds, or TD e-series products. Interestingly, the long term performance only varies slightly across the different risk portfolios, but that is a topic for another post.

The other day I was examining their ETF based model portfolio (see screen capture below), and I was struck that the values they gave for weighted MER for each portfolio seemed too low to me.
Screen capture (Feb 2017) of the Couch Potato model ETF portfolios. Note the weighted MER line.
Although I don't hold the BMO bond ETF ZAG, I had recalled that the MER for it was 0.23%, and I knew that the Vanguard Canada broad Canadian equities ETF VCN (which I do own) has a MER of 0.06% and the iShares All World Except Canada equity ETF XAW (which I also own) has a MER of 0.21.  Even without a calculator, there was no way, using these numbers, the weighted average MER on the conservative couch potato portfolio would be only the 0.12% stated.

Just to be certain, I first checked with both morningstar.ca and with BMO directly, and sure enough both currently (late Feb 2017) give 0.23% as the MER for ZAG. I proceeded to calculate the weighted MER for some of the portfolios using that value, and for the conservative model portfolio it was 0.209%, versus the Couch Potato value (see screen shot above) of 0.12%, while for their balanced portfolio, with 40% Zag, 20% VCN and 40% XAW, I calculated a weighted MER of 0.188 versus the stated value of 0.14.

I could see from the weighted MER values in the model portfolios that the difference must be in ZAG, since the differences were higher for the portfolios more highly weighted in that, so I dug around a bit more. The ZAG MER value that they used in their calculations was 0.10%, not 0.23%, I was able to determine by backward engineering from the weighted MER. If I assume that value for the ZAG MER, I obtained 0.118 for the conservative portfolio and 0.136 for the balanced one, both consistent with the weighted MER given on the Canadian Couch Potato site. So you ask, which is the correct value for the ZAG MER, 0.23% or 0.10%?

The stated MER for funds is normally obtained from audited financial statements.  Of necessity that is based on results from the recent past, since the auditors only get to work after the financial documents for the financial year have been completed. In the BMO ZAG case an asterisk notes that the MER is based on the 2015 year audited statements.

Since that time, BMO have announced lowering of management fees on a number of their ETFs, including this one. For ZAG, they lowered the management fee to 0.09, and they estimate that that will result in a current MER of about  0.10. Problem solved.

There are several implications for investors, however. The true MER is based on audited financial documents.  Since management fee is the dominant component of most ETF MERs, if that is announced as lowered, we can expect the MER will drop by a similar amount. For most ETFs the MER is pretty stable from year to year.  If the MER has dropped significantly, we need to evaluate whether we are confident that it will stay at this lower value, and if the return of the fund will change due to the different amount of investment advice, supposedly related to the management expense.

Secondly, when making long term ETF choices and comparing similar products, it is important to go beyond the stated MER, to make sure that there are not significant recent changes that will influence the current and future effective MER. For example, with the previous MER for ZAG, it appears obvious that the similar bond ETFs VAB from Vanguard Canada and XQB from iShares have lower MER values.  That situation is reversed, however, with the lowered management fees for ZAG.

While the MER is to be based on audited statements, the management fee can be adjusted to the current value.  An easy way to check if there has been a significant change is to examine both the MER and management fee for the fund you want.  Normally the management fee makes up most of the MER.  If they are very different, check around for announcements of recent management fee changes, and in particular check company statements about whether the lowered fees are temporary or a long term change.

Some readers will correctly point out that the difference here is small enough that it may well be lost in your overall financial fees.  If you had invested $10,000 in ZAG the difference per year in the two MER values would be $13.

This posting is intended for education only and should not be considered investment advice. The reader is responsible for their own financial decisions.  The writer is not a financial planner or investment advisor, and reading this column should not be interpreted as obtaining individual financial planning or investment advice. For major financial decisions it is always wise to consult skilled professionals. While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Disclosure:  The author of this column holds the following ETFs mentioned in this article: VAB, VCN, XAW and XQB.