1. Stock markets in the US and Canada were up this year. The gains were small enough that some would call this a “sideways” market where only stock-pickers can make money. Of course, stock pickers can only make more money by taking it from each other. For every extra dollar that one stock picker made above this year’s average market return, some other stock picker made a dollar less than the average. 2. Apple stock more than doubled. Technical analysts who study patterns in stock price charts could no doubt show you how this could have been predicted by their methods. Personally, I think it has more to do with those little iPod things that everyone is buying. 3. The Canadian dollar overtook the US dollar. Only a few years ago the Canadian dollar was the butt of jokes. (What’s another name for the Canadian twonie? A US dollar.) I think Canadians told these jokes more often than Americans did. The higher Canadian dollar should have caused the price of goods imported into Canada to drop, ...

Typical advice on asset allocation is that you should put fixed percentages of your savings into each of stocks, bonds, and cash. Usually, the advice is that the percentage in stocks should go down as you get older. I’ve never understood this rigid approach to investing. It makes no sense to me. The theory is that this approach will reduce risk, particularly as you get older and closer to needing the money for retirement. I think the use of the work “risk” here is misleading. We are really talking about volatility. The asset allocation advice is designed to reduce the volatility of your year-to-year returns. But, you pay for this lower volatility with lower long-term returns. To illustrate what I mean, consider the following example. Suppose you win a raffle, and your prize is that you get to grab a fistful of cash out of one of two large buckets with your eyes closed. One bucket has just twenty-dollar bills, and the other has half tens and half hundreds. If we say that y...

Many people will need long term care at some point usually late in their lives, and this care is expensive. The insurance industry offers long-term care insurance to pay for this care. However, you have to be aware of the many possible abuses with this type of insurance. This Consumer Law Page article provides an excellent explanation of long-term care insurance and the types of abuse and fraud that are possible (the web page with this article has disappeared since the time of writing). Disclaimer: I have no affiliation with the law firm associated with this article. The abuses include such things as loopholes that allow the insurance company to deny benefits, lack of inflation protection, and targeting seniors by getting them to churn their policies. Churning refers to the practice of getting someone to buy a “new and improved” policy every year to boost premiums and boost the salesperson’s commissions. There is another problem that probably would never have occurred to me, but ...

My wife isn’t much of a shopper, and I shop even less. So, maybe retailers have been talking about “Boxing Week sales” for some time without me noticing. Until recently, I thought it was just “Boxing Day.” We seem to get whipped into a frenzy about post-Christmas sales. We also get very excited about trying to find certain toys (particularly video games) that are scarce. I can’t say that I’m an expert on the methods used to get people to shop, but it seems that this scarcity is created intentionally to generate excitement and keep prices up. The rise in the Canadian dollar relative to the US dollar has created a sharp rise in Canadians crossing the border looking for bargains. There is no doubt that US prices are usually lower, and the trip can be worthwhile when buying expensive items. However, most people seem to just buy a few small things. I hope they are enjoying the trip because not much money is saved, if any at all, once you factor in travel costs and time spent. On the...

Jim Cramer has a show called Mad Money on CNBC where he makes (or screams) numerous stock recommendations amid strange sound effects while jumping around. This can be entertaining for a while, but a more serious thought comes to mind. Can we make money from Cramer’s picks? Bill Alpert analyzed Cramer’s results in an interesting short article on page 34 of the December 2007 issue of “R News”. The main result of Alpert’s analysis is that Cramer’s stock picks jump quickly the day after his show, and then tend to trail off over the course of the next month. The earliest opportunity for the average investor to buy these stocks is the day after the show, and so it is clear that buying right away is not a good strategy. Alpert looked at various other strategies such as waiting an extra day or two or five, but none of these gave good results. I haven’t watched Mad Money enough to know whether Cramer’s picks are intended to make money in the short or long term, but it is clear from Alper...

Christmas is approaching fast. You have only four days left to overspend your budget and run up credit card bills that will take months to pay off. Okay, okay, I’m sorry to sound so negative about the whole thing. It’s just that so much money is spent at this time of year, and it’s not clear that we really get our money’s worth. I’m all for buying gifts for children. I get a bigger kick out of watching a child open a gift than I do opening one myself. That’s not to say that I don’t want to receive gifts. I would be disappointed if I didn’t get anything. But, I would be happy to receive a thoughtful, low-cost gift rather than an expensive gift if it meant that the giver would have less financial stress when the credit card bills start arriving in January. I suppose that I’m not the first person to call for changes in the way we approach the holidays, but I’m not going to complain about commercialization and the lost meaning of Christmas. In fact, my advice applies even if you don’t cel...

I don’t waste a lot of time feeling guilty about things, but it wouldn’t be too hard to feel guilty about succeeding financially because others make poor financial decisions. Let me explain. I have saved my money and have put some of it into bank stocks. Many people get second jobs to pay the interest on their credit card balances, and some of these interest payments flow back to me in the form of bank stock dividends. Similarly, the value of my shares in retail stocks goes up because other people shop compulsively. We have all heard the sound financial advice to save some of your income and invest in stocks for the long term to get rich slowly. Once you have enough money, you can stop working if you like. But this advice only works because most people don’t follow it. If everyone saved and invested for 20 years, we couldn’t all quit working. There aren’t enough young people to do the jobs that keep our society functioning. If we all saved and invested, stock market returns would have ...

Do you still have some tech stocks lying around in your investment account from the boom days? Some of your stock positions might even be worth less than $100. What good could they possibly be now? The answer is that they might help out on your taxes. When you sell an investment for more than you paid for it, you have made a capital gain , and you will have to declare this gain on your taxes if it is not in a tax-sheltered account, like an IRA in the US or an RRSP in Canada. If you sell an investment for less than you paid for it, you have a capital loss . Fortunately, each year you pay taxes on your net capital gain, which means that you get to subtract all your losses from your gains. So, if you are going to have a net capital gain this year, you might consider selling one of those high-tech stinkers to create a capital loss to offset your capital gain. Take some time to think through all the relevant tax implications, though. For example, if your income is unusually low this yea...

An RESP is a Canadian tax-advantaged savings vehicle for funding a child’s education. I’ll leave most of the details of RESPs to others and focus on one aspect: the actual investments bought with RESP money. Back when my children were very young, I looked into RESPs and was disappointed to find that there were severe restrictions on how the money could be invested and what the money could ultimately be used for. For the plans I investigated, investments were restricted to mutual funds with MERs over 2%, and the rules for how the money could be used were more restrictive than was required by law. When the Canada Education Savings Grant (CESG) came along, things were looking up. The government was going to match 20% of RESP contributions (up to a maximum amount). Surely this would make up for the high fees charged by the mutual funds, right? Not so fast. Costs due to MERs accumulate year after year, but the 20% CESG is only added to each RESP contribution once. So each dollar that...

In an earlier post , I explained that stock trading costs consist of the visible commissions and the less visible costs due to stock spreads . In the case of commissions, it is obvious who gets the money – the brokerage. In the case of stock spreads, it is less obvious where the money goes. If traders lose money due to spreads, who gets this money? You could imagine a stock trading system where potential buyers and sellers each submit a price and a number of shares, and a computer tries to match them up. This sort of system might work well for a very liquid stock that trades millions of shares each day, but it wouldn’t work as well for thinly-traded stocks. Suppose that you are looking to sell 100 shares of little known XYZ stock, and for three days running there haven’t been any reasonable bids to buy the stock. You would be quite unhappy. To make the system run more smoothly, each stock has one or more market makers whose job is to create a market in that stock. Market ma...

Why are there so many different dates associated with dividends? Most companies that pay dividends do so every 3 months on a fixed schedule. They don’t have to do it this way, but shareholders like predictability, and companies want to keep their shareholders happy. You might think that the only important date is when you get your dividend money, but you would do well to understand a few more dates, the most important one being the ex-dividend date. Declaration Date . Just because a company has paid its dividend every 3 months for years, and they are highly motivated to keep the shareholders happy by continuing to pay dividends, there are no guarantees. On the declaration date, the company announces whether it will pay a dividend and whether there will be any change to the dividend amount. Ex-Dividend Date . When buying or selling a stock around the time that the company will be paying a dividend, you may wonder who will get the dividend, the old owner or the new owner. The ex-dividend...

Me : “Hello.” Unknown Caller : “Can I speak to whoever handles the gas bill?” Huh? This really threw me off guard the first time, but not the second or tenth times. I guess this saves them the trouble of trying to pronounce people’s names. These calls from 623-238-6131 have been quite persistent. When I was young, I used to talk to telephone solicitors as though they were people, but this took a lot of time, and it was hard to get off the phone. My next strategy was to yell at them, but by acting angry, it left me feeling angry for a while. Yelling at them didn’t help much anyway. The person on the phone is stuck in a low wage job and is not a decision maker with the telemarketer. The next strategy I tried was to say “just a minute” and set the phone down for a few minutes before hanging it up. This was amusing for a while, but sometimes I’d forget to hang up, and if my wife wanted to make a phone call, she would have to run around the house to find the off-hook phone. Now I jus...

The first things you’re going to need are six pillows and a waterbed. Oh, wait a minute, that’s something completely different. The Smith Manoeuvre is actually a method of deducting interest payments on your taxes. In case you’ve heard about this, but can’t make any sense out of it, let me try to simplify things. In the US, homeowners can deduct their mortgage interest on their income taxes. However, Canadians can’t. The Smith Manoeuvre is sometimes presented as a method of deducting mortgage interest for Canadians. This description is somewhat misleading. Let me explain. Ordinarily, Canadians can’t deduct any interest payments on their taxes unless the loan was taken out specifically for investing with the intent to earn investment income. Borrowing to invest is called using leverage and can turn out badly if the investments don’t do well. In an earlier post , I explained how some financial advisors like to recommend using leverage because it increases the amount their clients inv...

In an earlier post I discussed how using a limit order to beat the spread doesn’t really reduce spread-related trading costs. Does this mean that investors should always use market orders when buying or selling stocks? Definitely not. Let’s continue with the example of SPNS that had a quote of bid $1.45x200 and ask $1.60x2500, and we wanted to buy 6000 shares. In the earlier post we put in a limit order at $1.52. But there is a significant risk that this order won’t be filled. Maybe we really want to own this stock. (Please note that I don’t own SPNS, and I don’t know anything about it other than its quote worked well for my example.) We could just put in a market order and see what happens. One possible result is that we get 2500 shares at $1.60, and the rest at $1.61. Great. We get all the shares we want at a reasonable price. But what if we get the first 2500 shares at $1.60 and then 500 at $1.70, 1000 at $1.95, and 2000 at $2.40? This works out to $11,600 when we expected to p...

In my post about trying to use limit orders to beat the spread , I mentioned that the spread between a stock’s bid and ask prices can be worse when you are trading large blocks of stock. What we mean by large here depends on the stock you are buying or selling. When you get a quote on a stock, you get not only the bid and ask prices, but volume information as well. In our SPNS example in a previous post , the quote was bid $1.45x200 and ask $1.60x2500. This means that there were orders to buy 200 shares at $1.45 and sell 2500 shares at $1.60. If we had bought 6000 shares with a market order, the first 2500 shares would have cost $1.60 each, and the remaining shares would have cost more. So, in the case of SPNS, a $10,000 trade qualifies as a large trade that increases the spread cost. In a quick look at Microsoft stock (ticker MSFT) as I write this, the price is a little under $34, and the bid and ask volumes are both above 3000 shares. So, even a $100,000 trade in MSFT is small en...

In my last post , I explained what is going on with the tax amnesty granted to former JDS Uniphase employees who ran afoul of the rules for taxing stock options. I continue to read articles that are sharply critical of the government, but don’t accurately portray what happened. The main point that people I speak to about this situation don’t believe even when I explain it is that taxes are being charged on income never received. It is possible for employees with stock option plans to put $10,000 into their plans, later take $10,000 out of their plans, and then be expected to declare $500,000 in income on their taxes. See here for a full explanation. I disagree with those who say that these are high-tech high rollers who deserve what they got. I worked with people who were caught by these tax rules for smaller amounts. My colleagues were not high rollers or even particularly savvy with their money. Like most people they did their best to understand the benefits offered by the...

Here is a bonus post on some recent news. If you were looking for my promised post on trying to beat stock spreads, click here . The Canadian government has decided to forgive the tax bills of some JDS Uniphase employees who got caught by tax rules on employee stock options. The articles I have read on this so far haven’t explained things very well. I understand what is going on because I was caught by these same tax rules. When employees get stocks options, what they have is the right to buy a certain number of company shares at a certain price. This is different from owning stock. If employee Ed has 5000 stock options struck at $2, it means that he has the right to buy 5000 shares in his company for $2 each. When he exercises this right, the company comes up with the shares (usually by just creating new shares) and gives them to Ed in return for $10,000. At this point, Ed is holding 5000 shares in his company, and he can sell these shares if he wants to. Back when we were in th...

In my last post , I was explaining that the spread is the difference between the bid and ask prices on a stock, and that the spread contributes to the cost of trading stocks. Is there anything we can do to reduce the trading costs due to spreads? You can try to do this with what is called a limit order (rather than the simpler market order), but results are not guaranteed. A market order is an order to trade stock where you are saying, “just give me the best available price right now.” So, for a buy order you will get the ask price, and for a sell order you will get the bid price. Things get a little more complicated if you buy enough shares to exhaust the shares available at the current bid or ask price, but this is a subject for the next post. A limit order is an order to trade stock where you are saying, “give me the best available price as long as it is $X or better,” where $X is a price you specify. If there is no stock available at your price, then the order is held until ...

The buying and selling of stocks is a kind of auction. At any given moment, people are offering to buy a given stock at various prices, and others are offering to sell that stock at various prices. If a buyer and seller have the same price, then they get matched up, a trade occurs, and they leave the system. What is left is a list of buyers who are offering less than what the list of sellers are willing to accept. The highest price offered by the buyers is called the bid price, and the lowest price asked for by the sellers is called the ask price. The word “price” is often dropped, and people talk about the bid and ask on a stock. The difference between these two prices is called the spread . Let’s look at a real life example. As I write this, Microsoft (ticker MSFT) has a bid of $33.49 and an ask of $33.50. The spread is quite low at 1 cent. Such a small spread is typical of stocks that are traded a lot. So, if you want to buy Microsoft stock, someone is out there who will sell ...

As I mentioned in my last post on the cost of trading stocks, I pay a $10 commission for each stock trade. In most years I make between 5 and 20 trades. If I average one trade per month for 25 years, the commissions will add up to $3000 (ignoring inflation). This is low enough that it won’t have a serious impact on my returns. My strategy for buying stocks is to guess at the future prospects of the business, determine a fair price for the stock, and compare this to the current stock price. If I buy a stock one day believing that the business will be successful, it is unlikely that something significant will happen in the first week or month that changes everything. This is why I tend to trade infrequently. What happens if you trade more frequently than this? Suppose that day-trader Dave is playing with $10,000 and makes 2 trades a day, 5 days a week, for 50 weeks a year. (Even day traders need 2 weeks off, don’t they?) The commissions add up to $5000 per year. So, Dave needs to mak...

In my own portfolio, I choose to own several individual stocks. Even though I think that most people would be better off in index funds , I’m not against direct ownership of stocks. I happen enjoy tracking the progress of the businesses that I own, and I’m hopeful that I will prove to be slightly above average at stock picking.  ( Rereading this nearly 12 years later, I no longer own any individual stocks, and I realize that being above average doesn't mean being better than my neighbour; it means being better than most investment professionals. ) If you are not interested in analyzing businesses, and the time you spend following stocks consists mainly of checking current prices, then owning individual stocks probably isn’t for you. Over the long term it is the sales and profits of the business that determine your profits. Predicting the long-term future of a stock is best done by trying to predict the future success of the business rather than looking at wiggles in the chart of ...

The first time that I wanted to close an investment account with one company and move the contents to a new account with another company, I went about it in entirely the wrong way. You may have heard the expression “you can’t push a rope.” Well, the same seems to be true for money. Let me explain. I started by talking to my old investment advisor and giving him the bad news about my plans to make a change. He spent some time trying to change my mind, but gave up after it was apparent that my mind was made up. I asked him what I had to do to get the investments moved, and he told me that I had to contact some administrative person whose telephone number he didn’t have handy. After several telephone calls and some broken promises over the course of more than a month, I was getting quite frustrated. I didn’t realize it at the time, but my problem was that I was trying to push the money rather than pull it. When I spoke to the new company that would be handling my investments about m...

Another example of a bad deal is life insurance on children. In rare cases where a child actually has a substantial income that others depend on, it can make sense to take out life insurance on the child. But, in most cases, insuring a child’s life makes no sense; remember that the insurance offers no protection from death! I have had insurance agents try to talk me into insuring my children by arguing that I would need to cover funeral expenses, and that buying the insurance would guarantee future insurability. This was all nonsense. I can afford a funeral without the help of insurance, and if I couldn’t, I would choose something less costly than the standard funeral. The future insurability argument requires more explanation. When you buy term life insurance for, say, 10 years, it comes with or without the guaranteed right to renew the insurance at a particular price after the 10 years are up. If your insurance is renewable, then even if you develop a terminal illness in th...

Have you ever been to see a doctor who is obviously upset about something that has nothing to do with you? This has happened to me a couple of times where a doctor was complaining about something and I had little choice but to sympathize even though I was much more concerned about my own problems. Otherwise, why would I be seeing a doctor? One of these times the doctor was having a problem with her extended health coverage for topping up the basic Ontario government medical coverage. Her partners wanted her to go in with them on a plan that cost $400 per month for each doctor, but she saw in the fine print that the plan had a lifetime cap on all benefits of $25,000. She correctly figured out that she would pay $25,000 in premiums in just a little over 5 years. I asked her if she could afford to pay $25,000 right now if she had some sort of medical problem, and she said yes, which isn’t too surprising for someone with the income of a successful doctor. So, this means that the insura...

Some financial decisions, particularly about insurance, must take into account what is called the utility of money to get the right answer. Normally the concept of utility is explained in very mathematical terms, but it doesn’t have to be. Let’s take a fun example straight from a game show. You’re standing beside Howie Mandel playing a super-sized version of Deal or No Deal. You’re down to just two amounts left, 1 cent and $3,000,000! You get the following offer: take $1,000,000 now, or take a 50/50 chance at the $3,000,000. What should you do? If you got to do this many times, then on average, taking the chance you would win half the time and get an average return of $1,500,000. This is more than the million dollars you were offered, and so you should take the chance, right? Not so fast. Most people would correctly figure out that they should just take the million dollars. The reason is that the first million would make a huge difference in their lives, and an additional two mil...

In my last post, I discussed how insurance is a financial matter and doesn’t do anything to prevent accidents. So, if insurance is just about trading money back and forth, how can it be a good deal for both the insurance company and the person buying the insurance? When it comes to buying goods like food, it is easy to see why an apple is more valuable to a person buying one than it is to the farmer who owns an orchard full of apples. I’m quite happy to part with 50 cents for an apple when I’m hungry, and farmers are willing to take less than 50 cents for each of their apples. So, in this case, it is possible for both sides to win. When it comes to insurance, it isn’t as obvious that both sides can benefit. To keep things simple, imagine that a car insurance company has worked out that they will have to pay out an average of $600 per driver in claims for car accidents next year. If they charge each driver $1000 for the insurance, then they will make a $400 profit on each driver min...

A while ago during a temporary gap in my house insurance, some of my friends joked about coming over to my place and “having an accident” to make some big money. Of course they weren’t serious, and we all had a good laugh. Later on I thought about what had made the joke funny. If you think about it, a fraudster would have better luck getting a big settlement from an insurance company than from me. So, for a short while my house was probably the worst place to target for faking an accident. But my friends and I all got the joke instantly, even though it doesn’t seem to make much sense after some thought. What is going on? To answer this you need to look at how house insurance is marketed and sold. The best example is one insurance company that shows the image of a giant protective blanket enveloping your house. As long as you don’t think about it too much, you have the feeling that house insurance actually helps prevent accidents. The marketing promotes this subconscious idea. Of co...

In my last post, I discussed how stock price increases over the long term are possible. A reader, Steve, asks “If the value of stocks keeps on rising at a greater rate than inflation, wouldn't that mean that less and less people could buy stocks in the future due to lack of necessary funds?” This is a good question that points to the seeming paradox of the stock market creating value out of nothing. Let’s start with understanding inflation. Inflation is a measure of the increase in prices of the things we buy, like food, gas, and clothes. At the beginning of the year, a particular basket of items is selected as the typical things that people need, and the price of this basket of items is added up over the course of the year to measure the cost of living. If inflation is 3% one year, then the cost of this basket of items has risen 3%. Another way to view this is that the things we buy have constant value, and the value of money has dropped. Now, just because inflation is 3...

Over the last 100 years, the Dow Jones Industrial Average has gone from about 65 to 13,000, a factor of 200. But this is only about half of the return because it doesn't include dividends. So you can multiply this by another large factor to get the full returns. Of course stocks have had some major blips in the last 100 years, but this represents a relentless rise in stock prices. Even factoring out inflation, stocks have made an impressive long-term run. In the short term stocks rise because there are more buyers than sellers, and when demand outpaces supply, prices must go up. Over the long term it seems like the stock market creates wealth out of nothing. Science teaches us the law of conservation of energy, we often hear that there is no free lunch, and we talk of zero-sum games, but the stock market doesn’t seem to be bound by any such law. Over the long term, almost everybody who stays in the game seems to win. What makes stock prices rise over the long term? The short an...

This is the third post examining the arguments given by fund managers against leaving their funds and investing in an index . Argument #4: Over such and such a time period active funds beat index funds. It is true that over some periods of time, actively managed mutual funds give higher returns than index funds. When making this kind of argument, the fund manager has to select the time period carefully, because most of the time, index funds win out. Where actively managed funds tend to win is in periods where the stock market performs poorly. This is because most funds have to hold some cash (often around 10% of the money in the fund) to deal with the volatility of investors entering and leaving the fund. So over a period of time where stocks don’t do as well as interest on cash, a fund with 90% of its money in stocks and 10% in cash will beat an index fund with nearly 100% in stocks. However, stocks have been much better long-term performers than cash. The cash component of...

In the previous post , I started to examine some of the reasons fund managers give against leaving their funds and investing in an index . Here are a couple more. Argument #2: Our gains are more intelligent. Some of the arguments given by active stock pickers amount to saying that their returns are somehow better than the returns on an index fund because of some vague attribute like intelligence, precision, or global-mindedness. This raises an important question: would you rather make a 10% return intelligently or 12% mindlessly? I’m not advocating investing without thinking, but what matters ultimately to your financial future are results, not the process. Argument #3: Some people need their hands held. The argument here is that some people need advice, and if they try to manage their own money they might get nervous and sell at a bad time . There is a lot of truth to this. Many people do panic and sell near a market bottom when they would have been better off just holding on....

The investing strategy of indexing is a major threat to the mutual fund industry. (See some of my previous posts for an explanation of indexing , examples , and how to get into an index .) When you put your money in a low cost index fund, you are no longer paying the high fees charged by actively managed funds. Each investor with $100,000 in a mutual fund with a Management Expense Ratio ( MER ) of 1% pays $1000 per year in fees. Up that to the $500,000 you’re hoping to have one day and a 2% MER, and the fees are $10,000 per year. It is no wonder that the managers of these high cost funds are highly motivated to fight against indexing. Try typing “the case against index funds” into Google. You’ll get plenty of hits. The most amusing hit I saw was called “How to Market Against Index Funds.” At least the title makes the motivation very clear. I read through several of the articles I found while keeping an open mind about the possibility of learning about some real problems with indexing...

So you’ve been investing for a while, know some buzz-words, and now you’re a financial whiz. It’s time to start trading in and out of speculative stocks and stock options to make big money. Hold it right there! This could be a disaster. You could lose most of your money very quickly. There is nothing wrong with investing in individual stocks if you are truly knowledgeable and willing to put in the time to follow the companies you own. Following a stock price is not the same as following the company. If you own an individual stock you should have read its financial reports and have an informed opinion about the company’s prospects and whether the current stock price is high or low relative to those prospects. This is not true of the average investor. There is plenty of evidence that even most professional investors can't beat the market. Be wary of overconfidence. You may be better off sticking with the unexciting and low-action index fund strategy. Overconfidence can c...

Pundits, friends, and acquaintances confidently drone on about interest rates, the balance of trade, commodity prices, and the impending doom in the stock market. History tells us that when stock prices have been falling, the negative predictions increase. There is no reason to believe that these people know any better than anyone else whether stocks will go up or down in the short term. Anyone who could actually predict where the stock market was going in the short term could easily make a fortune fast. Some successful investors say that one of the best times to buy is when the masses agree that stocks are doomed. This barrage of negative news about the stock market leads to a common problem for nervous investors: selling when prices are low. If the stock market then rallies, these investors lose out. I’m not advocating waiting with your cash until the world seems to be crashing down and then buying in either. This kind of market timing works for few people. If your investments ar...

The idea of indexing is to put money that you won’t need soon into one or more low cost index funds for a long time. There are pitfalls with handling your own investments that might cause you to deviate from your strategy. One such pitfall is making quick decisions about your investments. It is very easy to place stock market trades with a web browser. While connected to your broker’s web site to look at your investments, the trade button is sitting right there on the screen. In a moment of weakness, you might make some trades you later regret. Fortunately, North American markets are only open from 9:30 am to 4:00 pm eastern time, and not too many people are making trades after a beer or two. When you pay the fees to work with a financial advisor, the advisor usually has to be contacted to make investment changes. One of the good things that most financial advisors do is to talk people out of doing anything rash. In the coming posts , I will discuss other potential pitfalls of st...

To those who have opened a self-directed brokerage account and have bought and sold stocks, this might seem like a trivial question. However, this whole business can be quite bewildering to the uninitiated. To start with, you need to choose a broker. I won’t recommend any particular broker, but the following surveys may help. U.S. Brokers. In a survey by SmartMoney, the top brokers in the premium category were E*Trade, Fidelity, and Charles Schwab. The top brokers in the discount category were TradeKing, Scottrade, and Firstrade. Canadian Brokers. In a survey by the Globe and Mail, the top Canadian online brokers were Qtrade Investor, E*Trade Canada, TD Waterhouse, and BMO Investorline. Opening an account. After choosing a broker, follow the instructions on the broker’s web site for opening an account. This process is similar to opening a regular bank account except that the brokerage account can hold stocks, bonds, and mutual funds in addition to cash. There are several types...

Low-cost index funds are a great way to own a very broad range of stocks without paying high fees. Of the many index funds to choose from, two are described in the table below. If some of the table entries don’t mean much to you, don’t worry because I’ll explain them. Country U.S. Canada Fund Name Vanguard Total Stock Market iShares Canadian Large Cap 60 Stock Ticker VTI XIU Description 1200 large U.S. companies 60 large Canadian companies MER 0.07% 0.17% MER25 1.7% 4.2% These two funds are called Exchange-Traded Funds (ETFs) meaning that they can be bought and sold like stocks in the stock market. Other mutual funds are bought directly from the mutual fund company or through an intermediary like a financial advisor who deals with the fund company. The stock ticker listed in the table above is the symbol that is used to identify the stock (or ETF) when making a buy or sell order. Low MER An important attribute of these funds is that they have very low Management Expense R...

I have been talking about the dangers and high costs of investing in typical mutual funds, which is useful to a point, but you may ask “well then, what should I do with my savings?” Of course, this is a question that everyone has to answer for themselves, but one possibility to consider is a strategy called indexing. An index is a measure of prices among a particular set of stocks. For example, the Dow Jones Industrial Average (DJIA) measures stock prices of 30 of the largest public companies in the U.S. When you hear that “the Dow is up 100 points today,” the commentator is referring to the index of these 30 stocks. Other familiar indexes in the U.S. are the Nasdaq and the S&P 500. In Canada, the main index is the S&P TSX, often abbreviated as the TSX. Each of these indexes is reported as a number that gives us a sense of whether stock prices have gone up or down. If an index goes from 10,000 to 10,100 one day, then stock prices have risen by an average of 1%. The investme...

This will be the last discussion of the ugly side of mutual funds for a while. After this post I will be talking about an alternative to the standard mutual fund . I have always liked Will Rogers’ advice about investing: “Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it.” There is a slight temporal problem with this strategy, but it is clear that if you could look into the future, investing would be easy. Another way to look at this quote is that you should wait until a stock goes up and then buy it at the old price. But who would be foolish enough to let you do this? Late Trading Back in 2003 there was a big scandal where some mutual funds allowed their preferred clients to do what is called late trading. Generally, mutual funds set the day’s price of their units when the stock market closes (4:00 pm eastern) and any trades (buying or selling of mutual fund units) during the day ...

Suppose that you have found a mutual fund called XYZ with a good track record of strong returns and an honest manager who has not closed and renamed losing funds and has not incubated funds as discussed in my last post . Hurray! XYZ fund manages $50 million making it small by mutual fund standards. The fund manager is very skilled at investing in small companies that are about to grow big. So, you switch out of your current mutual fund and switch into XYZ. This is going to be good! The herd is with you. It turns out that you weren’t the only person with this idea. Literally thousands of other people pile into XYZ chasing those high returns. Assets under management at XYZ swell to $2 billion, a 40-fold increase. This is great for the fund’s managers; they will collect 40 times the management fees. But, what are they going to do with all that investor money? XYZ fund was successful at finding a handful of small companies that give big returns. These companies aren’t big enough t...

My last post discussed how mutual fund managers close, rename, and merge mutual funds with a history of low returns to hide their poor record. To counter this, investors are advised to choose funds with a long history of good returns. Typical advice is to focus on 10-year returns. Investors do tend to choose funds with a history of high returns. However, they often focus on just the past 1 or 3 years of returns, rather than looking at longer periods. Not surprisingly, mutual fund managers are aware of this. Because mutual fund managers are paid a percentage of their fund’s assets each year, they are motivated to attract as many investors as possible to the fund to drive up its total assets under management. This has led to an interesting practice among some mutual fund companies to drive up reported returns. Incubation Some companies start up several mutual funds with small amounts of private money and run them aggressively. After a while, the poor performers are closed ...

I used to hold mutual funds in an employee savings plan. The first time that one of the funds I held changed its name, I was puzzled. Was I switched to a different fund? Why was this done? I asked the representative of the firm that managed our savings plan about this. He said I shouldn’t worry because the name change was inconsequential, and this seemed to be true. The number of units I held and their approximate value didn’t change. What was the point of all this? After comparing my last two statements, I did find one seemingly small difference. The part of my most recent statement with the 1-year and 5-year performance of my fund was blank. The previous statement listed these returns for the old fund name, and the returns weren’t very good compared to other mutual funds. Erasing History The purpose of the name change was to erase an unpleasant history and start over. Because of this little trick, mutual fund lists are purged of their poorest performers. There are definitely funds th...

The second financial advisor I actually invested money with was a pleasant woman who used to work at my bank branch handling my mortgage and had moved out on her own. I won’t use her real name; let’s call her Gina. Initially, my wife and I each invested a small sum with Gina in some mutual funds. We were contemplating moving the rest of our investments over from our first financial advisor, but Gina had an idea for something even bigger. The Pitch Based on our income and lack of debt, Gina said that we should be borrowing a large sum of money and investing it. Interest rates were low, and when it came to taxes the interest could be deducted from the big gains we were sure to make on our investments. At the end of 5 years, we would have big profits with “no money down”. Gina worked on us for quite a while with this pitch. Fortunately, the borrowing made us nervous, and we decided not to go for it. This all took place just before the high-tech bubble burst. We would have lost a l...

A few years after I began investing with a full service brokerage firm, my advisor Mike seemed excited to be offering me the chance to get in on a new type of account. For 1% of my assets each year, a professional money manager would handle my account making investments specifically suited to my needs. I misunderstood how this would work at first. I thought that this money manager would be picking individual stocks for me and running my account like its own little mutual fund. It turned out that my account would actually hold several mutual funds with the mix of funds shifted around once in a while as I got older. At the time I was just starting to understand mutual fund management expenses and financial advisor fees, and the rest of the conversation with Mike went something like this: Me: “So, each year I would be paying the MER on the mutual funds plus another 1% to you guys?” Mike: “Uh, yeah, but ...” followed by a bunch of confusing reasons why this was a good idea anyway...