Derek Foster who claims to be Canada’s youngest retiree wrote an interesting book called The Lazy Investor . Before I read the book, I thought the “lazy” part referred to the effort required to handle investments, but it actually refers to being lazy by quitting your job once your investments produce enough income. What sets this book apart from most other investment books is that he recommends specific investments and gives detailed instructions on how to open accounts and acquire shares as cheaply as possible. I tend to agree with most of his general advice: minimize fees, buy stocks rather than bonds, and minimize personal spending in areas that aren’t improving your life. I don’t think it’s necessary to focus exclusively on dividend-paying stocks, but following Foster’s advice would be a big improvement over how the average person invests. The book gives detailed advice on how to get started with very small amounts of money to invest without wasting too much of it on fees b...

The Big Cajun Man over at Canadian Personal Finance wrote an interesting post about Nortel’s recent pension cuts . He puts it into historical context and captures the employees’ feelings of betrayal. I would add that whether Nortel’s actions were legal or ethical, they were predictable. Complicating this story is the switch from a defined benefit pension plan to a defined contribution plan. A defined benefit plan guarantees employees a certain amount of money per month after they retire. With a defined contribution plan, the company sets aside a fixed amount of money per pay period for each employee, and the ultimate retirement benefits will be determined by how well the money is invested. It would be easy to misinterpret Nortel’s actions as simply changing to a new system. Make no mistake that this is a significant pension cut. Nortel expects to save $100 million per year in the first four years with the new system. Could we have seen this coming? With defined benefit plans, t...

In yesterday’s post , I showed that the interests of homeowners and the real estate agents who work for them are poorly-aligned. The concept of alignment of interests is an important one for understanding why people do the things they do. It can also be useful for predicting how others will surprise you or disappoint you, or maybe try to take advantage of you financially. I used to play on a softball team that was sponsored by a sports restaurant/bar. We were young and took our commitment to our sponsor seriously. We would sometimes show up after a game with more than 20 people including players, friends, and family. We were developing a great relationship with this sports bar, or so I thought. After the third or fourth time we arrived at this sports bar on a Monday or Wednesday around 9:30 pm, it became clear that they weren’t very happy to see us. They would tell us we couldn’t sit in one section or another, and would try to hustle us out quickly. We weren’t rowdy, and the...

The fundamental problem with incentives for real estate agents is that the extra commission on a higher price is too small to be worth the extra effort.  Agents have little incentive to work hard to sell a house for the highest price possible.  The interests of the agent and homeowner are poorly aligned. Let’s look at an example. Suppose that a fair price for Hanna’s house is $375,000, and that her current mortgage principal is $275,000. After she pays off her mortgage and pays the real estate fees, legal costs, and other costs, she’ll have about $75,000 left over. If the sale price is $25,000 higher or lower, it would make a big difference in how much money Hanna gets. Let’s say that Rick, the real estate agent, gets to keep 2% of the sale price of the house for himself. Of course, the full cost to Hanna is much higher than this, but Rick only gets a fraction of what Hanna pays. This works out to $7500 for Rick. If the sale price is different by $25,000, it only mak...

According to Bloomberg, General Motors will begin offering no-interest car loans on certain pickup trucks and SUVs for as long as 6 years. I suppose that this indicates a certain amount of desperation to sell these gas-guzzlers, but what strikes me is the “no-interest” part of this story. Surely most people understand that they’re not really getting a no-interest loan. In reality, they are paying an inflated price that includes the real vehicle price plus the loan interest amount. For loans extended to 6 years, the advertised price is just inflated by more. Even worse, no-interest loans are often only available on fully-equipped vehicles with many overpriced options. When it comes to paying cash versus financing a vehicle, Phil Edmonston’s Lemon-Aid Guide explains the dealers’ preference for financing: “Let’s clear up one myth right away: Dealers won’t treat you better if you pay cash. They want you to buy a fully-loaded vehicle and finance the whole deal. Paying cash is n...

Canada’s Supreme Court has decided that the planned BCE takeover does not violate any agreement with bondholders, and that the bondholders are not due any consideration beyond the contents of their contract. Like the Asset-Backed Commercial Paper fiasco, the BCE battle illustrates the risks of fixed-income investing. The safest bonds are offered by the government. If the government doesn’t pay on its bond obligations, then money probably isn’t worth much either. On the down side, government bonds pay the lowest interest rate among available bonds. Corporate bonds pay higher interest rates to compensate the bondholder for the risk that the corporation won’t be able to meet its obligations. It can be tempting to buy corporate bonds to get the higher interest, but there is always a slim chance that something will go wrong. In the case of the Bell Canada bonds, the promise to pay the bond principal and interest has not changed. But the huge amount of added debt to be taken on by BCE i...

Stéphane Dion’s Liberals have released their Green Shift plan that would make big changes in our tax system. Dion plans to shift some of the broad-based tax burden on all individuals and companies to just those who pollute. So, the final price of goods and services that cause pollution would go up. Whether you support this type of taxation or not, it is clear to me that this is the only way to cause people to change. Begging people to be green is mostly ineffective. But taxing people less and making some items expensive may cause people to make different choices. There are a number of big ifs in this plan. It will work if the Liberals get elected (does not seem likely right now), if there are no loopholes for polluters to get around the new legislation, and if the government doesn’t cave to pressure to make exceptions for certain polluting industries. It may not seem like it makes any difference to tax you $250 less and simultaneously make your living costs for the yea...

In yesterday’s post, I explained that Horizon BetaPro’s double exposure ETFs don’t give double the return of the index they are based on . One reason for this is the daily rebalancing of the doubled exposure as explained by Preet Banerjee in this post . Even without this daily rebalancing, the return would not be exactly double because leverage always comes with a cost. The simplest way to get leverage is to borrow money. Instead of investing $10,000 in an index, you could borrow an additional $10,000, and invest $20,000 in the index. This way, you double your returns. Well, not quite double your returns. You have to pay interest on the borrowed $10,000. This raises the question, is there any way to truly double your returns without paying any additional costs? We can show that the answer is no because it would create an arbitrage opportunity. Arbitrage basically means a risk-free way to make money. Suppose that an investment exists that gives double the returns of an ind...

The Million Dollar Journey had an article yesterday about Horizons BetaPro ETFs. These Exchange-Traded Funds (ETFs) are designed to give investors double exposure to certain indexes. This means that if you are invested in their S&P/TSX 60 ETF and the index goes up by 1% one day, the ETF should go up by 2%. They also offer a bear version of each ETF where a 1% rise in the index gives a 2% drop in the bear ETF. Obviously, the owners of the bear ETFs are hoping for the index to drop. Let’s focus on the ETF based on the S&P/TSX 60 index, which is based on the biggest companies in Canada. If the TSX 60 goes up by 10% one year, you’d expect the corresponding Horizons BetaPro ETF (ticker symbol HXU) to go up by 20% that year. But, that’s not how it works. For example, in its first year, HXU returned 13.28% and the TSX 60 rose 9.19%. If we double the TSX 60 return, we find that there is a 5.1% gap. What causes this 5.1% gap? I tried reading the prospectus, but like most such do...

In yesterday’s post on the economics of windfalls , I showed how difficult it can be to maintain wealth once you have it. We tend to think that the best way to get rich is to win the money somehow such as in a lottery. But, lottery winners usually burn through their money quickly. So, this raises the question, how do people get rich, then? This is the question that was tackled by Thomas Stanley and William Danko and led to their excellent book, “The Millionaire Next Door”. These marketing guys wanted to find rich people and figure out how to sell them stuff. They started by looking in upscale neighbourhoods, but soon found that the people living there weren’t rich. When they did find wealthy people, they tended not to live in upscale neighbourhoods. Wealthy people tend to live more modestly than most people would guess. The path to wealth is hard work and the self-discipline to spend less than you make for a long time. The book gives a profile of typical millionaires as a ...

Watching the U.S. Open Golf Championship and its top prize of $1.26 million made me think about windfalls. Many of us dream of coming into a large sum of money whether it is by winning a sporting event, a lottery, or getting an inheritance. If only you could win a million dollars; you’d be set for life, right? Not so fast. A little analysis will show that with a million dollars, you’re nowhere near as rich as you might think. Let’s assume that our lottery winner, Leon, starts out with a lump sum of one million dollars. He gets his winnings immediately, and if he has to pay U.S. taxes on lottery winnings, the prize was large enough that he is left with a million dollars after taxes. If Leon wants to be set for life, he has to grow his windfall by at least enough each year to cover inflation. He can only spend the investment gains that exceed inflation. Otherwise he is dipping into his capital and will eventually run out of money. Let’s start by assuming that Leon invests the who...

The Canadian government has tabled new copyright legislation that is similar in many ways to the US Digital Millennium Copyright Act. If the intent is to stop online piracy, then it will fail. Intimidating-sounding fines like $20,000 for trying to get around copy protection on CDs might stop many people who would otherwise have done it. It might even stop 90% of these people. But, it only takes one person to break the protection and put a copy online for the world to have access. It will never be possible to stop every single person from breaking protections. Even if the best protection technology in the world is used on some music, somebody will buy the music legitimately, and then record it while it is playing and throw a copy on the internet. I’m not arguing that any of this is right, because it isn’t. I’m arguing that it is inevitable. This legislation will make criminals out of people who copy a CD to their iPods for personal use, but it won’t stop piracy. Laws and law enforcement...

In yesterday’s post I showed how the stock market’s tendency to rise steadily gets lost in the day-to-day volatility of the market. In a similar way, the drain of investment fees on a portfolio can get lost in the daily choices made by money managers. Let’s suppose that Sam has his money in mutual funds with an average Management Expense Ratio (MER) of 2.5% per year. This works out to about 0.01% per trading day throughout the year, a seemingly trivial amount. On any given day, a money manager could make a choice that makes a 5% difference to Sam’s portfolio. This is 500 times bigger than the day’s MER. This is like worrying about an extra nickel on the price of a case of beer. The problem is that this 5% difference the money manager makes could be either up 5% or down 5%. Over the course of a year, the good and bad choices tend to balance out somewhat, and the 2.5% MER starts to look significant compared to the money manager’s performance. Over 30 years, the MER has cons...

It’s hard to see the steady rise of the stock market on a day-to-day basis because of the volatility of prices. Whether you focus on the long-term increase in prices or the short-term volatility determines whether you are an investor or a trader. Let’s suppose that the stock market is expected to rise 10% per year with volatility of 20%. The volatility (or standard deviation) has a precise mathematical meaning, but let’s just say that it creates a return range of 10% plus or minus 20%, or from -10% to +30%. In most years the market return will be in this range. Because there are about 250 trading days per year, you’d think that we could divide these numbers by 250 to get a range for each day of -0.04% to +0.12%, but volatility doesn’t work this way. From experience we know that daily market movements are very often outside this range. The problem with this thinking is that volatility partially cancels out over time. A big rise followed by a big drop may leave the stock price unchanged....

Warren Buffet bet Protege Partners, a money manager that invests in hedge funds, that they can’t beat the S&P 500 index over the next 10 years. Both sides are putting their money where their mouths are. They are each risking enough that the whole pot is expected to be worth a million dollars in 10 years. The winner will get to contribute the wagered money to the charity of their choice. Protege Partners manage money by choosing among hedge funds. A hedge fund is basically like a mutual fund with less regulation. To beat the S&P 500, the money invested will have to overcome the hedge fund management fees in addition to Protege Partners’ fees. Buffett has been a consistent critic of the high fees charged by money managers, and now at least one money manager is being put to a very public test. Of course, you can’t conclude much no matter which way this bet goes. The fact that the average money manager loses to the index because of fees doesn’t change because of the res...

You’d think that a 6% interest rate means that you’d be charged $6 in interest on a $100 loan after one year, but this isn’t true. You’d actually be charged more. The difference has to do with compounding periods. It’s not hard to calculate the actual interest rate being charged, but for some reason, banks aren’t required to tell the truth about interest rates. For loans in the U.S. and non-mortgage loans in Canada, interest is compounded monthly. For most mortgages in Canada, interest is compounded twice a year. I’ll explain Canadian mortgages first because they are a little easier to follow. If you get a 6% mortgage in Canada, it is really 3% interest every 6 months. This means that without any payments, your outstanding debt is multiplied by 1.03 after 6 months. After a year, it has been multiplied by 1.03 x 1.03 = 1.0609. This means that the actual yearly interest rate being changed is 6.09%, not 6%. So, what? The difference looks small. Well, over the life of a 2...

As a matter of principle, I try to avoid giving interest-free loans to utility companies. This may sound like a strange thing to say, but I’m willing to bet that many people who read this post are giving out interest-free loans. When you sign up with an equal-billing plan for gas or hydro, the payments are usually structured so that you’ll pay for more than you use at the beginning of the billing year and less at the end. This means that you’re lending a modest amount of money to the utility company, but they don’t pay you any interest. I can handle the seasonal variations in my bills, and so I just pay for my consumption each month. In theory then, I’m not lending any money to the utility companies. Enbridge has a nice solution to the problem of me not going on equal billing: estimated meter readings. In winter my back yard is difficult to access and Enbridge estimates our consumption. And curiously enough, the estimates are usually too high. Ordinarily, my wife and I look out for thi...

It seems to be conventional wisdom that once you start drawing from retirement accounts, your investments should be shifted into income generating assets such as bonds and dividend-paying equities. This makes little sense to me. Let’s consider an example. Suppose that Sam starts retirement with a million dollars in a tax-sheltered account. He invests in dividend-paying stocks and in the first year he makes $40,000 in dividends plus $60,000 in capital gains. He withdraws the cash dividends to live on and leaves the capital gains in the account. Another new retiree, Linda, invests her million dollars in non-dividend paying equities and makes $100,000 in capital gains in her first year of retirement. She sells $40,000 worth of stock to generate cash to live on. What’s the difference between these two cases? Not much. What matters are the returns you get and the risk you take to get these returns. In tax-sheltered accounts, the difference between capital gains and dividends isn’t i...

Recently, Rob Carrick discussed choosing an investment advisor. The conclusion is that a good advisor has the following 4 attributes: 1. Is comfortable speaking about fees and commissions. 2. Communicates clearly in everyday language. 3. Asks detailed question about clients’ situations. 4. Makes time for clients. These make sense, but they aren’t enough to avoid being taken in by a good salesman. The article acknowledges this saying that people “have to be at least a little involved in the running of their portfolios.” The problem I have at this point is that if you are knowledgeable enough to be involved in the running of your portfolio, then you probably know enough to pick a few ETFs yourself and forget the advisor. For the more complex financial planning activities (that many advisors don’t really do), investors can pay a fee-based advisor by the hour periodically. In my limited experience of listening to people talk about their financial advisors, they tend to pick t...

Many sensible investors like index Exchange-Traded Funds (ETFs) because of the low fees charged. However, just because an investment is ETF-based doesn’t automatically mean that it is low cost. The Wealthy Boomer posted about some new AIM Trimark ETF-based funds (the web page with this article has disappeared since the time of writing) that underscore this point. These new funds have MERs of around 2% (the management and advisory fees are 1.8%, but I wasn’t able to find out the cost of the other expenses included in MER). The marketing for these new ETFs include “GlidePath”, “PowerShares”, “Retirement Payout Portfolios”, and other impressive-sounding phrases. But, do you really want to pay $5000 per year in fees when your portfolio gets to $250,000? Any time a financial product becomes popular, you can count on fund companies to jump on the bandwagon. You can have products with any name you like as long as the fees are high. Just because a financial product’s description tal...

Amir Efrati of the Wall Street Journal asks the question “Are Borrowers Free to Lie?” in an article about a court case in California . A bank sued Cecelia and Norman Hill for lying on a mortgage application. What makes the case unusual is that the Hills have already been through bankruptcy. Even though the Hills’ debts had already been dealt with during the bankruptcy, the bank argued that the Hills should still be responsible for their mortgage because they lied on their application. This case illustrates the abuses that went on during the housing bubble. No matter which party you focus on, they deserve to lose. The Hills deserve to lose for lying. However, they have already faced the significant financial pain that comes with bankruptcy. Anything more would seem to be piling on. The bank deserves to lose because they ignored their own rules about checking the accuracy of loan applications. The application listed the Hills’ occupations as a delivery driver and an employee for an...