This is a Sunday feature looking back at selected articles from the early days of this blog before readership had ramped up. Enjoy. 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. 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 success...

1. Preet takes a detailed look at strategies for shorting bull and bear double-exposure ETFs simultaneously . All other posts in this list of Short Takes have dropped off the internet.

I was recently offered a 10% discount by a contractor for paying in advance. Of course, this raised warning flags for me. Believe it or not, this has a connection to the current trouble with Nortel’s pension plan. Ordinarily, I wouldn’t consider paying a contractor in advance for fear that he would just skip off with the money. In this case, it was a contractor I’ve used and trusted for about a decade now. I went for the deal with only mild misgivings. In the end, my contractor didn’t skip out on me, but he also didn’t give me quite the same service as he had in the past. The work was done a little later than usual, and I had to place a couple of extra phone calls to be the squeaky wheel that gets the grease. In the end, I’d say that the 10% discount wasn’t quite worth the extra trouble. This is often the way things go with an agreement between two parties where one side fulfills their obligations first. The other side may renege entirely, but much more often they just change th...

Many people are hurting financially in this recession, and the government has decided to help out with changes to the Canada Pension Plan (CPP). This is the same kind of help you might get from a stranger who sees you need money badly and offers you ten bucks for your iPod. The two big proposed changes are as follows. 1. You will be able to draw CPP at age 60 while still working without taking two months off. This is welcome news for older workers who have been laid off and are having a hard time getting by on half as much pay at a new job. (Thanks to Preet for pointing out the poor wording of this point in the original version of this post.) 2. If you take CPP at age 60, it will be reduced by 36% instead of 30%. Payments used to be reduced by 0.5% for each month they start before age 65. This will be increased to 0.6%. This second point is not well understood by some. If you take your CPP early, the reduction in pension amount is permanent. The pension will not go back up to...

In the past Bell has made me numerous offers for internet service that doesn’t work at my house . Their latest offer of a long distance plan is equally enticing. Apparently, the Canada Block of Time Long Distance Plan is only $17.95 per month. Just before this price is the word “from” written sideways in small letters. There is also a tiny “1” indicating the footnote on the back of the letter that informs me in ultra-small font that taxes and a $5.95 per month network charge are extra. The letter says that this “long distance plan matches your unique calling habits and saves you money.” It’s hard to see how this could be true given that in a typical month my family uses about $4 in long distance. This reminds me of the time when a life insurance salesman promised to save me money, but then proceeded to offer me plans that all cost more than double what I was already paying. I guess the target market is people who look at two numbers and can’t figure out which is bigger.

With the TSX index continuing to rise in recent weeks, only a select few market timers who remain out of the market are in positive territory. Looking at past prices, we can find the day during the stock market downswing that had the same price level as today. I call this the “market timer breakeven date.” The following chart shows what I mean: As prices continue to rise, this date travels further back in time. Apart from a few bumps in the TSX chart, the breakeven date is now back to October 6. Not too many market timers who jumped out of stocks during the downturn managed to do it before this date. Curiously, a few people I know who jumped out of stocks seem quite unconcerned by all this. They are content to wait until “things calm down,” but fail to see the fact that they sold low and are waiting to buy high.

This is a Sunday feature looking back at selected articles from the early days of this blog before readership had ramped up. Enjoy. Mutual fund managers often close, rename, and merge 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 amo...

1. New credit card rules are on the way in the U.S. My Dollar Plan outlined the expected changes . The most interesting new rule to me is the one requiring cardholders under 21 to have a co-signer unless they can prove that they can make payments on their own. This is an attack on the practice of extending credit to young people with the expectation that they will get themselves into debt trouble and get bailed out by their parents. 2. Canadian Financial DIY reports on a study showing that inflation is higher for retired people than it is for the general population due to rising health care costs . 3. The Big Cajun Man reports that while inflation overall hasn’t begun rising significantly, the price of food has been rising . 4. Preet observes that when markets are volatile and flat, leveraged ETFs tend to perform poorly making them attractive to short . Of course, the trick is to anticipate whether markets will remain flat and volatile.

The basic idea behind leveraged ETFs seems appealing. These ETFs seek to go up or down double or triple the amount of a given index. Since stocks tend to go up over time, you’d think that doubling or tripling this gain would be a good idea. Unfortunately, volatility punishes leveraged ETFs and some of these ETFs seem to have unexplained leaks. Many investors believe that if an index rises 10% one year, then a double-leveraged ETF will rise 20%, and a triple-leveraged ETF will rise 30%. If you think this is true, you need to slow down and understand where this reasoning goes wrong. These ETFs get rebalanced daily and this changes everything. Example Suppose that a stock index alternates between rising 2% one day and dropping 1.9% the next day for 250 trading days in a year. Superficially, you might think that you are gaining 0.1% every two days repeated 125 times giving a 12.5% gain over the year. Sadly, it doesn’t work this way. Over 2 days, a $1000 investment would be aff...

Conrad Black has won a U.S. Supreme Court review of his fraud conviction for taking money from hapless investors. He has been serving his sentence for a little over a year now and hopes to be released by the Supreme Court. Black has nothing to lose and much to gain from this appeal. Black and others were convicted of giving themselves illegal bonuses of $6.1 million. This money is just a small slice of the total amount in question during the investigation into Black’s actions. The cost of employing lawyers to continue his defense up to the Supreme Court is not a concern. In poker parlance, Black is on a free roll. At worst if he loses the appeal his situation remains the same and he is forced to serve the remaining 5 years of his sentence. At best he will be released soon. It would be much more entertaining if there was some downside risk attached to this appeal. In most cases, I see appeals to higher courts as an effective means of keeping lower courts in line. But this ...

In a very unscientific poll of a few acquaintances who claim to have a fixed percentage asset allocation between stocks and bonds, I asked whether they did any trading to maintain their percentages through the recent stock market turmoil. It turns out that none did. The idea behind asset allocation is that when bonds are cheap, you sell some stocks to buy more bonds, and when stocks are cheap (as they were a couple of months ago), you sell bonds to buy stocks. If done properly, you are buying low and selling high. However, if the few people I spoke to about this are any indication, even investors with a fixed plan often aren’t managing to follow their asset allocations at the very time when it would be most beneficial. It takes courage to buy when the world seems to be crashing down around you. However, a financial plan isn’t worth much if you don’t follow it.

Happy Victoria Day! This is a special edition of the Sunday feature that looks back at selected articles from the early days of this blog before readership had ramped up. Enjoy. 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 T...

This is a Sunday feature looking back at selected articles from the early days of this blog before readership had ramped up. Enjoy. 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 ma...

1. Morningstar conducted a study of mutual funds in 16 countries. Preet gives us Canada’s overall scorecard . 2. Jason Zweig explains how women get better investing results than men . 3. Canadian Financial DIY is a little concerned about his retirement finances and has an amusing modest proposal for dealing with the swelling numbers of retired people . 4. Big Cajun Man finds that the recession has made it easier to give things away . 5. Million Dollar Journey addresses the question of what a young guy with an extra $5000 should do with it . The extensive reader comments are the most interesting part. It’s not hard to see why some people are chronically short of money.

The Ontario budget announced plans to change the sales tax structure on new homes. The way the harmonized sales tax will be applied starting in mid-2010 will create some perverse incentives that are likely to result in a cycle of tax avoidance and modified regulations. Under the new plan, all new homes will be taxed at the HST rate of 13%, but those selling for less than $400,000 will get a 6% rebate. New homes selling for more than $500,000 will get no rebate. The rebate gradually fades away between these two prices. A common reaction to all this “good – let the rich people who can afford big houses pay.” Even if you think this way, consider that if these thresholds remain the same in the future, inflation will eventually push the price of even modest new homes past these thresholds. Inflation will create a hidden tax increase each year. The sales tax on a $400,000 home will be $28,000, and the sales tax on a $500,000 home will be $65,000. This means that the marginal tax ...

If you ever watch come-ons for trading systems you’ll find that they are a lot alike. “It’s possible to make money in any type of market, whether stocks are going up, down, or staying the same.” They promise to teach you how to make money, but there is a catch. It’s true that you can make money in any type of market. If a stock is going up, you can profit by buying a call option. If the stock is going down, you can profit by buying a put option. If the stock is going to stay steady, you can profit by selling both call and put options. The unstated catch in all this is what if you are wrong? The answer is that you’ll lose money. If the companies behind these come-ons really could predict stock price movements, they would use their systems to make money rather than waste time teaching you how to do it. These companies profit from your activity. You pay fees to them for their software and platforms and for teaching you, and they may get part of the trading fees you pay. They ma...

Financial incentives are a big factor in driving behaviour. Understanding how mutual fund salespeople are paid helps in predicting how they will do their jobs. Investors who understand this are better able to protect themselves from conflicts of interest. A friend of mine, who I’ll call Tim, was caught between careers and tried selling mutual funds for a few years. His pay was commission-based. When he signed up a new client, he got 5% of the invested money immediately, and each year he got 0.5% of the invested money as a “trailer” commission. Some of this money had to be shared with other salespeople in his firm. The up-front 5% commission is sometimes paid for with a front-end load that the mutual fund charges the investor. In other cases the up-front commission is paid for with either the yearly MER fees that investors pay, or if investors pull their money out of mutual funds within about 5 years, they are charged a back-end load to help cover this up-front commission. Tim dre...

Historical data show that stock market indexes grow faster than the economy as measured by Gross Domestic Product (GDP). On the surface this seems impossible. The stock market is part of the economy, and while it may grow faster than the economy for short periods, it makes no sense that it could outperform GDP over the long term, but this is what seems to happen. According to data from Angus Maddison, from 1926 to 2000, Canadian GDP per person grew by a factor of 5 above inflation. Because the population grew as well, overall GDP rose by a factor of 16 above inflation. The U.S. had a similar experience with per person GDP rising 4.3 times, and overall GDP rising just 10.3 times. However, according to Ibbotson and Associates, over this same period of time (1926 to 2000), large stocks with reinvested dividends rose by about a factor of 300 above inflation, and small stocks rose by a factor of 700 above inflation! This means that large stocks outgrew U.S. GDP by about 4.7% per ye...

This is a Sunday feature looking back at selected articles from the early days of this blog before readership had ramped up. Enjoy. A mistake that some mutual fund investors make is repeatedly getting hit with back-end loads on their mutual funds. This can be a very costly for the investor, but lucrative for financial advisors. What is a back-end load? A back-end load is a percentage of your investment that you pay when selling out of a mutual fund. Other names for this are “contingent deferred sales charge”, “redemption fee”, and “exit fee”. A common arrangement is for the mutual fund to charge a 5% load if you sell within the first year, 4% if you sell in the second year, and so on until the back-end load drops to zero after 5 years. In such cases, the fund typically does not charge a front-end load. You may wonder how the fund could afford to eliminate the back-end load after 5 years if they had to pay the financial advisor at the beginning without collecting a front-end load. ...

1. Where Does All My Money Go gives us an insider’s understanding of what a financial advisor’s “turn on assets” means . 2. The Big Cajun Man debates what to do with found money . I’d say to pay off debt, or if you have no debt, invest it. If you feel strongly about blowing some of it, maybe you could blow the interest savings or investment returns instead.

Yesterday, I looked at how to protect a portfolio from a big drop in stock prices using put options , but the result was unsatisfactory. Mark Wolfinger left a comment suggesting selling a call option as well to create what is called a “collar.” This may sound complex, but the effect of a collar is simple enough. Your stock market returns are limited to a range. If stock losses are too deep, the purchased put options compensate you to limit your losses. If stock market returns are very high, the call options you sell limit your gains. You may wonder why anyone would bother with the call option part if they limit your gains. The answer is that you get cash from selling the call options that you can use to buy the put options. So, in trade for the guarantee that you won’t lose too much, your gains are limited as well. The particular strike prices of the options are what determine the limits on gains and losses. Of course, we prefer a tight limit on losses and a generous limit...

For investors who can’t stomach the volatility of investing 100% of their long-term savings in stocks, the usual advice is to put some fraction of savings into fixed income investments. Another approach is to use stock options to protect against large losses. Suppose that an investor Irene has $100,000 that she wishes to invest mostly in large U.S. stocks, but is nervous about losing money. One approach for Irene is to just put all of her savings into the S&P 500 (which is sitting at 900.80 as I write this) and live with the volatility. The following chart shows the returns for Irene across a range of possible outcomes in the S&P 500. We’ll focus on her results as of June 2010, a little over a year from now. It’s the lower left hand corner of this chart that worries Irene. The thought of losing that much money is scary. One solution is for Irene to put some money (say 30%) into fixed-income investments. The following chart compares the all-stock approach to the 70...

Most investors who are stock pickers have had the feeling at one time or another that a particular stock would go down. The usual response to this is to sell any shares they have or not buy shares. Some are tempted to short the stock, but this is a difficult game. Shorting a stock means to sell shares that you don’t own. You are essentially borrowing shares from someone else and selling them with the promise that you’ll buy the shares back later and return them to the original owner. This is done with the hope that the shares will drop in value between selling them and re-buying them so that you’ll make a profit. Unfortunately for short sellers, stocks tend to go up. Suppose that the stock market tends to go up 10% each year. So, investors in low-cost stock index ETFs make 10% per year, on average, without doing anything. To beat the index as a short seller, you have to find a stock that will go down by about 10% or more. If a short seller just throws darts at a stock listing, h...

The book Luck of the Draw: True-Life Tales of Lottery Winners & Losers by Chris Gudgeon and Barbara Stewart is a fun read, but it contains some very bad financial advice. This book is packed with funny and strange stories about lottery winners, but it may not be very good for the financial health of people inclined to buy lottery tickets. One unavoidable problem with a book like this is that reading about a new lottery winner on each page creates the impression that winning the lottery is common. It is exceedingly rare. You won’t win the lottery. Many of the stories discussed whether or not the winners would quit their jobs, even with modest-sized wins like a few hundred thousand dollars. This is not enough to retire on. Perhaps $2 million would be enough if the winner invests wisely and lives a middle class lifestyle without excessive spending. But how likely is that? Winners tend to splurge with plenty of help from family and friends. Page 60 contains advice supposedly fr...

This is a Sunday feature looking back at selected articles from the early days of this blog before readership had ramped up. Enjoy. Many people have investments in the form of retirement savings. For Americans, this might be a 401(K) or IRA, and for Canadians, an RRSP. Often these investments have been set up by a financial advisor. I have dealt with many financial advisors over the years and have learned a few things. 1. Competence. Most financial advisors seem to be well-meaning people who don’t know as much as you might hope about investing. I’m sure that there are exceptions to both the well-meaning part and the competence part. 2. Main focus of the job. Their job is more of a mutual fund salesperson than what most people would think of as a financial advisor. 3. Individual Customer Attention. The comprehensive personal financial assessment that they perform with each client seems mostly geared toward figuring out how much they can get you to invest in mutual funds. 4. C...

1. The saga of the dealership that messed up the contract on a Lexus continues at Where Does All My Money Go? 2. Big Cajun Man gives us the best financial advice he ever received in the form of a parable .