Bernard Madoff was sentenced yesterday to 150 years in prison for investment fraud. At this point, the only people charged with a crime are Madoff and an outside accountant. Before his arrest, Madoff’s firm’s accounts showed $65 billion in assets, but only $1.2 billion have been recovered so far to return to investors. It is difficult to get a sense of scale of this fraud. One way to think of it is that the staggering 150-year sentence amounts to less than a day in prison for every million dollars missing in investors’ accounts. It seems inconceivable that only two people could have perpetrated this fraud. If prosecutors are unable to convict any other guilty parties, they would have to consider their efforts to be a failure.

The latest attempt to wiggle out of pension obligations to make the news is by the Globe and Mail in contract negotiations with its 440 unionized workers. Workers have rejected the latest offer and have given their union leadership a mandate to strike. Initially, the Globe and Mail wanted to move workers from a Defined Benefit (DB) pension plan to a Defined Contribution (DC) pension plan. Later they offered to allow current workers to remain in the DB plan (with higher contributions), but new workers would go into a DC plan. If financial pressures continue to mount for the Globe and Mail, it seems likely that there will be more attempts in the future to modify pension plans to reduce costs. There are many factors that go into how much DB and DC plans actually cost a company, but the bottom line is that if the company is saving money on its pension, then retired workers, on average, must be getting lower benefits. All this can be upsetting news for the wave of baby boomers reaching re...

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

1. Preet gives us a credit card payoff calculator . Hopefully this will inspire people to pay off their high-interest debt and not cause them to give up because it will take too long.

In many areas, grocery stores and other big box chain stores recently began charging a nickel for plastic bags. From a rational point of view, this should not have made a big difference. However, once the initial grumbling died down, there was a huge change in customer behaviour. In our household, this nickel charge would have added a little less than a dollar a week to our grocery bill. But, the drive to save these nickels is compelling to us and seemingly to most other people as well. We bring our own bags, and when we’re forced to pay for a bag or two, we put more items in each bag. The net result has been a huge decrease in the number of plastic bags given out by stores. And this change happened almost overnight because of a tiny charge for bags. Economic incentives like this one are often a much better way of driving behaviour than setting rules. Governments serious about driving citizens to greener choices would do well to design effective economic incentives rather than im...

President Obama plans to stiffen regulation of the U.S. financial sector, and critics are calling the planned changes socialism. However, this is far from the truth. In fact, the abuses that went on before the financial collapse were undermining capitalism, and changes are needed to regain a healthy capitalist system. To understand how the financial system was undermined, we need to understand the nature of the gambles taken by financial companies. What they did was to take risks that had a high chance of a modest payoff and a low chance of a huge loss. Why did they do this? So that the individuals involved could make money. Consider the following simplified example. Imagine that an employee can take a gamble with his company’s assets that collects a $5000 premium, but has a one in a million chance of losing $10 billion. From the company’s point of view, this is a bad gamble because if we do this a million times, we will collect $5 billion in premiums, but we expect to lose...

A former employer of mine, Entrust, is in the midst of a battle over a takeover bid by Thoma Bravo for $1.85 per share. Entrust’s board of directors is split over whether the deal is in the best interests of shareholders, and shareholders haven’t embraced the deal. The vote on the takeover was originally scheduled for June 8, but was delayed to July 10. The stated reason was to “allow stockholders adequate time to evaluate the new information,” but it seems obvious enough that the real reason for the delay is that the vote would have failed. I have now received 4 mailings urging me to vote for this takeover, each one more shrill than the last. The latest mailing contains the following on its own line: “WE URGE YOU TO VOTE ‘FOR’ BOTH PROPOSALS TODAY.” The “TODAY” part adds an amusing air of desperation to the request. The bid to complete this takeover took a blow when Arnhold and S. Bleichroeder Advisers, LLC, who control about 2 million votes and are accumulating shares, announced t...

Two years ago a law passed requiring airlines to advertise the full price of airfares. Unfortunately, it contained a provision to delay implementation, and this delay has continued to today. There seems to be little political will to enforce such a rule despite the fact that it is popular with Canadians. I decided to try a little test. Air Canada has a listing of special offers, the first of which is a $295 flight from Montreal to Bogota. However, here is a full listing of all the charges that came up for this route after I chose the lowest costs I could find: $314.99 outgoing flight $314.99 return flight -$15.00 receive no Aeroplan miles for outgoing flight -$15.00 receive no Aeroplan miles return flight $30.02 surcharge $252.00 fuel surcharge $31.00 airport improvement fee $17.00 air traveler security charge $11.18 JS $1.55 GST $36.88 Columbia domestic airport tax $979.61 Total So, $295 turned into $979.61, a 232% jump! If they just increased the $252 fuel surch...

This is a Sunday feature looking back at selected articles from the early days of this blog before readership had ramped up. Enjoy. Over the last 100 years, the Dow Jones Industrial Average has gone up by a factor of about 150. 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 century, 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 potential 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. ...

1. The Male Storm reports that if you’re willing to jump through a few hoops you can get $200 free from TD Canada Trust. 2. Preet has a great idea for a Father’s Day gift . 3. Big Cajun Man runs down the latest changes to the Consumer Price Index .

Some details of Obama’s plans for sweeping reform of financial regulations are now out. Even the full report lacks detail because of the scope of the reforms. It’s hard to figure out what effect all this will have on individual investors. The goals seem to be to prevent large financial disasters like the one the U.S. is now pulling out of and to increase consumer protections. Not surprisingly, commentators disagree on whether these reforms will achieve these goals. One of the more interesting things I found on this topic is that Edward Yingling, President and CEO of the American Bankers Association (which represents all banks), doesn’t like the reforms. If bankers were supportive of the reforms, I would have suspected that Obama was on the wrong path. A common theme from these experts is that “the devil is in the details.” There just isn’t enough information available yet to know what specific new regulations will be put in place to make investing in the U.S. safer. The com...

Until recently, if you accumulated points in some sort of loyalty program (like frequent flier points) while on business you were supposed to declare the value of these points as income. I doubt that many people actually declared this “income”. This was one of those rules that make a criminal out of many people who just didn’t bother to do the accounting (assuming they were aware of the rule in the first place). For most business travelers, the value of such points is fairly low and there was very little point in figuring it all out. Fortunately, the Canada Revenue Agency has changed the rule on loyalty program points. As long as you meet the following test, you no longer have to declare these points as income: - the points are not converted to cash, - the plan or arrangement is not indicative of an alternate form of remuneration, and - the plan or arrangement is not for tax avoidance purposes. I’m not 100% sure how these new rules would be interpreted, but it seems that t...

Recently, the Wealthy Boomer discussed the investment ideas of Zvi Bodie, a Boston University finance professor (the web page with this article has disappeared since the time of writing). Bodie advocates investing 100% of assets in inflation-protected bonds called Real Return Bonds in Canada and TIPS (Treasury Inflation-Protected Securities) in the U.S. These bonds pay a guaranteed rate of return on top of inflation. However, this guaranteed rate is quite low. Bodie uses 2% as a long-term estimate. The attraction is that these bonds are very safe even from inflation. Bodie uses the example of saving 100 kopecks per year for 40 years, and then withdrawing an inflation-adjusted 280 kopecks per year for 30 years of retirement. All this comes with no worries about stock returns or inflation. This sounds appealing, but it’s worth looking a little closer. To save for 40 years before retiring at age 65 means saving starting at age 25. I’m all for starting to save for retirement e...

The winners of the random draw for the book Inside the Mind of the Turtles: How the World’s Best Traders Master Risk , by Curtis M. Faith, are Marina and Alan. I have contacted the winners and have collected their addresses. The publisher, McGraw-Hill, says that the books should arrive in the next week or so. Thanks to everyone who entered the draw.

Many commentators advocate an investing strategy based on fixed percentage asset allocations among different types of stocks (large cap, small cap, domestic, foreign), bonds, cash, and possibly other things like commodities, real estate, or precious metals. This brings us to the question of what to do when assets grow beyond or shrink below their target percentages. The main debate is between rebalancing periodically based on time, such as quarterly, or rebalancing based on percentages, such as when an asset is more than 5% off its target percentage. I don’t particularly like either approach. I prefer a focus on costs. Suppose that an investor doesn’t have enough savings to qualify for low commissions on ETF purchases, and pays $25 per trade. If this investor doesn’t want to spend more than 1% on the sell and buy commissions, then all trades for rebalancing should be $5000 or more (and trades with new money should be $2500 or more). This leads to a simple rule: rebalance when the a...

This is a Sunday feature looking back at selected articles from the early days of this blog before readership had ramped up. Enjoy. An index investing strategy is a major threat to the mutual fund industry. 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 mutual funds with a Management Expense Ratio (MER) of 2% pays $2000 per year in fees. Up that to the $500,000 you’re hoping to have one day 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 w...

1. Preet explains the new “cash for clunkers” program in the U.S. that pays people to trade in old gas-guzzlers for a fuel-efficient car . Maybe this is a business opportunity for Canadians to sell their old vehicles to Americans who want a new car, but don’t have a clunker to trade in. 2. Big Cajun Man reports that membership in registered pension plans actually rose in Canada during 2007 . It seems a safe bet that this trend reversed in the past 17 months.

Much of economic theory is built on the assumption that financial returns follow the well-known Bell curve. However, there is much evidence to support the idea that the Bell curve understates the likelihood of extreme events. Some theorists believe that financial returns follow a Cauchy distribution, which is superficially similar to the Bell curve: However, the Cauchy distribution is narrower in the middle and higher at the sides. This means that mild events are a little less likely and extreme events are more likely. To see just how different these curves are for extreme events we need to look at the same curves on a log plot where each horizontal gridline represents a factor of 10: A 5-standard deviation event on the Bell curve is very unlikely, but the same event on this Cauchy distribution is about 6000 times more likely. So, if a financial institution was selling insurance against unlikely events based on the Bell curve, it might charge a million dollars, but really have a 6-bi...

“When most people are faced with making important decisions in the face of ... uncertainty, their gut reaction is to consult with experts ... even though [they] know that it’s impossible to foresee what the future will bring.” – Curtis M. Faith in Inside the Mind of the Turtles: How the World’s Best Traders Master Risk . Television shows are filled with experts predicting whether stocks, interest rates, and currencies will go up or down. The truth is that these people are just guessing. The odds may favour a given stock going up instead of down, but either outcome is possible. If we are betting on the outcome of a coin toss, no amount of consulting experts will allow you to determine whether it will come up heads or tails. However, for some reason we tend to seek and listen to experts who express opinions confidently about outcomes that, in reality, could go either way. A related human quirk is the tendency to seek the perfect course of action in the face of uncertainty. Committees...

The book Inside the Mind of the Turtles: How the World’s Best Traders Master Risk , by Curtis M. Faith is primarily about ways to both embrace risk and protect yourself from risk. The publisher, McGraw Hill, has graciously offered two giveaway copies for my readers. To enter the draw, send an email with the subject “Book” to the address shown on the upper right corner of this blog. The draw will close Sunday June 14 at noon. I will contact the winners to get (Canadian or American) postal addresses. Curtis Faith offers 7 rules for dealing with risk: 1. Overcome Fear. Fear clouds judgment. 2. Remain Flexible. Surprise outcomes may require a change of plan. 3. Take reasoned risks. Risk can be good if the odds are in your favour. 4. Prepare to be wrong. Plan in advance how to deal with unfavourable outcomes. 5. Actively seek reality. See the world as it is rather than as you want it to be. 6. Respond quickly to change. If your plan calls for some action in the face of unfavour...

A pleasant-sounding woman from Bell Canada called me up the other day to save me some money. She told me that I could switch from my current $20 per month long distance plan to a $15 per month plan that gives more free minutes per month. This seems like a no-brainer, right? For a second I was confused because I’m not on a $20 per month long distance plan. The Bell Canada lady checked again, and said that two different systems showed my records differently. Imagine that. No worries, though. She still seemed to believe that I’d be better off in the new $15 per month plan because I use Yak, and Bell charges me a dollar for each Yak call plus I pay the Yak charges. This confused me again. Surely, I would have noticed if Bell were charging me an extra dollar for each Yak call. She had lots more reasons why the new $15 plan is better than the roughly $7 I paid last month (a heavy long distance month for us). I had stayed on the call this long because I was interested in how Bell woul...

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

1. Canadian Financial DIY tries to get to the bottom of what Claymore means by “MER” and “management fees” . 2. Patrick makes a case against waiting until the market “calms down” . 3. Preet continues to look at strategies for simultaneously shorting both the bull and bear versions of leveraged ETFs . My suspicion is that over the long run the gains won’t exceed the interest on borrowed shares by enough to make this strategy sufficiently profitable, but I’ll reserve judgement until Preet is done fine-tuning this strategy. 4. Big Cajun Man saves money by buying meat at 50% off, but seems conflicted about whether he believes it is truly safe .

When you hold shares in a company, you get the chance to vote on issues that come up. Most of the time the results of these votes are expected to be a landslide, but occasionally the outcome is in doubt. This is the case for a former employer of mine. On June 8 shareholders will vote on whether to accept an offer from Thoma Bravo to buy Entrust for $1.85 per share. The curious thing is that Entrust closed at $1.92 per share on June 3. Shareholders are probably hoping for a better offer, or they believe the takeover will be voted down. The more interesting question to me is: Why would anyone vote to approve this takeover? It’s obviously better for a shareholder to sell shares for $1.92 now rather than approve the takeover and wait to receive $1.85. This reasoning makes sense for small shareholders who can sell without driving the price below $1.85. It’s possible that shareholders with large blocks of shares might prefer the takeover because they can’t sell their shares without driv...

I got the chance to view an advance copy of the DVD Let’s Make Money (available June 16) from Mongrel Media . It’s a documentary about the world’s financial system and how this system has failed some desperately poor countries. I like to hear multiple opinions on important issues, but that doesn’t necessarily mean that I buy everything I hear. One thing I look for is sensible detail. Accusing an organization of wrongdoing is more credible if the accusation includes details of how things were done and what the parties had to gain from their actions. One interesting part was remarks from John Perkins, a self-described former “economic hit man”. Perkins claims to have helped U.S. companies obtain natural resources cheaply from countries with the following steps: - Arrange a huge loan for the country from the World Bank. - Divert the loan to U.S. companies to build infrastructure projects in the country. - Choose projects that benefit a few rich and powerful people in the coun...

Banks seem to be getting quite generous with credit card rewards, particularly for premium cards. However, some Members of Parliament are unhappy with the fees charged merchants to pay for these rewards. On the surface it all seems like a great idea. You buy stuff with your credit card and later you get back a percentage in cash or in points that can be used to fly or buy stuff. Premium cards are even better because the rewards are bigger. But we know there is no free lunch. Who pays for all this? To answer this question we have to follow the money for a couple of steps. To begin with, merchants are charged fees for accepting credit cards. The amount they are charged is called the credit card interchange rate. This rate is higher for premium cards. Of course, since merchants get to keep less of the money from a sale, they have to raise prices. So, ultimately, consumers’ credit card rewards are paid for by consumers. But, consumers actually pay extra because banks keep a...

When homeowners try to break a fixed-rate mortgage, they can be blind-sided by a whopping interest rate differential (IRD) penalty. It’s important to understand what you are agreeing to when you sign for a mortgage. Periodically, your bank will send you a statement telling you what your current mortgage balance is, but this balance is not an accurate reflection of your obligation to the bank. To understand this, consider the following fictitious example. Bob and Sue Ward bought a house a year ago and got a $250,000 mortgage with a 5-year fixed term at 6% interest. With a 25-year amortization, the payments were $1599.52 per month. After 5 years, the remaining mortgage balance would be $224,592. Sue’s job is moving to another city and the Wards have now sold their house. Their latest statement says that the remaining mortgage balance is $245,501. However, this figure has no connection to the Wards’ actual obligations. When they signed for their mortgage a year ago, the Ward...