Archive | January, 2010

Review: Rob Carrick's Guide

Rob Carrick is one of a small number of journalists who stand up for individual investors in this country. If you’re not a regular reader of his columns in the Globe and  Mail, I encourage you to start. His latest book, Rob Carrick’s Guide to What’s Good, Bad and Downright Awful in Canadian Investments Today (Doubleday Canada), is classic Carrick: straightforward, easy to read advice that doesn’t kiss any asses in the financial industry.

The book is perfect for browsing, because it’s organized into lists such as “Seven dumb rookie mistakes investors make and how to avoid them,” and “Ten signs of a rotten adviser.” Here’s one of his assessments: “If an adviser isn’t an indexing adherent, then he or she should at least recognize the value of this investing approach. The test is whether an adviser trashes indexing, and many will. If this happens, then keep looking.”

Couch Potatoes will find lots of value here, including Carrick’s picks for “Five essential  exchange-traded funds”: iShares XIU (Canadian large-cap equities), XBB (Canadian bonds) and XIN (international equities), as well as Claymore’s short government bond fund (CLF) and Vanguard’s Total Stock Market (VTI).

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Random Thoughts

The Toronto media is abuzz with stories about jaywalking. Over the last two weeks, 14 pedestrians have died while crossing the street in the Greater Toronto Area, a surprising rate of carnage in a city that sees about 30 pedestrian deaths in a typical year. “Why aren’t we talking about lowering speed limits, increasing penalties or narrowing city streets?” asked one outraged scribe in The Toronto Star. The Sun called the deaths “a worrying trend for safety experts.”

So what does this have to do with investing, you ask? It’s a classic example of our inability to accept randomness: the same human failing that compels us to ascribe a rational explanation to every move in the stock market.

Humans are hard-wired to explain things with stories. A large number of pedestrians killed in a two-week span? It must be “a worrying trend” caused by fast drivers and wide streets. Except that drivers aren’t going any faster than they were three weeks ago, and the roads aren’t any wider. Overall, the number of deaths on Toronto roads has been trending down for years. Why is it so hard to accept that the current spate of pedestrian casualties is simply a random statistical event?

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The Trouble With Leveraged ETFs

Being a Couch Potato is about buying, holding and rebalancing over the long term. Exchange-traded funds are great tools for index investors, but not all ETFs are designed for Couch Potatoes. In fact, some are nothing more than gambling instruments.

Readers may have noticed that my list of Canadian ETFs does not include most of the offerings from Horizons BetaPro. That’s because many of the ETFs from this provider are radically different from those of iShares, Claymore and BMO.

Horizons’ so-called leveraged ETFs promise to deliver double the return of the index they track: if the Canadian stock market goes up 2% in a given day, the Horizons BetaPro S&P/TSX 60 Bull Plus should go up 4%. If the index declines, the ETF will lose twice as much. The Bear Plus ETF works the other way around, delivering twice the inverse of the day’s returns: if the market drops 2%, the fund goes up 4%. Canadian investors love these things: they are among the most frequently traded securities on the TSX.

In the hands of a professional, leveraged ETFs may be useful for managing short-term risk.

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The Next Hot Fund Manager

Still not convinced that the big returns you occasionally see from stock pickers and fund managers are the result of luck rather than skill? A Russian financial magazine reported this month that it has identified a money manager whose extraordinary stock picking beat more than 94% of professional fund managers last year.

Her name is Lusha, and she’s a circus chimpanzee.

At the beginning 2009, the magazine’s editors presented Lusha with 30 cubes on which were written the names of stocks. They asked her to choose eight of them, and her picks tripled in value during the year. According to a report in the UK’s Daily Mail, Lusha focused her picks on banks, a shrewd forecast. Her play on mining resulted in a return of more than 150%, though she missed out on the telecommunications sector, which rose 250% during the year.

Apparently Russian fund managers are not amused: “’If the experiment had taken place a year earlier, the monkey would not have had enough money to pay for her bananas,” one fumed. We beg to differ: if Lusha was charging her clients a management fee of 2.5%, we think she’d have done just fine.

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Should You Buy US-listed ETFs?

Jason, a reader of this blog, recently wrote to ask why an investor would want to invest in Canadian-listed  ETFs that hold US stocks when there are US versions with much lower fees.

For example, the iShares Canadian S&P 500 Index Fund (XSP) charges 0.24%, while the Vanguard Total Stock Market ETF (VTI) has an MER of just 0.09%. Jason had several specific questions—all very good ones—which I’ll attempt to answer.

Q: When one holds a US-based ETF, are the dividends paid out in US dollars and then converted to Canadian dollars by the brokerage, costing the investor conversion fees?

Yes, dividends earned from US-listed ETFs are paid in US dollars. If you hold the ETF in a taxable account, the dividends simply go onto the US-dollar side of the account. But if you hold the ETF in RRSP or other account that does not allow US dollar holdings, your broker automatically converts them before depositing them in your account. This usually incurs a fee of about 1% or more: check your broker’s website or call and ask.

While this conversion fee does cause a small drag on your dividend return,

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Couch Potato Basics, Part 5: Tax Efficiency

This post is the fifth in a five-part series outlining the primary benefits of the Couch Potato strategy.

All investors have to deal with the erosion of their returns by fees and taxes. The first post in this series explained how using ETFs and index funds can cut your costs by 90% or more. Now let’s look at how index investing can also cut your tax bill.

Fair warning: this subject is rather technical and it may leave beginners baffled. The good news is that if all your investments are in registered accounts—RRSPs, RRIFs, RESPs or Tax-Free Savings Accounts—you don’t need to worry about it. But if you’re investing in a taxable account with actively managed mutual funds, you may want to settle in. It just might save you some money.

Most mutual funds are structured as open-end trusts, which enables them to avoid paying taxes. Instead, funds pass along any interest, dividends and capital gains to their unitholders. (Mutual funds incur a capital gain any time they sell stocks, bonds or other securities at a profit.) Usually all of these distributions are reinvested rather than paid in cash, but unitholders are still responsible for paying tax on them: that’s why you get that T3 slip in the mail every year.

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Couch Potato Basics, Part 4: Flexibility

This post is the fourth in a five-part series outlining the primary benefits of the Couch Potato strategy.

Anyone who has invested in both mutual funds and individual stocks knows there’s a world of difference in how they are traded.

You can determine a stock’s current price almost instantaneously. If you place a market order to buy a popular stock, chances are your trade will be executed in seconds, extremely close to the quoted price. And if you’re adamant about receiving a particular price, you can place a limit order, which specifies the maximum you’ll pay when buying, or the minimum you’ll accept when selling. You can do this any time the markets are open.

Mutual funds are far less flexible. Funds calculate their net asset value (NAV) just once daily, after the market closes, and then carry out trade orders made during that day. So even if you place an order to buy or sell at 10 in the morning, the trade will be executed based on the price set at end of that trading day. If you’re moving a large sum, a market drop of even 1% or 2% can cost you a significant chunk of money.

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Couch Potato Basics, Part 3: Transparency

This post is the third in a five-part series outlining the primary benefits of the Couch Potato strategy.

Have you ever tried to learn exactly what stocks or bonds are held in a mutual fund? Don’t bother: it’s impossible.

Mutual funds are required to disclose their holdings only once each quarter, and by the time those reports are released the makeup will have already changed: the most you’ll learn is what the top holdings were weeks or months ago. That makes buying a mutual fund an act of faith as much as anything else.

ETFs, on the other hand, are refreshingly transparent. Their holdings are published every day on the fund company’s website. That makes comparing funds a breeze.

Say you’re trying to decide whether to buy the iShares Canadian Dividend Index Fund (XDV) or its competitor, the Claymore S&P/TSX Canadian Dividend ETF (CDZ). By visiting their websites and clicking the “Holdings” link, you’ll learn that XDV holds 30 stocks, while CDZ holds 56. You’ll know exactly what proportion each stocks represents in each fund. You can compare their weightings in the various sectors, and see their current yields.

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Couch Potato Basics, Part 2: Pure Asset Allocation

This post is the second in a five-part series outlining the primary benefits of the Couch Potato strategy.

Most investors understand the importance of diversifying. By spreading your money across different asset classes—cash, bonds, stocks, real estate, commodities—you can lower your portfolio’s overall risk and boost your returns over the long term. In fact, your asset allocation is probably your single most important investment decision.

Unfortunately for investors buying actively managed mutual funds, getting that target asset mix is often extremely difficult.

Say you decide to split the equity portion of your portfolio equally among Canadian, US and international developed countries. For your domestic and US stocks, you choose the Trimark Canadian Series A and Trimark US Companies, respectively. You round things out with the Dynamic EAFE Value Class fund, because it trounced its benchmark in 2009. (That benchmark, the MSCI EAFE index, includes 16 developed countries in Europe, plus Australia, New Zealand, Japan, Hong Kong and Singapore.)

You might reasonably expect this would put about 33% of your money in each of the three regions. But you’d be wrong.

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