Archive | August, 2010

Investing Lessons From the Poker Table

This week I beat a group of seniors and took $200 from them.

No, I’m not a purse-snatching hooligan who preys on the elderly. I’m just a guy who loves to play poker, and on Tuesday I took a day off to visit the local casino, where I played poker at a table with several amiable older gentlemen. The experience got me thinking about how poker and investing teach many of the same lessons:

Short-term results are meaningless. I’ve played poker alongside some truly bad players who always seem to hit miracle straights or flushes and scoop big pots. When these players beat you, it can make you wonder whether you should be playing differently — maybe you should start playing more hands, or calling big bets with weak draws, since it seems to be working so well for that guy. Investors fall into this same trap when they second-guess the Couch Potato strategy during every period of poor returns. In both poker and investing, you need to stick to a proven strategy: you will succeed in the long run, even if you have to suffer streaks of bad luck.

Play the percentages,

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Choosing a Dividend ETF

Rob Carrick’s column in The Globe and Mail this Saturday looked at the three dividend ETFs listed on the TSX. Rob asked three bloggers to share their picks: Canadian Capitalist, Million Dollar Journey, and yours truly. I’d like to explain my choice in more detail.

Let’s begin with a review of the three ETFs in question:

Horizons AlphaPro Dividend (HAL) is an actively managed ETF that “invests primarily in equity securities of major North American companies with above average dividend yields.”

Claymore S&P/TSX Canadian Dividend (CDZ) tracks the S&P/TSX Canadian Dividend Aristocrats Index, which focuses on dividend growth. Companies in the index must have raised their dividends in each of the last five years.

iShares Dow Jones Canada Select Dividend (XDV) holds the 30 highest-yielding stocks, though it also screens candidates based on dividend growth and average payout ratio.

I don’t think active management will add value after costs, so that rules out HAL. This ETF currently holds about 10% in cash, reserves the right to hold preferred shares and bonds, and its commentary talks about waiting for the market to reach its targets before deploying that cash.

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TD Responds to e-Series Concerns

In a recent post, I shared a reader’s story about how difficult it was for her to open a TD e-Series Mutual Funds account. That elicited responses from dozens of readers who had similarly unpleasant experiences, as well as several who weren’t sure what all the fuss was about.

I contacted TD about the issue and received a response from Maria Leung of Corporate and Public Affairs, TD Bank Financial Group. Her explanations should help clear up some of the confusion surrounding these otherwise excellent index funds.

Many people who commented on the original post said they tried to open an e-Series account at a TD branch, only to encounter staff who had little or no idea what the e-Series funds were. So my first question was about that unfamiliarity:

While TD Mutual Funds offers a broad range of investment solutions, not all are actively promoted in each of our distribution channels. For our TD e-Series Funds, customers purchase the funds online, either through TD Canada Trust’s EasyWeb site, or if they are TD Waterhouse Discount Brokerage customers, online using WebBroker (discount brokerage accounts can be opened at any TD Canada Trust bank branch or TD Waterhouse Investor Centre across the country).

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More Promises of High Yield Without Risk

Earlier this week I argued that savings accounts and GICs are still the best vehicles for short-term savings, because higher yield comes with higher risk. I thought that was an obvious point, but it seems that even the venerable Kiplinger’s Personal Finance has forgotten this basic truth of investing.

The September 2010 issue of the popular magazine features a cover story called 10 Great Mutual Funds That Deliver High Income, by senior editor Bob Frick. The article itself makes no outrageous claims, but in a podcast interview about the piece (available at iTunes), Frick takes a journey into Fantasy Land. After lamenting the low yields of US Treasuries, and the likelihood that they will fall in value in the near future, Frick recommends a Fidelity fund that invests in emerging market bonds. “You just cannot ignore a fund that is going to pay you 12%,” he says gleefully. Going to pay? The fund in question has posted excellent returns in the past, but no bond fund is going to pay any guaranteed return. For all Frick or anyone else knows, the fund might lose 12% or more next year.

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Lunch Is Still Not Free, Even If It’s Potatoes

I occasionally hear from readers who want to know which ETF or index fund portfolio would be a suitable place to stash their short-term savings. Inevitably I disappoint them with my reply: “Short-term savings belong in a high-interest savings account or GICs.”

With even online banks paying just 1.5% to 2% in savings accounts these days, it’s tempting to look at an ETF of real-estate investment trusts (REITs), preferred shares or high-yield bonds and try to pull down 5% to 7%, or more. It’s also a terrible idea for short-term investors.

The Couch Potato strategy works over the long-term because it dramatically reduces fees and provides broad diversification. However—and this is a critical but often misunderstood point—an index strategy offers absolutely no protection from falling markets. Indeed, it may offer less protection, since actively managed funds have the option to move into cash when markets are volatile. Index funds are as fully exposed to the market as a streaker on the TSX trading floor. That’s why index portfolios are not appropriate for people who want to protect their capital for a couple of years as they save for a house,

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Adapting the Lazy Portfolios for Canada

In Monday’s post, I had some fun at the expense of Paul Farrell, the MarketWatch columnist who champions index investing while at the same time forecasting the coming apocalypse. What got lost in the discussion was that Farrell’s Lazy Portfolios are actually worth a look. They’re all built with an eye toward rock-bottom cost and broad diversification.

There are loads of other model portfolios out there, too. The Oblivious Investor, a US blog that advocates indexing, lists 8 Lazy ETF Portfolios of its own. (Some are the same as Farrell’s.) The site’s creator, author Mike Piper, also includes links to the original sources of these portfolios, many of which include historical returns. Or you can shuffle over to Asset Builder, an advisory firm run by Scott Burns, creator of the original Couch Potato. His site is also packed with model portfolios.

The problem for Canadians is that all of these portfolios are designed for Americans. They typically include about two-thirds of the equity allocation—and all of the fixed income—in US funds. The good news is that adapting them for Canadian investors is quite easy.

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Will the Real S&P 500 Please Stand Up?

I received an email recently from Scott, a reader with a great question about index funds and ETFs that track the S&P 500. He agreed to let me share his letter and my response.

“I’ve been using index funds for some time now, but have been giving ETFs more thought. Specifically, I’m interested in switching my TD U.S. Index Fund (e-Series) to a U.S.-listed ETF such as the SPDR S&P 500 (SPY). Before I proceed though, I’d like to know why the TD fund has lagged behind SPY in terms of return? I was told in a forum that it may be due to the currency in which I am purchasing the funds. TD e-Series funds require me to use Canadian dollars. However, buying SPY would require me to use U.S. dollars. Do you have any insight about why there is much of a difference between the two?”

First, it’s important to note that there are actually three e-Series funds that track the S&P 500, and they all have very different characteristics:

Scott owns the TD U.S. Index (TDB902) fund, which is bought and sold in Canadian dollars,

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When Couch Potatoes Go Bad

Paul B. Farrell, a long-time columnist with MarketWatch, seems to have taken leave of his senses.

For years, Farrell has been a staunch defender of index investing, and he has tracked the performance of eight Lazy Portfolios of index funds and ETFs, each created by popular finance authors or prominent investment advisors. (All of them are designed for American investors, but Canadians can easily modify them.)

On July 13, Farrell wrote a column announcing that all of the funds in the Lazy Portfolios finally have a 10-year track record. So for the first time, he was able to review their decade-long performance, and the results were that all of them beat the S&P 500. Granted, the S&P 500 returned –1.59% over those 10 years, which means my chequing account was a better investment, and a large-cap US index is not an appropriate benchmark for a diversified portfolio. But in any case, most of the Lazy Portfolios managed to eke out gains between 2% and 5% during a decade that started and ended with massive crashes, which is a relatively good result.

The problem is that Farrell isn’t following his own advice.

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Would You Like Fees With That?

I’ve grown used to the antics of mutual fund companies and commission-based fund hawkers who criticize index investing. It’s predictable, pathetic and unlikely to change. What really disappoints me, however, is when the antics come from an investment company that I thought was one of the good guys.

Readers of this blog and my work in MoneySense know that I have often recommended the TD e-Series index funds for Couch Potato investors. They have the lowest MERs of any retail funds in the country, a long record of low tracking error, and the added benefit of being available online without a discount brokerage account. But this week I got an alarming email from Shannon, an investor in western Canada who is untangling herself from a large and notoriously expensive financial services firm. Shannon has decided to get started with index investing and, having read about the e-Series funds, gave TD a call. Here’s how she described the bank’s behaviour:

“First, we were encouraged to invest in regular TD mutual funds. When we said no, we wanted the e-Series index funds, we were told that the I-Series were just as good and could be bought at the branch.

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