Archive | August, 2011

Peering into the Permanent Portfolio: Part 1

On Monday I introduced the Permanent Portfolio, an investment strategy created in the early 1980s by Harry Browne. It calls for investors to hold equal amounts of stocks, long-term government bonds, gold and cash. I recently spoke to Craig Rowland, the blogger behind Crawling Road, to learn more about the ideas behind the Permanent Portfolio.

What attracted you to the Permanent Portfolio?

CR: My background is computer security, so when I test something I always start by trying to break it. And when I looked at traditional index fund portfolios, I noticed there were periods of time where they basically broke. By that I mean they either had significant declines, or they had extended periods where they didn’t have real returns after inflation. I noticed, for instance, that during the entire decade of the 1970s, a stock/bond portfolio didn’t even beat inflation. And I noticed that in other countries that type of portfolio failed over protracted periods of time. So I became convinced that the traditional idea of asset-class correlations was incorrect.

So I started looking at Harry Browne’s Permanent Portfolio,

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Introducing the Permanent Portfolio

When Scott Burns created the original Couch Potato portfolio back in 1982, he suggested that investors put half their money in an S&P 500 index fund, and the other half in a bond index fund. At the time, that was a revolutionary approach to investing. It was based on the idea that picking stocks and forecasting the economy are futile, and that investors would be better off simply buying entire asset classes in equal amounts, and holding them at all times.

But the Couch Potato wasn’t entirely original. The year before, an American investment analyst and libertarian named Harry Browne co-authored a book called Inflation-Proofing Your Investments, in which he laid out his own passive strategy based purely on asset allocation. Browne suggested dividing your money equally among stocks, long-term government bonds, gold and cash. He called it the Permanent Portfolio.

When Browne created the Permanent Portfolio in the 1980s, it wasn’t particularly easy to manage on your own. (A mutual fund version of the of the Permanent Portfolio was launched in California in 1982 and is still going strong, albeit with a more complex asset mix that includes silver,

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Meet the New Funds, Same As the Old Funds

Vanguard Canada has yet to launch a single investment fund, but at least now we know what’s coming. On Tuesday, the company announced it had filed a preliminary prospectus for its first six ETFs.

When Vanguard first announced that it was coming to Canada in June, I wondered whether its arrival would really change the investing landscape. As much as I have enormous respect for Vanguard, I wasn’t sure whether another family of ETFs or advisor-sold index funds would offer Canadians anything they can’t already get. This new lineup of ETFs hasn’t done much to change my mind.

Let’s go through each of the six Vanguard ETFs and compare them to funds already available from iShares and other Canadian providers.

The Vanguard MSCI Canada will track an index of 100 Canadian stocks, so it falls right between the iShares S&P/TSX 60 (XIU), which has 60 large-cap holdings, and the iShares S&P/TSX Capped Composite (XIC), which has 260. (BMO and Horizons also offer large-cap Canadian equity ETFs.) The index—which is currently tracked by the iShares MSCI Canada (EWC) in the US—is not an improvement over the S&P benchmarks,

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Golden Advice That Suits Any Investor

I receive a lot of press releases, but few are as useful as the one that hit my inbox on Friday. It arrived after the markets closed, so I wasn’t able to act on it, but I’m sharing it with you today in the hope that you’ll benefit, too. According to a Toronto investment firm, gold may be overvalued based on the gold-to-decent-suit ratio.

This breaking news, which was picked up in Friday’s Financial Post, revealed that “the cost for an ounce of gold in 1967 was $35, exactly the same price as a decent suit from Eaton’s,” while in 1975, “gold weighed in at $100 an ounce, a 1:1 ratio with a decent suit from Eaton’s during the same year.”

However, with the shiny metal now at well over $1,800 an ounce, the gold-to-decent-suit ratio—let’s call it the GDSR—is way off. Today, says the investment firm, “a Burberry London men’s black wool two-button suit” costs a mere $1,150 at Holt Renfrew. “Although no one knows for sure, we believe that the price of a decent men’s suit and gold will converge to the same level.” Personally,

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Does Your Portfolio Need a Makeover?

Broad diversification is one of the pillars of the Couch Potato strategy. But getting exposure to thousands of stocks and bonds doesn’t mean you have to hold a dozen funds in your portfolio.

I recently received an email from a reader named Thomas who was concerned that his investments were getting unwieldy: “I am concerned I have ETFs with too much duplication and am not keeping it simple.” He agreed to let me use his situation as an example of how investors can make their portfolios more efficient and easy to manage.

Thomas has a pension and adequate RRSP savings, so he’s not worried about covering his retirement expenses. However, he also has about $115,000 in a taxable account and another $15,000 or so in a TFSA. “I have been looking at the taxable account and the TFSA as one overall portfolio,” he says. “I plan to use this money in one of two ways. The first option is to dip into it to renovate our home, perhaps to add a pool. Or I can just let the investments grow until I retire and fund the renovations with a line of credit, paid off in a reasonable time.”

Based on his risk tolerance and goals,

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Why More Choice Can Be Bad For Investors

We’re accustomed to thinking of choice as a good thing. But behavioural economists now understand that too many options can lead people to make poor decisions—or sometimes no decision at all. In her outstanding book The Art of Choosing (Twelve, 2011), Toronto-born Sheena Iyengar shares a story about how this affects investors.

In 2000, Iyengar, a professor at Columbia Business School, published a now-famous study in which undercover researchers set up tasting booths in a grocery store. Sometimes the booths displayed six flavours of jam, while other times they displayed 24 flavours. Shoppers were 50% more likely to be drawn to the large display. However, those who visited the booth with only six flavours were 10 times more likely to buy a jar of jam.

The following year, Iyengar got a call from a researcher at Vanguard. He wanted to know why the percentage of people enrolling in employer-sponsored retirement plans was steadily declining, even as the number of fund options was on the rise. He’d read the jam study and wondered whether something similar was at work.

Iyengar and her colleagues examined Vanguard’s data and found that the highest rate of participation (75%) was among employees who had just four funds to choose from.

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iShares ETFs: Looking Back, Looking Forward

This past spring, a number of Canadian iShares ETFs celebrated their 10th birthday. The country’s largest ETF provider now has 10 funds with a history that goes back to at least 2001, and according to the research firm Fundata, six of them were first quartile performers for the decade ending June 30, 2011. (This means they outperformed at least 75% of their peers.) A pair of others were second quartile, with only two lagging the category average:

iShares ETF
10-year quartile

DEX Short Term Bond Index Fund
1

DEX Universe Bond Index Fund
1

S&P 500 Index Fund
1

S&P/TSX 60 Index Fund
1

S&P/TSX Capped Composite Index Fund
1

S&P/TSX Capped Financials Index Fund
1

S&P/TSX Capped Energy Index Fund
2

S&P/TSX Capped Information Tech Index Fund
2

S&P/TSX Completion Index Fund
3

S&P/TSX Global Gold Index Fund
4

.
Fundata also reports that 11 of the 16 iShares ETFs with a five-year track record were first quartile performers, too. That’s an impressive result for a family of funds that simply try to capture the returns of an asset class with no attempt to beat the market.

An ETF history lesson

Even before iShares,

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Do You Have the Right Asset Allocation?

In the midst of the meltdown yesterday, I got an email from my wife. Several of her work colleagues had been discussing the carnage in the markets and she was worried: our daughter will start university next year, and my wife wanted to make sure our RESPs would survive another crash.

The answer was yes, of course. Knowing that we’ll need about $15,000 this time next year, I’ve set aside that amount in cash. Another 60% of our daughter’s RESP is in bonds, with the duration carefully matched to our time horizon. The account has less than 15% in equities, which I will move to fixed income over the next couple of years. With that asset mix, even a 50% decline in the equity markets won’t jeopardize our investment plan one bit.

My RRSP, on the other hand, is 70% equities, so it has taken quite a hit over the past few months. I’m not thrilled about that, but since I don’t need the money for at least two decades, this latest market mess is nothing but a speed bump. In fact, I’m trying to scrape together some cash to take advantage of the fire sale.

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Lessons From the Last Decade

This has been a scary few months in the markets, and nervous investors may be tempted to second-guess their strategy. If you’re an indexer, you may be starting to believe that it’s time to reposition your portfolio for the changes that are “certain” to come. Depending on which guru you listen to, that might be high inflation, rising interest rates, a double-dip recession, the collapse of the U.S. dollar, or a long period of poor equity returns. The voices are all shouting at you: This is not a time to be passive!

I thought it would be interesting to put ourselves in the mind of a Canadian investor on January 1, 2001, the start date of the 10-year period I looked at in my Couch Potato report card. You’ll recall that this simple portfolio returned 4% annually during that period, a result that most people would agree was disappointing, even though it beat 86% of comparable mutual funds.

2001: An Investor’s Odyssey

Based on what you knew about the economy and markets in 2001, could you have built a portfolio that would have done better? As you woke up with your New Year’s Eve hangover,

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