Archive | September, 2011

When Should You Use an Advisor?

Dan Solin’s excellent new book, The Smartest Portfolio You’ll Ever Own (see my review here), devotes several chapters to whether passive investors should work with an advisor. It’s a question I’ve considered before, and I think Solin has a lot of interesting insights to share.

The suggestion that most investors should use an advisor is a tough sell in the financial blogging community. Most Canadians with significant assets work with advisors, but the proportion of DIY investors is surely much higher among regular visitors to websites like this one. Indeed, many Couch Potatoes embraced the strategy after a negative experience with an advisor, and that aftertaste will take a long time to fade.

As a DIY investor myself, I’m happy to support people who manage their own portfolio. At the same time, I believe that most investors are likely to do better over the long run if they work with an advisor—as long as it is the right kind of advisor. Unfortunately, there are huge problems with the advice industry in Canada, which is dominated commissioned salespeople who charge hidden fees embedded in financial products,

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Review: The Smartest Portfolio You’ll Ever Own

There comes a time in every Couch Potato’s life when he or she has to answer a nagging question: can I do better? Sure, the three or four plain-vanilla funds in the Global Couch Potato have an excellent track record. But they’re just so dull. Surely you can squeeze out even better performance with a more sophisticated portfolio.

Financial advisor and author Dan Solin hears the question all the time. His previous book, The Smartest Investment Book You’ll Ever Read (Viking, 2006) is one of my recommended reads for new or would-be passive investors. That book, he writes, “spawned tens of thousands of savvy investors. They wanted to know if there was any way to improve the returns of the index fund portfolios I recommended.”

The answer is the basis of Solin’s newest book, The Smartest Portfolio You’ll Ever Own (Perigee/Penguin, 2011). It takes things one step further—actually, it takes things two factors further. The book explains how index investors can use the Fama-French Three-Factor Model to tilt their portfolios to value and small-cap stocks.

A new dimension in ETFs

Solin is an adviser who uses Dimensional Funds,

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Ask the Spud: RBC’s Target Maturity ETFs

Q: I just read about the launch of RBC’s family of target-maturity corporate bond ETFs. They seem like they would be an attractive option for the fixed-income portion of my RRSP. How do these products compare with more conventional bond ETFs? How do I compare their yields? And can I use them in a laddered fashion? — Karl T.

RBC became Canada’s sixth ETF provider when it launched a family of eight corporate bond funds last week. Unlike traditional fixed-income ETFs, which continually buy new bonds to replace those that mature, these new products have a “target maturity.” That means all the bonds in the fund will come due in the same year, and once they’re redeemed, the fund will be liquidated and all the money returned to investors.

ETFs like these are not exactly new in Canada: BMO launched four similar funds in January, with target dates of 2013, 2015, 2020 and 2025. However, RBC’s offerings fill in the gaps, covering every year from 2013 through 2020. Each ETF will mature on or about November 30 of the target year.

Extreme couponing

Whenever you buy an individual bond or a bond ETF,

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Balancing Your Dividend Holdings

One problem with the two leading Canadian dividend ETFs is that they are not very well diversified across sectors. The iShares Dow Jones Canada Select Dividend (XDV) is half banks and financials. Claymore’s S&P/TSX Canadian Dividend (CDZ) has the opposite problem: it includes none of the banks, and although it has a broader overall mix it is 25% oil and gas stocks.

The newest Canadian dividend ETF hasn’t seemed to generate a lot of buzz, but in my opinion it tracks an index that is better than both of the incumbents. The iShares S&P/TSX Equity Income (XEI), which was launched back in April, simply selects the 75 companies in the S&P/TSX Composite Index with the highest yield, period. (If there happens to be fewer than 75 stocks with yields above the median, other rules kick in.) These companies are weighted by market cap, but no company can make up more than 5%, and no sector more than 30%.

This index avoids the problem inherent in CDZ (which had to kick out the banks because they haven’t raised their dividends for five years running) and XDV (which is hugely overweight in banks because there is no sector cap).

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Claymore’s New Dividend Grower

This week saw the launch of the Claymore S&P US Dividend Growers (CUD), an ETF that will have great appeal for income-oriented investors. The fund tracks the S&P High Yield Dividend Aristocrats Index, made up of the 60 highest-yielding US stocks that have increased their dividends every year for at least 25 years. (The stocks are then weighted by yield, not by market cap.)

These are companies with a very impressive record of paying their shareholders. By comparison, the S&P/TSX Canadian Dividend Aristocrats Index requires only five consecutive years of rising dividends. Of course, a fund of Canadian companies with a 25-year record of increasing payouts would have one holding: Fortis.

In my series of posts about dividend investing last January, I expressed some skepticism about the devotion to dividend growth strategies. It’s not that there’s anything wrong with the companies that have paid reliable dividends, of course. It’s just that some investors seem to take it for granted that these stocks will deliver above-market returns. They’re influenced by graphs like this:

The problem with this graph is that it’s entirely backward looking.

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Commission-Free ETFs Arrive in Canada

It seems like every week we hear high-profile announcements about new ETFs, very few of which promise anything genuinely new. Then along comes something unique in Canada and I haven’t seen so much as a press release about it. Yesterday I logged on to my Scotia iTrade account and discovered that the brokerage now offers dozens of commission-free ETFs.

This is a big deal. While ETFs in Canada are dramatically cheaper than index mutual funds (with a few exceptions), one hurdle remains: buying and selling ETFs incurs commissions. In small accounts with the big banks’ discount brokerages, you can pay as much as $29 per trade. Of course, $10 trades are now commonplace, but even that fee makes small monthly contributions and dollar-cost averaging prohibitively expensive.

Last year, several U.S. discount brokerages—including Fidelity, Schwab and Vanguard—began offering commission-free ETF trades. I wrote a post in February 2010 wondering aloud if any Canadian brokerage would follow suit, and suggested that BMO was the obvious candidate, since they are the only firm to have both a discount brokerage and a family of ETFs. Now it turns out they’ve been beaten to the punch.

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The Permanent Portfolio v. the Couch Potato

Let’s end the week with one final post about the Permanent Portfolio. Many readers expressed interest in this strategy, introduced by Harry Browne in the early 1980s. I’ve spent so much time on the Permanent Portfolio because I find it fascinating, and I enjoyed discussing its subtleties with Craig Rowland, who has studied it extensively. I’d like to thank Craig for taking so much time to answer readers’ comments so thoroughly over the last couple of weeks.

There are many things I like about the Permanent Portfolio, especially that it’s a passive strategy based on asset allocation and diversification, rather than forecasting or security selection. I also think it’s extremely low volatility is perhaps the best example of Modern Portfolio Theory in action. But I can’t encourage investors in Canada to adopt the strategy. Here’s why:

With just one quarter of the portfolio allocated to stocks, I don’t feel there is enough potential for long-term growth. Stocks have delivered—by far—the highest real returns over the 85-plus years for which we have good market data. Yes, they are volatile, but they have historically rewarded long-term investors with excellent growth in a way that cash,

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Is Gold a Hedge Against Inflation?

In series of posts last week, I looked at Harry Browne’s Permanent Portfolio, which includes a hefty 25% allocation to gold. The reason for holding such a large amount, Browne argued, is that gold protects investors from the ravages of inflation.

The problem with this idea is that there’s no evidence that the price of gold is highly correlated with inflation—at least, not in Canada. This is one of those pieces of conventional wisdom that just doesn’t stand up to scrutiny. Gold has held its value when individual curencies have collapsed, like in Weimer Germany in the 1920s or more recently in Zimbabwe. But those are examples of catastrophic hyperinflation, which leaves people pushing around wheelbarrows of cash to buy a loaf of bread. I don’t think that’s what most people mean when they talk of gold as a hedge against inflation in their portfolio.

You can see how the idea developed in the 1970s. Inflation in Canada averaged almost 9% from 1970 through 1982, and gold would have provided an enormous safety net during this period: its annualized return (in Canadian dollars) was over 25% during those 13 years.

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Peering Into the Permanent Portfolio: Part 2

Here’s the second part of my interview with Craig Rowland, the blogger behind Crawling Road and a champion of Harry Browne’s Permanent Portfolio.

Any index investor who has studied diversification would agree with your overall idea, which is that a portfolio should be built to withstand a variety of risks and economic conditions. But what surprises a lot of people about the Permanent Portfolio is that it has equal buckets for each of the four asset classes. I can see using a portfolio that was 30% bonds, 10% cash, 10% gold and 50% stocks, or something similar. Why use a 25% allocation for all four?

CR: I hear this from people all the time: “You should own less gold,” or “You should own fewer long-term bonds.” And this is something that Harry Browne got asked many times over the years. The original Permanent Portfolio concept did have a more elaborate split, but my understanding is that over the years Browne basically discovered that it is simpler to just keep it even. He didn’t notice any significant advantage to the other methods.

The other problem with splitting the assets in a disproportionate way is that you are making an assumption that you know what’s going to happen in the future.

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