Archive | May, 2013

Does Dollar-Cost Averaging Work?

Many readers were surprised when I answered a recent Ask the Spud question by suggesting you’re usually better off investing a lump sum rather than using dollar-cost averaging (DCA).

DCA is popular technique that crops up all the time in personal finance books—David Chilton’s The Wealthy Barber was one of the first to popularize it back in the late 1980s. If you need a refresher, DCA is a strategy for investing a large sum gradually. For example, if you have $100,000 you might invest $25,000 today and the same amount in each of the next three quarters, or perhaps $5,000 at a time over 20 months.

The idea sounds appealing: if the markets plummet after you invest a lump sum, you’ll suffer a major loss and be filled with regret. However, by investing a little at a time you avoid putting all your money at risk immediately, and if markets decline you’ll benefit by making some of your purchases when prices are low.

Roy, the eponymous hero of The Wealthy Barber, made DCA seem like magic: “Dollar cost averaging is as close to infallible investing as you can get.

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Ask the Spud: Should I Buy In Now?

I’ve just inherited a six-figure sum and am interested in investing using the Couch Potato approach. What is your opinion on entering the market now, given it’s at a record high? — C.T.

This is the most common question I hear these days. It took almost four years for investors to finally admit we’re in a charging bull market—US markets are up more than 150% since March 2009—but most of the chatter now seems to be about a looming correction. This week, one noisemaker even came up with 21 stock market warning signs giving global investors cold sweats. Hard to believe he could only come up with 21.

Even if the media weren’t shouting like this, investing a six-figure lump sum would still be difficult. That’s especially true with an inheritance, since it often takes a while for beneficiaries to feel like that money really belongs to them. But in general—assuming you’ve done a careful risk assessment and have a target asset allocation in mind—it’s usually best to invest the money immediately. Here’s why:

Not everything is at an all-time high. While US markets have been on fire recently,

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Bond Options for the Socially Responsible

Most discussions about socially responsible investing (SRI) seem to revolve around stocks. If you’re an index investor with an interest in SRI, there are a number of ETFs that screen companies according to their environmental, social and governance report cards. But what’s an SRI investor to do when it comes to fixed income?

You might argue that bondholders need to be even more discerning than stock buyers if they’re concerned about investing in irresponsible companies. After all, when you buy a company’s bond, you’re lending it your money (though you’re usually picking it up on the secondary market rather than infusing the company with new cash). And bondholders don’t even get a vote like shareholders do, so they can’t exercise any influence on management.

But there’s a problem for Couch Potatoes with a conscience: there simply are no bond index funds that screen issuers according to SRI principles. You’ll have to choose a different option:

Use government bonds only. Instead of using a broad-based bond index fund—which will include about  20% to 30% corporates—you might select one that includes only government bonds. BMO offers half a dozen ETF options (both federal and provincial,

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Equity Index Funds for the Socially Responsible

Last week I shared my interview with Timothy Nash, the blogger behind The Sustainable Economist, and an expert in socially responsible investing (SRI). This week I’d like to profile a number of investment products that may be appropriate for Couch Potato investors who are interested in SRI.

I’m not endorsing any of these investments: I don’t use any of them myself, and although I’ve made an effort to understand what they have to offer, I haven’t performed any due diligence on them. You’re responsible for thoroughly checking out any investment before adding it to your portfolio.

Canadian equities

The iShares Jantzi Social Index Fund (XEN), launched in 2007, tracks the best-known SRI benchmark in Canada. The Jantzi Social Index excludes companies involved in military contracting, nuclear power and tobacco, as well those involved in “significant controversies” such as environmental spills. The index includes 60 companies and is designed to roughly mirror the sector weights of the S&P/TSX 60. For what its worth, XEN has outperformed the iShares S&P/TSX 60 (XIU) over the five years ending in April despite is much higher fee (0.55%).

The Meritas Jantzi Social Index Fund tracks the same index,

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More on Socially Responsible Index Investing

Here’s part two of my conversation with Timothy Nash, president of Strategic Sustainable Investments and the blogger behind The Sustainable Economist. (Part one is available here.) Next week I’ll go into more detail about specific investment products that combine passive investing with SRI principles.

Many socially responsible investors seem to think buying a company’s stock is somehow giving them capital they can use to do evil, and that’s why they’re wary about owning index funds. I’m not sure I buy that argument.

TN: I often get asked how much of a difference I’m making by owning socially responsible index funds or ETFs. And it’s tricky, because obviously when you own equities the money doesn’t go directly to the company—at least not once you’re beyond the IPO. But you can make the argument about cost of capital. When companies have a large market cap, the more demand there is for that stock, and the easier it is for them to raise capital.

There is another argument, too. With ethical consumerism—whether you’re buying fair trade, or local, or organic—you are impacting that invisible hand of the marketplace.

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Can Couch Potatoes Be Socially Responsible?

In my latest MoneySense column, I explored whether socially responsible investing is compatible with the Couch Potato strategy. If you’re not familiar with SRI, it’s about finding investments compatible with your ethics, which often means avoiding so-called sin stocks and companies with poor environmental records. It may also involve selecting investments that have a positive social impact.

My main source for that column was Timothy Nash, who helps institutions and individuals create portfolios aligned with their values. Tim also has a blog called The Sustainable Economist and recently wrote a post called The Organic Couch Potato, where he shared his ETF suggestions.

Tim is a thoughtful, articulate advocate for SRI and I thought readers would like to hear more from him, so here’s an excerpt from our interview. I’ll run another in a few days, and next week I’ll go into more detail about specific investment products that combine passive investing with SRI principles.

In many ways passive investing and SRI seem incompatible. One of the fundamental ideas behind indexing is that you don’t pick individual companies. But with SRI, that is often what you’re doing.

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ETF Dividend Dates Explained

Occasionally when you buy an ETF you won’t be eligible to receive the fund’s next dividend payment. At other times you’ll sell an ETF only to be paid a dividend a few days later. This is confusing for many investors, so let’s look at some important dates surrounding dividend payouts.

When a fund announces a dividend (or other distribution, such as an interest payment from a bond ETF), it will declare a record date and a payment date. For example, it might announce it will pay a distribution of $0.10/share to investors who own the ETF on January 15 (the record date), with the payment to be made on January 18 (payment date). In this case, if you sell your shares on January 16, you will still receive the dividend two days later, even though you no longer own the fund.

Two business days before the record date, the ETF will begin trading ex-dividend (“without dividend”). This means if you purchase the ETF on this date or later, you will not receive the upcoming dividend. For this reason the ETF’s net asset value—and therefore its price—will drop by the amount of the distribution on the ex-dividend date.

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Are Investors Really This Clueless?

Franklin Templeton recently released its 2013 Global Investor Sentiment Survey, which polled 9,518 people from 19 countries. The survey found that 81% of Canadian investors “expressed optimism about reaching their financial goals.” However, many of the other results suggest this optimism may be misplaced.

I want to stress this wasn’t a random survey conducted on street corners, where you would expect some respondents to be oblivious teenagers or people without money to invest. All of them were at least 25 years old and owned a significant amount of stocks, bonds or mutual funds, ensuring they had “a knowledge base from which to answer the survey questions.”

Here’s the first head-slapper: 52% of Canadians in the survey believed the stock market declined or was flat in 2012. In fact, the S&P/TSX Composite was up 7.2% last year. That’s a remarkable lack of awareness that shows how many investors still refuse to believe we’ve been enjoying a bull market for more than four years. Even more amazing, almost a third of US investors also said the market was flat or down in 2012, despite a rip-roaring 16% return for the S&P 500.

Given these misperceptions,

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Understanding Floating-Rate Notes

By now every serious investor understands the consequences rising interest rates will have on bond portfolios. For more than four years we’ve been reminded that when rates go up, bond prices fall—and the longer a bond fund’s duration, the greater the losses will be.

The conventional wisdom is to keep your bond duration short if you expect rates to rise. The problem is, the iShares DEX Short Term Bond (XSB) has a yield to maturity of just 1.38% these days—once you deduct fees, that’s less than a savings account at an online bank. And unlike a savings account (which effectively has a duration of zero), short-term bonds will still lose value if rates move higher.

It should come as no surprise that the financial industry has come up with a product that tries to address this issue: it’s called the floating-rate note. A “floater” has a maturity date like a conventional bond, but its coupon is tied to a benchmark such as the Canadian Dealer Offered Rate (or CDOR, which is this country’s version of LIBOR). The coupon is adjusted every month or every quarter.

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