Archive | July, 2014

Do You Really Know Your Risk Tolerance?

Almost 75 years after it was written, Fred Schwed’s Where are the Customers’ Yachts? remains one of the most entertaining books ever written about the investment industry. Here’s one of its best remembered lines: “There are certain things that cannot be adequately explained to a virgin either by words or pictures. Nor can any description I might offer here even approximate what it feels like to lose a real chunk of money that you used to own.”

As Schwed recognized all those years ago, no one can really gauge their risk tolerance by filling out a questionnaire, or by pondering standard deviations. It’s easy to say that you have a long time horizon and you won’t panic in a downturn. But the fact is, no one really knows how they will react until they have actually lived through a devastating bear market.

And if you only started investing in the last few years, you haven’t been tested yet.

According to a Bloomberg article published earlier this month, the S&P 500 has now gone more than 1,000 days without a correction of 10%. The last time investors enjoyed a run like this was a 1,127-day period that ran from July 1984 to August 1987,

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Drilling Down into the iShares Core ETFs

When iShares launched its Core ETF series back in March it made some waves in the industry. The company cut the fees on nine ETFs it considers building blocks of a long-term portfolio. Its boldest move was to slash the cost of one of its flagship products, the iShares S&P/TSX Capped Composite (XIC). At the time XIC was weighed down by a management fee of 0.25%, much higher than its competitors from Vanguard and BMO. After that fee was reduced to a stingy 0.05%—making it the cheapest ETF in the country—it prompted BMO to follow suit less than a month later.

Now more moves are afoot. On July 21, iShares rebranded these nine ETFs to include “Core” in their names. They also launched a new addition to the family: the iShares Core Short Term High Quality Canadian Bond (XSQ).

The new ETF is extremely similar to the iShares Canadian Short Term Bond (XSB) in most respects: both are about 60% government bonds and 40% corporates, and the holdings are all investment-grade (rated A or higher). Their fundamentals are almost identical:

XSB
XSQ

Yield to maturity
1.58%
1.55%

Average coupon
2.98%
2.81%

Duration
2.83
2.77

Average term
2.83
2.92

Source: BlackRock Canada

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Why Practice Doesn’t Make Perfect in Investing

In almost everything we do—whether it’s learning the violin, playing chess or excelling in sports—practice makes us better. In his bestselling book Outliers, Malcolm Gladwell popularized the “10,000 hour rule.” It says no matter how talented one might be, becoming a virtuoso musician, a chess grandmaster, or an elite athlete typically requires approximately 10,000 hours of practice.

Even more important, you need to receive useful feedback during your practice. In Thinking Fast and Slow, the psychologist Daniel Kahneman explains that learning to drive is one activity where feedback is immediate and clear. When you’re taking curves, you instantly know whether you’ve turned the wheel too sharply or applied the brakes too hard. This makes it relatively easy to improve as a driver. By contrast, a harbour pilot learning to guide large ships experiences a longer delay between his actions and their outcomes, so the skill is harder to acquire.

Now consider how these ideas apply to investing. Someone who has little experience is likely to make many mistakes—which is normal in any new activity. They might think they’re well diversified even if they own just five Canadian stocks, or they may choose a bond based solely on its yield,

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Under the Hood: Vanguard FTSE All-World ex Canada (VXC)

This post is part of a series that takes a detailed look at specific Canadian ETFs or index funds.

The fund: Vanguard FTSE All-World ex Canada Index ETF (VXC)

The index: The fund tracks the FTSE All-World ex Canada Index, which includes “primarily large- and mid-capitalization stocks of companies located in developed and emerging markets, excluding Canada.” The index includes approximately 2,900 stocks in 46 countries.

The cost: The management fee is 0.25%. Since the fund is brand new we don’t know the full MER, but it should be less than 0.30% after adding taxes and incidentals.

The details: VXC started trading on July 7 and was one of five new Vanguard ETFs launched that day. The fund is a one-stop solution for those looking to diversify outside of Canada. Not so long ago, investors needed two or three ETFs to get exposure to the US, international developed markets and emerging countries (unless they were willing to buy US-listed ETFs). Now they can get it with a single fund.

VXC weights each country according to the size of its capital markets,

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Bond Bears: Admit You Were Wrong

One of the most common excuses made by forecasters is, “I wasn’t wrong, I was just off with the timing.” But that fails to acknowledge that timing is an integral part of any forecast. Imagine a weather reporter predicting rain on Monday and claiming he was still right when the downpour doesn’t arrive until Thursday.

We need to demand the same accountability from the commentators who have been predicting rising interest rates for about five years now. Even if rates do rise significantly in the next year or two—which would cause bond prices to fall—they won’t be able to claim their predictions were accurate but merely late. The only honest thing to do is admit they were dead wrong—and to stop making forecasts that encourage investors to abandon their long-term plans.

The bond bears had already been growling for a couple years when I wrote a column on this topic for a 2011 issue of MoneySense. The article quoted an advisor who had arrogantly told me “the bond index funds you recommend in your Couch Potato portfolios will soon be a disaster.” Like just about every other commentator at the time,

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