Archive | May, 2015

How Bad Data Leads to Poor Investment Decisions

Making smart investment decisions is difficult enough when you have reliable information. If you’re working with inaccurate or misleading data, good decisions become almost impossible.

The most popular source of confusion and misinformation has to be Google Finance. I don’t want to be too hard on Google: the company offers a suite of extraordinarily useful tools for free. But for Canadian investors, Google Finance provides information about ETFs and mutual funds that is highly misleading, and often flat-out wrong. Let’s look at some examples.

The price is right—but it’s only half the story

Google Finance (and other services offering online stock quotes) is useful for charting the changes in an ETF’s price over time. But it does not measure the effect of reinvested dividends and interest. That means you’re only getting half the story: the total return of an investment fund should always be measured assuming all distributions are reinvested.

This can make a dramatic difference when you’re looking at the performance of a fund that pays large distributions. For example, type ZRE into Google Finance and you’ll see the price change in the BMO Equal Weight REITs Index ETF during the 12 months ending April 30 was just over 5%:

The chart above shows the monthly distributions of $0.08 each,

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How Changing Interest Rates Affect Fixed Income

It’s been a tough few months for bonds. Since early February, the yield on Government of Canada five-year bonds has climbed from 0.59% to about 1.07%, and 10-year bonds yielding 1.24% have ticked up to 1.82%. The seesaw relationship between yield and price means bond values have fallen sharply: over the same period broad-based index ETFs such as the Vanguard Canadian Aggregate Bond (VAB) have lost well over 3%.

A 3% decline over several months is modest—it’s a bad day for stocks—but bond investors have been so accustomed to steady gains in recent years that it’s caused a lot of anxiety. More worrisome, it’s revealed that many investors have some fundamental misunderstandings about the relationship between bonds and interest rates, which admittedly can be confusing. Inaccurate information leads to poor investment decisions.

If the last five years have taught us anything it’s that forecasting the direction of interest rates is futile, and countless armchair economists have paid the price for trying to do so. A better approach is to get out of the guessing business and simply understand the risks of various fixed income investments.

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Should You Replace Bonds With Cash?

Not many investors are enthusiastic about bonds these days, and it’s hard to blame them. While rates have ticked up in the last few weeks, they’re still so low that even some sophisticated investors have abandoned them altogether. I’ve spoken to some investors who are ready to follow that advice, though they are not prepared to ride the roller coaster of a 100%-equity portfolio. So they’re asking whether they should just swap their bonds for cash.

At first blush, this looks like a good strategy. As of May 6, the yield to maturity on short-term bond ETFs is barely 1% after fees. Even broad-based bond ETFs (which have average maturities of about 10 years) have a yield to maturity well below 2% after accounting for management fees. Meanwhile, most investment savings accounts (ISAs) are paying at least 1%, and if you hunt around you can find high-interest savings products with much better yields: Equitable Bank offers one at 1.45%, while People’s Choice has a savings account at 1.60% and a TFSA savings account at 2.25%. Why take risk with a bond ETF when you can get a higher yield from cash,

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