In episode 24 of the Canadian Couch Potato podcast, I’m joined by Preet Banerjee, the Renaissance man of personal finance. After a stint as an investment advisor, which ended in disillusionment, Preet went on to become a media personality, an author, public speaker, fintech entrepreneur and academic. In our interview we discuss his current research on the plight of the Canadian investor, as well his latest project, called Money Gaps, an online tool designed to help advisors offer better financial planning services to their clients.
The worst argument for active investing ever?
In the Bad Investment Advice segment, I almost lose my composure responding to an article that recently appeared on the Forbes website called Why Most Index Funds and ETFs Are Not Good Investments.
The author of this piece uses a common technique in the financial industry: he takes some seriously biased data compiled by an investment firm, dresses it up as a “study” and tries to pass it off as evidence that active funds should be expected to outperform index funds and ETFs.
The term “study” suggests some academic rigor, but what we have here is actually a marketing piece created by Fidelity Investments to sell its active funds to advisors. Anytime someone with a vested interest presents data like this, it’s important to understand the methodology. And in this case, if you dig into the fine print you’ll be smacking your forehead in disbelief.
I wasn’t the only one who was blown away by this shabby, irresponsible argument: Jason Zweig refuted the Forbes article and Fidelity’s claims in a piece in the Wall Street Journal (subscription may be required). Sometime later, Fidelity removed the offending slide deck from its website. Can’t say I blame them.
Should you buy a condo or REITs?
Our listener question this time comes from Sheraz, who is thinking about buying a rental property and is wondering whether a REIT fund might be a good alternative.
A lot of investors like to draw a parallel between purchasing a rental property and buying real estate investment trusts. Some homeowners say they would never purchase REITs in their portfolio because they already have a significant amount of their net worth tied up in their house. Renters, on the other hand, sometimes argue they should add REITs so they’re not getting any exposure to real estate through homeownership.
The problem with these comparisons is that houses and condos are unique, undiversified assets, and they are unlikely to have any correlation at all with a portfolio of REITs. For example, the iShares S&P/TSX Capped REIT Index ETF (XRE) holds 19 individual Canadian REITs comprising about 30% retail properties, 24% residential, 11% office space, 10% industrial, and a number of other smaller categories. There must be hundreds, perhaps thousands of individual properties in this portfolio, and they will be spread out all over the country. The price of your suburban bungalow in southwestern Ontario or your two-bedroom condo in Calgary is likely to have zero correlation with Montreal office towers, a Burnaby shopping centre, or a senior’s residence in Moncton.
That’s why I think it’s unhelpful to think of this decision as, “Should I buy a condo or should I buy a REIT ETF?” This is not much different from saying, “Should I start my own business or by a broad market equity ETF?” Everyone can appreciate that owning one business is fundamentally different from owning a small stake in hundreds or thousands of businesses. But this seems somehow seems less obvious in the context of real estate.
The decision is really more about whether you are prepared to be a landlord, or whether you would prefer the more low-maintenance option of owning a diversified portfolio of ETFs.
It’s probably fair to say that a traditional index portfolio will generate less income than one that includes REITs, but that’s not necessarily a problem, even in retirement: it’s easy enough to generate regular cash flow from your portfolio even without investments that focus on yield.