Monthly Archive for January, 2006

Beating Bill Miller

Ever since my advisor recommended Bill Miller’s Value Trust fund I’ve been following him closely. An article, “Beating Bill Miller” caught my eye. The article raises the interesting point, that while he has beaten the S&P 500 every year for the past 15 years, there are other funds that, while maybe losing to the S&P500 in any given year, have beaten his fund over the same time period:

We congratulate Miller on his fine performance, but we’d be remiss if we did not point out that while he has indeed outperformed the S&P 500 Index since the first Gulf War, there are funds (22 of them, in fact) that have outperformed Legg Mason Value Trust over the same time period, according to Morningstar.

Even though these funds may not have beaten the benchmark in each and every year, they have produced returns higher than the 16.44% annualized posted by Miller over the same time period (net of fees and reflecting reinvestment of all distributions).

Miller himself tries to play-down the emphasis on beating the market on a yearly basis and tries to remind investors to think longer term:

In a letter this week to shareholders, Miller said that investors buying into LMVTX because of its 15-year run of benchmark-beating may be setting themselves up for disappointment. “Our goal is to construct portfolios that have the potential to outperform the market over an investment time horizon of three to five years without assuming undue risk,” writes Miller. “If we achieve that goal, we believe we will be doing our job, whether we beat the market each and every year or not.”

In the next couple articles I’ll go over a few of the article’s suggestions for other value-oriented funds which have beaten the S&P500 and Bill Miller’s Value Trust in the past.

Popularity: 5% [?]

Bad Real-Estate Advice

I promise this will be the last article with “bad” in the title in a while. There is never a shortage of bad financial advice though, in fact sometimes I feel like the majority of the advice out there is bad advice. Here is an excellent example of bad financial advice, “Tip For Ignoring Bad Advice In Money Magazine.”

The latest edition of Money Magazine profiles a couple, 46 years old, that together make $120k/year, have a $250k ARM mortgage, a $30k home equity loan, and $12k in credit card debt. The couple is very concerned about boosting their slim retirement savings; to this end, they’d like to leverage the equity on their LA home, which is now worth $1 million.

Here comes some — in our opinion — highly irresponsible advice from a CFA who suggests this ‘extreme makeover’ (Money’s phrase): Take out a new $500k ARM mortgage, pay off the debts, then plow the remaining $200k into the U.S. stock market (80%) and bond funds:

The article then gives several reasons why this is a BAD idea. I’ll let you read the article… The blogger who wrote the article above gives a possible alternative,

How about this approach — sell the house. Retire the debts. Take the remaining $700k and put away a big chunk for savings (invested not only in the US stock market). Then buy a more modest home, or rent until the housing market settles down.

I am amazed at how resistant people are to selling their home outright and renting. I’ve even heard people use the excuse “I don’t want to move because it’s a pain.” Even if you made just $100,000 on the sale of your home (many people in Vancouver have made much more in the past few years), combine that with the mortgage payment you will no longer be paying and that’s a lot of rent! Not only that but you should have plenty to spend on a moving company, making it less of a pain. Moving isn’t so bad. The first few times I did it, it was annoying, but you get used to it. Here’s another blog article I saw recently about buying vs. renting, “Buying vs. Renting a House.” Scroll down to the comments, they are more interesting. Here’s one,

I know lots of home owners who pay more money each year in real estate taxes than I pay in rent. And that’s not including landscaping, maintenance and repairs, expensive furniture to fill the expensive house. I don’t buy into the idea that buying a house now, at what may be the peak of a housing bubble, makes any kind of sense.

I got a bit side-tracked here. Nobody should go and sell their house just because the market has gone up, but if you are like the couple described in the Money article, who are “very concerned about boosting their slim retirement savings,” then make sure you get some “good” advice before doing anything drastic.

Popularity: 4% [?]

New Poll: Where are you from?

I was curious where people who see my blog are coming from so I just added a really cool poll feature called Democracy AJAX Poll. Please check it out on my sidebar. Sorry I lumped the entire world minus the United States and Canada into “Other.” I assume that most people are from these two countries. Who knows, if I get enough votes on this poll I might start having a weekly or monthly poll on various subjects.

Popularity: 3% [?]

Bad Timing

Here’s an article I found a long time ago, entitled “When Index Funds Go Bad [registration required: may I suggest Bugmenot.com?].” It has been sitting in a draft post for a long time and just today my last post inspired me to publish it. The title doesn’t accurately describe what the article is about. What she talks about applies to all investments, not just stocks. Here’s the main thesis:

Indeed, investors of all stripes are notorious for their poor timing: They often purchase investments after periods of strong performance and sell them belatedly after periods of weak performance. Those timing decisions thus have a major–and negative–impact on the returns shareholders actually pocket.

She then looks at “dollar-weighted returns to gain a better understanding of how investors have really fared, because dollar-weighted returns account for cash flows in and out of a fund.” The results, in my opinion, are quite staggering:

The results indicated that, as with most active funds, investors’ timing decisions were costly when it came to index funds. The dollar-weighted returns for virtually all large-cap index funds were worse than their official returns for the trailing 10-year period through the end of the third quarter 2005. As the table below shows, poor timing cost Vanguard 500 shareholders 2.7 percentage points of returns per year over the past decade. That’s not chump change.

There is a chart given which gives the dollar-weighted returns and the official returns for many index funds. Over a 10-year period the gap between the two returns ranges from -0.8% to -6.18%. The whole article is excellent and I highly recommend reading it. I will just provide the last paragraph as I think it sums things up pretty well:

Clearly, index investors aren’t immune from the behavioral biases that can produce bad results from good funds. Although many of indexing’s most vocal proponents (Burton Malkiel and Jack Bogle, for example) also preach the importance of disciplined, long-term investing, it appears that many investors didn’t heed that advice. True, investors were challenged by one of the most precipitous bubbles in stock market history, and I take some comfort from the fact that asset flows into index funds have smoothed out over the past few years. But many still have a propensity to pile into the hottest funds at just the wrong time. Witness the recent strong inflows many energy funds have experienced this year. I mistakenly assumed that index funds were less likely to invite such behavior, but this study proved me wrong. I still think index funds provide investors a great way to get low-cost, no-fuss exposure to the stock market, but they are good investments only if shareholders use them wisely and maintain the long-term orientation that’s necessary to benefit from all they have to offer.

Investors are always being told to pay attention to MERs. To look at low-cost ETFs as an alternative to index mutual funds or actively-managed mutual funds. Some people take this to the extreme, recommending ETFs (with MERs of around 0.25-0.5%) instead of index mutual funds (with MERs of around 0.5-1%). To save a few percent on your annual return? As this study shows, a much more important factor affecting your portfolio’s performance has to do with keeping your head. This is something that is easier said than done. As Benjamin Graham said on page 8 of The Intelligent Investor,

We shall say quite a bit about the psychology of investors. For indeed, the investor’s chief problem–and even his worst enemy–is likely to be himself.

This is what investing intelligently is all about. This kind of intelligence, explains Graham, “is a trait more of the character than of the brain.”

Popularity: 10% [?]

Bad Investment Advice

Interesting story came my way today. A good friend of mine (the person who bought me the Intelligent Investor last year), and a loyal reader of my blog, got his brother to go out and put some money into RRSPs for the first time. Most likely he has a little bit of cash saved up from working and is saving it up for rainy day. My friend wrote up a suggested portfolio for his brother that went something like this:

  • TD Canadian index fund (40%)
  • TD US index fund (20%)
  • TD international index fund (20%)
  • Some TD bond fund (20%)

I’d say this was an excellent suggestion for a starting portfolio. It has a low overall MER and is diversified in terms of equities and bonds, but also diversified across several markets, By keeping the allocation rebalanced and by supplementing it with monthly contributions, you could expect to hold onto this portfolio for a long time and you might just beat a large fraction of the managed mutual funds out there.

But I am getting ahead of myself here. My friend’s brother may have walked into the bank with this suggested portfolio (typed up and printed I might add), but he didn’t walk out with anything resembling it.

The person at TD Canada Trust suggested instead that he invest in a 100% Canadian equity mutual fund because it has done so well in the last few years. My friend’s brother of course went along with it (I would too if I was in his shoes). After all, from the age of 17 to 20 my paltry savings were all invested in AIC Advantage Fund, a Canadian equity fund. Why? Because it had done so well in the previous years. This is probably one of the most common traps people fall into: chasing good performance.

There are so many reasons why the portfolio the TD person suggested (or lack thereof) is just wrong. The fact that this person at the TD Canada Trust branch would ignore the excellent suggestion the client came in with is not too surprising I guess, but it still makes me puke.

Popularity: 4% [?]

Festival of Frugality #7

Canadian Capitalist is hosting the 7th Festival of Frugality today. It features two articles from myself, and also a few other ones I liked such as how to have a “Frugal Valentine’s Day,” how “Asian grocery stores can save you money.”

Popularity: 5% [?]

Carnival of Debt Reduction #19

The Canadian Capitalist is hosting the Carnival of Debt Reduction this week. My favourites: “Cash-Back Credit Cards,” “Contractions,” and “A Five Step Stategy for Getting out of Debt.”

Popularity: 4% [?]

How Not to Rebalance

In this article, “Rebalancing Act: Why You Shouldn’t Massage Your Portfolio Every Year” at the Wall Street Jounal Online, we are basically told to rebalance if the stocks that performed well in the previous year are not going to perform well in the upcoming year, and to NOT rebalance if the stocks that performed well in the previous year are going to do well in the upcoming year as well. Two examples are provided:

Over the five years through year-end 2004, value trounced growth. But this year, growth and value are neck-and-neck. Are growth funds on the mend? If they spurt ahead, you might hold off rebalancing, so you capture more of the recovery. Similarly, after 13 years of mostly dreadful performance, Japanese stocks started bouncing back in 2003. If you own a Japan fund, you might let your winnings run for a little longer, rather than rebalancing at year end.

This is the most ridiculous thing I have ever heard. Implementing this strategy correctly relies on having a crystal ball. And if you had a crystal ball, you wouldn’t bother with any rebalancing at all. You would just do exactly as your crystal ball told you to do. After all, a crystal ball can tell you what is going to happen in the future. It is dangerous to think that you have anything in your possession that resembles a crystal ball, or that you have any psychopathic abilities whatsoever.

Ah, but there is some sense in the article (very little), but you have to read through the entire article until you reach it:

There is, however, a risk in waiting. The further your portfolio strays from your target mix, the harder you will get hit if the market turns against you. Indeed, Richard Ferri, president of Portfolio Solutions in Troy, Mich., worries that less-frequent rebalancing is maybe too clever. “If you’re a sophisticated investor, you can look at the momentum and you might let it run a little,” he says. “But for most people, annual rebalancing works just fine. It’s ‘Happy New Year,’ I’ve got to rebalance my portfolio.” [emphasis/bold mine]

Popularity: 4% [?]

Google Shares At $2000

Google shares just took a little dive yesterday (8.5% drop). I recall seeing an article a while back, about some guy who had targeted Google Shares At $2000. To quote the first comment in the article, “Ridiculous.”

Popularity: 4% [?]

RRSP Snowball Effect?

In this article by Dereck Slattery he offers a few RRSP tips. His 2 tips basically boil down to 1) don’t contribute at the last minute, instead take some time and make a “good” investment and 2) apply your refund to your RRSPs for the following year.

He goes on and on about this second point as if it’s some magical thing and there are so many assumptions built into his advice. Here’s the entire section:

Make it a habit to re-invest your tax refund back into your RRSP over and above what you put into the RRSP on a regular basis.

The benefit of this is as follows. Let’s assume that you invest $200 per month into your RRSP and normally you receive $1,000 in refund when you file your taxes. If this year you were to re-invest your refund into your RRSP when you receive it, you will have contributed $3,400 to your RRSP for next year.

All things being equal, in a 40 per cent tax bracket, your refund should increase to about $1,400 next year.

You can see where I am going with this – you contribute the same amount out of your pocket each year, your refund grows each year because you have put your refund into the RRSP each year and the snowball effect begins.

Bit by bit, your total amount invested into the RRSP each year climbs and your refund gets a bit higher each year, adding greatly to the value of the RRSP as each year passes.

First of all, this is hardly a “snowball effect.” Using the numbers above, you normally get a refund of $1000 and after contributing that amount into your RRSP, your refund the following year is $1360 (he approximated it by $1400). If you contribute that $1360 refund into your RRSP, your refund the following year will be $1504. Contribute and deduct the $1504, and you’ll receive a $1562 refund. Contribute and deduct the $1562 and you’ll receive $1585. Actually if you keep doing this forever you’ll increase your refund to $1600 and it won’t increase anymore. Hardly what I would call a “snowball.” So by following his little technique we have increased our refund to $1600 from what would normally be a refund of $1400. He puts way too much emphasis on this “snowball effect” and misses the real point that he should be trying to get across, which is: contribute as much as possible to your RRSP. If your refund helps you to do this, then that’s great.

For those people who already maximize their RRSP contribution room with their monthly contributions, the “snowball effect” won’t apply to them anyways. You won’t be able to use your RRSP refund for your RRPSs because you are already maxing-out your RRSP room with your monthly contributions.

Popularity: 4% [?]