Month: March 2006

Stocks Buffett Would Stay Away From

This article, “Dreadful Stocks to Avoid,” explains a few good rules of thumb for conservative stock picking (also applies to mutual funds since they can own stock too!).

Stocks to avoid:

  • Businesses that bet the farm – “In some industries, companies periodically have to make critically important decisions. If the company makes the wrong choice, it will be dealt a crippling blow.” As an example, “. . . Boeing is betting the farm against the superjumbo, opting instead to develop the 787, a smaller, long-range jet that it expects to better address the market’s needs. But if Boeing’s analysis is incorrect and the market moves toward the superjumbos, it will lose customers.”
  • Businesses dependent on research – “. . . there is a downside to research. Often, innovative companies are required to do research simply to maintain their competitive position. And if the research dries up, the company suffers.” Although it was not for lack of innovation or good ideas coming from research, this rule would have prevented the majority of Canadians from buying Nortel and preventing a lot of pain.
  • Debt-burdened companies – “In general, Buffett avoids companies with a lot of debt. This makes sense. During the best of times, large amounts of debt mean that cash that could be put toward growing the business or rewarding shareholders is instead servicing the debt.” This seems like a no-brainer.
  • Companies with questionable management – “Some clues to look for here include excessively optimistic press releases, overly generous compensation or options grants, or the constant use of external circumstances to excuse operational shortcomings.”
  • Companies that require continued capital investment – “Over the long term, shareholders make spectacular returns by buying businesses that are able to achieve extraordinary returns on capital. This leads to excess capital that the company can use to repurchase shares, pay a dividend to shareholders, or reinvest in further growth.”

A House is an Asset

After seeing two articles in the past couple weeks discussing whether or not a house is an asset or a liability (“Personal Residence: Asset or Liability,” and “Your House: Asset or Liability?“), and seeing some of the interesting comments written below one of the articles, namely the latter article, I had to chime in.

Last time I checked, a house was an asset. I can not even imagine what a house as a liability would be like. Kind of like an asset with a negative value. One possibly scenario would be if there were an infinite supply of houses and zero demand. But even that would only make a house free it would not lead to the house having a negative value. I can not do the mental gymnastics of considering a house as a liability.

I just had to pull up Gnucash to make sure I was right. I opened up a new file and created a default “chart of accounts” for fixed assets (which includes a home), homeowner expenses, and a home mortgage loan. Here’s what you get:

Home Chart of Accounts

There is “house” right there under “fixed assets.” You will also notice “mortgage loan” there under liabilities. Some people seem to get confused by this distinction, as at least 2 commenters on Consumerism Commentary did:

RS said:

I agree that your home should be considered a liability…as long as I am paying my mortgage every month, then it is a liability to my cash flow.

mbhunter said:

I side with Kiyosaki on this one. My home is a liability because it costs me money. A rental with a positive cash flow is an asset. I don’t even consider my equity in my net worth.

Oh no, Kiyosaki is rearing his ugly head again. Fortunately someone stepped in to set them straight:
Sean said:

This line of thought (house being a liability) drives me absolutely batty every time I stumble across it. Your house is not a liability; your mortgage is a liability. An asset isn’t necessarily a money generating piece of property…

On Consumerism Commentary’s article, a professor is quoted as saying in “Ballooning equity doesn’t mean you’re rich“,

The right mind-set is to look at your house not as an asset, but as a liability, until you’re finally going to sell it and drastically change your living style. Obviously a house, something you have, is an asset, but the argument is by treating it as a liability. This way as your house’s value increases over time, you’re not lured into changing your lifestyle.

This does not make any sense to me, how you can treat a house like a liability one day and an asset the next.

Everything You Ever Wanted to Know About Bonds

Check out this amazingly long article on bonds at Bill Cara’s website. I am printing it out right now and it will soon be reading material on the bus for me, once I am finished the book I am reading currently. It is a part of my never-ending goal to learn more about bonds and how they work, the different types of bonds, and the different ways of investing in bonds (individual bonds, mutual funds, and ETFs).

If that page is a bit too wordy and complicated for you, check out Investopedia.com’s excellent bond tutorial.

Investing Inside an RRSP vs. Outside an RRSP

There were a couple of blog articles recently about investing inside an RRSP vs. investing outside an RRSP. Frugal Focus discusses a report by Phillips, Hagar & North called “The Retirement Savings Debate: Inside or outside the RRSP structure.” He makes note of the fact that

the publication of this report preceeds two potentially important events – the November 2005 announcment by the former Liberal government regarding changes to taxation for dividend income and the yet-unrealized election promise by the new Conservative government to allow capital gains to be eliminated for individuals on the sale of assets when the proceeds are reinvested within six months

The Canadian Capitalist orginally blogged about this and focused on an article by Derek Foster (author of “Stop Working”) in Canadian MoneySaver magazine that discussed ways of investing outside your RRSP. Foster has some interesting ideas, like this one:

Suppose you were planning to put $6,000/year into an RRSP to save for your retirement. You would be contributing to your RRSP and getting a portion of that back because you could use the RRSP contribution as a deduction. Thus, your out-of-pocket annual expense would be $6,000, less the amount of tax money you have refunded.

Another method of achieving the same result is to take out a secured line of credit (let’s say $100,000 @6%) and invest it in good quality, blue chip, dividend-paying equities. Now you’ll be paying the $6,000 towards interest instead of putting it into an RRSP, but you will still get the same deduction as your out-of-pocket expenses are exactly the same! Money borrowed to invest is tax deductible. The only difference is that now you have $100,000 invested in a non-registered account that holds dividend-paying stocks rather than a contribution of $6,000 every year in your RRSP. You get the benefit of the dividend tax credit, while still getting a full deduction on the $6,000 interest payment (exactly the same effect as contributing to an RRSP).

The Canadian Capitalist has a good argument for why leveraging may not work. The Phillips, Hager & North report mentions leveraging as one of the purported advantages of investing outside of an RRSP, although they mention that “borrowing money to invest in a non-registered accoutn has risks that are not addressed. . . ”

I strongly recommend reading the Phillips, Hager & North article. It is only 7 pages of easy-to-read material. Here is the conclusion though, for those with little time on their hands:

Our analysis shows that saving for retirement using a registered plan (RRSP) is more beneficial than saving in a non-registered, taxable account. There are a few exceptions to this, but for the most part, this conclusion will hold true for the majority of middle- and upperincome earners.

Six Figures Needed to Buy a Home in Vancouver

In Vancouver, a GVRD study shows you need to make six figures to buy a home.

Buying a home in Vancouver is now reserved for a privileged few. The results of a new GVRD study show just how much money you need to earn to permanently settle down in our city. To buy a single family home in Vancouver, you need to make $122,000 a year. That’s a luxury only a precious few can afford, when you consider the average annual income in this city is $42,000. And to buy a two-bedroom condo, you have to earn $67,000. Tom Durning with the Tenants Rights Coalition tells News1130, some American cities have begun building housing specifically for the workforce. Durning says, if workers can’t afford to live in a city businesses will have problems finding new staff. He says the problem exists region-wide and the situation has become so desperate, it’s time for the Premier to get involved.

As our combined income is somewhere in between $67,000 and $122,000 it does not look like we will be buying a home in Vancouver any time soon. Not only that but our student loan debt repayments only serve to lower our effective incomes even further (or you can think of it as increasing the amount of your mortgage on the same property by the amount of your debt). But we should not despair! We have found a nice place with decent rent ($1050, far lower, almost 50%, than the mortgage payment for a comparable place) for two people and meanwhile are packing as much money into our RRSPs as we can. It feels good to not be saddled with a massive mortgage in a rising interest rate market at peak housing prices. I cannot help but think that we will be better off in 20 years, with a healthy nest egg in our RRSPs. While others will be scrambling to catch up on their RRSPs, we will be paying down our mortgage. I think investing in the stock market now makes a lot more sense then putting all our hard-earned cash in a home,since the stock market has performed far better than real estate over the long term (here’s a great article that compares the U.S. stock market to U.S. real estate).

Mutual Fund Loads

When is a Front-End Load NOT a Front-End Load? Answer: when the front-end load is zero.

On a previous blog post of mine about my new portfolio allocation as proposed by my advisor, I received a comment from Average Joe in regards to the MERs and the loads on these funds (CI Value Trust fund, Templeton International Stock fund, and E&P Growth Opportunities fund):

These are all loaded funds as well (ie. they are not no-load funds). You will more than likely be locked in or have to pay a penalty to get out.

I had not looked into the loads of these funds before. In my reply to the comment above, I looked up the load options for 3 three mutual funds in question in their respective prospectuses:

I had assumed these funds were all no-load but they are not, as you have pointed out. I went and looked at the prospectuses (sp?) and here’s what I found:

-CI Value Trust can be purchased and sold after 3 years for free with the low-load option. If you sell before the 3 years are up, the sales charge is 3%.
-Templeton International Stock fund can be sold after 2 years for free with the low-load option. If you sell before the 2 years are up, the sales charge is 2%.
-E&P Growth Opportunities fund can be sold after 2 years for free with the low-load option. If you sell before the 2 years are up, the sales charge is 3%.

This does not concern me too much. I would much rather be locked in to something as it will force me to stay invested, at least on the 2-3 year time scale.

In the above, I am only quoting the “low-load deferred sales charge” option. There are actually three options for these 3 funds:

  • Front-end load (or initial sales charge) option: you pay a sales commission when you buy your shares. The commission is a percentage of the amount you invest and is paid to your financial advisor.
  • Deferred sales charge:
    • Standard deferred sales charge: varies depending on the fund, but usually higher initial penalty percentage than the low-load deferred sales charge option and a longer waiting period until the load disappears, and for some funds you may switch or sell some of your units every year. The penalty charge decreases every year you stay invested in the fund.
    • Low-load deferred sales charge: lower loads compared to the standard deferred sales charge option and shorter time until the load wears off. Usually the penalty is constant rather than decreasing, then after a short period of time, becomes 0%.

I had incorrectly assumed that the low-load deferred sales charge was the cheapest option for the investor. When I asked my advisor about this, he told me how Clearsight handles mutual funds. He said that all funds are available from Clearsight on a no-load basis. They do this by doing front-end loaded funds but with a load of zero. They do have a penalty of 2% if you want to switch or sell within the first 90 days to discourage silly trading. So essentially they have access to all funds on a no-load basis. Also, he told me they get paid a 1% trailer fee from the mutual fund company.

Anyways, that’s just a long-winded way of saying front-end load does not always mean front-end load. If your advisor or his company chooses not to charge the front-end sales charge then it is essentially no-load. After years of investing by myself in TD Mutual Funds through TD’s website, I have a lot to learn about mutual fees!

What $350,000 CAD Gets You in Vancouver

All Things Financial thought it would be neat to “show you what $300,000 USD will buy you in various parts of the country.” So far there is one other Canadian entry in Ottawa, where $350k can buy you a nice house.

I searched MLS.ca for any houses in Vancouver West for under $350k but no luck. I did not think I would find anything. I have searched before and one usually cannot find anything half-decent for less than $600k or $700k. I checked Vancouver East and there were only 2 houses out of 452 that were around $350k. I do not think it would be fair to say that you can find a house for $350k in Vancouver East when there are only 2/452 at that price range. Looks like you can only get an apartment/condo for that price.

I did a search for anything in Vancouver West between $325k and 375k. I then looked for something that I would actually like to buy, something in Kitsilano for example. Well there isn’t much selection actually. It turns out that if you have $350k your best bet is somewhere downtown. There’s far more selection at that price range. Here’s the one I’ve chosen:

Downtown Vancouver Apartment Outside

Downtown Vancouver Apartment Inside

It offers a bit more square feet (723) than some of the others, probably because it is a bit older than many of the apartments for sale downtown; however, the strata fee of $265 is a bit higher than some of the others. It does offer “huge indoor pool, Jacuzzi, gym, squash court, entertainment room.”

Block Trades in SPY

“Watch the Block Trades” from the Big Picture shows a chart of “block money flow,” a gauge of net institutional buying and selling activity in the S&P 500 ETF, SPY. He says this suggests “suggesting the U.S. equity market is on shaky ground.” Or perhaps better said, the institutional investors think that the U.S. equity market is on shaky ground. The author says “unless institutions come crashing back in, this is yet another data point that confirms the topping process . . .”

Is there any data out there like this for the TSX indexes? I did a few quick Google searches but did not find anything that was publicly available over the web for free.

Should Young People Hold Bonds in Their Retirement Portfolios?

Investing Guide asks should young people carry bonds in their portfolio?” This is question that I have mulled over before as well. I agree with Loi that “there have been some conflicting advice on whether young people should have bonds in their portfolio.” Personally I have been through one bear market already (without any fixed income) and I do not want to go through another one without bonds in my portfolio. Some of you will know what I mean. Others will not know the agony of seeing your portfolio’s value fall month after month as the stock market tanks. However, “having some bonds (15-20%) in a portfolio lowers downside risk by a large amount.” This is one of the key reasons that I want to have some bonds in my portfolio, to reduce downside risk.

The second reason that I want have some bonds in my portfolio is because Benjamin Graham says so (at least 25% bonds). Benjamin Graham knows what he is talking about. He was around for a long time, during the depression, post-depression and all the way until the 1970s. He has seen many ups and downs. In the Intelligent Investor (1973 edition) he says that:

even high-quality stocks cannot be a better purchase than bonds under all conditions–i.e., regardless of how high the stock market may be and how low the current dividend return compared with the rates available on bonds. A statement of this kind would be as absurd as was the contrary one–too often heard years ago–that any bond is safer than any stock. [emphasis his]

At the end of the chapter, after much discussion (you will have to read it), he concludes that

Just because of the uncertainties of the future the investor cannot afford to put all his funds into one basket–neither in the bond basket, despite the unprecedentedly high returns that bonds have recently offered; nor in the stock basket, despite the prospect of continuing inflation

In Chapter 4 he addresses bond-stock allocation in more detail for the defensive investor. It can be summarized as the following:

He should divide his funds between high-grade bonds and high-grade common stocks. We have suggested as a fundamental guiding rule that the investor should never have less than 25% or more than 75% of his funds in common stocks, with a consequent inverse range of between 75% and 25% in bonds.

Note that Graham does not discriminate by age. Jason Zweig goes on in his end-of-chapter why going 100% stocks may be ok for a small minority of the population:

For a tiny minority of investors, a 100%-stock portfolio may make some sense. You are one of them if you:

  • have set aside enough cash to support your family for at least 1 year
  • will be investing steadily for at least 20 years to come
  • survived the bear market that began in 2000
  • did not sell stocks during the bear market that began in 2000
  • bought more stocks during the bear market that began in 2000
  • have read Chapter 8 (The Investor & Market Fluctuations) in this book (The Intelligent Investor) and implemented a formal plan to control your own investing behavior

Personally I do not think I fit into this small minority. Secondly I think that going with a 100% portfolio goes against my third and final reason for wanting some bonds in my portfolio: rebalancing. If you have a 100% stock portfolio and the market tanks by 20% this year you cannot take advantage of rebalancing. If you have a 75% equities, 25% fixed-income/bond portfolio and the stock market tanks by 20% this year, your allocation will shift to 71% stock, 29% fixed-income/bonds. Assuming you can do this in a low-cost fashion, you can instantly get a hold of cheap stocks by selling part of your bond portfolio and buying equities.

Getting back to the whole age thing, I do not think it really matters. When you get really old you should obviously be more focused on income and capital preservation than when you are young. But I do not think people in their 20s should invest any differently than people in their 30s and 40s. That is, I think they should have some bonds in their portfolio no matter what. Capital preservation should be just as important to someone in their 20s. And as Loi mentioned in his article, the average return of a 100% stock portfolio from 1960-2004 was 10.5% whereas the average return for a 80% stock/20% bonds portfolio was 10.1%. I haven’t verified those figures but I have seen similar graphs and numbers quoted before so I am not surprised. I cannot think of why anyone would not want to take a small 0.4% hit on their return for the lower risk offered by a mixed bonds/stocks portfolio.

Initially my advisor did one of those risk surveys on me and I fell into the 100% equity category. Unfortunately those risk surveys are seriously flawed. Just because you have held stocks and mutual funds in the past, have a 30+ years time horizon, have a sound knowledge of investing, and can answer a bunch of other basic questions does not mean that you should automatically be in a 100% equity portfolio. I insisted that I have 25% fixed income (à la Graham) so my new portfolio at Clearsight will hold 25% TD Canadian Bond fund for now (great for rebalancing with as their are no commissions as with ETFs).