Result of Poll: What annualized return on your retirement portfolio do you expect in the next 10-20 years?

I’m kind of embarrassed about this, but I had this poll on my sidebar for almost a year now. I kind of forgot about it. It’s now gotten 106 votes (not necessarily unique votes, I think it allows 1 vote per IP address). Here are the results:

What annualized return on your retirement portfolio do you expect in the next 10-20 years?

  • <5%: 2% (2)
  • 5-6%: 8% (9)
  • 7-8%: 40% (42)
  • 9-10%: 26% (28)
  • 11-12%: 8% (9)
  • 13-14%: 3% (3)
  • 15-16%: 3% (3)
  • >16%: 9% (10)

Total Votes : 106

It’s good to see that most people are in the 7-8% range. It’s good to think conservative, at least when estimating what return you will get in the future in order to estimate how much you will have when you retire. It is interesting that I asked what return people expected on their “retirement portfolio” and some people actually selected the “above 16%” box. I find it hard to take that seriously. You would have to be taking on far more risk in order to expect that kind of return, and taking on a lot of risk in a retirement portfolio is not something you want to do.

Anyways, I’ll be removing the poll feature now. It’s part of an effort to clean up my site a bit by removing the clutter.

The Home Buyers’ Plan (HBP)

A few weekends ago I was at a taxation seminar put on by a local accounting firm and they were pretty much saying that you should use the HBP. They mentioned it several times. They even went on to say that if you currently have some other debt, say a student line of credit, you should be concentrating on paying that off rather than contributing to an RRSP. Well I don’t know if I agree with that, especially if your line of credit is at prime, as ours is. Not only that, but contributing to an RRSP gives a tax rebate (which you can then throw onto the debt after having maxed out your RRSPs); paying down debt doesn’t. They were pretty insistent that paying off debt should be the first priority. But, they said, you should contribute to your RRSP up to the $20,000 so that you can take advantage of the Home Buyers’ Plan. Huh? They really made it sound like you should contribute just $20,000 to your RRSP, then ignore it and continue paying down debt. It didn’t really make any sense to me.

At one point I raised my hand and asked: “Can you compare withdrawing $20,000 from a line of credit to pay for a down payment vs. withdrawing $20,000 from my RRSP? for example, if my line of credit is at 6% or so and my RRSP is earning maybe 8 or 9%?” Their argument was that they thought I would have to have a much larger return in our RRSP compared to our line of credit to make it worthwhile. Their second argument was that you never know what will happen to interest rates in the future. Their answers weren’t that satisfactory and I expected a bit more from accountants. To make a long story short, after I got home, I started reading about the Home Buyer’s Plan.

The Home Buyers’ Plan is often touted as a magical way to get $20,000 needed for a down payment. I say “magical” because it is often explained in a very simple way without discussing the disadvantages, or any discussion of the alternatives. Here are some examples of what I am talking about:

  1. Assumption Life makes the assumption that The Home Buyers’ Plan (HBP) is a “winning formula.” “This winning formula can thus help you fulfil your dream to own while also making it possible to maximize your RRSP contributions.”
  2. This TD article “A Larger Down Payment Means Greater Savings
  3. This article from North Shore Credit Union talks about the Home Buyer’s and lists the only downside as being “If the $20,000 were left in the RRSP for 15 years, given an annual 3% rate of return, it would grow to approximately $31,200.” 3%!!! I hope that is real return!

As for #1 above, I think the HBP actually makes it harder to maximize your RRSPs. You will now owe money back to your RRSP and you may be saddled with a fat mortgage on a house that is slightly more expensive than what you might have normally bought had you not taken money out of your RRSPs. You might have a tough time paying off that big mortgage, paying of your RRSPs, and maxing them out every year going forward.

Contrary to what TD says in #2 above, although a down payment means greater savings, I don’t think the HBP necessarily means “great savings.” Here is a comparison between HBP and non-HBP using actual numbers (10% compound return in RRSP, 8% interest on mortgage). It works out roughly the same.

#3 is just laughable. I don’t know where they get their 3% rate of return from. They also claim that “if the homebuyer doesn’t use the RRSP, he/she will acquire a larger mortgage and may possibly even need to purchase mortgage insurance for a high-ratio home loan, which is 3.75% of the mortgage amount.” First of all, 3.75% is wrong, the max is 3.25% or 2.90% (I can’t figure out which, I think it was just lowered though). Perhaps their numbers are out of date. Second of all, if you’re buying a house on the North Shore (North Vancouver), $20,000 isn’t going to lead to a 3.75% premium (from 0%), although it may move you from a lower premium bracket (3.25%) to a higher one (3.75%).

Here’s what I see as the basic alternative to the HBP: Leave the $20,000 in your RRSP and add an extra $20,000 on to your house’s mortgage. This might leave you short of the 25% mark required for you to be exempt from the CMHC premium (of up to 2.75%). Or, it might move you from one CMHC premium bracket to another. This leaves you with a few alternatives, hold off on buying a home until you’ve saved up another $20,000 or take out a loan for $20,000, thus avoiding the CMHC premium (actually I am not sure if the CMHC looks at your other debt or not, if they do consider your other debts, what I just said may not work). You can get everything in between here. In the case where you have 0% down payment you could, again, take out a $20,000 loan or just increase your mortgage by $20,000.

I’d also like to remind you how little $20,000 is nowadays, especially if you are living in Vancouver and buying a condo for $400,000. A 25% down payment would be $100,000. If I get $20,000 of that from my RRSP or from a loan, it not too significant. If you are a couple, the Home Buyer’s plan allows you to take $20,000 from each RRSP which makes it a bit more significant.

The big downside of the Home Buyer’s Plan is that the rates of return from the equities and fixed-income investments in your RRSP may be much better than the interest rate on your mortgage. The amount of lost gains in your RRSP from taking out the $20,000 may be more than the amount of interest you save by reducing the size of your mortgage. The main upside of the home buyer’s plan is that it might allow you to reduce the amount of your CMHC premium. However, another way to reduce the amount of your CMHC premium would be to take out a loan and apply it to your mortgage. In this case, the same logic I used in the beginning of this paragraph also applies. Your RRSP’s rate of return might be higher than the interest rate on your loan. Another downside of HBP is that it can be a disadvantage to have your RRSP descend from $20,000 to $0, let’s say. First of all, when you have $25,000 or more in an RRSP, at some institutions this means you are except from the $125 annual RRSP management fee. Secondly, at E*Trade, for example, when you hit $50,000 in assets your commissions are reduced from $19.99 to $9.99/trade. Lastly, if a bear market is just winding down, that is the worst time to be selling $20,000 in equities from your RRSP.

There is a book from the CMHC called “Impact of the Home Buyers’ Plan on Housing Demand.” It says that “even when the individual has to borrow to make the repayments to the RRSP, there is still a net financial gain.” I think what they are trying to say is that taking money out of the RRSP under the HBP and then paying it back into the RRSP by taking out a loan. I would like to see their actual numbers but I can’t get the report to download.

E*Trade Might Eventually Allow Exchange-Free Trades in RRSP

I emailed E*Trade Canada about buying and selling USD investments inside an RRSP. This was before I knew anything about at all. Eventually I received this reply:

You can only keep Canadian dollar in rrsp account. You can buy US stocks but the money will be converted to CDN dollars. It is not possible to sell US stock and then buy more US stocks without converting to USD to CDN. Etrade is working towards a option so that you do not have to convert funds back and forth in rsp account.

Sounds promising. At least they are looking into it. Although the more I think about it, this forced exchange between USD and CAD currencies is not such a bad thing. As I’ve said before, my biggest problem before was that I would trade too much. Buying and selling things, reacting to the market. With the 4% exchange hit, it is much less likely that I am going to want to go back to my old active trading ways.

Foreign Currency Investments and Exchange Spreads Inside Your RRSP

Well finally my E*Trade account has been set up and my XIC ETF has been transferred over and now I am just waiting for the mutual funds.

I was confused by something I read in E*Trade’s help:

E*TRADE Canada offers a U.S. dollar trading account and a Canadian dollar trading account for customers who wish to trade (and pay for their trades) in the currency of the market in which they trade, thereby insulating themselves from exposure resulting from fluctuations in Canadian/US dollar foreign exchange rates. This enables you to trade U.S. securities in your U.S. dollar account, and Canadian securities in your Canadian dollar account (except for registered accounts, which are available in Canadian currency only)

For a second, I thought this might mean that I could only trade Canadian-dollar based investments inside my RRSP. I realized that was probably not the case as I am sure that it was possible to hold USD based investments inside your RRSP. What they MUST mean is that the cash portion of the RRSP must be in CAD, therefore, every time you buy or sell a USD investment inside your RRSP you will be hit with the exchange spread. Apparently TD Waterhouse can do “wash trades” where you can buy a USD money market fund (and get hit with the exchange) but then you can sell part of that and buy a US stock, for example, without having to go back to Canadian dollars in between. Or vice versa, you can sell part of the stock and go back to cash (the money market fund is like cash) without incurring any expense from the exchange. You have to call TD for these trades and cannot do them online.

It turns out that Canadians are allowed to hold foreign currencies inside an RRSP, it’s just that no one has implemented it yet. A guy from Ontario is suing BMO over this issue. The spreads are about 4-5%. So if you take $20,000 CAD and change it to USD and then change it back to CAD, you will have about 4-5% less than what you had when you started. That is almost $1000 CAD. I am looking forward to hearing what happens in this case. I hope that once one company decides to (or is forced to) allow clients to hold USD or to trade between two USD investments without incurring exchange spread costs, that all the other online brokers will follow suit.

Update (2007/03/01): Larry McDonald talks about this in his article “Beware of the details of foreign diversification.”

E*Trade Bungling

So I applied for an E*Trade account a few weeks ago and I was wondering what was taking so long. I got through to customer service today after just a few minutes and asked them. They have received my application, but they haven’t processed it because I made the RRSP beneficiary (my wife) sign as the witness to the RRSP beneficiary section as well (is that so wrong?) Anyways, when were they going to tell me that? So now they’ve put the application through and my account will be opened soon. I guess it would take a lot of time for them to phone every person who filled out their application forms incorrectly, but to send out a quick email? Not hard… they have my email address, as the guy I talked to just resent the application so I can fill out the RRSP beneficiary section. Took him 2 minutes tops.

9 New Rydex Equal-Weight Index ETFs

Check out this podcast from November 15, 2006 about equal-weight indexes with a guy from Rydex Funds.

Rydex has recently created 9 new equal-weight sector indexes. He says that success of Rydex’s S&P 500 Equal Weight (RSP) is one of the reasons these 9 ETFs were introduced. If you are interested in equal-weight indexes at all I highly recommend listening to this, it’s so much better hearing about this in audio rather than in reading it in print.

Back-testing has shown that most of these equal-weight funds would have outperformed the market-cap based index. He seems to imply that this is due to the fact that they get more exposure to mid-caps, that have tended to perform better than large caps. I have mentioned before how RSP is actually closer to something like the S&P’s mid-cap index (MDY). Recently I looked up a bunch of recent additions to the S&P 500 and all of them had market caps of over $1 billion.

Recommended Personal Finance Books

Here is a decent list of personal finance books. The list was compiled from the recommendations of over 20 personal finance bloggers. I have only read one of those books, the Wealthy Barber, but I have read a bit of a Random Walk down Wall Street and I would like to read all of it. I was so thrilled to see that there were no Kiyosaki books in that list. That gives me some hope for the future of human kind. I am interested in checking out some of the books in the top 5, if anyone has any opinion on them, please let me know.

The one comment on that blog article that is written by someone who is clearly craving some Kiyosaki!

I must say that I’m suprised at the list. Most of these books tend to focus entirely on “spend less than you earn” philosophy. I was hoping someone would recommend a good real estate investing book; good precious metals or commodities book; and other tactical investment books on how to generate wealth and/or create successful businesses.

I recommended a conservative options trading book which (in my opinion) has some real potential for teaching people how to make money from stocks they may already own or may eventually own.

Real estate, precious metals, “generating wealth”, “conservative” options trading? Kiyosaki is that you? (The commenter has a website called “Get Rich Slick.” The first blog post I see is rant about the 10-minute delay he is experiencing on e-trade and how it “always works against him.” Wacko.)

IRR and Returns on Portfolios

There is a very interesting discussion at the Canadian Capitalist’s blog about how to determine performance and there was some talk of Internal Rates of Return (IRR):

In one comment, the Canadian Capitalist, said:

It is true that IRR is the true measure of performance but what I did in my earlier post was compare the IRR of my actual portfolios with the annual return of the benchmark (to which no money was added). That is really comparing apples to oranges.

He is referring to the fact that is benchmark sleepy portfolio earned 14.7% last year vs. a 9.55% annualized return (for last year) for his own portfolio.

I have a reply to that that is kind of long so I thought I’d post it here:

I think it is ok to compare your porfolio’s IRR to the annual rate of return of the benchmark. I went back to the definition of IRR since I had sort of lost track of what it really mean, and this sentence sort of brought it home for me:

IRRs can also be compared against prevailing rates of return in the securities market. If a firm can’t find any projects with IRRs greater than the returns that can be generated in the financial markets, it may simply choose to invest its retained earnings into the market.

When companies do this, they are comparing some IRR calculated with some complex set of cashflows to the prevailing annual rate of return in the market. The benchmark’s annual return is an IRR too, there is just one cashflow in, one cashflow out.

Essentially what I think happened with the CC’s portfolio is that his further purchases during the year were at (relatively-speaking) high points in the market. And the IRR comparison to the annual return of the index is correct. He had a worse return than someone investing all of their money in the index at the beginning of the year did.

But, the bigger/better question is, would he have done better had he put his cashflows throughout the year into the index/(or in his case, the sleepy portfolio). Well it depends on timing and what happened in the market but I think an IRR calculated from those cashflows might be interesting, because it would show how well he would have done had he invested in his benchmark portfolio instead of his real portfolio. So the IRR really can show you how well you did by revealing bad timing and such.

I just did the XIRR calculation on a spreadsheet to check this…but it looks like if we were comparing an IRR of a portfolio made up of purchases of an index ETF made throughout the year, let’s say, and the daily return was the same for every day of the year, the IRR of your portfolio would match the annual return of the index exactly. So I think it might be true that in the limit of a linearly increasing/decreasing market/investment, the annual return is equal to the IRR of any cashflows invested in that market/investment.

No time to look this over or spellcheck this, so I’m sorry, but I’m really busy!

Sleepy Passive Index ETF up 14.7% in 2006

The Canadian Capitalist once again posted the results of his sleepy portfolio, the portfolio he constructed using only passive index funds, which he uses as his own personal benchmark to which he can compare his own performance. Based on the sleepy portfolio’s stellar performance, I wonder if he’ll stop investing in individual stocks so much in the future and invest in more passive index ETFs instead.

This is basically the type of portfolio that I want to switch over to gradually. All passive index-passed. I’ll probably switch over slowly though, I don’t want to sell my mutual funds just yet. Selling now might get me back in the mentality of selling things and chasing returns which I used to do before. I’ll start by putting all the my new cash contributions coming in into index ETFs, then when the mutual fund parts get small enough I might get rid of them.