Hot Labour Market

The hot labour market just got even hotter. Check out these recent numbers from the Vancouver Housing Blog.

Wow! Check out the leap in the employment rate and the sharp drop in the unemployment rate. With seasonal adjustments, weird weather, etc., it’s hard to know what to make of month-to-month jumps in these figures. But still. Unprecedented.

What do I mean by unprecedented? Check out the graph going back to 1976.

Since things on the national front look similar, I think you can kiss good-bye to any hopes for B-o-C cuts anytime soon.

Canadian Financial Stuff had a post a while ago about unemployment numbers going up in Canada. I don’t think that small upward blip in January is an indication of an upward trend. If you look at his graph the trend is clearly downward and there are upward blips (some larger than the January one) all over the place. If the numbers were taken every 5 months instead of every month, his headline would be the opposite, “Unemployment down in January.”

The discussion quickly turned to housing. I’ll copy & paste a few interesting comments below:

Someone named dave said:

lj – yep, I hear you. OTOH it’s worth remembering what happened to Isaac Newton during the South Sea Bubble. He saw the crash coming and sold in time, making some good coin. But when everyone else continued making money he bought back in, and of course got nailed in the crash. The crash is happening now in some of the previously hot markets south of the border. The early warning signs are everywhere else, including in Canada. Will it be different in Vancouver? Heck, anything is possible. But it isn’t that likely, especially given BC’s boom/bust history.

fcf said::

Remember, there IS a huge demand for RE “ownership” but NOT for shelter. There is a big difference there. Real rents have been stagnant for years. That tells me there is no true demand for shelter above new supply. The huge demand for ownership based on the thinking that it’s the greatest-can’t-lose-investment-ever is what the boom has been all about (and its a global phenomenon). Price/rent ratios are way too high. It costs nearly twice as much to own than to rent. This disparity can’t last. People have been making more money on their homes than in their jobs! This is what’s been fueling this bubble. It amazes me that even rational analysts are predicting long term RE price growths of 5% a year. What the heck for? Are rents going up by that much?

I have a friend in Sacramento who owns 4 houses. He is obsessed with RE. He intends to buy more since the prices there have dropped a tad. I urged him to sell but he thinks I am retarded. He quotes the usual myopic RE bull arguments, “they are not making enough land anymore…etc”. I said to him, if there is such huge demand for housing, how come rents haven been stagnant. He just can’t fathom that. He equates price increases with demand for housing. In fact one of his houses has been empty for a year. He doesn’t care because its been going up far more than the carrying costs.

Renters, stay cool. Don’t make the mistake Isaac Newton did. After his investment loss he was quoted to have said “… I can predict the motion of planets and stars but not the madness of men…”.

Martin said:

I must say that I don’t fully understand the despair of the reluctant bulls. If purchase prices belong where they are, then rent and get the deal of the century, and put your money in another investment. No skin off your nose.

alpha_bear said in reply to betamax’s comment:

“…i would be more miffed at waiting on the sidelines for 10 years for the perfect moment to buy (saving a $100,000 in the process) and putting my life on hold in the meantime. life is short.”

I don’t understand why the bulls equate renting with sitting on the sidelines. It seems to me that the bulls are the ones whose life is on hold, while they pray for housing prices to rise.

I’m so happy renting that I don’t care if it takes 10 years or more for the inevitable crash. I’ll buy back into the market when prices are more justifiable. In the meantime, my capital is working for me, and I have more cash available than I did when I rented the money to “buy” my last house from the bank.

Life is too short to spend underwater in a large mortgage.

The Problem With Owning Lots of Mutual Funds

A long time ago I wrote about why having lots of mutual funds is a bad idea. Namely, lots of overlapping mutual funds of the same type, like Canadian equities, for example. In my case, I owned 4 TD large-cap Canadian equity funds. The punchline is that with so many funds and so many underlying stocks, I was starting to get so diversified that I was about as diversified or more so in the Canadian large-cap market than an index. But I was paying exorbitant MERs on the mutual funds, at least 1-3% whereas I could have just bought 1 index ETF and paid 0.17% MER. A 1-3% difference in performance is huge over the long term.

Tom Bradley at SteadyHand just wrote an article about the exact same thing, however, the example in his case is far more extreme: “The featured couple had registered retirement savings plans totaling $170,000 that were spread across 29 mutual funds.”

I’ll summarize his analysis:

Holding 29 funds is ridiculous whether you’re investing $170,000 or a million dollars . . . But more than anything, owning 29 mutual funds means you’re seriously over-diversified . . . If we assume that there were 45 unique stocks per fund, that’s 900 stocks plus the ones that showed up in multiple funds. Let’s say you own 1000 stocks. What you really own is a very expensive index fund.

and the conclusion/recommendation:

Through exchange-traded funds (ETFs) you could get the same market exposure for an average fee of 0.25 to 0.30 per cent a year on their management expense ratios. I hazard a guess that the couple in the article were paying in the neighbourhood of 2.5 per cent. It is no wonder they were disappointed with their mutual fund returns.

I suspect that there are many Canadians in a situation similar to the one that I was in, or similar to the one the couple above was in. My guess it that there is a subset of those people who DO look at the MERs on funds (so they are thinking about cost a little) and given two funds, will choose the lower MER one over the high MER one. But most probably fail to think about their cost relative to an index ETF and their risk-adjusted return relative to an index ETF.

Income Splitting for All Still a Possibility

Finance Minister Flaherty is still considering allowing income splitting for all (ie. not just those over the age of 65). It doesn’t sound like the benefits are that big. Well maybe one might consider them to be big; they are just smaller than I expected them to be:

The Canadian Taxpayers Federation calculates that a single-income family with a $100,000 earner would save $4,320 this year under a split-income scheme that would allow each spouse to declare $50,000.

By way of comparison, a family with one $75,000 earner and a $25,000 earner would save $1,000 if they split their declared income.

I’m glad that they have “go ahead with joint filing for pensioners and seniors with respect to pension income.” It means I don’t have to worry about spousal RRSPs at all. But would the government ever take away income-splitting for pensioners in the future? Maybe. Would the grandfather it to those with existing RRSPs? I don’t know. I mean the government can do anything if they want.

Status of Transfer to E*Trade

Well four of my mutual funds were finally transferred. My one ETF (iShares XIU, the S&P TSX 60 Index ETF) was transferred very quickly. But it took the mutual funds almost a month, and I am still waiting for one more (an Elliot & Page Growth Opportunities)! Yet another reason to get ETFs instead of mutual funds I guess. 🙂

I have just noticed that E*Trade’s website does not offer much. Beyond buying & selling that is. Would be nice if some of these online brokerages would include some performance data in there automatically. Or at least an open API or webservice (like Google or Flickr) so you can connect to your data and do some crunching or something. Then all sorts of applications would start popping up.

Upgraded to WordPress 2.1 and Switched to K2

I recently upgraded to WordPress 2.1 and switched to K2 from the plain old vanilla Kubrick theme. K2 is an amazing it allowed me to remove some modules because of it’s awesome “sidebar modules” features. You’ll just have to try it out to see what I am talking about. It’s also given me AJAX-commenting and AJAX live search. Also live archives. I recommend trying out all these features. 🙂 I also stopped using Jerome’s Keywords module and am now just using WordPress’ built-in categories. I was tired of always wondering if a module like Jerome’s Keywords was going to work if I upgraded WordPress. Now I have no modules that use the database besides K2 Means I can usually update to other WordPress version without much hassle.

Techie stuff:
I track WordPress upstream sources in my Subversion repository and then merge-in upstream changes into my trunk. If any of you geeks are interested in making your upgrades as painless as possible, that is the way to go. Far easier than WordPress’ upgrade instructions on their website. Not only that but I can hack any part of the wordpress core if I wanted to and still get upgrades.

Paying Down Debt vs. Contributing to an RRSP

The Canadian Capitalist had a link to article by the Smoke & Mirrors guy, David Trahair, called “Don’t Invest in an RRSP Before Paying Down Your Mortgage (Link no longer available).” He starts off by saying that the conventional wisdom of investing in an RRSP then applying the tax rebate to your mortgage every year is hard to do. Instead, he says, don’t contribute to an RRSP, but put down more principal on your mortgage. If you want to talk psychology about what is “harder to do” I would suggest that contributing your maximum room to an RRSP is a better forced savings plan than applying an extra lump sum on the principal of your mortgage ever year, but that’s just me. Or maybe he’s suggesting you re-amortize for a much shorter period (after forgetting about RRSPs) but he doesn’t say that explicity. His second argument is that banks just want your money for RRSPs so they can charge you “commissions and fees on your contributions,” and because the banks’ ideal is for you to be in constant debt. I don’t buy any of that as a reason to pay down a mortgage instead of an RRSP. What I care about is which one is better for me (regardless of whether the bank benefits). Just like I don’t care about MERs in principle. What I care about is the returns after costs.

In the latter part of the article, he argues why you should pay down your mortgage before contributing to an RRSP by showing an example of a couple in two scenarios. Scenario 1 has them paying their monthly mortgage payment and contributing to an RRSP $4000 each per year and investing the tax refund generated. Scenario 2 has them paying their monthly mortgage payment and instead paying $4000 each year onto the principal value of the home. 11 years into Scenario 2 the home is paid off so they redirect what was their mortgage payment into their RRSP (and they invest the tax refund generated into their RRSP). I’ll give you the punchline:

The debt pay-down scenario shows a net worth slightly higher than for the RRSP scenario—a difference of $14,590. So, after 20 years, the Harts would arrive at a similar point but would have taken a very different journey. The debt pay-down option, however, has two major advantages: it reduces the risk that the Harts could lose their house during the nine years of mortgage-free living, and there is less risk related to investment returns. How much confidence do you have that the markets are going to post better returns than the interest rate on your debt? Are you willing to stake your future on it?

This sounds very reasonable but I am very disappointed in his article for a few reasons. He assumes a rate of return in the RRSP of 5%. This seems unbelievably low to me. There might be a reason for that. Since paying down the mortgage (he assumes a fixed-rate of 6%) is low-risk he’s probably trying to match the risk in the RRSP and the mortgage. I am not sure why you couldn’t at least get 6% in the RRSP for almost the same risk. Secondly I would assume that the majority of people with large mortgages or any mortgage are younger rather than older. We can take on a little risk right? I mean we could at least put half our RRSP in equities and half in fixed income/bonds. A 5% return in an RRSP seems unrealistically low. And this is coming from someone (me) who sets his expectations fairly low (7-8%). Thirdly, he doesn’t explain what would happen if the rate of return were even a bit higher yet the difference in Scenario 1 over Scenario 2 is tiny compared to the other numbers involved. “The debt pay-down scenario shows a net worth slightly higher than for the RRSP scenario—a difference of $14,590.” Clearly his cooked up his numbers so that they work out to be better for the mortgage pay-down scenario. Because it’s not even a difference worth mentioning. He even says in the next line that the end points are similar: “So, after 20 years the Harts would arrive at a similar point but would have taken a very different journey.”

I tried to replicate his calculations in a spreadsheet of my own so I could try out some other combinations of rates. (You can now skip to the next paragraph if you get bored easily). I was pretty much successful, only off by a small percent. This is due to the complicated way that he decided to handle the tax rebates. When Joe and Karen each contribute $4000 per year to their RRSP they get a tax rebate equal to $4000 multiplied by their marginal tax rate (40% in this case). They take that $1600 tax rebate and contribute $4000+$1600 to their RRSP in the following year. Then they get a $2,240 tax rebate and contribute $4000+$2240, then the following year, $2,496 extra, eventually converging to some value. I already talked about this “snowball effect” before. Note that it is non-existent if you maximize your RRSP contributions every year anyways. (Do not NOT maximize your RRSPs just so you can get this effect. It’s not that exciting.) Anyways, another way to handle this in the simulation would have been to just assume the max contribution room every year was $4000 for each of them or whatever, and contribute the excess cash available into a non-RRSP account. Personally I would do the latter since we maximize our contribution room every year. Any excess monthly cash (that might come available after paying down a mortgage) would go into non-RRSP investments.

Anyways, if you just increase the RRSP rate of return a little bit, as you can see in this modified spreadsheet, the RRSP case beats the pay-down-debt case. If you increase the rate it beats it by a wider margin but never by much.

I think the takeaways here are:

  • That paying off a mortgage is a great low-risk investment.
  • Make sure you look carefully at any assumptions used in calculations by accountants and financial advisors. Are they realistic?
  • When looking at a return, never forget about the risk associated with that return.

MERs in the Globe & Mail

I sometimes wonder what it takes to be a reporter for the Globe & Mail these days. This article on MERs by Dale Jackson had an interesting final paragraph:

However, there is a tradeoff when it comes to ETFs versus mutual funds. Investors are exposed to the whim of the broader markets, without the benefit of an experienced portfolio manager to steer clear of danger.

That will be the day, when a portfolio manager of a Canadian equity fund “steers clear of danger.” And how are investors NOT exposed to the “broader markets” when they have the “benefit” of an “experienced portfolio manager.” I have yet to see any convincing evidence that mutual fund managers are capable of beating the passive indexes, after they have taken their expenses. In case you need any examples

In one of the earlier paragraphs he said:

It’s important to keep in mind that the cheapest funds aren’t necessarily the best funds. The DMP Canadian Value Class fund returned more than 28 per cent last year even after the 4.11 per cent MER was subtracted – nearly doubling the average Canadian equity fund and the TSX. The United-Canadian Equity Value Pool fund, on the other hand, returned less than 10 per cent in 2006.

Way to pick out a return from a single year and talk about it as if it means anything. It also seems to be the only data point he uses to back up his sub-heading “Fund fees can add up. But sometimes, you get what you pay for.” That return is spectacular though and I like value investing. But that is only one year’s return. It will be interesting to see how it does in the coming years. Investing in the best performing funds of the previous year is definitely not a winning strategy.

Equal-Weight S&P 500 Index

I found a little report on the equal weighted S&P 500 Index “Are equal weighted indexes better than market cap weighted indexes?” It summarizes what we knew already, that the S&P 500 Equal Weight Index holds more of more of the smaller large-caps and less of the large large-caps and so its superior performance of late can be attributed to the better recent performance of the mid-caps over large-caps:

There is nothing wrong with the S&P 500 Index – it is a well-constructed and maintained passive benchmark. For those who do not like market capitalization-weighted indexes,
the S&P 500 Equal Weight Index is an alternative. But as I have shown in Figure 1 through Figure 4, the S&P 500 Equal Weight Index behaves more like value and mid to small-cap indexes . . . Thus, if one wants to get the exposure to the factors that influence the S&P 500 Equal Weight Index, then they probably could combine a group of passive market capitalization-weighted indexes to produce a similar pattern of returns. Given the cost of replicating an equal weighted index (brokerage costs associated with periodic rebalancing), it would seem investors could do better over the long term by using a combination of lower cost, lower maintenance, market capitalization weighted index funds as opposed to an equally-weighted index fund to gain the portfolio sensitivities desired.

He is correct in that there are higher costs associated with an equal weight index. The rebalancing bonus is small but it might cancel out or even trump the effect of the slightly larger MER on the ETF that matches the S&P 500 Equal-Weight Index, the Rydex S&P Equal Weight ETF (RSP).

My Investment Advice for Young Adults

Rather than just bash Rob Carrick’s advice for young people, I’ll offer up my own advice:

  • Start investing as early as you can. The earlier the better.
  • As soon as you have some money, invest some of it. If you have a paper-route or a part-time job, invest 10-20% of it for the long term. Get in the habit. Invest monthly. You won’t miss that money.
  • If you are babysitting for cash, tutoring for cash, earning tips, basically if you earning ANY employment income, file a tax return and declare all your income to build up RRSP contribution room.
  • If you have RRSP contribution room, start an RRSP and contribute to it. Find a company that will not charge you any annual RRSP fee. I recommend something like TD’s Mutual Fund Account. Set up an automatic monthly contribution if you have steady income. Max out your available contribution room every year.
  • Set up one or more ING Direct Savings accounts or one ore more savings accounts at your bank. If there is anything big that you want to save up for, use that to save up for it.
  • Don’t get a credit card unless you have to. Keep your credit card limit low. Pay off your balance every month. Don’t be dazzled by rewards plans.
  • When you get a large chunk of money from a birthday, a scholarship/bursary, a tax refund, don’t put it in your chequing account or convert it to cash. Deposit it into a savings account. Sit on it for a bit. Don’t make an impulsive purchase.

Think any of my advice is bad? Think I am missing something? Let me know.

Rob Carrick’s [Bad] Advice to Young People: RRSPs? Nah.

Rob Carrick’s receent article is a beauty. His headline is “Under 25? Live it up! Financial advisers can wait.” The article gives very confusing advice, and is by no means “financial and investing wisdom” as he claims. It’s the opposite of wisdom, whatever that is. He main goal point seems to be that young adults should wait before starting to invest (“RRSPs? Nah.” he says) and that they should stay away from the financial industry.

His logic goes like this. The “the financial industry is always trawling for new clients” so don’t invest until you are older. “There’s no need to let the financial industry get its hooks into you just yet.” If you do some investing, “get aggressive, sure, when you’re young, but hold off on the adviser.” “Be wary of the financial industry at any age.” Did the financial industry abuse Rob Carrick as a child? When you’re a bit older, sure go ahead, get an advisor, he says. “My advice to people in their early 20s is to live a little, and then visit an adviser when you really need to.” “Expert help can be indispensable if financial matters baffle you.” He uses an example of a TD poll that concluded that people aged 18-24 are least likely to have consulted a financial planner. Rob, TD is not in the same business as the fast food industry. Advertising targeted at children/young adults is OK.

Rob makes a feeble argument as to why you should until you are 28 to invest rather than, say, 22. Here goes:

There’s a good, strong argument for contributing to RRSPs as young as possible, of course. The earlier you put money in a plan, the longer it has to compound tax-free. If you put $1,000 in an RRSP at age 22, you’ll have $18,344 at age 65 if you assume an annual return of 7 per cent. If you wait until 28 (the TD poll found this is the average age for starting an RRSP), you’ll have $12,223, and if you wait until you’re 32, you’ll have $9,325.

By these numbers, the right age to start contributing to an RRSP is 28. You just lose too much in tax-free compounding if you wait until 32. And what about the $6,121 in gains you miss out on by delaying until age 28? Call it a fair price for enjoying your youth and not rushing into financial adulthood.

I’m not sure how he concludes that the magic age is 28 from those numbers. May I remind you Rob that one is only allowed to contribute up to 18% of one’s gross income into an RRSP every year. In the worst case that would lead to an 18% reduction in enjoyment, in the best case, it would lead to less spending on unnecessary things and minimal impact on enjoyment. You said it yourself Rob, “There’s a good, strong argument for contributing to RRSPs as young as possible, of course. The earlier you put money in a plan, the longer it has to compound tax-free.”