If you had purchased shares in the S&P 500 index (through the SPY index ETF) in July 1997 (at about $91-92 per share), your investment would be worth the same amount today, but in today’s dollars. So technically you would have lost money if you consider inflation. So it has an annualized return of about 0%, neglecting inflation. All this ignores dividends which were roughly 1.5-3% during that period (very rough guess). So let’s just for sake of argument that the dividends cancel out inflation. So again, the annualized return would have been roughly 0%. If you made any more purchases of the S&P 500 index after 1997, well, you annualized return would have only gotten worse because except for a brief period in early 2003, SPY hasn’t been below $91-92 since 1997.
How do currency exchange fees factor into the decision between VEA and XIN? XIN’s MER is 0.35% higher than VEA’s, but it is purchased using Canadian dollars, so there is no exchange fee. VEA’s MER is nice and low, but don’t you immediately lose a few percentage points of your investment when you buy it due to currency exchange fees?
He’s exactly right. The answer to “which one is better, VEA or XIN, from a cost perspective” is “it depends.” In this case, it depends on how long you hold your investments.
I did some similar calculations to determine the “effective MER” of a foreign currency investment over time but this time I do it a bit more simply, to determine, simply, how long to I have to hold my VEA until it beats XIN.
When you buy VEA, you’ll pay a foreign exchange fee (spread). This varies depending on your broker but they range from 0.5% to 1.5% each way. Let’s assume it’s 1% each way. So when you use Canadian dollars to buy VEA they convert your dollars to USD but they take 1.5% for themselves. So our present value has gone down by 1.5%, or 98.5% of the original. When we sell your USD investment, VEA, in the future, the broker/banks will again take 1.5%. So your final value is also reduced by 1.5%. So originally, we had this:
Our initial PV needs to get reduced to 0.985 of the original, and the result of the right-hand needs to be reduced by 0.985 (when we sell the investment). So what we end up with is this:
If we invest in XIN, there are no foreign exchange, just an MER that is 0.35% higher. This 0.35% will reduce our annual return, so we get this:
We can get rid of PV (it won’t affect the result) and assume a return of 7% (i=0.07). It turns out that:
So if we hold onto our investment in VEA for 10 years or greater, we will end up better off, assuming a rate of return of 7% (note that the rate of return does not have much effect here, eg. 10% rate of return gives the same result) and a foreign exchange fee of 1% each way. The two variables that have the greatest effect here are the foreign exchange fee and the difference in MERs.
I was hoping to buy some VTI today but I couldn’t buy it through E*Trade’s website because there was no quote available. I had noticed in the past few weeks that there was an asterisk next to the market prices of my Vanguard ETF holdings that said: “A quote was not available on this security. It has been priced using the previous day’s closing value.” I called E*Trade and they weren’t much help. The lady kept saying “that is not the correct symbol” to which I kept replying “I don’t understand what you are saying.” Eventually she said that it was on the “Pacific Exchange.” Well the Pacific Exchange doesn’t actually exist anymore:
by 2005, the Pacific Exchange was bought by the owner of the ArcaEx platform, Archipelago Holdings, which in turn was bought by the New York Stock Exchange in 2006. The New York Stock Exchange conducts no business operations under the name Pacific Exchange, essentially ending its separate identity. Pacific Exchange equities and options trading now takes place exclusively through the NYSE Arca (formerly known as ArcaEx) platform
Googling for NYSE Arca and Vanguard finally gave me some hits. Apparently on September 19th, 2008, Vanguard ETFs are now trading on the NYSE Arca Exchange after moving from the American Exchange:
NYSE Euronext (NYX) announced that its fully-owned subsidiary NYSE Arca today began trading 34 Vanguard Exchange Traded Funds (ETFs) after the group transferred over from the American Stock Exchange (AMEX).
I wonder if E*Trade will ever support quotes from the NYSE Arca exchange? Apparently I can buy them over the phone. Going to give it a go tomorrow because the markets were closed by the time I sorted everything out.
Update (2008/10/7): They will not charge you extra commission because it is sold on an exchange that E*Trade’s website doesn’t support. They have apparently always done this with stocks that cannot be purchased through the online system. We just bought some VTI shares. I’ll give it a few days and I’ll let everyone know if I see any extra commissions drawn my account due to this trade.
European and North American markets are WAY down today. To tell you the truth, I haven’t really been following the markets too closely of late, although I have heard a lot of grumblings here and there and a noticed a few blog posts about it; however, because I don’t follow what the markets are doing every day, the fact that the S&P TSX Index Composite fell 500 points doesn’t really mean that much to me. For all I know, it could have been up 500 points last week/month and so all that really does is wipe a weeks/months gains. Ignorance is bliss.
No changes here in my investment strategy. Our RRSP monthly contribution amounts have been the same since last tax season when we adjusted them based on our 2007 incomes and they will continue to remain the same until June or so 2009. Every time my portfolio or my wife’s contains more than $2000 cash, we buy some more of the ETFs that we already own. No surprisingly, since our portfolio is 25% bonds and 75% equities, we haven’t purchased many bonds recently, since equities have performed so poorly, we have been underweight in equities in recent months.
I’m looking forward to the next bull market and remaining fully invested (only in low-cost index ETFs) until then.
Just found this great interview with John Bogle, “the father of index investing.” A must-listen for any investor, especially those who own mutual funds and those who have no idea what index investing is all about. If you already use indexes in your portfolio, they is still a lot of great information here, and it will help give you even more confidence that you are on the right track!
The Million Dollar Journey brought up 4 reasons why index investing may not be for you. His 4 reasons were:
- No Downside Protection
- No Control Over your Holdings
- An Indexed Portfolio will Always be Average. Never Better, Never Worse.
- It’s Boring.
Now onto the debunking:
- No Downside Protection What index investing gives you is the average return but with far less costs than active investing (either through an non-index mutual fund or do-it-yourself trading). Period. What does downside protection mean anyways? The only way to have true downside protection is to be able to forecast when the market is going to down. No one has been able to achieve this yet (and no one every will). The other way to have downside protection is to add some other asset class to your portfolio. In the extreme case, being 100% invested in a completely negatively correlated asset class would give you perfect downside protection. This is sort of how mutual funds offer some “downside protection”, however, one could also call this “upside suckage.” Mutual funds often carry some cash. This reduces their losses during down markets but also decreases their returns during up markets. In general, there are more “up markets” than “down markets” (ie. the stock market goes up over time). Therefore you want to be 100% invested all the time to maximize your return. So the fact that index investing has “no downside protection” (at least in the way that Million Dollar Journey means) is actually a good thing because it means you are less invested in cash and more invested in the market. I would say that even if you care about “downside protection” indexes ARE for you.
- No Control Over your Holdings He says that “This can potentially lead to over priced stocks having a larger weighting on the index” and cites Nortel as an example. Overpriced stocks in an market-cap weighted index (most indexes are market-cap weighted) do not pose a problem. I only hold indexes in my portfolio. If a stock in one of my indexes increases 100-fold tomorrow, my portfolio may go up a little. If that stock eventually falls back down to its previous levels, I haven’t lost or gained anything. The investor with “more control over his portfolio” may choose to do some trading in that stock. Because he/she cannot predict the future of the stock, he/she can have no effect other than to decrease his/her net returns due to increased trading costs. As for the Nortel example, the only people that would have suffered because of the fact that the index contained a high of Nortel stock (even more than Canadian mutual funds) are those that, say, switched out of Canadian mutual funds and into indexes while Nortel was at its peak. Those that held the indexes all along, would have experienced the huge increase in Nortel’s stock price as well as its decline, whereas those who held a Canadian mutual fund during Nortel’s rise and an index during its fall, would have experienced more of the fall than the rise. (This is all hindsight, of course. Nortel could have kept rising of course and fallen back less.) If you are worried about a re-occurrence of such a scenario, switch over to indexes gradually. Having less control is better. It means less trading, less costs, and higher returns.
- An Indexed Portfolio will Always be Average. Never Better, Never Worse. This is a good thing. Any portfolio, whether it be a carefully chosen assortment of stocks, a randomly chosen assortment of stocks, or a mutual fund, will on average get the average market return. What that means is that if we sum up the returns of a bunch of portfolios and divide by the number of portfolios the average return of those portfolios will be the same as the average market return (or equivalently, plot a histogram of the portfolios returns and the center of the bell curve will be the same as the average market return). The question is, can you control whether or not your portfolio’s future return will lie above or below the center of the bell curve? This is very difficult to do (if not impossible) in an efficient market, especially after you take into account trading costs. And consider the alternative if you fail in your quest to get above average returns. You may end up getting below average returns. Investing in the index is guaranteed to give you the average market return. It usually also does so at very low cost. The fact that the cost of investing in indexes is so low means that most indexes actually end up beating the majority of mutual funds (and probably those who pick stocks on their own as well). I would provide a citation but there are too many and I wouldn’t be able to decide which one to use.
- It’s Boring. The original poster admits that “this is probably the weaker of all the arguments.” He says that if you like “digging in research, watching the markets, and investing when you think the time is right” then index investing is not for you. I would argue that the main reason people do “research,” “watch the market,” and “invest when they think the time is right,” and find those activities non-boring is because they believe they can “beat the market.” Once you realize that you can’t beat the market and give in to that fact, you may find that index investing is not so boring after all. When you invest with indexes you will get the average return (sounds boring), but due to your decreased costs you will beat everyone else who is invested in mutual funds or buying individual stocks on their own, and that is exciting! I agree, however, that index investing is simpler, but that’s what makes it outperform everything else. Simpler means lower costs, and lower costs means greater returns.
As I was writing this, the Canadian Capitalist published a great reply to Million Dollar Journey’s post as well.
Vancouver Condo Info posted two housing market forecasts from Helmut Pastrick, one from March 17th, 2008 and one from August 20th, 2008. They are remarkably different.
The first one from the CBC goes like this:
housing prices will continue to rise by as much as 10 per cent this year and as much as seven per cent in 2009
And the second one from the Globe & Mail goes like this:
housing prices, down marginally from their peaks early this year, are likely to drop by 10 per cent before the market rebounds, he said.
It’s amazing to me how Helmust Pastrick, Chief Economist of the Credit Union Central of British Columbia, can make such an awful prediction when so many non-experts saw this crash coming. It is impossible to know when the market was going to peak and start falling but it had to happen eventually. Armed with the knowledge that it had to happen eventually, how could Helmut predict a 10% rise in 2008 and 7% in 2009 knowing that at any time the market could crash? The only alternatives are that either he knew the market was going to crash soon but chose to ignore it or that he was truly convinced that the market was going to continue rising just like it has for the past 6 years. The whole reason why there were so many non-experts who didn’t see this crash coming is a) because of idiots like Helmut Pastrick who feed their garbage predictions to the media and b) the idiots in the media who quote the idiot experts and their predictions without questioning them.
Over at Vancouver Condo Info, one commenter said “That’s a whopping 20% difference. I am sure reporters will ask Mr. Pastrick the tough question: why the 20% change in forecast?” I’d like to see a reporter do this, however, it is not going to happen, or at least it won’t make it into print. If anyone does see anything like this, let me know.
Anyone who owns iShares CDN S&P/TSX Capped Composite Index Fund (XIC) may have noticed that it is trading at around $20 when it should be in the $80s. It is because they announced a stock split, however, the additional units haven’t been disbursed to share holders yet. Meanwhile, in my E*Trade account it says that holdings in XIC have a market value 73% less than the book value because the split price has already taken effect.
Scotiabank has bought my broker, E*Trade. This the second time my broker has been acquired by an acquisition. Previously I was with a full-service broker, Clearsight, which was purchased by Wellington West. As soon as Scotia raises the commissions, I’m leaving. I’ll probably go to Questrade.
I have been trying to get rid of 2 old cellphones for the past 3 weeks. The phones are 3 years old but they are in great shape and these phones would still be considered an upgrade for many people out there. I advertised on Craigslist and Kijiji and started the price at $20 per phone. I got a couple offers and then I reduced the price to $15 after getting 2 offers that were lower than my asking price. I got a couple more bites but they didn’t end up coming to pick them up. So I got maybe 4 or 5 offers in 3 weeks or so. Then yesterday I decided enough is enough, I want to get rid of these phones so I put them up for FREE on Craigslist and Kijiji. Within the last 12 hours I have received 18 emails. I am planning on giving it to the first person who inquired but I’m leaving the ad up until them just in case they don’t show. 2 of the 18 people offered to pay me for the phones. Why did the number of inquiries (per hour) jump so much as soon as I made it free? I think the relationship between the asking price and the number of inquiries is highly non-linear when you get closer to $0. I’m curious how many inquiries I would have gotten had I posted them for $10 each (in hindsight the drop from $20 to $15 was too minuscule to make much difference).