Ask Dave: US Dollar ETFs

Another question (or should I say several questions) from a reader about US dollar ETFs. Paul wrote:

Thanks for the great blog – as a relatively new investor interested in building an ETF portfolio, I have found a great deal of useful information on your site – its much appreciated. I wanted to ask you a few questions regarding the use of the Vanguard ETF’s especially in light of the soaring loonie which is nudging US$1.06 these days.

Do you think that the strong loonie should be an extra incentive for Canadians to buy the Vanguard ETF’s to diversify their portfolios? I feel that the strong loonie offers us an opportunity to buy these US$ based shares at a discount given that historically the CAD has been weaker than the US$. But I have read some blogs that warn that that may all be changing and that with increasing global demand for Canadian resources and with the problems in the US economy, we may see our dollar at least on a par with the US$ for a while to come.

No, I don’t think that the fact that the Loonie is extra strong (relative to the past) should be any extra incentive to buy Vanguard ETFs (read: US dollar ETFs). You are right, with pending problems in the US economy and increasing demand for Canadian resources the Canadian dollar may go even higher, or the Canadian dollar may fall back (or the US dollar may rise) to it’s historical norm relative to the US dollar. It is difficult to predict. It is good to own Canadian dollars if you plan on spending the proceeds of you investments in Canada. On the other hand if inflation ever became very bad in Canada and the Canadian dollar fell against the US dollar it would be nice to have US dollars. Also, if the Canadian dollar fell against all other currencies and you planned to spend your retirement savings travelling, then it would be nice if some of those investments were in something other than Canadian dollars. I think it’s important to have a balance and to not put all your eggs into one basket. He continued,

Also, I read your post about the exchange rate spread issue when buying US based ETFs and how if you do not plan to keep these ETF’s for a long time, the MER is essentially boosted by the costs associated with converting CAD to US$ and then eventually back again. Would this issue not lend more argument to buying ETF’s like XIN or XSP which have higher MER’s but at least you do not have to pay a chunk of change when you convert back to CAD?

Of course you would have to do some calculations yourself to see which is better (or see my post about foreign exchange costs). There are a bunch of variables involved: the foreign exchange rate spread, the MERs of XIN/XSP, the MERs of the Vanguard US$ equivalents, and the length of the time the investments were held. In general you’ll probably see that as the length of time increases, the lower MER investment will become more attractive. As the length of time decreases, the investment without the foreign exchange fees will become more attractive.

Lastly, I have read a lot about the exchange rate risk Canadians face buying ETF’s like VWO, VEA, VPL or VGK. How much of an issue is this? Surely as long as the ETF grows and we are buying these ETF’s now with a strong loonie, the risk must be fairly small and one could do well when the CAD eventually returns to a more realistic level with the US$.

I try not to worry about it too much because if you look at the long term historical trend, the Canadian dollar and the US dollar have not diverged substantially, although they do encounter some pretty big swings, as we have recently witnessed.

Right now I am inclined to overweight my portfolio with VTI, VWO, VPL and VGK to take advantage of the buying power of the loonie and then rebalance it with more XIC later when the CAD weakens a bit. Would this make sense right now or is there serious risk to assuming the CAD will weaken in the next few years?

Personally I wouldn’t assume the CAD will rise of fall in the next few years. Plan for a probability of either situation happening. Stick with an allocation of CAD and an allocation of USD that you are comfortable with, no matter what the current state of the loonie/dollar is, and the stick to that allocation. If you want to speculat, that’s up to you, however, but if you’re talking about a retirement portfolio I would just pick an allocation and go with it. If one currency rises substantially above the other you’ll find yourself buying the cheaper currency just to keep the portfolio balanced.

Anyway, thanks for you help and I look forward to reading your thoughts on these issues.

Thanks for your question Paul, and sorry for the delay in responding to it.

B.C. Housing “Severely Unaffordable”

The 4th annual International Housing Affordability Survey has measured housing affordability in cities all over the world. Vancouver has a median housing price to median income multiple of 8.4 and Kelowna has a multiple of 8.5. 5.1 & Over is deemed “severely unaffordable. For housing to be considered affordable, the multiple must be 3.0 or lower. Assuming salaries don’t change much, that would mean the median house price in Vancouver would have to be $179,700 to be considered “affordable.” I’m not sure if that will happen but we’re going to have to see a decline eventually as the current levels are unsustainable.

B.C. Isolated From Economic Storm?

If you want a laugh check out “B.C. isolated from economic storm, say analysts.” There is a bit of a mismatch between the headline and the article. None of the analysts quoted in the article actually say “B.C. is isolated from economic storm.” The dumbest quote award goes to Aron Gampel who apparently said “we have this commodity and construction boom of epic proportions which is keeping the western provinces essentially at full employment.” Who knows, maybe he was misquoted; maybe he meant it as a warning rather than a positive thing. To me it seems like a BAD thing that a huge chunk of our employment comes from the construction/housing sector bubble (which is about to crash). Here’s another good one: SFU business professor Lindsay Meredith “predicts some British Columbians will start belt-tightening” but then a few paragraphs later Meredith “sees no black clouds on B.C.’s economic horizon.” Overall, shoddy journalism. Unfortunately there is no author given.

Link Fest – November 12, 2007

  • UK Housing Hurting – The British Housing bubble, “spurred by a borrowing spree, thanks to interest rates at 40-year lows from 2001 to 2006” may be in its last days after the “average home almost tripled in value in the past decade.” It looks like properties bought as investments are going to be the hardest hit (just as they will in Vancouver): “Gabay says so-called buy-to-let properties, which investors acquire for rental income, are more vulnerable to a fall in prices . . . As interest rates rise, buy-to-let investors are making less profit on rental property, which may drive down housing demand and prices.” There are already many properties in Vancouver where the owners are not making up their mortgage payments with the rent (a few searches on MLS and Craigslist are all it takes to verify this, in addition to my own research while looking for  a new place for rent in July ’07.
  • Buyers get real returns” – Apparently “if you’re purely interested in accumulating wealth, it’s hard to beat homeownership over the long term, according to a discussion paper (Are Renters Being Left Behind? Homeownership and Wealth Accumulation in Canadian Cities“) completed earlier this year by UBC real-estate professor Tsur Somerville and student research assistants Li Qiang and Paulina Teller.” The results vary by city, but even in “in those cities where it is even possible to accumulate more wealth than owners, renters must be extremely disciplined. They must invest on average nearly 80 percent of the difference between the annual cost to owners and the cost to renters . . . this is approximately equivalent to 9% of a person’s gross income.” 9% of gross income does not seem that bad. If one looks at Table 4 of the study it is not that bad for renters especially if they invest the difference between rent and a mortgage (100% in this case) in lower cost investments. They would have achieved 77% of “owner wealth” if invested only in GICs and 124% of owner wealth if invested in the only the TSX index with 0.75% annual expenses (ie. MERs). I noticed some possible bias in this study and that is that they used the years between 1979 and 1996 as starting years and 25 years OR 2006 as the ending year, then averaged all these scenarios. The later years are thus weighted more heavily in their average. The year 2004 is used in each scenario but 1979 is only used in 1.
  • Mishs Global Economic Trend Analysis: What Factors are Affecting the U.S. Dollar? – Just one paragraph here of note: “The housing bubble in the US is well known, but the bubble in Canada, the UK, China, and Spain is just as big (if not bigger) than the bubble in the U.S. In particular, the bubble in Vancouver is as massive as the bubble in Florida or California ever was. Vancouver housing prices are destined to crash. Don’t ask me when, but only fools are buying at these prices. The housing bubble in Australia was the first to start deflating.”
  • Buy the fund, or buy the company? – Rob Carrick discusses buying stock of mutual fund companies. I found this comment amusing: “Investors can even take their cues from CI chief executive officer Bill Holland, Paul Desmarais, founder of Power Corp., which controls IGM Financial, and AGF CEO Blake Goldring who all have “the majority of their wealth” tied up in their stock as opposed to the funds, Mr. Almeida added.” These guys are smart, they know that it doesn’t make sense to buy mutual funds when 2% or more (on average) of the return is eaten up by MERs every year. Carrick also comes right out and mentions that “with mutual funds, investors typically get market-type returns minus the fees collected by their managers . . . The allure of fund companies is that their business model allows them to collect fees on assets under management during the good and bad times.”
  • Who, in the real world, can afford to live here now? – Another housing story about Vancouver. I knew that the percentage of their income people are now spending on their home has gone up, but I was surprised to learn that “here in Metro Vancouver . . . In the second quarter of 2007, the average owner of a two-storey home spends 73 per cent of the family’s pre-tax income on financing and maintaining that home.” 73% of pre-tax income? How does this average Joe get approved for such a mortgage (or is it a variable-rate?). Or an ever better question, how does average Joe buy food after paying taxes?

Link Fest – October 4, 2007

I haven’t blogged in a while but over the past week I collected a few interesting links I present them to you now in my first “Link Fest” post. Enjoy!

  1. The Worst Recession in 25 years? – A guy named Robert P. Murphy talks about the Fed’s recent rate cut and how it will not only “pave the way for much higher price inflation than Americans have seen in decades, but it will also exacerbate what could be the worst recession in twenty-five years.”
  2. Vancouver’s big squeeze: Unreal estate – This article in the National Post profiles the Vancouver real estate market and its absurdly overpriced it is. Apparently a “psychologist in private practice” with income well above the norm cannot even afford a home.
  3. Dodge warns of inflated housing market – Bank of Canada Governor David Dodge is raising a red flag about housing prices in Canada, saying that increasingly loose lending rules may be helping overheat the country’s real estate market.
  4. Cake Financial – An interesting new website that (by the sounds of it) will calculate your portfolio’s performance based on the transactions you make through your broker. It does so by connecting to you broker’s website. That’s right, no more manually entering transactions manually into some piece of software. Unfortunately I am at E* and it looks like it only works with E* I am not surprised as I literally had to enter a fake zip code just to get into the site.
  5. Give a cheer for these index-beating mutual funds – Or… not. Instead give a cheer for random chance and probabilities. Rob Carrick fails to mention that 1) the performance of these top achievers is most likely due to random chance (just like if 1000 people flip a coin 25 times there is a high probability that at least one person will flip heads 20 times in a row). 2) Survivorship bias means that of all the funds that have lasted 15 years, the ones that actually last that long are quite likely to have beaten the index because the ones that didn’t were killed off. Returning to the coin-flipping example, if you also tell any coin-flipper that flips 5 tails in a row to quit flipping, by the end, the field will be smaller and thus the 20-head flipper will appear to be all the more impressive. As Rob Carrick said himself in his article, “just because a fund beat the index over the past decade and a half doesn’t mean investors can count on it to do so in the future. Again, too true.” So why write the article in the first place? Why celebrate past performance? Still not sure.

Cramer Loses It

Has anyone else seen the video of that nut job Cramer losing it? Basically he wants a rate cut and thinks that the Fed should bail out the banks who dolled out sub-prime mortgages at teaser rates. On the other hand, if the Fed does cut rates, the US dollar will collapse even further, and lead to higher inflation for everyone. Essentially, imposing a “hidden tax” on the American people in order to bail out some banks. Well, that’s how I understand it anyways, after doing a little reading about from various for and against sources.

The Fed cannot be absolved of all blame of course, they dropped the rates hard and fast in the first place, which got the US into this mess. Here’s what some other people over at had to say:

Instead of immediately absolving home-buyers of blame, remember that a lot of these assholes WAY OVERPAID for their homes, failing utterly to demand value for their money or use sound judgment. As a result, prices exploded to obscene levels and now many many people can’t even consider buying a home.

It’s hard to feel too sorry for people who screwed over a great many others by falling all over themselves to bid MORE THAN ASKING PRICE for mediocre homes. Had they stood up for themselves and for value, we wouldn’t be in this shitty situation.

This was just another symptom of the plummeting standards and intelligence of our society. You want to talk about “values”? How about starting with the value of a goddamned dollar?

I can’t help agreeing with that, seems like common sense. Here’s another:

I remember two years ago when everyone was going crazy in the market and people thought I was crazy for renting. I still rent today, I like having the space, the lower monthly payment, and generally a nicer place than I could afford to buy. People would ask me, “how much does this condo costs??” I would say, it’s not a condo, it’s an apartment, and they would give me that smug look and a snicker and say “Ohhh, you still rent??”, like I was too stupid or too poor to buy a house. Now all those people have those half a million dollar “investment properties” they can’t sell because they bought in an over-saturated, over-valued market. And to add insult to injury they also have a million dollar condo on a variable interest rate loan… me? I pay they same rent I did four years ago, who’s laughing now?

Sounds like he’s in the same boat as us. Happy to be renting, and annoyed when people give you that “ohh, you still rent??” deal. There was a reply to that comment:

And you have accumulated _NO_CAPITAL_ in the time you’ve been renting. This “renting is a better financial option” talk always burns me, go back to “sound financial planning 101” and you’ll know that 99.99% of-the-time, paying your own mortgage is better than paying one for your landlord.

“Who’ll be laughing” is me in 15 years. When my house is payed for, and Ive got a $250,000 asset and youve got zilch. In fact, Ive currently got a renter in my first (fully paid-for) home, paid $150k and now making $12,000 PA in rent — a Dead-Solid secure investment making ~7% income PA.

You enjoy your “extra space”, and when home _BUYERS_ are enjoing their lifetime of sound financial planning (read: Houseboat on Lake Tahoe/Cottage in Muskoka/Porsche) you can tell us all how rent was such a wise investment…

This is totally flawed reasoning. The renter in all likelihood accumulated capital as well, through investments, if he is as smart as he thinks he is. This is one of the biggest myths about real estate: that all renters accumulate no capital, which is utterly false. It is true that some renters accumulate no capital but it is also true that some renters accumulate lots of capital. Many people who buy a home especially when they are young (as many did in this market) cannot afford to make other investments (besides their home), so they tend to forget that other investment options (stock market, bond market inside or outside of an RRSP) even exist. Of course there are renters that blow their extra cash on beer and popcorn and a home makes a great forced savings plan. Oh, and here’s a real life example for you in case you still are not convinced: for the past year my wife and I were paying $1050 in rent and putting $1750 into our RRSPs per month. Our financial situation has changed a bit now, our rent is higher at our new place and RRSPs haven’t gone up much yet but we are actually still putting in more in our RRSPs than our rent. Ok, back to more comments:

If Bernanke cuts rates, China et al will have less incentive to continue to buy up treasuries at lower interest rates, and that’s presently the only thing keeping the dollar from falling through the floor. Therefore, Cramer is asking Bernanke to save his buddies’ asses at the expense of the $ itself (ie, at the expense of EVERYONE). My guess is Bernanke will stand pat, since it’s easier to deal with one Cramer than 300 million.

As for Cramer, he himself predicted the hedge fund implosion in this more sane commentary:
…so for him to scream that the sky is falling is flip-flopping of epic proportions. If Googling “failure” brings up links to Bush, then I’d say Cramer should be near the top of the search results for “douchebag”.

The article above is somewhat interesting and explains some of what is going on but I have to a admit I don’t quite understand all of it. Here’s another comment:

It’s funny how the “free market economy” should apply to all the companies out there, until the banks are in trouble. Then the government should step in to bail them out. Hundreds of thousands of jobs have been axed because of leveraged buyouts and takeovers in the last decade while the brokers and bankers made fortunes. Now we’re supposed to take it up the rear again just because they made some bad bets? Screw that.

iTulip made a great video calling Cramer for what he is, go check it out:

I’m not shilling for iTulip, I just think they can see through Cramer’s bullshit better than most.

Check out the iTulip video. And another:

This happens every time banks get into trouble (and they always eventually get into trouble). Banks lend out money. If lending standards are slackened, like they have been for a while, banks lend money to anyone, with little oversight. Eventually those loans turn sour, like they are doing in the subprime mortgage business. The banks are then caught short and don’t have the money to continue operating. In the Bear Stearns case we’re talking about two hedge funds that they’ve had to close, which is in turn affecting the parent company. So after a bank is facing a run on what little it has in deposits by creditors they’ll turn to the Federal Reserve, which is itself a cartel of banks. At the Fed a bank can be lent money to stay in operation. Also if Congress gets involved through pity they can authorize the Fed to give that other bank money interest free. The problem with this is that the Fed creates money out of nothing and in so doing they dilute the total pool of dollars in circulation which causes our dollars in our pockets to be worth less and less, this is known as inflation: the value of money goes down in relation to other commodities. So don’t believe people like Cramer or your Congressman or the Fed who will say that Government needs to bail these banks out. It’s a lie. They want to saddle the American people with a hidden tax (inflation) to solve their ill-conceived business practices.

Finally, does he really need to scream his point like that? I mean who can take that seriously?

Tough Times

Looks like the market has had a bit of a rough week, with Canadian and US indexes losing almost 3% in the last 5 days of trading. I have a feeling it will probably get worse before it gets better. Just try to block it out. If your time horizon is 10 years or more then the recent drops are completely insignificant. You can do more harm than good by selling.

How Panama Functions With No Central Bank

I just read an interesting article about Panama’s monetary system called “Panama Has No Central Bank. Here’s a summary of how Panama’s monetary system works and the effect it has had on inflation and the economy:

The absence of a central bank in Panama has created a completely market-driven money supply. Panama’s market has also chosen the US dollar as its de facto currency. The country must buy or obtain their dollars by producing or exporting real goods or services; it cannot create money out of thin air. In this way, at least, the system is similar to the old gold standard. Annual inflation in the past 20 years has averaged 1% and there have been years with price deflation, as well: 1986, 1989, and 2003.

Panamanian inflation is usually between 1 and 3 points lower than US inflation; it is caused mostly by the Federal Reserve’s effect on world prices. This market-driven system has created an extremely stable macroeconomic environment. Panama is the only country in Latin America that has not experienced a financial collapse or a currency crisis since its independence.

Read the article for more if you are interested.