Opened a Tax Free Savings Account (TFSA) at E*Trade

My wife and I just opened up Tax Free Savings Accounts (TFSA) at E*Trade. I’m still not sure what I am going to invest in, but my requirements are that the initial capital has to be protected because we will most likely be taking the money out for a down payment in the next few years. We might just buy some shares of iShares’ Short Term Bond Index Fund (XSB). The only other possibility I had considered was to open a Tax-Free GIC with ING or a hight-interest savings account at President’s Choice, but interest rates are so low, I figure I can’t do any worse with short term bonds. The disadvantage with XSB is that I would have to pay commission every time I buy and 0.25% MER on top of that. But I think it’s worth it for the diversification it offers. Building a bond ladder yourself would involve a lot of commissions and a lot of work, so something like XSB is really the cheapest way to invest in the bond market. Real return bonds are also a possibility, and not a bad one, since they virtually guarantee that you’ll at least beat inflation.

Ask Dave: How Do Bond Indexes Work?

A reader named Charles asks a very good question about how bond indexes work?

Quick question for you. I, of course, know how TIPS and bond works but what about a short-term bond indexes (XSB or XRB or TD e-Series) for instance? Does an investor actually gets coupon payment? (I dont think so…). Because the market value of the bond doesn’t change much, so the investor basically gets its return from the quarterly dividends only?

I have a good understanding about how bonds work myself although I don’t know much about the details of how bond indexes work although I sort of just imagine it as a basket of bonds with different dates of maturity, different coupon rates, and different face values, and that buying an index fund is just as if I had bought all the underlying bonds at their current face value. I will also receive all of the interest payments on the bonds in the index, or some of it will be reinvested into purchasing other bonds. That’s just my idea or assumption of how it must work.

Here is a short summary of how bonds work and how bond funds (mutual funds in this case, but an index should be no different in theory) from some website, but it is reprinted from American Century Investment Services, Inc.:

It’s easier to understand how bond funds work after you know how individual bonds work.

An individual bond pays interest at a rate set by the issuer. Usually, the issuer agrees to pay interest on a regular basis such as quarterly or semiannually. The current yield on a bond, which is the amount you earn, is calculated by dividing the amount of annual income by the bond’s price.

For example, if a $1,000 bond provides $80 in income, its current yield is 8% (80 divided by 1,000). Bonds pay interest income regularly and repay the face amount (principal) when the bond matures. Keep in mind that the price of a bond can change after it’s issued, which could change the current yield even though the interest rate stays the same.

With bond funds, the current yield also is referred to as the distribution yield, and it is calculated using the daily dividend per share. This is what is used to distribute income to the funds’ investors.

Another website called Quamut had a pretty good explanation of How Bond ETFs work:

Bond ETFs track indexes that contain individual bonds. Bond ETFs don’t have a face value or a coupon rate, however. Instead, bond ETFs have a share price that’s determined by the prices (face values) of the individual bonds in the index that the ETF tracks—when the prices of those bonds rise, the ETFs share price also rises. In place of a coupon rate, bond ETFs have a yield (interest payment) that equals the average interest rate of the bonds in the index that the ETF tracks. Though the interest payment on an individual bond is fixed, the yield of a bond ETF can change as the individual bonds in the index tracked by the ETF shift. Generally, these interest rates change only in small degrees.

If anyone else can find a better explanation out there please pass it on. So far the Wikipedia article on Bond Market Indexes is not great.

Why It’s Nice to Own Bonds

I have been checking my portfolio quite a bit lately (although it is getting a bit boring and the performance of my holdings has been predictably bad). The only part of my portfolio that has showed an increase in market value vs. book value were my two bond ETFs (Short-Term Bond Index ETF (XSB) and Real Return Bond Index ETF (XRB)). Makes me glad that 25% of my portfolio is made up of bonds. It helps me get through the night, so to speak. Even better is that it helps preserve capital during these bear markets and provides some holdings that are not so correlated with stocks for increased risk-adjusted return.

Ask Dave: Why Bonds Anyways?

A reader asked me:

I am 29 and am basically just getting started in investing. Since I am young-ish I have decided to start with an 80/20 mix of stock/bond in my portfolio. I’m pretty sure I want to buy bonds, but don’t know which short term bonds to buy. However, looking at expected returns for bonds (3%-6%), should I really get them in the first place?

I want to have 20% of my total portfolio in bonds. Honestly I can not decide between XBB or XSB and honestly don’t know how to pick one over the other or is there a mix of bond indexes I should buy into? However, if E*Trade is telling me their Cash Optimizer Investment Account is going to give me 4.15% why the heck would I even buy bonds (which fluctuate and introduce risk) when I can get 4.15% GUARANTEED on my money? What is the incentive (or logic) to buy the bonds? I have heard that if E*Trade went bankrupt – I might lose the cash I had in the Cash Optimizer Investment Account (since it was not technically invested in anything that is insured – is that BS or what?) – where as if I owned the bond index – that is a protected insured investment. Perhaps that is a reason I should actually buy the bonds? Comments?

First of all let me give the simplest answer possible: Don’t put all your eggs in one basket. I see the bond and equity markets as two very different markets. In a doomsday scenario, we could see second Great Depression (let’s call it the Greater Depression) and the stock portion of your portfolio could lose 70% of their value while the bonds will hold their value if held to maturity (obviously depending somewhat on the rating and such things but let’s assume we are talking about high-quality and government-backed bonds). Just as it would be foolish to invest only in one sector of the stock market, do not invest only in the stock market. Invest in bonds and invest in real estate too.

Benjamin Graham says a lot about bonds and bonds vs. stocks and asset allocation in The Intelligent Investor. His conclusion at the end of chapter 2 says much the same thing as above:

Naturally, we return to the policy recommended in our previous chapter. 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 case you are confused, before this Graham talked a lot about the inherent risk and uncertainty in the stock market (meaning that some bonds are necessary for safety) and persistent inflation risk (meaning that some stocks are necessary as a hedge against inflation, which be be disastrous for bonds). Chapter 2 is a great read, as is Chapter 4, which talks about bond-stock allocation:

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.

He actually favours a 50-50 split for the “defensive investor”, shifting the balance when stocks are at “bargain levels” or when the market level has “become dangerously high.” I would warn against such market timing and stick to one allocation and re-balance when necessary. That allocation should be set to whatever is comfortable for the investor, as he says long-windedly in Chapter 2, “the more the investor depends on his portfolio and the income therefrom, the more necessary it is for him to guard against the unexpected and the disconcerting part of his life. It is axiomatic that the conservative investor should seek to minimize his risks.”

I don’t know where you get your expected returns for bonds from, but the 10 year performance of the TD Canadian Bond Fund is 5.8% and the return of XSB since inception (7 years ago) is 5.71%. I remember it being better before, so I guess recent poor performance has dragged them down a bit. For the amount of risk involved, that’s not a bad investment. There are equity markets that have performed worse over the same period according to TD’s mutual fund performance chart (Note TD International Equity at 1.4% over the past 10 years).

Of course the other advantage of having bonds in a portfolio has to do with diversification which can lead to less volatility in your portfolio. Chapter 8 of A Random Walk Down Wall Street explains this very well (to see the section I’m talking about, go Search Inside the book on Amazon and search for “the benefits of international diversification have been well documented” and you’ll get to page 192, then read on).

Personally I think bonds will beat any high interest savings account in general. And in my opinion you shouldn’t worry too much about E*Trade going bankrupt unless you have over $1 million with them. I’m not convinced that the Cash Optimizer wouldn’t be covered by the CDIC but I haven’t really looked into it so I’m not sure. Maybe another rule of thumb should be to not have all your assets at one brokerage?

As for XSB vs. XBB, Martin Gale of complains that “the duration on these funds [XBB] was too high” making the risk-adjusted return too low compared to stocks:

Note the principle here: If you want to earn a higher return, you have to take a higher risk. Some investors try and earn the higher return by buying longer duration bonds, and taking on a higher interest rate risk. I think this is a bad idea: If you want to take on a higher risk, instead buy more equities and take on more market risk. Whatever risk/return ratio you achieved by buying longer duration bonds, you could achieve by holding fewer bonds and more equities. In general I think the equities have the better risk/return ratio. That could always change–but at least historically, it’s been the case that equities have been a better investment than long-term bonds.

You can read the full article here: “Changes To Barclays iShares: XSB and XRB” article. He was so strongly in favour of XSB and against the longer duration XBB that I went with XSB instead, along with some XRB (real-return bond index) as well (there’s also a mention of XRB in the Martin Gale article).

I hope that helps!

The Real 10 Commandments of Investing

Rob Carrick recently “gathered 10 of our favourite bits of investing advice, on topics ranging from stock-market risk to which mutual funds to buy” and called it the 10 Commandments. A commandment is “a command or order,” so something like “thou shalt not use the word commandment incorrectly” is a commandment. “Commandment” #10 is “Investors repeatedly jump ship on a good strategy just because it hasn’t worked so well lately, and almost invariably, abandon it at precisely the wrong time.” C’mon that’s not even a commandment! So what is the order here, that we should not jump ship on a good strategy that goes bad? or should we not use strategies? or should we abandon them at precisely the right time instead of the wrong time? The longer explanation does not leave things any more clearer, offering such advice as “ignore the slumps or use them as a buy-low opportunity,” or ” judge whether your fund manager has what Dreman calls a good strategy.” For what’s it’s worth, the only words of advice in there I thought were useful were Buffett’s (use low-cost indexes) and Malkiel’s (less fees are better).

A while ago a guy named Alan Haft (he wrote a book called “You can never be too rich”) made up his own 10 Commandments of Investing and it’s been in my drafts folder ever since I saw it. I think he sums up the most important things that people should do with regards to investing, they are well written, and they make sense. Here they are:

  1. Stick with the indexes
  2. Watch those fees
  3. Create a bond ladder
  4. Diversify
  5. Watch your money
  6. Don’t rush in
  7. Don’t take the risk if you don’t need the return
  8. Get out if something isn’t working
  9. Understand tax consequences
  10. Keep it simple

Here are some highlights:

1. Stick with the indexes
Leave the individual stock picking to gamblers and speculators. Very few people really understand how to successfully pick individual stocks, and if they do, the news that drives markets today is totally unpredictable, making individual stock picking a highly risky venture. Reams and reams of statistics prove index investing almost always outperforms the financial advisors, money managers, and stockbrokers. Stick with the indicies and you’ll likely wind up far ahead of the game. Care to speculate a bit on some individual stocks? Do it with a small portion of your money, but certainly not the bulk of it.

2. Watch those fees
Wall Street loves investors that don’t watch their fees. For those investing in funds, check out You might be shocked to find out the total cost your funds are charging you to own them year after year. Especially over the long haul, fees can destroy your returns. Minimize fees as much as possible by investing in low-fee, highly diversified investments such as one of my personal favorites, Exchange-traded funds such as those offered by

7. Don’t take the risk if you don’t need the return
Many people would do perfectly fine getting 7-10% returns on their money, yet their portfolios are invested in things that strive for well beyond that. Especially if you’re a retiree, if you doubled or tripled your money overnight, would you go out and buy a fancy new sports car? A mansion on the hill? Few of us would. And for that reason, always ebb towards the safer side of investing as much as you possibly can

Check out the original article for the rest!

My New Passive Index ETF Portfolio

Unfortunately this is the second time my portfolio has changed in the past two years. The first change was when I moved from a TD Mutual Funds account to Clearsight last year. My advisor had great plans for my portfolio. He wanted to eventually have me primarily invested in low-cost ETFs and we were going to have a 25-25-25-25 split between Canadian bonds, Canadian equities, international equities, and US equities. Due to the high commissions ($75) charged by Clearsight we bought one ETF and the rest was in mutual funds. Anyways, before we got very far Clearsight was acquired by Wellington West and my advisor was let go, so I began the transition to E*Trade where I could manage my portfolio on my own. I learned a lot from my advisor at Clearsight, like what an ETF is, and importance of lowering cost. I have come a long way since just owning just TD mutual funds and eFunds through a TD Mutual Funds account back in 2005. So before I introduce you to my new portfolio at E*Trade, here’s what my portfolio looked like when I was with Clearsight:

RRSP holding Symbol Type %
CI Value Trust US Equity 11%
Templeton International Stock Fund Global Equity 26%
Canadian TSX60 index ETF XIU Canadian Large Cap 34%
E&P Growth Opportunities Canadian Small Cap 4%
TD Canadian Bond Fund Canadian Bond 25%

Some of the things I did not like about my old portfolio are:

  • High cost – Too many mutual funds with high MERs. I checked all of these funds’ performance again and for the most part they didn’t seem to be capable of beating their benchmarks in the past. The Growth Opportunities has not beaten the S&P/TSX Venture Composite Index in the range I looked at. CI Value Trust (clone of Legg Mason Value Trust) has not been impressive of late, but even worse, it has assumed far more risk than an index, with its investments in Google and other high-tech stocks. The Templeton International Index fund (last time I checked) had not beaten the MSCI EAFE index over the long term. Also, the TD Canadian Bond fund is not all that spectacular compared to ETFs like XSB.
  • No emerging markets – I wanted some emerging markets to provide increased diversification and greater risk-adjusted return due to their low correlation with other markets. The fact that emerging markets have done very well of late is of no concern to me, I realize if I buy emerging markets equities now I might suffer a bit in the near future.
  • No real return bonds, or inflation-sensitive assets – I looked at the Ontario Teacher’s Pension Plan and the CPP Investment Board and both have significant real return bond holdings. The former has 11.1% and the latter has 3.5% in real return bonds.
  • Huge domestic bias – Although I had originally wanted 25% in Canadian equities my advisor had me at 40% because he had concerns about the US dollar, so we weighted Canadian equities more. This is way too much allocated to a handful of Canadian companies that make up a large part of the TSX/S&P 60 Index.
  • No foreign currency exposure – Foreign currency exposure can be a good thing. If inflation is high in Canada, our dollar will decrease in value relative to other currencies. More importantly, some of my investments, such as the CI Value Trust were hedged versions of USD mutual funds so I was paying extra management expense when I could have just owned the USD version and possibly reduced my total risk at lower cost.
  • Lack of US exposure – I only had something like 11% of my assets in US equities. This is extremely underweight for such a large market like the US. My advisor was planning to “ease in” to US equities (he had some issue with the falling US dollar) but I would prefer to just go with some desired allocation and re-balance when necessary rather than thinking one can be smarter than the market.
  • Lack of broad US exposure – Bill Miller’s Value Trust is invested in relatively few investments compared to the size of the US market. He also invested a lot in high tech companies like Google, Yahoo, Amazon, eBay, etc… I wanted to own more blue chips/boring companies, mid-caps, small-caps, etc…

So based on some of the things I did not like about my old portfolio, and some information that I gleaned from various blogs and internet sources, here is my new portfolio that I have putting together for the past couple months:

RRSP holding Symbol Type %
iShares CDN MSCI EAFE Index Fund ETF XIN-T International Equity 35%
Vanguard Emerging Markets ETF VWO Emerging Markets 5%
Vanguard Total Stock Market ETF VTI US Equity 32%
iShares Canadian Short Bond Index Fund ETF XSB-T Canadian Short-Term Bond 15%
iShares Canadian Real Return Bond Index Fund ETF XRB-T Canadian Real Return Bond 5%
iShares Canadian Composite Index Fund ETF XIC-T Canadian Equity 8%

Now I’ll expand on some of the reasons why I chose the above asset allocation as well as the reasons why I chose each investment in my new portfolio. This portfolio is inspired primarily by Martin Gale, Canadian Capitalist, Dan Solin (author of The Smartest Investment Book You’ll Ever Read), and Burton Malkiel (only part way through his book right now).

NOTE: I am under 30, I am looking for long term growth only, I am not planning to take out any of this money until I retire at age 55-65, and I can handle some short-term swings in the market.

ETFs vs. mutual funds
Using ETFs instead of mutual funds was a no-brainer for me. I have come to the realization that beating the market is virtually impossible for all but a few very talented people, and that passive investing can yield greater returns with less risk due to its lower costs. For more information, read my recent blog post “Malkiel, Bogle Argue Against Non-Market Capitalization Weighted ETFs” or read “A Random Walk Down Wall Street.” I can also give credit to the Canadian Capitalist and his blog for convincing me of this fact. He has been tracking a “sleepy portfolio” for a while now, consisting of a few ETFs and it seems to do pretty well.

It was clear to me that I was not going to have a 100% bonds portfolio, nor was I going to have a 100% equities (as my advisor wanted me to have last year). Benjamin Graham is very clear in The Intelligently Investor page 56-57 about his opinion on this issue when he says “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 . . .” There is much more discussion about this in the book. Martin Gale also has an excellent article about stocks vs. bonds. He says,

Many investors make the mistake of thinking that the least risky portfolio is one containing just cash and short-term bonds; or that the most aggressive portfolio is one containing only equities. Somewhat surprisingly, that is false. The safest portfolio contains a mix of stocks and bonds, as does the most aggressive. For any portfolio containing all bonds there is a less risky portfolio with a better return that contains some stocks. This is counter-intuitive because in and of themselves bonds are safer than stocks.

I saw some similar arguments in a Powerpoint presentation from an investment advisor recently, that basically said, no matter how risky you want to be, at least hold some bonds (like at least 10%). It is pretty widely accepted that you should have some bonds and some equities. How much of each is up to you. I followed Martin Gale’s advice on short vs long term bonds, and decided to stick to buying short-term bonds, because “whatever risk/return ratio you achieved by buying longer duration bonds, you could achieve by holding fewer bonds and more equities. In general I think the equities have the better risk/return ratio. That could always change–but at least historically, it’s been the case that equities have been a better investment than long-term bonds.” This backs up what I was told by my ex-advisor at Clearsight; stick with short duration bonds and avoid long duration bonds.

So, to minimize cost I see only two options. Buying iShares Short-term Bond Index Fund (XSB), or buying individual bonds and making my own bond ladder. I decided to buy XSB since the commission costs of making my own bond ladder would be prohibitive at this point, although when my nest egg is larger this might be more cost-effective because it would eliminate the MER.

Real-Return Bonds
As I said above, one of the disadvantages of my old portfolio was that I had no real-return bond component. Real return bonds are resistant to inflation because the interest is set to be x number of points above the inflation rate. I looked at the Ontario Teacher’s Pension Plan and the CPP Investment Board and both have significant real return bond holdings. The former has 11.1% and the latter has 3.5% in real return bonds. I decided to have 1/4 of my bond portfolio invested in real-return bonds which amounts to 5%. I might re-evalute this allocation later (in about 5 years).

Canadian Equity Component
Now that the foreign content limits are removed we are starting to see more and more people suggesting that Canadians hold somewhere around 3-10% Canadian equities in their equity portfolio, rather than the insane 25-70% allocations we used to see. At the Canadian Capitalist, Dan Solin comments on why investors should have no more than 10% Canadian equities in the equity portion of their portfolio. There is also a good article by Martin Gale here about domestic bias and foreign asset allocation. Finally, according to Carl Spiess at Scotia Macleod, “over the last 20 years, international markets have outperformed Canadian markets by almost 2% a year.” We have had some excellent years in the Canadian equities markets recently as well as in the late 1990s thanks to Nortel so people often forget that Canadian equities have historically underperformed against international markets. If you looked at the risk-adjusted return, the picture would probably be even worse. He continues, “it makes sense to invest globally not only based on historical returns, but also because many economic sectors (eg. Healthcare) are not significantly represented in Canadian markets. In addition, despite several good years recently, Canada only represents 3% of world stock markets.” He’s right; The Vanguard Total Stock Market Index has 12% in healthcare, for example, while the TSX Composite contains less than 1% in healthcare as it is dominated by financials and energy.

Another article here gives “10 key reasons for going global in your RRSP.”

US Equity Component
I relied heavily on Martin Gale’s advice on his Efficient Market Canada website. Specifically, his “Building A Globally Efficient Index ETF Portfolio (updated)” article (and it’s predecessor) and also “Foreign Asset Allocation in your RRSP.” I ended up making US Equities 40% of the equity portion of my portfolio, which corresponds to 32% of my total portfolio. The obvious choice here was some sort of S&P 500 Index, like XSP or SPY, but instead I went with the lowest-cost option out there, which is probably the Vanguard Total Stock Market Fund (VTI). It is even more diverse than the S&P 500 in that it currently holds 3692 different stocks. The US market is huge and this is a great way to own it all without having to purchase both the S&P 500 Index ETF (SPY) and the S&P Mid-Cap Index ETF (MDY) for example.

International Component
Again, as above, I looked at the global market capitalization and decided to put 50% of the equity portion of my portfolio into international stocks. This corresponds to 40% of my overall portfolio. Since Vanguard does not really have much for international index ETFs, and the iShares $USD MSCI EAFE Index ETF (EFA) has the same cost as the iShares $CAD MSCI EAFE Index ETF (XIN), the best option was to go with XIN (see “Exchange Traded Funds: Recommendations“).

I was worried that with my much lower Canadian equity component that I would end up having a lot of US dollar investments in my RRSP. As I mentioned above, since Vanguard does not really have much for international index ETFs, and the iShares $USD MSCI EAFE Index ETF (EFA) has the same cost as the iShares $CAD MSCI EAFE Index ETF (XIN), the best option was to go with XIN, which is traded in Canadian dollars. So now my only USD holdings are the Vanguard Emerging Markets Fund (VWO) and the Vanguard Total Stock Market (VTI) which take up about 37% of my total portfolio. Having less than 50% of my RRSP assets in USD seems alright to me. When I get older and closer to retirement I could move more of my money into CAD investments if I feel the need.

Emerging Markets
There are two emerging markets funds to choose from, the iShares one (EEM) and the Vanguard one (VWO). After much searching on Google for “EEM vs. VMO” and reading many articles I could not discern much difference between the two. The Vanguard one uses a slightly difference underlying index as I discussed in my previous blog post entitled “Foreign Exchange Costs Associated With USD Investments in an RRSP” and, like most Vanguard funds, has a much lower cost than its competitors. So I went with the Vanguard fund. Because of the high risk associated with emerging markets and because of their recent stellar performance, I put only 5% of my total portfolio in emerging markets, even though emerging markets make up about 9% of the world market capitalization. I may increase my desired allocation of emerging markets later, relative to my other international holdings.

REITs are a good addition to the fixed-income portion of a portfolio and they provide good negative correlation with other asset classes. Most of the large pensions funds hold a significant amount of REITs. XRE is the iShares offering and I will probably be adding this in eventually. I don’t want to do too many things at once. I need to decide if I should reduce my bond allocation from 20% and add in the REITs or if I should reduce my equities from 80% and add in REITs. Or lower both? My original thought had been to have 20% bonds, 5% REITs, which is why I went with 20% bonds rather than 25% bonds as I had before.

Please let me know if you have any comments and I will add any details to this article that I may have left out.

Canadian Tour of Personal Finance Blogs

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’s excellent bond tutorial.

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).

New Book: A Mathematician Plays the Stock Market

Just got a Christmas present from a very good friend of mine (same person who got me the Intelligent Investor for my birthday earlier this year) called “A Mathematician Plays the Stock Market” by John Allen Paulos. It appeals to me right away because of my math background and because I like to understand things like the stock market in quantitative ways. I’ll give you the blurb on the back:

With his trademark stories, vignettes, paradoxes, and puzzles, John Allen Paulos addresses every thinking reader’s curiosity about the market–Is it efficient? Is it rational? How should one pick stocks? Can one quantify risk? What are the most common scams? Is there a way to really outperform the major indexes? Can a deeper knowledge of mathematics help beat the odds? This wry and illuminating book is for armchair mathematicians, market followers, or anyone who wants to know how market work.

Some of the sections within the chapters that caught my eye were: “Technical Strategies and Blackjack,” “Efficiency and Random Walks,” “Fat People, Fat Stocks, and P/E,” “Are Stocks Less Risky Than Bonds,” “The St. Petersburg Paradox and Utility,” and “The Paradoxical EFficient Market Hypothesis.” There are many more topics. Practically everything in the investing world is touched on in some way. I am looking forward to reading it after I finish the book(s) I am reading now.

Yield curve inverts

The yield curve on US Treasury yields inverted today, as reported in this Globe & Mail article an event which has frequently signalled the beginning of a recession:

“Here is the historical record — we have endured eight Fed tightening cycles in the past three decades: the Fed has inverted the curve on five of those occasions, and out of those five Fed-induced inversions, the economy slipped into recession a year later all five times,” said David Rosenberg, North American economist for Merrill Lynch & Co. Inc.

The Big Picture quotes Alan Greenspan, who says “it’s different this time”:

Fed Chairman Alan Greenspan has noted that “its [sic] different this time.” He has challenged the view that “inversion signals economic trouble, pointing out that the shape of the curve is less predictive than it once was.” [emphasis theirs]

Others agree:

“[The inverted yield] has been taken as a negative omen, but I think you have to be cautious in today’s circumstances,” said Andrew Busch, global foreign exchange strategist for BMO Nesbitt Burns Inc. The yield has inverted at relatively low levels of interest rates and not the normally high levels of rates when the Fed tightens to subdue inflation, he said.


During the past 20 years, 10-year yields have exceeded two-year yields by an average of almost one percentage point, according to Bloomberg.

“This clearly suggests we are very close to the end of the tightening cycle … and it is not an indication of a recession,” said Michael Rottman, a strategist at Germany’s Hypovereinsbank.