I Told You So!

Hilarious video of bearish Peter Schiff on various talk shows in the past few years getting laughed at by his peers:

Somewhere around the middle of the clip there were a few stock recommendations. Ben Stein recommended buying Merrill Lynch when it was trading at $76.01. It’s now trading at $8.34. Someone else said Goldman Sachs is cheap and recommended buying it at $175. It’s now trading at $53.31. Ballsy Peter Schiff countered those recommendations with “Stay away from the financials. They’re toxic. They’re not cheap, they’re expensive. You think they’re at low P/Es? They have no earnings. Their earnings are going to disappear.”

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.

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 www.personalfund.com. 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 www.ishares.com

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!

Ask Dave: Costs of Switching From Stocks to ETFs

Another reader had some questions about how to switch from a mutual fund and/or equity-based portfolio to a passive ETF-based portfolio.

My wife and I have 3 accounts which have about 20 equities in each. As a whole, the accounts are not well balanced, and they are overweighted with Canadian securities from the days that there were restrictions to RRSPs in their foreign content.

I have taken over management of the accounts myself. They have been moved to a discount brokerage that was imposed on us because of some quirks in the accounts that forced us to use a particular broker who was agreeable to accept our holdings. Their trading fee is $29.95/transaction.

After doing extensive reading and research, I have decided to restructure the accounts to resemble a structure similar to your Passive EFT portfolio. I was very impressed with your rationale in formulating your post of April 15, 2007.

We are locked in to some mutual funds and other fixed income vehicles which will restrict our immediate restructuring abilities. I believe it may be best to leave the best of our Canadian equities that are already in place, rather than selling them and purchasing XIC. We will also need to keep the other restricted holdings, as mentioned above. As a result, we will need to take substantial new positions in VTI, VWO and XIN. In essence, we will be paring 50 or more holdings to less than 10. We will basically sell Canadian equities, mostly banks, to purchase diversified content, US and foreign (VTI, VWO, XIN).

First, I want to make a general point. Do not forget that stocks have no MERs. If you have a portfolio of 60 stocks it has no ongoing expense fee. Hold on to them for many years and you may do better than index ETFs which have a small non-negligible MER. So is worth it to sell those 60 equities you have spread out between 3 accounts? Maybe not. 60 equities is plenty of diversification in one market. If a portfolio of 60 Canadian equities was handed down to me I would think twice about selling them and switching to an ETF. The commission to sell those 60 equities is going to be $1200 at least, plus I am going to have to pay around 0.25% commission on the ETF annually. If some of the 60 Canadian equities were going to be sold in order to diversify into international and US investments then some added cost might be worth it. I just wanted remind people that stocks on their own have no commissions but ETFs do and in some cases it might be best to hang on to those stocks if they have already been purchased. In most cases, however, index ETFs are probably a better solution as they provide lots of diversification at a low-cost with little hassle. Another thing to consider is that the commissions to sell the stocks will one day have to be paid anyways; however the commission as a percentage of the investment will decrease because the stocks will surely grow over the long term.

I am guessing you were also thinking about costs when you said you “believe it may be best to leave the best of our Canadian equities that are already in place, rather than selling them and purchasing XIC.” I agree with you that selling all of them and buying XIC seems a bit unnecessary. Assuming you have a good number of stocks (>=30) that would be just as good as XIC, if not better, due to the lowered on-going cost.

For your international investment please consider Vanguard Europe Pacific ETF (VEA) as an alternative to iShares CDN MSCI EAFE Index Fund (XIN) if you can handle the extra foreign currency holdings, as it has a lower MER. Remember that VEA is equivalent to owning the underlying investments in their respective foreign currencies, not US dollars. So you should not be concerned with the US dollar but with Canada’s currency against world currencies. The MER is a lot less in VEA vs. XIN and it is basically the same thing as EFA (which XIN holds underneath but hedged to CAD dollars).

My questions are:

Should I be concerned about the costs of buying and selling the 30 or more holdings?

Well one thing I would be concerned about is if the cost of selling 30 or more holdings was more than, say, 1% of your portfolio (1% figure chosen arbitrarily). If your portfolio is only worth $1000 and you are paying $100 in commissions it doesn’t really make sense. It would take a year at 10% interest to make up the loss and leave you will no gain. That’s like taking one whole year off the investment period. Or another way of thinking about it is that the commission as a percentage of your portfolio is going to affect the final portfolio by that percentage as well, if you consider the commission as affecting the future value of your investments. Here’s the longer explanation. The future value without any commissions is:

FV_0=PV \times (1+i)^n

The final value after paying some one-time commission CC is:

FV_c=(PV-C) \times (1+i)^n

where PV is the present value (on the date you pay commissions), FV_0 and FV_C are final values (of the amount PV, not including any future contributions), i is the interest rate, and n is number of years until retirement (for example). If you find the percentage difference between FV_c and FV_0, or the percentage the final value will be reduced by, you get,

100 \times \frac{FV_c-FV_0}{FV_0} = 100 \times \frac{-C}{PV}

So if you you pay $1000 commissions selling 30 securities and your portfolio is currently worth $100,000 your final value will be reduced by 100 \times \$1000/\$100,000 = -1\% of whatever it ends up being in the future. If it would have grown to $1 million dollars eventually it will be reduced by 1% or $100,000. That was just a long winded way of explaining why I think one should always look at their commissions as a percentage of their portfolio’s present value, and remember that it will affect the final value of their portfolio by the same percentage.

By paring down the portfolios we will end up with a very substantial proportion of our assets in only 2 stocks VTI and XIN. Although I understand that these ETFs are made up of multiple equities, the diversification we presently have with 50-60 holdings will be lost. I am, therefore, concerned that the accounts will largely be influenced by movement in only 2 entities? Doesn’t this increase our risk?

Good question, I had not really though of this before as I have never owned that many individual equities before. Owning two ETFs should be equivalent to owning positions in all the underlying securities. Assuming there were no MER and assuming that tracking error was non-existant, the return would be the same and the risk would be the same, as far as I know.

I am impressed with the incredible power of the internet to stimulate discussion and to disseminate valuable information so easily. I would appreciate your answers to my questions as well as any other thoughts you might have about my portfolios.

I hope my answers made some sense. It looks like you are on the right track and I think you have spotted the main problem with your portfolio (lack of global diversification) and are looking to diversify while minimizing your costs (both one-time commissions and ongoing MERs).

Clearsight Comment on Current Market Conditions

Today I received a link to a Clearsight “market communique.” It starts off with a little technical charting stuff that I’m not too fond of:

After rebounding nicely from its June lows through the first week of September, the TSX Composite Index has fallen over 4%. As in previous setbacks, the index now stands at a key valuation level that if held might lead to another bounce. In the most recent rally and ensuing downturn however, there has been a general absence of many signals at key price breakpoints for the leading stocks in the index.

See what I mean? I’m not a big fan of “valuation levels”, “signals”, or “price breakpoints”…load of crap if you ask me. No offense to them, I just don’t get off on technical analysis (of stock price charts at least :-)).

Apparently a US slowdown has begun, “For over a year, economists have sounded an alarm that a U.S. economic slowdown would begin, as an unprecedented bull-run in residential housing comes to an end. This forecast has now become reality.”

No big surprise, economists can’t agree on what will happen (haven’t they invented crystal balls yet?):

Some economists and market observers are now predicting an outright recession, while others call for a ‘mid-business cycle slowdown’, i.e., soft landing to occur. Even the more optimistic admit however, that this slowdown will feel like a recession to many people.

There final advice is a bit mixed:

On balance, there appears to be a reasonable likelihood that the economy will avoid recession, at least in the near term. This in and of itself however, may not be enough to spark a genuine rally in the markets. Even so, abandoning one’s investments completely at this point would generally not be advisable for long term investors, not to mention impractical. But, cash is not a four letter word, and finding opportunities to take profits and increase cash holdings in markets such as the current one can help add comfort and stability for long term investors

In essence they provide some optimism, or hope for those who are worried about a downturn, and give some very sound advice, 1) to not sell the farm, but 2) hold some cash, and if you are a bit underweight right now, selling a few equities wouldn’t be a bad thing to do.

Bill Miller on Commodities and Market Physics

Here’s a really old article, flagged it a long time ago, and just got to it now: “Bill Miller on Commodities.” How true is that? To make some money by buying things at the right place and the right time (if that is your fancy) you have to be buying things that are in the dumps, things that no one has made money on in a really long time, things that are cheap. It is funny how most humans never figure this out. Part of the reason why this happens is that bull markets can be so prolonged. The other reason I think is that when the big crashes hit, no one has any spare cash around to invest in the cheap stuff because, well, it was all invested, and now you’ve lost it.

One final reason could be that humans seem to have Newton’s 1st law of motion hard-wired into their brains. The law says that an object will not change velocity until a force acts upon it. Humans have a slightly corrupted version of this law programmed in their brains, however. A version that ignores the “until a force acts upon it” part. People forget so easily that there are forces that can cause markets to “change velocity” from upwards to downwards, instead thinking that the velocity will stay upwards (as if the world was frictionless). Inflation, rising interest rates, commodity shortages, natural disasters, a huge shift from the historical mean, war, stupidity, corruption, routine market correction, etc… In fact, in another analogy with physics, you could probably say that the magnitude of the restoring force involved is proportional to how far away from the mean the market has travelled, just like a spring (see Hooke’s Law). In other words, the bigger they are the harder they fall.

I’m curious, what has done really badly in the past few years anyways? What has performed the worst? I did a quick check of index funds using globefund.com‘s fund filter and sorted them by worst performers over the past 3 years. It looks like tech stocks/nasdaq, bonds, and US equities (due to US dollar decline) have been the worst performers in increasing order of better performance. We also can’t forget about cash which also hasn’t performed too well (in never does, but it doesn’t do that badly either, just losing a few percent every year due to inflation). 🙂 What has performed the best over the past 3 years? Well just about everything, energy stocks, gold, Canadian equities, REITs, international equities, European equities, in decreasing order of performance. Anyways, don’t read too much into that, it’s just me playing around. I have a hunch though, that those investments that have performed well over the past 3 years are probably less likely to perform as well going forward.

Aside: Newton himself famously lost 20,000 pounds (in 1720, worth 1.9 million pounds in today’s dollars) on the South Seas bubble.

Covered Call Options

It is sort of unusual for me to write about a topic like covered call options. It is something that will come up in a future post about split shares I am drafting right now, and it is kind of a heavy topic so I thought I would give it a post all on its own instead of cramming it into a future post. I also find it a extremely interesting topic, even though I will most likely never take part in any options trading myself.

A book I read recently called “A Mathematician Plays the Stock Market” has a pretty good description of covered call options. But before understanding what a covered call option is, one has to understand what a call option is. A call option is a right to buy a stock (but not obligation) at a certain price (the strike price) within a specified amount of time. For example, stock options offered by companies to employees are call options (as opposed to put options). Although “stock options” involve the issuing of new stock whereas with call options, the shares are simply being transferred from one owner to another.

You can also sell a call to someone, ie. sell someone the right to buy shares in a company at a certain price within a specified time period. If the stock doesn’t move above the strike price, you keep the proceeds from the sale of the call option. If the price of the stock moves above the strike price and the buyer of the call option exercises their option, you have to buy some shares at the current market price and provide them to the buyer at the strike price. Essentially you are buying them at the current price (a high price) and selling them to someone else at the strike price (a low price). So selling calls is a bet that the stock price will decrease.

Another strategy is to buy shares and simultaneously sell calls on them (selling “covered” calls). You could for example, buy shares of ABC Corporation at $25 and sell 6-month calls on them with a strike price of $30. If the stock price doesn’t rise to $30 you keep the proceeds of the sale of the calls. If the stock does rise past the strike price of $30 to $35, and the buyer of the call exercises their option, you can sell your own shares to the buyer of the calls. Selling “covered” calls (calls in stock you own) is safer than selling calls because you don’t have to buy stock in that company at a high price ($35). You already own stock in that company which you bought at a low price ($25) and can sell it to the buyer of the calls for $30. You make money on the stock’s rise from $25 to $30 as well as the proceeds from the sale of the call option and the buyer of the call option makes money from the stock’s rise from $30 to $35 minus the purchase of the call.

Here’s an example from the Wikipedia article on call options:

  • An investor buys a call on Microsoft Corporation stock with a strike price of $50 (the future exchange price) and an exercise date of June 1, 2006, and pays a premium of $5 for this call option. The current price is $40.
  • Assume that the share price (the spot price) rises, and is $60 on the strike date. The investor would exercise the option (i.e., buy the share from the counter-party), and could then hold the share, or sell it in the open market for $60. The profit would be $10 minus the fee paid for the option, $5, for a net profit of $5. The investor has thus doubled his money, having paid $5, and ending up with $10.
  • If however the share price never rises to $50 (that is, it stays below the strike price) up through the exercise date, then the option would expire as worthless. The investor loses the premium of $5.
  • Thus, in any case, the loss is limited to the fee (premium) initially paid to purchase the stock, while the potential gain is theoretically unlimited (consider if the share price rose to $100).
  • From the viewpoint of the seller, if the seller thinks the stock is a good one, he/she is $5 better (in this case) by selling the call option, should the stock in fact rise. However, the strike price (in this case, $50) limits the seller’s profit. In this case, the seller does realize the profit up to the strike price (that is, the $10 rise in price, from $40 to $50, belongs entirely to the seller of the call option), but the increase in the stock price thereafter goes entirely to the buyer of the call option.

There is another example of selling covered calls at investopedia.org and another explanation here.


This article, “Cramer Google-Coaster (GOOG)” lists Cramer’s recent recommendations on Google stock:

January 3……….Buy…….$435.23 (going to $500)
January 4……….Buy…….$445.24 (going to $500)
January 13……..Buy…….$466.25 (going to $600)
January 23……..Buy…….$427.50
January 25……..Buy…….$433.00 (take profits)
February 2……..Buy…….$396.04
February 6……..Sell.. ….$385.10 (sell at $400)
February 14……Buy…….$343.32
February 27……Buy…….$390.38 (going to $500)
March 6………….Sell…….$368.10 (going down $15)
March 7………….Buy…….$364.45
March 13………..Sell…….$337.06
March 21………..Sell…….$339.92
March 23………..Buy…….$341.89
March 29………..Sell…….$394.98

I plugged them into Excel and set up some cash flows according to the following rules: purchase 100 shares of GOOG every time Cramer calls “Buy” and sell of half of the shares you own every time he calls “Sell.” I then used Excel’s XIRR function to determine the Internal Rate of Return, and got a -66% annualized return. Way to go Cramer. If you’d just bought 100 shares of Google on January 3rd and held it until March 29, you would have achieved a -34% annualized return. If you had of instead bought 100 shares of Google on all the dates above in order to dollar-cost average, you would have achieved an 8% annualized return by March 29th.

The analysts are always full of crap with their buy/sell recommendations and I am sure any reader of this blog is aware of that. What is sad is that Cramer’s show is insanely popular. What is even more sad is that a friend of mine’s dad is an investment advisor and he watches Cramer every day after work AND TAKES NOTES. To give him the benefit of the doubt, maybe he just watches the show and gambles 5% of his portfolio (his “mad money”) on some of Cramer’s picks. But still, I would not be happy if I suddenly found out my advisor watched Mad Money every day after work. I am extremely happy that I am not going to this person for financial advice/management. And I was very impressed when I first met my current advisor and he told me that he “does not pick stocks.” Nor does he sound like someone who would pay any attention to stock picks he heard on TV.

I only saw Cramer’s Mad Money once while in Hawaii (my only chance to watch the 24/7 American “news” stations). I think I watched for all of about 2 minutes until I dismissed it as crap and shut it off. Once in a while I hear about this Mad Money show. I remember Arrested Development poked fun at it and a little while back a stock recommendation on his show apparently caused Zarlink stock to increase 20% in one day.

Here are couple of comments on Cramer from “Ego Unleashed, or Everyman of the Market?“:

“What you are seeing when you watch that show is both a parlor game and real brilliance,” Mr. Bogle said. “But I think that when the final score is written, his return is very average, and below average when you factor in the costs of making the trades. We know that when you own the stock market and never trade, you will capture the market’s return. The more we trade, the greater the costs and the greater the loss. These are relentless truths that cannot be avoided.” [emphasis mine]

Another good article here: “Monitoring the ‘Mad Money’ Madness” by the Big Picture‘s Barry Ritholtz.

Stocks Buffett Would Stay Away From

This article, “Dreadful Stocks to Avoid,” explains a few good rules of thumb for conservative stock picking (also applies to mutual funds since they can own stock too!).

Stocks to avoid:

  • Businesses that bet the farm – “In some industries, companies periodically have to make critically important decisions. If the company makes the wrong choice, it will be dealt a crippling blow.” As an example, “. . . Boeing is betting the farm against the superjumbo, opting instead to develop the 787, a smaller, long-range jet that it expects to better address the market’s needs. But if Boeing’s analysis is incorrect and the market moves toward the superjumbos, it will lose customers.”
  • Businesses dependent on research – “. . . there is a downside to research. Often, innovative companies are required to do research simply to maintain their competitive position. And if the research dries up, the company suffers.” Although it was not for lack of innovation or good ideas coming from research, this rule would have prevented the majority of Canadians from buying Nortel and preventing a lot of pain.
  • Debt-burdened companies – “In general, Buffett avoids companies with a lot of debt. This makes sense. During the best of times, large amounts of debt mean that cash that could be put toward growing the business or rewarding shareholders is instead servicing the debt.” This seems like a no-brainer.
  • Companies with questionable management – “Some clues to look for here include excessively optimistic press releases, overly generous compensation or options grants, or the constant use of external circumstances to excuse operational shortcomings.”
  • Companies that require continued capital investment – “Over the long term, shareholders make spectacular returns by buying businesses that are able to achieve extraordinary returns on capital. This leads to excess capital that the company can use to repurchase shares, pay a dividend to shareholders, or reinvest in further growth.”

Altamira Canadian and Global Blue Chip Notes

While I was driving home work today I just caught the end of an advertisement for something called “Altamira Canadian Blue Chip Note.” I did not really know what it was all about but it sounded interesting. I have never owned an Altamira fund before but they have the lowest cost index funds in Canada (besides TD’s eFunds which are only available to TD clients) so I like them.

It turns out there are not one, but two varieties of Altamira Blue Chip Notes, the Canadian Blue Chip Note and the Global Blue Chip Note. Here are the important facts:

  • The issue date is March 1, 2006
  • The maturity date is March 1, 2014 (8 years from now)
  • The issuer (National Bank of Canada) has the option of “calling” (redeeming) the note early after four years. They will pay out a premium of 46.41%, which corresponds to about (1+0.1)4, 10% compounded over 4 years.
  • The Canadian Blue Chip note is comprised of 20 Canadian Blue Chip stocks in equal proportion (5% each) and the Global Blue Chip note is comprised of 20 global companies (primarily US).
  • When the note matures after 8 years the return is based on the price appreciation of the diversified basket of 20 Canadian companies. Essentially you capture the growth of the underlying stocks over the 8 year period; however, if the return of the stock basket was negative, you are paid out the principal amount. So effectively, your principal is preserved no matter what happens to the stock market.
  • No income taxes payable during the holding period.
  • Notes can be sold in a weekly secondary market maintained by National Bank Financial
  • National Bank of Canada guarantees repayment and has an A credit rating from S&P and DBRS.
  • 100% RRSP eligible
  • Minimum investment is $500 (5 notes, at $100 per note)
  • “The Bank will not charge any management fee in respect of the Notes. However, purchasers should realize that the Ordinary Dividends paid in respect of the shares comprising the Benchmark Portfolio will not be reinvested in the Benchmark Portfolio.”
  • No rebalancing of weightings in the underlying stock basket

These remind me of Canada Savings Bonds, but a bit more exciting. Have these things existed before? The top 20 stocks in the S&P/TSX 60 Index make up about 70% of the index, so owning the basket of 20 stocks in the Altamira Canadian Blue Chip Note is not much different. Also it looks like there is no management fee (how is that possible?) This seems like a great alternative to iUnits XIU ETF with the added protection against a market downturn.

One disadvantage is that you are somewhat locked in for either 4 or 8 years. Although I would see this feature as an advantage, preventing you from selling early and locking-in losses, and instead forcing you to ride out the ups and downs of the market to a higher return than if you had gotten out of the market after a downturn. The less we buy/sell/trade the better in my opinion.