Stocks end lower, rattled by housing

It looks like the shit is starting to hit the fan in the housing market. It’s starting to spill into the stock market with this announcement from Toll Brothers Inc. and more and more into the mainstream (unfortunately it probably hasn’t caught on with the speculative condo owners yet). Weston Boone, vice president of listed trading at Legg Mason Wood Walker says:

A soft real-estate market is not good for the consumer. It is not going to bode well going forward. You have to take into consideration the rising interest-rate environment. There aren’t a lot of catalysts for positive sentiment in the market.

Hopefully by the time the market is in the bottom of it’s trough, I’ll have enough of a down payment saved up. Historically, the time from peak to trough has lasted at least 7 quarters (or 1.75 years) in Vancouver. So I am extremely content to not be invested in real estate at this time. Not only is my rent far below the mortgage payment I would pay for the same place, but we can pick up leave with a month’s notice at any time. No, rent is certainly NOT throwing your money away.

Berkshire Hathaway Undervalued?

This article, Berkshire’s a Bargain lays out a convincing argument to buy Berkshire Hathaway:

“Rather than the historical increases in book value of 22% or 19%, I assumed that Berkshire’s book value only grows by 15% per year for the next 10 years. At that rate, the book value per share would go from $57,010 today to $230,637 by 2015. I then assumed that in 2015, the stock would be trading at a historical low in terms of multiple of book value (1.35 times). That would mean that the shares would be priced at $311,360. On the basis of those assumptions, if I buy the shares today at $85,200, I would earn a 265% return on my initial investment or a compound annual rate of return of 13.8%. On a risk-adjusted basis, I have a hard time coming up with anything that comes close.”

He refers to this site, which calculates Berkshire Hathaway’s intrinsic value. The author quotes Buffet in 1995, when his stock was trading at 2.44 times book value (price/book value of 2.44) as saying “historically, Berkshire shares have sold modestly below intrinsic value. But recently, the discount has disappeared, and occasionally a modest premium has prevailed.” Then, in 2000 when “new hot issues” (as Graham would describe them) were at their peak, boring stocks like Buffett’s were trading at lows. Berkshire Hathaway was trading at 1.35 times book value. When this Fool article was published on November 2, Berkshire was trading at 1.5 times book ratio (which he says is still a bargain), and is today trading at 1.58 times book value.

The only assumption that I did not like at first was the fact that he assumes that Berkshire’s book value will increase just has it has in the past. However, Warren Buffett is seen as a value investor, and I am confident in the value investing approach and Warren Buffett’s track record to believe that he can achieve even the most conservative gain of 15% increase in book value over the next 10 years.

Although BRK.A is difficult to afford because the cost of one share is currently just over $90,000 USD, the B shares, BRK.B should be affordable for many, at just under $3,000 USD per share.

ETFs, the Inflation Fighter

The article, ETFs, the Inflation Fighter, talks about how sectors such as energy, utilities, and health care can help your portfolio during periods of high inflation. Historically, these sectors have done well during these periods. Sectors which are worse off during periods of “inflation acceleration” are consumer-discretionary, financial, industrial, and information-technology. My own advisor has recommended I overweight my portfolio in the energy markets (which does well during periods of high inflation and rising interest rates), especially since the S&P TSX indexes are heavily weighted in the financial sector (which does poorly during periods of high inflation and rising interest rates).

I have no idea why the title was “ETFs, the inflation fighter.” ETFs are just one way of investing in the stock market, and clearly not ALL ETFs are inflation fighters. Well, Ghosh works for Standard & Poor, so that might explain the bias towards an ETF rather than a managed mutual fund or individual stocks.

Why Invest in Stocks?

This article, Armchair Millionaire Community Bulletin: All the Wrong Reasons to Invest in the Stock Market, gives some good reasons to invest in the stock market. He says that “as you make your investing decisions, don’t be misled by clichés that insist that stocks are simply the ‘best’ investments out there. You’ll need to dig deeper to learn whether stocks are genuinely right for you.” This goes for any type of investment.

Another advantage of stocks is that they “give you an excellent hedge against inflation. So while inflation will eat away at your portfolio at the rate of 3 percent or so a year, stocks will out pace inflation to provide you with a positive net return over time.” This is discussed in Chapter 2 of the Intelligent Investor, where Jason Zweig says in his commentary “In 50 of those 64 five-year periods, stocks outpaced inflation.” In periods of very high inflation, companies and their stocks will suffer, however.

Finally the author, Lewis Schiff says: “Shares of stocks rise and fall–sometimes dramatically–but that does not mean that investing in stocks is gambling. There are no guarantees in gambling, but stock investing does give you one guarantee: By buying shares of a company’s stock, you will get a share of that company’s future earnings and growth. So on a very small scale, when you invest in the stock market, you get in on the growth of capital markets. And there is one thing that has been proven over time: Capital markets work.”

The article linked to in the first paragraph comes from, a site based around the book by the same name. It has some good points about saving and investing, similar to those in the Wealthy Barber: invest monthly into an RRSP (or US-equivalent), and contributing another 10% of your gross income to another fund. He emphasizes dollar-cost averaging and has a good conservative approach to investing in the stock market. He suggests investing in a mix of index funds, large-caps, small-caps, and an international fund.

Paying Down Student Loans vs. Contributing to an RRSP

There are many people, me being one of them, who ask themselves “should I put money into my RRSP or pay down my debts?” For very high interest debt, such as credit cards and bank overdraft, this type of debt should always be paid down before anything else. For other debt such as student loans, bank loans, and mortgages, the answer is less obvious.

I have come up with a good, simple example, to answer the above question. Imagine you had at least $1000 room in your RRSP and you owed $10,000 at 7% as of January 2006. In January 2006, you have a choice of either putting your next paycheque (of $1000) towards an RRSP invested in a balanced portfolio of bonds and equities, or towards the $10000 loan. You can do nothing else with your loan or your RRSP until January of the following year.

  • Case 1: If, in January 2006, you put $1000 towards the $10,000 loan, you would be left with $9,000. Over the next year, you would be charged $630 in interest, a savings of $70 over what you would have paid had the loan principal still been $10,000. Your net worth based on the RRSP and the loan would be -$9,000 – $630 = -$9,630 at the end of the year.
  • Case 2: If, in January 2006, you put $1000 into the RRSP invested in a balanced portfolio of bonds and equities. To be conservative, we will assume that it will appreciate by 7%, however, it doesn’t really matter so much as we will not be realizing any value on this portfolio for years to come (until we retire, presumably). After one year, the RRSP portfolio will have appreciated by $70. In April 2005, you will receive a tax refund. Assuming a marginal tax rate of a modest 18%, you will receive $180 in refunded taxes in April. You can then apply this to your loan in April or put it in your RRSP. Let’s keep the calculation simple and just hold it as cash until the end of the year (not a smart thing to do in practice, as technically you owe that $180, more or less, to the government later on). During the year, our loan accumulates $700 in interest. At the end of the year our net worth will be -$10,000 – $700 + $1000 + $70 + $180 = -$9,450.

In Case 2, we are $180 richer than in Case 1. This came directly from the RRSP tax credit as the amount that the RRSP holdings grew by was exactly compensated by the extra amount we owed on the loan. This demonstrates the power of RRSPs. The $1000 + $180 is now pre-tax dollars. The government has refunded us the $180 in taxes on that $1000. The $180 is not free money, as we now owe the government some taxes when we take our money out of the RRSP when we retire. It is our hope, however, the when we retire we will be in a lower tax bracket and the $180 in taxes will actually be less (let’s say $150). So really we are $30 ahead, not $180, but still, thanks to tax deferral (deferring taxes on income until we retire), we are ahead.

One strategy is to contribute monthly to your maximum allowable limit, then to apply the tax credit in April to your loans. The tax deducted from your paychecks acts as a forced savings device for an annual loan principal payment.

Welcome to Investing Intelligently

This blog (and blog title) is inspired by the late, great Benjamin Graham, author of the Intelligent Investor. He was a pioneer the value investing approach, perhaps even the founder of value investing as a “method of investing,” even though many people probably practiced the technique much earlier. His value investing techniques can be applied to other investment instruments as well, such as bonds, real estate, and mutual funds. More than just value investing, Graham’s book made me look at investments using plain old common sense.

This blog is not just about value investing, however, particularly because I do not do a lot of individual stock investing myself. This blog will deal with common sense investing as well as personal finance. It will have a mostly Canadian slant, with of course some US content as well.

I really hope I can generate some interest with this blog. I find there are a lot of misconceptions out there about investing and personal finance. There are a lot of good books and a lot of bad books, and lot of bad financial advisors and some good ones, and some good investments and some which are downright bad. There are also a lot of people out there in the media and in the general public who have no idea what they are talking about that will try to give you free advice. That advice will more often than not be bad advice. The goal of this blog is not to give out advice. It is to educate people on the facts about investing and personal finance so they can make intelligent decisions themselves.