Saturday, 24 December 2011
Well done to Bean Counter Mark Goodfield for putting together this very successful initiative.
Monday, 12 December 2011
A reality of getting older is declining mental ability. As with the body, so with the brain. It may be more obvious with the body but small gradual or sudden drastic falling away in our ability to make financial decisions will occur. It may be due to disease or natural ageing but it happens. We need to anticipate that and plan for it.
Among the kinds of decline: short-term memory recall, a long slow progression that starts from around age 40 (see graph here in Flickr); language facility; mathematical and analytic capabilities. The result is that good financial decision-making falls off with age, even amongst those who have known and applied good financial principles for a long time.
Whether the onset is gradual or sudden, mental decline gets to be a bigger and bigger issue as one gets older. The rising prevalence of dementia and increasing life expectancy ensure that it will become ever more common for retirees to reach a point of being incapable, both legally and practically, of managing their own financial affairs.
The problem is that when such incapacity strikes, chances are we won't even be aware of it. Worse, even if we are aware, at the point when we have been medically certified as mentally incapable, we lose the legal power to do all sorts of critical things.
What a mentally incapable person legally cannot do:
• make a new will, add a codicil to an existing will or revoke an existing will
• prepare a power of attorney
• put a bank account into joint names with children
• change the beneficiary of his/her RRSP/RRIF or an insurance policy
• carry out estate planning, such as reducing probate costs
• give investment instructions to his/her financial advisor.
What to do about mental decline and incapacity:
Mental exercise ... “use it or lose it” – The Seattle study (http://www.memory-key.com/problems/aging/seattle-study) followed a large group of people throughout their lives and discovered that amongst other factors a complex and intellectually stimulating environment and efforts to maintain a high level of perceptual processing speed seem to help reduce cognitive decline. The study suggested that cognitive decline observed in community-dwelling older people was mostly the result of disuse and could be reduced through training. Along with such activities as reading books, guessing at the answers of TV game shows, taking courses and doing a part-time job (paid or not), consider that continuing to manage your investment portfolio can be good mental stimulation, a challenging game that never ends.
Physical exercise - “a sound mind in a healthy body” - Though the original Latin expression was more a prayer than a prescription, keeping fit can help stave off mental deterioration.
Simplified portfolio and financial affairs – The simpler and more automatic are your affairs, the easier and less error prone they will be to manage, whether it is you yourself doing the job or someone else.
Power of Attorney – It is a dangerous misconception that a spouse or an adult child can automatically step in when incapacity happens. A sensible step is therefore to put in place, in advance of anything happening, a Power of Attorney (POA) that authorizes another person to take financial action on one's behalf. The POA authority may be narrow or complete, with the exception that the delegate, known as the Attorney, can never make a will on the person's behalf. The authority can include banking, signing cheques, paying bills, borrowing money, hiring contractors, selling or buying real estate, stocks, bonds, consumer goods etc.
Qualities of the Attorney - There are some obvious qualities the person(s) selected to exercise the POA power should have:
the time and willingness to fulfill the responsibilities (BMO says the average time a person fulfills a CPOA role is four years - if you are well advanced in age, it probably isn't the best idea to name someone the same age as you, like your spouse)
POA Permutations - Many variations are possible in a POA to suit individual circumstances, including: when the POA starts (immediately, or upon incapacity) or stops (it ends automatically upon death but make sure it doesn't stop unexpectedly since special language needs to be in the POA to keep an immediate active when you do become incapacitated, since that event normally voids it), limits to the authority being granted, whether it is one or several people as Attorney, and whether they must act jointly or may do so separately, aka severally; and whether the Attorney must account to some third party regularly. Be careful about whether it is a continuing / enduring POA since one without that feature activated before incapacity would cease to be valid upon incapacity.
Consider using a lawyer or notary to prepare the POA – Consider how complex your finances and family situation are. The more complex, the more it makes sense to use a professional to set up the POA and avoid the nasty surprise that a home-made POA is not valid. Without a valid POA, someone will have to face the cost, time and trouble later on to go to court to apply for a POA. If there is no one around to step forward, the provincial government's Office of the Public Guardian and Trustee steps in as a last resort to manage the affairs of the incapacitated. Would it matter that a government official probably won't understand what you want done? If so, picking your own Attorney and creating a POA is the route to follow.
Watch out for – 1) Banks are apparently wont to ask people to sign their own POA forms, which might conflict with or invalidate a general POA. Try to insist on them accepting your own general POA or get words inserted that it does not alter other POAs. 2) Each province has its own variations and those slight differences might be critical. Get one for the province where you live, changing it when you move. If you spend time in the US and have US assets, a Canadian POA may not be accepted. You would need to consult a lawyer in the US state concerned.
Doing the Attorney job is work - Some may imagine that being appointed under a POA is an easy job but it is serious business, more onerous even than managing one's own affairs. There is a fiduciary duty, which obliges the Attorney to act in the person's best interest. The Attorney must avoid conflicts of interest, must keep records, must consult with the person when possible, must keep the other's assets separate from their own. As a result, an Attorney often gets paid. In Ontario, the permitted amount is 3% of monies received and paid out and 0.6% of average annual value of assets administered, though it is possible to state in the POA that the Attorney will not get paid (keeping in mind the Attorney is not obliged to accept the job either and is allowed to resign later on). It is also a good idea to name one or more substitute individuals as backup in case the first Attorney is unavailable for whatever reason.
Joint ownership and and Living Trusts as alternatives – It is possible to transfer property to joint ownership or to a trust, but those solutions have their own issues. Amongst the issues: deemed disposition rules can occasion capital gains taxes; risks of abuse by the joint owner, or dispute among siblings if only one is named joint owner (was it a gift, an advance on inheritance or merely a means to allow administration on your behalf? etc); exposure of the joint assets to the joint owner's creditors, spouse or estate; when the asset is real estate, joint ownership requires consent of the joint owner for sale, which will be problematic if you have become incapacitated, plus the provincial Public Guardian may decide to get involved; costs of tust administration if professionals are hired. Professional expert advice may help a lot to unravel the best option.
BMO Retirement Institute – videos and paper Financial Decision-making: Who Will Manage Your Money When You Can't? on mental incapacity from medical and legal viewpoints, points to consider in creating a Power of Attorney.
Sandra E. Foster, You Can't Take It With You – Common Sense Estate Planning for Canadians, 5th edition, John Wiley & Sons, 2007
Douglas Gray and John Budd, The Canadian Guide to Will and Estate Plannning, 3rd edition, McGraw-Hill Ryerson, 2002
Ontario Power of Attorney kit – pdf link from the Ministry of Attorney General
British Columbia Enduring Power of Attorney Form pdf link; Nidus Personal Planning Resource Center and Registry – centralized registry for POAs in BC with many FAQs
Quebec – pdf link My Mandate in Case of Incapacity instruction booklet and forms at Curateur Public du Québec; prior to incapacity - Power of Attorney sample text with rules explained at Ministry of Justice
Saturday, 10 December 2011
Publisher CCH's tax newsletter for December describes these significant tax incentives for student graduates in Tax incentives for Post-secondary graduates. The article gives more detail, and links to each province's program, but here are some key points:
- applies to any college or university graduate
- takes form of tax credit or rebate of provincial income tax, so you must live in the province
- are Not tied to graduates who are originally from that province or who attended school there (not necessarily even in Canada), i.e. they are designed to entice recent graduates to live and work in a province ... call it the "brain scoop by tax" strategy
- pay out over several years
- for year 2000 graduates onwards, varying by province
- Only in Saskatchewan (up to $20,000), Manitoba ($25k max), New Brunswick ($20k max), Nova Scotia ($15k max), Quebec ($8k max)
- claim is not necessarily made (e.g. not in N.B.) through the normal income tax return; it varies by province, so graduates need to check, and perhaps apply separately, to be sure to get it. It's a good check item to add to my review list, for provinces like N.S., where the claim is made on the tax return, when I do my annual online tax software ratings.
Wednesday, 30 November 2011
Almost four years ago, I reviewed the first edition of Bebee's No Hype book and gave it a high (by my standards) rating. The just-released second edition contains essential updates and excellent refinement of specific portfolio suggestions, which is probably what readers want most. The most notable addition is a new section on TFSAs, though there are also many revisions to organization names, website links, addresses etc that make the book practically useful for investors today.
There has also been reordering of material, such as moving the discussion of annuities into the retirement chapter alongside RRSP sections, addition of many more links and references to online resources, such as a list of useful blogs, (including my own I gratefully acknowledge!). Most of the links are available on her website www.gailbebee.com under Resources.
The Asset Allocation and Portfolio Building material has the most interesting updates.
- real return bonds added as a component of the fixed income asset class; they now get included as part of all suggested portfolios
- revisions (mostly downward) to guidance on what rate of return to expect, based on historical averages, as well as addition of figures for several very useful asset classes - Canadian vs US bonds, Canadian vs US vs Emerging Market stocks, real estate; all this allows better estimation of what various portfolios will yield and will be very useful as more and more investors are taking to the idea of diversifying beyond Canada
- completely ETF sample portfolios specified right down to percentage sub-divisions within asset classes e.g. 35% equities in the Large Income Focused portfolio broken down to 20% iShares S&P TSX 60 Index (XIU) and 15% Claymore Global Monthly Adv Dividend (CYH)
- all-in-one single mutual funds or ETFs that suffice as a good-enough ultra-simple portfolio solution
- one non-update is that the individual stocks suggested for the equities allocation in larger portfolios have pretty well remained the same; Bebee's picks from four years ago still seem to be holding strong!
To make this book even more convenient for the investor, maybe the next edition could combine the advice on what goes in RRSP vs TFSA along with sample portfolios e.g. take one of the more elaborate portfolios, like the ETF Growth Portfolio, which has 11 separate holdings, and lay out what should go where. For example, I just did this post - ETF Asset Allocation Across RRSP, TFSA and Taxable Accounts - about this topic on my other blog.
This book has established itself as a fine beginner's guide to investing that successfully bridges the challenge of a "good-enough" compromise between the practical simplicity that people will actually read and use and the ideal complete perfection of a thousand page brick that almost nobody would read or be able to apply.
Gail Bebee's website takes orders for the book directly, though it's also available from Chapters.ca.
My rating creeps up from its first edition four to 4.5 out of 5.
Disclosure: Gail Bebee provided me with a draft of the second edition (and a copy of the published version too - thanks Gail!) and I submitted comments and suggestions to her, some of which have been incorporated into it.
Monday, 28 November 2011
Meanwhile, the progress (recently tabled federal legislation) on the federal government retirement solution for the private sector, the DC-type Pooled Retirement Pension Plan, is revealing some interesting features of the PRPPs. The banks and insurance companies are apparently objecting to established pension plans like OMERS trying to get in on the action claiming that OMERS has unfair advantages on costs and regulation. Hmm, so now we see an admission that PRPPs run by banks cannot and will not do as good a job (costs, planning assistance etc) as traditional DB pension plans run by purpose-built organizations for public servants. Is there something wrong here?
Tuesday, 22 November 2011
Here are the rules:
1. I am auctioning off the opportunity to write a guest post here on CanadianFinancialDIY.
2. Bid in confidence to my email account - click on the "Email me" link in the right-hand column.
3. The auction will close on December 16, 2011. I will notify the winning bidder by email ( I will use your email for nothing else than this contest).
4. The winning bidder will be required to send me a copy of a donation receipt, dated between December 17th and December 31st (personal information can be blacked-out) to confirm the donation has been made e.g. using a scanned copy by email will do. Pick any registered charity (no, Greece or Italy are not yet charities) you want. It's easy to donate online, as I wrote about here. This donation will be tax deductible to the winning bidder when the donation is made to a registered charity.
5. For unanimity amongst bloggers, January 17, 2012 be the date all the Blogger for a Day posts are posted.
6. The winner can write a post on any topic (subject to censorship for stuff that is illegal, violent, profane, defamatory, links to naughty or nasty websites etc ... no, smartalec, that doesn't mean you cannot write about the financial industry), although in the spirit of the contest, it would be great if the winning bidder wrote about a charity or charitable experience, e.g. the best and the worst donation you ever made, but that is not a requirement. The guest post cannot be a marketing piece. However, at the bottom of their post, the guest blogger can provide their name, name of their company and a brief description of their company and its products. Alternatively, the guest blogger can remain anonymous.
7. This is an extra rule so that there are seven in all, a much luckier number than six.
Monday, 21 November 2011
Will this help the target group - people who have no company pension and are not voluntarily saving through RRSPs or TFSAs? The answer is a mild "yes" in absolute terms and a resounding "no" in relative terms.
Yes, it does help somewhat.
- Anything is better than nothing - The most critical problem is that those people right now are not saving for retirement, so any program that gets them to save will help. Despite the provisions of the PRPP legislation that do not require companies to opt in and that allow individuals to opt out, the default auto-enrollment rule (par.39(1)), the default investment option rule (par. 23(3)) and a default contribution rate (par.45(1)) will be quite effective in getting more people to save. "Nudge" works.
- Cost and fees have a fair chance to be less than for mutual fund RRSPs - Why might there be a grain of truth to the confident assertion by Minister Menzies who told the Globe and Mail, subsequent to receiving financial industry assurances, that management fees will be "substantially less" than they are for RRSPs? 1) Money will be locked into the PRPP unlike the RRSP. You may be able to switch between funds but the fact that the investment management company knows the money will not be withdrawn means less need for cash balances and less urgency for short-term return-chasing by funds that undermine returns. 2) Marketing costs, which are embedded into management fees could well be less since the target market for the financial industry is not the individual consumer but small and medium-size companies. That should mean no glitzy TV ads. There will be no trailer fees to salespeople (aka financial advisors); in fact, the draft bill specifically bans kickbacks by fund companies to employer sponsors (par.33). 3) The regulatory structure should help to control the most egregious overcharging. Good 'ole politics might even have a bearing since the Governor in Council, i.e. the government, gives itself the power to decide what "low cost" fees means (par.76 (1) (j)).
- NoHype Investing author Gail Bebee emailed me her comments, which I think are spot on, so I'll simply reproduce them with my highlighting):
"1. Employers are not required to offer this, or any other, employer-sponsored pension plan.
2. Employees will be able to opt out at will.
3. The financial industry, the same folks who charge Canadians some of the highest mutual fund fees in the world, will be managing the pension funds and will have a major say on the fees charged to do so.
4. More government bureaucracy will be set up to regulate this new program.
5. RRSPs already offer a similar retirement savings option. The issue is that not enough Canadians participate."
- Wealthy Boomer Jonathan Chevreau's comments in the Financial Post gave some nuance to Gail's points.
- The PRPP will complicate and confuse - The retirement landscape is already tough enough to understand, what with RRSPs, Defined Contribution and Defined Benefit Pension plans and TFSAs. Another layer of complexity is added. How will people make intelligent informed decisions about which to choose under what circumstances? There is no advice-giving component included in the PRPP structure. Blogger Preet Banerjee was right on the mark pointing this out in a CBC article on the announcement. With each province being required to implement its own complimentary legislation, it's a sure thing Canada will add another patchwork of permutations and combinations in rules, all of it totally unnecessary. What will happen when people move to different jobs in different provinces or with different companies? The minister says the plans are portable and transferable but sure as to betsy a lot of folks will end up with several plans. I already have two different LIRAs that cannot be combined (one is federal, the other provincial) on top of an RRSP and a TFSA. Another possibility to add?! Gimme a break!
- Low pay workers will likely get scr***d - Tax-wise, the logic of the PRPP will work the same as an RRSP. In a couple of posts here and here on the HowToInvestOnline blog comparing the TFSA and the RRSP for retirement savings, it is quite clear that anyone earning less than $37,000 is better off using a TFSA. If such workers get auto-enrolled into the PRPP and they don't opt out (who is to tell them to opt out except for lowly bloggers that they never read anyway?), they will be appreciably worse off in retirement. Thanks for your help, government!
- PRPPs pale in comparison to the CPP - The much debated alternative solution, that of expanding the CPP, as we have previously argued here and here, meets the criteria of what is needed much better. Over at Moneyville, author and pension expert Moshe Milevsky points out that the Pooled Retirement Pension Plan doesn't even live up to its name. It doesn't provide a pension - a lifetime of secure guaranteed income - at all, it is only a savings and investment plan that will go up and down with stock and bond markets.
Wednesday, 16 November 2011
Industry Prospects - The business environment remains weak.
- Residential slump continues - US Housing starts, a prime driver of demand for WFI's residential products, continue at an extremely low rate of about 500,000 - 600,000 starts per year vs historical norms well above 1 million. That situation doesn't look set to improve soon. In the latest conference call and in the published report on Q3 results, company management says it expects 2012 to see an overall industry decline of 10-15% for residential geothermal heat pump sales in the USA. Residential products, according to WFI management, have a higher profit margin than the commercial products that the company has emphasized to fill the sales gap. New housing, in which the substantial initial capital cost of geothermal is embedded and financed by a mortgage for amortization over a long period, overcomes the sticker shock impediment to geothermal's market success.
- Gross Profit Margin - GPM seems to be staying about the same. This is not so bad considering the shift in product mix from residential to lower margin commercial. But GPM is not improving as management says on page 3 of the Quarterly report - if one adds back the $727k difference for Q1-3 of 2011 that resulted from the change in method of calculating Warranty costs (page 31), then GM is not 37.7% as stated but only 32%, which is at the lower end of those in the last five years according to ADVFN.
- Net Profit Margin - The same ADVFN page shows that the NPM has stayed quite stable at around 10% through the last five quarters.
- Cash Flow - Whether it is by simple cash flow from operations or including capital expenditures (or depreciation instead of capex since the relatively new factory doesn't seem to be needing much investment for now), 2011 results are stronger than 2010 which were an improvement over 2009. WFI is thus adding to its cash reserves, probably more than it has an opportunity to spend effectively at the moment. No doubt this has enabled and justified the announced increase this quarter in the dividend from USD$0.22 to $0.24 per share.
- Dividend - The strong and improving cash flow, along with complete absence of debt on the balance sheet, indicates that the dividend is quite sustainable. The dividend salves the pain of the stock price drop since last year.
- Warranty Reserves - The rapidly rising warranty reserves, a non-cash liability but one which eventually happens in cash if the estimate is correct, could become an issue down the road. About half the increased liability, according to note 12 on page 31, in the first nine months of 2011 came from increased claim rates, not merely extra sales of units. It does not yet come to a level that is at all a problem but might be something to monitor.
- WFI's sales increased 2.3% in the first nine months of 2011 while competitor LSB Industries saw a 19% rise (cf its Q3 report).
- Though the numbers are out of date and have not yet even been released for 2010, WFI's shipments fell from 2008 to 2009 (as indicated by the figures Indiana) while those of LSB rose (cf the numbers for its home base of Oklahoma) according to the US Energy Information Administration website.
- The only activity in the past six months (see CanadianInsider.com here) consists of stock purchases or dispositions by gift.
Strategy - The theme at WFI seems to be "steady-as-she-goes".
- The HyperEngineering acquisition earlier this year has not been mentioned in the last two conference calls and is a minor revenue generator ($2.9 million in total with regular WFI international product sales) with a profit margin of around 8% (cf page 26 of the Q3 report), slightly less than the overall company margin.
- Cash is being given back to shareholders through dividends instead, for instance, being kept in the company to make acquisitions
- There are no initiatives to address a key issue of the large capital outlay required by a residential homeowner doing a retrofit conversion to geothermal of an existing home. The development of options to allow customers to finance installation costs as well as other strategic challenges and opportunities is laid out in the business school case study on WFI prepared by Charles Shanabruch in 2009.
- Not much has changed since that date under CEO Tom Huntington who took over from the dynamic former CEO Bruce Ritchey. Perhaps the only glimmer of a new direction is international sales expansion beyond the USA and Canada, where the tiny sales volume tripled despite receiving no focus by management.
- WFI has grown EPS 4.5%, and Free Cash Flow from negative to positive, over 2010; both are positives
- US housing starts remain flat, a constraining negative that tends to the lower valuation. The guess/assumption last year that it might take two years to get back to normal levels should probably be re-stated as two more years from today in order to be conservative.
- The stock price of WFI has slumped considerably from the $25-26 range of last year to around $19 nowadays. That makes WFI an even better value. Last year I said that WFI is a good buy, but for the long term. That is still my view.
Disclaimer: This post is my opinion only as to how and why I came to my own investment decision. Whether you agree or not, it should not be taken as investment advice.
Monday, 31 October 2011
Any book that reaches its 4th edition (updated to 2011) should be good. That's true in spades for Financial Statement Analysis. Fridson and Alvarez have written a classic. It should be required reading and a constant reference source on the bookshelf of any investor intending to buy individual company stocks or bonds. It is a book for those who intend to follow Warren Buffett and increase the security of their investments not by diversification but by depth of knowledge and confidence in the companies whose securities they hold.
The book is not primarily an accounting text in the sense of indicating the mechanics or the theory of accounting. It assumes basic familiarity with balance sheets, income statements and cash flow statements. What the book does thoroughly and brilliantly is to explain how to analyze and interpret the numbers to enable an investor to figure out what is really going on in a company.
The authors take account of and put heavy emphasis on the motivations of company management for their own personal ends - everything from presenting results in the best light at the legal end to outright fraud at the illegal end. Through many simple examples they show where and how to look for signs of manipulation of accounts. They admit the limitations of even the most expert analysis. They note, explain and give examples of the necessity to be wary of auditors, regulators and boards of directors. Frank and severe commentary abounds but the book is not a diatribe and the reader is not left with a sour or negative view. It is entirely practical and realistic. The book moves the investor from the textbook into the real world.
Though not to the same depth, the book also explains how industry conditions need to be taken into account in interpreting financial ratios. It explains how factors like seasonality, cyclicality, capital intensiveness, size of company, maturity of the company or the industry all can impinge on the safety/danger of debt or equity and the relative over-/under-valuation of securities. Want to know the hows and whys of leveraged buyouts, mergers, serial acquirers, stock buybacks, reserves and write-offs? This book will tell you.
The viewpoint is that of an investor arming him or herself with defensive detective tools. Its motto could be the modification of the adage "trust but check" to "check, and keep checking".
One of the surprising, given the subject matter, and delightful features of this book is that it is highly readable and accessible. The writing style is engaging with enjoyable turns of phrase, the sentences are understandable and never confusing, the examples are simple enough but not too simple, the organization of topics within chapters flows naturally. The authors have mastered the art of providing just enough detail - sometimes only a little, sometimes a lot - to make their point.
- The walk through the dividend discount model is the most intuitive and insightful version I've come across.
- The five pages on Nortel weave together the methods (mostly abuse of accruals) and motivations (management bonuses) of the company's death spiral into a succinct morality tale.
- My strongest takeaway is a sense that the integrity of management is a critical element to judge since there are so many ways for manipulation to be done and it can be very difficult if not impossible to detect till it is too late.
- Page 232 reflects a small lapse in updating the new edition as the dates in a table do not match the text and the table on page 234 does match the text, though one can still understand what is going on. Perfection is hard to achieve!
- The reader can only gain understanding through this book. Being able to apply the knowledge would require a person to work through examples to fully absorb it as a practitioner. Presto! The authors have written a companion Workbook.
Tuesday, 11 October 2011
It seems to have been doing too good a job, at least for investors, since the financial industry is now ganging up to undercut, criticise and opt out of OBSI being the one and only dispute resolution body (see various articles in the Financial Post over the last few months).
In fact, far from being watered down the OBSI needs to be protected and strengthened as a recent review commissioned by the OBSI Board suggests in the package of balanced recommendations that meets both consumer and justifiable industry interests. But the industry thinks the report is "delusional" according to a quoted reaction in a Financial Post article by Theresa Tedesco.
The financial industry needs to realize is that in-reality fair, and perceived-by-consumers to be fair, dispute resolution is good for it. One of the lasting psychological effects of the credit crunch is that bankers and investment dealers are a bunch of devious, avaricious crooks (witness the "Occupy" protests), lining their pockets and then letting taxpayers or investors take the fall. The industry's current campaign against OBSI reinforces the negative perception by showing unwillingness to fix errors or misdeeds . As both a shareholder in Canadian financial firms (directly and through ETFs) and an investor / consumer I want to see a fair, balanced system, not one that stacks all the advantages on one side (the FP Tedesco article cited above makes reference to the statistic that industry already wins 70% of cases adjudicated by OBSI - is it only 100% that is acceptable?).
It's not just perception either. When effective penalties are known to occur, firms will tend to improve their internal processes and controls so that problems don't arise in the first place. Industry calls this zero defects or six sigma. Consumers call this peace of mind.
What really needs to happen is for the federal minister of Finance Jim Flaherty to put the OBSI function on a stronger footing through permanent legislative authority on a national level, instead of its present voluntary, industry-funded status and to include insurance in its mandate.
Thursday, 6 October 2011
The problem is that when such incapacity strikes, chances are we won't even be aware of it. Worse, even if we are aware, at the point when we have been medically certified as mentally incapable, we lose the legal power to do all sorts of critical things, as the report Financial Decision-making: Who Will Manage Your Money When You Can't? from the BMO Retirement Institute points out, including:
"• prepare a power of attorneyAs the report recommends, a sensible solution is to put in place, long in advance of anything happening, a Continuing Power of Attorney (CPOA), that kicks in automatically if and when incapacity happens. The report also mentions some obvious qualities the person(s) selected to exercise the CPOA power should have:
• make a new will, add a codicil to an existing will or revoke an existing will
• put a bank account into joint names with children
• change the beneficiary of your RRSP/RRIF or an insurance policy that you own
• carry out estate planning, such as reducing probate costs
• give investment instructions to your financial advisor."
- the time and willingness to fulfill the responsibilities (BMO says the average time a person fulfills a CPOA role is four years - if you are well advanced in age, it probably isn't the best idea to name someone the same age as you, like your spouse)
- someone in whom you have complete trust (the CPOA has wide ranging power and possible abuse of the power is a major consideration; sadly, even one's own children can sometimes be less than reliable)
- financially-knowledgeable enough to handle your affairs, or astute enough to recognize the need for professional help (tax, accounting, legal etc)
The BMO website hosts five other short worthwhile videos by lawyer Elena Hoffstein and Dr. Michael Baker talking about topics such as: how to recognize mental incapacity; its effects on ability to marry (you can still do it! I can imagine the smart alec comments that one must already be mentally incapable to get married at all... ) or to make a will and the unintended consequences of the two facts together (you may end up with no will at all); pitfalls of joint ownership (of house, investments, bank accounts etc) as a method to address incapacity.
Wednesday, 5 October 2011
It is one thing for us to indulge in gawking at the financial catastrophe of others or to stoke our anger at the various "SOBs" who fail in their duty to protect us. More important is to remind ourselves how to do due diligence or exercise caution before we invest - a penny of investigative prevention is worth a million dollars in lawyer cure.
1) Official Sources like the various provincial securities commissions, the RCMP, e.g. through links in my previous post on this subject Scam and Investor Fraud Alert Sources - Fraudsters often do it again and again so they may well show up in previous judgments (maybe it's the light penalties and sanctions that encourage them? just asking). Do a search for Brost in the ASC website and lo and behold we see him caught doing naughty things way back in 2005.
2) Google search - Ain't the Internet handy, typing in Milo Brost brings up a whole host of links that would or should raise a dubious attitude. One that is wryly amusing is this 2004 Institute for Financial Learning discussion thread on www.scam.com where a certain Winer says the promised 40% return is entirely reasonable and is not a warning flag! The Internet savvy will always have their idiot and BS detectors in operation I hope. Bottom line: Trust, but verify. The more the stakes, the more you need to verify. The hard-hit couple featured in the CTV story did the former but obviously not the latter. It might even be worthwhile to get a second opinion from someone else with your interests at heart and without an interest in the potential investment.
The obvious answer to the CTV W5 title question right now is "you yourself, my friend, you are the only one protecting your investments". Caveat investor.
PS In one of my Google searches for this post, I came across the Behind MLM blog, an amusing anti-scam site. It also displays Google ads, one of which advertized a "200% Return on Investment Exclusive Diamonds from £5k". With the Google good comes also the bad ...
Monday, 3 October 2011
The book isn't just about investing risk though the book's subtitle is "A Guide for Investors". This must have been added by the influence of the publisher since the more accurate description of the content is on the back cover: "A Dynamic Framework for Forward-Looking Risk Management". Likely the latter would have been judged too technical and jargonish to appeal to a broad book audience.
The book is a broad conceptual guide, and a useful one, to figuring out what to do about various financial risks one faces in life, like house buying, insurance or investing. There is some jargon (do you want to figure out your lambda?) but it presents mostly common sense argumentation and nothing beyond arithmetic in the numerical examples.
Despite some attempt to flesh out their methods, the book falls short of being a practical guide. I find it difficult to see exactly how I could systematically apply, in order to develop an overall financial and investing plan, all of their ideas in their multi-step process, which consists of:
1) Know the value of your holdings today - I'm ok with this one, I think, though an important caveat is the definition of "my holdings", which they do not explore. They seem to think of such holdings as consisting only of a portfolio of financial securities, which I believe is far too limiting. The single most valuable financial asset we own is ourselves, our own money-earning capacity, often called human capital. Unlike almost every other financial risk, which they explicitly define as those subject to changes in the [external] environment (i.e. that we can do nothing about directly), we can enhance, or neglect, our earning capacity through education, diet, health protection etc. I suppose the authors might respond that their book does not intend to go into that detail. And I suppose that doesn't matter as long as this book is only considered a conceptual, not a practical, guide. This book does not hand you solutions on a plate. You would have to do quite a bit of work to apply them to your own circumstances.
2) Pick an appropriate future time horizon - Though Dembo and Freeman acknowledge that most people are likely to have multiple future financial goals (car, House, retirement etc) with different time horizons, they do not flesh out how to deal with the resulting complexity when this fact is added into downstream steps below. Nor do they address at all what to do about the very real fact that life contains surprises and your best laid plans / time horizons may not be the ones that actually happen e.g. a good number of people retire sooner than they thought due to job changes or health. That really complicates the next step.
3) Choose a range of scenarios of the future, making sure to include bad extremes and assign a probability to each scenario - This is the range of future end results for "the portfolio under consideration". Of course there could or would likely be multiple portfolio possibilities an investor might want to consider. This is the point where I'd guess almost anyone trying to follow their method would give up. Huh? How do I make up scenarios and figure the odds? They touch on but do not resolve the issue on page 81: " ... there are many occasions when it is impossible to attach useful probabilities to an unknowable future, then we have to find ways to model the uncertainties we face."
4) Pick a benchmark - The benchmark seems to be a kind of base case to compare the scenario & portfolio combinations (& presumably the multiple time horizons). They say that one can choose whatever benchmark one desires.
5) Value your portfolio and benchmark for time horizons under all scenarios - a lot of mechancial work
6) Compute the appropriate risk measure based on values coming out of step 5 - Here enters one of the intriguing contributions of the book, the idea that something they call Regret is the best measure of risk to use instead of popular commonly used measures like standard deviation (aka volatility) or Value-at-Risk (VAR, used by institutional investors).
Regret, with a capital R, is what I found to be the most useful, as well as the most accessible and natural, concept in the book. It is a way of taking account of potential harmful outcomes to make better decisions. Regret deliberately embodies the emotional impact of negative possible outcomes. A wrong decision, as judged later, can gnaw away at a person forever after. Second, the Regret evaluation process of Dembo and Freeman tells us to assess the cost of preventing the big negative, which in many cases is just insurance. Then we decide whether the cost is worth it considering more the consequences of decisions rather than the probabilities of particular outcomes.
As the authors say, "It is a sensible rule of thumb that an operation should not take on positions that expose it to the worst possible outcome - that a catastrophic loss might occur, resulting in ruin." This way of thinking would be very helpful in considering, for instance, whether to buy long term care or critical illness insurance. The same loss may matter a lot more to some people than others e.g. Warren Buffett will never be interested in buying long term care insurance since he can easily afford the fanciest care imaginable.
The obverse of Regret is what they call Upside, a positive consequence that can result from a choice. The thinking process is the same - how much could the positive result amount to and is the cost of the "bet to enter the game" worth it?
The book also has several interesting or amusing bits:
- there are a number of praiseful references (this book was written in 1998) to the revised and improved risk management techniques of major investment banks following big losses in the 1980s and 1990s, rather ironic given the 2008 debacle; the notion presented by the book that these financial institutions were really trying to manage risk and avoid disastrous financial consequences instead of going willy nilly for the gigantic gains strikes me as rather naively quaint. Dembo and Freeman's own framework provides a handy simple tool to figure out the big banker's personal risk perspective - lots and lots of personal $$$ Upside with the worst personal Regret being fired and having to look for another job.
- Dembo and Freeman show in Chapter 3 that Kahneman and Tversky are wrong to say that people are irrational or making behavioural mistakes when they make choices that violate expected value (EV = probability x outcome) rationality. They also make buying lottery tickets an entirely reasonable and rational decision (spending a few dollars a week won't cause even poor people financial ruin but it could, despite the bad odds, make them rich, so there's lots of Upside and really no potential Regret).
Rating: 4 out of 5 stars
Tuesday, 27 September 2011
1) Consider the publication of the report itself. Is it secret or not?
- Not Secret - Though I received a copy from Ken Kivenko of CanadianFundWatch.com (thanks, Ken) who forwarded the email attaching it sent out under the signature of IFIC CEO Joanne De Laurentiis.
- Secret - The IFIC original email has the warning at the bottom "This e-mail (including attachments) is confidential and is intended solely for the addressee..." Oh really?
- Not Secret - Why then does the text from De Laurentiis' say "It is the objective of the Report to clarify and counter misperceptions associated with active and passive investing so that research organizations and public policy makers can be better informed...". That sure looks as though it is intended to be publicly disseminated.
- Secret - The IFIC website itself, however, seems not to show the report in any public area, only in a reserved members area (through this search link).
- Not Secret - This secret public report meant to be used per De Laurentiis "... as a reference authority in materials developed by you (e.g., articles, reports, etc.)" can actually be accessed through (marvels of the Google and the Internet!) a link at the bottom of this post on Arbetov.ca.
2) The suspicion of devious intent gets stronger once one looks at the flawed report itself. Its basic approach is to show that passive investing can be expensive, done by trying to show that ETF costs are higher than many people think. However,
- ETF does not equal passive investing (and the flipside is that Mutual fund does not equal active investing). The report throughout treats all ETFs as if they are the same as passive index investments. That might have been a fair generalization ten years ago but today ETFs have become very diverse. Many high cost, poor-quality, narrowly focussed ETFs have come on the scene, some even with explicit active strategies.
- Mixing all ETFs together and calculating average costs raises the apparent cost of a passive index (i.e. a broadly based market-cap) strategy. Transaction costs, bid/ask spread and tracking error, which the report says add up to 1.2% ETF under-performance relative to index, is at most 0.1% for a fund like Vanguard's Total (US) Stock Market ETF (VTI) or the grand-daddy biggest-of-them-all SPDR S&P 500 (SPY). The true lesson is not that passive indexing is expensive, it is that today investors need to be just as careful picking ETFs as mutual funds. ETFs that are too small, too narrow and only sample stocks instead of replicating an index are prone to index under-performance from large tracking error.
- The 1% that IFIC says goes to providing advice to mutual fund investors, which ETF investors do not get, and therefore causes ETF under-performance by that amount, rests on the dubious conclusion that investors get 1% worth of advice. The previous IFIC report The Value of Advice (which also seems to be hidden away in IFIC's website) it cites as evidence received a thrashing on its release in 2010 - e.g. see Canadian Capitalist's Readers Rip IFIC Report to Shreds.
- Risk, as expressed in volatility, is not or should not be an end in itself, so for IFIC to state that actively managed funds offer investors the risk exposure they wish is beside the point. As books like Richard Ferri's The Power of Passive Investing, David Swensen's Unconventional Success and many others have repeatedly documented in great detail, actively managed mutual funds have performed poorly on a risk vs return adjusted basis. It doesn't help to take on risk if you lose in doing so.
- As I said in my review of Ferri's book, the issue is not active investing vs passive investing in principle or in general, it is with the funds actually available to small individual investors and how they perform in reality. That's why I am currently testing the RAFI fundamental strategy, which I think is better in principle and has been shown to be so using (non-investable) index data, against cap-weight using actual ETFs available to investors. A key question is whether the higher fees on the RAFI funds overcome their theoretical advantage and give off lower net returns.
Monday, 26 September 2011
- Darwin's Centenarians - "Survival of the Fittest" is the theme of this ETF. Darwin told us that merely surviving is the definition of being fitter. If a company has survived 100 years or more, it has to be fit, right? Twelve Ultimate Buy and Hold Canadian Stocks lists the Canadian stocks to include. Wikipedia's List of oldest companies tells us that no less than 21,666 companies worldwide are centenarians or better exist. That choice is good because diversification through holding a basket of many companies is still required. Age does not guarantee survival - witness the demise in 2006 of Kongo Gumi the oldest continually operating independent company that had been operating for 1400 years. It was a victim of, you guessed it, too much debt.
- Random Dartboard - We've all read that randomly throwing darts at a dartboard to select stocks works just as well as the average active mutual fund manager. So let's have that fund, please. In order to remove any human bias, and to give the fund a marketing handle, the fund management will consist of chimp Sammy Stockpicker (photo below) along with a human handler. Another advantage - the MER will be peanuts. . This will also help restore a bit of balance in markets, as apparently mathematicians like the one below are taking over trading in markets according to BBC's Quant Trading: How mathematicians rule the markets.
- High-Yield Sovereign Debt ETF - Nicknamed the "Merkel Put Fund" in honour of the German leader who will be backed into "bailing out" Greece (i.e. having German taxpayers paying for Greek non-taxpayers), this fund will hold the debt of various countries with dubious ability to repay. There are already high yield corporate bond funds like Claymore's CHB so this new fund would only extend the concept. It might be a challenge to define what countries to include since the bond rating agencies' ratings of countries doesn't correspond systematically with countries that pay high yields e.g. Ireland pays quite hefty yields upwards of 8% despite its BBB+ Investment grade rating (see Wikipedia explanation) from Standard & Poors in this list of Credit Ratings by country in Wikipedia. I would propose the "if it looks like a duck and walks like a duck, then it is a duck" method of determining what is high-yield.
- High Dividend Yield Country ETF - Nicknamed "the future will be like the past" fund, this one will invest in the market basket for the highest dividend yield countries. After all, if famous researchers Elroy Dimson, Mike Staunton and Paul Marsh tell us on page 21 in the Credit Suisse Global Investment Returns Yearbook 2011 (my review here) that an evenly balanced portfolio of the equity index for the highest dividend yield countries handily outperformed for 1900 to 2010 and multiple sub-periods within it, what could go wrong?
- The Liquid ETF - The ETF Stock Encyclopedia lists a whole range of sector ETFs like retail, telecommunications, oil and gas, mining, utilities, pharmaceuticals, biotechnology, the list goes on and on. Why not set a new direction for themes with a fund that invests in the industries that produce liquids, i.e. a combination of water infrastructure, oil and gas, beer and wine producers. There must be excellent diversification potential as companies are likely to have little correlation with one another.
- The Global Mega ETF - Finance theory tells us that an investor should hold the market portfolio, which consist of a holding in every available asset i.e. stocks and bonds in every country. Has anyone offered such a fund yet? The answer is No. Vanguard has something called the Total World Stock ETF (VT) but even that only includes 49 countries and no bonds at all. There isn't even a bond fund in its arsenal that tracks a total world bond index.
- The Celebrity Dream ETF - We cannot all look like Angela Jolie (from Top Beautiful Women blog) or Brad Pitt (from Celebrific.com) but maybe we could invest like them. After all, celebs are wont to give us their opinion on politics, social justice, climate change, etc and with such beautiful faces and acting skills, everyone is convinced they are right. And so they will be regarding investments. Markets will follow them! Their stock picks and predictions will be self-fulfilling prophecies. Besides things always turn out fine in Hollywood. We should remember that though markets in the long term are weighing machines, in the short term they are popularity machines, as all technical traders know. Why bother with charts, statistics, patterns, moving averages and the like when we can go to the next step and actually lead the markets where we want to go? The only possible drawback is that celebs don't come cheap and fees may be high, though surely nowhere near as high as what the typical Canadian mutual fund now collects. So the ETF should still be competitive.
Friday, 9 September 2011
Through a series of statistical tests on US equity data back to 1979, they show how the take-off of passive index investing since 1997 is strongly associated with their disquieting stock effects:
- "... the rise in passive investing meaningfully corresponds to a decrease in the ability of investors to diversify risk in recent decades" and
- "... the diversification benefits of equity investing have decreased for all styles of stock portfolios (small, large, growth, or value). The decline in diversification benefits can couple with increased market volatility and firm-specific volatility."
The chart below from the paper shows the vertiginous rise in correlations between pairs of stocks. Note how the more passively indexed segment, the SP500 large caps, has higher correlations than smaller caps, the non SP500 stocks in the chart.
They checked that the effects were not only manifest during the recent periods of extreme market crisis - the dot com crash in 2001/02 and the credit crisis crash in 2008/09 - when all asset class correlations rose significantly. The same pattern of rising correlations continued through the other more normal years of the study period.
There may still be value for individual investors to buy those passive index funds but the free lunch of passive diversification now appears to be merely selling at a discount. One thing for sure, as I tried to suggest in the thought experiment post What Would Happen if Everyone Did Passive Indexing? the success of passive indexing, when it becomes big enough, does have an effect on markets. In another post last year, Index Investing Becoming a Victim of Its Own Success, I noted research by Jeffrey Wurgler on the S&P 500 that reaches similar conclusions. No wonder the avant-garde of risk-aware, efficiency-aware institutional investors is moving away from cap-weight passive index investing, some to private equity direct investing, such as the big pension funds and others to alternative-weighting indices.
Thursday, 8 September 2011
FinViz.com - S&P500 grouped by sector, Foreign Stocks (including Canadian) Traded on US exchanges, US-traded ETFs. Data includes performance today to 1-year, P/E, P/B, P/S. Dividend Yield, Earnings
StockMapper.com - NYSE Euronext stocks (which includes 66 largest Canadian stocks), S&P 500, World Regions. Data includes today's percent change, latest news
SmartMoney.com - US stocks "over 500". Data includes daily percent price change organized by sector.
Friday, 2 September 2011
From then on, there would be no change in price of any stock as everyone, through the fund, simply accepted the last going price. There would not even be any reason to have different bid-ask prices. There would be no change in price in a day, a year, or ten years ... no matter what happened to any of the companies whose stock was in the portfolio. Now that would be interesting, we/ the fund could happily be paying big bucks for the stock of shrunken companies, or tiny amounts relatively speaking for vastly expanded others. The investor would receive no capital gains, only dividends, increasing from some successful companies and declining or disappearing from the unsuccessful ones. Things would get very out of whack.
The only change within index funds would come as a result of Standard & Poors or other index providers adding or dropping stocks from indices. It would be rather difficult for the index providers to decide which to include or exclude since the basic method relies on the market capitalization of stocks, a number which would never (or almost never, excepting new stock issuance) change in a totally passive world.
That situation wouldn't be at all stable given the reality that a) stock prices should reflect the value of the profits being generated by the components of the index, b) cagey investors would notice the too-high or too-low craziness of prices and start taking advantage by buying up strong companies with extremely high dividends. Prices would change. Active investors are thus the very mechanism that keeps prices more or less fair. Without the active investors constantly making judgements and moving prices up or down, the passive index investor wouldn't be buying a good product. Nobel Laureate Professor William Sharpe notes this ironic relationship between active and passive investing at the end of his easy-to-read article recommending Index Investing.
Why Stewardship is Proving Elusive for Institutional Investors from the Harvard Law School Forum on Corporate Governance and Financial Regulation notes a further likely effect:
- passive index funds exhibit poor ownership behaviour, effectively letting company management and boards run amok, as the focus on fund cost minimization leaves little money for company oversight and active involvement as a shareholder; in fact, many funds do not even have the shares to be able to vote as they lend them out to generate extra revenue and thus do not have them in hand to vote.
- passive index funds, which own the whole market of perhaps thousands of stocks, cannot practically exercise any corporate owner stewardship even if they attempt it.
Scott Vincent in the April 2011 paper published on SSRN called Is Portfolio Theory Harming Your Portfolio? argues that the rising trend to passive index investing is increasing the opportunities for informed investors to take advantage of market inefficiencies. First, he notes that such informed skilled active investors are not new: " ... In reality, there is an abundance of evidence that markets are less than perfectly efficient, yet most practitioners and academics find that exploiting these inefficiencies is, at minimum, very difficult. It is not easy to consistently outperform the market, but talented managers can and empirical data supports this fact... " He also maintains that most studies of actively managed funds get their measurements wrong because a majority of these supposedly active funds are essentially passive. Instead of holding a few stocks, they are quite diversified in fact and therefore mostly track the index, whether consciously or unconsciously.
Furthermore, he says, "Multiple studies indicate that funds which are more actively managed, or more concentrated, outperform indexes and do so with persistence (Kacperczyk, Sialm and Zheng (2005), Cohen, Polk, Silli (2010), Bakks, Busse, and Greene (2006), Wermers (2003), and Brands, Brown, Gallagher (2003), Cremers and Petajisto (2007))".
According to Vincent, the end result of the contemporary trend to passivity is that: "... as more money flows from truly active managers to investment vehicles that deploy money “blindly,” inefficiencies become more prevalent creating opportunities for those whose eyes are open to them."
Vincent's recommendation is that individual investors can take advantage by a) searching out mis-priced securities themselves, or by b) searching out and investing their money with those truly active and truly successful fund managers - " ... look for concentrated, fundamentally-driven, relatively small funds with talented managers. Since persistence has been demonstrated in this subset, it turns out that a good manager may be identified from past performance".
Sunday, 28 August 2011
Weekend Reading: ETF Danger, Visa a Scam?, Ireland's Woes Explained, Dividends = Low Risk/High Return, Debt Song
- "... if you are considering an investment in a mutual fund or ETF, you should understand that you will have little recourse if information provided in the prospectus turns out to be misleading or incomplete, even outright fraudulent" from A license to lie, backdated in Interfluidity.com commenting on the implications of a recent US Supreme Court Case. i.e. we should be very wary of new ETFs; the more complex they are, the more likely something dangerous is being done to investors; with the court case it will be more tempting too for the unethical operators.
- Michael Lewis' non-technical article in Vanity Fair explaining how things went pear-shaped in economic revival poster-child Ireland When Irish Eyes are Crying
- The Onion's satiric piece Visa Exposed as Massive Credit Card Scam ... isn't the best satire that with a good dose of truth? Found this link on The Browser, which has multiple links to a variety of good stuff
- Traditionalist (value investing, Graham philosophy) practically-oriented investment advisor firm Tweedy Browne Company LLC reviews research that reveals "... the importance of dividends, and the association of high dividend yields with attractive investment returns over long measurement periods"
- Who knew the debt crisis could be turned into song?! Have a listen to Split-Rated at Versus by Marcy Shaffer
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