Monday 24 December 2007

My Rebalancing Policy Refined

Readers of this blog may remember (well, you can be forgiven if you don't, I had to look it up myself) that in May I described a wholesale reworking of my portfolio including how and when to rebalance holdings back to a target asset allocation within the total portfolio. My best available information at the time was Richard Ferri's book All About Asset Allocation, so my rebalancing method was based on his recommendations. Then I came across a great article by David M. Smith and William Desormeau on the topic through a posting on Larry MacDonald's blog and wrote about the surprising findings. As a result I've decided to refine my policy on rebalancing.

The New Policy:
  • review portfolio actual market value vs target allocation ( target = the percentage each holding is to have within the total portfolio) once a year in December
  • purchase or sell holdings required to rebalance to target percentage of total portfolio if total bonds (funds and ladder combined) vs equities has moved more than 5% away from target; currently my bond target is 30%, so if bonds go up to 35% or down to 25% (the corresponding numbers for equities - all of them, domestic, foreign, real estate, commodities - is 70% up to 75% or down to 65%)
  • rebalance only those holdings where the transaction cost is less than 1%, currently that would be a trade of $1000 since my transaction cost is $9.95 or where a tax loss selling opportunity in the taxable account makes a trade worthwhile
The new elements are highlighted in italic.

Why the Changes?
  • the move to doing the review in December is to do it at the same time as tax loss selling, to kill two birds with one stone and to minimize trading;
  • the 5% or more deviation test is the major change, coming directly from the findings of the article; though I could have simply eliminated the yearly review and applied the 5% test at any time throughout the year, I still want to do an annual review of my portfolio, my net worth, the tax situation, decisions about RRSP conversions or withdrawals, perhaps a fundamental alteration of the portfolio targets (which is not the same as rebalancing). In the practical world, rebalancing has to contend with, and fit with, lots of other ofttimes more powerful financial forces;
  • tax loss selling on its own may justify a trade, so the opportunity to rebalance fits naturally.
Incidentally, one thing I have seen mentioned as a problem to do rebalancing based on percentages is one no longer. Formerly, it would have been a lot of work to constantly track a portfolio and actual vs target percentages but that is no longer an issue. Google's wonderful online spreadsheet with constantly updated market values for the holdings, including a good-enough kludge to calculate the foreign exchange component, does it for you. I have placed a Google spreadsheet at the bottom of this blog that replicates my portfolio structure and tells me at any given minute-hour-day the portfolio value and target vs actual percentages so I can see where I have gains or losses and how much they are (I have to apply a multiplication factor to convert the model into my own total but that's not too difficult).

What I Still Wonder About
Unlike the researchers' model portfolio of two holdings - stocks and bonds - my real portfolio contains 16 different holdings (more, if my bond ladder is broken down). Most are quite small - 5% or less; only three are 10% or more (see the Asset Allocation tab in the Google spreadsheet). Several, especially REITs and commodities, are supposed to be volatility reducing with very low or negative correlation to the mainstream equity holdings. It means they are likely to go up while the mainstream equities go down. So, the question is when or if to rebalance in the case that the overall equity total is within the 5% limit (i.e. it says don't do rebalancing at all) but one of the minor holdings has doubled for instance. I don't want to be arbitrary to go back to the days of doing things by "feel" so I need a rule and a good reason for that rule. Perhaps I need not worry, though. Seven months after my portfolio revamp, the most any individual holding has strayed from its target is Vanguard's European Equity (VGK), down only 1.2% despite being hammered by the rising Canadian dollar, which has been almost as strong against Sterling as against the US dollar.

Saturday 22 December 2007

A Blog about Finance and Investing Blogs, Books and Resources

The Value Blog Review is a blog whose purpose and content is "Devoted To Helping New Investors Determine What Blogs, Websites, And Other Resources Are Essential To Stock Market Success". Check it out - there appear to be a lot of links to high quality sites.

Friday 21 December 2007

What is Retirement, anyway?

Came across a neat, thought-provoking post about how to define retirement titled the Five Minute Retirement Plan on the The Financial Philosopher blog. His definition - doing what he wants, when he wants, within reason - has a lot of merit. It isn't age-dependent, it doesn't rely on a specific level of wealth or income. And his admonition not to blindly accept his, or anyone else's definition, to make up your own, has even more merit.

Indeed, these days, I wonder what to answer on the immigration arrival cards when flying back and forth between Canada and the UK because I have not been working in a job but don't rule that out. And what would happen if thousands upon thousands of people defined retirement as our friend above does because they do what they want when they want? Would travel statistical systems go haywire (what do they use that information for, anyway?)? At some point, would authorities get concerned and charge people with providing false information - immigration officer: "retired, huh? let's see, you also checked that the purpose of your visit was business, how could that be? please step aside, we'd like to ask you a few more questions, if you don't mind." ... tasers ready! shunt to suspicious person queue.

So what is my definition of retirement? "The time when I rely on various passive sources of income (government payments and private investments), as opposed to active work (though that may still occur, but by choice), to pay my living expenses with the confidence that I will not run out of money till I am at least 120 years old doing my current activities and pastimes." Unlike The Financial Philosopher I prefer to define retirement directly rather than indirectly in financial
terms. His definition is a little too general, too much of a philosophy of life, albeit a good one, that can apply at any age and under any circumstances. If the definition doesn't provide a distinction between retired and not-retired, then it isn't too useful.

What's your definition of retirement?

Thursday 20 December 2007

Survey Results: Number of Times Laid Off

The results are in for the survey question "how many times have you been laid off in your career?". Thirty-five brave people answered as follows:
  • 17 (48%) Never
  • 6 (17%) Once
  • 5 (14%) Twice
  • 7 (20%) More than twice
On to the next fascinating topic to survey.

Tuesday 18 December 2007

Book Review: Learn to Bounce by Anita Caputo & Lee Wallace

Bounce is a sneaky book. Read it straight through quickly and it will seem a bit mundane, dry and repetitious. That's a mistake. Read it slowly, one short case at a time, and you will find yourself drifting off into reflection on your own life and career. That's quite therapeutic.

Three quarters of the book consists of two to four page stories of twenty-eight real individuals or couples (most often with their real names and given some of the details they reveal, it was a brave act to do so ... but then I always found tech work culture and people to be more direct and open) going through a layoff and ultimately successful job search after the high-tech bubble burst. One of the authors, Anita Caputo, tells her own story. From high-tech job she has now made the career transition from IT business manager to career coach, motivational speaker and management trainer. Disclosure: I am proud to say that Anita is a former colleague at the big N and a good friend. Fellow author Lee Wallace brings his 30 years experience as a career counselor and coach to the book.

The other quarter of the book consists of the authors' tips and strategies for success in finding new work. The book focuses on the impact of emotions and state of mind since the authors believe through their experience and that of the interview subjects that those are the critical elements of a successful bounce back, not just into any old job, but something that is fulfilling. Curiously, the presentation and writing style is not emotional, it is very matter of fact, but maybe that's a reflection of the philosophy of successfully bouncing back - "_ _ _ _ happens", the sooner you accept it and move on, the better off you are.

The large number of stories allows the authors to present a very wide variety of types of people, obstacles and eventual outcomes. Many are more difficult situations - people highly specialized, mid-forties or fifties, lengthy time with one employer (and thus not used to the job search process), children to support, medical problems to deal with, spending years out of work (technical skills getting rusty etc).

All are success stories, there are no tales of permanent failure and woe, though hardships along the route to success are not glossed over. No doubt, the tech meltdown caused some to fail (I know some tech families ended up staying in the City of Ottawa's homeless shelter, though I don't know what happened ultimately). There are many ways to fail. The authors have decided to focus on the positive.

Despite all its subjects coming from high-tech, this is not a book about high-tech. Company names are completely absent from the text, evidently a deliberate attempt to distance the message from the specific industry. The significance of high-tech is that the meltdown provoked a quite unique set of extreme and highly instructive circumstances - educated, skilled and experienced people suddenly faced a situation where their industry and technical knowledge were more or less useless because there were almost no jobs in the sector. They were thus forced to be imaginative and resourceful. But the gratifying result is that they succeeded anyway.

The importance of networking appears consistently in many stories, how making connections through others produced far more results than browsing the Internet. The interviewees and authors say over and over that the time to do networking is always - never to stop. When I was out of work, I found networking to be the most awkward and difficult of things to do. But it did get me at least one job and played a role in the other job I found after my layoffs. Networking is a two-way street - being able to help others find a job is deeply satisfying. In financial terms, it could be termed social capital. Just as you have financial capital, which store financial assets to be spent when you need them, and human capital of training, education, knowledge, experience and skills, which store value of use to employers, you have social capital of connections with people, favours and services rendered, which you can lever/"spend" to find a job (and can be extremely useful in doing a job as well). The authors note that quickest to find work were those with the best networks in place.

In terms of personal finances, the book mentions in passing a number of principles that seem self-evident but they sure help or hurt if you do them or not so the reminder is salutary: having savings to fall back on relieves some of the pressure; having to take on debt during unemployment "rots the gut"; investing in high-tech while working in the sector is a stupid thing to do (mea culpa, I did it), i.e. diversification is more important than "investing in what you know"; household expenses can be cut drastically if necessary (one family cut down to a third of what it spent before the layoff), ideally when the warning signs appear; the time to pay attention to family finances is during good times, i.e. start saving, mind diversification now and if you are too busy working to do it yourself, hire a good advisor.

If you ever get caught in a layoff, you need this book. It will remind you that, no matter what your circumstances, you can bounce back and it will guide you how to do it. Others did it, you can do it.

If you are working in a job you don't like or you feel in a rut, there's a fair chance you will get laid off sometime to relieve you of this problem (e.g. in my mini survey on this blog half the respondents had been laid off at least once). This book will give you ideas what to do next to find something better and make you feel thankful for the layoff.

If you are happily working in a great job (as I was in high tech before laid off), this book will help you understand that being laid off is not the end of the world. It is not even necessarily a net negative. Happiness does not come in only one job. In short, the people in this book exemplify the philosophy in the Tom Hanks line of the movie Forest Gump, "Life is like a box of chocolates. You never know what you're gonna get."

My rating on this book: 4.5 out of 5.

To order a copy on-line, go to the LearntoBounce website. On Chapters it seems to be "temporarily unavailable". Update Jan.12 - Chapters has finally fixed the problem and it can now be ordered there as well.

Monday 17 December 2007

Preferred Shares in a Portfolio?

A reader asks what I think of blue chip preferred shares. A good question since I have to admit not having any in my portfolio right now and I have not thought about them a great deal. Maybe I'm missing an opportunity!

Preferred shares are stock of a company. They pay a usually fixed, but sometimes variable, dividend to shareholders. This article titled Why I Don't Use Preferred Stocks from the Motley Fool by David Braze provides more detail, explaining features like participating, callable, cumulative and convertible that can alter their character, sometimes quite significantly. Shakespeare's Primer, linked on the sidebar of this blog, has another excellent explanation of preferreds.

There are two key elements of preferreds to focus on:
  1. The fact that they pay dividends not income for tax purposes in Canada (and the UK at least, since in the USA, the tax rules are that they constitute income). The tax status makes a big difference due to the much lower tax rates on dividends as compared to income - e.g. 8% in a middle tax bracket vs 31% (see the table in this post on Canada vs UK tax rates for the rates in the various brackets).
  2. Their price moves up and down with interest rates primarily, though a company's default risk does enter into pricing, mostly negatively. In other words, they behave like long-term bonds, moving down in price when interest rates rise, or up when rates fall. How closely they do so is an open matter. I looked in vain on the web for correlation matrices that include preferreds as a potential asset class, so I stand to be corrected. On the basis of their characteristics, for the time being I consider their role in a portfolio to be a tax-advantaged substitute in fixed income for bonds.
I took a quick look today at the current yields on Royal Bank of Canada's W series preferreds (ticker RY.PR.W) - 5.182%, and on a range of investment grade straight bonds of 10 years or more to maturity - 5.0 to 5.6%. Since yields are comparable and since bonds rank before preferreds (a company must pay its bond interest before paying preferred dividends), I see no reason to hold preferreds in a non-taxable account. All my fixed income is within tax-deferred RRSP or LIRA accounts so I don't hold any preferreds at all.

Some people are big fans of preferreds. There is a really good blog by J Hymas called PrefBlog. The fellow is also a regular poster on the Financial Webring thread devoted to Preferreds, a really excellent source of discussion and an opportunity to ask questions of very opinionated and (most often ;-) knowledgeable people. The article Putting Income-splitting to Work by Rob Carrick in the December 14, 2007 Report on Business contains description of how some people are using preferreds to their advantage on taxes.

A critical word goes to investment god Benjamin Graham - a quote from his classic book The Intelligent Investor: "Really good preferred stocks can and do exist, but they are good in spite of their investment form, which is an inherently bad one." Mind you, he was writing in the US context, where their tax status is no better than bonds, so perhaps that is too harsh. I cannot complain about anything that can save on tax.

Saturday 15 December 2007

Rethinking Rebalancing Policy: Is the Rip Van Winkle Model the Best?

Rip Van Winkle is the fictional character who goes to sleep one day and wakes up twenty years later to discover that his principal problem in life - his wife - has died and he can now live an indolent life in peace. Is a similar approach the best for investors who use a portfolio approach?

Larry Macdonald has noted in his blog posting titled "No need for annual rebalancing" on Dec.3, 2007 a fascinating and shocking study "Optimal Rebalancing Frequency for Bond/Stock Portfolios" by David M. Smith and William Desormeau in the November 2006 Financial Planning Journal that seems to suggest an "almost never" approach is best. They studied the two popular approaches to rebalancing: at regular intervals (monthly, quarterly, yearly etc), or based on percentage deviation of asset values from the target (1%, 5%, 10% etc). They did this for a wide range of bond vs stock portfolio proportions using US data for the long period of 1926 to 2003.

Their conclusions are these:
"Rebalancing frequency and threshold level are associated with significant differences in portfolio scaled returns. We show that this is true across a wide range of policy weights. From the perspective of both frequency and threshold levels, patient rebalancing policies tend to dominate quick-trigger policies, even before trading costs and taxes are considered. If such costs were taken into account, the advantage in favor of patient policies would be even more dramatic."
Scaled returns means returns that take account of returns relative to risk. Policy weights means the bond vs stock mixes. The threshold means that if bonds are meant to be 40% of the portfolio and the threshold is 10%, then rebalancing was only done if bonds went down below 30% (or above 50%) not when bonds went below 36% (10% of 40%).

They found that the optimal frequency using a time trigger was 44 months, or 3 years 8 months! For percentage deviation triggers, 5% or more was best; 10% was best or second best for about half the portfolio mixes (see table 2). And that is before transaction costs! I am bit puzzled by Figure 4, which if I read it right says that if one had adopted a 10% trigger for rebalancing, then no matter what the portfolio composition, during the whole period of 1926 to 2003, one would NEVER have had to rebalance. Or maybe, the graph is hard to read and it is less than 25 trades in 78 years. Either way that's astounding. Hello Rip, I see you've been a successful investor during your wee nap. Given that equities produce superior returns when calculated over long periods, I wonder how the portfolio could never have deviated that much from the targets.

Maybe the best rebalancing policy is above 10% deviation from target and only if new money added to the portfolio, or withdrawals from it, don't take care of bringing the portfolio allocation within the range. Isn't it good to know that being lazy can be a virtue?

Friday 14 December 2007

Tax-Loss Selling Index ETFs: How to Do It Right

When December rolls around it is time to look over the portfolio and see where certain holdings are in a significant net loss position to decide whether it is time to lock in the loss to offset against current year or past year capital gains (past year because losses can be carried back or appllied against gains up to three years in the past to reduce taxes and get a refund). The objective is to reduce net capital gains to reduce taxes.

In looking over my own holdings, as shown in the model portfolio at the bottom of this blog, just about everything is showing a loss since I remodelled the portfolio in May and booked a pile of capital gains. Lesson number one is therefore to keep a running total of capital gains to be able to tell at any moment whether it is necessary or advisable to do any tax loss selling at all for this year's return. That's why I have my Cost Base tab in the model portfolio spreadsheet, which I update with every trade. Note that capital losses can be carried forward indefinitely into future years so if you think you may have higher income down the road, it may be beneficial to take a loss now to offset future higher gains. For the passive index investor, present market difficulties and losses presents an opportunity to lock in those losses with the confidence and expectation that sectors / asset classes (e.g. REITs have taken a hammering) will eventually recover. The indefinite carry forward feature of CRA rules means that one doesn't have to try predicting when markets will recover, only that they eventually will recover (if they never do, we are all in deep trouble or if you die before they do, will you care?). Patience is a virtue.

First, I note that one holding - AGG, the US Intermediate Term Bond Fund - has gone up in price in US funds from $99.37 to $100.38 yet it shows a loss in Canadian dollar terms, which is what counts for Canadian tax purposes. The reason for that is, of course, the tremendous appreciation of the Canadian dollar vs the US dollar; in this case, the C$ has appreciated from about CAD1.0920 per USD on May 23 to about 1.0167 today (yup, that's right appreciation means it takes less CAD to buy USD). It is thus very worthwhile to track a portfolio taking into account the shifting exchange rate. Volatile exchange rates can easily and quickly change a net Canadian dollar gain into a loss (or vice versa).

However, most of my portfolio is held within my RRSP or my LIRAs so there is no chance to claim capital gains or losses. Two holdings are in my non-registered taxable portfolio - VV, Vanguard's US Equity Large Cap ETF and VNQ, Vanguard's US REIT ETF. In the case of these two holdings, the USD price loss has been accentuated by the falling USD, creating a significant enough opportunity to spend the commission costs to lock it in.

Note that the Canada Revenue Agency does not require, nor does it accept, the reporting of foreign exchange gains or losses of $200 or less (see page 18 of the CRA's Capital Gains guide T4037).

Note also that the date on which to do the foreign exchange calculation is the settlement date, when you receive the money from a sale, or pay the money for a purchase, NOT the trade date, which is three business days earlier. It is thus a fact of life that the exchange rate will shift, perhaps a lot, between the trade date and the settlement date, so you can never know exactly how much your gain or loss on foreign property will be. Well, perhaps if you had millions at stake it might be worth locking in the exchange rate with a foreign exchange futures transaction but for us hoi polloi, it won't be practical.

The settlement date rule is especially important to note when one is selling right at year end - if the trade date is in 2007 but the settlement date is in 2008, you cannot report the loss on your 2007 return, you must report that in your 2008 tax return, probably not what you want if you are trying to minimize taxes now. Due to normal holidays when exchanges are closed, this year the last trading day for counting transactions in 2007 is Dec.24th. Incidentally, I phoned CRA and asked for a reference to a written guide where this rule on the settlement date is stated but they had none to point me to except general statements like subsection 40.1 of the Income Tax Act which mentions gains or losses are counted when actual value is received.

Incidentally, there are of other things than ETFs to which tax loss selling applies and a good summary of tax loss selling by Kevin and Keith Greenard appeared in the Dec. 8, 2007, Victoria Times Colonist. As the Greenards point out, it is worthwhile to review capital agins reported in the last three years since present year losses can be carried back to offset past tax and obtain a refund.

One tip that can reduce your foreign capital gain or increase your capital loss by about 2% depends on the exchange rate that you use to convert to/from Canadian to US dollars (or other currencies if you are able to trade in such). The CRA accepts as standard the published Bank of Canada rates account and the funds had not passed into or out of actual CAD. Though they could not quote me a written source to confirm this and therefore there may be some doubt they misunderstood what I was asking, which might mean it is incorrect, such a position conforms to the logic of what a real trade would follow. but these are nominal mid-market (half-way between buy and sell) rates not the rate you or I pay to our broker to buy or sell. The commission charged by the brokerage means you get fewer USD when you buy them / buy the US equity, and less CAD when you sell. In the case of BMO Investorline, it's about 1% commission each way, or 2% for a round trip. The CRA told me when I called their public tax info line at 1-800-959-8281 that I could use the actual broker buy-sell rate, even though the purchase and/or sale may have occurred entirely within a USDCRA is not that unfair to force people to use FX rates that understate their costs or over-state their proceeds of sale. In other words, you and I are better off using the broker foreign exchange rate instead of the Bank of Canada rate . The only requirement is that you must document and be able to show the CRA, if they should ever ask, the actual broker rate. I simply took a screen shot image of the BMOInvestorline FX quote for the CAD-USD exchange on my settlement date. You must also use the same method of FX, Bank of Canada or broker rate, on reporting both original purchase and eventual sale. You don't have to follow the same method for all holdings, however - it can vary holding by holding.

Another key rule has to do with passive index ETFs (or mutual funds), identical properties and a superficial loss. If you want to sell for a tax loss but stay invested in the market in the same asset class, you must not buy an ETF that tracks the same index as the one you just sold for the loss. Otherwise, CRA will deny you the loss, i.e. deem it a superficial loss, and treat your transactions as if you had never sold the losing ETF (your adjusted cost base of the new ETF will be considered the same as the old one). That the practical interpretation of identical properties regarding ETFs is such is stated on pages 164-165 in Howard Atkinson's book on ETFs, the New Investment Frontier III (see my review of this book here). Jamie Golombek, with AIM Fund Management at the time, in a Canadian Tax Highlights March 2002 article referred to a Dec. 5, 2001 CRA bulletin (TI 2001-008038) that used the example of two funds which track the TSX 300 from different companies as being identical in CRA's view. I am still awaiting a response two weeks later to my enquiry to CRA's public info line on the matter to confirm this interpretation.

Update January 11, 2008 - a representative of CRA phoned and said that the 2001 bulletin mentioned above is the only and latest information on the subject. He also emailed me a copy. Some key excerpts: "... the determination of whether investment instruments are identical properties requires a review of all the facts of each particular situation which would include a review of the legal structure of the investment entity, the composition of its assets, risk factors, rights of investors and any relevant restrictions. ... a TSE 300 Index Fund, for example, would generally not be considered identical to a TSE 60 Index Fund. ... Accordingly, an investment in a TSE 300 index-based mutual fund of a financial institution would, in our view, generally be considered indentical to an investment in a TSE 300 index-based mutual fund of another financial institution."

In my case, VV tracks the MSCI US Prime Market 750 Index and I bought IVV, the iShares ETF that tracks the S&P 500 Index. By the CRA rule if I now try to sell the IVV and buy SPY, the SPDR S&P500 to lock in further losses (a hefty drop this week), that loss would be disallowed. The VNQ that I also sold tracks the Morgan Stanley REIT Index while my replacement fund, the RWR from SPDR tracks the DJ Wilshire REIT Index. That should not violate CRA's test while keeping me fully invested.

It is thus very handy to keep a list of alternative acceptable ETFs within each asset class, such as the one in the Asset Allocation tab at the bottom of this page. You should also note what index they track to comply with the identical properties rules when selling for tax losses. In my original off-line spreadsheet, I've added that info in the cell Notes, though unfortunately the Notes cannot be displayed in the Google on-line spreadsheet.

Tuesday 11 December 2007

A Canadian Investor's Christmas Wish List

It's the time of year that Santa comes around and this year I'd like him to bring me these small gifts:
  • the capability to hold foreign cash in registered accounts like RRSPs and LIRAs, starting with US dollars but why not other currencies like GBP, EUR and JPY, to avoid having to settle trades back into Canadian dollars and then to repurchase USD again to re-invest, which incurs foreign exchange commissions on each end and 2% extra trading costs. I had suggestions from one discount brokerage (not one of the big five banks) that it was finally about to launch such accounts this month - fingers still crossed.
  • discount brokerage accounts, both registered and non-registered, that enable low cost trading ($10 per trade sounds reasonable) directly on other major world exchanges like London, Tokyo, Paris, Frankfurt; TD Waterhouse, this should be especially easy for you since it already exists in your UK service offering
  • passive index tracking mutual funds with low MERs (0.3% or less is a good target) like those of Vanguard in the US as a competitive alternative to ETFs; this will enable small purchases, re-balancing and will simplify reinvesting and tax returns. Note to TD Canada Trust - start offering your e-Series index funds through other brokerages and not force people to open an account with you ... oh, and lower those fees a wee 0.10% please; at Christmas you will find that if you give something, you will receive too.
  • combined account portfolio reports from my discount brokerage for all types of accounts, into one integrated portfolio, to save me the trouble of copying all the data from my regular trading account, my RRSP and my LIRAs into a spreadsheet; a very useful extra capability would be to enable me to add labels of my choosing for asset classes and to summarize that as well across all accounts; plus, capital gains tracking on the regular accounts, to make it easier to do my income tax return plus plan year-end tax-loss selling or gains lock-in.
  • real tax-exempt savings accounts (wonder if Jim Flaherty reads this blog) from our federal government like the ISAs in the UK, in addition to the tax-deferred RRSPs; it's so much simpler and more flexible - no tax deduction since the funds come from after-tax income but growth is completely tax-sheltered and no tax is due on withdrawal, no matter what the type of investment, one's income or age.
  • again from the federal government, an annual tax-exempt capital gains amount, say $10,000, like that of the UK
That's not a lot to ask is it, only six things? And I've been a good boy all year.

Sunday 9 December 2007

Thoughts on How to Start a Portfolio from Scratch

A reader has asked:
"This question is about what to do with your money if you have a lot of it to invest every month. Lets say I had $5k per month to invest, how much would you recommend I save up before I purchase more ETFs and as such, re balance my portfolio? You see, if you read what I have been reading, many people promote the passive strategy (i.e: minimal trades per year, spending less time watching each individual holding etc), I have been reading blog posts, and people have been saying that they wait until they have about 2-3k saved up, and then they "buy more ETF's". But if I did that, I would be buying ETF's every month or 12 times/year, and if I have 6-7 holdings (even at e*trades low cost of 9.99) I'm still spending over $700+ in the year just on trades. So that seems bad right? On the one hand I hear I should wait and just "do the couch potato" and re balance once per year - but I also feel like sitting on $60,000 (saving $5k/month for a year) and just plopping in such a large sum every December would be ridiculous. So the answer must
lie between purchases every month (too often) and purchases once per year (not often enough). What is recommended and why? How often should I purchase more?"

My comments:
  • first, all what follows supposes that the intent is to establish a diversified portfolio with specific proportions of the total portfolio value to be invested in various asset classes; my own portfolio structure is shown at the bottom of my blog - you can see the percentages for each asset class on the Asset Allocation tab and the ETFs I have chosen, as well as alternatives. You can adjust the percentage allocations as you wish, the point is to set a target allocation.
  • for someone who will quickly accumulate a portfolio in excess of $100k, using only ETFs and a broad range of them - I have 16 of them in mine - makes it possible to invest in minor asset classes which can provide greater diversification and higher returns.
  • in practical terms there is a trade-off between trading costs and portfolio balance; since any cost is a certain negative return, I believe that's the most important consideration, especially in the short term (a couple of years) while the portfolio is building. At $10 per trade, the commission on a $5,000 purchase is 0.2% but for $1,000 it is 1.0%, which starts to hurt. Do that twice in a year to re-balance and it takes away an appreciable chunk of returns. For that reason, until two or three years had passed (at your rate, you would have $120k invested after two years) I would be very surprised if any asset class had changed so much that it was necessary to do a trade only for re-balancing, so I would only use new funds to progressively establish the portfolio, asset class by asset class and not bother doing trades specifically for re-balancing
  • I would therefore do one monthly trade - a purchase of one ETF with all of the $5k - to get the funds invested immediately. There is no reason to sit on the cash and wait; the method I outline below is simple enough I believe.
  • I would also start with core asset class ETFs to get the basics in place (sooner rather than later since one never knows when it might be necessary to interrupt the build-up; it will be better to leave an in-progress portfolio that is at all times reasonably balanced ).
    For example to build my portfolio:
month 1 - buy $5k of XIU,
month 2 - buy $5k of VGK,
month 3 - buy $5k of XBB,
month 4 - $5k of VV,
month 5 - $5k of VPL,
month 6 - $5k of VWO,
month 7 - $5k of VGK again,
month 8 - $5k of XBB again,
month 9 - $5k of XIU again,
month 10 - $5k of XSP,
month 11 - $5k of DJP,
month 12 - $5k of VGK again.

Total trading costs $10 x 12 = $120. The first table shows the investments at end of year 1 in terms of dollars, actual percentage of portfolio and the eventual target portfolio percentages for reference. The smaller asset classes are over-invested but that quickly begins to change in year 2. The row and column totals for the assets are already taking shape.
  • Continuing this pattern in year 2 buying $5k per month, month 13 - buy $5k of XBB, month 14 - XMD, month 15 - AGG, month 16 - XRE, month 17 - XSU, month 18 - RWX, month 19 - XBB, month 20 - EFV, month 21 - XBB, month 22 - VGK, month 23 - XIU, month 24 - XBB. Only one non-core asset class remains to enter the portfolio - VNQ, US Real Estate. The row and column totals are getting close to the target allocations.
  • The principle is simply to put each new month's purchase into the asset class that is furthest away from its target percentage. Since the evolution of the markets will move the actual percentages away from their initial purchase value, putting each new purchase into the asset class that is furthest away in actual terms as of the day of purchase will perform re-balancing. As long as you continue to put new money in, I would not see a need to do any annual re-balancing at all. For my model $100k portfolio, in the six months since I set it up in May the furthest any asset class has moved away from the target as of today is VGK, down $930; multiply that by 5 to get a hefty $500k portfolio and that could be re-balanced with one purchase. As time goes on, each $5k purchase represents a smaller and smaller percentage of the total portfolio, and each previous purchase goes down in percentage terms, bringing ever greater accuracy to the portfolio balance, especially among the minor asset classes.
  • With fewer ETFs in the portfolio, it would be even easier to attain the target percentages - instead of VGK, VPL and VWO, you could simply buy VEU, the Vanguard Rest-0f-World (non-US), for XIU and XMD, take XIC, the S&P TSX Composite, for XSP, VV, XSU, buy VTI, Vanguard's US total market fund (though that would mean all your US holdings would be subject to the effects of the US$ fluctuations, something I think is too extreme, preferring to have half of my US large cap equity in the hedged XSP). The only minor one I would always wish to own is real estate due to its proven negative correlation with other asset classes, which thus provides very valuable volatility reductions for the portfolio.

That's it.

Thursday 6 December 2007

Selecting the Bond ETF(s) and Why Bonds instead of Cash

A reader sent in a couple of excellent questions on the practical aspects of setting up the bond portion of a portfolio:
  1. which Canadian bond ETF to buy for a portfolio - the iShares Short-Term Fund (Ticker: XSB), or the iShares Canadian Universe Fund (all issuers and maturities; under ticker: XBB), or possibly other funds
  2. why buy any bond fund if cash in ETrade is paying a healthy 4.15%?
To start a portfolio, I would favour XBB since it covers the whole Canadian bond market. Buying and holding the market is one of the fundamental principles of passive index investing. If one were to buy only XSB, that cuts out a substantial portion of the bond market.

The attached chart, using data from the iShares Canada website on December 6, illustrates more key differences between XBB and XSB:
  • long term, the performance of XBB will be superior - note the five year return of 5.89% vs 4.37% (these figures are for the reference index that the fund attempts to track; the tracking error shows how much the ETF deviates from the index); Since XBB holds some long term bonds, it has a longer duration (see here for an explanation of bond duration as opposed to the term to maturity), which means more sensitivity to interest rate changes and more volatility, but which also provides greater yields in the long term.
  • XBB's tracking error is a little more than XSB's, partly a reflection of the 0.05% higher MER on XBB
  • currently, the yield difference is much slimmer than the long term averages for different maturity funds
  • XBB has some of its distributions in the form of capital gains (cf 2005 and 2004), which benefits from a lower tax rate if held outside an RRSP or other registered account
  • XLB has a much higher longer term performance, as shown by the results of the index it tracks
Note also that TD CanadaTrust also offers a mutual fund - the TD e-Series Cdn Bond Index - that tracks the same whole of market Scotia Capital Universe Bond Index as XBB. The TD fund has a higher MER of 0.48%, which almost certainly results in lower net returns than XBB. However, being a mutual fund, it charges no commissions, so if regular purchases of small amounts in a building up phase of a portfolio are taking place, it may be a better choice (e.g. the 0.15% extra MER is about the same as a $10 trading commission on a $6666 purchase of an ETF) . The other caveat is that one must have an account with TD to buy that fund.

I would note in passing that other commentators like Efficient Markets Canada and Investor Solutions, seem to be saying that short bonds / XSB are a permanently better choice because of the return to risk/volatility relationship - i.e. that long term bonds are too volatile for the small extra return. Perhaps at a moment in time, or for a specific time period, the relationship may be out of whack, but finance theory and research say that they will get realigned. There are bubbles and anomalies in the markets but they get eliminated.

Another point to consider is that just as the equity portion of a portfolio is better off with holdings beyond the Canadian market, so too is it for bonds. The next stop is likely the addition of a US fund. Major ETFs available to Canadians through US markets include BND, the Vanguard whole of US market bond fund and AGG, the iShares Lehman Aggregate Fund. There don't yet appear to be any international bond index ETFs, which would be good for even wider diversification. The Google spreadsheet at the bottom of my blog shows how I have structured my portfolio - instead of my bond ladder, just substitute XBB.

As of today, the minimal difference between the yields on cash and short, medium or long term bonds suggests that it may be just as well temporarily to hold the cash. Sooner or later larger rising differences for longer maturities will re-establish itself. ETrade's fine print does state that the interest rate can change anytime, which means having to monitor it and the funds to decide when to make the shift into the bonds. Incidentally, the ETrade folks said to me in a phone call that cash balances are protected for up to $1 million by the Canadian Investor Protection Fund.

Bonds and cash can provide a highly beneficial diversification effect in a portfolio with equities; through being un- or sometimes negatively-correlated with equities, they can increase returns and lower volatility at the same time. This surprising result has been documented and explained in such fine books as Roger Gibson's Asset Allocation and Richard Ferri's All About Asset Allocation, which I have reviewed previously.

International Book Shopping - Where is the Best Place to Buy?

Books are wonderful in their own right and they are also one of the most convenient items to ship anywhere in the world as a Christmas gift to far-flung family members and friends, especially when ordering on the Internet.

I have conducted a small shopping comparison using Amazon to see where is the cheapest and fastest place to buy and ship books, in this case to southeast Asia. Amazon has nine different websites listed here but I have compared only those of the UK, the USA and Canada.

The attached table shows the results of my survey with the green highlighted cells indicating the lowest cost or fastest delivery. When a non-Amazon seller offered a much cheaper book, that's what I picked, which means the Marketplace shipping rate would apply.

My observations:
  • none of the Amazon sites is best across the board
  • many prices are fairly close after the exchange rate is taken into account - a surprise given the huge swings in currencies these days - but there are significant differences for some books; it may be worth shopping around for a book.
  • the UK is far and away the best place for the fastest low cost shipping, and the only place from which one can still order to ensure delivery before Christmas, while Canada is just horrible - is that our pathetic postal system in operation?
Of course, your friendly credit card company will charge you a few percentage points to convert your purchase from a foreign currency back into your home billing currency, unless of course you are a citizen of the world and have credit/debit cards in multiple currencies. However, it may still be worth it. In the past, I have ordered a number of books through the UK website, paid in GBP for delivery to the UK, which were actually shipped from the USA and it all worked just fine.

So now we have international book arbitrage. Happy reading everyone.

Thursday 22 November 2007

Student Working Holiday Visas and the WWB in Canada and the UK

"A fine idea until the governments got involved" might be a good way to summarize how this looks at first contact. The working holiday programme is a series of agreements amongst a number of countries, including Canada, the UK, the USA, New Zealand and others to encourage short-term and temporary visits by students and young people from 18 to about 30 with the permission to work while travelling.

The exercise of finding the information for a family member has unfortunately revealed the usual confusing and frustrating way that governments operate, despite all the ballyhoo in recent years about seamless, joined up government. Here are the ins and outs as I have discovered them.

Working in the UK
The non-government UK Student Life website has useful general information and points to the official UK government Border and Immigration Agency page on Working in the UK which states that an applicant should use form VAF1 (actually it is written as VAFI). Oops, Wrong! After considerable poking around, scratching my head and following other links I eventually found the truth as revealed in Working Holidays INF15 on the official UK Visas website that it is Employment Form VAF2 one must use. Want to know how much the visa costs? Too bad the FAQ includes everything except this obvious important fact. Oh, and don't bother phoning the general enquiries telephone number listed on this page - you will get a recorded message that live answering has been suspended due to lack of funds till January. No kidding, the government has no staff to answer questions by the public. More searching .... Does the UK Visas list of fees for the various types of visas page include the Working Holiday Visa? You guessed it, nope! I eventually found the British High Commission in Canada page of fees as converted to Canadian dollars showing a price of $420 for the Working Holiday Visa. First, why are they using an exchange rate of $2.10 when it is now around $2.03 and was as low as $1.90 within the last month. Second, isn't this a large amount, a punitive rate for students when the part-time restaurant and retail jobs they are likely to find only pay minimum wage rates of maybe £7/hr. The visa thus costs about two weeks worth of gross wages. Talk about an incentive to visit and work. It's probably more an incentive to come as a non-visa visitor and work illegally.

The Canadian Federation of Students has sponsored an organization called SWAP to arrange working holiday trips by Canadians students abroad, as well as foreigners to Canada.

Working in Canada
The Canadian government's Citizenship and Immigration website page on Working Holidays has general information on the program, as well as a link to the UK program within it. The UK program has four options, the operations for two of which have been outsourced to BUNAC (British Universities North America Club). Does the Citizenship website FAQ or the Fees link say what the visa fee is for the Working Holiday visa? You guessed it - no.

On to BUNAC. BUNAC requires students to sign up for a bundled service which includes the visa application process. I phoned BUNAC and reached a human being very quickly, who told me that up to now there has been no fee charged by the Canadian government for the visa, a fact not stated on the above government website. The BUNAC person also told me the Canadian government has advised them that there would be a visa fee in 2008 but they had not yet been told and would only learn it in early December. That's rather interesting since the processing time for applications is said to be approximately 4-6 weeks. I decided to phone the High Commission of Canada in London visa service to see if I could get the information. The telephone number at first seemed to want to lead me only to recorded messages and not have any options for speaking to a real person but luckily, (or unluckily, given what I was told by the real person), when I dialed 0 a live lady answered. She professed to know nothing about the working visa cost, referring me to BUNAC. When pressed about the fact that the visa and its cost is after all, a Canadian government decision exclusively, she seemed peeved that I should even expect to obtain this information from the High Commission and refused to provide me with any other Canadian government contacts who might elucidate the matter. So much for help from the Canadian government about its own requirements. The cost of the 2008 visa thus remains a mystery. I've sent an email to the Canadian Hogh Commission to try finding out and will post any results.

... Later in the day ... I phoned the official Citizenship and Immigration Call Centre and spoke to an agent who: a) denied that a visa is required at all to enter Canada on a Working Holiday basis; b) that only a work permit, costing $150, is required, just like any other worker; c) the website is NOT an official government of Canada website because it does not use the domain name, despite all the links to official websites, seemingly official-looking downloadable forms, use of both the Citizenship and Immigration logo and the Government of Canada word with the flag logo, a statement that the website is that of the Immigration Section of the Canadian High Commission London, a whole raft of carefully prepared, grammatical, organized, fully-translated into French information and, most of all a direct link from the official Foreign Affairs Canada Canadian High Commission London website Yet there seems to be no link to this website from the Citizenship and Immigration's Do a search on working holiday on this latter website and there are zero hits. Sigh!

All this trouble on one simple question, the cost of the visa in each country. Never mind all the rigmarole and documentation required (I love the UK form which requires you to fess up if you are a war criminal or a terrorist). Welcome to the WWB (World Wide Bureaucracy), students. You are better off using one of the student placement services to keep your sanity in my humble view.

Monday 19 November 2007

Book Review: Against the Gods (The Remarkable Story of Risk) by Peter Bernstein

This book is a popularized introduction to the long history of the development of the theory of risk. It is a welcome and useful entryway into a vast subject as Bernstein has taken care to provide footnotes and a substantial 12 page bibliography of original material. Bernstein manages quite a feat in effectively summarizing in plain language the findings and theories of so many highly mathematical and subtle ideas.

The author's attempt to make the book more entertaining is fairly successful. The meandering descriptions of the personal foibles of the men (why not even one woman among them?) who have advanced the theory of risk along with various anecdotes and trivia (e.g. the English national debt began on Dec.15, 1693) provides amusing distraction but the cutesy chapter titles (e.g. "The Man Who Counted Everything Except Calories") are an annoying artifact of our times.

The book is replete with bold sentences that make wonderful quotes (see below). I found many to be very thought-provoking.

  • At the extremes, the market is more likely to destroy fortunes than to create them. (p.150)
  • It is perilous in the extreme to assume that prosperity is just around the corner simply because it has always been just around the corner. (p.172)
  • We are in the business of managing and engineering financial investment risk. (quote of Charles Tschampion, manager of GM's pension fund; p.247); interesting because engineering only applies when the inputs and assumptions are accurate and as Bernstein states often, we cannot necessarily assume that the future will be like the past and all the assumptions are based on data about the past.
  • The capital markets are not accommodating machines that crank out wealth for everyone on demand. (p.251)
  • Investors diversify their investments because diversification is their best weapon against variance of return. (p.252)
  • Well-informed investors diversify because they do not believe that investing is a form of entertainment. (p.275)
  • It is hard to over-estimate the importance of house price trends for consumer psyches and behavior. ... Consumers view their home equity as a cushion or security blanket against the possibility of future hard times. (quote of former US Federal Reserve Chairman Alan Greenspan, p.290); given the current slide of house prices in the US, one has to wonder what the repercussions will be on consumer spending and economic activity.
  • ... investors had met the enemy and it was them(selves) ... (p.303)
  • ... if all savers and their financial intermediaries invested only in risk-free assets, the potential for business growth would never be realized. (quote of former US Federal Reserve Chairman Alan Greenspan, p.328)
  • ... in spite of all of our efforts, human beings do not enjoy complete knowledge of the laws that define the order of the objectively existing world. (p.330)
  • Uncertainty is a consequence of the irrationalities ... in human nature, ... (p.331)
  • Wars, depressions, stock market booms and crashes, and ethnic massacres come and go, but they always seem to arrive as surprises. (p.334)
  • ... diversification is not a guarantee against loss, only against losing everything at once. (p.336)

I wish Bernstein would more explicitly address the difference between the research or theory that is prescriptive or normative, i.e. which says what people should do, from that which is descriptive, i.e. what people actually do. There is a danger, manifested today in investing as rote acceptance of structuring a portfolio based on a person's "risk preference", to magically transform irrational, illogical behaviour into acceptable practise. Bernstein's example (p.105) of the varying degrees of fear displayed by passengers going through turbulence in an airplane illustrates the point. Why does he describe the varying reactions with "And that's a good thing"? The risk and the consequences to the passengers are the same and presumably none actually want to die so should the reaction not be the same for all despite the observed variety of emotional reactions, however understandable that reaction might be. In a later chapter describing other research on irrational behaviour (p. 273), Bernstein writes: "This behaviour, although understandable, is inconsistent with the assumptions of rational behaviour. The answer to a question should be the same regardless of the setting in which it is posed."

There are some fascinating statements which I wish had received more treatment - perhaps in another book? One statement is that the perceptions and behaviour of investors are shaped by their own times and experience (p. 54 and 301), especially nasty painful ones, like the Great Depression of the 1930s. So, how would Bernstein characterize today's generation? Another is the surprising result that despite all the irrationalities displayed by people/investors the market for all practical purposes - the phrase he uses, borrowed from John Maynard Keynes, is "when it really counts" - operates as though rationality prevailed. In investment terms it means that it is very difficult to exploit mis-pricing, over- and under-valuation in any systematic, profitable way. A third such statement is that the advances in risk management techniques have encouraged greater risk taking. Everyday life, including especially investment management that is dominated by the professionals who supposedly practise risk management in the most extensive and sophisticated way, fall down in the most spectacular fashion. Witness the unfolding sub-prime mortgage lending credit crash and the world's biggest banks who are getting hammered, with the economic debris already starting to fall upon the heads of ordinary people.

The book is somewhat schizophrenic in that it presents the thesis of mastery and a confident answer on the one hand, but on the other hand it asks a key question to which no answer is given: "But to what degree should we rely on the patterns of the past to tell us what the future will be like?" Suppose there is no mean to revert to in the stock market, or suppose the mean has or will shift? In that case, investing theory is a house built on sand.

For the practical-minded individual investor, a quote (p.49) by 18th century gambler and mathematician Girolamo Cardano in the book gives a neat summary of the book's value: "... these facts contribute a great deal to understanding but hardly anything to practical play."

PS a small note to Mr. Bernstein, please find synonyms for the word remarkable; it is a tad over-used in this book.

Overall, a thought-provoking read, succeeds in the story-telling but leaves one confused about how to tell quantifiable risk from unknowable uncertainty and in doubt that such a goal is even achievable. Useful to individual investors to heighten their sense of the need for caution. 4 out of 5 stars.

Thursday 15 November 2007

Job Loss Survey, Emergency Fund and Bounce Book

Thanks to all who ticked a response to my latest mini survey about how many times you have been laid off during your working career. Though the survey is unscientific and comprises a very small sample, the fact that about half of you have been laid off at least once confirms to me that planning and for and making provision for a job loss is important for most people, as I had concluded in my previous post on Emergency Funds: Job Loss.

In a few weeks, I'll be reviewing the newly published book Learn to Bounce, which is about the experiences of a whole raft of people caught in the technology meltdown of 2000, how they turned a negative into a positive in their life. Written by Lee Wallace and friend and former colleague Anita Caputo, the very concept of the book - to show with real examples that a job loss disaster is not necessarily the end of the road - appeals to my philosophy: never give up and never be a victim.

Tuesday 13 November 2007

ETFs, Fundamental Indexing and Oysters

Fellow blogger Preet Banerjee over at WhereDoesAllMyMoneyGo was kind enough to send me a link showing an impressive-looking long-term out-performance graph of the RAFI Canadian Index over the S&P TSX 60 Index. The return is about 3.1% higher in the back-testing period of 1987-2006 with a lower volatility, as measured by standard deviation. Very impressive! Is it time to dump XIU (the iShares S&P TSX60 tracker ETF) and move over to one of (there appear to be a number of choices for the investor on these mutual funds - deferred sales charge, front-end, no-load) the ProFTSE RAFI Canadian Index Funds?

A bit of googling turned up a brief but instructive analysis titled Fundamental Indexing and the Three Factor Model by noted financial author William Bernstein (of Four Pillars fame). The article deals with the US but the principles remain the same for Canada and would for anywhere else. In it he finds that the approach of the RAFI index can be mostly accounted for by the value-equity tilt and, to a lesser extent, by the size tilt that fundamental indexing imparts and about one-third due to its own unique characteristics. And furthermore about the unique third, Bernstein concludes: "Unfortunately, this latter effect is not statistically significant, raising the issue of data mining. ... Differences in the expenses, fees, and transactional costs incurred in the design and execution of real-world portfolios can easily overwhelm the relatively small marginal benefits of any one value-oriented approach."

When one looks at the annual expense ratio of the Canadian Pro Index Funds at 1.85%, that latter warning becomes especially relevant considering that XIU's expense ratio is only 0.17%. So, if one takes the 3% out-performance of the RAFI index, which is not the fund and is before expenses, subtracts 2/3 for the value tilt, (which can be obtained with by buying the relatively new XCV iShares Canadian Value Index ETF, with the admittedly higher MER of 0.50%), one is left with only 1% out-performance, a gain that is completely lost with the higher expense ratio.

Fundamental indexing, as opposed to market capitalization weighted indexing, is an intriguing idea and has stirred a lot of debate since Rob Arnott launched the concept upon the financial world a few years ago.

But, for now I will follow the lead of the old wise oyster in Lewis Carroll's poem the Walrus and the Carpenter in Alice in Wonderland. The walrus and the carpenter invite the oysters for a pleasant walk along the beach, and this is the dubious oyster's reply:
"The eldest Oyster looked at him,
But never a word he said:
The eldest Oyster winked his eye,
And shook his heavy head--
Meaning to say he did not choose
To leave the oyster-bed."

If you don't know already, you can find out here what terrible fate awaited the oysters who succumbed to the ruse.

Friday 9 November 2007

Off Topic: Glasgow Wins 2014 Commonwealth Games - Brilliant!

Today's announcement that Glasgow will host the 2014 Commonwealth Games from July 23rd to August 3rd is great news for the city, for Scotland and, I dare say, for sports fans. Since coming to Scotland just over a year ago, I have been very impressed by the friendliness and general competence and efficiency of the people (and hopefully will therefore not be bad news for taxpayers). Glasgow is a city on the rise with a good atmosphere, a feeling of safety and the Scots do know how to party .... warning to Canadians, don't try to outdrink the Scots!

The Games website has lots of information and the Candidate City Summary document indicates that prices are reasonable - the most expensive is £175 for best seats at the opening or closing ceremonies. For individual sports, best seats are a max of £40 or £25 in most cases. With the Canadian dollar appreciating almost daily against the GB£, now at $1.96 per £, it is beginning to get less costly for Canadians.

Scotland has long been a tourist mecca and all those other attractions can add to the pleasure of the games, like visits to single malt distilleries, castles, museums, hill walking and golf courses for those of my tastes. The only funny thing visitors might find is the language - Scots will understand your english with no difficulty at all (too much american tv I think) but depending how careful they are in speaking, you may not understand them because of accent, phrases and words (e.g. cannae = cannot, to blether is to chat, or "tell her I'm asking for her" means "say hello to her for me")

Wednesday 7 November 2007

An Intriguing Free Book to Download plus a UK Mortgage Primer

Check out the Mortgages Exposed web page for access to a free download of the book In My Opinion by Michael Kelly, a successful retired entrepreneur. I've just skimmed through a few pages so don't have a firm opinion of it, but first impression is good: it looks quite readable and hey, it's free and it's the complete 110 page tome, not just excerpts. The style looks breezy and light-hearted, advice on what the grandfather has learned and wants to pass on to his grandchildren. The topics he covers includes some financial and budgeting advice, along with relationship advice (from a guy, no less!), education, children, running a business, being an entrepreneur, gambling and even death.

Here's a sample quote I can relate to: "You need not give self-created wealth away. Spend it first. But if you must give it away, do it when you are still alive and can directly observe and enjoy the happiness it might hopefully bring."

Another part of the website has an excellent series on mortgages as done in the UK, actually another short book that can be downloaded with working spreadsheets. The explanation starts from scratch, assuming little or no investment knowledge, and works through the various types of mortgages and related topics - fixed rate, variable rate, interest only, lifetime/revers/shared appreciation, buy-to-let, gearing, buy or rent - in short all the common situations with tips and tools for comparing and deciding between alternatives. There are a series of downloadable spreadsheets to work your own calculations, perfect for DIY types. There is a little bit of theory and lots of practical guidance. The perspective of someone who spent 30 years in the business shows through, who made his money, retired and is now giving back his knowledge to anyone who wants it. Overall, a gem of a resource.

Tuesday 6 November 2007

Patientline UK: a Company as Sick as Its Customers

How is it that a company with a virtual monopoly on a convenient telephone and TV service for patients in UK hospitals can degrade financially to a state of life-support while antagonising the public with high and confusing charges and while attracting the ire of the telecoms regulator? Patientline UK is the company soon to provoke a crisis at the National Health Service when its seemingly inevitable slide into insolvency results in its demise.

Patientline has installed 75,000 bedside terminals (pictured on this post) throughout hospitals of the NHS all around the UK. The custom all-in-one terminal provides inbound and outbound telephone service, TV (with a fair range of channels), radio, Internet access (browsing and email) and games in some hospitals. On first impression and limited use so far, the unit appears to be very good from an ergonomic and functional point of view - the wall-mounted swivel arm can put the screen in any position and angle over the bed, the buttons are big and well-spaced, the right-hand handset has a full, albeit tiny, flip-open qwerty keyboard, the headphones (for TV/radio) keep noise levels down, the screen is bright, clear and plenty big enough for close range viewing/reading, the terminal is encased in such a way that it can be wiped and disinfected and the services are accessed through a 4-digit pin code that can be used anywhere in a particular hospital, very convenient for patients moving from ward to ward. Beyond this good stuff, it's all bad for Patientline.

On the surface, the problem is the charges, for TV and especially, for phoning. The BBC article from April 4, 2007, titled Hospital Phone Charges up 160%, describes the proposed phone rate increase, and the vociferous objections that aroused, from 10p per minute to 26p for outgoing calls at any time of day from the patient/hospital to UK landlines. Note my specifying ''outgoing'', ''UK'' and ''landlines'' because rates for incoming calls, to or from mobile phones, non-UK places, on/off-peak hours all are different, and higher. Complexity and confusion is part of the problem for the customer, particularly when everyone's primary concern is for the health of the patient. The various rates are not posted in the hospital that I have been visiting. Finding out later that things cost a lot more than they thought/guessed/feel-is-fair makes people much more annoyed because they feel exploited - ergo the harsher backlash - read reactions here at the Register and here as well, here at SayNoto0870. (Consider in contrast that people happily pay £1.50 per minute to call those adult chat lines.) Probably as a result of the press criticism, the phone rate increase has been rescinded - we are paying 10p now.

However, the TV rate decrease has gone through - it's now £2.90 per day instead of £3.50. So the company has done a good thing, but shot itself in the foot financially.

The charges for incoming calls, which are billed to the external caller, are the other source of phone-related ire. They are 49p per minute during peak 6am to 6pm hours Monday to Friday and 39p at other times. However, the last part of the rate story is untold - the fact that outbound calls to mobiles are 80p per minute during the peak and 40p off-peak. I don't know exactly how the revenue is split between Patientline and the mobile operators but I'm sure the latter are getting a healthy share. On the inbound side, I checked Orange and they charge 55p per minute for calls to Patientline according to a general tariff for calling 070 numbers. Thus, Orange treats hospitals no better than anyone else. Shouldn't the mobile operators be getting some of the criticism here?

What would be an acceptable price for phone calls? Perhaps in the order of 25p per minute, which is the Orange tariff for Pay-As-You-Go? I doubt few would expect rates to be as low as 3p per minute typical of mobile plans.

Closely connected to the cost as an irritant is the fact that most hospitals still ban the use of mobiles within the premises. Formerly this was justified by concerns about interference with sensitive medical equipment. However, this is now officially not a problem since mobiles are no longer believed to interfere with medical equipment (the Health Minister said so! though the studies continue to create doubt as reported at the Register). The remaining hospital ban on mobiles makes people believe that it is only a ploy to protect Patientline's monopoly. Whether the company has successfully brought pressure to bear on the NHS or on individual hospitals is for the walls of backrooms to know but the company certainly blames part of its woes on the loosening of the ban in this Sept.27 announcement.

The last element that acts as an irritant is the fact the NHS seems to consider bedside telephones as a luxury, part of an entertainment unit. Reading the flaming comments and knowing my own situation, being able to talk to family and friends is extremely important for the patient and others. It is more or less an essential part of the getting better process. TV is less essential in my view but this modern day ''opiate of the masses'' can play a big part in relieving the boredom of being in hospital for those awake enough to notice. It's dehumanizing enough to be poked, scanned, jabbed, stripped, drugged, cut open etc. that a little bit of normal outside life can be a big morale booster. The action of the NHS in allowing the service to be introduced, designed and priced as it has displays poor judgment and planning. Blogger Simon Howard struck the nail on the head way back in 2005 when he defended the position of Patientline and knocked the NHS.

seems to have off-loaded responsibility with a poor concept. Though outsourcing to private companies can be an extremely effective mechanism for reducing costs and improving effectiveness of service delivery, it won't work if the concept is wrong. Patientline obviously had (still has?) a vision for a complete patient interaction system at the bedside with the ability to order meals, view patient records, conduct satisfaction surveys and provide related health information. None of this seems to have come to pass. Instead the NHS/Patientline is delivering entertainment at entertainment prices but the customer/patient wants treatment support at NHS-level prices.

The question of the service concept affects the system design and the size and sophistication of the service put in place. If Patientline had the wrong over-blown idea about the future uses or applications, it is quite possible that the £160 million the company is now trying to recoup, is much more than it would have spent for a simple phone and TV system delivery system. Over 75,000 bedsides, that's £2133 each, quite pricey for a phone and a TV on a dangling arm, I would think (OK, there's Internet too but it comes free for TV users ... now why would Patientline go to the extra cost of a computer monitor just to offer it free??). Blogger Wayne Morgan posted this critique of the technology adopted by Patientline, saying it could have been much much cheaper to use IP telephony instead of what he describes as the ''classic digitally switched way''.

One thing for sure is that the company Patientline is not profiting from the high prices. It is a public company whose only business line is the hospital service so nothing is mixed up with it to conceal the truth. The financial reports are posted on the company website under the Investors tab. Losses have been considerable and constant. The BBC report cited above quotes a company representative as saying last April that the company only had sufficient funds to last another 12 months. Nothing seems to have improved since then and the September 28th Trading Update has an ominous warning: ''If the current revenue trends continue then the liquidity position of the Company will become increasingly tight towards the end of this calendar year.''

  • Patientline UK will go bust, provoking a crisis in hospitals
  • NHS will respond by allowing mobiles to be used in most areas of hospitals
  • Another company will take over the Patientline infrastructure for a pittance, thereby attaining a low fixed cost structure; the new company will eliminate phone service avoiding the controversy and concentrate on TV, which is cheaper and easier to manage and bill, and which constitutes 70% of the actual usage of the terminals by patients (ah yes, the sweet spot!); the new company will be a highly profitable cash cow
  • Hospital staff and patients will have to cope with lost/missing mobiles, a lot more ringing phones, battery chargers, some extra calls through staff for those few who do not have mobiles
  • Mobile operators will continue to make their healthy margins in the immediate future
  • In the long term, the adoption of VoIP by hospitals for internal use, such as has just been done by the Birmingham trust, will enable and entice (i.e. get money from) the NHS/hospitals to use this standard infrastructure, to solicit competitive service offerings from multiple providers for phone, TV, radio, Internet, anything digital, as well as medical and hospital admin functions through the bedside device (note the irony of the Patientline terminal image above, obtained from their own website, which shows a menu choice, a service that is not offered through Patientline).

The story could probably serve as a business school and public administration case study on how not to do things.

Update May 26, 2008 - The Interim management statement of February 15th shows that revenues had dropped another 25% in 2008 vs 2007 and includes these words: "Shareholders should note that it is unlikely that any value will be attributable to ordinary shares following any restructuring of the Company's debt." The company is now owned by debt-holders. With annual statements due in June, will the long, slow fall be interrupted by a conversion of all the debt into equity? That would still not make it a viable business however.

Sunday 4 November 2007

Comparison Shopping on Computers: Canada vs USA vs UK

There has been a lot of complaining lately on the slow downward movement of prices in Canada compared to the USA. Since I probably will soon be in the market for a new computer and I have the luxury of buying it in the UK or in Canada as I travel back and forth between the two countries a lot, I decided to do a simple comparison. Computers have the convenient property of being pretty well standardized worldwide so it is easy to make apples to apples comparisons, especially when there are are worldwide vendors like Dell Computer, whose online ordering and configuration website make it possible to build the identical machine for different countries. Purchasing power parity would lead us to believe that identical items in different countries should have the same price after currency conversion.

Below are the results of my little experiment on the delivered price, including taxes and shipping, for a Dell Inspiron 530s. The only substantial difference is that the Canadian version has Windows Vista Home Premium while the US and UK versions have XP Professional. There might be a price difference on that account but since Dell offers some systems with a choice of Vista or XP at the same price, surely there cannot be a big difference in the total cost of the system.

The currency conversion rates are those on Yahoo as of today UK£ = 1.9528 C$ and USS$ = 0.9344 C$.

Total Delivered Price
  • UK £597 = C$1165
  • USA $1158 = C$1082
  • Canada $1435, or 23% more than the UK and 33% more than the USA!!
Looks like I will be buying my next computer in the UK, not Canada. I used to think that the UK's cost of living was shockingly high compared to Canada's but the substantial rise of the Canadian dollar against the pound sterling is changing that situation. My cost of living (in C$ terms) here has declined by about 10% in the last year as a result (which is a great consolation, since my portfolio investment losses in the Vanguard Europe ETF (VGK) have thereby been offset to a large degree).

A final insult is that only Dell Canada does not offer any systems with Ubuntu Linux, an operating system I have been happily using on a 2000 vintage Dell laptop. In fact, the only reason I will replace the laptop is an intermittent and growing hardware malfunction (my cursor seems to wander uncontrollably around the screen at times). Linux will enable me to use the hardware till it breaks, as opposed to having it become obsolete in half the time due to software bloat in the Microsoft environment.

Dell Computer in particular has no excuse for the above pricing differences since it doesn't manufacture any systems in Canada and since it manufactures PCs as and when they are ordered and so has no inventory pipeline with embedded costs to cycle through that might somewhat justify a delay in adjusting prices downward.

Friday 2 November 2007

More Lessons from Who Wants To Be a Millionaire

As host of the UK version Chris Tarrant would say, ''this is serious business''. A previous post of mine made a light-hearted comparison of the show to investing. Ha-ha, the joke is on me. I've just discovered a heavy duty study on the subject. Do you like equations with lots of Greek letters, then download Who Really Wants To Be a Millionaire: Estimates of Risk Aversion from Game Show Data, a paper published in 2005 by Roger Hartley, Gauthier Lanot and Ian Walker of Warwick University? Attached is a sample ... just don't ask me to explain.

The paper includes some fascinating trivia based on a complete inventory of the first 11 series of UK shows up to June 2003 (the authors had the cooperation of the show sponsors):
  • 3 out of 515 contestants won the £1 million top prize (using my higher math skills, that works out to 0.6% not the 1-2% I from my first source), which is the same number who went away with nothing
  • the mean of winnings was much higher at £54k than the £16k I'd guessed, though the standard deviation was a whopping £106k (i.e. those infrequent big prizes distort the stat)
  • 2/3 of people voluntarily stopped by deciding not to answer versus the 1/3 who had to stop by getting a question wrong
  • the quitters left with an average of £72k while the wrong guessers ended up with an average £17k (and this latter figure includes the £1 million winners who the authors decided had not quit voluntarily!); unfortunately the authors don't comment on this difference and I wish they had ... maybe it's called knowing when to quit while you're ahead?
  • the probability that a phone-a-friend will know the answer is only about 40%
  • the ask-the-audience lifeline is as valuable as both the phone-a-friend and the 50-50 put together; is this a manifestation of the wisdom of crowds / markets?
  • 3/4 of the contestants were men, who the authors say are less risk averse than women
  • the early round questions are more weighted with pop culture and sport
  • the show's production team sorts the possible questions into 15 bins one for each of the questions levels, using their judgment and experience to make them progressively more difficult
  • being more educated doesn't help much
Now I don't know if the authors truly would conclude this because it isn't said so in words (maybe the results of one of the equations says as much?), but a fascinating media report in the New Scientist magazine, titled Too Scared To Be a Millionaire?, says: ''The economists’ analysis, based around a mathematical model, suggest that more people would have won a million – and the contestants have taken home more overall – if they were less risk averse and willing to gamble.'' People are risk averse, and the authors find that again in regards to WWTBAM. I really wonder whether people are unjustifiably risk averse in general and with respect to investing as well. In other words, do people stick too much of their investments/savings into safe but low yield things like bank accounts and GICs? Isn't it curious for example that in the richest country on earth, the United States, people are at the upper end of the ladder in holding equities, as I noted in yesterday's post?

Thursday 1 November 2007

Wealth Trivia - Where do You and We Stand?

Came across this interesting post titled Wealth of Nations on the Enough Wealth blog. Want to know where you personally stand on the wealth ladder, or Canada or the UK or the USA? Check out
the original paper "The World Distribution of Household Wealth" by J. Davies, S. Sandstrom, A. Shorrocks, and E. Wolff''. It has lots more fascinating trivia. The data is from the year 2000 in US$ so one would need to add for inflation (16-20%?) to bring absolute numbers up to date.

EnoughWealth does a little calculation to figure out that the USA isn't the richest country per head, it's Japan. Canada is 7th while the UK is 3rd.

Other goodies from the paper:
  • Canadians are much less adventurous than people in the USA when it comes to holding stocks and equities - 32% vs 51% of total financial assets (the other choice is liquid assets) are held in stocks and equities; the UK is even further behind at only 25% (cf Table 3) but the Italians are the champions at 55%
  • there are about 13,568,229 millionaires in the world, 451,809 people with ten million, 15,010 with a hundred million and only 499 with a billion - each higher step has only 3.3% of the number in the group below
  • Canada has its wealth spread more evenly than both the USA and the UK - the wealthiest 10% held only 53% of the total in Canada vs 70% and 56% respectively
  • the highest net worth per capita was in the USA at about $144,000 - where do you or your family stand? (I think the reason that Enough Wealth's table differs and puts Japan ahead of the USA is that he draws his data from a table in the original report which is per adult not per capita); Canada's net worth per capita was only $89,000 (or $72,000 according to another method the authors used to estimate the figure) and the UK was $129,000; interestingly, Greenland is at $138,000

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