Thursday 27 September 2007

Question on Bond ETFs Doing Poorly

A reader asks: ''Interested in any comments you might have on XBB & XSB bond ETF's. Performance has been poor this year even with dividends.''

You are right, the performance of both has not been very good, barely keeping pace with inflation over the past year at around two and a half percent total return (for details see the Fixed Income list at product page). That's the reflection of the usual pattern - when interest rates rise, as they have, bond prices go down and so the market value of XBB and XSB suffer. If interest rates remain stable, the yield of around 4 to 5 % will re-establish itself as the bond return. Though the returns haven't been good, I'd still consider them a good long term investment as part of a diversified portfolio with equities. I don't actually own any myself since I have been buying individual bonds, which have also gone down in market value.

If equities are having their day now, bonds will again have theirs sometime. Compared to bond mutual funds, the iShares XBB and XSB have lower MERs so from that perspective they give you more. And they are passive index trackers, rather than active managers, which most bond mutual funds are. That's another advantage of XBB and XSB.

Meantime, you can keep receiving the cash distributions (not technically dividends but interest income when it comes to tax reporting). If you treat them like I do as part of a portfolio, come rebalancing time if they are still down in value and less than their target percentage of your portfolio, I'd sell some equities and buy more XBB and XSB to get back up to the target. I call it the autopilot ''sell high, buy low'' strategy.

Thanks for the question Patrick. Best of success with your investing.

Tuesday 25 September 2007

Credit Card Negligence

Yesterday, I was checking my credit card balance and transactions using Visa's automated telephone system and noticed a charge of $1600 from Air Canada that I had not made. A worried call to the TD Visa security center and a review of recent transactions suggested that it wasn't fraud but negligence, both on Air Canada's part in submitting the charge under my card number and on Visa's part in accepting the charge with - obviously - insufficient validation.

Air Canada does not have my card details on file. The Visa rep could not tell me what actual validation took place, though I know it can have only been to accept the card number presented, i.e. no expiry date, name of cardholder, address or other details was required by Visa. Air Canada could not have had the full details, even using Aeroplan, since the card details that were stored on Aeroplan (not any longer, since they've now been erased ... at least, I think so; who knows whether Aeroplan has kept them anyway) included an old expiry date. So any transaction that would have referred to Aeroplan would have had the wrong expiry date and the transaction would/should have been rejected by Visa. Ironically, yesterday I did try to make a booking on Air Canada through the Internet using Aeroplan's old card details / expiry date and Visa rejected my genuine attempt to book on Air Canada.

The Visa ''I only deal with fraud'' rep then blithely told me it was my ''dispute with the merchant'' and I had to get in touch with Air Canada to get my money back. There was no question of simply cancelling the charge, even despite the fact that the charge is so recent that it hasn't appeared on my current balance due statement.

Huh? How does this happen? Any merchant with an account with Visa can simply supply your card number and Visa will stick any charge up to your credit limit on your bill? And on top of that, the error which you had no part in creating is one where you must chase after the merchant to get a reimbursement? Apparently so.

TD Visa's published security advice on this matter is vacuous and insultingly misleading:
''Check your monthly statement carefully and report billing errors to your credit card issuer as soon as possible and always within 30 days of the statement date.'' They neglect to add, ''so we can tell you to go fix them yourself.''

Incidentally, the incorrect charge by Air Canada was apparently a telephone transaction, not one via the Internet, so it isn't a question of online security. I learned this by contacting TD Travel Rewards, the travel agency connected to the TD Visa card, which I had phoned in trying to figure out what was going with the charge.

There, fortunately, the rep did help by contacting Air Canada and finding someone there who admitted that the charge was an error and who promised to reimburse my account within 48 hours (fingers crossed that it actually happens). Kudos to Sheng at TD Travel Rewards for outstanding customer service since she didn't have to fix it since the error had nothing to do with TD Travel but knew where to go and extracted the promise to reimburse me from Air Canada. A raspberry to TD Visa for its unfair policy and to rep Jomo for crappy customer service in refusing to do anything about TD Visa's negligence.

The big question is how to prevent this from happening again in future and short of cancelling all credit cards, I am a bit at a loss. Peripherally, it may help a bit to never leave any credit card details on any website or with any vendor. Having as low a credit limit as possible probably would help too but then, with too low a limit, what good is having a card?

Maybe some folks out there have some suggestions? Are some cards better than others or is this endemic to the way all credit cards run their operations? This website describes a system used for large scale fraud that appears to have similar holes to that which caused my problem. It's very scary, especially since the information on the website dates back to 2002 and one wonders if the banks and credit card companies have essentially made any improvements since. Has anyone else had this problem with Air Canada? Are some vendors better or worse than others and is there some list or website that tracks this?

Update September 30 .... Well, haven't I been surprised at the further developments! It turns out the original error was committed by TD Travel who used my credit card by mistake to pay for another family's travel booking. The error was compounded and abetted by both Air Canada and Visa, neither of whom bothered to verify anything beyond the correct card number and expiry date. All that rigamarole we go through as individuals for web bookings to authenticate ourselves apparently doesn't apply to travel agencies. TD Travel say they are very concerned about the slip-up and are investigating their internal processes. They agreed to give me some compensation (in the form of more of their travel points) for all my trouble. The compensation has now been provided, though my Visa account has not yet been credited for the actual ticket reimbursement.

It also turns out that Visa will look into a charge that a customer like me officially reports as not being their own. During several initial contacts, neither customer service nor security at TD Visa
mentioned this facility. Meantime, despite explicit recognition that it was a case of error not fraud, TD Visa still blocked my card for a few days till I phoned them back to ask the block to be lifted.

All in all, none of Air Canada, TD Visa or TD Travel comes out looking very pretty in this incident. We'll see if TD Travel chooses to make a public statement on this blog since I told them I would be writing about the outcome and offered to print their comments, should they have any.

Update Oct. 2 - My Visa has finally been reimbursed so I am ''whole'' again. Whew!

Thursday 20 September 2007

Tax-Free Saving for Children in the UK

What is the best way to save for the future for a child in the UK? Recently, that question was put to me by a family member who had seen a TV program in which Martin Lewis of the MoneySavingExpert has said something to the effect that an ordinary child savings account at a bank or building society could give a higher tax-free return / rate of interest than specialized products such as Child Trust Funds. I decided to take a very broad approach to comparing the options, including using a parent's ISA or other investments like National Savings and Investments various tax-free bonds. It turns out that there are a number of excellent alternatives all offering tax-free saving but which differ considerably according to flexibility, control of the funds, types of risk, likely after-inflation returns, ease of investing or topping up and amount of effort to manage.

Child Trust Fund
Every child born in the UK after September 1, 2002 gets a CTF, courtesy of the government which provides a £250 voucher (plus £250 extra for low-income families) that parents can use to open a CTF account. If you don't bother opening one yourself, after a year the government will open one for your child with the voucher and pick a provider at random, so you'd be just as well do it and choose yourself. The government adds another £250 (plus £250 again if eligible) when the child reaches age 7. You have a choice of one of three types of CTF available - 1) a savings account with a bank or building society, 2) a stakeholder equity account and 3) a self-select equity account. You can change from one type of CTF to another later on without penalty.

The CTF ''wrapper'' imposes certain common rules that should be considered when deciding how much of the savings for the child should be deposited in it. The first is that the funds are locked in till the child is 18 and cannot be withdrawn, not by parent nor child. The second is that the funds belong to the child, not the parent (or the government). At 18, the child can do absolutely whatever he/she wishes with the money. If you have doubts about whether the child will spend the money wisely at 18 and blow it all on frivolities, then you may want another type of vehicle. On the other hand, isn't part of your job as a parent to teach your kids how to handle money properly? They can't be children forever.

One additional good thing about the CTF is that the child can choose at age 18, when the account must be closed and the funds paid out, to transfer the whole amount into an ISA, which allows it to continue to grow tax-free. Given that the balance in the CTF may have grown far above the annual contribution allowed of £7000 for an ISA, that provides a way to avoid feeling that the money must be spent immediately. Perhaps the 18-year old will want to save further for a house purchase.

In other words, the CTF is meant to be a long-term savings vehicle. If you think you might need the funds before then, you should use another tax-free savings method. To my mind, the CTF should not be invested in a savings account, whose chief merit is to be safe from loss / decline in value in the short term, but whose long-term return is minimal after inflation. Instead the CTF should be in equities of some sort, either the Stakeholder account or the Self-Select. As I described in a previous post on Stakeholder CTFs, all such CTFs are invested in some form of UK Index Tracker Fund. F&C's is the best of the lot since it has slightly lower fees (1.22% per annum vs the usual 1.5%, which is the legal cap on this type of CTF). You don't have to watch the stock market and worry what to do since you are just getting the UK market average, a very good thing for busy parents who don't have the time or inclination to be an investment expert. In fact, it's best to ''file and forget'', ignore the market ups and downs, just let it grow on average over a long period as equities show their long-term superiority over savings. The Stakeholder CTF is the ideal way to have a no maintenance investment in equities for amounts up to perhaps £2000. Above that, a Self-Select Share Dealing CTF offers the opportunity for lower overhead costs and better diversification. My preferred choice there is Self-Trade due to its zero annual account admin fee, though The Share Centre is a close second because of its low trading fees. Why diversification? The UK is not the only market in the world and good investment practice is to include holdings from around the world and in other types of assets such as real estate. The Self-Select CTF accounts offer the ability to invest in any type of equity, or bonds available on the UK market, though I am partial to ETFs ( and not OEICs or other types of actively managed funds). There is apparently now even a shari'a compliant CTF for Muslim parents. I would put all the CTF money into equities and not any into bonds or cash-type fixed income since the other types of tax-free vehicles below can meet those needs and provide total portfolio balance of equities and fixed income. The chart below shows the detail of the terms and conditions.

Individual Savings Account (ISA)
An ISA is another tax-free account wrapper that enables various types of savings and investments free of income or capital gains tax. It is really a product for adults - you must be at least 16 to have one in your own name - but parents can use their own annual allowance of up to £7000 to save for the future needs of their children or themselves. The funds within the account are under the complete control of the parent/adult and can be withdrawn at any time. The money of and for the child is mixed in with the adults' own money.

Normally, this shouldn't be a problem, unless the parents themselves are spendthrifts and cannot save or unless a situation like a marital break-up complicates matters. Grandparents, other relatives or friends who may wish to contribute may feel more comfortable giving money to a child when it is clearly in his/her name. Better, I believe, to establish a formal and psychological barrier between what belongs to the child and what is the parents', i.e. not use ISAs at all for children. Anything invested for the children reduces the amount that parents can save tax-free for themselves. In any case, the £250 government voucher cannot be put into an ISA, only into a CTF.

ISAs from different institutions offer the same range of investment alternatives as CTFs - everything from bank and building society savings accounts, to investment funds, to self-select investment accounts. An additional player is National Savings and Investments, which offers two types of mini cash ISAs (whose annual contribution limit is £3000). The one in the table below on the best ISAs, shows the higher-yielding alternative, the Direct ISA, which can only be managed by phone or on-line. The other one, the Cash Mini ISA, currently pays about a percent less at 5.35% but it can accept additional contributions of as little as £10 at a time (vs £100 or £250 for the Direct ISA), better for those of more modest ability to save.

Child Bonus Bonds and Index-Linked Savings Certificates
These two investments are available only from National Savings and Investments, a government agency that started out as the Post Office bank (which explains why Post Offices in the UK display racks of NS and I brochures). Both types of investment are automatically tax-free. Both belong legally to the child and in-trust forms are available for non-parents to buy the bonds for children under 7. It is interesting that the Index-Linked certificates can be controlled by a child 7 or over ... hmmm, imagine a 7 year-old with £15,000 under his/her own control.

Both are better considered for medium-term three to five year investments. Though the funds are not locked-in and can be withdrawn on demand, interest is not earned at all or is considerably reduced if the funds are withdrawn early. A week ago, it might have been said that the direct backing of the government provided extra protection from loss than other bank accounts, but now that the Northern Rock debacle seems to confirm that no bank depositors will be allowed to lose their money, that seems to be a moot point.

The interest rate offered is almost identical - 5.1% vs 5.15% - but the index-linked certificates offer a guarantee that they will beat UK inflation by 1.35%, not a lot, but that eliminates the major risk of fixed rate investments, that inflation will reduce their value in real terms. I think I'd rather have the Index-linked Certificates. The table below gives the details of these two savings alternatives.

Child Savings Account at Bank or Building Society
Yet another alternative is to open an account in the name of the child at a bank or building society. Very many, if not all, such institutions offer them. The advantage is that most often a higher rate is offered. In the quick search for the best rate from the MoneySavingExpert's website, the Chelsea BS had the highest the day I did it, but it can and does change almost constantly and that's the problem. Unless you are prepared to be checking the website and changing banks frequently, a hassle in itself, you wouldn't be getting the absolute best rate for long. On top of that, at some point down the road, the bank/BS might just drop the rate without notice, a point that MoneySavingExpert warns about. There's also a limit of £100 interest per year that the child can earn from a parent's gift (the idea being to quash parents hiding their own savings in children's accounts), which equates to about £1600 max in the account. In order to avoid tax being deducted automatically (at a tax rate of 20%) from the interest earned on the account, you must fill in form R85 (said to be normally available at the bank branch) and send it on to HMRC, which is a bit of extra work, though only needs to be done once. Despite the complications, such an account may still be a valuable tool for a child to learn how to save and spend money under his or her own control. The table below gives details of a Child Savings Account.

Bare Trust
Not to leave out any, another option is the bare trust which is, in the definition of HMRC:
''A bare trust, also known as a 'simple trust', is one in which each beneficiary has an immediate and absolute right to both capital and income. The beneficiaries of a bare trust have the right to take actual possession of trust property.

The property is held in the name of a trustee. But that trustee has no discretion over what income to pay the beneficiary. In effect, the trustee is a nominee in whose name the property is held. The trustee has no active duties to perform.''

The child is the beneficiary and gets taxed at his or her rate on dividends and capital gains, which is usually lower than the parents'. The £100 limit on interest income from funds donated by each parent applies to a bare trust as well so the maximum benefit accrues when non-parents donate funds for the trust. Bare trusts are used to reduce inheritance taxes and are most appropriate when many thousands of pounds sterling are involved given that professional legal and accounting advice to set things up correctly is highly recommended e.g. see this UK DirectGov website on trusts.

Since the alternatives are not mutually exclusive, I tend to feel that the best course of action is to spread things around and utilize several simultaneously.

Other Websites with Useful Info - see Savings and Investments in Your Money section
Child Trust Fund Official website

Monday 17 September 2007

Book Review: The New Investment Frontier III by Howard Atkinson

This is the 3rd edition of Howard Atkinson's book on Exchange Traded Funds. The fact that a 3rd edition was published in 2005, following so quickly on the first edition of 2001 and the second in 2003, reflects the enormous growth and success of ETFs as a new investment vehicle. There's a good reason for that success and Atkinson, with writing assistance from financial journalist Donna Green, explains the what, who, why and how of ETFs with much practical detail, balance and thoroughness. This book is a detailed compendium of ETFs, tailored for Canadians through the inclusion of a great deal of pertinent and useful Canadian tax information, probably everything an individual investor could need or want to know.

The thorough treatment is accorded not just to the tax implications. The same completeness characterizes the rest of the book. The book begins with a brief explanation of what ETFs are and why index investing makes sense, why passive index ETFs offer better returns than actively managed mutual funds and even index mutual funds. It does a lot of comparison to mutual funds, especially useful since that is the alternative for most investors, and shows how ETFs are more tax efficient and lower cost than mutual funds. He demonstrates the tremendous negative effects that higher costs have on an investor's net return returns over the long run. The balance I mentioned above is evident in this section since Atkinson lists such advantages as mutual funds do have over ETFs - namely ability to invest small amounts on a regular basis, automatic dividend reinvestment, no trading commissions on purchases or sales (the term commissions excludes the onerous and pernicious deferred sales charges on many mutual funds) and the availability to obtain certificates to be able to use the fund holding as collateral. There is lots of explanation and discussion of the merits of different indexes that many ETFs track, very handy for making informed decisions about one's asset allocation choices.

Atkinson throughout the book names products, ticker symbols and companies, giving references and copious weblinks; it's a very practical book. Probably, it would be possible to amass through the Internet all the same information that's in this book. However, it would take a huge amount of time and effort. Some of the more arcane detail in the book - things like the effect of trading by institutional investors - comes from Atkinson's position as an industry insider. He works for, or did at the time of publication at least, Barclays Global Investors Canada, which offers many of the leading ETF products. However, it is worth saying that the book does not read like an infomercial for Barclays - all the competing ETFs and companies with their various flavours are reviewed in a factual manner.

One area in which I find Atkinson goes a bit over the top is the discussion of how ETFs are perfect for doing tilts, style weightings, sector rotations in a portfolio termed the Core and Satellite (pages 93 to 122) and then how ETFs can support those who like to do technical analysis (page 123). I think Atkinson knows better since he includes a note of caution that says those tactics really amount to market timing and he has put forth the evidence right at the beginning of the book of the book that market timing doesn't work. Just because ETFs can be (mis)used that way doesn't mean he should tell everyone how to misuse them. He even quotes John Bogle, founder of Vanguard Group, saying that ETFs are like giving investors a loaded shotgun. Yes, indeed! This part of the book is the explanation of how the shotgun can be used, instead of for hunting geese, ducks, or partridge, as it was designed to do, for blowing off your own financial foot. Effectiveness isn't always the test of whether you should be doing something. Atkinson isn't completely wrong - there are two tilts, justified by proper peer-reviewed financial research, that produce greater risk-adjusted returns. These are small capitalization and value (as defined by price/book value only) companies/equities, known as the Fama and French Three Factor Model (see this Wikipedia entry for a brief explanation and link to the scholarly research article). There may other tilts and it is possible that they are beneficial but they remain to be proven so the average investor is best to stay away.

The chapter on using ETFs with a financial advisor provides an excellent introduction to the alternative types of fee arrangements that are possible. It shows how ETFs enable a convergence of interests of the advisor who charges fees (instead of collecting commissions and trailer fees from fund companies) and of the investor. The fee-based relationship with ETF investments can save the investor money compared to mutual funds and provide more comprehensive advice to boot. This happy result is illustrated and explained with real examples of advisers citing hard numbers. Atkinson, however, says forthrightly that for total holdings of under $100,000 the investor is better off with a DIY approach or simply the famous Couch Potato Portfolio.

  • ''... some active managers do beat the market, sometimes even after costs, but the trick is to find them before they do it.'' before, not after, is indeed the key; manager out-performance does not typically last so you cannot reliably use the past good performance to pick the future winners
  • ''The more you pay in management fees and expenses, the less you get in returns. Period. Always scrutinize MERs.''
  • ''The capital gains distribution and consolidation confuses many investors and advisors.'' investors, ok, but advisers too? ... a good example arguing for mandatory formal training for advisers, n'est-ce pas?

The biggest negative of this book results from the passage of time and the inevitable hazard that information has become dated. The explosion of ETFs and similar new products such as Exchange Traded Notes (ETNs) has continued unabated. Of particular note to Canadian investors are:
My thanks to Mike at the publisher Insomniac Press for providing a free copy of the book to review.

I look forward to version four of this very useful book. Four and a half out of five stars.

You can buy it at

Friday 14 September 2007

As Fear Grips the Market, Bargains Appear or Are They Bargains?

This morning, shares of Northern Rock (Ticker LSE: NRK), one of the biggest home mortgage lenders in the UK (18.9% of the market according to the BBC) are down 24%. That's on the day only. The 12 month decline is 41%, all of it since March this year. The company is caught in the crosswinds of the mortgage lending squeeze, though it has itself no direct connection with any of the sub-prime mortgages in the USA. Is this one of those bargains we dream about, a solid company whose shares are dragged down by external events and which will recover when the storm passes? Check out BBC reporter Robert Peston's blog posts on NRK and why central banks are bailing out commercial banks and the comments, many of which suggest NRK has its own UK sub-prime mortgage over-lending.

Is the UK government likely to allow a company with that proportion of the market to fail, especially a company that deals primarily with consumers i.e. voters? (reminds me of the old saying, if you owe the government a million dollars and can't pay, then you're in trouble, but if you owe the government a billion dollars and can't pay, then the government's in trouble). The Aug. 20 post provides a good explanation of how the US sub-prime mess has spilled into Europe.

Thursday 13 September 2007

Capital Losses and Superficial Loss Rule Using an RRSP

Investoid posted a comment that is worthy of a new separate post. In it he says he was not aware of the tactic to sell a holding in an open taxable investment account to lock in a capital loss then to immediately re-acquire the same holding inside an RRSP.

Oops, should have noticed that in the document before posting. There's a rule of investing - if it looks too good to be true, it probably isn't. It applies here. Or does it? Let us say we have conflicting opinions, including from the CRA itself!

This extract from Chapter 5 of the CRA's T-4037 Capital Gains Guide seems to say no, you cannot do that, the superficial loss rule applies. It states:
''you, or a person affiliated with you, buys, or has a right to buy, the same or identical property (called "substituted property") during the period starting 30 calendar days before the sale and ending 30 calendar days after the sale ....
Some examples of affiliated persons are:
  • you and your spouse or common-law partner;
  • you and a corporation that is controlled by you or your spouse or common-law partner;
  • a partnership and a majority-interest partner of the partnership; and
  • after March 22, 2004, a trust and its majority interest beneficiary (generally, a beneficiary who enjoys a majority of the trust income or capital) or one who is affiliated with such a beneficiary.''
In other words, the RRSP is a trust and you are the beneficiary so the CRA says no it isn't allowed. Probably, people started taking advantage too much and the CRA changed the rules in 2004 to stop it.

That's not the end of the CRA story, however. It doesn't actually say trust = RRSP and you = beneficiary. In my zeal to get a definitive confirmation I called the CRA helpline. After a good long wait to get to a rep and then again while he went off to consult with someone, the answer was, the CRA says yes it is allowed, and quoted me from an internal document #2001-008077, written in 2001. When I expressed my doubts and asked him to re-confirm, since I was about to post this on the Internet and I am not out to embarrass the CRA (really!), he said he would get back to me by next Tuesday at the latest. (For those who think badly of the CRA for this, ask yourself whether a service rep at a typical corporate helpline, say Bell Canada's, would even consider looking further into such a matter.) Wouldn't it be nice if the CRA added a specific mention of RRSPs (and RRIFs since they would presumably be similarly affected) to their Capital Gains guide regarding this matter?

Web sources don't seem to agree either, perhaps no surprise. Here's a brief sample of results from a bit of Googling:

No, It is Not
AIM Trimark's Capital Loss Planning
Posting in Canadian Business forum in April 2006
Another posting in Canadian Business from Jan. 2006 that mentions an Altimira Funds publication saying No as well.
CIBC Wood Gundy article on Tax Loss Selling with no date and the added footnote, hilarious in light of the absent date, ''The information contained herein is considered accurate at the time of posting.''

Yes, It is OK
Milestone per the previous post (April 2002) And it's one of my favorites! column by Jamie Golombek (a VP at AIM at the time of writing in Nov. 2002)
Canadian Shareowner article from NovDec 2000
Bylo posting of Jonathan Chevreau article in the National Post from Nov.21, 2000
Sterling Mutuals article Avoid Superficial Losses in Nov.2001
Institute of Chartered Accountants of BC Tax Traps and Tips article Nov. 2003

My bet is on the ''not allowed'' side. Any opinions? I suspect all this is to re-discover the sad truth of stale content on the web and the fact that one cannot necessarily believe everything that is written, even from reputable organizations.

Thanks, Investoid for the topic!

Update Oct.10 - Finally got a call back from Revenue Canada and the answer is now NO, you are not allowed to do it, or more precisely, your capital loss will be declared superficial and denied on your tax return. The relevant subsection is 251.1 (g) of the Income Tax as modified in 2005.

Wednesday 12 September 2007

Tax Minimizing Strategies from a Financial Planner

Came across this interesting summary list of tax strategies for Canadians on the website of Milestone Investment Counsel. Good stuff!

Mutual Funds and Total Expense Ratio (TER) vs Management Expense Ratio (MER)

Management Expense Ratio (MER) is the overhead cost of running a mutual fund. It is required to be published by mutual fund companies in Canada, which is good since high cost mutual funds return less to the investor. In fact, the simplest way to shop for a mutual fund is just to find the one with the lowest fee since that is apparently an effective way to find the ones which will give an investor the best return.

But the MER doesn't include all costs as the Investment Funds Institute of Canada (IFIC, the mutual fund industry trade body in Canada) explains in this FAQ on fees. Some of those costs can substantial, further reducing returns to an investor.

Notable excluded costs are:
  • brokerage commissions for trading; with turnover in funds up to 80% in a year, that can add up and reduce the performance of the fund (See The True Cost of Funds on Fundscope)
  • sales charges, either front-load or deferred/back-end; actual performance for the investor is reduced to the extent that these charges apply - the front-load negative impact is obvious but it has been found that the deferred charges usually come into play since typical mutual fund investors apparently have short holding periods, averaging perhaps 3 years, while charges apply typically for six years.
  • miscellaneous other charges, that may or may not be levied, such as RRSP admin fees, account opening fees, transfer out fees, short-term trading fees.
  • trading impact costs aka the buy-sell spread, an opportunity cost, explained in The Hidden Costs of Mutual Funds by Milestone Investment Counsel
Note that yours truly discovered that the above IFIC FAQ said the direct opposite - that trading fees ARE included - but a phone call to the IFIC reached a certain Dennis, who said they are NOT included in the MER. He promised to correct the FAQ within the day. Hmmm, the document was dated 2005! Either no one reads the IFIC website or many people have been misled - not good. ... Update Friday, September 14th: The IFIC FAQ document still has not been updated to correct this error. Later on Friday, Dennis says the updated document will be posted next week. Update Oct.10 - the link to the IFIC FAQ doesn't work any longer. There has been a wholesale change to the IFIC website and the FAQ seems to have disappeared altogether. Better no information than wrong information, I suppose, but it isn't very helpful either way.

Nor are brokerage fees included in US published MERs, which are often called simply Expense Ratios. However, Total Expense Ratio does include include it - See this description of Total Expense Ratio in the Investopedia. In the UK TER also includes brokerage commissions and the information is usually published. Out with MER, bring on TER.

Monday 10 September 2007

Consultants Advise on Ways to Pluck Us Financial Chickens

Came across this fascinating study by the hot-shot consulting company McKinsey as publicized in a pr piece on the CTV website. The study discusses retirement anxieties of consumers in the United States, at least some of which one might presume would also hold true in Canada, and suggests ways for the financial industry for ways to either better serve us consumers, or if you have a suspicious outlook, to pluck more of our money. It's interesting to see how the industry looks at us consumers.

The report contains this too-true observation about the financial industry, which is almost certainly also the case in Canada and probably the UK:
'' ... our research uncovered a widespread belief among consumers that
financial advisors are primarily interested in "pushing products," as opposed
to providing unbiased retirement advice, and are placing their own
compensation objectives above the interests of their customers.''
It says that comprehensive (holistic and integrative covering all the financial elements not just one at a time), high quality (knowledge of products and alternatives) and neutral/unbiased advice is lacking, with the exception of independent financial advisers. The attached chart from the McKinsey report is spot on as far as I'm concerned. Let's hope that financial companies take the analysis to heart and improve those dimensions of their current offerings. The thought struck me that the report doesn't say anything about the Internet and bloggers - perhaps the growing popularity of such information channels partly reflects the inadequacies of the financial industry.

The recommendations include simplifying offerings but then gives an example of a structured product that sounds much like index linked GICs, something that is generally not a good deal for the investor. Simplification is a laudable aim but it should not be a cover for products that raise costs for the consumer and extract more hidden fees and commissions. One major recommendation is to push reverse mortgages as a way for retirees to stay in their homes while using some of the equity to fund retirement. If that is to be the aim, the high costs of reverse mortgages would have to come down.

Thursday 6 September 2007

Book Review: The Canadian Retirement Guide by O'Donnell, McWaters and Page

The Canadian Retirement Guide, published in 2004, aims to be a comprehensive handbook on aging, retirement, care-giving and health by setting up ''... a process by which we can plan for retirement as a family, taking into consideration the retiree, the spouse and those who depend on them''. The book is like a 298 page checklist of questions to answer, of issues to consider and of situations that may arise as one gets older. The net effect is to raise awareness rather than to offer enough information to develop a solution. Particularly in the legal and financial sections, there is the constant refrain, ''go consult a specialist'', and indeed, there are thirty pages of appendices with checklists of information to prepare to meet with a financial advisor or lawyer and questions to ask of them. There is almost no reference information to specific books or websites that provide further detail on the topics covered. This book is somewhat like the old joke about statistics: statistics are like a bikini - what they reveal is interesting, but what they conceal is vital.

Here is a typical example of the level of depth and manner of treatment of subjects. Regarding sex, ''While sexual activity does tend to decline with age, there are tremendous individual differences. Chronological age isn't the critical factor in sexual activity or physical intimacy. Neither age, nor illness, nor dementia necessarily diminishes or extinguishes sexual desire. It's a normal and healthy part of of being human, at all stages of life.'' That's it - no further references, no further mentions throughout the book. Would that be helpful to you?

The book is written by a team of authors, each evidently handling specific chapters in their area of expertise: Jill O'Donnell, a gerontologist and registered nurse; Graham McWaters, from a major financial institution (un-named); John Page, a financial planning advisor and holder of the Certified Financial Planner certification which I mentioned in my recent post on financial planners in Canada; with contributions from Rev. Dr. George McClintock, a United Church minister who specializes in the pastoral care of elders (I don't know why but that word elder grates on me), Barbro E. Stalbecker-Pountney, a lawyer with special interest in elder issues and estate practice, Philip Crawford, an undertaker, and finally, Rick Page, another financial planner (but minus the CFP).

Subject Matter Covered
  • growing older and life planning, personal mission statement (yup, they use that corporate jargon)
  • health of body and mind, stress (unfortunately, neither pets, nor sex are prescribed as stress-relievers!)
  • housing situations - house, apartment, retirement homes, living with family
  • relationships with family, second marriages
  • legal - wills, power of attorney, trustees, executors, family law
  • death - funeral, burial, cremation
  • care giving and dementia
  • financial planning (about half the book) - financial plan, investments, diversification, risk, life & disability insurance, taxes, pensions, estate, annuities, reverse mortgages, financial advisers

  • ''... the longer you live, the sooner you are going to die.''
  • ''If a family member's irritating habit is not destructive, try not to worry about it.'' (p.80) (of course, this stress-saving tip only applies to older folks ... ;-)
  • ''A will speaks for you from the grave; powers of attorney speak for you from your hospital bed.''
  • most old, retired people, oops sorry ''elders'', live independently; less than 10% are in care or homes (p.66)
  • a person who is paid to care for someone may not legally have power of attorney for that person (p.86)
  • a guardian outranks someone with power of attorney (p.87)
  • under family law, if you have supported someone, the obligation to continue the support will survive your death ... in other words, your cannot put whatever you please in your will and expect that it will happen, the courts may over-rule what you say (p.93)
  • along the same vein, your executor is not legally bound to dispose of your household and personal assets as per your will (p.91)
My Take Away Action Points
  • pre-pay up to $15k in funeral expenses, known as an eligible funeral arrangement (EFA) in tax-code speak, to a funeral home for funeral expenses; interest on the $15k, which is invested in GIC, is tax-free (p.105)
  • continue writing this blog for mental stimulus, since it is not known if Alzheimer's is caused by genetics or whether deliberate mental activity can stave it off (p.142)
There are certain inaccuracies or mis-wordings in the financial sections that diminish the usefulness of the information, for it does provide a reasonable introductory over-view. For instance, this statement, ''If your portfolio were 100% fixed-income and interest rates dropped, your whole portfolio would suffer. '' Huh? If interest rates drop, then the market value of existing fixed income holdings would RISE and the value of your portfolio would increase, which is the opposite of suffering. Probably, the author means that over time as the fixed income investments matured and needed to be reinvested, the income stream from interest payments would drop and that would cause suffering for a retired person who lives off that income. That's exactly what happened through the 1990s. Unfortunately there are a number of other instances of sloppy language. Was there peer-review prior to publication that might have helped clear these up?

Many thanks to Mike at the publisher Insomniac Press for supplying a copy of the book for review.

My rating: 3 out of 5 stars.

You can buy it at Chapters.

Index Investing Imperfection

A new blog, Behavioural Investing, by author and investment industry professional James Montier has a worthwhile post titled Something the Bogleheads wouldn't want you to know, or index investing isn't passive. The posting reviews a research article called Index Rebalancing and Long Term Portfolio Performance by Cai and Houge. Montier's provocative headline (are the adherents of John Bogle annoying people and causing others to want to poke holes in their balloon?) states that indices such as the S&P500 and the Russell 2000 are not passive. Well, that turns out to be merely a reflection of the fact that companies are added or dropped from the index on a regular basis. Big deal, that's what an index is. The important point is that better returns and lower risk could have been achieved merely by buying and holding the original members of the index. Montier cites another paper by Siegel and Schwartz, The Long-term Returns on the Original S&P 500 Firms, that finds the same thing as Cai and Houge.

The challenge now is turning that research result into a practical investing strategy. Buy and hold is obviously the core of such a strategy as Montier says at the end of his post. But what exactly to buy and hold? An individual, Warren Buffett aside, cannot buy all 500 stocks in the S&P 500. I haven't come across any Exchange Traded Funds out there that implement the ultimate buy and hold. In the meantime, those index ETFs still seem to be the best available practical investment vehicle. Little is ever perfect, even index investing, which is an encouraging thing since that means there's always room for improvement and it is worth the effort to find those improvements.

Wednesday 5 September 2007

Financial Advisers and Planners in the UK

Just as I was about to write this post on finding financial advice in the UK, a family member pointed me to the famous MoneySavingExpert website. It turns out that it has a great primer on that very subject. Part 1 is advice on when to use an adviser, how to find a good one and how to pay, while part 2 covers picking and paying for an Independent Financial Adviser (IFA).

While generally excellent and quite comprehensive, part 1 needs to do better than this comment about seeking Investment advice:
''While research helps, there's always an element of gambling when it comes to investment picking. If you go it alone, you get a head start because, do it right, and there are no charges (read Discount Brokers article). So the IFA has to pick substantially better than you to make up this difference.''

If one looks at investing as gambling, then one is likely to have the same success rate as gambling. The ''do it right'' is exactly the problem. Individual investors too often do it wrong (see Richard Deaves' book What Kind of Investor Are You? for citations of studies that prove this). The website does correct this bad piece of advice somewhat with the last comment, ''... planning, structuring and timing investments for events (e.g. funding university fees) can be very complex and here IFAs can come into their own.''

It's not just for events, however. It's all the time when investing. Much better would be a statement like this: ''Unless you understand, or are prepared to spend the time to learn, aspects of investment such as financial analysis, portfolio theory, diversification, risk and return characteristics of various investment alternatives, then getting the advice of an IFA is a good idea.''

In part 2 under the ''what qualifications do you have?'' question to ask a prospective IFA, it does not but could mention that the Certified Financial Planner designation offered by the Institute of Financial Planning offers almost the same extra qualifications as the Chartered Financial Planner mentioned - completion of the renamed AFPC (the new name is the Diploma in Financial Planning, but many planners still use the old term). To find a CFP in the UK here is the IFP's search tool.

There are also a number of other advanced qualifications, all approved by the Financial Services Skills Council, the body authorized by the national UK regulator the Financial Services Authority, to set and maintain qualification standards for anyone wishing to offer financial advice. The good thing about the regulatory set-up is that anyone offering advice may not pretend they have competence when they don't - if they haven't the necessary approved qualifications, they should refuse your business.

The FSSC-approved courses are offered by various bodies:
Some of them are:

  • CeMAP and Advanced CeMAP (which adds competence in commercial mortgages and lifetime mortgages) (IFS)
  • CeLM - Lifetime Mortgages (IFS)
  • CF6 - Certificate in Mortgage Advice (CII)
  • CF7 - Certificate in Lifetime Mortgage Activities (CII)
  • MAPC - Mortgage Advice Practice Certificate (CIOBS)
  • LMAPC - Lifetime Mortgage Advice Practice Certificate (CIOBS)
Taxation and Trusts
  • G10 (old code but commonly used still) Taxation and Trusts; now, J01 Taxation and J02 Trusts or AF1 Personal Tax and Trust Planning seem to overlap and match G10 (CII)
  • G60 (old code) Pensions; now J05 Pension funding options and J06 Pension Income Options or AF3 Pension Planning provide this (CII)
  • CF9 Pension Simplification (CII)
  • CF* Long Term Care Insurance (CII)
  • G20 (old code) Personal Investment Planning and G70 Investment Portfolio Management; now replaced by J06 Investment Principles, Markets and Environment and AF4 Investment Planning (CII)
  • CertIM - Certificate in Investment Management (SII)
  • IMC - Investment Management Certificate (UKSIP)
Though it is not as breezy and informal as the MoneySaving Expert material, the Financial Services Authority itself has an excellent guide to finding financial advice. You can't get the rules, restrictions and rights wrong when the word comes from the horses' mouth. The last few pages of the guide includes a whole raft of financial organizations and websites, both government and private, on a very wide range of financial topics for consumers. A one sentence blurb says what each has to offer. The FSA's own consumer advice website called Moneymadeclear includes excellent material on savings, investments, mortgages, insurance, credit cards, loans, pensions and retirement, including calculators for mortgages, pensions, budgets and a product comparison tool for annuities (prices are not right up to date apparently), mortgages, savings accounts, ISAs and investment bonds.

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