I Hate It When the Government Owes Me an Income Tax Refund

Am nearing completion of preparing my 2006 tax return and have discovered to my horror that the government owes me money! That's the intellectual reaction at least, based on the logic that when the government owes me a refund, it means I have, in effect, made an interest-free loan to the government for most of 2006 (since the government does not pay any interest on refunds to a taxpayer). It's strange that despite knowing this and thinking it for years, there's a residual emotional reaction of pleasure that I am getting money back. The reaction reminds of buying fries from a chip stand - when the vendor puts in too little initially and then adds some, it's more satisfying then when the vendor puts in too much then removes the excess even though you may end up with less in total in the former case.

The way to prevent the government owing a refund is to request that less tax be withheld at source from your pay cheque by one's employer using the TD1 form that is distributed and filled-in annually at work. It is even possible to contact the CRA district office to request that the employer be permitted to reduce tax withheld for items like RRSP contributions that one is planning, which are not normally on the TD1 form.

TIP: Reductions on Commissions for Sales of Leftover Stocks

Here's a tip that that a friend brought up recently which may benefit some out there. Ever been in the situation of having sold all your shares in a company only to discover some days later that a few shares have been credited to your account as a result of a Dividend Reinvestment purchase (DRIP) that you had forgotten about? Those shares may hardly be worth the sales commission. What to do? Phone up your broker, explain the situation and ask if they can give you a break on the sales commission. Sometimes they might give you a part or a complete reduction on the sale of such small odd lots that got there inadvertently.

Book Review: The Art of Asset Allocation

Here's the one word review: yucchh!

This book is to asset allocation and finance as metaphysics is to philosophy. Much complicated ado that ultimately is of little use.

I was really looking forward to reading this book by David Darst, which I had bought at the same time as Richard Ferri's All About Asset Allocation. The contrast between the two could not be greater. Ferri is excellent, as I have written in another review. Darst displays the worst of financial writing - dense, boring sentences, superfluous numbers and tables, chart junk illustrations, endless checklists, non-actionable general recommendations and worst of all, radical departures from financial theory that will get an investor into trouble - I refer to tactical asset allocation, which is nothing more than market timing in disguise. A little less "art" and a little more "science" in asset allocation is what we need.

Consider that the book has no footnotes, no references or reading lists - as if Darst's exposition is self-sufficient. Even Newton found it beneficial to stand on the shoulders of others. On the other hand, Darst does take time to say, "Of particular value have been the advice and counsel provided by: ...", followed by four and half pages of names, which I guesstimate is over 600 people. Really?! 600 people?

The hilarious epitome of useless complication is the chart on page xiii, a series of circles within circles with overlapping wheels, which shows an alternative sequence of reading the chapters. I would suggest an author's task is to simplify for the reader and present the material in one logical sequence of chapters, not complicate matters as he has.

I almost get the impression Darst wrote this book to show how smart and knowledgeable he is, a career move to impress his boss and others in the industry. But it doesn't help Mr. Average Investor. The net effect of trying to read this book for an average investor would be to feel that asset allocation is such an esoteric and arcane subject that only someone like Darst or Morgan Stanley (Darst's employer) could possibly do it.

Is Currency Hedging on Foreign Equity Too Expensive?

Someone named George$ wrote a very pertinent post on the Financial Webring asking what people think of the Globe and Mail article by Allan Robinson in which several major fund managers like Franklin Templeton and Fidelity Investments say they do not do currency hedging on their international equity funds to eliminate the effects of foreign exchange shifts because it is not worth it. I've replied to George$ on the site, where hopefully others will comment too, but here is my reply. This is an important question for anyone who wants to use international investments, whether equities or fixed income, to diversify and reduce risk.

I'd sure like to see those studies done by Templeton because there can be very long term trends between currencies, for example the Canadian vs the US dollar. In the ten years from January 1997 to April 2007, the CDN$ went from 0.73 to 0.87 a 20% increase and from 0.62 to 0.88 in the five years between November 2001 and November 2006, a 42% increase. That would be enough to wipe out a substantial chunk of the US market gains for a Canadian investor. How long does the investor have to wait for currency fluctuations to even out and what is to be done in the meantime if the investor needs to cash in? Is Templeton referring to the situation of a large number of currencies with a very broad portfolio such as the MSCI EAFE index? But then, iShares Canada sells the XIN fund that mirrors the MSCI EAFE index and is 100% hedged to CDN$. Its MER is 0.15% - quite reasonable. The similarly hedged XSP mirroring the S&P 500 also has a 0.15% MER. In the end I ask myself, why do I want to bet on the currency as well as the foreign stock/index if I can avoid doing so at a reasonable cost.

One possibility I cannot admit to having modeled or seen done by someone else is the effect of re-balancing under an asset allocation policy. That would have one pushing more funds into markets when the exchange rate changes, a kind of dollar cost averaging. Not sure if that would reduce or completely eliminate the currency effect over time. Anyone have a view?

I've previously posted other comments on this question on my blog.

I wish Allan Robinson had gone to see the iShares folks but it was good to read anyway.

Book Review: All About Asset Allocation by Richard Ferri

Author Richard Ferri delivers what the subtitle of this compact (300 pages fairly large typeface) book promises: "the easy way to get started". It's a fine introduction that explains what asset allocation is and why it is so important to investment success for the average individual investor. It then shows in straightforward, practical terms exactly what to do, right down to listing the funds that one can choose to form a portfolio according to the asset allocation principles. The words I use to describe this book - "simple, practical and introductory" do not mean this is a dumbed down version or lacking in the theoretical grounding of modern finance.

Asset allocation is a very sure method for an average investor to ensure unspectacular but steady investment results with risk that is well managed through effective diversification. And it requires a minimum of time to maintain once the initial set up is done. As Ferri says: "Asset allocation eliminates the need to predict the future direction of the markets and eliminates the risk of being in the wrong market at the wrong time." (think technology stocks in 2001/2002) The fundamental concept of asset allocation is that different sorts of investment assets do not go up or down in sync. That property, and that property alone, allows one to combine those unconnected types of investments into a portfolio that both raises investment returns and reduces risk. That is true diversification, as opposed to the common misconception that merely having many stocks accomplishes diversification. The holdings required for real diversification and asset allocation, as it turns out according to Ferri, should include European stocks, Far East and Asian stocks, Canadian stocks (for natural resources), Emerging market stocks, US small company stocks, US total stock market, US value stocks, real estate and fixed income. Within the fixed income part of the portfolio, he recommends diversification as well, noting that this is often overlooked by financial advisers. Accordingly, he advises holding a combination of a total US bond market fund, US Treasury inflation-protected, US high-yield corporate bonds, Emerging market bonds and US municipal bonds. All of these stock and bond holdings he says are best obtained through low-cost index funds or ETFs, because of their market representativeness of the asset class, their savings on fees and their ease of re-balancing. What is reassuring is that in each case, he establishes through a review of the correlation of returns that there is indeed worthwhile non-correlation with other classes which creates a diversification benefit.

The book is structured into thirds. The first part lays the foundations and the principles that serve throughout - how risk works, how asset classes are determined, how diversification results from non- or negative-correlation, the importance of re-balancing. The second part examines each asset class mentioned above in turn, analyzes the correlation characteristics of each, including the possibility of alternative investments such as fine art, wine, collectibles. I very much like the fact that he addresses home ownership and finds it to be a worthwhile investment though he concludes that it cannot practically be part of an asset allocation investment strategy since one cannot re-balance when necessary by selling a part of one's house. The final third is devoted to discussing historical rates of return and variability/risk, building a portfolio adapted to one's real risk tolerance (as opposed to the over-estimate of risk tolerance most people apparently display when encountering a market downturn), dealing effectively with taxes, investment fees and financial advisers.

This is quite a complete book ... for US investors, for that is his audience. Canadian and UK or other non-US investors have to take the principles in hand and assume that the same kind of asset class relationships exist elsewhere. If I were to adopt his actual recommendations and invest mostly in US holdings, I would be incurring significant exchange rate risk of the Canadian dollar versus the US dollar. Mr Ferri only briefly notes the existence of such risk but does not recommend doing anything about it. Will re-balancing fix that problem? It would be better to see an explicit discussion and recommendation within the book.

Another recommendation that Mr Ferri does justify in a bit more detail but it could still do with more in my opinion is that re-balancing of the portfolio be done annually, as opposed to more or less often, or according to thresholds of departure from the target allocation percentages.

The presentation of the book is excellent. There are lots of helpful tables and charts, there are chapter summaries and key points, there are references and extra readings and a glossary of terms. The writing is clear, grammatical and engaging. Most useful of all and a great time saver, is a list of potential funds (from among the thousands available), at the end of each chapter.

Overall, this book could do the job perfectly well for a US investor. For Canadians and others, we need a "foreign" version, Mr Ferri but I still recommend it to everyone.

You can find another review of this book at the Chartered Financial Analysts Institute.

Buy this book at
chapters.indigo.ca

For Once I Agree with Jack Layton of the NDP

I didn't think it would happen but if what Jonathan Chevreau says is true in his April 3 blogpost about comments made by Jack Layton leader of the federal NDP party then I have to say I agree wholeheartedly. The comments in question are that the Canada Revenue Agency should provide tax calculation software for download or as a web application for free to every citizen / taxpayer. After all, the CRA provides the paper forms for free. All we taxpayers are doing by using the commercial tax packages is data entry for the CRA and paying for the privilege!

The CRA is partly along that path that would be necessary to develop free software for taxpayers since it has developed comprehensive test suites for certifying the commercial packages. Since the CRA seems to be stuck on saying no to going the rest of the way, perhaps the next best alternative is for people to develop their own. There is one free package out there that is Netfile certified called StudioTax but it has a few situations it won't handle (see this CRA webpage for details). Is it time for a true public, permanently free version under open source licensing to be created? Any views out there? Are there software developers and accountants willing to work on creating such software?

Insider Trading and Securities Regulation in Canada

The posts by Larry MacDonald on a number of studies which found highly suspicious statistical evidence that insider trading is rampant in Canada are sickening (the insider trading, not the posts!) to say the least. A big thank you to Larry for bringing this up. A few years ago I sent a complaint to the Ontario Securities Commission about what seemed to me to be very suspicious price changes shortly before surprising and important news on a small company called CSI Wireless. I only ever got an acknowledgement back, months later, from the OSC that they would "look into it" and never saw or heard anything more. Maybe there was or there was not information leakage and insider trading but without confidence in the fairness of trading in that stock, it's one reason I eventually sold out and will not consider buying again.

The lack of control over insider trading is another confirmation that a properly funded national securities regulator is badly needed in Canada; I'm with Canadian Money Blogs Reviewer on this one.