Last Sunday, GlobeInvestor posted the news that henceforth Canadian retail investors in Ontario and Quebec would be allowed to open accounts to trade in Contracts For Difference (CFDs). As Wikipedia describes, CFDs have long existed in the UK, Australia and elsewhere but not in the USA.
In a CFD, the investor bets against a market making broker, in Canada's case CMC Markets, either that a stock or other security will go up, by going long, or that it will go down, by going short (see CMC's examples for how it works). The amount the stock moves away from the price at the time of taking the position/contract to the sale is the difference and that determines the investor's loss or profit. The key unique characteristic of CFDs is the huge amount of leverage they entail, which creates an enormous bang for your investment buck - good or bad. CFDs are essentially a way to get rich or go broke at warp speed. Due to the magnification effect of leveraging, unlike regular stock purchases, you can lose far more than your initial investment.
Since CFDs do not have an expiry date, unlike options which do expire, it might be thought that a retail investor with a long term perspective might for example, simply buy the TSX index long and hold on till the market eventually rises, making sure to keep plenty of cash around to meet the almost inevitable calls for extra cash to maintain margin requirements. However, there's a catch - long positions are subject to a daily interest charge as long as they are open. It is as if one has borrowed the whole amount (see section 2.1 of CMC's rates and fees). The interest rate on the notionally borrowed money is currently low - about 2.8% annualized by my calculation (just a bit less than discount broker BMOIL's 3.5% interest rate on margin debt and a bit more than the TSX 60's current dividend yield of 2.7% ... raising the question, unanswered on CMC's website, whether the Canadian version of CFDs pays out the dividend to the long investor as is the case for CFDs in the UK for instance) - but it still lowers returns and creates a disincentive to anything but short-term speculative day trading with CFDs.
The supposed hedging value of CFDs is minimal. If one takes an offsetting short CFD to balance against a long stock position one already holds, then one simply freezes the total value (excepting the inevitable costs) of the two holdings since a rise or fall in the CFD simply mirrors in the opposite direction the stock holding's movement. Most people think of hedging as downside protection, not both downside and upside. An investor is better off with a straight put option or a stop loss order.
About the only party sure to benefit from CFDs is the market maker CMC Markets, from collecting the bid-ask spread on buys and sells, the interest on open positions, trading commissions and other charges. It is ironic that CMC's website links to this Financial Post story which says that the founder and CEO of CMC Peter Cruddas is London's richest man (interesting isn't it that he is at the top of the Times 2009 online richest list just ahead of a some online gambling site owners). That's where you money will go folks unless you are one of the lucky few who play and win the CFD lottery.
Thursday, 29 October 2009
Tuesday, 27 October 2009
TFSA Account Adoption Creeping Steadily Up
RBC has just released a survey that shows the number of Canadians opening TFSA accounts is climbing steadily and is now at a quarter of eligible (18+) Canadians. Back in April Jonathan Chevreau had reported in his Wealthy Boomer blog that 20% had opened accounts to that point. The good news is that most people - over 70% - are mostly aware of the TFSA. Hopefully, the slow to act will soon join the list ... hint to some members of my family!
It was a wonderful coincidence that the January 1st start-up date more or less marked the bottom of the equity slump so those who were quick to jump in have seen a very healthy return so far - my initial $5000 evenly split between XIU and XMD has risen 33% or so since my account opened in February, a great tax-free return.
Maybe more Canadians should be a little more adventurous than the cash savings and the GICs that dominate TFSA account holdings according to RBC. Interest rates are so low that there isn't much point to tax-free savings if there isn't any income generated. RBC's headline to its press release - Why aren't Canadians taking advantage of tax free savings accounts? - is true in more ways than one.
It was a wonderful coincidence that the January 1st start-up date more or less marked the bottom of the equity slump so those who were quick to jump in have seen a very healthy return so far - my initial $5000 evenly split between XIU and XMD has risen 33% or so since my account opened in February, a great tax-free return.
Maybe more Canadians should be a little more adventurous than the cash savings and the GICs that dominate TFSA account holdings according to RBC. Interest rates are so low that there isn't much point to tax-free savings if there isn't any income generated. RBC's headline to its press release - Why aren't Canadians taking advantage of tax free savings accounts? - is true in more ways than one.
Friday, 23 October 2009
Friday Fun: How Much do Pro Golfers Make?
Ever notice how the sports reporting on the winners of golf tournaments says little or nothing about how much money pro golfers make? In these hard economic times it isn't wise to rub it in how much these guys and gals make.
Canadian Business / MoneySense in Golf Earnings 2009 has dug up the data and done a bit of calculation to make us envious. Isn't it a hoot to know that Tiger earned $4191 for each stroke he played?!! It really puts in perspective the three hacks it took me to get out of a sand trap in a recent round. I calculate my $$$ per round not in revenue but in cost - green fee and lost balls.
Worse, as much as these guys make on the course, it is the off-course endorsements and related business (like course design) that their competitive success makes possible which really brings in the dough. It is astounding that Woods in his career could make $1 billion from golfing.
Canadian Business / MoneySense in Golf Earnings 2009 has dug up the data and done a bit of calculation to make us envious. Isn't it a hoot to know that Tiger earned $4191 for each stroke he played?!! It really puts in perspective the three hacks it took me to get out of a sand trap in a recent round. I calculate my $$$ per round not in revenue but in cost - green fee and lost balls.
Worse, as much as these guys make on the course, it is the off-course endorsements and related business (like course design) that their competitive success makes possible which really brings in the dough. It is astounding that Woods in his career could make $1 billion from golfing.
Thursday, 22 October 2009
Government Ban on RRSP - TFSA Swaps Revisited: One Red Herring and the Real Problem
Sometimes I'm a bit thick and it takes a while for the real reality to distinguish itself from the illusory reality.
The Illusory Reality: Yesterday I noted the scenario mentioned by two other bloggers - see here and here - for supposedly moving funds tax-free from an RRSP to a TFSA. The illusion is that the investor moved funds but what has actually happened is that the investor made a profit on an investment in the TFSA account and made a loss in the RRSP account. To see this, it is only necessary to remember that the exact equivalent result could be achieved by simply buying and selling on the market instead of doing a swap. In fact, a swap is just that - instead of the investor buying or selling on the open market, his accounts buy and sell to each other.
Another tack is to think of it in the investor's shoes - after the stock price rises in the TFSA, you are $XXX better off in total wealth. Would you really want the stock to decline after your RRSP buys it so that the TFSA can buy it back? After the round trip of swaps and the stock decline, the investor has less money in total than after the TFSA made a profit. The TFSA is the same but the RRSP is worse off. In any case, there is no guarantee that the stock will happily fluctuate up and down within the range needed to come out ahead on a net basis. That's why day trading is a highly risky proposition.
This non-problem is a manifestation of the sunk cost fallacy. At each step of the process, the investor is faced with a clean slate and a new decision about how to invest. The past, however recent, is irrelevant. I certainly hope the Department of Finance policy is not meant to stop this kind of investor operation because the government would then be taxing the profits of normal risky stock purchases and sales.
The Real Reality: The real problem is revealed in the discussion on the Financial Webring TFSA thread. It is the fact that the tax rules allow an investor to choose which price within a security's trading range on the day of the swap to have applied to calculate the value of the swap. The difference between the high and low price is what generates the tax-naughty riskless profit for the investor who has eliminated the market risk through judicious use of options. A more volatile stock, or a volatile day to perform the swap, is better because it produces a higher high-low spread and that increases the risk-free profit. Options also use less capital than straight stock, which boosts the returns.
That being the case, the Government would seem to be engaging in throwing out the swap "baby" with the dirty hi-lo price "bathwater". Instead of banning swaps (which doesn't make sense anyway since direct stock trades can effect the same outcome) or changing the rule that any price during the trading day when the swap takes place may be used to value the transfer amount, either declare that two-way swaps of the same security will automatically be valued at the same price within the same day, or perhaps within 30 days in a manner akin to the superficial loss rule. There's even a catchy name to give it - the superficial swap rule.
The Illusory Reality: Yesterday I noted the scenario mentioned by two other bloggers - see here and here - for supposedly moving funds tax-free from an RRSP to a TFSA. The illusion is that the investor moved funds but what has actually happened is that the investor made a profit on an investment in the TFSA account and made a loss in the RRSP account. To see this, it is only necessary to remember that the exact equivalent result could be achieved by simply buying and selling on the market instead of doing a swap. In fact, a swap is just that - instead of the investor buying or selling on the open market, his accounts buy and sell to each other.
Another tack is to think of it in the investor's shoes - after the stock price rises in the TFSA, you are $XXX better off in total wealth. Would you really want the stock to decline after your RRSP buys it so that the TFSA can buy it back? After the round trip of swaps and the stock decline, the investor has less money in total than after the TFSA made a profit. The TFSA is the same but the RRSP is worse off. In any case, there is no guarantee that the stock will happily fluctuate up and down within the range needed to come out ahead on a net basis. That's why day trading is a highly risky proposition.
This non-problem is a manifestation of the sunk cost fallacy. At each step of the process, the investor is faced with a clean slate and a new decision about how to invest. The past, however recent, is irrelevant. I certainly hope the Department of Finance policy is not meant to stop this kind of investor operation because the government would then be taxing the profits of normal risky stock purchases and sales.
The Real Reality: The real problem is revealed in the discussion on the Financial Webring TFSA thread. It is the fact that the tax rules allow an investor to choose which price within a security's trading range on the day of the swap to have applied to calculate the value of the swap. The difference between the high and low price is what generates the tax-naughty riskless profit for the investor who has eliminated the market risk through judicious use of options. A more volatile stock, or a volatile day to perform the swap, is better because it produces a higher high-low spread and that increases the risk-free profit. Options also use less capital than straight stock, which boosts the returns.
That being the case, the Government would seem to be engaging in throwing out the swap "baby" with the dirty hi-lo price "bathwater". Instead of banning swaps (which doesn't make sense anyway since direct stock trades can effect the same outcome) or changing the rule that any price during the trading day when the swap takes place may be used to value the transfer amount, either declare that two-way swaps of the same security will automatically be valued at the same price within the same day, or perhaps within 30 days in a manner akin to the superficial loss rule. There's even a catchy name to give it - the superficial swap rule.
Wednesday, 21 October 2009
TFSA Ban on Asset Swaps with RRSPs
Updated later in the day - see red text.
The proposed new rules to eliminate potential abuses of TFSA accounts announced the other day by Finance Minister Flaherty includes one strange rule (see the Department of Finance's Backgrounder section on Asset Transfer Transactions) that bans swaps between TFSAs and registered accounts like RRSPs, LIRAs, RRIFs.
I must admit I was puzzled since I had not previously seen anyone proposing a way to avoid taxes by doing a swap.
There seem to be several explanations of what the rule prevents:
My direct question to the Department of Finance for an example has yet to be answered (stay tuned for what they eventually tell me). Here is what they said: "The idea would appear to be that overall, advantage is rarely gained but the scheme is such that a large number of small swaps, particularly involving volatile stock, could enable capital gain to exceed tax liability, using financial software and hedging strategies."
In this first year of the TFSA when the contribution limit is only $5k, it is likely Michael's strategy would hardly be worth it considering each swap is charged a fee by the broker ($45 flat fee per security swapped at my discount broker) and it would eat up much of the tax savings. However, down the road when accumulated TFSA room gathers bulk, the benefit becomes more attractive.
Yet to be confirmed also is the import of the tax penalty. The Department of Finance phrase is: "TFSA amounts reasonably attributable to asset transfer transactions will be taxable at 100%." I would think that what it means is that you would be taxed on whatever "excess" you had managed to transfer - the $1000 in Michael's example - at your normal marginal tax rate i.e. just as if you had withdrawn the $1000 directly from the RRSP, and not at a 100% tax rate, which would amount to confiscation by the government of the excess shifted, an action that even for the government is a tad harsh. " Update: I was wrong, ouch! quote from an official spokesman of the Department of Finance - "No it’s not the marginal rate, it’s a levy of the full amount of the *gains*. It won't matter much anyways since the brokers will all block any sort of swaps with TFSAs and registered accounts.
I wonder if the government will now ban swaps between locked-in registered accounts and non-locked-in registered accounts since the same technique Michael describes could be used to move value and unlock locked retirement money.
The proposed new rules to eliminate potential abuses of TFSA accounts announced the other day by Finance Minister Flaherty includes one strange rule (see the Department of Finance's Backgrounder section on Asset Transfer Transactions) that bans swaps between TFSAs and registered accounts like RRSPs, LIRAs, RRIFs.
I must admit I was puzzled since I had not previously seen anyone proposing a way to avoid taxes by doing a swap.
There seem to be several explanations of what the rule prevents:
- A visit to the Financial Webring where all the usual suspects gather and gleefully point out such tax "work-arounds" uncovered in a TFSA thread a post by Marty123 on Oct.20th detailing a highly sophisticated strategy using massive over-contributions and options.
- Blogger Michael James on Money's post TFSA Abuse shows another scheme that seems to fit the bill.
- The Canadian Tax Resource blog gives a similar example to Michael's.
My direct question to the Department of Finance for an example has yet to be answered (stay tuned for what they eventually tell me). Here is what they said: "The idea would appear to be that overall, advantage is rarely gained but the scheme is such that a large number of small swaps, particularly involving volatile stock, could enable capital gain to exceed tax liability, using financial software and hedging strategies."
In this first year of the TFSA when the contribution limit is only $5k, it is likely Michael's strategy would hardly be worth it considering each swap is charged a fee by the broker ($45 flat fee per security swapped at my discount broker) and it would eat up much of the tax savings. However, down the road when accumulated TFSA room gathers bulk, the benefit becomes more attractive.
Yet to be confirmed also is the import of the tax penalty. The Department of Finance phrase is: "TFSA amounts reasonably attributable to asset transfer transactions will be taxable at 100%." I would think that what it means is that you would be taxed on whatever "excess" you had managed to transfer - the $1000 in Michael's example - at your normal marginal tax rate i.e. just as if you had withdrawn the $1000 directly from the RRSP, and not at a 100% tax rate, which would amount to confiscation by the government of the excess shifted, an action that even for the government is a tad harsh. " Update: I was wrong, ouch! quote from an official spokesman of the Department of Finance - "No it’s not the marginal rate, it’s a levy of the full amount of the *gains*. It won't matter much anyways since the brokers will all block any sort of swaps with TFSAs and registered accounts.
I wonder if the government will now ban swaps between locked-in registered accounts and non-locked-in registered accounts since the same technique Michael describes could be used to move value and unlock locked retirement money.
Monday, 19 October 2009
Book Review: The Secret Language of Money by David Krueger with John David Mann
I like this book. Reading it made me reflect, it explained puzzling human behaviour about money and investing with a neat combination of physical and psychological science and good stories, it gave me practical, implementable advice to, as its subtitle says, "make smarter financial decisions and live a richer life".
The book provides a welcome new approach to improving our own investing and financial success. Unlike the general run of investing books written by economists, mathematicians, engineers, author Krueger formerly practised as a psychiatrist and is now an executive coach. Instead of the facile and useless "just say no" kind of thought that seems to follow from the huge catalogues of irrational investor behaviour (e.g. see Behavioural Finance), Krueger offers ingenious solutions to defeating to defeating our own bad tendencies. One I laughed at is his suggestion to counter impulse spending on a credit card by freezing it a block of ice.
Money is such an essential part of our lives (quoted in the book is the statement of Albert Camus: "It is a kind of spiritual snobbery that makes people think they can be happy without money.") that even one practical thought that a reader actually does something about will make its price more than worth it. And the book does cover a lot: basic attitudes, emotions about money and its alignment with life values and goals, aka our money story, debt, reckless spending, scams, bubbles. Find out why everyone, no matter what their income, thinks that about twice their current income is what it would take to make them happy (oops, caught me too!) and then what to do to make the numbers match up better so you can stop having money be a source of anxiety and become merely the means to an end that it should be.
Quotes:
- re out of control spenders: "The spender's true goal, whether it is affection, intimacy, prestige, esteem, comfort, or connection, is something that money cannot buy."
- "A balanced healthy approach to spending means using your money in those ways that best serve your values and your goals in life."
- "Cons work because they tell us what we want to hear."
- "... the graying of America has created a bull market on fraud" because the part of the brain that is most useful to detect the irrationality of scams, the pre-frontal cortex, tends to wane with advancing age
- "Success has less to do with skills and intelligence than with a mindset." ... phew!, I was worried there! I'm not making fun of this statement. The story on page 55, which I presume is true, about the two anthropologists who have totally different outcomes in an experiment because of a difference in mindset struck me as powerful illustration of what I have observed so often - people who succeed but should not have based on "rational" factors and others who fail when by all rights they should have succeeded.
- "Focus your energy on where you are headed rather than where you've been."
- "Why do we keep walking the same path over and over, as if "trying harder" will make the critical difference - when we know very well where it is almost to lead?"
Maybe another edition in future will beef up that part but in the meantime this is an excellent book in my opinion. 4.5 out of 5 stars.
Thanks to McGraw-Hill for providing me with a free copy to review. Check the book's own website to get a flavour of the book with some substantial content.
Other bloggers have reviewed this book too: Thicken My Wallet, Michael James on Money here and here and Million Dollar Journey
Friday, 9 October 2009
Canada's Place in World University Rankings
How do Canada's universities rate when compared with the best in the world. Pretty darn good, I'd have to conclude after looking through the just-published latest Times Higher Education - QS World University Rankings 2009. The ranking are based primarily on ratings of 9300 academics around the world, along with, in order of declining importance, research productivity, student-faculty ratios, employer reviews and proportions of international faculty and students.
- Canada took 11 of the top 200 spots, better than many other countries with much larger populations, like Germany with only 10, France with 4
- Canada had 12 in the top 200 last year - apparently Asian universities are moving into the top rankings displacing mainly US universities (and what longer term effects will the recession aftermath do to further erode that result?) - competition is hotting up and Canada has no cause for complacency as all but McGill and U of T moved lower in the rankings. See also the 2008 vs 2009 table
- the USA (54 of the top 200) and the UK (29) dominate the world higher education business, with all of the top ten between them and 18 of the top 20
- in terms of "punching above its weight" in terms of population, Canada is 3rd in the world, at a ratio of about 0.33 (11 universities for a population of 33.8 million) behind the leader UK (ratio 0.47) and Australia (ratio 0.41); the USA is way behind at a measely ratio of 0.18; if one subdivides the UK as Scots are fond of doing(!), wee Scotland with only five million people has the highest ratio of all with 4 universities in the list - ratio = 0.8! ... too bad it doesn't have a very good football team, so everyone could be happy...
- McGill is the best university in Canada and number 18 in the world, followed by:
U of Toronto (29th),These Times-QS rankings correspond fairly well with those of Maclean's magazine, which also put McGill on top amongst the medical/doctoral schools, though Queen's is second there and Dalhousie, Saskatchewan and Ottawa rate ahead of Western.
UBC (40th),
U of Alberta (59th),
U of Montréal (107th),
U of Waterloo (113th),
Queen's (118th),
McMaster (143rd)
Calgary (149th)
Western (151st)
Simon Fraser (196th)
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