Category: Investing

On June 6th I lost most of the gains on BMO and ROC that I’d previously made (about $400). The market seemed to turn against them (no specific bad news), and both stocks dipped back to where they were when I bought them.

Its a little bit nerve wracking, but I just doubled my position in both. I bought $5K of each originally because that’s how much I had to spend. I now had some more free cash, so its seems like if they were worth buying at that price before, they should still be and the rational thing is to grab another helping.

Ideally I would have preferred to buy similar companies in different sectors (expand beyond banking and tobacco), but of the stocks I’m currently looking at, these two still stand out (National Bank is closing in though). I’m comfortable focusing so intently on such a small position because I’m still in the early days of building my portfolio, I’m young enough to be a bit more aggressive, and I really see bank stocks as forming the core of my portfolio anyway (and I don’t have a problem with having a tobacco position if the price is right).

I’m glad the drop has happened to test my nerves a little bit. I’m looking forward to a huge drop (25% after I’ve bought something perhaps) and am hoping that I’ll have the courage buy when that happens.

For anyone who regularly buys stock on a value basis, how do you decide how much more to buy when it drops below a previous purchase price?

EDIT: I got “lucky” and had a big drop after writing this (but before it went live on the site). Currently (June 7th), my portfolio was down $400 at one point in the day. Considering that I was up $400 at one point, that’s a lose of $800 (8% of my portfolio).

Of course, there is no way, except in hindsight, that I could have known what the high and low points would be (I still don’t). I continue to be happy to own these companies, and look forward to future dividend payments!

(now I just need to figure out a better way to decide when to buy more of a stock I own after a drop).

EDIT 2: There seemed to be a bit of a rally (as of mid-afternoon on June 8th), I’m currently down $200.

Today I’ll talk about the equities portion of our portfolio which represents 75% of our entire portfolio. This section of the portfolio is a combination of low cost mutual funds, ETFs or exchange traded funds and one stock.

The breakdown for equities by type is as follows:

The first number is as a percentage of equities portion, the second number in brackets is a percentage of the total portfolio:

Canadian equity 20% (15%)

US equity 33% (25%)

International equity 33% (25%)

Emerging Mkt 8% (6%)

Reits 5% (4%)

How did I come up with this allocation? Good question…

Canadian equity: My Canadian equity portion has gone from about 90% before last year to around 30% last fall and now goes down to 20%. The reality is that for Canadians to be diversified they need to limit their Canadian exposure which is tough to do when you spend Canadian dollars and tend to think that your home country is a lot more economically important than it really is. I’m not too concerned about currency fluctuations since my investment time horizon is fairly long so I can handle currency swings. The Canadian dollar is at a 30 year high so maybe loading up on Canadian dollars is not the greatest thing at the moment.

US equity: As a percentage of the world equity, I believe US equity is around 45%, in my portfolio it’s only 33% of the equity portion. I don’t have any good explanation for the amount I choose except to say that it’s “a lot more than I had before”. Perhaps along the lines that it’s hard to reduce your home country holdings, it’s also hard to put 45% of your equities into another one country. US equity returns have been hampered by the rising Canadian dollar but according to Bernstein the best time to buy is when things look their worst. Feel free to convince me I should have more (or less) US equities!

International equity: This is Europe + Asia – this portion should be 33% according to Martingale, so I have the proper allocation according to it’s world equity weighting.

REITs: I’ve chosen 5% for this. As mentioned in an earlier post, this asset class has a low correlation with other types of investments, namely equities. I’ve only looked at Canadian REITs but I will also be considering US (such as VNQ) and international REITs as well. I really have no idea how much I should have in real estate but I’ve heard anywhere from 5% to 20% of your portfolio should be in real estate. Anyone have any input on this one? Should I increase this amount?

Emerging Markets: The global market capitalization is 9% and I have 8% so that’s pretty close. This section makes me nervous for two reasons, the emerging markets have had a great run over the last few years and although it could continue for quite some time, it could also come crashing down in a hurry. Another thing is the China factor, it’s really hard to believe that this market will not hit a brick wall at some point and if that happens, all other emerging markets will get hammered as well.

Another aspect of emerging markets that I’m not keen on is that the long term returns don’t seem to match up with the incredible risk levels involved. One of the tenets of Bernstein’s Four Pillars (and many other books) is that increased risk leads to increased returns over the long term but I’m not sure if that’s true in this case. I have a separate post for this issue.

I thought I would take a break from the exciting portfolio building series and write about market timing. This post was inspired by one of my favourite Globe & Mail writers, John Heinzl who wrote this morning about market timing and why you shouldn’t do it. Although he manages to contain himself in that article, he has a very funny sarcastic wit – check out his Saturday Stars & Dogs column sometime to see what I mean.

I used to be an avid market timer, when the markets went down I would switch my equity mutual funds to money market. When the market went back up, I would switch back to equity. I realize in retrospect that I probably could have just stayed invested in the money market fund the whole time and achieved the same return with less risk and stress.

Part of my new investment strategy which I’ve been developing over the past year or so is to avoid market timing since I’ve established that I can’t do it successfully. In his article, Heinzl talks about how last June, the markets had tanked and it really looked like a great time to adopt a more defensive portfolio approach but since then the Canadian market has gone up 30% which is an incredible run.

I’m not suggesting the Canadian market will go up another 30% over the next year but Heinzl’s point is that nobody knows what it will do which means that any moves based on predictions are useless.

Today I’ll talk about the fixed income or bonds portion of our portfolio which represents 25% of the entire portfolio. This section of the portfolio is a combination of GICs, real return bonds ETF (iShares XRB), short term bond ETF (iShares XSB), and a bond mutual fund.
The 25% bond portion is made up of 20% bonds (see detail list below) and 5% real return bonds. Note – real return bonds are referred to as treasury inflation-protected securities in the US.  I don’t know if the real return bond allocation is high enough so if anyone has any thoughts then feel free to let me know. According to Bernstein and this from Canadian Capitalist, long term bonds are not worth owning because they don’t give a return that matches their risk (historically at least). With this in mind, I’m planning to buy the XSB ETF (short term bond – duration 2.56 years) in order to lower the average duration of our bond portfolio to an estimated 3.5 years. I could lower it further by owning less of the bond mutual fund and buying more of the ETF but this is what I have for now.

These are the weightings of each security as a percentage of the entire portfolio:

GICs – five years or less – 7%

Bond mutual fund duration 6 years MER = 0.65% , 5%

Short term bond ETF duration 2.56 years, MER = 0.25%, 8%

Real return bond ETF – MER = 0.35%, 5%

In case you’re wondering why we own GICs, a mutual fund and an ETF for the non-real return portion of our fixed income, the GICs are my wife’s, the mutual fund is very useful for rebalancing, and the ETF has a low duration and a low cost.

One other thing I learned recently about fixed income – when buying or renewing GICs you can negotiate the rate and can often get a quarter or half percent more.

In this post I want to outline the basic asset classes that make up my portfolio and also to give some extra information on two classes (REITs (such as VNQ), and real return bonds) which I’m not as familiar with.

 

In the bonds area I have various bond products (ETF, mutual fund, GIC) and a real return bonds ETF.  Note – real return bonds are referred to as treasury inflation-protected securities in the US.

 

My equities are divided up into Canadian, US, international (Europe, Asia and Far East), emerging market and REITs. I’ll be posting soon about my exact proportions of these different areas.

 

 

REITs – Real Estate Investment Trusts

 

These are considered a separate asset class since real estate has a low correlation with other types of investments.

These securities are trusts that purchase properties and pay out a high percentage of their income in the form of dividends. This group was the only type of income trusts to be excluded from last year’s income trust tax change so investors have to be aware that government tax policy on REITs could change at any time. An example of a REIT is VNQ which trades on the AMEX and is run by Vanguard.

Canadian REITs trade on the TSX so they can be bought individually but I’m buying the iShares ETF XRE which represents the TSX Capped REIT Index.

 

This site has some great info on REITs.

 

 

Real Return Bonds

 

These are Government of Canada bonds that pay you a rate of return that is adjusted for inflation. Unlike regular bonds, this feature assures that your purchasing power is maintained regardless of the future rate of inflation.

These bonds can be purchased individually through any broker but I’ll be buying the iShares ETF XRB which represents the Scotia Capital Real Return Bond Index.

 

Bylo has a lot more details on these bonds.

 

Other Stuff

 

I noticed today that Middle Class Millionaire has a series on asset allocation as well – I thought it would be interesting to list some bloggers and their equity asset allocation along with their ages for comparison. This would have been better in yesterday’s post but better late than never! Please note that I’m including cash as part of the bond portion.

 

Middle Class Millionaire – age 27 – 95% to 100% equity

Outroupistache – mid 50’s – 70%

Canadian Capitalist – early 30’s – 80%

Moi – late 30’s – 75%

I’d love to hear from anyone else about what kind of asset allocation they have?

 

I love dividends.

Growing up I started investing with GICs and Canada Savings Bonds as a child when interest rates were around 10% (I turned down a 12% GIC at a credit union because I didn’t like the idea of having to buy a share of the union for $40). Naive me, I thought this was a standard ROI and dreamed of future wealth. Fast forward 20 years and the reality of GICs out pacing inflation by 1 or 2% sinks in they start to look a lot more like a wealth protection device than a wealth creation device.

I dabbled in stocks and lost 75% of my money during the tech boom.

That’s why I was so excited when I came across the ideas of dividend-paying (regular money payouts from the company to you the shareholder) blue chips (established companies). It seems to have ALMOST the long term stability of GICs, with the growth potential of the stock market. Pretty sweet.

One of the most fundamental ideas for good dividend stocks is the “Dividend Yield” which is how much you should expect to make on your investment in the next year (a dividend yield of 4% on $100 of stock means you should earn $4 in the next year through dividend payments). For Canadian companies, this dividend is taxed more favourably than interest income (the higher your tax bracket the bigger difference this makes).

Even more exciting is the idea that good companies should regularly increase their dividends. This is like a low-taxed GIC that will randomly increase its payout! There’s a small chance that the company will cut its dividend (which in addition to the lower payments would also cause the stock price to plummet), but that risk is the price for the more attractive gains.

Some people like to talk about “personal yields” which is the dividend-yield of a stock, based on the price you purchased it at. So going back to the above example, if the company increased their dividend payments by 25% to $5 and the stock price increased so that your shares were now worth $125, the dividend-yield is still 4%, but your PERSONAL YIELD is 5% (since you bought the stock for $100).

The fallacy with this outlook is that your shares are now worth $125. You’re ROI is $29 (29% in one year, not too shabby! Of course capital gains taxes would kick in when you sold, but still…), but if you decide to keep the stock and keep collecting dividends, there’s nothing magical about this “pile” of your money and the dividend-yield is still the same (if you like the looks of another stock that is paying 5%, the $125 might be better off there).

By bragging that your new dividend is 5%, you’re lumping the capital gains in with the dividend payments, which isn’t really rational.

Say I bought a GIC for $1000, invested it for a year at 4%, then reinvested the $1040 for 4% for another year. Am I earning 4% or 4.16% in the second year? Clearly I’m making 4%, I’m just confusing things if I want to lump in the $40 gains from the previous year. The only way to decide between buying another GIC or putting the money elsewhere is to ignore the past, look at the current value, and pick what looks like the best investment.

Landlords make a similar mistake when they buy a house and start patting themselves on the back about the financials after a decade. Rents should increase, and you need to compare them to the CURRENT value of the property to see how the property is doing as an investment, not the original purchase price.

Compounding is good, but don’t use it to fool yourself.

There’s probably an economic term for this fallacy, does anyone know it? I think the basic idea is when you segment your money and start looking at the “pools” as separate, you’re in self-delusion territory. If you want to evaluate an investment, factor in the CURRENT value of the vehicle, not the original price to determine the ROI going forward.

Last year I felt a lot of stress from being financially over-extended in the form of a mortgage that was too large. One of the obvious remedies to this problem was to concentrate on lowering that debt, which we’ve done with some success. The other significant thing we did was to lock in our mortgage for five years. I realize that studies like the one done by Moshe Milevsky show that shorter terms are cheaper in the long run for mortgages, but in our current situation, the peace of mind of not having to worry about the possibility of increased interest rates is well worth any extra cost that locking for five years might end up causing.

The reason the mortgage payment is such a concern is because our budget is too tight to handle a big increase in payments if interest rates jump up. By locking in, we don’t have to worry about that for five years, at which time the mortgage will be low enough, we’ll be able to handle higher interest rates if need be.

I can’t predict if interest rates are going to go up or down in the future, but I can accurately predict that with the longer term mortgage, I will sleep better at night.