Category: Investing

I recently heard about Optimize.ca from one of Rob Carrick’s newsletters.  The service launched earlier this month and promises to help Canadians save money on their investments, savings accounts and credit cards.  All this and it doesn’t charge any fees.  They will make money from online advertisers and presumably the recommended brokers that appear if you select the “Invest Now” button.

How it works

Basically the way the site works is you enter your current investment products and the site will suggest lower cost replacements.  It’s an interesting idea, since it can be very difficult for someone who is not familiar with mutual funds and other investments to be able to come up with suitable low-cost replacements for their current high-cost investments.  Things like bank accounts and credit cards are difficult to analyze because there are so many factors to consider.

The key concept behind finding a cheaper replacement for your existing funds, is to find something that has a similar investment mandate (ie Canadian dividend stocks), but has a lower cost.

The site is very slick and easy to use.  Unfortunately, when I started testing it out, the results were not all that good.

Summary

The service really doesn’t work very well.  The problems that I see are:

• Inappropriate recommendations – The whole point of this service should be to provide similar products with lower fees.  As you can see from my examples below – this doesn’t always happen.
• One to one replacement – Many mutual funds have different parts – they invest in Canada and the US, or they have equities and some bonds.  Restricting the replacement suggestions to one product is very limiting.
• Poor matching – More time needs to be spent on analyzing the different products and ensuring that they closely match the original fund.
• Rankings should be by product match, then MER – It appears that the website comes up with a list of possible replacement products, lists them by increasing MER and doesn’t seem to place much emphasis on how close the replacement product is to the original.

I’m also not sure how many people need this kind of service.  If someone is moving from high-priced mutual funds, typically they have a whole pile of expensive funds and will likely want to start fresh with an asset allocation and few low-cost products.

I’ve included three examples of funds below if you wish to look at the details.  Try out the site for yourself and let me know what you think in the comments.

Example #1

For my first test, I tried out Mackenzie Ivy Canadian Series A, because that was the default value when I first visited the site.  This fund is mostly equities.  According to GlobeFund it is 47% invested in Canada, 30% in US and the remainder elsewhere in the world according to this fund profile.  The MER (management expense ratio) is 2.38%.  From the top holding list, it appears that the fund invests in large, safe  companies.

I selected the “search all” option which means that replacement investment products of all types will be shown.

The first problem is that when it shows you the information for the current holding (Mackenzie Ivy fund), it indicates that you can save a pile of money by replacing your current fund with your current fund.  Obviously this is just a bug that needs to be fixed.

Now let’s take a look at the first three recommended replacements in order:

1) iShares Canadian Completion Index ETF

The Canadian Completion Index ETF (XMD), is made up of small and mid-cap companies that are not in the Canadian TSX 60, which of course is the largest 60 companies.  The MER of this ETF is 0.55% which is indeed cheaper than the 2.38% MER of the original mutual fund.

The problems with this selection are:

• Company size.  The original fund is mostly Canadian and American large companies – the fund mandate is one of low risk.  The iShares replacement has much smaller companies which implies higher risk.  It’s apples to oranges.
• Different countries – the original fund was only about half Canadian whereas the replacement index is 100% Canadian.

In my opinion, this recommendation is a dangerous one, because the recommended fund has a different and far more risker investment philosophy than the original fund.  The investor would probably be better off keeping the high priced Mackenzie fund.

2) iShares Canadian Materials Index ETF

The Canadian Material Index ETF (XMA), is made up almost entirely of Canadian mining companies.  Barrick, Potash Corp and Goldcorp make up 39% of this index.  The MER is 0.55%.

The problems with this selection are:

• Far more specific and risky compared to original fund.  This is basically a mining fund.
• Different countries – the original fund was only about half Canadian whereas the replacement index is 100% Canadian.

This recommendation is a poor one, for the same reasons as listed for the Cdn Completion index ETF.

3) Claymore S&P/TSX Canadian Dividend ETF

This ETF is in my opinion a much better choice than either of the first two choices for the simple reason that the type of companies in this ETF are similar to the type of companies (big, solid) in the original fund.  The MER is 0.55%.

There is still one big problem with this selection:

• Different countries – the original fund was only about half Canadian whereas the replacement index is 100% Canadian.

Example #2

Let’s try another fund – how about the huge $13 billion dollar, 2.67% behemoth Investors Dividend fund?  This fund is made up of 85% Canadian equities, 10% bonds and 5% cash.

The suggested replacements are as follows:

1. BMO Down Jones Canada Ttitans 60 Index ETF.  MER 0.15%
2. iShares CDN LargeCap 60 index. MER 0.15%
3. iShares Cdn Composite Index

I think these products are all a good replacement product, but they ignore the fact that the original fund was only 85% equities and the replacements are all 100% equities.  Perhaps it could be indicated on the website that this fund only replaces 85% of the original fund.

Last example – a balanced fund

The last example is a balanced fund – this will contain some equities and some bonds.  I used TD Balanced Income.  This fund has about 50% Canadian equities and 50% bonds and cash.  MER is 2.12%.  In this case I would expect the ideal replacement to be two ETFs or index funds that cover the Canadian equity portion of the fund as well as the bond portion.

The first four replacements were:

1. Claymore Balanced Income CorePortfolio ETF.  0.25% MER
2. TD Balanced Index I.  0.84% MER
3. RBC Monthly Income D.  0.84% MER
4. CIBC Aggressive Portfolio. 0.96% MER

The first three choices are quite reasonable in that they are good substitutes for the original fund.  They all invest in 50% Cdn equity and 50% Canadian bond and some cash.

CIBC Aggressive Portfolio is an odd choice.  It invests in other CIBC mutual funds. According to the CIBC website, this fund will generally invest in 90% growth (equities) and 10% income (bonds) which goes along with the fund name.  Clearly this is not a good substitute for a 50/50 balanced fund.

It seems that this system is designed to provide 1:1 replacement suggestions.  In this example, Claymore Balanced ETF is a great replacement for the TD Balanced fund with an MER of 0.25%.  Replacements #2 and #3 match the investing mandate of the original fund very well and are much cheaper than the original fund, but with MERs of 0.84% and 0.96% – are nowhere near as cheap as buying two separate replacement products.

If you own stocks, mutual funds or ETFs that pay a dividend, you will have to consider what to do with the dividends.  Reinvesting in the same investment that produced the dividend is probably the most common strategy.  But is it the best?

The basic options for dividends are:

• Reinvest the dividends in the same investment.
• Take the dividends as cash, but leave them in the account for future investment in a different investment.
• Take the dividends as cash and withdraw them from the account.

Here are some factors which might alter your choices regarding reinvesting dividends.

1) You can save the cash dividend you withdraw from an account

Just because you withdraw a dividend from your investment account, doesn’t mean that it has to be spent on beer.  You can use that money to pay down debt, savings – all sorts of worthwhile things that should help your financial position.  This generally would only apply to non-registered accounts.

2) You can reinvest in a different investment

This is sort of a half point – you don’t have to reinvest in the same stock/fund.  You can instead direct the dividends to a different stock or mutual fund.

3) Taxes on withdrawals

If the investment is in a tax-sheltered account such as an RRSP, you shouldn’t remove any dividends because that will be a withdrawal and will be considered taxable income.  In this case the dividend should always be reinvested within the same investment account.  It doesn’t matter if the dividends are reinvested in the same investment or a different one or even left as cash.

4)  Taxes on dividends

If the income investment is in a taxable account then the dividend will be taxable.  This means that your tax bill will go up and you need to be able to get the money to pay the extra tax from somewhere other than the dividend if you reinvest it.

5) Pay interest on investment loan

If you borrowed to invest then you might be in a situation where you need to get the cash dividends in order to make the interest payments on the investment loan.

6) Reinvestment reduces choice

Setting up a DRIP on a stock or mutual fund means that you are always going to be buying more units of that investment whenever there is a dividend issued.  An active investor might want more control over where that money goes so getting the dividend in cash (and keeping it in the account) allows them to choose where and when that money gets reinvested.

What do you think?  Would you ever consider not doing a DRIP if one exists?

I made some recent purchases during the volatility in the stock markets. Being quite new to stock investing, I feel like a bit of a “green recruit” being tested in the first skirmishes of a war. I think in “A Random Walk Down Wall Street” they talk about investing on paper (not actually buying the stocks, just tracking an imaginary portfolio) is like a virgin reading about sex. The real experience is different.

Losing money isn’t fun. At the end of the dot-com bubble, I lost about 75% of what I’d invested ($15K of a $20K investment). As bizarre as it may seem (you might not believe this if you’ve been reading my blog for a while), I’m actually not all that motivated by money and I pretty well just shrugged my shoulders and carried on with my life. a couple of years ago I finally sold my position (it hadn’t done anything since) and just recently got around to re-thinking about the stock market and getting into it again.

I *really* wish I could have put that $20K into Canadian dividends 7 years ago, but such is life.

Most people don’t seem to react this way. Losing 75% of their money would make them freak out in a major way (like jumping out of a window). I’ve always followed the advice “don’t invest what you can’t afford to lose”, which is maybe what lets me be a bit more detached.

Losing 5-10% recently was nothing. More then anything I worried about missing the bottom, which as I mentioned yesterday I may have done with NA. I guess this makes me more greedy then fearful :-). If the market dropped enough to trigger a margin call, as I mentioned yesterday (say 20%), I *HOPE* that I’d respond by paying the call and transferring in more cash and buying more.

Buying on margin was scarier than I expected. My $28K margin debt is the second largest debt I’ve ever had (my $95K mortgage is the largest). With both of these debts, the things they were used to buy (the condo and the stocks) are still there and still worth money. Its *NOT* the same as $28K credit card debt. I’m not losing sleep over either debt (which I tend to be a worrier, so I think that means I’m very comfortable with them).

With both the BMO and the NA, I’m comfortable with the businesses. Every time the prices drops 5% from the lowest price I bought at, it seems to me that they’re worth buying more of (if it was worth X, its should definitely be worth 95%of X). I’m confident these are secure, strong companies that will be around for the long term (or at worst, would be acquired for a healthy portion of what I’ve paid). I felt the same way when I signed on the dotted line to purchase my condo, and that’s worked out well so far.

I was talking to a friend recently and made reference to the real rate of investment return and had the thought that it would be a very useful concept for anyone who hadn’t encountered it before. Basically the real rate of return is the annual rate of return on an investment minus inflation.

For example, stocks apparently average around a 10% return over a long period. With 3% inflation, we’d say the real return is 7% (10% cash in your pocket minus 3% lost to inflation). If you’re happy about the 5% you recently got on a GIC, the real return on it would be 2%.

You might ask, “Why do I care what the real return is? The money I get is cash in my pocket!” Great question. You care because you won’t get the cash until a later date. The real return tells you what that money will be worth in TODAY’S DOLLARS at that later date. Its easier to calculate your return in future dollars, but it can be hard to shift gears and realize a dollar is worth less in the future than now.

Suzy Orman (among others) loves to tell people how much they’ll have when they retire if they save $X amount. Say you inherit $5,000, invest it an index fund returning an average of 10%. When you retire in 30 years, you’ll have $87,247.01 (5000*(1.10)^30) they say and you’re suitably impressed. What is $87K worth 30 years from now though? Given that a movie will probably cost $25 bucks, it wouldn’t go as far as $87K would today.

A comparable investment would have a real return of $38,061.28 (5000*(1.10-0.03)^30). This is $38K which would buy $38K worth of goods today (so basically after 30 years the $5K investment will give you enough to live a pretty respectable lifestyle for a couple of years, enough to buy two nice cars or enough to take a number of pretty deluxe vacations – about 7 times the buying power of the $5K today).

I like to do all my investment projections in real returns (as Bernstein recommends). This lets you factor inflation into your plans, yet still understand at a glance what sort of buying power your money will have.

You can use all your current numbers for expenses, and if you’re comparing them to the real return of your investments you don’t have to do anything else. For example, my current living expenses are around $1200 / month. If I’m working with real returns, I can use this as my living expenses when I’m 65 and it will still be valid (I can compare expenses in today’s dollars with returns in todays’ dollars). Otherwise I’d have to adjust my expenses for inflation to compare it to future dollars.

E.g. my $1,200 expenses would be $2,912.71 (1200*(1.03)^30) 30 years from now (after inflation). The $87,247.01 above would pay for my living expenses for 29.95 months (87247.01/2912.71). The real return would cover my expenses for 31.72 months (38,061.28/1200). Basically the same results (living expenses for 2.5 years), but much easier to calculate. The difference is due to rounding errors and the fact that 1.07*1.03 ~= 1.10 (but not exactly). No one can tell you exactly what the market returns or inflation will be over the next 30 years so all these predictions are far from certain (and a slight difference between the numbers isn’t a big deal – these AREN’T precise calculations).

Clear as mud? If anyone thinks they can explain this better than I have, feel free to take a shot at it in the comments or link to better explanations (I won’t be offended 🙂 ).

As I’ve complained many times over the years, I bought some LSIF (Labour Sponsored Investment Funds) many years ago. These were the worst investment ever. High fees, crazy redemption schedules and poor performance add up to a bad investment. They had great tax breaks at the time, so I committed the cardinal sin of letting taxes control my investment choice.

Lesson learned – Don’t ever buy an investment solely for tax reasons.

Lesson 2 – Don’t ever buy LSIFs. They are a bad investment.

The last of my funds came due in February of 2010, but I’m only now getting around to redeeming them. I think my reluctance to sell these funds stems from two reasons:

1. Small amount – The amount of the funds is small enough that it wasn’t critical to sell them right away.
2. Redemption freezes – I’ve heard that many LSIF funds have frozen redemptions so you can only get money out of them at certain times. Canadian Capitalist wrote about LSIF redemption freezes a while back along with Jon Chevreau of the National Post.

The funds I originally bought have changed hands and names numerous times.  The funds I own are called CIG6940 VentureLink Brighter Future I (yah right) and CIG987 Covington Venture Fund Inc. Sr. I.

I had these funds at Questrade discount brokerage where I keep all my investments.  After placing the orders, nothing happened for a couple of days which made me wonder if the funds were restricting redemptions.  I phoned CI, who looks after administration for both of these funds.  The rep was able to determine that the trades were placed as wire orders. This means that Questrade places the orders with CI to sell the funds and then follows up later with the documentation which will allow the trades to settle.  Sure enough, three days later I received confirmation that the trades were completed.

The value was a bit over $5,000 which is ever so slightly down from the original purchase price of $15,500. Because of the tax breaks associated with LSIFs, my true cost was around $10,000.  Considering most of the funds were bought between 1996 and 2002, the final result is pretty disappointing. Any other kind of investment would have done much better.

Canadian MoneySense had a good article about Canadian tax shelters with a similar warning to not let taxes be the sole driver of your investment decisions.  The article also references MURBs which were a tax-sheltered real estate investment which didn’t do so well.  Interestingly enough, my Dad made a similar investing mistake in the 70’s, and his investment poison was MURBs.

Lesson learned

As has been written elsewhere – don’t invest your money based only on tax considerations. Buy investments low and sell them high – the taxes will take care of themselves.

Any other LSIF/bad tax break investment survivors out there?  Let’s hear your story in the comments!

As anyone following the markets has seen, they’ve been jumping around the last while, mostly moving downwards. The stocks I bought are down ~$1,600 (~4%) from when I bought. My father has his sympathetic face on when I talked to him about this, but I’m happy and wish they’d dropped further.

With real estate or stocks, the only time the price really matters is when you’re buying or you’re selling. If you’re buying, low prices are good. If you’re selling, they’re bad. With real estate I buy for the income stream of rent. With stocks I’ve been buying for the income stream of dividends. When I start bulking up my RRSP, one strategy I’m looking at is index funds, which I’ll buy in order to sell after I’m 65.

In “Four Pillars” Bernstein (or it *might* be random walk – the problem with reading a bunch of personal finance books right after another is that they blur together) repeats a few times that a market crash is great for a young person and bad for an old person. A booming market is the reverse.

Ben Stein wrote an interesting article about how massive an over-reaction to the sub-prime problems the current downturn is and how he feels this is a massive buying opportunity (after reading the article I was wishing I had more cash to put into the market – I really need to get working again 😉 ).

Since the stock market is a “secondary market” (people buying and selling ownership of companies, with the money and ownership involved not really affecting the companies in any significant way), the income stream (dividends) aren’t affected by the stock price. With a lower price, the dividend yield increases, and the income stream becomes more affordable. A massive crash would be the same thing on a larger scale. Bring it on!

I was asked last year what I had been buying during the stock market meltdown. I had been saving the bulk of my margin for just such a buying opportunity, so I definitely went shopping.

I previously posted my stock position as of the end of July. Since then, on margin, I’ve put another $15K into the market (two $5K buys of BMO and $5K of NA). I regretted purchasing RUS almost immediately after the purchase (somehow I didn’t realize it was a cyclical), so even though its down a lot I haven’t extended my position in it). It was up $200 after I bought it and realized it didn’t meet my criteria, so maybe I should have sold… Hindsight is 20/20. I feel like I over-bought Rothmans, and in some ways I worry that it might be riskier than banks (they haven’t banned banking in public places yet). At one point my portfolio was 1/2 ROC (and I basically said at that point “enough”).

Stock	Shares	Dividends / month
ROC	705	$70.50
BMO	294	$66.64
RUS	159	$23.85
NA	168	$33.60
Margin	$28K	-$164.45

On a monthly basis, this gives me a “cashflow” of -$5.42 (so my passive income has become passive debt 😉 ) $32.64 (stupid addition!). I was tempted to pick up another $5K of NA, and actually put in an order for it at $53.38 (2 hours after it had been that price), but its just been moving up since then so I missed out.

My hope is that the dividends will pay the interest charges mostly, and if one or two of the dividends gets raised, pretty quickly it’ll start paying down the debt. If there was a massive drop (to the point where my margin debt reached 70% of the value of my securities – if my stocks dropped 18% from their current value) I would have to pay a margin call (add money to the account to prevent them selling off my securities), which I’d be willing & able to do (I have $10K cash right now, and a $20K LOC). The other risk is if none of the dividends are raised, or if RUS cuts its dividend, eventually I’ll have to transfer money into the account to pay off what would become the mounting debt. I am aware of this risk and accept it. The other risk is if interest rates shoot up, E*Trade’s margin debt interest rate is based on prime, so it would increase as well. I would just start paying it down more aggressively in this situation.

Since I can deduct the interest charges (as investment expenses) and the dividends are tax preferred, I’m expecting the tax savings will more then make up for the $4 / month.

While there are some risks, and my passive income has gone down a bit, I think this is a rationale attempt to take advantage of what I hope was an irrational dip in the market. If all of these companies went bankrupt, I could afford the $163 / month payments (and you’d read me grumbling about it for some time 😉 ).

I realize also that I am very focused on banks (long term I’d love to add in some solid dividends from companies in an unrelated sectors such as Loblaws and an Energy stock and a partially unrelated insurance and investment company). Furthermore I realize I may be over-focusing on high-yielding dividend stocks rather then stocks with high dividend GROWTH. Right now I like the money in the bank and being able to have a foundation I can count on rather then buying for (less certain) future gains. As long as the dividends keep up with inflation (3% annual growth, which would be considered VERY meager), I’m content.

So there I am :-). It doesn’t really matter, but the current value of my securities is $48.8K (down $750 from what I paid for them) and I’ve received $72.60 in dividends so far (from ROC). I’m expecting my next dividend to come at the end of the month from BMO.

Are you willing to invest in oil company stocks if you had the money? A new poll commissioned by Edward Jones revealed only 23% of Canadians would! Whereas Calgarians were most likely to invest in oil at 40%, Quebecers were the least likely group at 10%.

Why?

Why are 77% of Canadians not interested in oil company stocks?

With oil companies dominating the headlines with mostly bad news, I think that by the end of July Canadians were fed up with BP’s oil spill fiasco in the Gulf of Mexico, followed by Enbridge’s ruptured pipeline in the Kalamazoo River in Michigan. Add to that a string of bad publicity aimed at the oil sands of Alberta and you got yourself an answer.

I can understand that while the result represents a reaction to the afore-mentioned events, it by no means justifies ignoring the Canadian oil sector totally for the following reasons:

Growing Demand: The combined populations of India and China represent one-third of the world’s total population but only account for 12% of global oil consumption. In comparison, the U.S. represents 5% of the world population but uses 25% of its oil. As these economies grow, they will be consuming more and more oil as they buy more cars, ships, planes and machinery. Keep in mind that they would like to reach the same standard of living we enjoy over here which will place a lot of pressure on supplies in the future.

International Exposure: Oil is an international commodity that gives you exposure to world markets. Many developing countries are increasingly dependent on oil as a cheap source of energy to fuel their economic growth.

Sector Diversification: A balanced portfolio with sector diversification is recommended having 15% in the energy sector. Holding a mix of Canadian integrated oil and gas companies would improve diversification and enhance returns.  One can pick a set of stocks or simply choose from a number of ETFs trading on the TSX.

Political Stability: By investing in Canada you do not have to worry about political stability unlike investing in far away lands under dictatorship regimes. You will be paying a premium in comparison to companies established overseas but this will be offset by reduced currency risks.

Currency Risk: You don’t have to convert your dollars into another currency in order to invest in this commodity. Moreover, the price of a barrel of oil will move inversely to any devaluation to the currency used for pricing.

Sector Stability: It should be noted that Canada has the second largest reserves of oil after Saudi Arabia and is the top exporter of oil to the USA. As such, the Canadian oil companies won’t be disappearing anytime soon.

Would you consider investing in the Canadian oil sector now?

If you wish to learn more about the case for oil be sure to read The Fundamentals of Investing in Oil. Besides the oil sands, Canada has one of the hottest oil plays in North America: Alberta’s Cardium Formation where several intermediate and senior Canadian companies are operating.

About the author:

Mich is the author behind Beating The Index: a personal finance blog with a focus on energy stocks and precious metals. You can follow his fight with the TSX as he tries to beat the index with a DIY approach.   Please subscribe to his RSS feed here.