Tag: investment

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Investing

Do You Really “Earn” Your Investment Income?

I met an acquaintance a while back who told me that he was day trading while in between jobs. I was quite curious about his strategies and how much he was making but he wouldn’t give me many details and I didn’t know him well enough to push. He did tell me on several different occasions though that he “was making good money” with the day trading.

The reason I wanted to know what kind of returns he was getting was because I was skeptical that he was doing as well as he said he was, and also because I wanted to point out to him that in a year when the market goes up around 18% as it did that year, it’s not hard to “make good money” by doing pretty much any kind of investing.

Stock markets go up and down over time. The main reason people invest in them is because they believe that over time, the stock market goes up more than it goes down, which has held true since the beginning of time (or stock markets). The reality is that nobody can accurately predict what the market is going to do any given year. It might go up 10%, it might stay flat or there could be a big loss. The phrase “A rising tide floats all boats” applies very well to equities. In years when the market gives double digit returns, everyone looks like a great investor. In years when the markets drop, almost everyone is a loser.

My point is that someone who is invested in equities in a market that goes up 10% and gets 10% on their investments didn’t really “earn” anything because of their investing prowess since they only got the market return which is easily obtainable with a basic ETF or index fund.

I think that all active investors should measure how much value they are adding by choosing their own stocks or mutual funds by comparing their returns to some kind of index or passive alternative based on an index such as an index fund or exchange traded fund. This would apply regardless of if you are trading stocks hourly or buying stocks for the long run (hello Siegel!).

For example if you trade your own stocks or bought active mutual fund and got a 10% return in a year, that sounds pretty good but is it? Did you really “earn” 10% by picking your own investments? What if the index returned 8% that year. Then I would say that your stock picking really only earned 2%, not 10%. Conversely, what if the index returned 12% that year. I would then say that your active management cost you 2% of your potential portfolio that year.

To accomplish this comparison if you trade stocks and/or buy mutual funds is to find an ETF that covers similar stocks. If you are an investor who likes to buy large American companies then you might want to look at an ETF like Vanguard Large-Cap ETF (VV) or even just look at the entire American stock market with Vanguard Total Stock Market Index VTI (the “American” is silent). ETFs and index funds charge a small fee so they will never match the index but should be pretty close.

Another thing to think about is the absolute amount of dollars you are earning from your investments.  If you spend a lot of time trading stocks or planning investments and you are really only earning say a 2% premium return on your investments per year then how does that work out per hour?  If you are investing $10 million dollars then 2% is $200k which is well worth the effort.  But if you only have a couple of hundred thousand then 2% is only $4k which is not a lot of money if you spend a lot of time on your investments.

Categories
Investing

My New Asset Allocation (Part XIV)

Yes, that’s right – after reading countless books and posts about asset allocation and writing several convoluted and contradictory posts on the topic myself, I’ve finally decided on an asset allocation model for our investments. The problem with asset allocation is that there is a lot of theory behind various models and the more you know about the subject then the more confused you will probably get. I’ve concluded recently that maybe just picking a simpler asset allocation is probably the best approach since I’m not sure how much it really matters what your exact asset allocation is, as long as you pick one and stick with it.

And now (drum roll please..) on with the allocation!

Equities vs Bonds

The split will be 75% equities and 25% bonds. I like to have a fairly aggressive portfolio but at the same time the bonds will steady the returns and will also allow for more equity purchases in case the equity markets go off a cliff. According to Mr. Bernstein, 75% equity gives you the maximum benefit from owning equities.

Equities 75%

These percentages are of the equity portion (not percentage of the total portfolio).

Canadian equity – 25%

US equity – 37.5%

International equity – 37.5%

Bonds – 25%

20% is a short term Canadian bond ETF (iShares XSB) and some GICs.

5% is a real return bond ETF (iShares XRB). Real return bonds are a hedge against inflation and are supposed to be negatively correlated with regular bonds.

Other asset classes?

What about real estate and emerging markets? I’ve decided not to invest in those right now because both of these classes have done so well in the past several years that it’s hard for me to justify buying them. I’m also not convinced that emerging markets are all that great an investment. When you consider the exposure that a lot of North American companies have to developing markets, I already have enough emerging market in my portfolio.

Anybody want to share their asset allocation philosophies?

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RESP

RESP – Keeping It All In Perspective

This post is part of the Big RESP Series. See the entire series here.

See the previous post on How To Get Started.

Since the government started giving grants for RESP contributions in 1998, the RESP program has become quite well known and has become a new source of stress for new parents. I know a lot of friends who have set up RESPs for their kids which is great since most of my friends are older parents and have reasonably good finances. For someone who is younger and/or doesn’t have great finances, RESPs should probably be a lower priority to things like lowering debt and saving for retirement. It’s important to make sure your own finances are in good shape before saving for a future expense when you don’t know how much that future expense will be or if it will even occur. There is no point in making RESP contributions and then later on you have to withdraw the money to pay for the mortgage.

Try not to listen to the hype from investment companies – the same people who write the ads that try to scare you into investing with their company (you need 70+% of your income to retire or you will be living in a cardboard box) also create the ads for RESPs. Investment companies often come up with fairly “worst case” scenarios for their projections of how much post secondary education will cost in 18 years or so. They try to make it sound like your child’s education will cost a certain large amount and if you don’t have that much saved up when they finish high school then they won’t be able to go on to post secondary school.

The reality is that most parents (hopefully not me) are still working when their kids go to school so they always have the option of diverting some of their income to make up any shortfall. The investment company ads also don’t seem to include the fact that most students work during summers and can offset a portion of their schooling that way. The last point I want to mention here is that like most things in life, post-secondary education involves choices that cost more or less money. If a student can live at home and go to school, that is much cheaper than going to school in a different city. The student may not like that choice but sometimes money (or lack of) can help simplify the decision making. Other factors that I can think of are housing – do they live in a dorm, shared accommodation or their own apartment? Do they have a car? All these choices will play a significant role in the amount of money required for the students education.

Summary

RESPs are a good thing but they are not as important as your family finances. You are not doing the child any favours by maxing out the RESP grants but they can’t participate in some activites because you don’t have enough money.

Establish your family finances first, then worry about the RESPs. You can carry forward the contribution room so there is no rush to start the account as soon as the child is born.

Categories
Investing

My Portfolio – An Asset Allocation Decision

Last fall I sat down for the first time ever (after 13 years of owning mutual funds) and looked at all our investments and did an analysis to determine what our asset allocation was. As I recall we had over 90% equity and a good portion of that equity was in Canada. At that time I decided to make the equity/bond split to be 80%/20%. This was chosen somewhat arbitrarily although it seemed to be a good mix for a fairly aggressive portfolio with a long investment time horizon. I also changed the country mix in order to reduce the Canadian holdings down to about 30% of the equity portion.

At this point in time I will be revamping my portfolio once again since I decided to move about two thirds of our rrsp to a broker (Questrade) in order to convert it to ETFs. The remainder will stay in low cost mutual funds and GICs. I’ll be discussing some of the specific investments in future posts but I plan to start with the asset allocation since that’s the most important decision in my opinion.

The first asset allocation decision was to lower the equity portion of the portfolio down to 75% from 80% and to raise the bond portion up to 25%. I decided to do this mainly based on the research of William Bernstein (Four Pillars of Investing) which showed that having an equity portion of a portfolio higher than 25% wasn’t worth the extra risk since it usually didn’t result in a significantly higher return and of course results in more ups and downs with the market.

Interestingly enough Bernstein says that although 75% equity should be the maximum for an investment portfolio, 50% should be the minimum regardless of your age. The reason for this is that if you are retired and have a more conservative portfolio ( less than 50% equity ) then inflation is a bigger risk. Another great point he makes about asset allocation is that you should have a more conservative portfolio if you’re not sure if you can handle the volatility in a downturn. If you sell equities every time the market drops and then wait until it goes up before buying in again, then you are better off in a more conservative portfolio (ie 50/50) if that allows you to stay invested during the downturns.