Tag: portfolio

Categories
Personal Finance

First Margin Call

This post was originally published on Mr. Cheap’s original blog.  When he brought over all his posts – some of them didn’t make it so I’m planning to publish a few of them over time.

I recently got my first margin call from E*Trade for about $3K. It scared the hell out of me, not because I could pay (I had the money sitting in a cash account and just transferred it over), but the call was unexpected and I was worried that I misunderstood the system to the degree that I had triggered it.

The day after the call, I got on the phone to E*Trade and admitted that I’d had a margin call, told them that it was no problem paying it (and I’d already transferred the funds), but that I didn’t understand what had put me into a margin call situation. The man on the phone didn’t apologise, but it turns out that the problem was on E*Trades end and they considered a bunch of “safe” stocks (which they’ll loan 70% of the stock value on) as “riskier” stocks (which they’ll loan 50% on). He told me the call wouldn’t be enforced, and after checking my account assured me I was fine (even if I hadn’t transferred the cash in).

I used the situation to get more details about margin calls and what would have happened if it had been a real call. Apparently the speed on which they’ll sell your stocks depends how far over the line you are (he said they’ll give you 3 or 4 days if you’re just a little over, bit will sell immediately if you’re significantly past your limit). I asked him for good customers with a conservative portfolio if they ever will waive a margin call or increase their loaned %, and it turns out that its actually a law how much they can allow people to buy on credit (so short answer, no).

In the end I was happy to have my understanding of the margin account challenged (and happy that it was a problem on their end and not in my understanding). I learned some new things about my account, which is always a good thing.

Categories
Investing

Comparing Market Cap ETF vs Dividend ETF – How Much Duplication?

I had a reader question the other day where they mentioned buying both XIU (iShares Cdn Large Cap 60 ETF) and XDV (iShares Cdn Dividend Index Fund ETF) for their portfolio.  I had responded that although I wasn’t sure, I suspected that might be a lot of duplication in the two funds since XIU has all the biggest public Canadian companies – a lot of which are good dividend stocks and would probably also be in XDV.

Duplicate holdings is a common problem in mutual funds – especially in a market like Canada where there are not a lot of different companies to buy for the larger funds.

I decided to do a bit research and find out if there was as much duplication as I suspected in the two funds.  The question I want to answer is if it is worthwhile to own both funds for diversification purposes or will just one do.

Number of companies in common

The first and simplest criteria was how many companies are in both ETFs.  This isn’t necessarily all that meaningful since one ETF might have a lot of XYZ company whereas the other might only have a small holding.

XIU 60 has 61 holdings (can’t they count?), XDV dividend has 31 holdings, there are 15 companies that they have in common.  This seems like quite a bit since it means that half of the companies in the dividend ETF are also in the XIU ETF.

Amount of market cap in common

What I did here is take the companies that are in both ETFs and compare the percentage holdings and add up the smaller number.  For example if CIBC was 9% of the dividend fund and 5% of the XIU then I counted that as 5% in common (by market cap).   This totalled up to 31%.  This was a smaller number than I expected which means that a good portion of the dividend ETF is not represented in the XIU 60.

Measuring correlation between the ETFs

The next test I did, which should have been the first and only test since it is the only one that has any real meaning is to measure the amount of correlation between the two ETFs.   Correlation is a measure of the relationship between the prices of the two ETFs.

A measure of 1 means that they always move in price exactly the same way, a measure of 0 means they are completely uncorrelated and a measure of -1 means they always move in price in exactly the opposite direction.  One of the main concepts behind building a portfolio is to try to find different assets that are not correlated with each other.

To accomplish this I needed some historical price data which I managed to find at Yahoo Finance.  To figure out the correlation I used the Excel correl function (is there anything Excel can’t do?).  XDV dividend has only been around since the end of 2005 so the data is only for a bit less than 4 years.  Not being a stats guy I’m not sure if this is a long enough period to be meaningful but it’s all I’ve got.  Regardless, the correlation “r” number was 0.72 which implies some benefit for diversification but not a whole lot.

Performance

The last thing I looked at was performance.  Since the time period is fairly short I’m not looking to see which ETF did better but rather to look at the difference in performance.  Ishares.ca website has a handy calculator just for this purpose.  I choose the last 3 years since the next category was 5 years which wouldn’t work for XDV dividend.

3 year total return

  • XIU Large Cap 60 = -12.98%
  • XDV Dividend = -18.19%

From what I’ve read the XDV dividend has a higher ratio of financials than the XIU 60 which is probably one of the reasons for the big performance difference.  The XDV dividend has a higher mer (0.5%) than XIU 60 (0.17%) which would account for about 1% of the 5% difference.

Conclusion

I looked at 4 categories to see how different XIU and XDV are:

  • Similar companies – half of the XDV dividend companies are in XIU.
  • Similar companies by stock market capitalization – 31% of the companies market cap are in both ETFs.
  • Correlation – over the last 4 years the correlation is 0.72.
  • Performance – the two ETFs were about 5% off in terms of total performance over 3 years.

What does it all mean?   Hard to say – there are much better ways to diversify your portfolio – REITs, small cap, foreign holdings would likely all have correlations that are less than 0.72.  I’m also not crazy about the higher mer of the dividend ETF.

I think if you want to have most of your equity in Canada then buying partially overlapping ETFs might be the only way to diversify without getting into individual stocks.  Personally I like to be diversified over the whole world so for me, the XIU Large Cap 60 by itself is good enough – in my case adding XDV would not increase my diversification enough to make the higher mer worthwhile.  XIC (TSX 300) is also a good choice.

Categories
Investing

Why Retirees Need Equity In Their Portfolios

One of the standard pieces of advice for retirees is that they have to have a very conservative portfolio since they are too old to take any chances with equities. There are “rules” around what percentage of fixed income (ie bonds) a retiree should have. “90 minus your age” is one that I’ve heard a lot.

These rules were probably pretty good guidance at a time when your average retiree finished work at 65 and could reasonably be expected to live for another ten years or so. With a short term investment horizon it didn’t make sense to invest a lot of money in equities because the retiree wouldn’t live long enough to recover from any major losses. Inflation was also not a major concern since the time line was fairly short.

Fast forward to now and there are two major differences in retirees – first of all they are retiring earlier which lengthens the retirement time and they are living longer which of course also increases the retirement time which in turn means that they have a longer investment time horizon so a higher allocation of equities is appropriate. Typically most financial planners will assume an estimate lifetime of around 90, so if an investor retired at aged 60 and lived until age 90 – that’s a 30 year time horizon.

You might be asking – who cares how long the retirement lasts for? Shouldn’t you just be conservative and buy guaranteed fixed income products or annuities and live off the payments? One problem is that while retirees might be living longer once retired, they aren’t working longer, in fact they might even have slightly shorter careers on average so current retirees might not have any more money saved (adjusted for inflation) than someone who retired a generation or two ago and they are less likely to have any kind of company pension plan to help fund the retirement.

The reality is that historically equities have outperformed bonds by a long shot. According to William Bernstein – author of “The Four Pillars of Investing”, two reasons to invest in equities are for the higher expected return and because equities can keep up to rising inflation. If you are retired and your portfolio is entirely fixed income (or annuity) you might run into the problem of a steadily lower standard of living if inflation increases.

Other reasons to invest in equities are that interest is taxed at a higher rate than dividends and capital gains (in Canada and USA) so you will probably be better off if you can only pay dividend and capital gains taxes rather than income tax on interest payments.

What to do?

The answer is two fold. First of all, retirees should have a significant equity holding in their portfolio. Bernstein recommends anywhere between 50% to 75% equities depending on your tolerance for risk. One of the key points that Bernstein emphasizes is that whatever asset allocation you choose, you have to stick with it so pick an allocation that you can handle in rough times. If you choose a higher percentage of equities and then sell when the equities drop and then buy back in when they go up, then you will be further behind compared to if you had just picked a more conservative portfolio and stuck with it. Even if you choose to have an equity allocation of less than 50% then stick with that allocation.

Tomorrow we’re going to discuss the 4% withdrawal rule which will help determine when you can retire.