Yearly Archives: 2017

There is no place for commodities in your portfolio

In the balcony with friends

Commodities make me sick

I get sick to my stomach every time I hear an investment expert saying that we should own commodities in our portfolios.

The purpose of investing is to get a return for your money

The purpose of investing is to get a return on your money. You buy a financial product and you get a higher value when you sell, you get a dividend, you get an interest payment, you  get royalties, you get paid rent, and so on…

I am appalled when I hear financial experts suggesting that we should invest in gold and other commodities.

I wrote a blog called “Why investing in gold is a dumb idea.” The same principles apply to other commodities.

What are commodities

Let’s begin by describing what commodities are. Commodities are standardized goods and services, most of them are traded in an open market. It’s easy to explain commodities by giving you an example:

  • Agricultural products such as wheat and corn
  • Metals such as gold and silver
  • Energy such as oil and coal

These products are actively traded in the commodity market and they might have a lot of volatility.

The people who make money in the commodities market are the broker houses that facilitates all the transactions. During the The California Gold Rush (1848–1855) the people who became millionaires where the ones selling the pick and shovels, not the miners. It’s the same in the commodity market, the people who get rich are the ones who sell the dream of commodities as an investment.

Commodities don’t make babies

The truth is that when you put two bushels of corn in a barn, they don’t have sex and produce a baby bushel. They just sit there, do nothing and you have to pay insurance and storage. Commodities are  non producing assets, they are no different from any household item in your house, like a chair or a table, therefore they are not investments.

Anyone who insist that commodities are investment class, they want to sound smart, they want to make you feel as if you need their services and they are direct beneficiary of the service they are selling you.

Supply and demand

In the long run commodity prices increase at the rate of inflation. In the short run, commodity prices are influenced by the laws of supply and demand.

If there is higher demand than supply the prices go up. When prices go up consumer buy less and producers produce more, bringing the price to some equilibrium.

If there is higher supply than demand the prices go down, consumers start buying more, producers produce less and the price comes back to equilibrium.

Here is a graph of the Commodity index ETF for the past 5 years. As we have become more efficient producing commodities, supply have increase, the prices have gone down and if you were a believer of commodities as an investment, you have lost 50% of your money during the past 5 years. Show that to the person who recommended commodities for your portfolio.

Governments stop subsidizing commodities

While I am on the subject. I want to express that I dislike it when governments get involved in commodity markets. It costs million of dollars to taxpayers and to consumers. Governments all over the world subsidize all kind of agriculture products. This subsidy comes out of tax payers pockets. This is the subject for another blog.

Hire me 🙂

I am a money coach, if you would like to talk about your financial life, if you need help, write me a message….

My Favorite Canadian ETFs

There are hundreds of ETFs in Canada. Which ones are my favorites?

The evolution from Mutual Funds to ETFs

Painting an apartment with friends.

First of all, what is an ETF? ETF stands for Exchange Traded Fund. Many investors are familiarized with the term “Mutual Fund,” whereas many investors pool their money, give it to a mutual fund manager and that mutual fund manager would buy and sell stocks according to his investment style.

Mutual funds were the favorite investment vehicle for many small investors. With a small amount of money, they bought instant diversification. Imagine that your capital is only $10,000. By giving this amount to a mutual fund manager, the manager takes your money, along with the money of hundred of other investors and he buys and sells hundreds of different stocks during they year.

Other advantages of mutual fund was to have a professional making those decisions on your behalf.

The disadvantage of Mutual Funds were many. The number one was the cost. Most Canadian Mutual funds charge 2.5% to 3% management fees. This is fine if the end result is great performance, but the problem is that investors were not receiving great performance, they were receiving less than mediocre performance. When compared to a benchmark, let’s say the average return for Canadian stocks, they were under performing.

Another disadvantage of mutual funds is the compensation for financial advisors. Financial advisors would have a conflict of interest. They would feel tempted to recommend to their clients the funds which would give them the biggest commission. If there was a fund which didn’t offer a commission, the advisor simply didn’t recommend it, even if it was the best fund for their clients interest.

Index funds

And so the Index fund was invented. The index fund simply buys all the stock that have similar characteristics, lest say: All Canadian Big Companies, or All Canadian Banks, or All Canadian Oil. The index buys all those stocks, without doing any individual stock research, picking and choosing. It so happens that when you pool all those stocks together, and charge small managing fees (because you have no research staff, nor experts choosing and picking) the returns are consistently higher than the returns of managed mutual funds.

The problem with Mutual Funds and Index Funds is that you have to buy them directly from the mutual funds company. This only happened at the closing at the market.

The birth of ETFs

And so, the ETF was invented. The ETF is the same index fund, but now it can trade freely in the stock market as if it was a regular stock. This means that the process to buy an ETF which represents the whole Canadian economy is no different from buying a regular stock. You can log into your trading account and just buy it.

Another great advantage of ETF is their low management cost. Generally, a good ETF had management cost of less than 0.5%. When you compare that with the cost of Mutual Fund with a cost of 3%, the decision is a no-brainer.

This brought me to one of my most important investment philosophies: Invest in low-cost ETF costing no more than 0.5%.

 Which ones are my favorites ETFs and from which Suppliers?

I will not include bonds in this list and will not include a whole bunch of new ETFs called Smart Beta nor Sector investing. I will only include plain vanilla ETFs.

Vanguard

My favorite ETF supplier is Vanguard. Vanguard has built a reputation of low-cost ETFs and it has transformed the industry. The lowering of ETFs prices has been called “The Vanguard Effect.” Vanguard has done for the personal finance industry what Amazon.com had done to the retailing industry. It offers great products at very low prices. Either way these are my favorite funds.

  • TSXVCN – Vanguard FTSE Canada All Cap Index ETF
  • TSXVDY – Vanguard FTSE Canadian High Dividend Yield Index ETF
  • TSXVRE – Vanguard FTSE Canadian Capped REIT Index ETF
  • TSXVUN – Vanguard U.S. Total Market Index ETF
  • TSXVFV – Vanguard S&P 500 Index
  • TSXVXC – Vanguard FTSE All-World ex Canada Index ETF
  • TSXVDU – Vanguard FTSE Developed ex North America Index ETF
  • TSXVE – Vanguard FTSE Developed Europe Index ETF
  • TSXVA – Vanguard FTSE Asia Pacific Index ETF
  • TSXVEE – Vanguard FTSE Emerging Markets Index ETF

BackRock Inc.

This is the largest ETF provider in Canada.

  • TSXXIU – tracks the S&P/TSX 60 Total Return Index
  • TSXXIC – tracks the S&P/TSX Capped Composite Index
  • TSXXMD – tracks the S&P/TSX MidCap Index
  • TSXXCS – tracks the S&P/TSX SmallCap Index
  • TSXXEG – tracks the S&P/TSX Capped Energy Index
  • TSXXIT – tracks the S&P/TSX Capped Information Technology Index
  • TSXXGD – tracks the S&P/TSX Capped Gold Index
  • TSXXFN – tracks the S&P/TSX Capped Financials Index
  • TSXXMA – tracks the S&P/TSX Capped Materials Index
  • TSXXRE – tracks the S&P/TSX Capped Real Estate Investment Trust Index
  • TSXXTR – tracks the S&P/TSX Income Trust Index
  • TSXXDV – tracks the Dow Jones Canada Select Dividend Index
  • TSXXCG – tracks the Dow Jones Canada Select Growth Index
  • TSXXCV – tracks the Dow Jones Canada Select Value Index
  • TSXXEN – tracks the Jantzi Social Index
  • TSXXSP – tracks the S&P 500 Index (currency hedged)
  • TSXXSU – tracks the Russell 2000 Index (currency hedged)
  • TSXXIN – tracks the MSCI EAFE 100% Hedged to CAD Dollars Index (currency hedged)
  • TSXXEM – tracks the MSCI Emerging Markets Index Fund Index
  • TSXXWD – tracks the MSCI World Index Fund Index

All the other Canadian ETF companies

There are many other ETF providers, but they are either too expensive, or have little liquidity, or are not a great product for investors.

Stages of Asset accumulation and asset decumulation

How we get into investments
Going out to a concert with friends. 🙂

Most people have little interest in personal finance and investments. It’s hard to believe that one day your money could earn more money than you earn yourself, so the idea of living out of your investments is in the same area of your brain as winning the lottery.

Then, as we get a job, we start seeing advertisement about investments about Retirement Savings Plans promoted by many banks and employers. Canadians see these savings plans as a way to reduce their tax bill.

Little by little we start getting bank statement and we discover that in fact our investments are making money. Our investments go up and down in value but on the long run, we should see the balance of our account steadily increasing.

How we optimize our investments

It is at this period that many of us become interested on how to optimize our investments. Maybe we make the following discoveries:

  1. We discover that most actively managed funds under perform Index funds.
  2. We discover that most fund companies have high management fees 2.5% to 3%, these high management fees rob us of a big chunk of our investments.
  3. We discover that it is better to own Index Funds and ETFs than individual stocks. The average return is the same but the risk is much lower.
  4. We also discover that Canada is only a small part of the global economy and that we will be missing out by staying invested in Canada and ignoring the rest of the world.
  5. We discover that bonds under perform stock and unless we have hit our wealth number, we should continue preferring stocks over bonds
  6. We discover that investing in gold, does not produce higher return nor more security. Instead it adds a lot of risk to our portfolio.
  7. We discover that commission based advisers have a conflict of interest. Would they recommend the best investment for us even if it didn’t pay them any commission? I doubt it.

The process of learning all these lessons is long and many times painful. It could take many years to discover that you are overpaying for actively managed funds. It could take years to diversify out of Canada. It could take years to stop believing in having gold as a fundamental part of your portfolio.

Winning the lottery and investments

Other investors get seduced into investments by the big technology companies. The Googles, Apples, Amazons of the world. They say: “If I would have invested $10,000 in Amazon 10 years ago, I would be a gazillionaire by now.” These investors might jump into a stock just based on the mass enthusiasm of the moment and many time they could win but also, the probabilities are high that they lose. “When to get in and when to get out” remains the most important question. After getting burn a few times, these investors (like me) might look for more conservative/predictable approaches or might pull out of investments all together.

On the long run, who are the winners?

The people I have seen succeeding over time, are the people who year after year make small improvements to their portfolio without increasing their risk. They find a better way diversify, to cut unnecessary cost, to get rid of expensive commission. After 10, 20, 30 or 40 years, they see that their asses have grown substantially and now they have reached the second stage of their financial life, the decumulation stage.

The decumulation stage

At this stage of their life there are many questions which come up:

  1. Will I have enough to retire?
  2. Will I outlive my money?
  3. Will I have some money left over to leave to my heirs?
  4. How much can I safely withdraw each year?
  5. Will I invest my money any differently?
  6. What it the correct asset allocation?
  7. From which account should I withdraw first.
  8. What are the tax implications when I start withdrawing my money.
  9. How much should I rely on my Canadian/Quebec pension plan.

All these are difficult questions to answer. Investors find bits and pieces throughout the years. Many times the information is not complete or many times there is too much information.

Filling the information gap

There are two alternative to fill the information gap.

  1. To educate yourself and buy books on how to approach asset decumualtion
  2. To hire a fee only financial expert for a second opinion. Please don’t consider talking at a commission based adviser. There will always be a conflict of interest.

I will do my best to continue writing blog post to narrow the gap between not enough information and too much information.

Looking for Fat Profit Margins

Birthday party with friends

Imagine that you want to invest in a business. If your objective is to maximize profit, your main question should be: How much money do I get to keep? What’s my profit margin?

The new trend in investing is to just put all your money in broad based ETFs, set and forget it. And I must admit that since I have been reading about personal finance, this is the best deal in the market for the little guy and for many big guys as well.

This new approach is effective because of its simplicity. If we can just manage to find the low cost ETF provider (avoid actively managed funds) then success is the most likely outcome.

However, A few of us would like to squeeze a little bit more profit out of our invested dollars. To do so we have to look a little bit deeper into the numbers.

Business comparison

Let’s imagine your are considering buying two different business.

  • One is a grocery store: After you finish paying for all the merchandise, rent, salaries and taxes, you are left with a net profit of 3%.
  • The other business does computer programming. After you pay the rent and all your programmers, you are left with a net profit of 20%

Which one of these two seem to be the better investment? I would say the computer programming business sounds better to me.

How about if we apply the same logic to the stock market. How about if we look for companies with fat profit margins.

The S&P 500 is divided into 10 different industries. As a whole, the profit margin of the S&P 500 is about 9%. But of course, there are some companies that have a fatter profit margins than others. Let’s figure it out.

Here we have the profit margins of the S&P 500 and all of its individual sectors for the 3rd quarter of 2017. The data comes from this research: https://www.yardeni.com/pub/sp500margin.pdf

Energy 3.4%
Consumer staple 6.6%
Consumer discretionary 7.5%
Industrial 8.7%
Healthcare 8.6%
Materials 9.2
Telecommunications 10%
Utilities 10.2 %
Financials 13.6%
Information technology 19.2%

But does profit margins returns actually translate into stock market gains?

Here is my research as of November 15 2017

5 year returns

Technology 116%
Consumer staple 104%
Consumer discretionary 100%

2 year returns

Technology 42%
Consumer staple 30%
Utilities 26%

1 year returns

Technology 35%
Consumer discretionary 20%
Healthcare 17%

In short, the profit margins of 20% and the stock return of the technology sector of 35% for the last 12 months can lead us to believe that there is a correlation between fat profit margins and stock returns. But there is no such correlation when we look at the other profit margins and compare it to their stock returns.

Conclusion: Maybe the implied relationship between profit margins and stock returns is not as strong as I believed to be true.

 

Socially Responsible Investing in Canada

Dancing Tango for “A Closer Look.”

Recently my friend Elijah asked me about ethical investing. His concern is that he doesn’t want any of his hard earned money going towards oil companies.

I sense that Elijah is really interested in socially responsible investing (SRI). The idea goes by other names such as: green investing, ethical investing, sustainable investing, impact investing, or socially conscious investing.

In general, Elijah and millions of others like him want to avoid investing in companies involved with alcohol, tobacco, gambling, pornography, weapons, human rights violations, or poor employee relations.

At this moment Elijah is invested in a the TD Canadian Index e with 20% allocation towards the energy sector. For this index he pays 0.32% management fees. He makes a monthly contribution of whatever he can afford.

I did a bit of searching and I found:

  • Jantzi Social Index Fund (XEN) This is a Canadian ETF with 16.82% allocation in the energy sector and 0.55% management fees.
  • iShares MSCI KLD 400 Social ETF (KLD) in the US. with 0% Energy and 0.5% management fees.
  • iShares MSCI KLD 400 Social ETF (DSI) in the US. with 0% Energy and 0.5% management fees.

In short, ethical investors don’t have much choice.

If you invest in the US and want to avoid oil, one option is to buy all the sectors except the Energy sector if this is the sector that worries him the most, but this option is a bit unrealistic if he’s only investing $100 or $200 per month. And all the other sectors have companies that would not qualify as socially responsible investing.

As opposed to the US, the Canadian market is so small that there are not ETFs or index funds which separate different sectors of the Canadian economy.

Another option is to buy individual stocks and only buy those stocks which meet his criteria. But again, this will expose him to risk of lack of diversification and he doesn’t have that much capital.

One of the problems with ethical investing is that people’s moral values are different.

Some examples are clear cut. If a company makes bombs or machine guns, there is no doubt that those weapons are for killing people and I think that most ethical investors would want to avoid those companies.

But what about companies like Walmart? Some people say that it violates human rights because it prevents workers from forming an union. Other people say that Walmart is a savior for poor people by providing good quality products at low prices.

Another example is a chicken farming company. Some people say that it provides affordable chicken and eggs to the masses. Other people say they represent cruelty against animals.

A winery in California. Millions of people see nothing wrong with drinking a glass of wine after dinner. Others see the sale of alcohol as a complete violation of their moral principles.

And to address Elijah’s distaste for oil. We depend on oil products every second of our modern life. From the plastic keyboard on our computers to the plastic toothbrush we use every morning. We can get our oil from the oil sands in Canada (this is considered dirty oil) or we can get it from the middle east where there are constant human rights violations, but there is no replacement for oil derivatives products in modern day society.

Sure, green energy is advancing rapidly but I don’t see how green energy could replace all the plastic, rubber, and other chemical byproducts which are derived from oil.

The truth is that a portfolio is not the best way to express one’s moral choices.

Let’s imagine two companies: “Good Company” and “Bad Company”

Both companies have shares in the stock market for $10 and both companies pay $1 dollar in dividends every year. In short, return for investment is 10%.

A campaign against Bad Company and in Favor of Good company moves the share price of each company. Now Good Company shares cost $20 and Bad Company shares cost $5. But regardless of their share price, they still pay $1 in dividends.

As an investor, if I pay $5 in Bad Company for my $1 of dividend, now I make 20% return on my investment. If I pay $20 in Good Company for my $1 of dividend, now I make 5% return on my investment.

In the stock market, the Bad Company shareholders will be rewarded and the Good Company Shareholders will be penalized.

How to create an impact

The best way to create an impact is to vote with your dollars. As a consumer your voice is much louder and corporations eventually listen.

For example. My friend Cheryl has been a vegetarian and then a vegan for many years. When I met her she was the odd person with the different eating habits, but little by little the vegetarian and vegan community has continued to grow. Now there are more and more vegan restaurants all over the city. Cheryl and millions of other vegans have voted with their money and corporations are listening.

Another example is the company Gucci which announced that they will no longer use fur in their designs. Obviously they are responding to demands of the consumer. The consumer has spoken and Gucci is listening.

You can have a much bigger impact as a consumer than as a stock holder

The best way to change a company’s behavior is not by buying or selling its share in the stock market, it’s by buying or not buying its products. If you and millions of others boycott their products, management will realize that they have to change quick.

Other ways to create changes is to lobby government and ask government not to buy products from those companies.

You can also express your SRI with your political vote. For example, in the US, the people voted for Donald Trump, a person who denies climate change and who wants to revive the coal industry at the expense of cleaner sources of energy. Many people who care about the environment  didn’t bother to vote, and so, they have to live with the consequences of having Donald Trump as president.

In short, you will have a bigger voice if you express your SRI by the way you consume and by the way you vote than by the way you invest in the stock market.

Make sure you get an unbiased financial adviser.

Elsa from the film Frozen

Picture this scenario

It’s RRSP season. You see advertisements in all the metro stations, all the TV stations and all the social media. You have until March 1st to make your RRSP contribution and to get that tax break you have been hearing about.

You make an appointment with the financial adviser at the bank. You get one hour. In that one hour, your financial adviser, anyone who happens to be available at the time, gives you a questionnaire. From this questionnaire he’s supposed to assess your risk tolerance and present you 5 or 6 mutual funds which fall into your risk tolerance. Sing here, sign there, initial here and here and we are done, thank you very much. Next…

Asset allocation is one of the most important decision an investor must make and yet, we give it so little time, so little consideration.

There are a few problems with this scenario.

  1. The client and adviser don’t get to know each other. The adviser don’t discover anything about the client’s goals, knowledge nor expectations.
  2. The adviser only show the client the products offered by the bank. Most of the time the adviser will try to nudge the investor into actively managed funds, these are the funds which offer the highest revenue to the bank and thus the lower revenue for the client.
  3. If it is a Financial Advisory firm, not affiliated with a bank, the firm will definitely push actively managed funds. They would never suggest index funds nor low cost ETFs and on top of that, they will charge an additional management fee. They will do what I call “double dipping.”

What’s the solution?

  • The solution is to look for a fee-only financial adviser. These adviser will charge you for their time. They have no conflict of interests, they won’t try to sell you products.
  • Have a long conversation with your adviser. Let him know about your plans, your goal, your knowledge, your expectations.
  • Take a holistic view of your situation.  Are you planning to work after retirement? Do you have other investments? Are you planning to leave a money for your heirs?
  • Build a long term relationship with your adviser, but continue informing yourself. If at any moment you detect conflict of interest, you suspect that he is charging but getting a commission somewhere else, his opinion in no longer unbiased and you should question his decisions.
  • Make sure that the products he offers you don’t have trailer fees, or other kind of compensations. You want to make sure there is not even the perception of conflict of interest.

Finding a financial adviser without conflict of interests is very difficult but not impossible. If you find him, don’t be afraid to pay him his hourly fee, in the long run you will save a ton of money.

 

Cash is trash. Inflation is the biggest killer of your money

Spending time with friends.

Many people think that having money in cash is the safest investments of all, but in reality, it is the worst investments of all. Having cash money is the only investment where you are guaranteed 100% to lose money.

How do you lose it?

You lose it to inflation, the silent killer of capital.

Why does inflation occurs.

In order to create economic stimulus, governments try to have a stable rate of inflation, both Canada and the US favor an inflation rate of about 2%.

The reason the governments wants inflation is because the government wants to discourage people from holding money. If your money lose value day by day, then you are better off spending in goods and services. If people buy goods and services then businesses make money and this economic activity creates jobs.

Who is the big loser in the inflation game?

The poor and the financial ignorant are the big losers.

The poor are losers because every time prices increases the poor have to pay more for goods and services, but many times salaries don’t increase at the same rate as inflation, therefore the purchasing power is less and less.

The financial ignorant loses out because they don’t know how to invest their money in a way which will produce a rate of return higher than inflation.

Imagine this scenario:

Inflation is 2% and your bank offers you 1% interest for your money, at this rate your money is losing 1% power every year.

Here is the Canada’s rate of inflation for the past 10 years.

2016: 1.50%
2015: 1.61%
2014: 1.47%
2013: 1.24%
2012: 0.83%
2011: 2.30%
2010: 2.35%
1009: 1.32%
2008: 1.16%
2007: 2.28%

It doesn’t seem like much, but assuming you had $10,000 on the year 2007. How much will it be worth today?

Your 10,000 would be worth $8,617.

This means that you lost 13.83% or your money. That’s a big hit.

So what to do?

If anything, don’t hold cash, and don’t get investments which produce less than the inflation rate. Government bonds, generally don’t keep up with inflation.

Corporate bonds do a bit better than inflation, but the best of all are stocks.

Stocks are volatile, but in the long term have have consistently outperformed other investments.

Good luck with your investments.

I am a money coach. If you want to talk about your investments, let’s talk.

Financial Analysis and recommendations: Elijah Baker

Elijah is a friend I met at the McGill toastmasters club. His speeches have always been thought provoking and inspirational.

Elijah is a true hustler. He has several side gigs and job. Due to his many activities he hasn’t much time to think about his financial goals. He only started saving after having a conversation with me about the possibility of retirement or having some money for emergencies.

This interview was held May 2017

Age: 33
Work life: Different jobs at different places and side hustles.
Education: Bachelor’s in communication and music.

Alain: What are your professional ambitions?
Elijah: After graduation, I never wanted to work a 9-5 job. So far, I have succeeded at that.

At “A Closer Look” rehearsal

Alain: How do you earn your living?
Elijah:

  • I have been a musician for years, I do gigs at different bars and events.
  • I teach guitar and drums to a few private students
  • I started a videography company, I do corporate videos, weddings and events with my small business www.triplebottomlinemedia.com
  • I am a teacher at Trebas Institute

Alain: Can you tell me a bit about your financial planning?
Elijah: In the past I have accumulated some savings, but I always ended up spending it.

I haven’t been disciplined about saving because:

  • I didn’t have the motivation,
  • I didn’t have the knowledge
  • It wasn’t that important
  • I never had a steady income

Only recently I have had the capacity to set aside a certain amount of money to save regularly.

Alain: Have you ever thought about retirement?
Elijah: I don’t think that far into the future. I can’t imagine what life would be like at age 65.

I am trying to set up my life so that even at 65 there will be demand for my services. I hope that people will want to have videos made, they will want to listen to my music and will want to learn to play musical instruments.

Alain: Do you have any goal which could affect your financial life? Do you want a house? Kids? Get married?
Elijah: Yeah, probably, but at the moment I am more focus on living on the present.

Alain: So what are your financial goals?
Elijah: I would like to have a bit of money set aside for emergencies. I would like to continue working until old age without the pressure of having to produce every month. I would like to work because I want to, not because I have to.

Diagnosis

The whole idea of financial planning is new to Elijah. He lives a frugal lifestyle and he is happy with it. His priority is to have lots of freedom, not to have a 9 to 5 but not to lack anything either. He doesn’t mind living a spartan life but if he feels like having a beer with friends, or taking a trip to Costa Rica, he would like to have the money to do it without worrying too much about how to pay for it.

  1. We started by opening a brokerage at his main bank
  2. I asked Elijah not to listen to the advice of the financial adviser at the bank. The bank offers actively managed mutual funds with high fees. The more a fund cost, the less money it makes for its investors.
  3. We spoke about choosing and Index fund, a broad based investment products which represent the whole economy of a county.

Actions

  1. Elijah opened an account and deposited some money he had in his bank account.
  2. We chose the Canadian Index Fund with management fees of less than 0.33% per year.
  3. He’s making contributions every month.

Conclusion

  1. This is just the beginning, his present savings are not enough to fund a retirement. After a few months he will have enough money to face any short term emergency.
  2. Our first goal was accomplished, to get into a habit of saving and planning for the future.
  3. In future meetings we will speak about the saving a bigger amount and about how to start diversifying his savings.

Follow up

Next meeting will be May 2018.

Pitch. I am a money coach. If you would like to talk about your financial situation, please get in touch with me.

Asset allocation for a Canadian 10 years into the past

Hanging out with friends. Inas and Daniel

If you have been reading my blog for awhile, you will know that my favorite asset allocation for Canadians is ⅓ Canadian stock, ⅓ US stocks, and ⅓ International stocks.

Let’s say that you met me 10 years ago (October 2007) and you asked me how to invest your money. And let’s say that I gave you the same advice that I give out today. Would you have been a happy investor? Let’s find out.

If you invested on October 2007, you were in for a wild ride. The national and international markets where about to tumble due to the financial crisis of 2008. You would have been looking at your portfolio and calling me a complete idiot, cursing yourself for ever talking to me.

I often say that if you are going to invest in the stock market, you have to have a 10 years outlook and that at the end, if you are well diversified, you should come out fine. That prediction turned out to correct.

The financial products which I use to do my investing are as follows:

  • Canada: The XIU. This represents the 60 biggest Canadian Companies
  • US: VTI. This represents the whole US. Market
  • International: XIN. This represents big size companies from all over the world.

As you can see in the graphs, on 2008 everything dropped. The Toronto and US market lost about 50% of their value while the international index lost about 40% of its value. At this time, many retail investors without a financial adviser would have bailed out.

Let’s say you endured the pain. Where would you be today?

  • Your International exposure would still be negative by 14.7%
  • Your Canadian exposure would be positive by a mere 5.04%
  • But your US exposure would be positive by 67%

Your average of these three investments would be 19.15%.

Divided by 10 years, this will give you about 1.9% per year.

These are not great returns, considering the amount of risk involved. The amount of pain related to seeing your investment dropping by over 50%.

There is a problem with my calculations. I don’t know how to add the dividends earned during these past 10 years. Let’s say that on average you earned 1.5% in dividends. Now your total return per year is 2.4%. This is less bad, but It’s still very poor return. Consider the psychological stress, I would have preferred to lose out to inflation and have my money in cash.

What are the alternatives?

During the same period, bonds have gone down the the less that 1% territory. You might as well keep your money under the mattress.

And real estate, also had a big drop in the States. Since then it has recuperated as well, but let’s be honest, real estate is not a real passive investment. I invest in real estate and believe me, it gives me plenty of headaches.

In conclusion, in spite of a 50% in the stock market. Stocks are still the best place to put your passive money. However, the faith that I once had on the stock market, it has been badly bruised. I feel that 2.4% is not enough compensation for putting my money in harm’s way. I am still investing in the stock market, but I feel a lot less enthusiastic and optimistic than when I first started writing this article.

Currency diversification for Canadians

Here is a 10 year graph of the same investment, the S&P 500, being held in Canadian dollars and being held in US dollars.

Because of the cost of hedging, the investments in Canadian dollars under performs the investment in US dollar by a whooping 15.60%, that’s a lot of moolah.

Long ago I suggested that the ideal portfolio for a Canadian would be composed of ⅓ Canadian index stocks, ⅓ US index stocks, and ⅓ international Index stocks.

Now the question is: In which currency should you hold  those investments which are not in Canadian dollars?

Filming “A closer Look” with my friend Elijah.

The way I have decided to do it is by investing my ⅓ of US index in US dollars.

I would have considered investing the ⅓ of international in foreign currency but it is just too complicated. I would have to deal with Euros, Yens, Yuans, and all the other currencies of the emerging market. My portfolio in not big enough to burden myself with all those details.

On the other hand, my US investment is ⅓ of my portfolio, that is quite substantial. So the question is valid. Should I invest my US portion in Canadian dollars or in US dollars.

Many of you may be unaware that there is such an option.

When we buy the most popular US index, the S&P 500, we have the option to buy it with US dollars or  in Canadian dollars. The S&P in Canadian dollars is protected against the currency fluctuation of the Canadian dollar vs. the US dollar. But that protection comes at a price. It is like paying for home insurance, it’s not for free. This hedging cost is about 0.15% of your US assets. Not a lot, but it’s just another erosion of your capital.

If you are investing for a short term period, you should not be investing in the stock market.

If you are investing for a long term goal, then you are further diversifying your portfolio not only by investing in the US market but also investing in the US dollar.

As Canadians, we have to be aware that our currency fluctuates a lot with the price of oil. We think that Canada is an advanced economy, but we are nothing more than a big gas station for the rest of the world. If oil prices go up, our currency goes up, If oil prices go down our currency goes down. Our currency is in fact too volatile and the US dollar is the more stable currency; their economy is more diverse.

Looking it from that point of view it makes sense to have some of our money in US.

In regards to cost, how does it compare.

When I keep my US investment in Canadian dollar I have to pay the hedging cost every year, this hedging erodes my returns over time.

When I keep my US investment in US Dollar, since I earn in Canadian dollar, I have to pay the conversion cost from Canadian to US and then when I retire, from US to Canadian.

In the long run, I feel that keeping my US investments in US dollars is less expensive and I feel more diversified.