Monthly Archives: February 2017

ETF or Index Fund? Which one should I buy?

ETFs or Mutual funds?

A regular investor has four investment vehicles.

  1. Bonds. I don’t recommend bonds because on the long run they always under-perform stocks.
  2. Single stocks. I don’t recommend single stocks because you have two risks; the stock risk ( lower profits, corporate scandals, etc. ) and the market risk (this risk can not be avoided).
  3. Mutual funds. I strongly discourage actively managed funds and equally promote index funds.
  4. Exchange Traded Funds (ETFs). Which are extremely similar to index funds, except on the way you buy then and sell them.
If you were my sister or my good friend, which one would I recommend to you

Both, ETF and Index funds are in all practical sense the same investment. Let’s say that I am interested in the Toronto-60 (which is an index of the 60 biggest Canadian companies). Both the ETF and the index will have exactly the same 60 companies.

The only difference will be on the way you buy them.

Let’s say I have $10,000. If I want to buy the ETF, I would go to my broker account, let’s say at 11:00 am. See what’s the price, imagine the price is $25/shr, and buy 400 shares. Most brokers charge $10 commission, so the total cost of my 400 shares would be $10,010.

If I want to buy the index fund. Most likely I will not have to pay a $10 commission, but my order to buy can only be executed at the end of the trading day. Let’s say that at 4:00 pm the stock closed at $25.05 then my transaction would cost me $10,020. On the other hand, they could had closed lower, let’s $24.90 and at this lower price, I could have saved a few dollars.

The bottom line is that with ETFs you have a bit more control over the purchase price than with index funds. But on the whole scheme of things, if you are investing long term, If you are planning to add this investment in your TFSA for many years, this little discrepancy should make no difference one way or another.

Buy this one if you have no money

However, let’s say you are my little sister, and you don’t have $10,000 just sitting in your checking account but could put $200 every month. In this case, an index fund would be the overwhelming choice. With an index fund, you could just buy $200 every month without paying a commission. The index fund company would even allow you to buy fractions of a share. Let’s say that after the first month, the price went up to $25.15. You could buy 7.95 shares.

To summarize, If you have a chunk of cash and you are planning to invest for a long time, it doesn’t make any difference if you invest in mutual funds or ETFs ( for the record, I prefer ETF ). But if you don’t have that much cash but you are willing to make periodic small purchases, then index fund would be the way to go.

Coaching services

I am a money coach, don’t hesitate to write me if you want to talk about money or anything else that is going on in your life.

Window dressing, mutual fund lying to their clients

Window dressing, spending time with friends
Hanging out with friends

We window dress in our lives all the time. When people post pictures in Facebook, they post the happy moments, they are displaying their best smile. We don’t see how they look in between each one of those photos.

Mutual funds company are supposed to report their holdings at the end of each quarter. This is when they show us their best picture, However, This report does not reflect the holding the fund held during the previous 89 days. By the time a client reads the prospectus the fund could have a totally different portfolio. In short, as a mutual fund investor, you will never know for sure which equities you have in your portfolio.

What is Window Dressing

In order to show the best face for the public, many funds engage in the practice of window dressing, this means that right before the quarterly report they get rid of losing stocks and buy the best-performing stocks in the market.

Imagine a fund that trades in the technology sector. Imagine that Google went up 20% while Apple went down 15%. What the fund would do is to buy Google and sell Apple. That way, when the investors get the report, they will believe that fund manager was able to choose the rising stars and drop the dogs. But it’s not true, it’s all make believe.

Since there is a lack of transparency in the mutual fund industry, managers also get away with buying stocks which are outside of their mandate. For example. Imagine a mutual which claims to invest exclusively in big companies. Well, this mutual fund has an 89-day window to buy stocks in small companies and then get rid of them before the next report.

What are the problems with Window Dressing

The biggest problem is the lack of transparency. The investor deserves to know which stocks he owns at all times. What if he doesn’t like to have stocks which deal with arms, tobacco or alcohol? Doesn’t he deserve to know?

The next problem is worse, I call it buying high and selling low. This is totally the inverse of what an investment should be, but if a portfolio manager buys a stock after it has gone up, to showcase it in his portfolio, he’s buying high. And if he’s getting rid of poor performers because they are an embarrassment for the portfolio, he’s selling low.

The last problem that I see, it the excessive transaction cost. When the fund manager buys and sells stocks simply to showcase them in the portfolio, he is engaging in a lot of transactions. These transactions are expensive and they drive down the performance of the portfolio.

What can you do as an investor

The best thing to do is not to have actively managed funds in your portfolio. Instead, opt for index funds or ETFs. With index funds, you know exactly what you own at all times and in which proportion. For example, when I buy the XIU (iShares S&P/TSX 60 Index Fund) I know that I own the 60 biggest Canadian companies on the Toronto Stock Exchange. There is no mystery to that. I know 365 days a year what I own, I don’t have to wait once a quarter to find out.

I don’t have to worry about excessive transactions and about buying stocks when they are high and selling them when they are low.

Overall, index fund investing has proven to be an investment strategy which is totally transparent, has little or no transaction costs, is 10 times less expensive than actively managed funds and has proven, with time, to outperform 90% of the actively managed funds.

Action steps

Next time you see your financial adviser, ask him about index funds and ETFs.

Coaching services

I am a money coach, don’t hesitate to write me if you want to talk about money or anything else that is going on in your life.

Asset Allocation, my opinion and how I do it

Doing a speech evaluation at McGill Toastmasters

Disclaimer: Please be advised that this article represents my opinion only. I am not suggesting you do the same.

Asset allocation

Ever since I got my first finance book, I have been reading about the bond vs stock asset allocation ratio. In theory, the percentage of bonds vs stocks in your portfolio should change every year. The older you get, the bigger the bond ratio should be.

Financial advisors only recommend bonds and stocks because these are the asset classes for which they can get a commission. There are many other asset categories which are completely ignored. For instance, my asset allocation is 50% stocks and 50% real estate.

My stock portfolio is divided as follows: 33% Canadian, 33% US in US dollars and 33% international in either US or Canadian dollars. For the moment I only use ETFs (mostly from Vanguard). I don’t use (and I recommend never using) actively managed mutual funds.

Stocks are as safe as bonds

Financial pundits will tell you that bonds are safer than stocks. But that is not true. Stocks are more volatile than bonds, yes, but not necessarily riskier. Let’s not confuse volatility with safety. At any 30 year time period, stocks has never lost money (in North America) and it have always outperformed bonds. The historic rate of return for bonds is about 2% and the historic rate of return for stocks is about 8%.

It is suggested that, as we age, our bond portion should increase and our stock portion should decrease.

Why would you shoot yourself in the foot

Many advisers, recommend to start adding bonds to your portfolio as early as age 20. Really? A person in their 20s has about 60 more years of life and already a financial adviser is handicapping the growth potential of his portfolio.

Another advice which kills me is to have about 65% of your portfolio in bonds at the time the person retires at 65 years old. Really? A person who made it to 65 could easily live past 90. So for 25 years, the growth will be hampered.

My personal situation

As I mentioned, 50% of my portfolio is in real estate. Eventually, I will sell my real estate and I will be 100% in stocks. I am planning to hold stocks until the day I die. I will not have bonds. The price to pay for reduced volatility is simply too high.

Coaching services

I am a money coach, don’t hesitate to write me if you want to talk about money or anything else that is going on in your life.