All posts by Alain Guillot

About Alain Guillot

My name is Alain Guillot. I was born in Colombia. I speak and write three languages (Spanish, English and French), but none of them very well. If my friends don't edit my writing you will find many spelling mistakes, for that I apologize. I created this blog either because I like to share my thought with the rest of the world, or because I am in constant need of attention, it fluctuates from one extreme to the other in any given day. The subjects that I like to discuss are: the stock market, tango dancing, real estate, marketing, writing, public speaking. I also venture into politics and religion but not as much as I would like ( I am afraid of the reaction that my comments could create). Please feel free to contact me through any of the social media, my email or the comments section after each blog.

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.

At what point should you start adding bonds to your portfolio

Preparing for winter

I advocate not to have bonds in a portfolio, but the conventional wisdom is to have a portfolio of stocks and bonds.

Let’s clarify a few points:

  1. Stock are not more risky than bond in any 10-20 years time period, they are just more volatile.
  2. Stocks produce a higher return than bonds.

If stocks are not more risky than bonds and if they give higher return than bonds, why should anyone own bonds? Because they reduce volatility, because with smaller ups and downs an investor is better able to withstand the changes of the market.

Let’s assume a portfolio of 50-50 stocks and bonds. Let’s assume that the expected return of stocks is 8% and the the expected return of bonds is 2%. The expected return of your portfolio is 5%.

What I suggest is to put 100% of your portfolio in stocks. then draw a line that goes up at the rate of 5% per year. This means that if you start your portfolio with $100,000, by the end of the year you should have $105,000.

Here is an example the Toronto Stock Exchange vs. a 6% growth line.


In this example, I overlap the real returns with the 6% growth line. If the returns are in excess of the 6% line, they are not to be considered are part of your assets, they are meant to be considered as insurance money, or protection against a downturn. Just like you don’t consider the money that you pay in insurance as part of your assets.

If the returns are less than the 6% line, then you just have to be patient and have faith that eventually the returns will catch up.

All that being said, you think  you should own some bonds. At what stage should you add bonds to your portfolio?

Most financial advisers suggest adding bonds as percentage of your assets as you grow older. They will say that if you are 60 years old, you should have (for example sake) 60% of your portfolio in bonds, and the older you get, the biggest the percentage of bonds you should have.

But let’s be realistic. If you only have $100,000 at age 60, you don’t have much money to protect and therefore, you should be more concerned with growing your portfolio than protecting it. On the other hand, if you have $5,000,000. You don’t care about making more money, you care about protecting your assets and you could easily be 100% in bonds.

Actual amount of money matter more than percentages.

So here is the question again: At what stage should you add bonds to your portfolio?

Answer: When you have reached your capital objective.

Let’s say that you believe that to retire you want to have $500,000 in your bank account. After years of hard work you have reached the amount of $500,000. Then, the next step should be to start protecting your asset.

Let’s say that your portfolio of $500,000 grew 8% in one year. That would be $40,000. You would sell about $40,000 worth of stocks and buy some bonds. And do that for every year thereafter until you reach a level of dampen volatility which will make you feel good at night.

Disclaimer: Of course, this is my way of thinking which fits my risk profile. I am not saying you should do the same or that you should follow my example. You may have different risk tolerance or time frame.

The way that I think about it is that first you want to make your money and then you want to protect it. As you grow your assets you should keep in mind that there is an strategy to make your money, and there is another strategy to conserve your money. You don’t want to be too conservative if you have very little to protect and you don’t want to take risks if you don’t have to.

There is no solution for income inequality

There are two seasons in Canada: Winter and July.

Social inequality is nothing new, it has existed since the beginning of civilization. Some people like to focus on building wealth and some people focus in other activities other than building wealth.

Here is a short excerpt for Plutarch in the year 594: “the disparity of fortune between the rich and the poor had reached its height, so that the city seemed to be in a dangerous condition, and no other means for freeing it from disturbances… seemed possible but despotic power.”

No only has income inequality existed for thousands of years, but it has existed in all the geographical areas of the globe. In short, income inequality is just one more trait of humankind.

And why wouldn’t it exist? Business people who like to accumulate capital practice their craft with the same tenacity that a pianist practice his scales, or a painter practice his techniques. If a musician gets better with each practice session, shouldn’t a capital accumulator get better with each business deal? Imagine that we tell a guitarist who practice 8 hours per day, that he has to give half of his skills to someone who only practice 30 minutes per week. It doesn’t make sense, but we don’t think twice to tax a business person more that 50% of his income to re-distribute his wealth.

We live in North America, a land full of opportunities and choices.

You present two college students with two career options. One career pays $80K per year and the other pays $35K per year. One student picks the career which is better paid and the other picks the career which is less well paid. These are choices these students took out of their own free will. One student is going to earn more than the other one. Why should we penalize him/her by taking some of his earnings away?

Two consumers are presented with two smart phones, an iPhone and an Android. One cost almost $1,000 and the other one cost about $100. Both of the phone do phone calls, text, Facebook and YouTube just the same. One buys the iPhone and the other buys the Android and invest the savings. For sure, after 10 years, the one who invested the money will be better off. Why should that person be penalized.

There are two apartment renters, each one renting a two-bedroom apartment. One uses the extra bedroom as an office/storage room. The other one uses the extra room to rent it to a friend. One is going to accumulate more money that the other one every month. Why should we penalize his money making decision?

Income inequality will never go away. We should not penalize a person for making a decision which will benefit him/her financially. Instead, we should educate people to become more savvy consumer, better informed investors. We should teach people about the magic of compound interest, about  investments, about how to become better consumers and don’t waste money on brands.

Once we do a better job educating people about the investments opportunity presented at their feet every day, then we will have a better chance of reducing income inequality.

Investing in commodities is worse that dead money

Smoking shisha with friends

Most financial advisers recommend capital diversification between two asset classes: stocks and bonds. But every now and then I see some financial advisers recommending two additional asset classes: real estate and commodities.

A common portfolio including those additional would look like this:

  • Stocks: X%
  • Bonds: X%
  • Real estate: X%
  • Commodities: X%

In previous articles I have explained why I don’t like investing in bonds. I think the opportunity cost is too high. In the long run stocks outperform bonds and stocks are NOT more risky than bonds, they are just a more volatile.

In previous articles I have also mentioned that I invest in real estate. In particular, I own a condo in the coolest neighborhood of Montreal. Obviously, I like real state as an investment. As long as the tenants pay the rent on time and don’t destroy your property, it’s a sweet business.

One asset class which I dislike worse that bonds is commodities.

what are commodities?

Commodities are standardized raw materials or products such as wheat, sugar, corn, coffee, cocoa, oil, gold, copper, etc.

How do people make money with commodities?

Investors speculate on whether the prices of any one of those commodities will go up or down. If they think the price of of corn will go up they buy corn. If they think they price of corn will go down they sell corn. If their speculation works out, they make a ton of money. If their speculation doesn’t work out, they lose a ton of money.

Why I don’t like commodities as a long term part of your portfolio?

Commodities is a zero sum game. For every trade there is a winner and a loser. If we add commissions into the equation, on the long run, investing in commodities is a losing game.

When you invest in stocks, you get dividends or the price of your stock goes up as the company retains earnings. See article on what kind of return to expect from the stock market.

When you invest in bonds, you get paid interest.

When you invest in real estate you get rent.

When you invest in commodities you get nothing.

Let’s say you buy a bar or gold. You hide it under your bed. 10 years later, you look under the bed and you see the same bar of god. You don’t see a bar and a half, you don’t see two bars, none of that… Your bar of gold has remained the same. You check  the price of gold and most likely your bar of gold has increased in value at the same rate as inflation. Nothing more, nothing less. If your investment is going to grow at the rate of inflation, you might as well buy government bonds.

See article on why investing in gold is a bad idea.

There are similar scenarios for all kind of commodities. They have violent swings up or down, but if you look at any long term chart, on a 20 year period or longer, the value doesn’t go up higher than inflation.

Summary

My ultimate recommendation is to continue piling up your money in real estate and stocks. You will continue getting dividends checks or rent checks. Let the money continue working for you. 🙂

 

How to chose a mutual fund

With my friend at the military academy

Mutual funds is one of the most flexible and available financial products for new investors. They are within the reach of practically any one. With as little a $25/month, anyone can get started.

See my previous article about what are mutual funds.

Let’s say that you decide to get started investing in mutual funds. Open your browser, type “mutual funds” and you will be presented with myriad of options. There are more mutual funds than stocks in the stock market.

The first step is to ignore all the mutual funds which are advertised. The reason is  that these funds take money from the pocket of investors to buy advertisement. Not only the fund pays for advertising, but they also pay handsome yearly commissions to the financial advisers (financial product pushers) who sells it to you. These commission are often called trailer fees and they about 1% per year.

How much are you paying in management fees

Most mutual funds in Canada have management fees of between 2% to 3%. You should avoid those at all cost. Canadian mutual fund companies should be ashamed to charge such ridiculous high prices.Those generous commission are coming out of the pocket of the investor year after year.

Unfortunately, those are the mutual funds which most financial advisers (financial product pushers) will recommend to the public, the reason is that those are the products which will pay the highest commission.

Here is a rule of thumb. If the management fee is more that 0.5%, run away. Don’t even consider it.

Actively managed funds under perform index funds by a lot

By this time I have read hundreds of reports claiming that most actively managed funds do not beat the index. Some reports say that 75% of actively managed funds under perform, other reports say that 90% of actively managers under perform. It doesn’t matter… The conclusion is that the investor is better off investing in index funds than on actively managed funds.

Steps to invest in Index funds

All major Canadian banks are catching up with the index fund reality. Most of the time they will not promote their index funds, they rather promote their actively managed funds. But all of them have their own version of index funds, you just have to ask for it. Look or ask for funds with this keywords: “Canadian Index,” “US index,” and so on.

Some banks offer index funds with expense ratio of more than 0.5%, simply ignore those funds and go with the bank who is offering index funds that cost 0.5% or less. Remember, the more you pay the bank, the less that it’s left over for you.

What are Mutual Funds

Giving a speech at local Toastmaster club

One of the best financial instruments to get started as an investor are mutual funds.

How a mutual fund operates

An investment company solicits investments from many investors. Those investments can be  as small as $25 per month. This is what makes mutual fund so appealing, that it is within the reach of practically anyone who can put together a small amount of money.

The money collected is is used to make investments, generally of stocks, but also bonds and other securities. A professional mutual fund manager is the person in charge of making daily investments decisions.

Having a large pool of money allows the money manager to diversify into many investments. Small investors generally don’t have the capital to invest in hundreds of different companies. Also, small investors don’t have the time nor expertise to research hundreds of companies.

Different focus of mutual funds

Many mutual funds companies have different focus of interest. For example, some funds may invest in technology companies, other funds may invest in dividend paying stocks, other may invest is small stock. It is up to the investor to decide which of those investments philosophies he/she prefers and then buy the mutual fund which reflects that philosophy.

Advantages of mutual funds

One of the big advantages of mutual funds is the elimination or reduction of single stock risk. Those who once owned Nortel, Enron, or Blackberry are well aware of the single stock risk. Single stock risk exist when an investor can lose a significant amount of money because the single stock they own, has a big decline in price. By having hundreds of stocks, the single stock risk is greatly diminished.

Disadvantages of Mutual funds

However, mutual funds are risky and many of them could do so bad that they could be closed down. It is quite possible to lose 50% or more of your money when investing in mutual funds.

Another big disadvantage of owning mutual funds is their high fees. Canada has one of the highest mutual funds fees in the world. While you, the investor, are putting your money at risk, the mutual fund company could easily eat away more than 50% of your profit. It’s very important to make sure your fees are low. Most Canadian mutual fund charge between 2% to 3% in fees. This is outrageous, they should be ashamed of themselves, but is it also, the generally public faults.

Side note: I have a friend, who continues investing in expensive mutual funds because the mutual fund salesperson invited him to a nice steak dinner.

Look for low fee index funds

If you are interested in mutual funds, make sure you don’t pay more than 1% in management fees. There are many alternatives out there.

It has been proven over time that most active managers don’t beat the benchmark to which their funds are compared. For example, a Canadian mutual fund may be compared to the Canadian stock market index. Most mutual fund don’t beat their benchmark because of their high fees or because of many other mutual funds inefficiencies.

The solution to diversify your investment and pay a low fee is to invest in a mutual fund which follow the national index. For example, in Canada, I would invest in a mutual fund which follows the the Toronto Stock Exchange 300. In the US, I would invest in a mutual funds which follows the S&P 500. The fee for this kind of funds is generally 0.10% or less.

Historically the US market and Canadian market have grown at the rate of over 8% per year. If you subtract the index fund expense of 0.10% then you will be left over with a profit of 7.9% or more. This is a more interesting scenario than paying 2 to 3% in fees to a mutual fund a mutual fund manager.