Canadian Capitalist

59 responses so far ↓

• 1 Michael James // Jun 16, 2008 at 9:16 pm

  This is an excellent analysis of who really benefits with the Smith Manoeuvre. A good rule of thumb is if it’s complicated, someone other than me is making money.

• 2 The Financial Blogger // Jun 16, 2008 at 9:19 pm

  It is true that both the advisor and the banker (I would even add the accountant!) benefit from the Smith Manoeuvre. However, I don’t think that market will only do 4-5%.

  And if so, why not just taking GIC’s at the same rate then? Or buy rental properties which gave back the same returns (4-5%) for the past 50 years?

  If you invest and make 7% and more, then, the Smith Manoeuvre will become beneficial for you as well.

  By the way, it is the same situation for any financial products (loans, mutual funds, brokerage account, insurance), regardless of the SM strategy

• 3 squawkfox // Jun 16, 2008 at 9:43 pm

  I tend to keep anything involving a “manoeuvre” out of my portfolio.

• 4 Traciatim // Jun 16, 2008 at 9:46 pm

  I think there may be some confusion here. For one, in order for the loan to be tax deductible it needs to be invested for income. So therefore, capital gains are out as the primary reason for investing.

  This leaves dividends and interest income. So bonds and shares that produce dividends, or a business loan or something (I wonder about Peer to peer loans). Though capital gains can be part of the picture, the main goal can’t be as far as I thought.

  Also, I believe the actual definition of the ’smith manoeuvre’ was if for instance you have a 100K mortgage, 100K in assets, and a 200K house. You sell all of your assets, pay off your mortgage, borrow back the money to buy the assets and voila, tax deductible mortgage. If it isn’t done in this order, it’s just borrowing to invest, or some other catchy plan. Possibly I’m just way out in left field though.

  I really like the borrowing to invest by using your home idea though. I would really like to get ramped up with a loan to invest in dividend payers and then use the dividends to fund my RRSP taking a tax deduction that I put in a TFSA, that I borrow against to buy more dividend payers . . . and I call my plan ‘the great circle of investing’. I just hope the great circle doesn’t turn in to a black hole.

• 5 Neil // Jun 16, 2008 at 9:56 pm

  Can you explain what “taxed on an ongoing basis” means?

• 6 slickvguy // Jun 16, 2008 at 11:05 pm

  As a financial advisor, I applaud you.

  This “smith manoeuvre” is nothing more than a leverage againt your home, being marketed heavily by my advisor brother and sisters - much to my disgust. I do not sell them. Period. The ONLY time I would consider selling them (and have sold a few in the past) is when a) the market has taken a MAJOR hit, and b) the client is financially secure, has VERY stable income, and the right temperment. Im’ pleased to report that the few I’ve done over the years turned out very well. I’ve seen horror stories though.

  You are 100% correct that the reason these are being pushed so heavily by the salesmen masquerading as financial aadvisors is because it generates commission out of thin air. How else do you make a $5,000 gross commission when the prospect has no more money?

  Aside from the reasons you mentioned (all valid, btw), there are other reasons why these are bad strategies for the average investor to pursue. The most important one is that the average investor does *NOT* have the stomach to keep paying monthly interest payments while (if) his portfolio is under water. How many years of payments will Client X continue to make while his $100k investment is worth $85K (which would be just a small amount of volatility to the downside)? Most people will get fed up, shut down the loan, and take the loss.

  The type of client this is best for is not a mutual fund client at all - they are more the type who take matters into their own hands. The DIYers. Why? Because those people have the knowledge and temperment to stick with the strategy through thick and thin, and will minimize fees. Because over the long run, it’s a sound strategy, but only for certain people at certain times. Range-bound markets (like we have now) or declining markets will kill ya. High mgmt fees will kill ya. Wrong temperment will kill ya.

  Keep up the good work.

• 7 Canadian Capitalist // Jun 16, 2008 at 11:12 pm

  Michael: The SM seemed to be more popular last year after 5 years of 20% equity returns and an average prime rate of 5%. It is not reasonable to expect that wonderful state of affairs to last forever.

  FB: I don’t understand your comment about 7% return. Is that nominal or real expected return from equities? Prof. Siegel himself says that the 7% real return from equities is a thing of the past and not a reasonable expectation now.

  I’m not sure I understand your GIC comment either. If you’re saying that someone paying 2.5% in MERs is better off with GICs, I’m in agreement

  Traciatim: I am no accountant but I believe that even stocks that don’t pay a dividend today pass the “reasonable expectation of profit” test because they can be expected to someday pay a dividend.

  The strict interpretation of SM means that only the principal portion of mortgage is taken out as an investment loan with every mortgage payment. The version you are describing is SM + an initial leverage.

  Neil: Capital gains tax is due only when you sell and can be deferred at your discretion i.e. you have complete control over when you want to trigger capital gains and pay a tax. Dividends, on the other hand, are paid regularly and taxed on an yearly basis.

• 8 DAvid // Jun 17, 2008 at 12:00 am

  Traciatim,
  You have described the ‘Singelton Shuffle’ where business equity is withdrawn to pay a mortgage, then the mortgage is used to fund investment in the company. The Smith Manoeuvre is the incremental invstment in a portfolio one principal payment at a time.

  DAvid

• 9 millionaireby45 // Jun 17, 2008 at 4:09 am

  “Prof. Siegel himself says that the 7% real return from equities is a thing of the past and not a reasonable expectation now.”

  I will provide you with quotes from “EXPERTS” who state that the US is in a huge recession and to not expect positive returns in the near future. I can also provide quotes from “EXPERTS” who state that now is the time to invest and you will not find another opportunity like this in the near future. Quoting one economist does not make your statement correct. As an example, 30 leading economist were poled within the last month to determine rather interest rates would rise or fall or remain the same in Canada. All 30 agreed that interest rates would be cut by at least .25%. Guess what? All 30 economists were wrong.

  Will I guarantee 10% returns over the next 10 years? NO!!!!

  However, anyone who says this time is different is kidding themselves.

  History has a way of repeating itself and I believe that the market is no different. Historically, the market has returned at least 10 %.

  I would not bet my lifetime savings on this return but I would not “Not Invest in the Stock Market” because I believe that the market will not be stagnant. If the market took a downturn and provided only a 7% return over the next 25 years, than I would still be very happy and better off after implementing the SM manouevre.

  The tax implications are not complicated as many would want you to believe. Your mortgage is not tax deductible. Basically, you are borrowing to invest.

  My last two comments.

  1) I would never use Mutual Funds as part of an SM Strategy. By investing in ETF’s, the MER’s are approx 0.5% on average. If you use Mutual Funds, than choose a Mutual Fund that has exceeded the comparative index which it follows over the last 5 years at least.

  2) If you choose the SM strategy than be aware that in any quarter or year, your investment may decrease but over a longer period of time, historically, you should always benefit.
  It takes a lot of discipline and time. I agree that it is not for most people. You need a lot of time and acceptance of risk. You WILL NOT get rich quick but if you have the discipline than it will benefit you to use this strategy.

  When you leverage you are taking on excess risk, however this risk is mitigated by diversifying and having a long range outlook.

  Just my two cents.

  Although you may be shocked, I have been wrong before. This is my opinion and for myself, I feel that the SM is a great strategy. I am currently implementing this strategy ( as you may have guessed) and although I am not 100% confident that it will provide positive results, the risk outway the rewards in my circumstance.

  Cheers,

  Millionaireby45

• 10 The Financial Blogger // Jun 17, 2008 at 6:54 am

  CC, I am doing 13% (that would make about a net 8% after inflation and interest charges) annualized return since I started my Smith Manoeuvre in February 2007.

  While 1 year is definitely not enough to look at returns, I still made it while the market was going down the toilet.

  I don’t get why people would risk their money on the market to expect a small 4% or 5% when you get can GIC’s giving 4% anyways. There is no point in investing in the market if you believe you won’t get more than 5%! Pay off your debts (that are probably all more than 4%) and invest in GIC’s and you would get a 4-5% return anyway.

  On the other side, the SM is definitely not for everybody. It should be offered only to clients who are considered aggressive investors, have a lot of cash flow and a decent net worth. This is the case of any leverage strategy.

• 11 consigliere // Jun 17, 2008 at 7:44 am

  Leverage is dangerous, and the people recommending and implementing this strategy are usually not sophisticated enough to understand the risks they are taking.

  What I find very distasteful is the branding. This was a well known strategy long before it was called the “Smith Manouevre”. I laugh at some advisors who present this as the “next big thing.”

  Warning to all: beware investing in anything involving a return of capital (income trusts, REITs, etc). This may limit your interest deductibility.

  Add the tax reassessment risk to all the risks outlined above and most people should not be doing this.

• 12 Canadian Capitalist // Jun 17, 2008 at 8:03 am

  slickvguy: I totally agree with you about people feeling differently about their risk tolerance when they’ve just “lost” a huge chunk of money. Mr. Smith never addresses this risk in his book either.

  Millionaireby45: “Historically, the market has returned at least 10 %.”

  That’s incorrect. Real stock returns have ranged from 16.9% to -4.1% over 10 year holding periods from 1802 to 2006. Over 20 years the range is 12.6% to 1.0%. Over 30 years, the range is 10.6% to 2.6%. Source: Stocks for the Long Run

  “If you use Mutual Funds, than choose a Mutual Fund that has exceeded the comparative index which it follows over the last 5 years at least.”

  Many studies have shown that past out performance of a mutual fund is unlikely to persist.

  “I would never use Mutual Funds as part of an SM Strategy. By investing in ETF’s, the MER’s are approx 0.5% on average.”

  I think our views are quite similar. I did note that without a 2.5% performance penalty to your average mutual fund, the SM might be worthwhile for a DIY investor even in a low-return environment.

  FB: I’m talking about *real* i.e. inflation-adjusted returns. You’re talking about nominal returns. The 4% to 5% number is the average return from stocks after subtracting inflation over a long time period. Add up 2% to 3% inflation to end up with a 6% to 8% nominal return expectations from stocks.

  For a investor just investing his savings, a 2% extra return is worth the risk of being in equities. For a leveraged investor, the dynamics are totally different because you only keep the difference between stock returns and what you pay the bank and the middlemen.

• 13 slickvguy // Jun 17, 2008 at 10:16 am

  ““If you use Mutual Funds, than choose a Mutual Fund that has exceeded the comparative index which it follows over the last 5 years at least.””

  This is typical thinking for amateurs. It is absolutely wrong.
  Unfortunately, and in spite of what most advisors say/think and what most mutual fund investor’s think, there is no way to predict WHICH mutual fund will perform well in the future. Past performance is meaningless. People are unwilling to accept this simple truth. No matter how much evidence to the contrary, they believe they can pick the “winning horse”.

  This is one of the reasons that mutual fund investing is a poor choice. The main problem is the ridiclously high fees. You cannot have an annual vig of 2% to 3% grinding away month after month on your portfolio and expect to perform well. Do the math. But you also have such a low chance of choosing a mutual fund that will perform well (I’m not even talking about “outperform”, which is impossible to pick. If you are lucky enough to be in a fund that has consistently outperformed it’s benchmark, you need to accept that you got lucky, and that it’s not repeatable). People just don’t want to accept what a crap shoot it is. There are maybe a handful of money managers in Canada who I believe have consistently ourperformed and said performance cannot be completely attributed to pure luck/randomness. But AFTER you identify them, there is still a very poor chance of their outperformance continuing over longer periods of time into the future. Of the few who are true outperformers, the mgmt fee robs you of the edge.

  What to do? Listen to WEB. It’s amazing that here is this man who is probably the world’s greatest investor, and he speeks frequently about how he does it, yet so few LISTEN to what he is saying. It’s simple, folks. UNless you are the 1 in a million human being who is wired for success in investing, invest in a diverse, cheap, and low-tax array of investments. ETFs and index funds will do fine. The vast majority of market participants are hopelessly ignorant and out of their league, but since humans seem unwilling to accept that truth about themselves, the WEBs of the world will profit from it. It’s as silly as me trying to compete against Tiger Woods. Yet, that is precisely what every avg Joe investor/trader is doing. it’s one giant poker game, folks, and YOU are the dupe. SO, listen to WEB. Either you are in the league of a WEB, in which case you can pick individual stocks yourself, or you best diversify as cheaply as possible. The other alternative is to find a CHEAP and tax-efficient excellent money manager. That means NO mutual funds in Canada. BRK and the like are good alternatives.

  The funny thing is that most investors (and clients) that I know would be very glad to achieve long run returns anywhere near the performance of the indices. I don’t know any who have even come close. Yet, they just cannot help themselves from “playing the game”, regardless of how poor the outcome is. They just can’t sit on their hands. Thus, it has much more to do with satisfying psychological and emotional itches than portfolio return. Which is why they don’t do the right thing (which keeps the casino, aka wall st., in business).

  Food for thought from an advisor of nearly 20 years.

• 14 slickvguy // Jun 17, 2008 at 10:27 am

  “Historically, the market has returned at least 10 %.
  ”

  If you’re going to talk about performance, it would help if you defined clearly which market and what timeframe you are talkgin about. There’s no such a thing as “the market”. And without specifying which time periods you are talking about, you are really just speaking in incredibly vague and general terms which is meaningless.

  Also, real returns matter - not nominal.
  e.g. 10% returns with inflation of 8% is nothing to celebrate.

  Last, even if the data showed long-term 10% total returns for certain indexes, it has NOTHING to do with what YOUR return will be!!! I wish people would realize this. I find it so annoying to have to explain it over and over.

  Fees. Taxes.

  Total return indexes re-invest dividends. Investors may or may not, and they usually pay fees when they do re-invest (whether it be commission or mgmt fees).

  Taxation takes away a HUGE chunk of your return (in various ways and at various times). How can anyone compare a tax-free fantasy return of an index.

  Plus, underperformance of most investments vs. the indices.

  Oh, let’s not forget to mention currency too. Oops.

  And also, you need to remember that indexes are lists of SURVIVORS, i.e. the huge losers are dropped from the index. That’s one hellvua way to always win! lmao.

  On and on the list goes. It is LAUGHABLE to think that you will get an actual return anywhere near the long-term total return of a major index. Indexes are a fantasy.

• 15 Canadian Capitalist // Jun 17, 2008 at 11:00 am

  slickvguy: You must be a pretty rare advisor and your clients are lucky to have you managing their money. I simply can’t understand why most advisors won’t build passive portfolios for clients in return for fair compensation. Unfortunately though, most “advisors” are really commissioned salespeople providing services of dubious benefit for the investing public.

• 16 Unspending // Jun 17, 2008 at 11:22 am

  I have asolutely no idea what you just wrote. My goal is to one day understand all things financial, including what “tax arbitrage between the deduction from income of interest paid and the capital gains tax rate on investment income” means.

  I like your blog a lot. I don’t always understand it but it constantly reminds me of how much more I have to learn about the wacky world of finance. Thanks!

• 17 mcf // Jun 17, 2008 at 11:49 am

  The message I got from this article is that any financial strategy is expensive when packaged by financial advisors. Going back to the example, if the proceeds were invested in the sleepy portfolio (MER under 0.5%), and the money borrowed from a variable rate mortgage instead (rates 0.5% below line of credit rates), we would get the “not too bad” real return of 2.5%.

  Granted it would be expensive to reinvest on a monthly basis, but more reasonable annually or semi-annually.

• 18 Canadian Capitalist // Jun 17, 2008 at 12:12 pm

  Hi Unspending: Thanks for visiting and your comment. I’ve written many posts on Smith Manoeuvre and skipped over the details covered in other posts.

  The tax arbitrage refers to the different treatment that tax deductible interest expense receives when compared to capital gains income. When you borrow money to invest, subject to strict conditions, you are allowed to deduct 100% of the interest you paid on the loan from your income. If your borrowed $1,000 to invest at 10% and you pay taxes at a marginal rate (i.e. your highest tax bracket, let’s say it is 40%), you would have spend $100 in paying interest on the loan over one year. But, since you can deduct the interest expense from your income, your actual cost is only $60 (you get $40 back from the tax man).

  Now suppose that you used the same $1,000 to invest in stocks and made a $100 profit when you sold it at the end of the year. You have a capital gains of $100. But only 50% is taxable and at your 40% marginal rate, you’ll pay a tax of $20, leaving you with $80.

  On the actual investment you haven’t made any money. You borrowed at 10% and made 10%. But due to different tax treatment, you are left with $20 in your pocket. That’s tax arbitrage.

  I hope this makes it clear. Feel free to ask for clarification on anything. Cheers!

• 19 Millionaireby45 // Jun 17, 2008 at 1:29 pm

  CC,

  Great article and some great comments. Although I may have differing opinions on varying comments that have been posted, it allows me to re-evaluate my investing decisions and goals and provides an alternate view to my investment philosophy. By doing so, it forces me to go back and review all of my assumptions, goals, and decisions. This can only be a good thing.

  One comment that has been mentioned a few times that I totally agree with is “about people feeling differently about their risk tolerance when they’ve just “lost” a huge chunk of money”.

  My portfolio has performed quite well over the past 7 years (~12% annualized return) with my best year being 22% and my worst year being -8%. It was much easier to justify being in the SM when I made 22% than when I lost 8%. You definitely have to have a very high risk tolerance and be honest with yourself.

  My advice:

  1) Be honest with yourself and set realistic goals.
  2) Before investing in anything, ask yourself what the maximum downside can be and what you plan on doing if the worst does happen.
  3) Do the benefits out way the risks? If you feel that they do not then choose a different investment philosophy.

  Cheers,

  Millionaireby45

• 20 slickvguy // Jun 17, 2008 at 3:59 pm

  Thanks for the kind words, CC.

  But the truth is that while I’m probably one of the most honest advisors you’ll ever come across - I always tell my clients the truth - I’m still part of an industry (scam?) that I’ve become very disenchanted with.

  I’ve considered making a change of some sort for quite some time (maybe go fee-based?) - but the bills have to be paid too. I’m not a big producer (don’t like “selling” and I’m not much of a “people person”) though I make a pretty good living. It’s a difficult situation, especially since the public is also a large part of the problem. For example, most people prefer the cuirrent system wherer they pay a very high fee that is buried/hidden in the NAVPS - rather than a lower fee billed directly. “Out of sight, out of mind”. How do I deal with such irrational thinking? I’d like to charge a flat fee per client and just manage and advise them on what I think is best for them. Total impartiality. I hate to say it, but even most of my clients (who are better clients than average) wouldnt’ appreciate what Im’ trying to do for them or the difference versus their current holdings. People who are DIYers and read sites like this one are the exception.

  I’m really not sure what to do at this point. Any and all suggestions welcome.

• 21 slickvguy // Jun 17, 2008 at 4:23 pm

  MB45,

  I have no way of knowing what you’re invested in (unless you want to disclose it), but if you’ve only experienced an 8% decline (is that peak-to-trough or annualized?) - then you haven’t really tested your stomach yet. Try -30%, then get back to me. j/k.

  You seem like a thoughtful well-informed person, so for you this might be a very good strategy.

  The problem isnt’ the strategy. It’s the tin-man approach to trying to sell it to everyone. I’ve been approached to push this nonsense - I laughed in the fund stooges face. It’s just plain irresponisble and unethical. They are pushing these things on people who do not understand them and are not prepared for what is going to happen. I know reps who sweep their client base with the sole purpose of jamming these leverages down their mainly inexperienced clients’ throats. It’s a great way to make fast, big commissions. And there’s no problem until/unless the client goes underwater. That’s one reason it’s so important to get off to a good start. Because if you put a client with $100k of borrowed money into a basket of mutual funds that decliunes by 15% their first year, they are going to be very unhappy. No matter what clients tell you about accepting risk BEFORE they make an investment, almost every one of them can’t handle the true downside. Can’t blame the reps for that. Most investors are ignorant and totally unrealistic about investing no matter how hard we try to teach them. There’s two sides to teh coin. I read a lot of advisor bashing on DIY sites. And most of it’s justified. lol. But what’s missing is the other side. Way too biased. From our perspective, clients are nuts. Most advisors I know are good people. Basically honest. Trying to make a living. They didn’t create the Canadian financial system. They are just cogs in the big machine. And they try to do right by their clients. But it’s very difficult when people refuse to accept reposnibility, don’t educate themselves, aren’t mature, don’t look at the long-term, etc. You’re dealing with people’s money - a very emotional thing! Clients are so irrational. I’ve been at it for almost 20 years. It hasn’t changed. They all say they want this and that, but when their funds go down, they whine like it’s the end of the world. Totally unrealistic expectations. And the regularotry agencies put all the onus on teh advisors - instead of on the clients. It’s that lack of personal responsibility and participation that works against both the advisor AND the client. Clients don’t want to know, they just say “I trust you - where should I put my money”. And then when you do, if it works out, great, but if it doesn’t - they complain. And the KNow Your Client form is a farce. The govt would have us believe that a form with a few checkboxes can clarify and communicate an investor’s complex and frequently irrational ideas on risk tolerance, etc.??? Ridiculous. Trust me - the advisors are in a very difficult position. Clients are always complaining. Make them money - it’s never enough. Lose money - you took took much risk! It’s a no-win situation. People on sites like this are by and large MUCH more responsible than the average investor/client. Please bear that in mind. I have little old ladies who have given me their life savings to invest. It’s a huge responsibility. You try to do your best, but I’m not God - I don’t control the markets. Their ignroance is a BAD thing for them and for me. And no matter how many times I teach them the fundamentals, it goes in one ear and out the other.

  It’s the financial institutions and the govt. that you should set your sights on. *THEY* are the ones who are perpetrating this “scam”. It’s the clients and the advisors who are the low men on the totem poles. The brokerage houses, dealers, mutual fund distributors, and regulatory agencies get away with murder. And guess who is stuck/squeezed by ALL parties? Yep - the advisor. And dont’ forget, the advisor does not keep the gross commission! Depends on teh dealer, but some places onyl payout 50%. So on a commission that generates $5k gross, the advisor will get $2,500. Then he has all sorts of fees to pay, licenses, liability insurance, educational credits to get every 2 years which costs time and money, and finally income taxes. Most advisors do not make such a great living. A handful of “superstars” make huge amounts of money. They are marketing machines. The rest are very average in terms of income.

  Sorry if I’ve hijacked this comments section. Just thought that people should get an advisor’s perspective on things. I rarely see that on financial websites.

• 22 venter // Jun 17, 2008 at 5:12 pm

  slikvguy, bravo. I am also an advisor (1.5 years only) and agree with everything you said. I didn’t change careers at age 50 (I’m a biochemist by trade) to become rich on the backs of the unwashed masses. I really thought I could help people make intelligent investment choices, budget, save, protect their assets etc. Like you said MOST of us do the best we can given the tools we have. I do lots of things for clients that I don’t get paid for because they are my clients and need the help. I get really tired of reading in all the financial blogs about evil, greedy advisor’s. If we were an ethnic group or gay we would have a strong discrimination case

• 23 Canadian Capitalist // Jun 17, 2008 at 5:56 pm

  slickvguy, venter: I agree with your viewpoints that clients should take responsibility for their finances as well and take the effort to learn the basics. I hear you loud and clear that many clients have unrealistic expectations (”I want 10% with NO risk!”) and they’ll probably end up with an advisor who says that it is achievable. And you could say, the advisor and client deserve each other!

  My point is never that an advisor shouldn’t make fair compensation for his or her services. If an investor is not willing to DIY, they should be prepared to pay someone to do it.

  But it does bother me when I see “advisors” who haven’t done basic things for clients such as setting up an asset allocation or writing down a IPS. Or when they make unrealistic claims about the SM. Clearly, you guys don’t fall under this category but such people exist. Of course, that doesn’t mean every advisor is “evil” or “greedy”. The world is too complicated to be just black or white.

• 24 Aleks // Jun 17, 2008 at 6:54 pm

  This sort of thing reminds me of the ads you see in February for RRSP loans. The bank gets to loan you money to buy their funds; they get you coming and going.

• 25 Thicken My Wallet // Jun 17, 2008 at 7:16 pm

  I have written this before but if you yield below average returns doing whatever you are doing investing then don’t complicate matters by trying a SM or analogous structures. It is analogous to barely being able to ride a bike and then getting on a unicycle. The law of averages dictates you will fall.

  If you have success with SM then congrats but it is fool-hardy to try to convince people of that they should engage in a SM unless they are in the exact same context as you.

  Another interesting post.

• 26 The Financial Blogger // Jun 17, 2008 at 8:13 pm

  CC; that makes a lot more sense Still I think that our economic situation is no different then the past 15 crisis we had. It is always the same thing; “experts” claim it is the end of the world. Maybe one day they will be right

• 27 Canadian Capitalist // Jun 17, 2008 at 8:55 pm

  FB: Well, among the experts who think equity returns will be low is one guy who has a pretty good track record in such matters - Warren Buffett. The logic is pretty simple: we’re starting off with low dividend yield of 2%. Add to that a 5% earnings growth rate (similar to earnings growth in the past) and valuations remaining where they are today and you get a 7% expected return from equities.

  The investors in the “better than 7% to 8%” returns camp should have a better justification for their expectation than simply saying “that’s how it was in the past” because they are forgetting that there have been long stretches in the past with poor equity returns. The past 25 to 30 years have been extraordinarily good for stocks because of ever rising valuations. But valuations don’t go up forever. Just look at the S&P 500 performance from 2000 to 2008 to see what decreasing valuations can do to the stock market.

• 28 slickvguy // Jun 17, 2008 at 11:53 pm

  Nobody can predict what future rates of return will be.
  The past does not predict the future. The future might be similar to the past, but not BECAUSE of the past. Hope that’s clear. We do not know what the future will bring. We merely project the future based on the past. Dumb.

  You also can’t predict inflation rates, taxation rates, etc.
  For example, Quebec already took away a lot of the incentive for leverages. The Fed might follow.

  Are you aware of what the CAD$ S&P500 has returned over the past 10 years? $10,000 invested would be worth $7,842. Ouch. How about in US$? $11,618. That’s right …a mere 16% total return over 10 years. Would have been far better off in t-bills. So much for the past predicting the future, eh? The past NEVER predicts the future. It’s just that they are sometimes similar. How could they not be?

  As mentioned before, the main reason the leverage works over the long run is because the rate of tax savings on the loan interest deduction is greater than the rate of taxation on dividends and capital gains. It’s simply the after-tax return versus the after-tax cost. So long as dividends and cap. gains are taxed at a lower rate than the interest deduction, even if the loan interest charged was the same (or even a bit higher) than the return, the investor would still come out ahead.

  Bottom line: For certain investors, it’s a good strategy, if implemented properly. However, it definitely *NOT* suitable for most investors.

  Just imagine how many complaints and lawsuits there will be if the markets get clobbered over the next few years. Reminds me a little bit of the subprime mess. Getting (some) people to sign on the dotted line who really don’t understand what they’re doing. As long as their investment does ok, all is well. But if it falls in value like real estate in many parts of the USA, it’ll trigger all sorts of problems.

  You might find this interesting….

  When I first got into the business, leverages were very rare and heavily scrutinized. We did them through the major banks only. There was always a credit check, documentation verification (tax returns/assessment, employer), etc. You had to invest a certain amount yourself (collateral), for example you would invest $50,000 and the bank would lend you a matching $50,000. Also, the monthly loan payment included principal. There were also margin requirements, i.e. if the value of the funds dropped by a certain amount, you had to put up more assets.

  Fast forward to today. Are you aware that I could get a husband and wife about $250K with merely their signatures! The loan would be approved in about 20 minutes. Just a quick credit check. Done through any number of lenders. And the conditions have changed: zero down, interest only payments, NO margin calls ever, etc. They’ve made it as easy as it could possibly be for just about anyone to get a large sum of money to invest into mutual funds. Just sign a few forms, and voila, you too can be an instant “player”. Thus the client gets to see a portfolio statement with a balance that’s a multiple of what they’re really worth. “Look at me everyone - I’m rich!!!”

• 29 A happy user // Jun 18, 2008 at 7:57 am

  Lots of interesting discussion here. Agree that SM and its cousins are not for everyone and sometimes being pushed for the wrong reasons. But let’s also recognize that it is a good strategy in some situations. My example:

  - Had 6 figure non-registered investment portfolio that I needed to liquidate to buy house
  - Did not want all my non-RRSP assets tied up only in house, conscious of risks (and opportunities) of leverage
  - Significant positive cash flow (income - expenses) so I can optimize portfolio for total return, not cash flow to pay the loan

  I’m doing this with - I hope - reasonable expectations
  - 10-20 year horizon
  - target investment rate of return 7.5% (3% inflation + 4.5%)
  - P-0.75 fully open mortgage 40 year amortization against house, for investment purposes only
  - currently having advisor manage funds - fee-based, his fee+total expenses (combination of ETFs and some stocks) is about 1.25%. Considering DIY with fees of about 0.5% once I retire

  If interest rates as they are (might be overoptimistic), my economics are anticipated to be as follows
  - After-tax investment returns averaging about 5.2% (nominal, not real; an understatement since it assumes capital gains taxed each year while some will be tax deferred)
  - After-tax interest costs of 2.4% (50% of 4.75%), leaving a spread of 2.8%
  - …after-tax investment expenses of 0.6% (1.25 at 50%) giving a target return of 2-2.5% on otherwise inaccessible equity in my house

  There is of course market risk in this, but over the long term given my situation I think this makes sense.

• 30 Canadian Capitalist // Jun 18, 2008 at 9:55 am

  Happy User: In my opinion, you seem to have reasonable expectations and paying the advisor directly gets you a tax deduction and I think the odds are with you that you’ll hit the 2 to 2.5% goal you are aiming for.

  My post is strictly in the context of implementing the SM through an advisor using an average mutual fund that charges 2.5%.

• 31 A happy user // Jun 18, 2008 at 4:16 pm

  We’re in full agreement. In my mind, SM is a strategy that under the right combination of circumstances can create value with tolerable risk. The value comes from the spread between returns, interest paid, and fees, plus the tax the tax arbitrage effect. This spread is non-negligibly positive when done right, but every 0.5% and maybe every 0.1% counts.

  Your question “who profits” (under your assumptions) is an interesting one. You point out the spread (pre-tax) is zero. By my calculations (based on your assumptions, highest tax rate, diversified cap gains and dividend portfolio etc), because of the tax arbitrage effect, the return for the investor is about +1.5%.

  If I make further back-of-the envelope assumptions about how much corporate tax the bank pays on the spread and income tax paid by the advisor on his fee, then a) the government makes back almost exactly what it lost on the tax arbitrage, and b) the investor, the advisor, and the bank make about the same after-tax profit on the manoevre - each about a 1.5% return (though the investor takes all the risk).

  Of course, paying attention to the fees can increase the spread and capture more value for the investor rather than the advisor.

• 32 Bogle and Buffett’s Modest Expectations // Jun 18, 2008 at 11:05 pm

  [...] returns from stocks can be expected to be in the neighbourhood of 4% to 5%”) assumed in the post on Smith Manoeuvre earlier this week came in for some criticism. Fortunately for me, among the “experts” [...]

• 33 The Financial Blogger | Financial Ramblings // Jun 21, 2008 at 6:00 am

  [...] Capitalist comes back with another vengeance against the Smith Manoeuvre. He is wondering who are the real beneficiaries from the Smith Manoeuvre. While his analysis is correct in a sense that both advisors and banks are making money out of this [...]

• 34 Brian Poncelet, CFP // Jun 22, 2008 at 7:26 pm

  Hi CC,

  Let’s talk about risk. I am going to rise a point that I don’t see anyway here. How about disability? Yes the market goes up and down but what about your health? If you become disabled what happens to your mortgage payments?

  This is called Risk Management. Take care of the little details like this and you can’t eliminate market risk but your health is the most important asset. Readers should deal with all risk management before thinking about leveraging. Even those who are in a lower tax bracket should review their employee benefit book regarding their disability insurance coverage etc.

  If you are interested I can send you some information regarding this. As an example you have about 8X a chance of a disability lasting 90 days than an insurance company paying a death claim from a term policy.

  Most financial advisors and insurance agents and do-it- your selfers do not spend much time on the subject of disability insurance, because it is complicated and expensive vs. term insurance. Investments are easy to talk about, like the price of gasoline everyone has thoughts on what can or can not be done.

  regards,

  Brian Poncelet, CFP

• 35 Ed Rempel // Jun 22, 2008 at 9:38 pm

  Hi CC,

  I agree with some of your conclustions, but I can’t say I agree with your return figures. I got a bit lost in the excess returns and risk-free rates you quoted. If you just calculate it simply, secured credit lines now are at 4.75%. With a 40% tax refund, this costst me 2.85%. Since capital gains are only 50% taxed, I only pay 20% tax on the capital gain, so the gross return I need to make I need to break even is 3.56%.

  We are quite confident that we can make at least 3.56% long term average return for our clients.

  In actual fact, this is lower, since you can hold investment forever and pay little or no capital gains tax for many years. So, we only need to earn about 3.3% long term.

  Even if future returns are a bit lower than their historical averages or if interest rates rise a bit, making an adequate return for the client to make money over the long term should not be that difficult.

  Part of the issue is that you deducted MER’s from average returns to get average returns of mutual funds. The longest figures we have from Morningstar show that the average Canadian Equity mutual fund earned 9.5% over the last 25 years with an average MER of 2.06%. The TSX Composite Total Return index for that period is 10.2%. So, the average mutual fund earned only .7% less than the broad index, even though the MER is much higher than this. This is hardly less than an index fund would have made.

  There is a similar result with global equities where the average global equity mutual fund earned 9.0% over the last 25 years with an average MER of 2.5%. The MSCI index in the same period made 10.6%. So, the average fund earned 1.6% less than the index with a 2.5% MER.

  Note these figures are for mutual funds only and exclude seg funds and index funds. Seg funds have higher MER’s for insurance and of course, 100% of index funds underperform the index.

  The conclusion is that there is some benefit from professional investment management.

  We agree with you that the Smith Manoeuvre is an aggressive strategy that is not appropriate for anyone that cannot stay invested for the long term through bear markets.

  However, mutual funds are a valid investment for the Smith Manoeuvre. Not only are the long term returns only a bit less than indexes, mutual funds tend to be lower risk than index funds. They tend to underperform by wider margins in bull markets (such as the last 5 years), but beat indexes in bear markets, which is when we have the biggest risk with leveraged investments.

  The longest standard deviation on Morningstar is 13.9% for the average Canadian Equity mutual fund vs. 14.9% for the TSX Composite. In every year in the last 25 years when the TSX Composite lost more than a minor amount (2%), the average Canadian mutal fund matched or beat the index. These years were 1984, 1990, 2001 & 2002. The largest loss for the TSX Composite index in that time was 12.6% in 2001, when the average mutual fund lost only 5.9%.

  You are right that most advisors are really just salespeople selling funds or insurance, and do little or no financial planning. However, there are many good advisors honestly trying to do the best for their clients - as some of the commentators above eloquently show.

  One of our biggest responsibilities as advisors is to keep our clients invested for the long term. This is an important part of successful long term investing and is part of why a good advisor should be worth paying for. A good advisor should be able to recommend funds that are at least better than the average mutual fund. The few studies that reflect on the subject imply that the average DIY investor makes far less than the average mutual fund. This is mainly because of buying and selling at the wrong times. This will probably prove true (when we have stats) especially with ETF’s, since having all those sectors encourages more trading.

  We also agree that the Smith Manoeuvre is being vastly over-hyped. Nearly all of the marketing is from mortgage brokers, however, not financial advisors. There are all kinds of regulations on advertising by financial advisors that does not apply to mortgage brokers.

  The tax rules of the Smith Manoeuvre do not require an accountant (although I am one), since it is basically just borrowing to invest - unless you take money or distributions from the investments. Most of the marketing for the Smith Manoeuvre includes investing in funds that pay out a high, return of capital (ROC) distribution, which means you lose the interest deductibility over time and there is a complicated calculation to figure out how much of the loan interest is still deductible. Anyone that invests with these ROC distribution funds should have an accountant do their tax returns.

  Ed

• 36 slick // Jun 22, 2008 at 10:40 pm

  Well, here it is folks, on full display. Witness the advisor/salesman with his lies, half-truths, deceptions, and false promises. He’s got all the answers. Smooth as silk. Even adds how the OTHER advisors are salesman, but not him.

  Ed, you must make a lot of money. Good for you.

  Allow me to list just a few of your whoppers:

  ” The longest figures we have from Morningstar show that the average Canadian Equity mutual fund earned 9.5% over the last 25 years with an average MER of 2.06%. ”

  1) Total bs. And dont’ quote me the number from Morningstar. I’m saying that the number itself is meaningless. It does not represent what you are inferring from it.
  2) The past 25 years has nothing to do with the next 25 years.

  How many Canadian equity funds have been around for 25 years? How many funds are in that “average” compared to howe many funds there are today? What do you mean by “average” (makes a BIG difference)?

  “Nearly all of the marketing is from mortgage brokers, however, not financial advisors. ”
  Oh please. That is such utter bullsh*t. “Nearly all”???
  If you said that more of the marketing is from mtg brokers, and actually had some FACTS to back that up, then I might believe you. But you have absolutely NO data to back up your assertion, whereas I, otoh, just from personal experience know that this simply cannot be true. But what you are trying to do there is make us advisors look like the good guys, which is a crock.

  “Not only are the long term returns only a bit less than indexes, mutual funds tend to be lower risk than index funds. ”
  1) Define risk.
  2) Absolutely false in terms of REAL RISK (not standard deviation). WEB says standard deviation is not risk. I agree.

  “The conclusion is that there is some benefit from professional investment management.”
  Bullsh*t. This has been proven to be completely the opposite by a number of studies. Google is your friend. In FACT, the so-called professional management has a negative impact on return.

  “A good advisor should be able to recommend funds that are at least better than the average mutual fund.”

  Absolute, total 100% bullsh*t.
  You could not possibly be able to prove this because it is exactly the opposite of the truth.
  Also, you are being so vague to render what you are trying to imply meaningless. Define “better”. Define “average mutual fund”.
  Not only are advisors incapable of selecting outperforming mutual funds greater than one would expecty from pure luck/randomness, but in all my years as an advisor I have NOT ONCE seen a financial advisor ever keep track of his picks and his performance! The data to back up your assertion does not exist because they know what the answer would be: Ugly. It’s hard enough to keep track of individual client performance - do you realize how complex it would be to give clients an ADVISOR performance number, i.e. how well the advisor picked funds based on his entire client base!

  Every advisor, like myself, picks some funds that perform great, others that do so-so, and others that suck. And most of it has to do with dumb luck. For example, a client inherits money from a parent who has passed away. The timing of said investment is completely random. While over the VERY long-term, that timing may not make a big difference (or so the mutual fund propaganda would have you believe), over the short and medium term it can make a huge difference. Imagine if the beneficiary received that money in 1995 versus 2000 and invested in a typical well-diviersified portfolio! That isnt’ the advisor’s fault at all.

  It’s very simple. 1) The average mutual fund will always underperform it’s benchmark index. Why? Because of the MER and because they *ARE* the market. 2) The odds of selecting those few that will outperform are absolutely horrible since the vast majority of funds will underperform. If 75% of funds underperform, and since no reliable criterion exists to select funds that will outperform in the future, throwing a dart is about all you are doing. Except, that you get all warm and fuzzy because a guy like Coleman or CUndill has performed well in the past, so you feel more comfortable putting your money with them for the future.

  Ed, there’s a reason why every document has that disclaimer about past performance. Maybe you should start believing it?

  Game. Set. Match.

  See, I don’t have a problem with the reality of the game, because most people are just totally clueless and that’s just the way fo the world, but guys like Ed misrepresent the truth either through ignorance or intentionally. Hopefully it’s just ignorance, but I can tell by his propaganda that he is drowning in the kool-aid.

  No offense, Ed. But you’re absolutely wrong on many key points.

  Maybe you should participate in that bet that WEB has with the hedgies if you’re convinced that mutual funds will beat the indexes.

  See, one of the biggest problems is that the mutual fund industry uses statistics and data to misrepresent the truth. You can never really call it a lie, because the data isn’t false. However, the *TRUTH* is a far cry from what they would have you believe. Dont’ know how long you’ve been an advisor, Ed, but I’ve been int eh game almost 20 years and I can tell you ***FROM THE CLIENT’S ACCOUNTS*** that they do far worse than any of those nice-looking charts and projections show.

• 37 Canadian Capitalist // Jun 22, 2008 at 11:27 pm

  Ed: You are not going to pull that on me. The 4.75% you assume was 6.25% not very long ago. Also, in your return calculations you are mixing up returns from different years. i.e. the interest payments made today should be assumed to grow at the risk-free rate in calculating future capital gains.

  But, let’s leave that aside and come back to my key assumption that the average mutual fund will trail the index by its MER. I don’t know about the Morningstar study (Does it adjust for survivorship bias? Is it available online?) but I can show you any number of studies on mutual fund underperformance. Here’s one:

  In a 1998 study, Arnott et al. found that the average mutual fund under performed the Vanguard 500 Index fund by 3.5% over 10 years, 4.2% over 15 years and 2.1% over 20 years, without adjusting for survivorship bias and before taxes. After taxes and relative to Vanguard 500 the shortfall was 4.5%, 5.1% and 2.8% respectively.

  “The conclusion is that there is some benefit from professional investment management”.

  Only if you pick the winning fund. The odds after-tax over 20 years according to the study was 14 to 1. And if you were lucky to pick the winning fund, the average out performance was 1.3% and the shortfall 3.2%.

  “The few studies that reflect on the subject imply that the average DIY investor makes far less than the average mutual fund”.

  Which studies? And while on the topic, what about studies that show the “benefit” of your average financial advisor:

  http://www.people.hbs.edu/ptufano/bbenefits_Nov2004.pdf

• 38 Ed Rempel // Jun 23, 2008 at 1:04 am

  Hi Slick,

  My, you are frustrated with the financial industry! Why are you still in it if you are so anti-advisor? You asked earlier for suggestions. What is it you really believe in, Slick? If you are confident you are helping people, this is a fullfilling profession. If you get caught up in the marketing, it can be a very frustrating business.

  You may know a lot of slick salespeople, Slick, but I can assure you I am not one. Do not presume you know anything about me. We actively turn away at least 2/3 of the people that want to meet with us and only take on clients with a comprehensive, written professional plan. I am not much different as an advisor than I was as an accountant.

  I stand completely by my post and fully believe all of it - and do not hide who I am (I link to our site). I do the Smith Manoeuvre personally and buy all the same funds I recommend for our clients. This is what I believe in and we know we are making a huge difference in our clients lives, mostly because of the financial plan.

  As for your comments:
  - Morningstar is the main mutual fund data source. The figures are theirs. They maintain the data from closed funds, so they do not suffer from survivorship bias. It is also dollar-weighted, so it gives more weight to the funds people actually invested in. My comparison is the same 25-year period of the average Canadian mutual fund to the broad index - which is apples-to-apples over a long time period.
  - We define risk as downside risk - the amount a fund declines in down markets. Note in my post that the average Canadian mutual fund has declined the same or less than the TSX Composite in all significant market declines in the last 25 years.
  - I don’t know what part of the country you are in, but here in the Toronto area, the Smith Maneouvre marketing is mainly by a couple of large organizations that are run by mortgage brokers.
  - You’re comment that mutual funds must underperform the market by their MER because they ARE the market is a nice logical generalization that is mostly true, but does not explain years like 2001 when the average mutual fund beat the index by 6.7%. Most fund managers are just salaried employees of a big firm trying to keep their job, so they intentionally invest more conservatively than the market. They also hold cash, which the index does not. Mutual fund managers are not all of the market - there are also foreign investors, pensions, seg funds, hedge funds, private corporate investors & DIYers. The stats by Morningstar are an apples-to-apples comparison of actual data - not just a logical generalization.
  - We accept Morningstar’s definition of “average fund”. To beat the average, you don’t have to choose the #1 fund - just an above average fund.
  - We focus on the fund managers, not the funds, and spend a lot of time researching them - and those are the only investments we buy ourselves. We may or may not eventually be right, but we fully believe our fund managers will be above average over time.

  I’ve been an advisor for 15 years and do understand your frustration with the industry, Slick. I spent a few years writing courses and teaching financial planners basic financial planning and mutual fund investing. I found writing the courses to be very valuable in creating a logical process and defining what I really believe.

  While this has been mostly an intellectual debate, we fully believe that what we do is the right thing for our clients.

  Ed

• 39 Ed Rempel // Jun 23, 2008 at 1:49 am

  Hi CC,

  I don’t understand your point about “the interest payments made today should be assumed to grow at the risk-free rate in calculating future capital gains.” I just calculated the simple breakeven return.

  Prime was briefly 6.25%, but was 4.0% just 2-3 years ago. Today’s prime is about the average of the last 10 years.

  Even if you take the highest prime (6.25%), then we still only need to make 4.7% as a long term average return to make money. That seems quite achievable.

  The studies you mentioned are all U.S. studies. The U.S. is the most efficient market in the world. Indexes in the U.S. are very hard to beat, but this is much less so in Canada or elsewhere in the world.

  For example, while it varies from year to year, only about 20% of fund managers beat the S&P 500, but in Canada it tends to average closer to 40%.

  In less efficient markets, such as the emerging markets, it can vary hugely. The indexes are often heavily weighted in a small number of stocks, so mutual funds can be completely different than the indexes.

  There are tons or articles and books about indexing and the Efficient Market Theory, but almost all are American & written about the U.S. indexes. Do some research in Canada or globally.

  Morningstar is the main fund data source in Canada. You can access them at http://www.morningstar.ca . I don’t think they have all stats on the public site, such as the average fund stats by each category. Their figures all maintain closed funds, so they take into account survivorship bias. They are also dollar-weighted, so they emphasize the funds that investors actually owned.

  There are studies critical of average fund managers and of advisors, but little on DIYers. Investing is far more complex than most people realize, so you would expect DIYers to do even worse than the pros, which seems to hold true in the few studies that shed any light at all.

  One study that I wish I could find again, tracked all transactions in several discount brokerages over 10 years. They tracked hundreds of thousands of transactions. They looked for any investment sold with the proceeds used to buy another investment within 30 days. The result was that the investments sold out-performed the investments purchased. In other words, all trades done by all investors in the discount brokerages resulted in a net loss - returns would have been higher if nobody ever traded anything.

  Many studies show that strategies with fewer transactions usually beat strategies with more transactions. Most DIYers I talk with are quite active traders. For those that just buy indexes and hold them forever, that would tend to work, but I don’t think many do this.

  My main point was just that you should not write off all mutual funds. There are some that are good investments and work very well with the Smith Manoeuvre.

  Ed

• 40 Jordan Clark // Jun 23, 2008 at 2:30 am

  @slickvguy

  I loved reading your comments from the point of view of an advisor who boldly acknowledges the flaws in the industry and with a lot of investors. I like your own sensible advise that repeats these basics principals of investing that everyone forgets (including myself), I wish I could find a local advisor like you.

  Until then can I hit you with a question, what’s your take on a well diversified portfolio of “enhanced” index funds from Dimensional Funds? They base their strategy on the research of Fama & French which holds true to all of your advise/Bogle/Buffet, except they seek to add additional value in several ways. Their results appear to have beaten comparable indexes and funds over the long term. What are your (and anyone else’s) thoughts?

• 41 Canadian Capitalist // Jun 23, 2008 at 11:38 am

  Ed: I’ll have to write a post to explain my point about adjusting by the risk-free rate but I’ll jump to your argument about “efficient” markets. Even in supposedly “inefficient” markets, active management is a zero-sum game because it is simple arithmetic.

  I don’t have access to the Morning star study and I’m not aware of it. But I can point to publicly available studies, such as from the S&P.

  http://www2.standardandpoors.com/spf/pdf/index/SPIVA_Canada_Q42007.pdf

  Oh, and before you tell me how well active funds perform during a bear market, here is the five year scorecard to 2004:

  http://www2.standardandpoors.com/spf/pdf/index/spiva_canada_2004_SC.pdf

  Look at the difference between the returns of the asset-weighted fund and the S&P TSX Capped index that ranges between 2% and 3%. The difference is entirely attributable to fees.

  I don’t deny that a good advisor can add value and help investors from bad behaviours that are arguably more hurtful than fees. That’s not my point. My point is how can an average investor expect to make a profit ex-ante by leveraged investing when paying for an advisor to invest in your average actively managed mutual fund.

  As as aside you are referring to the research by Terrance Odean and Brad Barber, which found that trading is hazardous to investment returns. Which brings me to another point: what about turnover for actively managed funds? How come so few of them disclose it publicly?

• 42 slick // Jun 23, 2008 at 1:31 pm

  “Why are you still in it if you are so anti-advisor?”
  Excellent question, Ed. If you read my earlier comments, you’d see that I’m trying to figure out how to transition from what Im’ currently doing and still make a living.
  BTW, I am most certainyl NOT “anti-advisor”. Au contraire. I am a strong believer in most investors needing a “coach” to help them. I am anti-BS (pro-truth). It’s the govt., dealers, and mutual fund companies that are the main problem. One problem is that we are in a transaction oriented business when it should be completely relationship-oriented. Another is that there are far too many hands in the pot, which is why the fees are so high. At the very least, we should be able to sign direct contracts with the mutual fund companies. The dealer is a layer of bureaucracy that is totally unnecessary. You and I deserve to make our money and so do the actual fund managers. But 2.5% MER? That’s just nuts for something that has such a dismal chance of outperforming.

  Sorry if I misjudged you - I did leave it open to debate. The fact that you refuse prospects/clients tells me a lot of how you operate. Bravo, sir.

  I’m not going to write a book in order to convince you of where you are wrong. You can view that as a copout. Fine with me. Honestly, I just don’t see the payoff of putting that much effort into convincing you (or anyone else) about the truth of mutual funds in Canada.

  A few points.

  1) There is no meaningful 25 year number for Canadian equity mutual funds. There just aren’t enough funds that have been around that long to have a meaningful sample pool. Monringstar’s data is highly suspect and DOES not actually show what they are intending it to.
  2) Even if you did have a true 25 year past performance figure, it would be meaningless in today’s environment for a number of reasons. I could probably write 25 pages on this subject alone! lol. Just a few items to consider: the vast number of funds today, so many managers moving around, fund mergers/closings, past returns of mature economies (i.e. growth rates) were much higher in the past than they are now, etc. So many factors to consider.

  But the main point is this: YOU derive comfort from the past as if it is bound to repeat. You have an expectation that the future will be close to what you think the past was. I do not.

  “We define risk as downside risk - the amount a fund declines in down markets. ”

  That is *NOT* risk! That is volatility.
  Also, you should not focus on just Canadian equity mutual funds when comparing supposed returns of the funds verus the indices since clients very rarely have only those funds in their portfolio, right? Most clients have a lot of US equity in their portfolios as well. How’s that worked out for them? How about Japan? Europe?

  Also, the Canadian indexes are not adequately diversified. They are very skewed. So it is easy to see why you will get weird results. (Remember when Nortel was over 30% of the index?) Again, just using our tiny Canadian market is a bad benchmark because most portfolios do not only have Canadian equity (as well as most Canadian equity funds not being pure Canadian equity, i.e. they usually have US exposure), and also when you have commodity boom years like we’re having (gold/oil) or when financials outperform, Canada does very well. You need to use a BROAD index otherwise comparing funds to a narrow index misses the point entirely.

  And the fact that there are years where the opposite is true (your 2001 example) is meaningless. I never said there werent’ exceptions. My point is that an advisor cannot pick the excpetional funds. It is nothing more than EGO and a false sense of confidence. When you are in the game as long as I have been, you start to realize that. I’m not going to repeat all my earlier points. Even if you have a 1 in 4 chance of picking an outperformer (I am being generous here), would you consider that a good thing for clients? I dont know about you, but I’d rather be on the 3 out of 4 side of that bet.

  And there, Ed, is IMO the biggest *LIE* in our industry. Clients look at their advisors as if they are able to choose “winning funds”. They see our whole rason d’etre as being a handicapper, pick the winning horse. Except there’s one problem - we have no idea who will outperform. None! The past does not predict the future!!! Once you accept that unfortunate fact, the rest kinda falls into place. Many advisors play into that in one way or another (usually by allowing the client to keep that ridiculous notion or by actually believing it themselves). You and I know we can provide many valuable services to our clients (asset allocation, financial planning, etc), however the truth is that clients are looking at us to MAKE THEM MONEY. Thus, the mutual fund industry is selling snake oil. While never coming out and saying “we’ll make you money”, so much of the marketing is geared towards performance/returns!!! It’s complete bullsh*t.

  Another thing: the vast majorioty of market participants believe themselves capable of performing well or outperforming when in truth only an extremely small number of people have the “right stuff” in order to do so. It is laughable to see these mutual fund managers (and market analysts) being so consistently wrong and so out of their league, and yet they continue to convince themselves and others that they can do something that they cannot! It’s absolute, total nonsense. I’d say 99% of all mutual fund managers should not even be trying to outperform. To be blunt, they SUCK at it. Again, it’s not their fault because they are trying to do something that is next to impossible (with a 2.5% vig), but I do blame them for lying/pretending to themselves and others. I wonder if they really are so stupid to believe their own bullsh*t? And if so, what does that say about their analytical skills? lol.

  One last thing. I do believe that *YOU* believe you are doing well by your clients. After reading your post, I will give you the benefit of the doubt and assume that you are well-intentioned, ethical, etc. But you wouldn’t be the first person to be blind to something. And that you make your living and have invested your time, money, reputation, etc., in being right about this should tell you that you have a strong bias. Big red flag. And I’m not so sure the word “belief” belongs in a discussion like this. This isn’t religion - or is it? heheh. It’s not about belief or faith - it’s about The Truth.

  Here is the simple truth: The better we do, the worse the clients do. It’s a zero-sum game. The more the mutual fund industry charges, the less the client makes. Pretty simple, right? And the big lie is that in order to justify these outrageous fees, we are supposed to be giving outperformance or at least good average performance, which simply does not happen BECAUSE a) most people (read: fund managers) are average, and b) the high fees!!! So the entire industry is built on a lie.

  **************************************************
  So what would be best for the average client? Low-fee, low-tax broadly diversified passive investments w/ as inexpensive a coach as they can find.
  ***************************************************

  Don’t get me wrong. I’m not saying that the industry is full of evil people who are intentionally trying to screw over clients! But the smart people DO understand the game. Doing nothing is not a good defense. Willful ignorance?

  And *I* am guilty because while it took me a few years to figure out the game, by now I should have changed the way I run my practice to something along the lines of private mgmt or fee-based or ??? I care a great deal about my clients, and it just *RIPS* me to see how everyone else is making off like bandits EXCEPT for the clients! Every industry has it’s bad side. It’s “secrets”. Can you imagine how bad it is in the medical/health field - where it’s literally a matter of life and death (not “just” money)?

• 43 slick // Jun 23, 2008 at 1:48 pm

  “One study that I wish I could find again, tracked all transactions in several discount brokerages over 10 years. They tracked hundreds of thousands of transactions. They looked for any investment sold with the proceeds used to buy another investment within 30 days. The result was that the investments sold out-performed the investments purchased. In other words, all trades done by all investors in the discount brokerages resulted in a net loss - returns would have been higher if nobody ever traded anything.

  Many studies show that strategies with fewer transactions usually beat strategies with more transactions. Most DIYers I talk with are quite active traders. For those that just buy indexes and hold them forever, that would tend to work, but I don’t think many do this.

  ”

  Most of the above is 100% correct.
  These are important points to consider, and why most people NEED a financial advisor. It is *NOT* because the advisor can pick winnign funds. It’s because it’s a helluva alot easier to manage someone else’s money than your own! Just like we’re all great at giving opther people advise - but don’t necessarily apply it to our own lives.

  The human brain is not wired to be successful at investing. That’s why there are so few great investors. You have to be a “freak”, so to speak. lol.

  Given that fact, the vast majority of people could benefit from having someone else take the emotion out of the game for them.

  A lot of DIYers who buy ETFs and index funds are talking a great game right now, but trust me, when the sh*t hits the fan, mos tof these peopel are going tomake mistakes. It’s human nature. They will do the wrong thing at the wrong time. They will panic. Or get greedy. They will become active instead of being passive. They will not resist the urge to “tweak” the portfolio.

  Excuse my language, but there is no bigger mindf*ck than investing. WEB is not some onld guy who happaned to make billions and is just talking in general terms. His advice should be listened to very carefully. He knows fully well that despite most human being’s unwillingness to accept the truth, the reality is that we have severe limitations vis-a-vis being successful investors. It’s nice to dream about being Jimmy Page or Tiger Woods or George Soros - but it’s just a fantasy.

  When the odds are so severely against you, why go with the losing side of the proposition? That is totally irrational.

• 44 slick // Jun 23, 2008 at 2:05 pm

  @Jordan,

  I have not studied Dimensional enough to give you a strong opinion, but I will say the following. It seems like a similar approach to what I’ve discussed, but…

  I am not a fan of Fama and the other eggheads. So much of what they have written over the years is such utter nonsense it is laughable. They are academics - not investors or traders. So as soon as I see anything about “models” and fancy theories - it makes me nervous. LTCM. Hello? heheh.

  Think about this for a moment. *WHY* does the SPX beat so many managers? A large part of the reason (aside from fees) is that it’s just a list of big companies that doesn’t change much! roflmao. Follow? Theya re not trying to pick superior companies based on “value” or “growth” or whatever. They do not do in-depth analysis of the future trends of the industry, etc. People don’t stop and think about that. They just pick big companies. Interesting, no? Thus it’s fair to conclude that IN THE PAST a well-diversified group of large companies - bought and held forever with dividends re-invested - achieved a very nice rate of return over the long run. Seems like a reasonable approach to me. So why attempt anything else? Only thing I would add, is that as Canadians, the currency risk is there. So buy a bunch of GLOBAL big companies as inexpensively as possible, hold them forever, invest the dividends, minimize the taxes and fees. Ta da! Don’t even bother to re-balance. I’ve seen contradictory evidence that re-balancing (using vearious schemes) makes a difference.

  But us silly human beings just can’t leave it alone. Seems like everyone is trying to find the Holy Grail. There is NO Holy Grail! If it could be found, others would find it too, and your advantage would disappear.

  I have long held that the biggest problem to our success in investing is *US*. it’s not the investments, it’s US! We make costly mistakes and bad decisions. Therefore, the smartest move is to remove yourself from the equation. Make good decisions, and then HANDS OFF!

• 45 Ed Rempel // Jun 23, 2008 at 9:37 pm

  Hi Jordan,

  We only looked at Dimensional briefly and I agree with Slick - it does not look like a winning strategy.

  I think they are victims of “hind-sight bias”. You analyze 1,000 stats and you will always find some factors that beat the index in the past. But will those same factos beat the index going forward?

  I learned that years ago after spending a couple of weeks analyzing mutual funds in every category with hundreds of stats. When I was done and looked at the results, it ended up with a list of those that had done well recently. It is always difficult in any analysis to not just end up with what has worked recently.

  So far, Dimensional (DFA) has underperformed the indexes by a wide margin.

  Ed

• 46 Ed Rempel // Jun 23, 2008 at 10:10 pm

  Hi CC,

  Morningstar is not a study - it is the main database of mutual fund data. The stats I quoted are available for any time period.

  I noticed in your bear market comparison that you conveniently switched to the capped TSX, not the TSX Composite, which is the normal index comparison.

  You obviously noticed that the average mutual fund beat the TSX Composite for the 5 years ended 2004 by 1.1% - after their 2.06% MER. In the bear market, more than half of all mutual fund investors beat the index. Quite clever of you to pick a different index.

  I realize that is a better comparison, but it is not the normal index. Even the capped index under-performed the average mutual fund in 2001 - a 5.9% loss for the average mutual fund vs. 8.4% loss for the TSX capped and a 12.6% loss for the TSX Composite.

  With leveraging, we find the big risk is that clients may panic after a decline, so minimizing the decline is very important. This is where mutual funds have an advantage over indexes.

  This does lead to an interesting anomoly. Indexers always say that that mutual funds can’t beat the index because they ARE the index. Extreme market situations show how often this is not true. As Slick pointed out, in 2000, Nortel was 33% of the index. That was the TSE300. At the peak, Nortel was 48% of the TSX60. Even then, indexers were promoting it as a properly diverisfied investment.

  The big question is, since mutual funds are not allowed to have more than 10% in one company, how did the TSX become 48% Nortel?

  A bit might be because the 10% cap is at cost and the market value rose, but not nearly all mutual funds had the maximum Nortel.

  In short, it appears that nearly 80% of Nortel holdings were not mutual funds. Who owned all that Nortel? What happened to the mutual funds ARE the index?

  This is exactly why mutual funds lost far less in the ensuing crash. Many indexes globally have little diversification. And why nobody should buy indexes that are not capped.

  Ed

• 47 Ed Rempel // Jun 23, 2008 at 10:34 pm

  Hi again, CC,

  I got carried away on that last post. The main point I want to make is that I really don’t understand why you would think making money doing the Smith Manoeuvre with an advisor and mutual funds.

  As I mentioned above, with prime now being 4.75%, which is about typical of the last decade, we would only need to make 2.85% after tax (40% tax bracket) to break even - which is about 3.5% before tax. As a long term average return, this should be quite easy.

  The risks are the client not staying invested long term and bad market timing, and guarding against the risks is critical.

  But making enough return to make a profit is easy - even with an MER and even with lower future returns. In the last 20 years, 95% of equity mutual funds have made more than 3.5%/year and this period includes the largest bear market in 40 years.

  Ed

• 48 slick // Jun 23, 2008 at 11:22 pm

  Ed,

  You bring up an important point in the discussion of indices versus mutual funds. We both raised the same topic, but for different reasons, and we’re highlighting the various pros and cons.

  If you have an index that is NOT broadly diversified, perhaps one in a country like Canada (or as you said Emerging Markets), or for a specific sector/cap/etc., then the POSSIBILITY of beating that index (or underperforming it) definitely increases, i.e. the odds of tracking it are reduced. If an index is not broadly diversified - then what is it really? It does not represent the whole universe, therefore the funds cannot be “the average” - since it does not exist!

  Imagine an index made up of just two companies, let’s say DELL and IBM (50% of each) and 3 mutual funds investing in the same universe of just those two stocks. Fund A goes 50/50, Fund B overweights DELL, Fund C overweights IBM. If IBM outperforms DELL, Fund A tracks the index, Fund B underperforms, and Fund C outperforms. If Fund A and Fund B had both overweighted IBM, then 2/3 of the funds would have outperformed. That’s the Canadian example you’re using. And we see it perfectly over the past few years. The Canadian equity value managers who chose not to go heavily into resources are looking real bad compared to those who did.

  But the phenomenon cuts both ways. It’s less reliable and will deviate more. It’s a function of the NUMBER of choices in the index versus the number of overall choices in the universe (not what you called “efficiency”).

  Certainly there will always be outperformers - regardless of how widely diversified the index is. The problem is - we have no way of knowing who those outperformers will be! As our research and expereince proves. Because we both want our clients to do well, we have searched for ways to choose better funds. The honest truth is we cannot do it. Only liars in our business pretend that they can consistently pick winning funds. It’s a fool’s game. I stopped trying quite a few years ago once I realized how futile it was.

  So how do I select? Individual managers are selected based on style (true value), trustworthiness, reliability, safety, and experience. Anyone who has all those things HAD to have had good long time performance. I put much more emphasis now on allocation than individual managers.

  So I think it’s fair to conclude that if an investor is inclined to invest in less diversified universes, that the odds of picking a mutual fund manager who can outperform might be better.

  However, taking all the factors into consideration, big picture, mutuals (sold in Canada) versus indices is a losing proposition.

• 49 Canadian Capitalist // Jun 23, 2008 at 11:32 pm

  Ed: I’m not simply cherry picking data. The fair comparison between a mutual fund which is mandated to hold 10% in one stock is the TSX Composite Capped Index. It must be very nice to make a virtue out of necessity.

  The TSX Capped Indices aren’t just fairy tales constructed after the fact. An ETF tracking the index (the original XIC) was introduced precisely due to concerns about concentration in XIU. Concentration is a valid concern but tracking the capped index by holding the component stocks directly is a viable option for many investors.

  Okay, let’s take another look at the returns you are so happy about. The first table shows that only 42% of active funds outperformed the index that offered “little diversification”. You had 4 in 10 chance of picking a fund doing better than the index even after all the advantages such as holding cash and being limited to 10% of holdings. What about the subsequent bull market then? The number of funds beating the index was only 8.5%!

  Here’s the more important point: we are comparing the same index which can be captured through any index fund or ETF with the universe of mutual funds. Even then, the comparisons don’t show mutual fund performance in a good light.

  I don’t know any passive investor who recommends holding the TSX Composite Index and nothing else. The TSX is just one component of a properly diversified portfolio which includes cash, bonds and foreign equities.

• 50 Canadian Capitalist // Jun 23, 2008 at 11:48 pm

  Hi again Ed: I love a vigorous debate as much as the next guy

  slick: I wouldn’t pick an actively managed fund unless there is no cheap index fund available (as it is in many group RRSP plans). If I did, I’ll pick a fund that is (a) one of the smaller ones around (b) low fee (c) low turnover and (d) is honest and diligent about the impact of costs and taxes. And I’ll simply stick with the fund even if it lags the index.

• 51 Ed Rempel // Jun 23, 2008 at 11:50 pm

  Hi Slick,

  Thanks for you honest comments. For the most part, I agree with you completely. The industry, client attitudes and investments can all be frustrating. Here is what we do to avoid being totally frustrated.

  I guess the way we look at it is that most people need advice, both with investing and more importantly with planning, and we have to do the best we can.

  Our main focus is on comprehensive planning. Most clients don’t realize the importance of this, but knowing what needs to be done for them to have the retirement they want and using the right strategies are more important than the investment choice.

  Then we have to recommend the best investment strategy we can. I agree that this is more difficult than it sounds. We cannot assume that what has performed well recently will continue to perform well. That does not work

  This is especially true now when we have this really wierd market where the same sectors have led for 5 years. Now a 5-year record is not very relevant, since it only shows good performance in one type of market.

  We do not believe that indexing is the right strategy. Mutual funds and indexes are not really apples-to-apples, since mutual funds supposedly include the cost of paying the advisor for comprehensive financial planning. We would need to charge 1-1.5% on top of the index MER (since a comprehensive financial plan takes us 15-20 hours of work in total), which would put the return 1.5-2.0% below the index. Plus, indexes don’t have risk control and by defintion are forced to fully particate in all large bubbles. We think there are better options.

  With mutual funds, we need a logical strategy. First we elimate all funds where the fund manager has a boss. If he is an employee of a large bank or insurance company, their bosses will usually interfere to force them to stay close to the index, own popolar stocks on the last day of the month, etc. So, we only use fund managers that are truly independent.

  Then we eliminate all the closet indexers. You cannot outperform unless you are different from the index. A good fund manager must have a definite discipline and strategy - not just be similar to the index.

  After that, we focus on the fund manager, not the fund, and try to choose the best ones. We call them “all-star fund managers”. We often need to trace them through several funds in their history. There are fund managers with long term returns far higher than their indexes with reasonable risk and where it seems to not be luck or created just by taking on more risk.

  Much of our time is actually spent figuring out which funds work together well in an effective portfolio that should stay within a predefined risk level. We define risk as our clients do - by how much a portfolio can decline in a very bad year.

  Is this perfect - of course not. Does it work all the time - of course not. But it is the best strategy we can think of. Even looking backwards, the top fund managers only outperformed about 70% of the time.

  I’ve read hundreds of business books and can tell you what almost every book in the investing section of Chapters says. We read and study all we can and try to identify what strategies are proven to work long term.

  What else can we do other than our best?

  I agree, Slick, that it would be much better if there was a less cost and fewer parties taking their cut - dealers, 13 regulators, etc. - but we can’t control any of that.

  My suggestion, Slick, is to define what you really believe. Then find a way to adapt your practice. Your belief may be very different from ours, but if you do what you honestly believe is best, our career can be very fulfilling.

  Ed

• 52 DAvid // Jun 24, 2008 at 12:25 am

  CC,
  You may be missing one point when just stating the frequency with which a fund beats the index. It can also matter WHEN it beats the index. The link below shows the results of one of Canada’s Value Investment firms. Over the period shown, they did very well, beating the index about 60% of the time (far better than the 40% or so you indicate is common). What becomes interesting, though, is that the times they beat the index was often in bear markets — the value investor did not fall as far. As you can see from the graph, over the period it about doubled the TSX, even though it has exorbitant MERs. There are other funds managers who similarly beat the index with enough frequency on an annual basis to build a considerable lead on the same investment in the index.
  http://www3.telus.net/NFtoBC/Images/Example.bmp

  Or you can spend some time looking for individual stocks that beat the index. A few that come to mind include Shaw Communications, Sask Potash, and a number of utilities. If you are going to be in it for the long run, it might be wiser to choose from the market of stocks, rather than buy the whole market.

  DAvid

• 53 slick // Jun 24, 2008 at 2:08 am

  CC,

  I agree.

  Optimally, *if* one is going to pick a mutual fund over an etf or index fund, then make sure it’s one that does NOT mimic an index. What’s the point of paying 2.5% without going for alpha? That to me is what makes no sense. If you have a typical widely diversified fund that has everything in it, and they charge you 2.x%, you’re guaranteed to underperform. Over decades, it’s a HUGE amount of money being taken. People dont’ think long-term, so they don’t appreciate how much of a difference of 1.5% over 20 years can make.

• 54 slick // Jun 24, 2008 at 2:36 am

  Ed,

  I disagree with how you define risk, but I’m glad you recognize how imperfect your attempt at predicting moves to the downside is. What did all the historical data predict about C, BAC, BSC et al?

  Yes, it’s better than nothing. What else are we to do - right? We have to at least TRY to give the client the ride they want. But every now and then something blows up. I’ve seen it every few years. Something that was rated low or medium volatility experiences an outsized loss. It’s Russian roulette.

  “My suggestion, Slick, is to define what you really believe. Then find a way to adapt your practice. Your belief may be very different from ours, but if you do what you honestly believe is best, our career can be very fulfilling.”

  Thanks, Ed. I’m giving it a lot of thought right now because I’m at a crossroad in my life (business and personal). I’m really not well-suited for this occupation because I don’t like selling and I don’t like calling people, etc. I’m an introvert. More of a thinker/philosphical/independent type of person. I have the nature of a fund manager or hedgie - not advisor. Outgoing people are very well-suited for our profession. I’m not ambitious either - not driven for more, more, more. (I know, I know - that’s BLASPHEMY in our society! lol). I have enough. I’m happy with what I have. Although I’ve been doing this a long time, I really don’t have much of a client base. I have well-off clients only, but just not that many of them. I could’ve made a lot of money (I’m very good at selling when I want to - good at closing/presentations - and am well-connected to wealthy people) - but I chose not to. Odd, eh? I spent my time raising my kids instead. No regrets. If I do stay in this field, it’ll have to be done differently. Otherwise, I’m going to go into something else.

• 55 Canadian Capitalist // Jun 24, 2008 at 10:05 am

  DAvid: I’m not denying that there are funds that beat the market, sometimes significantly over rather long time periods. But this becomes apparent only after the fact.

  The difficult part comes in finding out who will out perform in the future. Here, past performance has been shown to be a poor predictor. The history of mutual funds is littered with hot managers who became stone cold.

  The problem with active management is that the odds are not in the investors favour of outperforming the index with the same fund over the long term of 20 years or more.

• 56 slick // Jun 24, 2008 at 5:21 pm

  “The difficult part comes in finding out who will out perform in the future. ”

  Not “difficult”. Impossible!
  When I choose a “winning fund” for a client - regardless of what I based the selection on - I know that it was pure luck.

  The only truism that seems to hold up over long periods of time is that disciplined value managers tend to do ok. There are of course many exceptions, but if you start with a pool of disciplined value managers who have shown the ability to choose undervalued stocks over a period of MANY YEARS, then your odds of selecting “a winner” are better than they would be otherwise. Chasing winners is probably the worst strategy, yet the easiest to sell the public on. In fact, when I get calls from clients asking me to put them in a particular sector or whatever, then I know the top is in. heheh. Great contrarian indicator.

  And while I don’t have the data to support the following belief, I think buying into a fund managed by someone who meets the criteria I outlined above, at a time when the manager has performed POORLY, is a good strategy. Buy the WEBs when they look bad. If you buy value at the ugly point of the cycle, and you are patient, the wheel will come around again and you could do very well.

  p.s. Great comment thread. So rare.

• 57 DAvid // Jun 24, 2008 at 9:02 pm

  Our host stated: “The problem with active management is that the odds are not in the investors favour of outperforming the index with the same fund over the long term of 20 years or more.”

  But should one expect the same fund to meet that goal for that period? Even the Sleepy Portfolio has a regular rebalancing. Should not the investor review their portfolio at some interval to see if it or the manager is meeting the stated goals? We re-evaluate our vehicle needs as time progresses, we may change homes a number of times in the same span of years, why should we expect the same fund to continue to be satisfactory all the time? Just as there are times to exit individual stock holdings, there must be times to exit various funds, even certain ETFs — i.e. you might have wanted to be out of NASDAQ based funds in late 1999 or so……

  If value investors such as Buffett can get great returns by purchasing temporarily out-of-favour giants, can others? While the returns may not be stellar every year, they don’t necessarily have to be. Comparison shopping Stock market returns can be as disheartening as learning your co-worker paid less for his car than your identical one. Set your goals, and work toward them, and adjust as necessary. Racing for the last penny may not get you the goal you truly seek.

  I worry that too many of us want something for nothing, and look for the easy way to riches! Spending the time and effort should have rewards, whether it is our profession, family, hobby or financial health.

  DAvid

• 58 Brian Poncelet, CFP // Jun 25, 2008 at 7:51 am

  Hey DAvid,

  Once again you have made some excellent points. Probably better than most. The last paragraph said it the best.

  I was trying to raise a point not discussed in this blog, that is Risk Management…see my comments on #37. My guess is many people who like the SM or don’t like the SM have not reviewed their situation or just don’t understand Risk Management and are only looking at the markets and not looking at their best asset …their health! Is it covered?

  regards,

  Brian

• 59 Canadian Capitalist // Jun 25, 2008 at 10:20 am

  Brian: I don’t know what relevance having disability insurance has with leveraged investing — I’m not disagreeing that our earning ability is our biggest asset and protecting it is important and I’m not saying that disability coverage isn’t an important topic — it’s just that it’s tangential to the topic on hand.

  DAvid: “I worry that too many of us want something for nothing, and look for the easy way to riches”.

  I wouldn’t call any investing “an easy way to riches”. Passive investing is simple, for sure, but definitely not easy. It is hard to resist the temptation to tinker and improve chasing the dream of a perfect plan, when you already have a good plan.

  “But should one expect the same fund to meet that goal for that period?”

  We’re talking about leveraged investments held in taxable accounts. Every time, you switch, you incur a tax penalty that handicaps long-term returns.

  “If value investors such as Buffett can get great returns by purchasing temporarily out-of-favour giants, can others?”

  I don’t deny that you can beat the market. Only that it’s hard and a very high hurdle. And the active managers are starting out with a 2% handicap they have to overcome just to break even. That’s why the odds are against picking a winning manager prior to the fact.

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