Archive for July, 2008

Why invest your own money?

July 22, 2008


In his latest column in Report on Business, sleuth investor Avner Mandelman asks DIY investors: “you don’t wear suits you sewed yourself, or shoes you cobbled yourself, or feed your family bread you baked yourself, so why would you try to invest your family’s assets by yourself?” and somewhat self-servingly suggests hiring a professional:

So once again, how much of your investing should you do yourself? I had better step carefully here because it would sound self-serving – I am, after all, in the biz of managing OPM (other people’s money) – but I’ll say it plain: Just as you occasionally can bake your own bread for fun but would not think of doing it on a regular basis (not if you want to have time for work), so you should not think of investing all your funds yourself.

Let’s assume you can earn 2 to 3 per cent a year better than the pros, long term. It is very difficult, but let’s assume. On a $100,000 investment, that’s $2,000 to $3,000 a year. For the same amount of time you put in, couldn’t you make more in your own business?

While you can easily counter that with – you brush your own teeth, take out your own garbage or pay your own bills, so why not invest your own money – there is an excellent reason: the consistent failure of professional money management in providing market beating returns to retail investors. A 2000 paper titled How well have taxable investors been served in the 1980s and 1990s? shows the magnitude of this failure – over the ten-year period ending in 1998, only 14% of mutual funds outperformed the Vanguard 500 before taxes. Only 5% outperformed over fifteen years and a more respectable 22% beat the index fund over twenty years. These figures do not reflect survivorship bias.

Canadian fans of active funds contend that the U.S. market is “more efficient” and the Canadian experience is different (without any studies to back their claim). The S&P Indices versus Active Fund Scorecard (SPIVA) record shows how flimsy the claim is: the percentage of mutual funds beating the TSX Composite index over a 5-year period was 42% in 2004, 31% in 2005, 11% in 2006 and 8.5% in 2007. The early record looks better than it actually is due to the massive weighting of Nortel. Compared to the TSX Capped Composite index (which an investor can easily track using XIC) the record over the same time periods is 23%, 26%, 10% and 8.5% respectively.

A more apt question a DIY investor could ask a professional money manager would be: if I visited my barber, asked for a haircut and came away with a shaved head and lost my shirt in the process and paid for the privilege nonetheless, why wouldn’t I cut my own hair?

How large is the Canadian Bond Market?

July 21, 2008


The data on the size of the Canadian equity market is easily obtained – various sources suggest that it is roughly $2 trillion*. But the size of the bond market is a bit of a mystery. An article in The Province (thanks to Preet of Where Does all my Money go? for the sources in this post) says:

New investors are often surprised to learn the size of the bond market.
The Canadian secondary debt market is approximately 30 times greater than the total Canadian equity trading market.

Initially, I thought they were referring to the total value of Canadian bonds and was puzzled because one of the interesting ideas in The Intelligent Portfolio (Read Review) is the concept of a market portfolio, in which asset classes are held in proportion to their weighting in total world market value. According to the book, data provided by Financial Engines was used to estimate that the global market portfolio has a weighting of approximately 60 percent to 70 percent in equities and about 30 percent to 40 percent in bonds. In other words, the bond market is smaller than the total stock market value. Is there any reason to believe that the Canadian market is different?

Another source suggests that there is no reason to. In Triumph of the Optimists, the authors note that the total value of the Canadian bond market at start-2000 was $539 billion (data obtained from Merrill Lynch and World Bank) compared to the total stock market capitalization of $801 billion. It is very unlikely that the proportion has changed so dramatically since then.

A bit more reading clears up the mystery. A 1996 Government paper on Financial Transactions Taxes: Pros, Cons, Design Issues and Revenue Estimates, says: “At $3.6 trillion per year, the bond market in Canada is 13 times larger than the equity market”. The title of the paper clearly suggests that “size” refers to the total value of transactions, not the total value of assets.

It is not clear why the total value of transactions is of much relevance to an investor (other than the implication that the market is very liquid). But, the total value of the bond market is clearly important because it reveals the wisdom of the market – i.e. how investors as a group have allocated their portfolio between various asset classes.

The DEX Universe Bond Index tracks a market of investment grade bonds that totalled $645 billion in 2006. I wasn’t able to find a source for the total value of the Canadian bond market but I would venture to guess that it is between $1 trillion to $2 trillion. If you do know the size of the Canadian bond market (as measured by total market value), do let us know in the comments section.

* All dollar amounts in U.S. dollars.

Finding a Financial Advisor, Part 2

July 20, 2008


In response to the first post on the series on finding a financial advisor, Thicken My Wallet posed an interesting question – why would anyone want to search for potential financial advisors off the internet? – and further suggested that getting referrals from friends or colleagues might be a better option. There are a couple of reasons why I got most of the short-listed planners from the CFP website: First, I am interested in finding out how easy (or difficult) it is for an average person to find a competent planner and the sample set I ended up with would be a good cross-section of what’s available out there. Second, if I did hire a planner, it would be strictly on a fee-only basis. I believe that investment advice isn’t worth paying for but everyone I know deal with investment advisors, brokers or mutual fund representatives, not fee-only planners and pretty much get investment advice only.

Now, I was ready to talk to the short-listed candidates over the phone. I had a list of five planners: Ruth* from Scotia McLeod, Kevin* from Investors Group, Alan* from RBC Dominion, Todd* from Berkshire Securities and June* from an independent planning firm. Of these planners, the only disappointment was Kevin because the first question he asked me was the size of the account and the interview went downhill from there, centering mostly around the great services he offered (i.e. mutual funds from the “best” companies around. Apart from Investors Group funds, Kevin also sold funds from Fidelity, AGF etc.), rather than trying to figure out what I was looking for. He was reluctant to speak about fees but was quick to mention that I don’t pay anything directly and it took much prodding to get him to admit that he gets a sales commission but probably forgot the trailer fees. I mentioned to Kevin that I don’t believe in paying for active investing and would want to continue to hold my current ETFs, only to be interrupted by his question — “ETF? What’s that?” I probably should have thanked him for his time and hung up after the first question but I was fascinated by the train wreck the interview was turning out to be.

The rest of the advisors were straightforward with their answers and as far as I can tell were quite competent but only two (Ruth and June) offered fee-only planning. They were happy to mention exactly what their fees were – typically starting at 2% of portfolio for account sizes starting at $200K – and were impressive with their knowledge of the financial planning process. Almost everyone mentioned that they provide clients with an analysis of their insurance coverage and have a team to assist with wills and estate planning and tax planning. Next week, we’ll look at potential questions to ask prospective advisors.

* All names have been changed.

You can read Part 3 of this series here.