Our Portfolio
Our portfolio is comprised of six different accounts. I’ve listed our target weight and the actual market weight of each security as of June 15/09.

Phil’s RSP
Below are the holdings of my RSP, with target weights and actual weights (both expressed in terms of the overall value of the account, not the portfolio as a whole). The securities marked with a * are the ones I plan to sell as soon as I can cover my average cost. I have made several mistakes in assembling this portfolio. For example, I bought XSP and XIN before I learned about the cheaper USD denominated alternatives. The clear message I get from looking at my RSP portfolio is that I need to dramatically bump up my fixed income.

Bonnie’s RSP
Like my RSP, Bonnie’s RSP is almost 40% tied up in the Life Points fund. Bonnie has more protection on the fixed income side with a 3 year GIC from TD Mortgage Corp and a corporate bond from Scotia Capital (maturing in 2011), but apart from that our RSPs are very similar. Like my RSP, the investment horizon for this account is definitely long term (+30 years). [Ed. Note: For the sake of brevity, I've dropped the actual allocation but it is similar to Phil's table above]

Joint Non-registered brokerage account
This account is in shambles. In addition to putting us in the Life Points fund, our advisor also suggested we dump a sizeable sum on a basket of six Canadian securities (CIBC, Royal Bank, TD Bank, Potash Corp., Shoppers Drug Mart plus Enbridge, which I recently sold for a small profit). The US ETFs are pet projects of mine and have taken a big beating in recent months. I do not think 5 stocks (or 7 if we include the ETFs) are enough to eliminate market risk (especially since 3 of them are in the same industry – Canadian banks). I don’t even feel 100% comfortable holding individual stocks, but if one wants to go down this path a much broader basket is needed. [Ed. Note: The Canadian Equity portion targets consists of 2% each in Royal Bank, TD Bank, Potash Corp., Barrick, Encana, Shopper's Drug Mart, Canadian Hydro Developers, Rugged.com plus XIC, XEG, CDZ and CPD. The US ETFs include VTI, PZD and PBW].

Phil’s TFSA
My TFSA is currently empty. In a very foolish attempt to time the market, I liquidated my TFSA account in early January and put all of it into HOU, a leveraged ETF offered by Horizons Beta Pro that is long on oil (NYMEX crude futures). I made the trade through an account with Questrade (See Questrade Review). I have not included the Questrade account in my portfolio because I intend on shutting it down once (and if) HOU returns to my average cost. It was very foolish to get involved with a product I didn’t fully understand (e.g. I’m not convinced HOU actually does what it says it does). So it’s a waiting game for now.

Bonnie’s TFSA
We made the full contribution to this account (ING High interest savings) in January but subsequently withdrew the full amount to put against our mortgage. We are waiting until 2010 to re-contribute. Our intention for both TFSA accounts is to concentrate on building a bond ladder through direct bond purchases.

Joint Savings Account
Come June 2009, our intention is to plough anything we have leftover (after monthly RSP and TFSA contributions and a small contribution to our non-registered account) into this account. We would like to build a large cash cushion to prepare for a potential maternity leave and to save for a hopeful cottage purchase one day. The yields right now are very low but I’m OK with this because it’s risk free (if and when our balance ever exceeds $100 k we will open an account at another branch, or open individual savings accounts, etc. so as to qualify for full CDIC protection)

What we are hoping to get is candid feedback on the target weights of the securities in our portfolio, our choice of securities and our strategy with respect to spreading our investments out across the six accounts that comprise our portfolio.

Related Reading:

• Portfolio Case Study 1, Part 1
• The TFSA December Transfer Strategy
• Sleepy Portfolio 2Q-2009 Report Card
• iShares DEX Floating Rate Note ETF (TSX: XFR)
• The Sleepy Portfolio Building Blocks II

Portfolio Case Study 1, Part 2 is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

The idea for this exercise was generated after reading the very popular Amateur Investor Manifesto series of posts in December. I think all readers of the blog benefited from seeing Reader J’s thought process and the reasons behind his asset allocation. One of the things that I thought was missing, however, was a discussion about how to split the allocation across the different types of accounts that are available to Canadian investors (e.g. RRSP, TFSA, RESP, non-registered account, high-interest savings accounts, etc). The other big difference between Reader J’s situation and mine (and perhaps many others’ out there) is that I’m looking to make changes to an existing portfolio (which, courtesy of my former advisor, is weighted about 90% in equities and is down about 28%).
What I’m hoping to get out of this post is candid feedback about where you think I may have gone wrong with my investment strategy, and where you think I can improve.

Background
My wife (Bonnie) and I (Phil) are both 33 years old and we both work full-time. We do not have kids but we hope to start a family within the next 12 months.

Objectives/Constraints
Our main short term goal is to save enough money to buy a cottage. Over the longer term, our goal, like that of most Canadians, is to save enough to live comfortably in retirement. I would like to retire at 55, my wife would like to retire from full-time work at 65 and continue working part-time. Roughly 50% of our monthly after tax income is required to meet our monthly expenses. The remaining 50% is free for investing.

Asset Allocation
Our target asset allocation is 50% Equity, 32% fixed income, 2% cash and 16% alternative investments.

History
We have been investing since 2007 (up until that point any excess savings we accumulated simply went to debt repayment – we both had large student loans). We spent two years (February 2007 to May 2009) with a Scotia McLeod advisor whose main recommendation (which we followed) was to devote 100% of our monthly RSP contributions to the LifePoints Long Term Growth, a “fund of funds” mutual fund with a heavy (80%) equity focus managed by Russell Investments Canada. The fund has a 2.5% MER and the NAV as of mid-June is about 28% below our average cost. Needles to say, we are very disappointed with the fund’s performance, but we need look no further than ourselves for someone to blame. And to be fair, the fund is not the worst performer in its category. In addition to our monthly RSP contributions, our advisor also recommended that we start a non-registered account, with a starting position of 5 blue chip Canadian stocks (see portfolio section in Part 2 for details).

The advisor got paid by taking one quarter of 1.5% of the market value of our portfolio every three months. In truth, I’m not sure that the advisors’ fees were greater than the trading fees that we would otherwise have incurred had we been investing with a self-directed account. However, we recognized that as portfolio grew every month, the fee-based relationship with our advisor became more and more expensive. The other problem we had was lack of control (i.e. we couldn’t make the trades ourselves and had to call them in real-time, etc.).

While still under the advisory relationship, we took over management of our portfolio in mid 2008 and immediately shifted into ETFs. This was interesting to me because we were in effect eschewing the advisor’s advice yet continuing to pay for it! I’ve been a proponent of passive investing ever since reading A Random Walk Down Wall Street. We completely terminated our relationship with the advisor in mid-June and are now DIY investors with Scotia iTrade.

While we’ve been generally happy with the new direction we set for our portfolio, there are a lot of uncertainties ahead. Our first concern is how to intelligently balance our portfolio. The challenge is that our portfolio has never been balanced, and we’re starting the process in the midst of a recession where most of our equity holdings are underwater. Clearly it’s much less painful to balance a portfolio when one can sell one’s holdings for a profit. Should we continue to buy equities at what could turn out to be historically low prices? This would drive down our average cost and position us well for a market rebound. Or should we buy fixed income to balance the portfolio? And should we buy bond funds or individual bonds?

A second challenge is how to allocate our various positions from a “tax advantaged” perspective across the six accounts that comprise our portfolio. For example, I’ve read that it’s best to hold fixed income in one’s RSP and Canadian equity (especially dividend paying stocks) in one’s non-registered account.

Finally, there’s the issue of our units in the LifePoints mutual fund. It comprises the bulk of the value of both my and my wife’s RSP. Should we buy more units to lower our average cost and speed up our breakeven point (at which point we would likely redeem our units)? This would seem to be throwing good money after bad.

Other issues: are we holding too much USD in our portfolios (e.g. Vanguard ETFs?) The short to mid-term outlook for the US dollar is not pretty. Should we bother at all with GICs? Are the Claymore sector ETFs (e.g. water, agriculture, etc.) too thinly traded to be useful as a long-term investment?

Continued in Part 2

Related Reading:

• Portfolio Case Study 1, Part 2
• The Renaissance High Interest Savings Account
• BMO expands its ETF line up (again)
• Wealth of Canadians: Assets
• Sleepy Mini Portfolio Q2-2008 Update

Portfolio Case Study 1, Part 1 is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

I have pointed out many times that insurance is an important part of your financial plan; it is there to protect you and your family should the unexpected happen. However, many families, unfortunately, have found out that it does not always work that way. The issue here is Mortgage Insurance sold by banks and mortgage brokers. Ellen Roseman recently wrote in The Toronto Star about the experience of the Feldman family, who have been paying premiums for years but their claim was initially denied. The Feldmans did get their claim paid out on “compassionate grounds” after The Star got involved, but many families have not been so lucky.

Working in the insurance industry, I have seen too many families being unaware of the dangers of mortgage insurance. Insurance is a complicated topic and the mortgage professionals who sell these products are usually not trained or licensed to sell life insurance. I strongly recommend that you do your homework and deny any insurance offered by your mortgage lender.

In this post, I will point out some of the differences between the insurance you purchase with your mortgage and one purchased from an insurance company.

Post Claim Underwriting

The biggest issue with insurance from the bank is that they have post claim underwriting, which basically means that the underwriting will be done after a claim has been submitted. Technically you could be declared uninsurable after you have submitted a claim and your claim denied as happened to the Feldmans. If you purchase it directly from your insurance agent, all underwriting will be done before the policy is issued. Therefore you know your claim will be paid out when needed according to the terms of your contract, unless fraud can be proven.

Other issues with Mortgage Insurance

1. Beneficiary is the lender. With life insurance, you select the beneficiary.
2. Insurance amount decreases with your mortgage, but premiums stay the same. With life insurance, your coverage and premiums remain the same.
3. Not transferable to new lender.
4. Payout can be used only to pay the mortgage.
5. Cannot change policy if situation changes. Policy can be modified as needed.

If you need insurance to protect your family, speak to a qualified insurance advisor to determine the appropriate insurance coverage for your family. Many opt for Mortgage Insurance tempted by the very low premiums but these low premiums come at a huge risk and a few extra dollars saved today could cause your family great pain in the future.

You may also want to check out a story that CBC Marketplace ran on this topic titled In Denial about a year back.

Related Reading:

• Reader Question: Joint First-to-Die Life Insurance Policy
• Life Insurance: How Much?
• Questions on Canceling Mortgage Life Insurance and Stock Ex-Dividend Date
• Mortgage Free? Ask for a discount on your home insurance
• How Much Life Insurance Do I Need?

Mortgage Insurance versus Life Insurance is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Should you go with a fixed-rate mortgage (FRM) or a variable-rate mortgage (VRM)? One thing is clear about questions of this nature: nothing is ever clear. In the same way that RRSP vs. mortgage vs. TFSA can never be answered definitively for all cases, the decision on whether to take a variable or fixed mortgage interest rate can also never be resolved in cookie-cutter fashion.

To paint broad strokes, banks charge a premium on FRM’s to accept the risk that money will not be so cheap in years to come – by accepting a VRM, and hence the risk, you stand to save money, historically, and on average.

Widely-reported Dr. Moshe Milevsky of York University authored a study in 2001, with a subsequent update summarized nicely here, where 90.1% of the time over 1950-2007 it was better to have chosen a VRM over a FRM (down to 77.1% if you have good negotiation skills and credit, and can secure a discounted rate). As discussed in the comments there, it would be nice to know what conditions existed in those minority of times when it was better to have a FRM, ie. historically, given that prime rate was x%, what was the probability that fixed would fare better than variable over the next finite time period?

Given that mortgage interest rates are currently at an all time low, one has to wonder whether historical studies have the same relevance when brought to bear on current market conditions. The spread between VRM and FRM is extremely slender at the moment – on a standard 5-year term closed mortgage, the best discounted VRM today is just north of 3% and the best discounted FRM is about 4%. The narrower this gap, the better one’s probability of doing better with a FRM.

Some have argued that when rates do begin to go up, as they almost certainly will in time, the increases will be modest at first and at that point early in the rise one can lock in to a fixed rate. However, it is a certainty that by the time the average Joe realizes it’s time to lock into a fixed rate, the banks will have raised the fixed rate higher than he could have gotten today. This becomes a case of pay less today on your VRM, pay more tomorrow on your FRM.

In a recent discussion, Dr. Milevsky states generally that people with a lot of assets and therefore increased ability to deal with risk should still consider a VRM. Dr. Milevsky offers that those with small home equity, or low or unstable income, may want to consider a FRM.

Historical studies aside, there are some elephants in the room these days. Job stability is at generational lows, house prices are in steady decline, the future of North American automakers hangs in the balance, and governments are pumping trillions into the financial system with uncertain results. These are uncharted waters.

Ultimately with mortgage rate choices, as with all other aspects of personal finance, it comes down to risk management. If we pull out all the stops in efforts to maximize the slice of pie at retirement, we run the risk of burning the pie, or finding we’ve arrived at the dinner table without a plate and fork. If we don’t take the occasional calculated risk, however, we may find that there’s not enough pie to eat on Tuesdays.

And as always, more important than the decision you make on VRM vs. FRM is the decision you make in your day-to-day life to control your expenses, increase your income, and direct the net savings toward paying off the mortgage and maximizing registered and non-registered investments.

[Update: You may want to check out this post on Canadian Mortgage Trends on the same topic.]

Related Reading:

• Mortgage Rates: Fixed or Floating
• Time to opt for a variable-rate mortgage again?
• Bank of Canada Rate Hike
• Banks don’t match Bank of Canada’s cut
• This and That

Bucking the conventional wisdom on a fixed-rate mortgage is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

I want to thank Canadian Capitalist with giving me the opportunity to guest post on his well-deserved vacation. If you are a regular reader of this blog, you know that Canadian Capitalist is rightfully a passionate supporter of the KISS (keep it simple stupid) principal of personal finance (my words, not his) and that fees destroy returns over the long term.

As this age of financial excess is unwinding itself ever so painfully, it is interesting to note how the smartest guys in the room are probably not the financial wizards the media makes them out to be.

For example, CC wrote a recent series on Manulife’s IncomePlus products — a stunningly successful product for the company. But, as CC noted, the product had many flaws including an outrageous MER of approximately 3.5%. A moderately educated investor could replicate the product’s return using a portfolio of bonds.

So Manulife has designed a fail-proof product for itself and we should invest in the issuer and not the product right? Well… the Globe and Mail ran an interesting article on Manulife’s recent troubles resulting in part from products like IncomePlus.

In the simplest sense, insurance is like banking without money. Like banks, insurers are regulated and the regulators demand that a certain portion of money be set aside to cover its liabilities. Conventionally, an insurer’s largest liability is that all of the insurance policies it underwrote are called at once (analogous to all the bank’s customer’s withdrawing their money at once). The chances of everyone passing away at the same time are quite remote so an insurer’s risk is, statistically speaking, quite low.

But, insurance companies started dabbling into more exotic financial instruments. One such product is something known as viable annuities. Like a regular annuity, an investor pays the insurance company a sum of money in return for guaranteed payments in the future.

However, an investor in a variable annuity is also asking the insurance company to invest the money in the stock market for them and to participate in any profit the insurance company makes (IncomePlus is a variable annuity). The key attraction is that no matter how badly the insurance company invests your money, the investor will be guaranteed a stream of money in the future- so, theoretically, no down-side, all upside.

If you are a regular reader of this blog, you understand that active management of funds statistically underperforms the board based equity index. Thus, even in regular markets, one is already giving money to the “smartest guy in the room” (sorry, they are mostly guys who got us into this mess) to under perform.

In markets such as this? Remember that the insurance company has to guarantee the annuity payment but it has taken the investors’ money and lost a lot of it in the stock market. The only way to make up that loss is to take profits and top up the reserve fund mandated by the regulators to ensure that the annuities are paid on time.

The topping up of reserve funds can only be accomplished mainly through a couple of different methods: (i) issuance of new shares, creating a dilution issue; (ii) raising debt, leveraging the company more; and/or (iii) move profits into the reserve fund, reducing earnings per share. Manulife has done all three and its shareholders have suffered as a result; it posted its first loss ever since the company went public.

Why didn’t Manulife hedge its position? According to the Globe article, it stopped doing it in 2004 (remember they thought they were the smartest guys in the room).

Is Manulife in trouble? It will most likely feel a lot of short-term pain but its trouble pale in comparison to many of its industry counterparts and the money in the reserve funds can be moved back into earnings over time (to be clear, this is an industry issue not particular to Manulife).

Is a Manulife annuity in trouble? Most likely not since it reserve funds have been sufficiently topped up (in other words, it has the money).

The moral of the story?

The smartest guys in the room are not very smart when it is not their money.

The author is a shareholder of Manulife and, obviously, not a very happy one.

Related Reading:

• Manulife IncomePlus: The high cost of peace of mind
• Manulife IncomePlus versus a Bond Portfolio
• Dividend Investing in Financials, Part II
• Questions on Canceling Mortgage Life Insurance and Stock Ex-Dividend Date
• Mortgage Free? Ask for a discount on your home insurance

Who are really the smartest guys in the room? How Insurance Companies Forgot Their Way is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Asset Allocation
So based on my hare-brained idea of mixing indexes I’ve got to split the overall allocations further into the actual ETFs that will make it up. I don’t know the best way to do it properly, so I’ve often taken the coward’s way out and split it at arbitrary amounts. The equities are shown broken down into the % of the asset class and % of the portfolio as a whole.

Canadian Allocation
I’ve split this allocation right down the middle, half for the standard S&P/TSX Index and half for a value / small cap equities. For this second part, I used 35% of a RAFI fundamental index, which apparently has more of a value tilt and then 15% small cap:

50% / 8% — iShares Composite Index (XIC)
35% / 5.6% — Claymore Canadian Fundamental Index (CRQ)
15% / 2.4% — iShares SmallCap Index (XCS)

United States Allocation
This split was even murkier because the Total Stock Market has exposure to all US stocks (small, mid, large, growth and value), I wasn’t sure how to tilt it to value & small cap. The super-low fees are awesome and make it even harder to justify combining with a fundamental index which costs nearly ten times more (MER of 0.65% vs. 0.07%). Also it should be noted the RAFI fundamental index is hedged in Canadian dollars and as explained earlier, my hope is that this allows the portfolio to carry a lower percentage of Canadian equities without as much currency risk.

In previous revisions, I had selected 2 different small-cap funds. The Russell 2000 index was eliminated because apparently right before the index is reconstituted it would be subject to price volatility that would drag performance by 1-2%. Then the iShares S&P SmallCap 600 was eliminated simply because Vanguard’s MER of 0.1% was half as expensive.

48% / 13.2% — Vanguard Total Stock Market (VTI)
40% / 11% — Claymore US Fundamental Index (CLU) – Hedged
12% / 4.13% — Vanguard Small Cap (VB)

International Allocation
Vanguard has great fees, so it’s an easy choice for a standard cap index. The interesting thing here is the RAFI fundamental index doesn’t hedge the currency. I found out even though these funds are in US dollars there is no US currency risk, the currency risk should be less volatile because it is actually Canada against a basket of currencies. I haven’t been able to find a small cap international index.

60% / 14.55% — Vanguard Europe Pacific Index (VEA)
40% / 9.7% — Claymore International Fundamental Index (CIE)

Emerging Markets Allocation
Vanguard has the lowest fees for international and there doesn’t seem to be much else I can do to add a value / small cap tilt, especially since the allocation is such a small part of the portfolio.

100% / 4.25% — Vanguard Emerging Markets (VWO)

REITs
I’ve split Real Estate into 75% Canadian, 25% International. The question here comes from iShares REIT Sector Index XRE. It has a high MER of 0.55% but only a few equities. With my estimated starting allocation of around $30,000 it might be best to unbundle and save a bit on fees. This is appealing because I’ve never bought and sold stock myself, this could serve as an interesting lesson. The next idea is what about owning REITs in a DRIP plan which has no fees, plus lots of real estate trusts give drips a 3% or more bonus/discount. It would be more work and harder to rebalance, is it worth it? Would a REIT portfolio try to mirror the cap weighted index or evenly spread out between different types of trusts (malls, offices, senior’s homes, residential, etc). Is it worth it?

75% / 6% — iShares REIT Sector Index (XRE)
25% / 2% — Wisdom Tree International Real Estate Index (DRW)

Cash & Bonds
For the cash component of the portfolio I feel safer having 6 months of core living expenses in a cash emergency fund in high interest savings accounts, current this is about $16,000 or 4% of the total portfolio.

The remaining 16% is going to be invested in short term bonds with the goal of lowering equity risk. The Sleepy Portfolio uses the iShares Bond Index (XSB) but I am planning to use the lower cost Claymore 1-5 Year Laddered Government Bond ETF (CLF). Since it lacks higher yielding corporate bonds present in XSB, so would it make sense to split the bond allocation further with 80% CLF and adding 20% of iShares Corp Bond Index (XCB)? Combined the weighted MER would be 0.2%, instead of 0.25% for XSB. Is it worth it?

How and at what point should you buy real bonds directly?

40% / 8% — Claymore 1-5 Year Laddered Government Bond (CLF)
10% / 2% — iShares Corp Bond Index (XCB)
50% / 8% — High Interest Bank Accounts

Related Reading:

• More New ETFs
• The Amateur Investor Manifesto, Part 2
• Vanguard to Introduce Six New ETFs
• Building a diversified portfolio out of Claymore Exchange-Traded Funds
• Investing Small Amounts of Money

The Amateur Investor Manifesto, Part 3 is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

Ready, Set, Go
Now I am at the point of transition, where I actually craft an asset allocation and implement it. I find this step to be rather difficult, so I will share my thoughts and hopefully get some feedback.

Dimensional Fund Advisors
Several smart people I’ve bumped into lead me to the path of a slightly different indexing strategy by Dimensional Fund Advisors that isn’t cap-weighted. Their research and track record in the US looks very promising that they can build a better index with lower risk and higher returns. Being a [new] money nerd, I get turned off their requirement to only sell through advisors — I have a bad history with them; from now on I want to be more involved. DFA Canada also doesn’t seem to be performing as well as its US parent, but if I had the choice to use them to build my own portfolio held at a discount brokerage, I would have. In fact the first step to choose my risk tolerance comes from the quiz I took from the IFA website which only sells DFA funds. I fit into the “Indexfolio 70” which gives me a start to my asset allocation with 20% bonds, 80% stocks. In stocks I’ve tried to keep generally the same allocation as follows:
16% — Canadian stocks
27.5% — United States
24.25% — International (developed)
4.25% — Emerging Markets
8% — Real Estate
20% — Bonds & Cash

Fund Selection
Without DFA my fall back choices are using traditional low costs indexes from iShares, Vanguard and maybe also “Fundamental” indexes from Claymore which are sort-of like DFA. Vanguard is instantly appealing because of their great history and ultra-low fees. I just wish they operated in Canada. iShares seems pretty good and has fairly low fees. Claymore costs more, is less liquid, and seems like more of a risk because their implementation hasn’t performed as well as their back-testing, but hopefully over the long term they will outperform a normal index. I’m hoping that by mixing these different styles of fund I can lower the weighted MER and possibly a little get a better return and/or little less volatility.

Amateur Versus Sleepy
Compared to the sleepy portfolio this allocation has significantly less Canadian exposure. I understand that based on the cap weighting Canada only makes up about 3% of the global market, but we overweigh it because of home bias, currency risk and local dividend tax advantages. But where does a 24% or 16% allocation number come from? I generally agree that currency hedging is a performance drag, but is it possible that by using some indexes with a currency hedge to US/foreign markets that this would in a way help bridge the 16% to 24% currency risk discrepancy of Sleepy vs. Amateur?

Do any nerdy individual investors go so far as to do mean variance optimization as described in the Intelligent Asset Allocator? Is there some a practical way to build and test asset class correlation and other metrics like alpha, beta, standard deviation? Without knowing how to do this myself, I’ve decided to copy IFA which probably has measured these technical indicators to back test their risk based performance.

Continued in Part 3…

Related Reading:

• The Amateur Investor Manifesto, Part 3
• Tidying up the Sleepy Portfolio
• Introducing the Sleepy Portfolio
• Asset Allocation
• Asset Allocation Explained

The Amateur Investor Manifesto, Part 2 is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

I’ve known of passive investing with index funds for several years, but I’ve never trusted my own intuition to do it. Even though my gut was telling me my “financial advisor” wasn’t adding value and wasn’t able to time the market, I never spent enough time to really research indexing enough to make my mind agree with my gut. I felt at the time it was better than nothing since I was preoccupied with work and family.

Starting in 2008 I made it my goal to begin to manage my own personal finances. I quickly found out it is actually a very interesting topic and a natural extension to my nature of being a “saver” and a nerd. So I’ve spent much of year reading books and blogs, taking my time to understand and not feel rushed into making any decisions. As Buffet says, it’s better to “move like a sloth”.

I’ve not invested anything extra with my advisor for probably 2 years, so at the beginning of the year one of my major concerns was “time risk” of investing a lump sum of cash. As we see now that risk was very significant, and just by pure dumb luck, I missed a lot of the pain. I feel like there needs to be more information on how to make this transition. I probably would have used dollar cost averaging or value averaging, but now that the market is already so much lower I think the risk is much tolerable and timing won’t make a significant impact on future returns.

Reason for Sharing

What I’d most like back from posting my plan is just feedback of any sort. Let me have it, the plan is personal but put yourself in my shoes and let me know why it doesn’t make sense or that you think it’s a good idea. I wish there was a place to post and compare investment plans and asset allocations, leave comments and track the performance over time.

Investment Goals

Before writing this plan down on paper I was talking about “the 10-year plan” that we would continue saving but also buy a house with a 10-year fixed-rate mortgage that we would aggressively pay down in those 10 years. The goal being we would have the safety and shelter of a paid for house plus by that time our investments and savings would have grown at an assumed 8% real return to provide enough income (assuming a continued 8% return) to “financially retire” with a modest life style living on $40,000 in today’s dollars.
But is that really retiring when most people only assume a 4% real return / withdrawal rate in retirement? Doesn’t that mean in years like we are currently in the retirement would fail and necessitate new income from “having” to work again? Is it possible to retire extremely early if you have to assume this rate of return, or should I be more realistic and say the goal is “early semi-retirement”? It’s a personal question, but I still wonder which is appropriate since I’m so far outside the normal realm of how average people save, invest and plan to retire.

Continued in Part 2…

Related Reading:

• A Nest, Not A Nest Egg
• How Much House to Buy?
• DIY Smith Manoeuvre, Part 4
• Investment Time Horizon Explained
• Portfolio Case Study 1, Part 1

The Amateur Investor Manifesto, Part 1 is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

My father always taught me that there are three ways to do things in life: the Easy Way, the Hard Way and the Smart Way.

Investing based on this principle has provided me with more consistent success than I would expect if I had strictly stuck to the traditional two ways of doing something. Whenever I encountered failure early in my life my father would repeat these three methods and often later in reflection the best path to correcting my mistake would become evident. Often the Smart Way was a combination of the Easy Way and Hard Way found through collaboration, teamwork and looking at the bigger picture of interpreting my surroundings differently.

The Smart Way is a different interpretation of how things come together to make better sense and achieve higher efficiencies. My investment motto of “allow money and debt to work for you instead of against you” is based on this principle. When you invest you want to do things that make sense, are fundamentally sound and require very little effort or energy to maintain.

My interpretation of value investing is much more than simply looking at a stock’s quantitative value, underlying fundamentals and financial position. To me it’s about assessing all aspects of a business and asking myself if the intrinsic value of that company is more or less than the market price. Often there are times when I don’t need a massive stack of financial statements, insights into global operations or a tour of a manufacturing plant to get a sense within the first hour or two whether an investment is something that fits my style or requirements to own.

Based on the Smart Way principle I want to highlight some introductory areas that many individuals get caught up in when investing. A De-Value Investor is an individual investor who de-values their investments and opportunities for creating wealth by ignoring basic fundamentals and avoiding the bigger picture or Smart Way.

After each quote and explanation ask yourself if you are a Value Investor or De-Value Investor in each situation based on what you might do or already do. Each of the following statements I have heard in person within the last year.

“I’m going to borrow money this year to invest in my RSP.”

Any money you borrow to invest in your RSP will not be tax deductible in comparison to borrowing to invest in a non-registered account. While this may appear to be a great idea proposed by your bank or financial advisor any loan taken to borrow money to invest in your RSP will have no tax savings on the interest. Receiving a tax rebate for your RSP contribution to pay down onto the loan may make sense, but ask yourself how far ahead you might be if you are in the highest marginal tax bracket and paying full interest on your loan. Examining this situation the Smart Way could show you how you might save almost half your interest cost.

“An extra mortgage payment? I’ve got 25 years to pay off my mortgage. I need a new TV instead.”

On a $250,000 mortgage at 6.5% interest amortized over 25 years the total interest paid will be almost $252,400 – that’s only interest!

You’ve essentially paid for two homes: one in principal and one in interest. Pre-paying one additional payment of $1600 each year would decrease your interest to $203,500. You could save nearly $49,000 in interest and have your mortgage paid off in 21 years just adding an extra payment each year. Have you ever used a mortgage calculator to see how you can meaningfully decrease your interest?

“Why would I need to diversify? I don’t need to diversify! I hold only as much stock as I can hold in one hand.”

While being over diversified can negatively impact returns, not being diversified at all can leave an investor exposed and vulnerable to unexpected events in one sector, industry, country or investment. Effective diversification is ensuring you have exposure to investments that behave differently in various market conditions and buffer your overall portfolio against extremes of volatility and risk.

“They don’t need profit…the company is going to the moon! I have to invest in this stock…just look at that chart!”

Trees never grow to the sky and the fundamentals of gravity dictate that what goes up must come down. Speculation has high rewards, but also a high potential for losses. Companies without profits are dangerous because they’re burning through more cash than they can generate and this eventually catches up to a company.

“Oh…that’s what that company does?”

Do you understand what you’re buying? Do you know what factors can influence changes within the market a company operates? Is there sustainable demand for products or services? Are their operations complex? Can you explain what they do in a single sentence? What are the risks?

“I can’t sell…there’s still potential…plus I’m only down 40%.”

Knowing when to buy is always easy; knowing when to sell can be painful and difficult to ascertain. Do you have a rule, guideline or minimum loss (percentage or dollar amount) that you can tolerate on your investments? How important is capital preservation to you? Do you have as much confidence in yourself to sell as you do to buy?

“I’ve procrastinated for years with saving and investing. Now I feel I need to catch up.”

There are a lot of investors in this boat and the sea can be rough and unforgiving. Do you have a tolerance for risk? What is your definition of risk? How much risk can you tolerate? Have you ever asked yourself these questions?

“This stock has gone nowhere in 4 months! I need to sell. The analyst said that this stock should have doubled by now!”

Adequate patience and realistic expectations are hallmarks of successful long-term investing. Analysts have two knocks against them: they are paid for an opinion and view the business from external sources. What you need to do, in any situation, when receiving advice is ask yourself who stands to benefit most from the advice being given. If the quick answer is not “you” than you have to question if there’s a conflict of interest that is impacting the opinion you are receiving.

“I haven’t met with my advisor for almost two years. I like them because they send me chocolates at Christmas each year.”

When you pay for a product or service you should expect to receive something tangible in return. If you’re paying a premium to receive advice and no advice is being given than you should be asking why you’re paying that premium in the first place. How much is a 3% MER on your portfolio worth to you? 3% over ten years is 30% of your potential returns that you’ve paid for a service – are you getting a value-added service or performance? Whose interests are being served as a priority?

Related Reading:

• Reader Query on Lump Sum Investing
• Pre-pay Your Mortgage
• Comment on Mr. Kiyosaki’s Bad Advice
• DIY Smith Manoeuvre, Part 4
• Profit from Employee Stock Purchase Plans (ESPP) – II

Are you a De-Value Investor? is brought to you by Canadian Capitalist -- Helping you to invest & prosper.

One common complaint this year regarding the market crash is that people who were planning to retire in the next few years might have to delay their retirement. I’ve heard of a similar problem recently with the failed BCE takeover, where some people are upset because they had plans for the money once their shares were bought out. Yet another situation was someone thinking of buying a house and using the Home Buyers Plan to borrow money from their RRSP – however the RRSP account had lost so much value, they can’t borrow from it anymore.

One of the key concepts in financial planning is that of investment time horizons. Your investment time horizon is the amount of time from now until you need to sell your investment. In order to manage risk, you need to try to match your time horizon with the risk level of your portfolio.

Volatility and risk

The expected return from equities is higher than that of other investments such as cash and bonds. This difference, which is called the “equity premium”, reflects the higher amount of risk assumed when owning stocks. Sometimes investors make the mistake of forgetting that expected returns for equities are only reasonable over the long term (i.e. 20 years or more). Any individual year or even group of years can have a very wide range of returns — both positive and negative. 2008 is a great example of an extreme negative result.

Long term bonds can also be fairly volatile if there is a long time to maturity. If interest rates rise, then bonds will fall and vice-versa.

On the other end of the spectrum we have good old cash. The great thing about cash is that although the expected return is very low – roughly 3% at the moment (which doesn’t include inflation), at least you don’t have to worry about any volatility. If you put $5,000 into a high interest TFSA on Jan 1 then that $5,000 will still be there in June plus a bit of interest.

Match the investment to the horizon

The lesson to be learnt here is that you have to choose the right type of asset class for your time horizon. If you have a long investment horizon then you can afford the risk of owning equities. If you have a very short time horizon then you should probably stay in cash. Anything in between should have some combination of risky/guaranteed investments.

The idea behind choosing the proper investment to your time horizon is not to increase your investment return, but rather to increase the probability that the required amount of money will be there when you need it.

Some scenarios

Here are some sample investment time horizon scenarios – please keep in mind that there are no “agreed upon” lengths of time for various term lengths.

Short term – Susan is 25 and saving part of her RRSP to use as a down payment for a condo in the next couple of years. In this case, the portion of the RRSP to be used for the downpayment has a very short time horizon and should not have any stocks or long term bonds. This amount should be in cash or some sort of money market funds.

Medium term – Bob and Gertrude are 33 and want to buy a cottage in about 10 years. In this case they should have some equities but not too much. Perhaps a 50% equity/ 50% cash/short term bond would be appropriate. As they get closer to the potential purchase date, they will want to increase the non-equity portion. Once they get to within 4 or 5 years of the purchase they might want to be 100% cash or short term bonds.

Long term – Johnny is 38 years old, has $100,000 in his RRSP and is not planning to retire for at least 20 years and will probably live another 25 years after that. Johnny can afford to have most of his investment in equities because of his long time horizon. But, he does have to consider other factors such as how well he can handle volatility.

Don’t lump everything together

If you will be drawing from your investments at different time intervals then it is important to separate your portfolio by time frames. If you are retiring in 3 years then consider putting away about 5 years worth of withdrawals into cash. As you use up that cash in retirement you can sell equities to keep up the cash cushion. Since you have 5 years worth of cash, you also have the option of not selling any equities for 5 years – a retiree might choose to wait it out after a year like this one, rather than sell any equities. Younger retirees have several different investment time horizons ranging from short to long, so they need to have a portfolio that reflects that. They shouldn’t have all bonds or all equities.

Similarly, a house hunter who wants to borrow $20,000 from their RRSP should put that money into cash or money market funds. The remainder of their RRSP, however, should be considered a long-term investment and allocated appropriately.

Related Reading:

• How Much in Equities?
• A Tour of ETFs: iShares Bond ETFs (XSB, XBB)
• Why lower stock prices should make us smile
• Stick with Stocks
• Short-Term versus Long-Term Bonds

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