Canadian Capitalist

The nice thing about NETFILE is that if CRA owes you a refund, you can expect to receive it by direct deposit in about eight business days. I owed the CRA a bit of money this year but my wife got a big refund and we wondered what to do with it. Jon Chevreau writes in The Financial Post that a lot of Canadians will face a similar decision - more than half of 25 million tax payers can expect a refund averaging $1,382 - and offers some ideas:

• Pay down Consumer Debt: Probably the best option for those carrying credit-card or other high-cost debt is to use the refund to pay it down.
• Pay down the RRSP loan: People who borrowed money to contribute to their RRSP should use the refund to pay down the RRSP loan.
• Contribute to Your RRSP: If the big refund is courtesy of a last-minute RRSP contribution, the refund can be used to start a virtuous cycle - get a head start on RRSP contributions for the current year.
• Pay down the Mortgage: The conventional advice is to use the tax refund to pay down the mortgage. Another option is to repay other low-cost loans.

We ended up picking the last option and paid down an investment loan.

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1. Your taxes are due on or before April 30, 2008. If you haven’t done so already, now would be a good time to start working on your taxes. Tim Cestnick has tax tips for last-minute filers.
2. While the stock markets have recovered somewhat from the deep losses around the middle of March, Larry MacDonald writes that it is too soon to sound the all-clear.
3. Mark Hulbert reports on a surprising research finding that questions the conventional wisdom that investors reduce their equity allocation as they approach retirement.
4. Rob Carrick says that variable-rate mortgages are still a better bet even if the commercial banks are reluctant to move in lock-step with the Bank of Canada.

Blog Roundup:

1. If you invest in mutual funds, Jon Chevreau has some pointers to help you pick one.
2. The Dividend Guy finds that Financials and Consumer Staples are biggest sectors represented in dividend ETFs.
3. Canadian Mortgage Trends reported that Prof. Moshe Milevsky has updated his study comparing fixed-rate and variable mortgages.
4. Million Dollar Journey asks if you’ve given money as a gift and if so, how much?
5. Thicken My Wallet wonders what investing ideas George Costanza would give out.
6. Preet of Where Does All My Money Go writes about how easy it is to become a financial advisor. That explains why a friend of mine purchased corporate bonds after being assured by his advisor that they don’t lose money.
7. Thanks to Happy Rock for including my Top Three Investing Mistakes post in the Carnival of Personal Finance.

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The Romans said nosce te ipsum - “know thyself” and in this excellent new book, Dan Ariely, describes experiments that illuminate aspects of human behaviour that are, in turns, surprising, delightful, amusing and yes, even disturbing. Subtitled “The Hidden Forces That Shape Our Decisions”, the author who is a professor at MIT says that we are not only irrational, but predictably so.

The book seeks to answer questions such as why we overpay for a fancy cup of coffee, why CEO compensation has skyrocketed, how choices distract us from our goals, why we fail to save, why we should beware of “trial offers”, why a little cheating is so common etc. Prof. Ariely encourages readers to “pause at the end of each chapter, spend some time thinking about how the principles of human behavior identified in the experiments apply to your life”. For instance, take the TD Bank iPod offer I blogged about rather excitedly last year. When I really stop and think about it, I rarely listen to music on a portable player. In the basement somewhere we have a Walkman, a Discman and a tiny SanDisk MP3 player that were used a couple of times and now gather dust. So, it’s a good bet that the iPod would have met the same fate and it’s irrational that I would be ready to jump through hoops to get one. But, hey, when something is FREE!, we simply go nuts over it.

Prof. Ariely is an excellent story teller and his writing is charming, witty and funny. He is also a very clever guy with a mischievous streak and his experiments (and that of his colleagues) in the book are very ingenious. If this book is available at your local library, try and get it. If you liked Freakonomics, you’ll like this book as well. You may also want to check out Prof. Ariely’s Predictably Irrational website, featuring a blog, YouTube videos and links to his research websites.

Rating: 9 out of 10

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Financial Jungle recently wrote about a study put out by Tweedy Browne that purports to show the clear superiority of investing in high dividend yield stocks. One of the examples quoted in the Tweedy Browne study is the Dogs of the Dow.

Constructing the Dogs of the Dow is simple - after sorting the stocks in the Dow Jones Industrial Average (DJIA) by their dividend yields, pick the top ten stocks and invest equal amounts in each stock. Next year, construct a new list and repeat the process again. In Beating the Dow published in 1991, authors O’Higgins and J. Downs calculate that the Dogs strategy would have returned 17.9% annually, compared to 13.0% for the DJIA for the 1973 to 1998 time period.

Did the Dogs of the Dow actually outperform simply buying and holding the DJIA by a massive 5% per year? The answer, it turns out, depends on who does the measuring. In a paper titled, The “Dogs of the Dow” Myth, author Mark Hirschey of the University of Kansas, calculates the returns for the same time period and comes up with an annual return of 15.3%, 2.6% less than the O’Higgins numbers cited in the Tweedy Browne study, for the same time period!

The outperformance also depends on the time period under consideration. While there is still a 2.3% outperformance for the 1973-98 time period, Hirschey find that the outperformance for the 1961-98 time period is only 1.55%.

The excess returns discussed thus far do not account for the excess trading costs (in the past trading costs were significant) and turnover compared to simply buying-and-holding the thirty stocks in the DJIA because the Dogs portfolio needs to be rebalanced every year to sell the stocks that aren’t Dogs anymore, buy the new Dogs and rebalance the existing Dogs to equal weights. If held in a taxable account, the excess turnover in a Dow Dogs portfolio would create an additional drag in the form of taxes. Hirschey estimates these excess costs and concludes:

Thus, implementation of a Dow Dog investment strategy results in added annual brokerage costs of 0.34%, plus added income taxes on dividends of 0.74%, plus added capital gains taxes of 0.50% — or 1.58% in annual transactions costs. These transaction costs are roughly equivalent to the previously unexplained excess returns of 1.55% per year for the Dow Dog strategy over the 1961-98 period.

In a future post, we’ll take a look at the High Yield, Low Payout paper quoted in the Tweedy Browne study.

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The Bank of Canada followed up its previous 0.5% reduction in interest rates with another cut of the same magnitude today. At this point, it looks like our central bank is expecting to lower rates even more as it noted that “some further monetary stimulus will likely be required”. You can read the full text of the Bank’s statement here.

The surprising part of the rate cut is what didn’t happen. The big banks have thus far resisted matching the cut by the Bank of Canada and maintained the prime rate at 5.25%. If the banks do not lower the rates in lock step, consumers would not see a reduction in the interest paid on variable-rate mortgages and personal loans.

[Update: The major banks did match the Bank of Canada by lowering the prime rate by 0.5% to 4.75% later in the evening.]

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Sometimes authors or publishers offer to send me a book for a possible review. I usually accept with every intention of reading the book and writing a review. Unfortunately, as I didn’t have the time to read the following books - I didn’t get past the first chapter on two of the books and skimmed through the other two - I thought I’d at least acknowledge receiving them.

The Young Investor by Dan Fournier. Subtitled “The North American Guide to Investing Online”, this appears to be a comprehensive book for the investor who is just starting out. I read two chapters “General Investing Guidelines & Tips” and “Avoid Mutual Funds…Embrace Exchange-Traded Funds” and found that the author writes well and gives solid advice. There is an intriguing chapter at the end titled “The Offshore Advantage” in which the author suggests that “all investors, at some point, should move a portion of their assets offshore”; something that I don’t recall ever reading in a finance book. The book has 336 pages and is available in paperback format for $24.95 from The Young Investor website.

Invest Now by A. Dawn. The author is a fellow blogger (A. Dawn Journal) who has self-published a book that he says is “jam-packed with timely information and timeless advice for the beginning Canadian investor”. The book starts off well-enough discussing different types of investment accounts but I found it a little light (it’s only 136 pages including blog posts reprinted from the author’s blog) on information on what an investor should actually do after opening an account. The author does suggest an “easy portfolio” which has a 25% allocation to non-Canadian Income but no rationale was given in the subsequent pages. The book is listed at $15.95 (US) and is available from Amazon.ca and more details can be found on the author’s website.

The Brainwashing of the American Investor by Steve Selengut. The author lost me in the first chapter where he claims that “Trading absolutely always produces more growth in capital, more growth in income, and more inflation insurance than any other strategy”. Right! Fortunately, Million Dollar Journey did read the book and wrote a review.

A Million Bucks by 30 by Alan Corey. The enterprising young author chronicles his journey from his mom’s basement to a seven-figure net worth by the time he turned thirty. Mr. Cheap wrote a review of the book yesterday and Thicken My Wallet featured an interview with Alan on his blog.

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Last week, it was widely reported in the press that Telus was ordered to refund the “network access charge” ($2.95 per month) that was slapped on customers who did not use its long-distance network. The news is a reminder to check your phone bill and see if you are still paying a fee for the privilege of making long-distance calls through your local phone company.

Bell, for instance, charges a $5.95 monthly long distance network charge, which it claims was introduced “to support investments to enhance and expand our network” and its best per minute calling rate within Canada and to the U.S. is 5¢ per minute. Telus (TSX: T) charges a $4.95 per month “administration fee” for its long-distance plans and if you don’t pay a “subscription fee” on top of that, calls within Canada cost 7¢ per minute. To call the U.S. requires a monthly subscription of at least $1.95 and the per minute rate is 7¢ per minute. It’s the same story with Primus - a $4.95 monthly network fee and calls within Canada and to the U.S. at 5¢ per minute.

Fortunately, long distance is so competitive that there is no reason to pay any kind of monthly fees to get low rates. One example is Yak, which doesn’t charge any monthly fees and offers calls to Canada and the U.S. for 3.5¢ per minute (If you know of any others, do let us know in the comments). Check your local flyers - the options are plentiful and if you are still paying any kind of long-distance monthly fee, you could switch and painless save at least $5 per month.

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1. Warren Buffett took questions from yet another group of business students and Fortune magazine was there to record his answers.
2. ETFs were supposed to be a good thing that offered broad diversification in a low cost, tax efficient manner. Trust Wall Street to spoil the fun.
3. Ellen Roseman wrote about online resources available for picking a discount broker (and thanks for the mention!).
4. Rob Carrick notes that savvy mortgage borrowers can knock 0.6% off prime a variable-rate mortgage and 1.5% off the “posted” rate for a five-year fixed-rate mortgage.
5. Prem Watsa has been called Canada’s Warren Buffett. The Star reports that the chair of Fairfax Financial Holdings (TSX: FFH) is extremely bearish on equities.
6. Tim Cestnick writes in The Globe and Mail that doing the little things right can help save tax.

Blog Roundup:

1. Triaging My Way to Financial Success highlighted Rob Carrick’s article on mutual funds that have increased the MERs since 2003. Even if MERs stayed the same, the fund companies are not passing on the 1% GST cut to the customer.
2. Now that spring finally seems to be here, Canadian Financial stuff reminds us to take the snow tires off the car.
3. Squawk Fox started a series of posts about succeeding in most people’s biggest asset - their careers.
4. Four Pillars wrote about using the new Tax-Free Savings Account for an emergency account.
5. Million Dollar Journey reviewed TradeFreedom, a deep discount broker.
6. Middle Class Millionaire offers the secret to financial success.
7. Thanks to Gather Little by Little for including my post on Another Reason to Avoid Hedge Funds in the Carnival of Personal Finance.

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You can’t make up things like this if you tried. Jonathan Chevreau recently wrote about the second annual Lipper awards that gives new meaning to celebrating mediocrity. In addition to four overall awards, thirty (30) Lipper Awards were given to mutual funds in each of the 1 year, 3 year and 5 year categories and a modest twenty (20) were given out in the 10 year category. Awards are given for every possible combination of categories - for example, there is Canadian Neutral Balanced, Canadian Equity Balanced, Canadian Fixed Income Balanced, Tactical Balanced, Global Equity Balanced, … well, you get the idea.

Now, for the really funny part in The Wealthy Boomer post: “if you’re such a sad-sack fund company that you couldn’t muster up a single win in the 113 categories, there may yet be hope for you. You can order a large Lipper trophy for just $155, a medium one for $119 or a small one for just $95″. Yep, “the instantly recognisable symbol of fund performance and success” can be ordered on this website.

No wonder, Tom Bradley of Steadyhand mutual funds is ecstatic about winning a coveted award for Best Mutual Fund Performance for the Week of July 23rd.

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Taxes have a huge impact on investment returns. The Bogleheads Guide to Investing cites a study by Charles Schwab that found that for the 30-year period from 1963 to 1992, $1 invested in U.S. equities would have grown to $21.89 in a tax-deferred account but only to $9.87 in a taxable account for a taxpayer in a high tax bracket.

Index funds are tax efficient in two ways. First, index funds can be bought and held “forever” with high confidence that they will outperform the vast majority of investors, who are presumably chasing performance and buying “hot” funds and selling them when they almost invariably turn cold. Second, the turnover of the index funds is extremely low because changes are made only when stocks are added to the index or when stocks leave the index or when companies merge, are taken over or go bankrupt. Hence, realized capital gains that are distributed to the investor and taxed in her hands are very low.

Consider the Vanguard Total Stock Market ETF (VTI) whose portfolio turnover for the past five years were 4%, 4%, 12% (due to a change in the fund’s target index), 4% and 2% respectively. In contrast, it is impossible to tell what the turnovers for the larger U.S. equity mutual funds in Canada because such information is not available in the prospectus. Leith Wheeler, to their credit, publish such information for their U.S. Equity Fund and reported a turnover of 17% (to June 2007) and 25% in 2006. The Vanguard Europe Pacific Fund (VEA) also has very low turnover: 6%, 4%, 4%, 5% and 9% in the past five years. The low turnovers will result in lower realized capital gains distributed to investors over time and result in higher after-tax returns when compared to actively managed funds.

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