Canadian Capitalist

Recently I posted a sample Investment Policy Statement (IPS) that a DIY investor can use to guide her investment decisions. Subsequently, I received a sample IPS from a financial advisor who is hoping to elicit feedback from you: Is it too complicated? Too detailed? Let us know your thoughts in the comments section. Personally, I thought that the IPS covered all basics I can think of: the asset allocation policy, investment vehicles, rebalancing policy and the benchmark for the portfolio.

Here’s an excerpt from the IPS:

An Asset Class can be defined as a group of securities that tend to behave in a similar fashion relative to each other in general and are constructed and regulated by a common set of rules. Asset Allocation is the actual distribution of money across different asset classes. One of the fundamental assumptions of asset allocation is that the best‐performing asset class changes from year to year and there is no reliable predictive tool for determining which asset class will be the best performer in the upcoming year. Therefore, combining the asset classes together is a prudent strategy as the non‐correlating asset classes will reduce the overall volatility of the portfolio – indeed, lowering the portfolio’s variability of returns for a given level of expected long‐term return is the goal of Asset Allocation. As such, this portfolio will aim to reduce portfolio return variance and increase overall long‐term returns through the selection of multiple asset classes that are expected to be noncorrelating or negatively‐correlating, as well as having long‐term net positive return expectations.

If you invest through an advisor, do you have a written IPS? If you do not have an IPS, ask your advisor why he hasn’t created one for you.

Note: Don’t forget to enter your name in the draw for one copy of The Intelligent Portfolio. Entries will be accepted until 8 P.M. EDT on Friday, July 11, 2008.

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Canadian investors who want to passively track our equity markets through ETFs have two choices - the iShares CDN Large Cap 60 Index Fund (XIU) or the iShares CDN Capped Composite Index Fund (XIC). As the name suggests, the XIU tracks the performance of a capitalization-weighted index of 60 large, liquid stocks that trade on the TSX. The MER for the ETF at 0.17% is the lowest for a Canadian equity fund. The XIC tracks the performance of the broader TSX Composite index, which is composed of more than 250 stocks, and is slightly more expensive, charging a MER of 0.25%.

Either ETF would be a fine choice for the Canadian equity portion but, in my opinion, the XIC is a slightly better choice as it tracks a broader index and the weight of a single stock is capped at 10%. The XIC allows passive investors to avoid the “Nortel effect” or concentration in a single stock. Recall that in 2000, at its 52-week high, Nortel (TSX: NT) alone accounted for 34.2% of the TSE 300 Index. On the downside, the XIC is far less liquid and the bid-ask spread could be as much as 10 times larger when compared to XIU. However, this shouldn’t be a huge concern for long-term, buy-and-hold investors as the cost will be negligible when spread over the entire holding period of XIC, which could be decades.

XIC was introduced to track the capped version of the Large Cap 60 Index but in the fall of 2005, the mandate for the fund was changed to track the TSX Capped Composite Index. XIC is the appropriate benchmark for tracking the performance of active management, whether it is mutual funds or a portfolio of Canadian stocks.

Useful links
S&P/TSX 60 Factsheet from Standard & Poors.
S&P/TSX Capped Composite Index Factsheet from Standard & Poors.
Standard & Poors versus Active (SPIVA) reports.
Shakespeare’s Primer — Canadian Content chapter.

Note: Don’t forget to enter your name in the draw for one copy of The Intelligent Portfolio. Entries will be accepted until 8 P.M. EDT on Friday, July 11, 2008.

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The Intelligent Portfolio does an excellent job of explaining ten basic concepts needed to make good investment decisions in a simple and straightforward manner. The book will be invaluable for a beginning investor and there is plenty to keep sophisticated investors interested as well. I found the discussion of market portfolio, which is composed of asset classes weighted by their proportion of total world market value and real return expectations derived by reverse optimization to be particularly interesting. The book has garnered rave reviews and I couldn’t do better than concurring with Peter L. Bernstein’s praise for the book:

Books on personal investing are a dime a dozen. But if we add them up, all those dimes come to plenty of money. This book is worth all that and lots more. With its strong foundation in theory, the depth of its insights, the power of its message, the clarity of its exposition, and the value of its examples, The Intelligent Portfolio is worth many multiples of anything else in this overcrowded field.

The author, Christopher L. Jones, works for Financial Engines, a firm that puts sophisticated techniques like Monte Carlo simulation, investment analysis and portfolio optimization in the hands of individual investors. The book includes a 1-year subscription to the Personal Online Advisor service from Financial Engines. The service allows you to do retirement planning but it seems to be of limited use for Canadian residents because data for Canadian bonds, mutual funds, tax rates, CPP and OAS are not available. The retirement planner is a nifty tool — if you input a savings rate, the current portfolio holdings, the retirement target date and the desired income in retirement, the planner runs Monte Carlo simulations and displays the probability of achieving the target through icons borrowed from weather forecasting. It would be wonderful if Financial Engines starts offering this service in Canada as well.

Book Giveaway: If you missed Million Dollar Journey’s giveaway of the book, here’s your second chance. The publisher has generously provided an extra copy for our readers. Participation is very simple — just leave a comment to this post and don’t forget to include your email address. Deadline for entries is Friday, July 11, 2008 at 8 p.m. EDT. One entry per person. Canadian residents only. Your email will not be shared with anyone. I’ll pick one entry at random after the deadline. Good luck!

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1. ING Direct is the first out of the gate in announcing a no-fee, no-minimum, high-interest Tax Free Savings Account. Also, check out the top ten things to know about the TFSA.
2. Proponents of active management make a virtue out of necessity (of holding some cash) and claim that their style performs better in down markets. Well, not always. In the first quarter of 2008, the asset weighted returns of Canadian equity funds was -4.25% compared to -2.84% for the TSX Composite Index. I should also point out that the Sleepy Portfolio lost a miniscule -0.7% due to the 25% allocated to low-risk assets.
3. Rob Carrick writes that it is better to fill up the car where it is cheaper instead of looking to earn loyalty points. He specifically mentions Ultramar, which I find to be the cheapest gas station around as well.
4. Ellen Roseman finds out how an airfare advertised as $99 each way, ended up costing $408.41.
5. Canadian Financial DIY posted the expected real rate of return for major asset classes from various sources.
6. Mike from Four Pillars debated how to exchange Euros into Canadian Dollars.
7. Million Dollar Journey featured a guest post on disability insurance.
8. The Dividend Guy’s temporary relocation has affected his dividend reinvestments.
9. Thicken My Wallet’s take on the top personal finance stories of the year so far.
10. Around the Personal Finance Network: Squawkfox developed a nifty mileage calculator and put together a little video tutorial. Money Ning boils down all money management to a single rule.

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While chatting with a friend, I found out that it is not common knowledge that if you didn’t contribute to a Registered Education Savings Plan (RESP) in previous years, you can catch up on contributions and possibly still get the lifetime maximum Canada Education Savings Grant (CESG) of $7,200 that your child can receive. It’s hardly surprising — for many families paying down debt or saving for retirement takes priority over saving for a child’s education. If you missed contributing to a RESP, it may not be too late to catch up on past contributions and get every dollar of the CES grant.

First, a quick primer on CESG rules: (1) Starting in 1998, the CES grant accumulates every year for a child until she turns 17. The basic grant room is $400 per year from 1998 to 2006 and $500 from 2007. (2) The maximum CES grant that a child can receive in a calendar year is $1,000 provided grant room is available. (3) The lifetime CESG is $7,200.

As you can deduce from the rules, in every calendar year, you can catch up for roughly one more year of missed contributions. For example, let’s say no RESP contributions have been made so far for a child born in 2000. The total CESG room for the child is $3,800 ($400 for the years 2000 to 2006 and $500 for 2007 and 2008). If a RESP account is set up for the child and $5,000 is contributed to it, the child will receive a grant of $1,000 and have the remaining $2,800 carried over to future years. In this example, it will take another 6 years to bring the grant room down to zero.

Globe and Mail columnist Rob Carrick has written a couple of articles on RESP catch-up contributions available here and here. Note that the CESG rules are slightly different now.

[Update: You can find the unused grant room for your child by calling Service Canada at 1-888-276-3624. You'll need the child's Social Insurance Number.]

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The Sleepy Portfolio continued to tread water in the second quarter of 2008 losing 1.08% through the quarter. The only winner was Canadian equities with XIC posting an 8% gain from the first quarter. Foreign equities had a poor quarter — US equities were down about 5%, EAFE markets were down 6.3% and emerging markets also fell 6%.

As our portfolios are mostly indexed, our performance was pretty much the same as the Sleepy Portfolio. Apart from the periodic investments in a Group RRSP, I spent the quarter in masterly inactivity, neither buying nor selling.

I’ll be rebalancing the Sleepy Portfolio in the near future as dividend income has pushed cash levels close to 8%. I’ll be selling a portion of XIC to bring the allocation to 20% and buying VTI and VEA to bring them both to the target allocation of 22.5%.

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Vanguard recently introduced a ETF to capture exposure to the world’s major equity markets weighted by their market capitalization. The ETF, which started trading last week on the NYSE Arca exchange under the ticker symbol VT, charges a MER of 0.25%. While the ETF is an interesting addition to the Vanguard stable, it is hard to get excited about it for the following reasons:

1. VT is more expensive: Canadian investors can get exposure to the entire world through a combination of VTI, VEA and VWO for a composite MER of 0.12% or so. At 0.25%, VT is almost twice as expensive.
2. VT has no exposure to small caps: The Vanguard Total Stock Market Index Fund has about 20% weighting in small cap equities giving Canadian investors a 8% weighting in small caps in their foreign allocation. VT is almost solely invested in large-cap and mid-cap stocks.
3. Like VEU, VT includes Canadian equities: Canadian investors would want to allocate more to our local market than the roughly 3% weighting in VT and this fund faces all the same issues that make VEU unattractive for Canadian residents.

You may also want to check out other posts on this topic by Four Pillars.

Regular programming will resume on July 2nd. Happy Canada Day everyone!

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The Personal Finance Network is a group of six blogs - three Canadian, two American and one ex-pat Canadian - formed as a forum to exchange ideas. The other members of the group are:

1. Blunt Money lives in South western U.S. and is currently working on saving & learning about investing, building her small businesses. Her posts focus on saving, frugal ideas and debt reduction.
2. Clever Dude is married, just-shy of thirty, lives in the Washington D.C. area and writes about family, marriage, finances and life.
3. MoneyNing is the ex-pat Canadian who currently resides in Southern California and writes a blog focussed on saving money, investing, early retirement, mortgages and stocks.
4. Quest for Four Pillars doesn’t need any introduction. Mike and Mr. Cheap write about finances, parenting and real estate investing.
5. Squawkfox doesn’t need any introduction either. She writes from BC and promises to make personal finance and frugal living sexy, delicious and fun.

We’ll be doing weekly roundups and group projects and there are no changes to our regular program schedule.

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1. Peter Bernstein writes in the New York Times that our assumptions about the future may be wrong and risk management should be a process of dealing with the consequences of being wrong.
2. Jon Chevreau reports that a million dollars ain’t what it used to be. There are now 1.1 million Canadian families with a net worth of $1 million or more.
3. Larry MacDonald discussed how real estate agents don’t have an incentive to get the best price for the home owner. Michael James agreed with Larry’s ideas on improving the incentives for Realtors.
4. Ellen Roseman talked about Dividend Reinvestment Plans (DRIPs) as a cheap way to invest for the long term.
5. As stock markets are in free-fall mode once again, Preet reminds us how important it is to stay the course.
6. Thanks to Canadian Financial Stuff for pointing out that Ontario residents can renew their license plate validation stickers online.
7. Million Dollar Journey’s shares his top ten ways to save money in University.
8. If a stock you held cut its dividend, what do you do? Some suggestions from the Dividend Guy.
9. Thicken My Wallet on how to survive a bad economy.
10. Canadian Dream upbraids Million Dollar Journey for being a workaholic.

Have a great weekend everyone!

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According to the CRA, you can deposit Canada Child Tax Benefit or Universal Child Care Benefit payments into a bank account or trust account in your child’s name and have the interest payments treated as your child’s income:

Generally, when you invest your money in your child’s name, you have to report the income from those investments. However, if you deposited Canada Child Tax Benefit or Universal Child Care Benefit payments into a bank account or trust in your child’s name, the interest earned on those payments is your child’s income.

If you already contribute the maximum allowed to the RESP and want to save more, it might make sense to deposit the CCTB and UCCB payments into a separate bank account and use the funds to invest in a diversified portfolio such as the Sleepy Mini portfolio. Another possibility is participating in a DRIP or SPP plan. As kids have little or no income, they are unlikely to pay any tax on investment income. Has anyone taken advantage of this tax break? I’d love to hear your comments.

Note: Thanks to Jordan for this tip.

[Update: I found this interesting thread on Red Flag Deals on the topic of investing the CCTB and UCCB payments in the child's name]

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