Questrade Mutual Funds - Earn Like a Broker

If you're a Canadian with mutual fund holdings, you might want to consider moving them to Questrade. Why? Trailer fees. Trailer fees are the commission that is paid to your broker for selling the mutual fund to you. This is why most brokers will not charge you for trading mutual funds - they're getting money from the management company. A bit like commission except they are usually an ongoing payment as long as you keep your money there. Obviously, if you are paying to trade mutual funds, and they're pocketing these trailer fees, you're getting ripped off by your broker.

Questrade has a different strategy. They offer a program where they'll deposit the trailer fees into your account, and charge you $9.95 for trades, instead. The headlines number is thet you'll get 1% of your holding's value, but it does vary by fund, as there are different fees and different structures. Since most people own mutual funds as a "fire and forget" type of investment, and probably only review their position annually, if that, paying for trades instead of simply owning them seems like it would be a great deal. Also, until April 30, Questrade is running a promotion where they'll pick up the transfer fees for bringing you funds in from another broker. There's also the potential to win $1000, but since I never win anything, I wouldn't consider that to be a reason to move.

If you're considering the move, you can contact me for a referral, and then you'll get $50 in free trades when you sign up.

The Biggest Mistake

The biggest mistake most individual investors make is buying high and selling low. I know that this sounds dumb, but I'm surprised how common it is. I have a few coworkers who have proudly announced that they have recently reshuffled their retirement portfolios into GICs (guaranteed investment certificates). Indeed, one of the most vocal proponents of this strategy told me this about 2 months ago, when the market was within spitting distance of its (local?) bottom.

Now, if you believe the market is going to go lower before it goes higher, then cashing out what you've got and sitting until things improve is a decent strategy. But these are people have sworn off the markets permanently. They say they are not going to get back into volatile investments. So they've taken the full loss that the market handed them, and are going to make it back at interest rates that are currently about 2% annually, and might optimistically rise to 6% when the economy improves.

Worse...I don't believe they're out permanently. If they're driven by their emotions in this down market, it seems likely to me that when they look at all the money other investors are making in the next bull market, they will be tempted to get back in...probably again near the peak of the market. And so this kind of emotionally driven investing will continue to compound their losses with each cycle.

I think this is the reason for the popularity of the Buy-and-Hold strategy. It allows people to hold over the long term and so, while they won't see the big gains of people who sell during bull markets and buy during bears, they will at least see the overall long-term up trend in markets. It works if you don't chicken out, just as the contrarian approach works if you have the willpower to buck popular sentiment.

I don't know that I have any advice, other than if you don't like the market's ups and downs, you should get out during the next bull market, not now. For me, I'll continue with my current strategy of keeping my speculative holdings until I'm convinced they're not going anywhere, and keeping my retirement savings in fairly volatile, equity heavy mutual funds...they've actually only lost 25% in the bear market, and stand to gain much more when the bull returns.

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Photo by Timothy Valentine, used under the terms of Creative Common By-NC-SA 2.0.

Living Within Your Means, part 1 - Setting up a Tracking System

The first article in my series on living well, without breaking the bank.

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While getting budget in place is very important to getting your finances in order, I think there's an even more important first step. Finding out where you're already spending your money.

There's a number of tools available for this. For the most part, I'm going to discuss Intuit Quicken, as it's the software package that I've been using since I was a teenager. There are however, some other options, some free and some not, and the same principles can be applied to them as well. If you are interested in buying Quicken, the $40 version will do nicely for our purposes, but the $93 version adds better investment management tools - as well as some basic small business tools - if your finances are more complicated than just cash and loans.

The goal in any financial tracking program is to track where your money is being spent based on broad categories, and where your net worth is headed. This information lets you know whether your current spending habits are acceptable, and also gives you a baseline to start on a budget. The simplest approach to tracking spending is to move all your spending onto a credit card that offers a spending report. There may be others, but I am only familiar with CIBC's program...any credit card with them will assign your spending to a category based on what store it goes to, a sample is shown to the right.

This approach has some failings. It does not track any spending that comes directly out of your bank account, and this might cause you to think of cash spending as "not really spending." Indeed, it only tracks a single account, so can make it difficult to tie together your total financial picture. Also, it relies on using a credit card, which can be an expensive option if you ever forget a payment or don't pay the balance.

For these reasons, I prefer the hands-on approach of a separate software program into which you enter every transaction as it happens. This gives you up to the minute data on your financial situation, which can help in making purchasing decisions. It also allows you to track all of your spending. I have discussed Quicken above, the other big commercial player is Microsoft Money - though I discourage that as I've had nothing but problems whenever my grandfather upgrades to a new version - and there are some free options such as Gnucash, Buddi, and Clear Checkbook. Unfortunately, some of the more feature-heavy online providers , like mint.com and Quicken Online, are geared specifically to the American market. I have yet to sample any of the free offerings, though product reviews are now on my to-do list.

Setting up your categories
Once you've picked your software, you need to figure out what categories to track. I suggest keeping the list to a manageable length, but still detailed enough to know where your money is going...if a catch all, misc category represents more than 2-3% of your monthly spending, you're probably not detailed enough. Also, while Quicken encourages you to set up all the details of your paycheck, I'd suggest that uncontrollable expenses like taxes and benefit deductions represent noise that will get in the way of figuring out where the money you actually have control over is going.

The big categories are easy - housing expenses, utilities, groceries. It's the smaller ones that bear some thought. Do you want to track how much you spend on your car, or is it more useful to know how much you spend on all forms transportation. A good software package should allow you to group expenses under a parent heading, so you can get more detail in your reports if you're interested. The end result is the same categories as you'll put into your budget later, so make sure they're relevant.

That's it, that's the tracking system in short. What remains now is to use it. I've made it a habit, that when I come home each day, I'll take any receipts out of my pocket and put them in the system. Takes about 5 minutes, and gives me an up to the minute picture of where I am that allows me to make intelligent spending decisions the next day. In the end, that what it's all about.

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Next time: using your categories to make your budget.

The Other Half of Personal Finance

I have been reflecting a bit lately on what makes a person well off. Compared to many of my peers, it seems like I am well off. They often seem to have regular complaints about having no money, and how I am so lucky to be able to go on holidays and enjoy my life.

But here's the thing. My wife and I have an income that puts us marginally below the median for 2-person families, while many of our friends...I don't know exactly how much they make, but many have at least one engineer in the family, so I doubt they're doing too badly. Additionally, we were later into the housing market, so have a larger mortgage, and have a not insignificant amount of student loans debt.

Yet we seem to be better off. Never carry a balance on credit cards, have money to do the things that we want to do, and - most importantly - on top of all of our monthly expenses, we're still able to put away $720/month into savings...mostly for short term goals like trips, but some for retirement as well.

A lot of people seem to blame their lack of funds on the idea that the government's inflation numbers are goosed to make inflation look lower than it really is. This seems to be why so many people are buying into the story told by shadowstats, despite many of his claims being soundly debunked. How often do we hear that things keep getting more expensive, while wages stay the same? The reality, of course, is that we've never had more disposable income, but it's also never been so easy to dedicate most of it to your bank's bottom line.

I have become convinced that most people's complaints about not being able to make ends meet are due to an inability to track and understand where they spend their money, which leads to owing money on their credit cards, which then creates a vicious circle where it becomes increasingly difficult to get their finances under control. I am constantly disappointed with my lack of self control in spending money, and yet, I can only think of how much worse we'd be if we didn't watch it, and just waited for the bills to arrive to figure out where the money to pay them was going to come from.

So, for the rest of the month, since I really don't have any investing news to discuss, I'll be doing a series on money management. How to turn that modest income into a comfortable, happy, lifestyle.

Gold Stock to Gold Price Ratio

One of the blogs I follow, World of Wallstreet, in his post Obvious (But Original) Thought About The Gold Stock To Price Of Gold Ratio, showed the graph below, hypothesizing that since stock indices have declined 40%, the fact that the gold stock:gold price ratio is down 40% doesn't mean that they're undervalued. He points to the ratio's September 2000 trough (0.15) as evidence that they may decline further.

It's a good thought, certainly suggesting that in the short term this "reversion to mean" may not pan out the way some people are hoping. That said, I'd like to see a longer term chart - it looks to me like the early end of this chart was also up around the .5 range, and that dropped right up until September 2000. That is - the $HUI:$GOLD trough coincides perfectly with the TSX peak during the tech boom. While the NASDAQ isn't as perfect of an inverse correlation, as it was already off its March 2000 peak, its catastrophic decline also significantly accelerated in September.

The ratio then rose through the recession that followed the tech crash. This suggests to me that the ratio's decline was due to money moving into trendy tech stocks, not an overall stock market decline.

My guess - stocks are leveraged against their underlying resource price, since they have a production cost that's more or less fixed. The fact that they're trailing the recent precious metal recovery suggests that investors are concerned that precious metals may once again decline.

Also, I'd point out that while some of the decline in indices is panic selling, some of it reflects reduced profit from individual companies. But a gold miner's profit is entirely related to the price he gets for gold, so at a minimum their decline relative to the gold price should be lower than the decline of the whole index.

I've never professed to be an expert at this. And I've certainly lost a fair bit of money making bad calls on where things are going. But it still seems to me that precious metals - whether producer stock or bullion - should hold up until financial volatility dies down.

Where to live: Renting vs Owning

I recently read this article on Smart Money, making the argument that renting a home, and using money saved each year to invest in stocks, was a smarter financial decision than owning a home. He brushes off pro-ownership arguments as clever uses of emotional language "throwing money away," "pride of ownership," and so on, claiming that stripped of emotional considerations, it's actually homeowners that are throwing money away.

His argument basically boils down to stocks having a real return of 7% annually over the long term while houses only match inflation. Factoring in that homeowners have maintenance costs that significantly offset the rent saved by owning, this makes renting the superior financial decision.

This clearly flies in the face of conventional wisdom, and reading his argument, I was unconvinced. So I've spent the last couple of days thinking on it and trying to determine the fallacy in the argument - I was pretty sure it had something to do with the way he threw away inflation - and I think I've nailed it down.

The experiment
So I ran my own analysis using his numbers, but this time adding inflation back into the mix. My world works like this:
- Average annual inflation: 3%
- Average annual stock returns: 10% (7% real return)
- Increase in house prices and rents: 3% (0% real return)
- Each year the homeowner must lay out 2% of the current value of his home in upkeep costs and property taxes.
- annual rent paid is 5% of the current house value
- A 4.3%, 25-year mortgage interest rate (ING Direct's current 5 year fixed rate)
- Any money saved in a given year will be put into the same stock investments regardless of which party saves it
- $1000 in closing costs for purchasing the house.

I looked at the 40 and 50 year time horizons, figuring that these represent the years around retirement, when you are most likely to be interested in your equity.

Results:
Okay, so using these numbers, it turns out that the renter will indeed finish richer. Interestingly, though, the homeowner will have more equity during years 2-6. If homes generate even a modest 1% real return, this homeowner advantage lasts to year 19.

But, I tried some tweaking of my admittedly simple model. Here's some situations where the homeowner will be wealthier than the renter:
- High inflation. If inflation is equal to the real return on stocks, (7% in my model), the homeowner has an advantage up until year 39. 1% more than stocks' real return, and the advantage lasts the full 50 years that I'm looking at.
- Rent is more than 5% of purchase price. If rent is 6.6% of purchase price, the 50 year mark is in the owner's favour. This represents a 15:1 ratio between rent price and purchase price. I consider this to be the most likely situation, since the 5% used in the article is kind of a bait and switch - he uses long term averages for the maintenance cost relative to purchase price, but only the rent to purchase price achieved during a market peak.

Effect of interest rate
My model wasn't well set up for dealing with changes in interest rates. Notably, I was kind of lazy about setting up the annual payments. Should I feel like revisiting this, version 2 will have better handling of interest rates.

Other factors
There's of course lots of other factors in here. Aside from the emotional decisions - stability, pride of ownership, etc - there's also some variables in terms of people's ability to manage their money. Most people, having made the decision to be lifelong renters, will not figure out what owning a place would have cost them, and then put whatever savings they have over than into an investment account. Most people will wind up increasing their standard of living instead, so some of my assumptions about growth on money saved each year don't translate well in the real world.

Even if stock markets continue to match historical long term averages - which is by no means certain - it's unlikely that average individual investors will exactly match this performance. While index funds make this easier, they have small but still material management fees that over the long term may kill the homeowner's advantage.

Uncertainty
I haven't independently researched the ratios used in the original article, and just accepted them as truth. Logically, I've having trouble with the idea that house prices and rents have both matched inflation, but the ratio between the two has more than doubled.

Conclusion:
The decision to buy or rent is not as clear cut as most Canadians believe. Deciding between the two, even if we stick purely to a financial calculation, requires making a lot of assumptions about how the world is going to behave in the future. The difference between the two can be significant in one model, but making a small change to one of the many variables involved, come out showing the exact opposite.

Myself, I'm still happy to own a home, and don't think I much want to sell in the near future. But this project has, I think, shown that I obsessed too much about home ownership, that delaying home ownership doesn't necessarily put you behind.

Odd Links

While I continue to have little investing news to update, I did have an odd convergence of interests today, when I discovered that one of my travel photos had been linked from an article about Jack Madoff.

Aside from that, I continue to sit on my stocks. Their value has dropped to the point that I can put them all into a TFSA, which I will be doing on Friday. FR has started to recover, so I'm again feeling optimistic about the future. WEE continues to lag behind, and has pretty much flattened around the 50 cent mark. I'm looking forward to the next financial report, as I think their revenue growth should help the stock price.