ING Direct used to be the Canadian leader with short term savings. Unfortunately they have now become normal.
The end-result is as follows:
Nelson writes the following:
It seems to me that the financial advisory industry as a whole spends a great deal of time creating instruments and building an investor culture that tries to act as if investing (or trading) can be simplified to a set of easy-to-follow rules and, hey, we’re professionals, so leave your money with us. I think it’s made even easier for them to convince people because the majority of people want to be convinced. They’re not that interested in thinking about how to invest their money — not really — so they do their best to wipe their hands of it, with all the consequences that entails.
This is absolutely correct. The psychology of “easy investing” has not changed since the dawn of cheap trading on the internet – the initial “brain-dead” way to invest was always going with a “trusted professional” (financial adviser, stockbroker, etc.) to make your decisions for you, since they clearly knew more than you did. Then for those that got jaded with the performance of such “trusted professionals” and eventually want to do-it-yourself, you have a whole host of products that essentially boil down to “stock pick” type newsletters (e.g. publications like the Motley Fool and TheStreet.Com, which are really fronts for subscriptions to newsletters). All of these don’t really involve any type of thinking – monkey see, monkey-do – if Cramer’s buying Amazon, might as well buy Amazon, eh?
Big banks, especially in Canada, will have you sit down in a branch with a “financial adviser” (who is really a salesperson for the funds the bank sells) and get you to fill in a simple questionnaire, which asks many questions to put you in one of three risk categories. If you were high risk (likely a “young” investor), you were suggested to invest 70% in equity funds, and 30% in bond funds. If you were medium risk, you are suggested to invest 40% in equity funds, 30% in “balanced” funds, and 30% in bond funds. If you are close to retirement and low risk, the suggestion will be 10% equity, 40% balanced, and 50% money-market funds. More “modern” suggested asset mixes may include 10-15% for “commodities”. Simple formulas to make investing easier.
Unfortunately, such cookie-cutter solutions will never provide superior returns. In fact, they will dramatically underperform. The reason is because of the fallacy that asset mix determines 90% of portfolio performance and neglecting to look at valuations.
Once an investor starts to realize that there is no informational benefit to newsletter-type subscriptions, or mutual funds, they will eventually shift to another form of control – exchange-traded funds, which essentially are mutual funds that are easier to buy and sell by virtue of being exchange-traded and not having to deal with an annoying bank middle-man. Once you give up and realize you can’t beat the market (the literature that suggests this starts to be compelling when you suffer losses), you will invest in the S&P 500 index fund, which apparently has slipped the actual index by 0.19% (which is actually not that bad, but slippage should be less than 5 basis points for such a large fund).
Even investing in different ETFs you have to do your homework and cannot apply a “cookie cutter” solution. There is no better example than with commodity-based ETFs.
Commodity-based ETFs that invest in underlying commodities with futures are very bad products. They experience huge trading losses when they have to rollover front-month contracts – the biggest culprit so far has been UNG, the United States Natural Gas ETF. Traders have absolutely ripped UNG’s investors to shreds, and rightfully so – investing in futures is not the same as investing in the commodity itself.
Commodity-based ETFs that invest in the underlying commodity (not futures) are legitimate long-term investment products – the best example is the Gold Trust (GLD), which invests in the physical metal. Your cost of investment is 0.4% per year instead of taking delivery of a gold bar and storing it in your own safety deposit box.
Note that I am making no opinion on the future pricing of natural gas or gold – I am just using these ETFs as an example. If I wanted to bet on a higher price of gold over the long run, I could consider the Gold Trust ETF. If I wanted to bet on a higher price of natural gas over the long run, I would not use the UNG ETF.
I have no issues with investing in ETFs – they provide much cheaper coverage than most mutual funds do, although there are some ETFs out there that are clearly geared towards traders/gamblers than actual investors. People that invest in most ETFs would likely be much better off looking at the top ten holdings and just investing proportionally in the common shares of such companies and will be able to save significant amounts of money from management expense ratios.
Just as an example, if you think energy will be a hot product in the future and choose to invest in XEG.TO (a Canadian energy sector fund), we see the following as the top 10 holdings:
17.74% SUNCOR ENERGY INC
14.02% CANADIAN NATURAL RESOURCES
9.31% ENCANA CORP
7.36% CENOVUS ENERGY INC
6.72% TALISMAN ENERGY INC
5.09% CANADIAN OIL SANDS TRUST
4.45% NEXEN INC
3.63% IMPERIAL OIL LTD
3.05% PENN WEST ENERGY TRUST
2.82% CRESCENT POINT ENERGY CORP
The MER of the fund is 0.55%, so if you invested $10,000 in XEG, you are paying roughly $55/year for management of the fund. This $55 is reduced from the dividend payments you would otherwise receive had you been invested in the common shares (which is a tax-inefficient way of paying for management expenses since such dividends are tax-preferred eligible dividends – a better way would be to bill ETF holders directly and they can take a full deduction for this expense from income). If you can scale into the 10 positions for less than $55 (which is easily done at a properly selected brokerage firm) then with a little mouse-clicking, you can save money on your long-term investments. Since 74% of the fund is invested in its top 10 holdings, the tracking error is trivial since the top 10 securities (74% of investments) are likely to be highly correlated investments to the other 26% in a sector fund.
The conclusions are fairly clear – for most passive index funds out there, it is better to just invest in individual components unless if you are dealing with small amounts of money, or small amounts of time.
True out-performance is difficult to achieve – it requires research, work, and sharp decision-making. It is very unlikely that Joe Investor out there will be able to outperform without going into microscopic details of individual securities. This requires skills such as being able to read financial statements, and knowledge of the sector. Not many people will want to do this – and thus, they will dump their RRSP money in some index fund since it is an easy decision to make and will likely underperform since others will be doing the same thing.
The place where I normally park cash is in ING Direct, which has been a mainstay financial institution for myself for a very long time. When they first opened, they were by far and away the best place to park cash. Now they are a mediocre offering of the many online products that are available out there. I am guessing that they achieved their desired level of deposits and have achieved their desired debt-to-equity ratio with their residential mortgage offerings.
ING Direct hasn’t contaminated their customer experience by spamming their customer base with too many useless services, but this encroachment to simplicity has been eroding at a faster pace as of late – see my post about RSP loans, for example. It is simplicity that has caused me to stick around with ING Direct instead of shopping for other services. However, that time has now come.
So today I sent in a cheque to Ally, which used to be known as GMAC. Obviously since GM tarnished their brand with their bankruptcy filing and investing money in an institution that shares the same name with a bankrupt entity doesn’t inspire much confidence, they changed their name in 2009. In Canada, they are run by a firm called ResMor Trust Company, which otherwise does mortgages. In any event, they are CDIC insured and this means that the taxpayers of Canada will be picking up the guarantee for deposits up to $100,000.
Since I will not be depositing more than $100,000 in Ally, the safety issue of the institution is more or less mitigated.
Their peak offering is a savings account which delivers 2% interest (which is subject to change at anytime), but since this is significantly higher than ING Direct’s offering at 1.2%, it is a trivial process to click a few mouse buttons and transfer the money. Every dollar counts.
As interest rates rise, it will be interesting to see the spread between these two institutions since they are competing for the same bucket of capital from Joe Saver.
One of the most powerful concepts that most beginning investors confuse is the concept of cash flow, and the concept of net income. In capital-intensive industries, an investor must know enough about the underlying accounting in order to make a proper investment decision.
Probably one of the easiest textbook cases for this concept is looking at the year-end report for Sprint Nextel Corporation. For 2009, they reported a net loss of $2.44 billion, but generated about $2.7 billion in cash at the end of the day.
The simple reason for this is that the company made huge investments in telecommunication assets in prior years and is continuing to depreciate those assets – the actual cash has been long since paid and as such, the depreciation expense does not represent a cash transaction.
So while Sprint will be reporting net losses for the foreseeable future, the company will still be generating cash to pay off its debt. Eventually this process will stop when the assets have been further depreciated, but it is up to an investment analysis to decide whether the company will put more cash into more capital projects, or whether to milk their existing investments and just spend money on maintenance.
Telecommunication companies, in this respect, are relatively easy to analyze.
Finally, as a bondholder in Sprint, all I am concerned about is their ability to service debt. The company does not pay a dividend and at the rate they are able to generate cash, will be able to service their debt for the foreseeable future. Back in October 2008 and March 2009, I was busy picking up equivalent units of debt that will continue to give off insane returns on investment (averaging roughly 18% in coupon payments and 5% in annualized capital gains upon maturity). There is no chance that equity will be able to repeat this at the risk I am taking!
Even today, such units are trading at about a 9.3% current yield, and about 1.9% capital growth to maturity, which is likely better than what you would get from equity over the next 19 years.
I was reading an article on the Globe and Mail about David Trahair, who advocates a GIC-only investment strategy.
Despite the relatively negative income tax implications (the income from the GICs are fully taxable unless if sheltered in an RSP or TFSA), it is not a bad strategy because it can be implemented with a few clicks of the mouse and should provide protection of principal in most situations. It is something even the most unsophisticated investor can perform and you can shop around for the best GIC rates by using a site like GICBroker.com as a guideline for where to get the highest rates.
The only relevant risk worth mentioning is that you are exposing yourself to is inflationary risk (loss of purchasing power of principal), but given the relatively low duration of investment (an average of roughly 3, assuming you are using a GIC ladder) should properly capture heightened interest rate expectations if and when CPI inflation does occur. Right now the best 5-year GIC is a good 100 basis points higher than the equivalent Government of Canada 5-year benchmark bond rate (2.47% vs. 3.5%).
The other comment is that James Hymas makes a very good argument for preferred shares in a portfolio that will diversify the risks associated with having a GIC-only portfolio, and makes for a very good read. Implementing such a change in a portfolio does involve quite a bit of financial sophistication for the do-it-at-home investor, however.
I noticed at the start of the year that ING Direct was offering a 3% 90-day GIC for RRSP accounts (no transfers required) and also 3% for a TFSA account, but with the rate subject to change at any time.
Anybody with an RRSP in ING Direct would do well to lock in the 90-day rate as soon as they can; even though they stated they will offer it until March 1st, they could revoke it. The difference between a 3% rate and a 1.25% rate (which is more representative of the current market rate for a 1-year GIC) is $43.15 on a $10,000 investment. It is not huge money, but it is more money nonetheless.
The 3% TFSA offer is quite a lure, but it is designed to trap as much money before they reset the rate back to a lower rate. The trick with the TFSA is that once customers have deposited their money into the TFSA, it is a lot of unnecessary paperwork to get their money out of the TFSA account once the rate resets to something lower. If customers decide to withdrawal the TFSA once the rate goes lower, then they lose the contribution room into their TFSA until January 1, 2011.
For those people that want to keep their money in a risk-free instrument (e.g. a GIC), use the ING Direct TFSA at your own peril. As a matter of financial planning, the TFSA should not be used as a risk-free account anyhow, but some people will want to use it to park idle cash.
ING Direct used to be the undisupted best place to save money, but over the past few years they have become just “normal”. They are still excellent with respect to having a no-fee operation and this works to their benefit – if money is easy to get out of them, then I feel much safer keeping money with them. For matters such as RRSP and TFSA transfers, however, there is a real bureaucratic cost associated with these and it is not worth it to capture an extra 0.5% elsewhere for the dollar amounts in question that people typically deal with.
If ING Direct wanted to raise a lot of longer duration capital, they’d do fairly well if they offered a 5% 5-year GIC.
I have successfully liquidated my debentures in Harvest Energy (series D and E) for 101.5 and 102.0, respectively. Since they are trading above the 101 that will have to be offered after the takeover, it is unlikely that investors will tender the debt. I am happy to be rid of the bonds so my capital can find some more productive areas. My opportunity cost of this transaction is giving up about a 6% yield, but there are equivalent risk instruments that the money can be parked in the interim.
I have another issue (Bellatrix Exploration, formerly True Energy Trust) that has seen its equity rise about 400% over the past four months and its bonds have correspondingly traded near par. It is very close to my liquidation point and there will be a high probability it will be sold very soon.
As such, my portfolio is starting to look cash rich. While cash is good, it is also earning a return that is less than flattering (mainly zero) and while I can shift the funds into a short term savings account for 1.2% (or 2% if I shopped around) I am always looking for a better place to put my money – something that will give a yield.
In my tax sheltered accounts, I am looking for investments that will generate income. Outside the tax sheltered accounts, I am looking for investments that can generate capital gains (taxed at half the rate) or eligible dividends (taxed significantly less depending on what income bracket you are in).
Most of the income trusts have been bidded up to yields that are not representative of the risks embedded within the company – for example, a trust that is always on my watchlist (but I never get around to purchasing) is A&W – currently yielding about 8.01%. This is not adequate compensation for a company that is distributing more cash than its distributable cash allotment. It is possible that A&W could trade higher (and yield lower) but this is essentially the equivalent of gambling and could just as easily go to 8.5% ($14.82/unit) as it could to 7.5% ($16.80/unit). I do not want to get into coin flipping competitions with the market.
Since my hurdle rate is above 8%, I am forced to lower my standards if I am to seek a home for my cash. This means either accepting higher risk, or accepting a lower rate of return.
Right now if I accepted a lower rate of return, I estimate I could generate about 10% a year with debentures, but this is still a relatively low rate of return in consideration of the risk taken.
As such, I must broaden my search to more obscure securities and companies. This will also require some research and time. It will also require appropriate market conditions when people are less confident.
Fortunately, time is on my side – while the cash is sitting there, earning nearly nothing, it will at least be there when I need it. The temptation to quickly deploy cash is one of the most destructive psychological behaviours one has while investing.
This does not scale up beyond a couple hundred dollars, but if you are planning on sending a large quantity of first-class letters across Canada, investing in some stamps is not a bad method. Currently stamps are 54 cents and are marked as “permanent” which means that the face value of the stamp will increase as prices increase. Stamp prices will increase to 56 cents in 2010 and 58 cents in 2011.
Implicit in this price increase is a 3.7% protection against price increases in the future. Since interest rates are currently well below this figure, there is a minor amount of inflation-proofing available to buy stamps now for the next few years.
Canadians that have been employed and contributed to the Canada Pension Plan currently have an option whether to take their pension at age 60, or wait until later before they start drawing benefits.
The general rule is that if you worked 35 of 42 years of your working career (i.e. from age 18 to 60 minus 7 low income years) at a full level of CPP contributions (in 2009 this implied a $46,200 salary) you will receive approximately $11,210 per year at age 65 as your CPP pension.
If you decide to take CPP when you hit the age of 60, you will be penalized 0.5% per month, or a 30% total sum; this will reduce your annual take-home to $7,847 per year. The advantage is that you get to collect $7,847 a year for five years, while in the scenario of taking CPP at age 65, you would receive nothing until reaching that age.
If you wait until you reach age 61, your penalty goes from 30% to 24% and this is not a 6% increase in benefits; it is actually (0.3-0.24/0.7) or a 8.57% difference.
Most commentators on this issue do a “breakeven age” analysis of CPP. While this is mathematically correct, even if your life expectancy is expected to be longer than 76.7 years (which is the breakeven age between taking CPP at age 60 vs. 65), there are two very relevant factors to take into consideration:
1. The guaranteed income supplement (GIS). If you have no other expected income at the age of 65, you will effectively be taxed on CPP income at the rate of 50% because for every dollar of CPP you earn, you will have your GIS reduced by 50 cents.
2. If you take CPP, if you ever work again, you no longer have to pay CPP, which is a 4.95% savings on your paycheque.
3. A dollar earned at age 60 is more useful than a dollar earned at age 65 simply because of the probability of dying goes higher and because money is easier to spend while (relatively) younger. This “quality of life” factor is almost never discussed.
The only reason one would want to delay taking CPP beyond the age of 60 is because they are expecting to make enough other supplemental income where the GIS clawback no longer becomes a factor and also that they have enough bottled income stashed away (i.e. through RRSPs) that they are in no need of money at the present moment. In this case, the expected lifespan of the individual becomes the primary determinant of when to take CPP.
All of this discussion does not discuss the rule changes that will be taking place for people taking CPP in 2012 and beyond. I have analyzed this previously. The rule changes will discourage people from taking CPP early.
Read the Reddit (a link aggregation/dissemination site that is mainly dominated by teenager/sub-30 year old people) comments on “I have about $12,000 to invest, what should I do? I’m 26 and never invested before!“.
There are some decent responses (for example, people asking for more information on the person’s balance sheet), while there are a lot of comments that sound quite sophisticated but are quite incorrect.
While responses like these are not typical of the pricing you typically see in the marketplace, if you were locked in a room with teenager/sub-30 year old people and were forced to trade with them, you could use this information in a way that would give you a disproportionate advantage.
That said, in most cases people that have never invested before, if they do invest in risk-bearing instruments, will lose money. Even indexers, adjusting for management expenses, will not be able to outperform the rest of the market because so much money is tracking the S&P 500, Nasdaq 100 and the TSX 60 in Canada.
Outperforming the market requires you to know what you are doing, and to know it better than the people you are playing against in the marketplace. Most of the time the market gets it close, and knowing when the market is errant is crucial.