Financial Literacy

The government of Canada commissioned a task force to study the issue of financial literacy in Canada. The report they released can be found here.

I will restrain my comments to say that just as how (in Western Europe) illiteracy was reduced from about 2/3rds in the 18th century to less than 10% today, I would estimate the financial literacy of Canada as being quite low.

By improving financial literacy, people will have a toolbox to make more efficient decisions. Just like literacy today, where you can be bombarded with outright false information, a financially literate population can be bombarded with financial garbage (such as scams that promote a risk-free 30% annual return), but will be better prepared to discard such trash. This is similar as to how people do not take the items printed on the supermarket tabloids seriously.

Financial literacy is a good idea in concept, but it requires a completely different skillset than written literacy – quantitative know-how. Having the mathematical know-how to properly process financial parameters is not an easy skill to teach. Genetic aptitude towards mathematics greatly helps the process.

Bank of Canada holds steady

The Bank of Canada holds the overnight target interest rate steady which resulted in a very mild decrease in the Canadian dollar as traders positioned themselves when reading the language in the statement.

Specifically:

Underlying pressures affecting prices remain subdued, reflecting the considerable slack in the Canadian economy. Core inflation is projected to edge gradually up to 2 per cent by the end of 2012, as excess supply in the economy is slowly absorbed. Inflation expectations remain well-anchored. Total CPI inflation is being boosted temporarily by the effects of provincial indirect taxes, but is expected to converge to the 2 per cent target by the end of 2012.

This is “fed speak” that is likely “We’re not going to do anything on our next meeting as we see how things unfold.”

BAX Futures have nudged slightly up in reaction to the statement:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 FE 0.000 0.000 98.590 0.000 0
+ 11 MR 98.620 98.625 98.575 0.050 23240
+ 11 AL 0.000 0.000 98.520 0.000 0
+ 11 JN 98.380 98.390 98.350 0.040 29808
+ 11 SE 98.150 98.160 98.140 0.020 14591
+ 11 DE 97.940 97.950 97.940 0.000 13813
+ 12 MR 97.770 97.780 97.780 -0.010 6012
+ 12 JN 97.630 97.640 97.640 -0.010 1493
+ 12 SE 97.250 97.580 97.520 -0.010 814
+ 12 DE 97.350 97.410 97.370 -0.010 36

I still maintain that long-term rates maintain much more relevancy – 10 year benchmark bond rates are at 3.25%, and it is likely that in order for the Bank of Canada to raise short term rates that the long-bond will need to go higher. It is my guess that the BOC has a silent objective to keep a 2-2.5% yield spread between short term and 10-year rates.

TFSA Update

A brief history of my TFSA: My strategy is to invest the TFSA in high risk-to-reward candidates that ideally will generate income that would justify its positioning in the TFSA for tax sheltering. My goal is a rapid compounding of capital with high risk/reward candidates. The TFSA will not be diversified as it is part of an overall portfolio, hence the lack of diversification.

In 2009, $5,000 was deposited into the TFSA. The first investing was invested in debentures of Harvest Energy Trust on February 2009, which was bought out by KNOC in October 2009. I cashed out the debentures and the account was left with a balance of $13,043 at year-end. Result: A 161% gain for the year. This is obviously unsustainable year-to-year.

In 2010, $5,000 was deposited into the TFSA. On January 2010, I invested the proceeds of the TFSA into debentures of First Uranium Corporation, which turned out to be a badly timed entry (if I had waited a week later I would have received a price 10% less than what I paid for due to bad news that was released literally a day after I had made the purchase) and the setback tested my investment acumen. The fundamental reason why I had invested had not changed, so I kept the debentures. In October 2010, I swapped half the debentures for (secured, convertible at a relatively low equity price) notes in the same company which has turned out so far to be a good decision. Result: The TFSA ended 2010 at $20,486, which after adjusting for the $5,000 deposit, is a return of 13.5%. Given the risk, however, I would judge this as a poor performance.

The two-year annualized performance (adjusting for deposits) of the TFSA was 72%. Again, this number will not likely be repeated in the future for 3, 4 and 5 year periods – this number will be going lower.

In 2011, after transferring in $5,000 into the TFSA at the beginning of the year, there is approximately CAD$5,500 sitting in the account that is currently languishing. I have been researching investment candidates and while I could deposit the proceeds into a relatively low risk investment that would yield around 6-7%, this is below my return threshold. The TFSA is still sensitive to the performance of First Uranium debentures and notes which should provide some element of growth in the portfolio (should be around 15%), but the rest of the cash needs to be deployed otherwise it will drag performance. I do not wish to invest in any more First Uranium at existing prices.

I do not want to invest cash for the sake of investing cash, so I will be patient and continue looking for opportunities. Such a bland strategy of holding zero-yield cash is boring and does not make for good writing, but it is disciplined.

Bank of Canada 2011 Review

In 2011, the Bank of Canada will have eight announcement dates for the short term interest rate target:

January 18
March 1
April 12
May 31
July 19
September 7
October 25
December 6

Currently, the BAX Futures have the following quotations:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 JA 0.000 0.000 98.590 0.015 0
+ 11 FE 0.000 0.000 98.555 0.015 0
+ 11 MR 98.540 98.545 98.540 0.005 8486
+ 11 JN 98.340 98.350 98.340 0.010 14721
+ 11 SE 98.160 98.170 98.160 0.010 15777
+ 11 DE 98.000 98.010 98.000 0.000 14316
+ 12 MR 97.850 97.870 97.850 0.010 6577
+ 12 JN 97.730 97.750 97.730 0.010 2365
+ 12 SE 97.620 97.630 97.610 0.030 692
+ 12 DE 97.440 97.510 97.460 0.030 0

The markets are inferring there is a chance the Bank of Canada will raise rates by 0.25% during the March 1 meeting, and if not by then, then a good chance on April 12.  Three month corporate paper is currently yielding 1.18% (98.82 on BAX).  Clearly, the market is pricing in inflationary fears as opposed to factoring in economic or currency differentials, relative to the USA.  For people that have floating rate mortgages or margin loans, your cost for these loans is likely to increase slightly throughout 2011.

What to do with RRSP and TFSA contributions

I notice Larry Macdonald is tackling the age-old question of where to put cash into work. This would be cash that is earmarked for an RRSP and/or TFSA contribution.

The sensible answer is that you don’t have to contribute and instead concentrate on debt reduction. Many people have a mortgage accruing interest at 4%, and assuming your marginal tax rate is 30%, it would amount to an equivalent pre-tax investment at 5.7%, not bad on what amounts to a risk-free return.

If you are fortunate enough to have no debts to pay off, then the question becomes more difficult to answer.

I would agree with the sentiment that the marketplace feels “frothy”, albeit equities are likely poised for further gains early this year.

The worst decision somebody can make is to contribute cash and put it immediately to work in an investment without regard to the valuation of the investment. For example, dumping the money into an ETF (which is what most casual investors will do) is unlikely to produce a market-beating return unless you can explicitly justify why the ETF components are undervalued.

This question is amplified for myself, mainly because I have been on a liquidation spree at the beginning of this year. It hurts to see cash earning 2%, but it would hurt even more to see that cash earn -10% on a snap decision investment. All I can do at present is pile stocks up in my research queue, and be patient for valuations to correct themselves or to wait for a volatility shock in the marketplace.

It is for this reason, high levels of cash, that I am not terribly optimistic about my 2011 performance.