Canadian Capitalist

Reasons for Caution in Comparing Real Estate Returns with Stocks

Canadian Capitalist — Wed, 22 May 2013 14:09:17 +0000

In a recent column in The Financial Post, Garry Marr pointed out that even in hottest bull market in real estate, stocks beat homes as an investment:

By the end of last year real estate prices had climbed about 85% over the previous decade, according to the Teranet/National Composite Bank House Price Index.

Stocks? The TSX/Composite Index has had a total return of about 141% during that period or about 9% annually. Go back 20 years and stocks still return more than 9% annually over the period.

One can sympathize with Mr. Marr’s intention to provide a counterpoint to the constant rah-rahs from the real estate industry (As a matter of fact, many years back, I wrote a very similar post in response to industry claims that real estate beat stocks here). However, Mr. Marr is incorrect in comparing home prices with stocks. Here’s why:

The total return from stocks includes the change in price level of the TSX index from 6,614 in 2003 to 12,433 in 2012. That’s a gain of 88 percent. The rest of the gains came from reinvested dividends (The TSX Composite yields about 3 percent per year). The return from housing was measured solely as the increase in the level of the Teranet – National Bank National Composite House Price Index and does not account for rental income from a property. It is true that owning a home entails expenses such as property taxes and maintenance but even in frothy markets like the present one, housing typically will have a positive yield net of expenses but excluding the cost of financing. Therefore the column presents an incorrect picture by comparing total returns from stocks with just the increase in price level of real estate.

Even if it turns out that stocks beat out real estate over the past decade, it still does not mean anything unless one takes risk into account. After all, if stocks beat bonds in most time periods, investors would hardly express surprise because stocks are riskier than bonds. The TSX Composite annualized returns had a standard deviation (a measure of riskiness of stocks) of 19.53% in the 2003 to 2012 period. The Teranet / National Bank National Housing Price Index, on the other hand, showed a standard deviation of just 2.6% during the same time period (assuming I did the calculations correctly with the information available from housepriceindex.ca). If real estate is less risky than stocks, one would expect real estate to have lower returns as well.

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This and That: Excel Errors, Housing Bubbles and more…

Canadian Capitalist — Fri, 17 May 2013 04:29:10 +0000

Economics may be a dismal science but a recent flap between two renowned Professors and a grad student simply trying to reproduce their results for a school assignment makes for a fascinating story.

Paul Krugman lashed out at the pundits who “turn their backs on the unemployed” based on the flawed findings of Reinhart and Rogoff in The New York Times.

Globe and Mail columnist Rob Carrick highlighted a rent versus buy argument that finds “owning never wins”. As is usually the case with buy v. rent debate, the case study is filled with assumptions like 4 percent maintenance expense on homes.

The United States may just be recovering from the previous housing bubble but sharp recent gains are giving rise to worries that another bubble may be forming in some markets.

While the S&P 500 and Dow Jones Industrial Average are hitting new highs, the US remains stuck in slow economic and employment growth. This New York Times column took a look at disconnect between the stock market and the economy.

Charlie Munger doesn’t get the same attention as Warren Buffett but he probably has better zingers. In an interview with CNBC, Mr. Munger bluntly characterizes high-frequency trading as “legalized front-running” and “basically evil”.

In an interview with CNN Money, legendary money manager Charley Ellis says that investors who see fees not in terms of assets but in terms of expected alpha will find fees “unbelievable”.

This Wall Street Journal video segment says that everyone should have a contingency plan and suggests some ideas. Some tips like the one to have 4 weeks of water around the house sound completely impractical.

Remember how BRICs became investment fads a few years back based on rosy economic forecasts looking ahead more than two decades? The Economist says that with the four emerging market economies slowing markedly, we may already be in a post-BRIC world.

Now for something completely different: Slate ran a story on the best pictures captured by Commander Chris Hadfield aboard the International Space Station. You can find many more pictures on Col. Hadfield’s Facebook page here.

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This and That: China Housing Bubble, Gold and more…

Canadian Capitalist — Fri, 03 May 2013 05:06:43 +0000

If you thought Canada has a housing bubble, this 60 Minutes story on China’s real estate bubble, where entire city blocks, malls and even cities are virtually empty, will make us look like small potatoes. One particularly scary statistic: a typical apartment building in Shangai costs 45 times an average resident’s annual salary.

CBC Television’s DocWorld featured a story called The Secret World of Gold that alleged that the price of gold is manipulated. That may be. But it seems to me that the rise in the price of gold can be traced to the enormous increase in demand from investors. It shouldn’t be surprising, therefore, that the price of gold moves in the other direction when the demand from investors falls.

Some advisors are reported to be experiencing “goldenfreude” or pleasure from the suffering experienced by gold investors this year. Any such feelings may be premature considering that stock prices can plunge sharply as well.

If you need another reminder to get your wills and power of attorney done, here is a story on a wealthy New York resident who died intestate and whose estate could end up going to the state.

The renting v. owning debate is being played out in the wake of discussions around the housing bubble in Canada. Robert Shiller argues in this New York Times column argues that forecasting future housing prices may not be possible. His advice: “it may be wisest to choose the housing that best meets your personal needs, among the choices you can afford”.

“Always look at the productive ability of the asset you are buying, whether it is a farm, apartment house or company” counsels Warren Buffett in an interview with Fortune magazine.

The CBC’s Neil Macdonald takes a critical look at the power wielded by the world’s central bankers and the unintended consequences Quantitative Easing is having on savers. Outgoing Bank of Canada Governor Mark Carney points out that the consequences of high interest rates will likely be much worse.

This column in The New Yorker argues essentially that savers should simply “shut up”. It seems to me a far too unsympathetic attitude towards primarily older savers and pensioners.

Money apparently does buy happiness. A new study contradicts widely held belief that more money beyond a certain point does not make people happier. It suggests instead that the relationship between money and happiness is much more complicated than earlier believed.

The Wall Street Journal featured a story that contained four tips to simplify your portfolio.

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RBC and BMO Offer Cheaper Business Banking Options

Canadian Capitalist — Wed, 24 Apr 2013 02:22:36 +0000

Many small businesses may make only a couple of banking transactions each month — a couple of deposits and maybe a withdrawal or two — but still end up paying a chunk of it in banking fees. As far as I know, there are no free business chequing accounts available anymore (HSBC Canada briefly offered a free business chequing account but doesn’t any longer). All the big banks offer a basic pay-as-you-go business chequing account for monthly fees ranging between $6 per month at RBC and CIBC and around $10 at BMO, TD Canada Trust and Scotia Bank.

If you average just one or two transactions every month and are unable to maintain a large cash balance, you should take a look at the RBC Business Essentials Savings Account. There are no monthly fees and no minimum balance requirements but you will pay $1 for every electronic or cheque deposit. The first two withdrawals are free but every subsequent withdrawal will cost $3.50. If you are averaging less than 2 deposits and 2 withdrawls every month, you’ll save approximately $50 per year in business banking fees. CIBC also offers a no monthly fee business savings account but since each debit transaction costs $5, any savings are likely to be quickly wiped out.

If you are able to maintain a large cash balance and perform a larger number of transactions, you may want to look into BMO’s Small Business Banking Plan. The account has a monthly fee of $9.50 which is waived if you keep a minimum monthly balance of $4,000. The plan includes a fair number of free transactions but keep in mind that a $4,000 balance translates into an opportunity cost of $40 (assuming a 1 percent interest rate). TD Canada Trust and Scotia Bank also waive monthly fees for maintaining a minimum balance but the limits are higher ($8,000 at TD Canada Trust and $5,000 at ScotiaBank).

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Sleepy Mini Portfolio Q1-2013 Update (and TurboTax Online Giveaway)

Canadian Capitalist — Thu, 18 Apr 2013 15:43:11 +0000

The Sleepy Mini Portfolio has gained 6.7 percent my previous update. The Sleepy Mini Portfolio was launched in August 2007 with an initial investment of $1,000 with a target allocation of 20% bonds, 20% Canadian stocks, 30% US stocks and 30% International stocks to illustrate how a regular investment program can slowly build wealth over the long term. Another $1,000 was added to the portfolio every quarter since then for a total investment of $22,000 so far. Here’s how the portfolio looks as of April 18, 2013:

TDB909 – Canadian Bonds – $5,037 (19.0%)
TDB900 – Canadian Equities – $4,882 (18.4%)
TDB902 – US Equities – $8,336 (31.4%)
TDB911 – International Equities – $8,263 (31.2%)
Total – $26,518
Total Invested – $22,000

I’ve been a little bit tardy in adding new money to this portfolio. It’s better late than never, so let’s add another $1,000 to the portfolio and rebalance it to the original target allocation using this rebalancing spreadsheet. Here are the results:

Transactions

TDB909 – TD Canadian Bond Index (e-Series) – Buy units for $420.
TDB900 – TD Canadian Index (e-Series) – Buy units for $580.

It is interesting to note how market leadership has shifted from Canadian stocks and bonds to foreign stocks.

TurboTax Online Giveaway

Thanks to TurboTax Online, I am giving away four (4) online coupons for filing one (1) tax return with TurboTax Standard, Premier or Home & Business. To enter just leave a comment in this post and don’t forget to include a valid e-mail address. If you are reading this through your favourite RSS Reader or via-email, you have to click on the headline, get through to the website and scroll down to the bottom of the page and type in your comment.

Some quick rules:
(1) No purchase necessary. A skill-testing question may be required.
(2) Deadline for entries is 11:59 p.m. EDT on Friday, April 19, 2013.
(3) One entry per person please.
(4) I treat your privacy very seriously. Your email will be used for the sole purpose of contacting you if you happen to win.
(5) I’ll pick four (4) entries at random and announce the winner after the deadline. All decisions are final.

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New Currency Unhedged ETFs from iShares

Canadian Capitalist — Tue, 16 Apr 2013 14:35:17 +0000

ETF investors have long clamoured for Currency unhedged funds traded on the TSX for reasons outlined here, here and here. While it is true that Canadian investors can get direct access to foreign stocks through a long list of ETFs that trade in the US exchanges, these funds have one drawback that cannot be overcome — US-listed ETFs are considered in situ property and could be subject to US Estate Taxes. Granted, US Estate Taxes have become less problematic for most Canadian investors since the passing of last-minute legislation to avert the fiscal cliff. Essentially, Canadians with less than $5 million (US) in total assets will be able to avoid US Estate taxes entirely.

Still, Canadian-listed ETFs that do not hedge currency will be valuable for investors who do not want to look for cheaper methods of converting Canadian dollars into US dollars and who do not want to pay the usurious foreign exchange fees charged by most discount brokers. Last year, Vanguard Canada introduced the S&P 500 Index ETF (TSX: VFV, MER 0.18 percent), a fund that tracks the S&P 500 index. Now, iShares has launched three new ETFs that started trading on the TSX yesterday. They are:

iShares S&P 500 Index ETF (XUS): Track the S&P 500 index, a market-cap weighted index of 500 large US corporations. MER is 0.14 percent. Note that the ETF is essentially a wrapper around the iShares Core S&P 500 ETF (IVV) that trades on the NYSE Arca exchange.

iShares MSCI EAFE Index ETF (XEF): Track the MSCI EAFE index, a market-cap weighted index that tracks stocks from Europe, Australasia and the Far East (essentially an index of developed market stock markets excluding the US and Canada). MER is 0.30 percent. The ETF is a wrapper around the iShares Core MSCI EAFE ETF (IEFA).

iShares MSCI Emerging Markets ETF (XEC): Track the MSCI Emerging Markets Index, a market-cap weighted index that tracks stock market performance of emerging markets. MER is 0.35 percent. The ETF is a wrapper around the iShares Core MSCI Emerging Markets ETF (IEMG).

Take-away for Investors

These ETFs are great news for Canadian investors wanting Developed Markets ex North America and Emerging Markets exposure from securities listed in Canada but do not want currency hedging because the new ETFs are far cheaper than existing alternatives.
Investors should keep in mind that owning a Canadian-listed ETF that holds foreign securities in their RRSPs means incurring a 15 percent withholding tax hit on dividends. i.e. an investor who holds $1,000 worth of XUS in a RRSP will incur a tax hit of $3 per year compared to holding $1,000 worth of IVV. Note that the withholding tax hit is only for RRSPs and RRIFs.

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Budget 2013 clamps down on Advantaged ETFs

Canadian Capitalist — Tue, 09 Apr 2013 12:04:10 +0000

Advantaged ETFs refers to exchange-traded products that use derivatives such as forward agreements to transform one form of distributions (often interest income) into another (such as capital gains or return of capital) that is lightly, if at all, taxed. For example, an investor holding the iShares Advantaged Canadian Bond Index Fund (TSX: CAB) in a taxable account will have received capital gains and return of capital equal to the income generated from a portfolio of Canadian Government and corporate bonds (less fees and expenses). Capital gains are taxed at half the marginal rate. If the investor had instead directly held the portfolio of bonds, the interest income would have been taxed at the investor’s marginal rate.

Budget 2013 proposes to put a kibosh on what it calls “character conversion transactions” such as the ones employed by Advantaged ETFs.

Character conversion transactions link a derivative investment with the purchase or sale of an otherwise unrelated capital property to form a derivative forward agreement. If the derivative investment were made separately from the purchase or sale of the capital property (i.e., as a cash-settled derivative financial instrument), any income from the derivative investment would be taxed as ordinary income.

To ensure the appropriate tax treatment of the derivative-based return on a derivative forward agreement, Budget 2013 proposes to treat this return as being distinct from the disposition of a capital property that is purchased or sold under the derivative forward agreement. This measure will apply to derivative forward agreements that have a duration of more than 180 days. Whether a particular property is held on income or capital account is largely a factual determination and is unaffected by this measure.

ETFs Affected by the Change

iShares Canada put out a press release saying that seven funds in its ETF line up will be impacted by the changes proposed in the Budget. It is interesting to note that all these ETFs used to be traded under the Claymore brand name. They are:

iShares Advantaged Canadian Bond Index ETF (CAB)
iShares Advantaged Convertible Bond Index ETF (CVD)
iShares Advantaged U.S. High Yield Bond ETF (CHB)
iShares Advantaged Short Duration High Income ETF (CSD, CSD.U)
iShares Global Monthly Advantaged Dividend Index ETF (CYH)
iShares Broad Commodity Index ETF (CBR)
iShares Managed Futures Index ETF (CMF, CMF.A)

ETFs Not Affected by the Change

Horizons also put out a news release saying that the Budget proposals are not expected to impact the popular Horizons S&P/TSX 60 Index ETF (HXT) because the ETF makes no distributions and hence there is no re-characterization taking place. Horizons confirmed that the Horizons S&P 500 Index ETF (HXS) is also not expected to be affected by the move. Nevertheless, investors should weigh the risk of an adverse change in tax treatment of swap-based ETFs against the tax advantage of earning total returns.

See also: Canadian Financial DIY’s and Canadian Couch Potato’s takes on this topic.

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This and That: Grantham Interview, RESPs and Another Giveaway

Canadian Capitalist — Fri, 05 Apr 2013 03:15:01 +0000

In a wide-ranging interview with Charlie Rose on PBS, Jeremy Grantham says that the era of 3 percent economic growth is over.

Jason Zweig says that automatic enrolment with opt-out can help alleviate the retirement savings crisis.

Rob Carrick says that you can give your kids their inheritance early by starting early and contributing regularly to a Registered Education Savings Account (RESP). It’s good advice because the Government kicks in at the very least an extra 20 percent.

Bitcoins were in the news this days as the value of these virtual coins soared in the wake of events in Cyprus. This blog post takes a deeper look into the strengths and weaknesses of Bitcoins.

As the old saw goes, investing is simple but not easy. This article offers ten tips for overcoming some common investment errors.

Larry Swedroe highlights the findings of a study that found that there is no special advantage to a strategy of investing in dividend-paying stocks.

Michael James calls value averaging — an investment strategy that involves adding or withdrawing money from a portfolio based on a pre-determined rate of return — “non sense”.

Canadian Financial Stuff says that he finds passive investing still means you have to pay attention to your portfolio. I tend to agree but it should be mentioned that the time demands of a passive portfolio are fairly minimal.

Google recently announced that it is shuttering the Reader product. Blessed by the Potato wonders why Google is killing off some of its useful products.

H&R Block Online Giveaway

Thanks to H&R Block, I am giving away five (5) online coupons for filing your family’s tax returns (valued at $23.95). To enter just leave a comment in this post and don’t forget to include a valid e-mail address. If you are reading this through your favourite RSS Reader or via-email, you have to click on the headline, get through to the website and scroll down to the bottom of the page and type in your comment.

Some quick rules:
(1) No purchase necessary. A skill-testing question may be required.
(2) Deadline for entries is 11:59 p.m. EDT on Tuesday, April 9, 2012.
(3) One entry per person please.
(4) I treat your privacy very seriously. Your email will be used for the sole purpose of contacting you if you happen to win.
(5) I’ll pick five (5) entries at random and announce the winner after the deadline. All decisions are final.

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The Hysteria Over Bail-ins (and a Giveaway)

Canadian Capitalist — Wed, 03 Apr 2013 02:04:14 +0000

In Budget 2013, Finance Minister Jim Flaherty proposed the establishment of a risk management framework for systemically important banks. At first glance, the proposal looks fairly innocuous (See Pages 144-145 of the Budget document available here) because the Minister is simply proposing that the Government of Canada “intends to implement a comprehensive risk management framework” for the Big Six banks. The framework will include higher capital requirements, a “bail-in” regime that will convert “certain bank liabilities” into regulatory capital and more oversight from regulators.

Many Canadians (aided and abetted by certain vested interests) began to conclude that the Canadian Government is calling for insured bank deposits to take a haircut in the event of a major bank failure. That does not appear to be the case. Bail-in simply refers to a partial conversion of certain unsecured debt into equity under specific conditions. A 2011 paper titled Contingent Capital and Bail-In Debt: Tools for Bank Resolution put out by the Bank of Canada has some ideas on the liabilities that can be converted into equity [emphasis mine]:

There is some debate about the scope of the liabilities that should be subject to such bail-in conversion, but a focus on senior, unsecured debt instruments would be relatively straightforward. This particular scope of application would leave secured creditors, insurable depositors, short-term securities holders and a bank’s counterparties unaffected by bail-in provisions.

In other words, deposits in a bank up to CDIC insurance limits will likely be safe during a bank failure. In fact, The Financial Post is now reporting that a Finance Ministry spokeswoman clarified that “the bail-in scenario described in the budget has nothing to do with depositors’ accounts and they will in no way be used here.”

One would think that a bail-in mechanism for banks is a good thing because recapitalizing too-big-to-fail institutions with tax payer money (a.k.a bail outs) while leaving bond, preferred-share and sometimes even equity investors with little or no losses will incentivize reckless risk taking. After all, who wouldn’t love to gorge on a free lunch if someone else gets a stomach ache?

UFile Giveaway

Thanks to UFile Online, I have ten (10) online coupons that are good for filing your family’s tax returns (valued at $24.95 plus tax) to giveaway. Entering is real simple — Just leave a comment in this post and don’t forget to include a valid e-mail address. If you are reading this through your favourite RSS Reader or via-email, you have to click on the headline, get through to the website and scroll down to the bottom of the page and type in your comment.

Some quick rules:
(1) No purchase necessary. A skill-testing question may be required.
(2) Deadline for entries is 11:59 p.m. EDT on Friday, April 5, 2012.
(3) One entry per person please.
(4) I treat your privacy very seriously. Your email will be used for the sole purpose of contacting you if you happen to win.
(5) I’ll pick ten (10) entries at random and announce the winner after the deadline. All decisions are final.

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How Budget 2013 will affect your pocketbook

Canadian Capitalist — Thu, 21 Mar 2013 23:24:39 +0000

Federal Finance Minister Jim Flaherty tabled the Federal Budget in Parliament today. Unlike previous budgets, there is nothing concrete to report but there are some interesting measures that may impact your pocketbook.

Another Budget, Another Tax Credit

Budget 2013 introduces a new temporary tax credit called the First-time Donor’s Super Credit (FDSC). A first-time donor is an individual (or her spouse or common-law partner) who has not claimed the Charitable Donations Tax Credit (CDTC) or FDSC in any taxation year after 2007. The first-time donor will be allowed to claim a 25 percent tax credit on up to $1,000 of donations once in 2013 or a subsequent tax year before 2018.

Deduction for Safety Deposit Boxes Eliminated

Currently, tax payers are allowed to deduct expense incurred for renting a safety deposit box provided they use it to store and protect papers relating to the portfolio. These days most records are available in electronic form and the importance of paper copies is declining. Therefore, starting in Financial Year 2014, the cost renting safety deposit boxes cannot be deducted as a carrying charge on the income tax return.

Increase in Tax on Non-Eligible Dividends

A non-eligible dividend refers to income received from corporations that are not taxed at the general corporate rate (such as private, small business corporations). If all you receive are mostly dividends from Canadian public companies, this measure will not impact you.

Budget 2013 proposes to reduce the gross-up factor applicable to non-eligible dividends from 25 percent to 18 percent. The Dividend Tax Credit will change from 2/3 of the previous gross-up amount to 13/18 of the new gross-up. The combined effect of this measure will increase the personal tax rate on non-eligible dividends received from corporations. (Note: KPMG reported that the net result of this measure will increase the federal effective tax rate on non-eligible dividends to 21.22 percent from 19.58 percent).

Crackdown on Charitable Donation Tax Shelters

It appears that Budget 2013 is proposing measures that may turn out to be final nail in the coffin of Charitable Donation Tax Shelters. First, the Budget proposes to extend the reassessment period for a participant in a tax shelter by three years to six years. Second, the Budget permits CRA to collect 50 percent of the any tax, interest or penalties resulting from a reassessment of a participant in a tax shelter even if a notice of objection is filed.

Hasta La Vista to Labour-Sponsored Venture Capital Funds

Labour-Sponsored Venture Capital Funds have, in general, turned out to be a poor investment for Canadians. Therefore, it is heartening to see that Budget 2013 is proposing to eliminate the 15 percent Federal Tax Credit for investments of up to $5,000 in Labour-Sponsored Venture Capital Funds gradually by 2017.

There are other interesting measures in the Budget regarding reporting requirements for foreign assets that we will take a look at in future posts. Meanwhile, if you are looking for some bedtime reading, you can find the entire Budget 2013 document here.

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