Financial Jungle

It’s been a notoriously busy week for me so far, so I don’t have a financial article prepared. Instead of going two weekdays without a post, I’ll chat about the blog instead.

Financial Jungle is an editor’s pick

I was thrilled to learn that Money Smart Life selected my article, The Dirty Secret Behind Closet Index Funds, as an editor’s pick for the Carnival of Personal Finance #102. You might want to check out the other 68 articles. Some of which are quite interesting, and I may expand on a few in later posts.

Canadian Capitalist votes for Financial Jungle

Canadian Capitalist, one of my most admired Canadian financial blogs, generously mentioned Financial Jungle yesterday, and included my blog to his blogroll. Canadian Capitalist is a passive-investing advocate, whom I enjoyed a healthy debate with on passive versus dividend investing just a few days ago. If you’re looking for unbiased opinions on personal finance from a source with integrity, www.CanadianCapitalist.com, is it.

So, what does it mean when Canadian Capitalist mentions a blog? The blog scores a lot of high-quality hits. Yesterday, Financial Jungle received a whopping 44 hits (36%) from a single source, which easily shattered the previous and distant record.

A writing tip

Being a software developer, my typical day involves writing and commenting computer code. I don’t get too many opportunities to practice writing articles, and this is why I believe blogging will help to improve that aspect of my communication.

I’m a keen believer of the Pareto principle, where 20% of the effort is responsible for 80% of the result. Life is too short to be a perfectionist. Naturally I went on a quest to discover the one writing gem that can turn a fair writer into a good writer with as little effort as possible. I turned to bloggers who have always captivated me with their bottomless supply of charismas. Bloggers, like Darren Rowse from ProBlogger and Vince Chan from Investorial, have clear and attention-getting writing styles that any new blogger would love to emulate.

After deciphering their blogs, I believe their secret is to pick concise and interesting rather than general and boring words. General words like talk, get, give, go, make, look and take force reader to work harder to understand your story, thus should be used sparsely. Good bloggers rarely write sentences like “he talked to her”. Instead, they replace “talked” with something more descriptive that conveys how he talked to her. Did he whisper, shout, congratulate, praise, criticize or persuade her? Descriptive words like these offer readers a head start on your story, and make reading effortless and enjoyable.

This is probably the most abused Warren Buffett quote I’ve read in many financial forums:

Wide diversification is only required when investors do not understand what they are doing.

For one reason or another, investors seem to interpret this as an excuse to concentrate. Let me rephrase the quote a bit.

If you don’t know what you’re doing, you ought to diversify.

Even Buffett, arguably the most astute of all investors, relies on 42 stocks to cut risks. Granted that the high stock count is probably necessary given his enormous wealth. However, if you don’t know what you’re doing, concentrating your stock portfolio will not turn you into an astute investor. Since no investor is omniscient, s/he can cushion any unforeseen blows from company-specific risks, such as strikes and natural disasters, by spreading your eggs to different baskets.

In my own portfolio, I have about 27 core holdings, a number of smaller positions, a couple of ETFs and a handful of mutual funds. Admittedly, the number of holdings seems excessive, but certainly not enough to qualify as diworsification. I don’t have plans to scale down at the present. Being primary a quantative investor, I find the current portfolio quite manageable.

Reduce volatility without sacrificing return
One of my favourite theories is the Modern Portfolio Theory, which goes something like this: when you construct a collection of high-risk, high-reward and uncorrelated stocks, it reduces the volatility of the overall portfolio without sacrificing the expected return. The key is to pick businesses that don’t correlate with each other. That way, individual stocks may oscillate violently around the expected return, but due to the low correlation, the oscillations cancel each other out, and you benefit from a smoother and more consistent return.

Reduce unsystematic risk
Diversification also reduces company-specific risks, also known as unsystematic risks. Examples include strikes at railway companies, broken oil and gas pipelines, and natural destructions by fires and hurricanes. This one goes along the line of not putting all your eggs in one basket. By diversifying, you can improve you odds of hatching most of your eggs.

I’ve been told that investors cannot diversify away from systematic risks, which include inflation, interest rates, recessions and political instability. Even though we can’t eliminate systematic risks, I’m open to the possibility of at least minimizing systematic risks by investing in companies with these characteristics:

• Ability to pass inflationary costs to the customers
• Clean balance sheet to insulate from rising interest rates
• A lineup of consumer stables including essential products and services
• Diversified international revenues

Further readings on diversification:
- Modern Portfolio Theory by Investopia
- Systematic Versus Unsystematic Risks by Investment Review
- How Many Stocks Diversify Unsystematic Risk? by Morningstar

If it looks like an index, quacks like an index and charges you 2.5% in MER, it’s a closet index fund.

A closet index fund describes a mutual fund that’s a copy-cat, look-alike, mirror image, carbon copy or whatever you call it, to the underlying benchmark. Typically, these funds hold remarkably similar stocks under the hood. You’ll find little differentiations between buying a closet index fund versus a vanilla index fund, but there is one big dirty secret that fund companies won’t tell you; closet index funds charge you about 2.5% in management expense ratio for doing practically nothing. When the portfolio looks virtually identical to the market, the manager has a daunting task of consistently overcoming the 2.5% disadvantage every year. It’s in investors’ best interest to stay away from closet index funds.

Here is one example of a closet index fund. Compare the top holdings between RBC Canadian Equity and TD Canadian Index. It’s bad enough that RBC Canadian Equity fund managers imitate the TD Canadian Index fund, but the fund also trails the benchmark by 3.14%/year over the previous 15 years.

TD Canadian Index

RBC Canadian Equity (a.k.a. closet index fund)

Here are 3 methods to spot a closet index fund:

1. Repeat what we just did. It’s less scientific, but looking under the hood works reasonably well. Visit www.globefund.com or www.morningstar.ca, type in the mutual fund name, and compare the top holdings with an index fund, such as the TD Canadian Index e-Fund. If they look similar, then it’s a potential closet index fund.
2. Another easy way is to compare the charts between the fund and the benchmark. Here is an example of comparing RBC Canadian Equity with the benchmark, and another example with ABC Fundamental-Value . Make sure you select “S&P/TSX Total Return” from the Compare vs. Benchmark drop down.
3. The advanced method is to get the R-Squared value, which reveals how much of the price movements are due to fluctuations of the underlying benchmark. It’s a number between 0 and 100; the greater the value, the closer the fund follows the index. I’m typically suspicious of R-Squared values greater than 90. Unfortunately, FundScope is the only site that I know of which offers R-Squared information, and there’s a $39.95 annual fee. If you know of a free site, please share.

Further readings on closet index funds:
- Closet Indexing by Canadian Funds Watch
- Closet Index Funds, Investors Don’t Ask, Funds Don’t Tell by Will McClatchy
- Beware of the Closet Index Fund by O’Reilly

Vancouver, the most bubbly city in the world

declared by Yale economics professor Robert Shiller, the oracle who predicted the tech market crashed, and author of Irrational Exuberance.

Someone ought to hand this guy some mouthwash, eh?

These days, Vancouverites are rushing into the housing market like there is no tomorrow. With prices doubling over the past 5 years, it’s no wonder that our greatest fear is being priced out forever. While every homeowner is celebrating the brisk market in harmony, critics like Prof. Sheller are in an immensely unpopular position. Nevertheless, there are always two sides to a story, and listening to these critics gives us a well-balanced discussion. We don’t want our biases to blindside our views, right?

If you believe that the long-term health of our housing market is resting on solid foundations, consider these 2 arguments:

• Despite prices doubling over the past 5 years, rents are still trailing by a wide margin. This is irrational. Contrary to popular belief, price increases do not signify housing demand; rents do. It’s all about the rents. Over the long-run, rents are the engine driving prices higher. Renters bid to put roofs over their heads. Buyers, on the other hand, look at the rear mirror and speculate the good times ahead. If prices keep sprinting ahead at this pace, can you imagine renting a $2 million house for a paltry $3,000?
• According to data from RBC, the affordability measure for a detached Vancouver bungalow is 68.5%. It means over 2/3rd of a family’s pre-tax income goes toward housing expenses. To put this in perspective, Toronto’s affordability measure is 42.6%; Calgary 40.9%; Montreal 35.3%; Ottawa 30.0%; the entire Canada 39.4%. This places Vancouver on a commanding first place as the most unaffordable city in Canada. Unless you can double your household salaries in 5 years, we’re unlikely to see the double-digit growth that we’re accustomed to.

This post doesn’t predict a bubble burst, but tries to lower homeowners’ expectations to an attainable level. Only buy when you’re ready, and don’t let anyone persuade you into borrowing a high-ratio mortgage. Paying today’s top dollars will not recoup your lost opportunities. In my view, the easy money has already been made.

Further Reading
- According to GVRD, a benchmark house is sold for $682k in March; townhome $428k; apartment $349k. If the market doubles again in 5 years, it’s impossible for a young family to afford a starter home (apartment) at $698k.

Canadian Capitalist recently wrote another thoughts-provoking article. This time the subject was on Fidelity’s Retirement Math.

Instead of going off-topic with a long comment, I decided to write a separate article on an unconventional way to retire; live in exotic countries on a shoestring. My wife and I went on a vacation two years ago to Thailand and Malaysia, and we were thrilled to discover how affordable these two countries were. We ate delicious Thai curry chicken noodle soup for $0.75 Cdn, and stayed in a Chiang Mai hotel for $8/day with air conditioning. Although I haven’t done a complete analysis, this retirement seems doable.

The best time to travel is during the Canadian winters when utility bills are the costliest. Some of the eliminated expenses include electricity, heat, telephone/cell phone connections, cables, internet, grocery, gas, car insurance and dine outs, all of which could cost around $1,200/month depending on your lifestyle. $1,200/month is a lot of money to spend in Thailand and Malaysia. To give you some ideas:

• Pad Thai noodles for $1.25/plate. Desserts are even cheaper.
• Hotels in Bangkok run around $25/night. As mentioned, you can rent hotels in Chiang Mai for less than $10.
• Air Asia has countless sub $50 flights inside South East Asia.
• Meals in Malaysia range from $2.50 to $5.00. We ordered a $5/person meal that included a sting ray, chicken satay, frogs, vegetables and drinks. Yummy.
• $30/night for a courtyard double right at the heart of Kuala Lumpur, Malaysia.
• $42/night for an executive room with air condition at Sepilok Jungle Resort, Malaysia.

Another money-saving tip is to plan for extended stays in exchange for rate discounts. To help fund the trip, you could also hire a property manager to lease out your home temporary during your vacation. Again, I’m only scratching the surface here, but it’s something to ponder on.

I read about this ingenious anti-global warming billboard done by Draft FCB. The billboard is designed to face West such that as the sun sets, the shadow creates the illusion of rising water levels.

More links:
- Media In Canada
- Save Our Climate

My previous blog enhancements are paying off. Last week, Financial Jungle’s traffic improved from 47 hits/day to 52 hits/day. Not quite ground shaking, but respectable considering the lack of blogging tour participations. I hope the modest success is also feeding off to blogs on my Favorite Blog widget as well. As no blog is an island, the only way to thrive in the blogosphereis to connect and be connected. If you’re a financial blogger and believe Financial Jungle is worthy of a mention, please consider linking it through your blogroll. Conversely, I’m happy to reference financial blogs that bring in engaging and fresh ideas, so don’t be shy to ask.

For this week, I’ve installed several promising WordPress plugins to elicit reader interactions and retentions:

1. The Similar Posts plugin quickly finds and suggests related articles based on MYSQL’s fulltext search capability. This plugin saves readers’ time by leveraging the more sophistical search algorithm, instead of the rudimentary search box functionality. It also helps me because the plugin uncovers some of the older (brilliant?) articles buried too deep in the archives.
2. Readers participating in discussions are immediately recognized by having their names displayed on the Recent Comments widget. Moreover, new visitors can glance through the widget to find the most talked-about posts. (For the life of me, I can’t figure out where I got this widget from.)
3. Thanks to the NoFollow plugin, bloggers leaving comments at Financial Jungle are rewarded with link-backs to their own blogs. A link-back helps to advance your Google PageRank score, thus making your site more visible in Google searches. The plugin expires the link-backs after 2 weeks to encourage return visits.

I forgot to mention this earlier. Scroll to the bottom of the page to find the ClustrMaps icon. Clicking at the icon brings you to a world map showing off where the loyal Financial Jungle readers are coming from.

1. Canadian Capitalist reviews the two bond ETFs offered by iShares: iShares CDN Bond Index Fund (XBB) and iShares CDN Short Bond Index Fund (XSB). In his article, Canadian Capitalist explains what investors should look for in a bond fund and offers a few links for further research.
2. Frugal Trader from Million Dollar Journey outlines his top 5 reasons why buying a home is better than building.
3. Big Cajun Man from Canadian Financial Stuff isn’t surprised by the disappearing of middleclass in Canada.
4. Middle Class Millionaire shares his view on the potential pitfalls to look out for when pursuing your dream job too early. This is a 2-posts series.
5. Before accepting the next “hot tips” from your friends, co-workers or family, be sure to read Investoid’s post on How To Access Hot Stock Tips.
6. The charismatic Money Diva announces to the world that she’s indeed an impulse shopper.
7. Who wouldn’t want to click on a catchy title like 5 Ways To Become A Millionaire by Generation X Finance?

The Dividend Guy is rightfully scolding IGM’s Investors Dividend fund for milking $291,117,000 a year in mutual fund fees. I’m both proud and guilty of being an IGM Financial shareholder. I’m proud because IGM has been steadily increasing revenues, profit margins, earnings and dividends, while maintaining Return on Invested Equity above 20%, and decreasing debt levels. I’m guilty because the prosperity rides on the backs of investors’ ignorance. Let’s face it. By analyzing Investors Dividend’s top holdings, one can easily conclude that the Investors Dividend fund is nothing more than a closet index fund with a tilt toward dividend paying stocks. Even an amateur like myself can assemble an index look-alike portfolio. Heck, pay me 1/100th of $291,117,000, and odds are favouring me to beat this fund over the long-term.

Not only is the Investors Dividend the largest mutual fund in Canada, the MER is also a whopping 2.88%. So much for economies of scale. To appreciate just how much investors are forgoing with the MER, let’s compare the performances between Investors Dividend and the TSX total return. The 5-year compounded returns are 9.71% and 12.43% respectively, or a difference of 2.72%. Peculiarly similar to the MER, the point is investors are better off buying cheap index funds and ETFs, rather than enriching IGM Financial with a jumbo MER for inferior performances.

Here is a totally unoriginal idea. Don’t buy this mutual fund. Buy the company that operates the fund. Buy IGM Financial. At 400 shares, this position is spoiling me with $684 worth of dividends per year, and this money is coming out of the $291,117,000 pot. I’m a guilty IGM shareholder, and you can give me some virtual spanking.

Introduction: My wife, Financial Jungle Gal, has written the following piece out of her own free-will. She’s been busy as a bee fixing up my goof-ups in every post - including this intro. To show a token of my appreciation, I’ve decided to share the fame with her. Please give her a warm welcome.

“How Much is That Doggie in the Window?”

If you are a dog-lover, it can be hard to resist taking home every puppy that looks at you with its doggy eyes through the window. The puppy is small and cute, oh so cute, especially when it does funny things like rolling around with its roommate or trying to terrorize a toy. The breeder asks for $$$$ or the pet shop lists the sale price for $$$$$$, but how much does it really cost to own this dog?

Here is a list of common items that need consideration for Fido (estimates):

One-Time

• Dog: $500 to $1,500
• Pet carrier: $50
• Brush: $10
• Leash / Collar / Harness: $50
• Dog Mattress: $30
• Food & Water Dish: $10

Annual

• Food: $250
• Vet Examinations/Shots: $100
• Flea prevention (such as Program or Sentinnel): $100
• Dental Care (Toothbrush/Toothpaste): $15
• Shampoo & Towel: $15
• Toys: $50
• Treats: $70

Optional

• Dog Training Classes: $75
• Dog Grooming: $45 each visit
• Doggy Day Care: $25 per day
• Dog Walker: $20 per hour

Wow, this adds up!

Of course, Fido does not need all of these things. You can save money on doggy day care and doggy walkers if Fido has a companion at home all day (ex. Human companions (stay-at-home moms, dads, kids, retirees, or other pets), or Fido likes to sleep all day. Some inexpensive toys include old socks, worn shirts, paper toilet rolls, and tennis balls.

Why do we spend so much on our dogs? It is tough to put a price tag on the intangible benefits we receive from Fido’s unconditional love. So although we may spend hundreds or thousands of dollars on our furry friend, in the end having a well-adjusted pet is priceless.

Disclaimer: Just a dog lover’s two-bits. Estimated costs based on a toy-size dog.

Canadian Capitalist is graciously hosting the third Canadian Tour of Personal Finance Blogs. There is no way I am passing up this opportunity to be mentioned in his blog. This will be my second participation to this tour. Enjoy!

Organizing your portfolio into neatly divided asset classes appears to be the sensible thing to do, but what if your financial advisor is offering you only a half-baked solution? Take my friend, Mel, for example. He and his wife walked in to a bank seeking an optimal way to invest a $10,000 windfall. The advisor had them fill out a Know Your Client form to learn their financial goals, risk tolerance, investment knowledge, time horizon and financial position. Based on his assessment, the advisor recommended a 70/30 split between equity and bond funds commanding a hefty 2% in management expense ratio (MER.)

What’s wrong with this picture? Like typical young couples, Mel and his wife still owe an approximate $200,000 worth of mortgage. Since homeowners pay mortgage interests with after-tax money, a 5% mortgage rate is costing Mel 7.14% of pre-tax income - assuming he’s in the 30% tax bracket. None of these bond funds could have guaranteed that rate, especially after MER. Why lend his money to a bond fund, only to borrow it back in his mortgage at a higher rate? He may as well pay down the mortgage instead of buying bonds.

The problem with the financial industry is that it’s not in their best interest if you pay down your mortgage. It’s a double-whammy for them:

• They stop collecting mortgage interests from you.
• They stop collecting MER on the bond fund.

A better solution – in my opinion – is to reduce the scope of your portfolio. Instead of investing $3,000 in bonds, pay that toward the mortgage. A dollar saved is a dollar earned. Paying down your mortgage is equivalent to earning 7.14% guaranteed. The net result is a reduced $7,000 portfolio invested 100% into equities. Sounds scary at first, but simply imagine the other $3,000 is invested in your mortgage. 7.14% guaranteed is a yield on steroid, that no one else can match.

SearchRank recently wrote the 10 Signs That You May Be a Blog Addict. I think I may be in trouble. At the moment, it is a bit of an addiction to me, but I’m sure I’ll get over this a few months down the road. I hope.

Here are some of my favourites on the list:

• In order for your family to keep up with what’s going on in your life, they have to read your blog. Furthermore, if they want to communicate with you, they have to comment on your blog.
• You have actually considered setting up a blog for your pet of which you would post the entries pretending you are your pet (weirdo).
• You can’t remember dates for your wedding anniversary, kids birthdays, etc., but you know what your Technorati rank is.
• You tell customers that you missed a project deadline because “some things” came up but in reality, you were blogging.