He’s got the largest TFSA …but did the investment qualify?

The Financial Post believes they’ve found the individual with the largest TFSA account in Canada.
The article describes how the individual has an amazing $172,382 in his TFSA account.

The problem is, did this investment qualify for inclusion in the TFSA?

The financial planner in the article, purchased the penny stock Fannie Mae (FNMA) (OTCBB).

As per the CRA bulletin, ‘Prescribed Stock Exchanges In and Outside Canada’, this over-the-counter (OTC) security is not a qualified investment for a TFSA.

Should the Canada Revenue Agency (CRA) penalize him?

I’m no tax expert, but yes, I believe the rule has been broken.

Originally, I thought that the penalty would be to pay 1% of the market value of that investment for each of the three months (March 2013 – May 2013) that he held the security in his TFSA. However, a couple of readers have corrected me on this point. The 1% figure is the penalty for over contributions.

The actual penalty could be 50% of the fair market value of the property.

The financial planner in this article probably didn’t realize he had broken the rule. He should contact the CRA for clarification and pay any resulting penalty.

Update June 18, 2013 9:00 pm
Kudos to the Financial Post for updating their online article with the possible CRA implications.
The article now states that the Canada Revenue Agency has been contacted by the Financial Post.

CRA bulletins are often incomplete and subject to misinterpretation.
Here’s hoping that this gentleman gets a favourable CRA ruling and gets to keep the gains from his shrewd stock picking.

Update June 19, 2013 11:00 pm
The Financial Post updated the article with a quote from the CRA media representative in which she added, “since Fannie Mae is also listed on designated exchange, Mr. Hirani is allowed to hold it in his TFSA.”

Update June 21, 2013
The article was again updated. It sounds like the previous CRA statement was “somewhat” retracted. In it’s place is the following statement from the CRA.
“Given the wide variety of investments that exist, the CRA does not make determinations as to whether a particular investment is a qualified investment except in the context of an advance income tax ruling or audit.”
Although, they wouldn’t confirm this particular transaction, the CRA did provide the following general comments.
“Only the official market (i.e. regulated Stuttgart Stock Exchange) is considered a designated stock exchange for Canadian tax purposes. The unofficial market (i.e. the unregulated portion of the regulated Stuttgart Stock Exchange) does not qualify.”

Assuming this particular security was on the regulated side of the Stuttgart Stock Exchange, I would assume Mr. Hirani’s winnings are safe.

The story has also added a quote from Mr. Hirani, if the CRA ultimately claims the investment ineligible. He states, “He got approval from his bank before making the trade.”

Canadian Brokerages – Options Commissions

The June 2013 issue of MoneySense magazine looked at Canada’s Best Discount Brokerages.

MoneySense partnered with Surviscor to look at the Canadian Discount Brokers.
It compared the brokerages, in a chart, on several categories, including stock commissions and option commissions.

In their chart of the 14 brokerages, 12 brokerages tied for the ‘lowest’ option commissions at around $9.95+$1.25 per contract.

My disappointment? They forgot, or chose to ignore a 15th entry, Interactive Brokers Canada (IB). Interactive Brokers has always offered Canadians the best options pricing at $0.70 per contract.

Wow, no other Canadian brokerage is even close.
For example, 5 equity option contracts would cost:
Iteractive Brokers (IB) = $ 3.50
Canadian Banks = $ 16.20

Those 14 brokerages seem quite content in having the same non-competitive options commissions at $9.95+$1.25 per contract. They don’t seem worried about people discovering, or going over to IB.

No, this isn’t a paid advertisement post. The main reason that I use IB is for the cheap fees in executing the options portion of my non-registered portfolio.

I just don’t understand why IB always seems to be ignored as a viable candidate to hold your non-registered portfolio. If you are an options trader, I feel there is no better choice in Canada.

How to successfully bid on Priceline Hotels

My wife and I just completed a vacation of several southern US cities. The biggest travel cost that you incur is accommodation.

I decided to use Priceline to book our hotels for this vacation. I’m glad I did.
I believe Priceline offers tremendous savings over other booking websites (like Expedia, hotels.com, etc.)

Our hotel needs were fairly simple. Typically we don’t spend a lot of time in our hotel room. Instead, the majority of our time is spent sightseeing. A 3 star or 2.5 star hotel suits our needs. Luxury amenities, such as a hotel spa are not necessary. We’re just looking for a clean, reputable hotel for a night of sleep. Those that prefer a 4 star or luxury resort shouldn’t shy away from Priceline. The savings for these upper end properties can be significant.

You shouldn’t use Priceline if:
1. You want a particular property or want to utilize your loyalty program.
For example, you are fond of Hilton properties and only want to stay there.
2. You want an exact geographic location.
For example, you only want to stay in the city’s downtown core.

If you aren’t too picky, and want to save money, then continue with Priceline.

Three pricing models
Priceline offers three levels of pricing, as shown in the following screen tabs.
Priceline Hotel Savings - Name Your Own Price

1. List View

The results of your initial search criteria is shown in the list view. Here the exact hotel property and price is shown. If you see something that you like in this list, go ahead and book it.

But, I think we can do better. 🙂

2. Express Deals

There are some great deals here. My guess is that these are hotels that are trying to fill significant vacancies in the next few days. (i.e. last minute)

The problem that many people have with this model is that you don’t know what hotel you are getting. It only lists the geographic area. For example, “3 star, East End City”. The name of the hotel and exact location is only revealed to you once you’ve confirmed your intention to book, by submitting your credit card number.

I have utilized Express Deals when I failed in my use of the ‘Name Your Own Price’ option.

3. Name Your Own Price

Finally, here’s my favorite option: bidding on your hotel room. This option presents the most potential savings. Priceline states that you can save 60% here. Based on my experience, I would agree with that statement. However, you’ve got to do a little work with this option. Priceline only allows you to bid once in a 24 hour period. But they do allow you to make multiple bids, as long as you alter your accommodation criteria.

Here’s a step-by-step example of how I make a successful bid.

1. Search criteria

Enter your search criteria and select “search hotels now!”
In this example, I’m looking at San Antonio hotels for an upcoming Sunday night.
Priceline Hotel Savings - Search Criteria

The List View is displayed showing you the search results.
This gives you an idea of the costs of the hotels that you are looking for.

2. Express Deals Map

Click on the ‘Express Deals’ tab. Once again a list of prices is presented. Scanning the list, you’ll get a feel for the costs of certain star properties in a particular geographic zone.

Next, I click on the ‘Show Map View’ icon.
Priceline Hotel Savings - Express Deals - Map View

Now it’s time to make some Notes.
a) On a piece of paper, identify those geographic areas that you are willing to stay in, and rank them in order of preference. I noted that I only wanted to stay in the 6 zones closest to downtown and southeast in San Antonio.Priceline Hotel Savings - Geographic zones

b) Click on each of your preferred geographical zones on the map.
Here you will note the lowest Express Deal price, for your star rating, in each zone.
For example, in the screen shot below, I can see that a 3 star hotel in the downtown San Antonio Riverwalk area is $69.
Priceline Hotel Savings - Express Deal Zones - Best Price

3. Make several Bids

Here comes the part where you set your parameters and make some guesses. Sometimes you’ll get a deal that is much lower than the ‘Express Deal’. Sometimes, it will be close to the ‘Express Deal’ price. In my example, there is a 3 star hotel in one of my selected geographic locations, that can ‘be had’ for $69, using the ‘Express Deals’.

Now ask yourself the following questions:
What is the highest price that I’m willing to pay for a 3 star hotel? I’ll say $60.
What is the lowest price that you think this property can ‘be had’ for? I’ll guess $40.

Priceline Hotel Savings - Minimum price for star rating and zone.There’s a hint on how to determine the lowest possible price. In the ‘Name Your Own Price’ panel, enter a ridiculous low number. In this screen shot, I’ve entered $25. When I tab away from the field, a red message is displayed indicating, “Based on recent data, your price only has a small chance of being accepted”. Keep increasing this number and tabbing away from the field, until the red message disappears. This will give you an indication of the minimum price.

Now it’s time to submit your first bid.

The plan here is to slowly increment our bid, until we hit that ‘sweet spot’ where Priceline will accept our bid, at the cheapest price.

In my example, I can make 6 different bids, running through 6 geographic zones.
We’ll increase our bid $4, for each bid iteration (i.e. 60 minus 40, divided by 5 incremental bids)

Bid #1. Select 3 star hotels. Select your favorite geographic zone. Enter a bid of $40. If the bid fails, move on to Bid #2.
Bid #2. Select your 2nd favorite geographic zone. Enter a bid of $44 (i.e. 40 + 4)
Bid #3. Select your 3rd favorite geographic zone. Enter a bid of $48.
etc…

Usually this method is successful. But, even if my six bids fail, I still have other options. I can switch and bid on another star level. For example, I can go ahead and try the same above bidding process for 2.5 star hotels. Alternatively, I can also simply go back and accept an earlier ‘Express Deal’.

Conclusion

In almost every case, I was successful with my bidding procedure.
I know that in a few instances, I have saved well over 60%.
I feel this small amount of work was well worth the hundreds of dollars that I saved over the course of my vacation.

Best Canadian REITs

[Last update: Feb 2013]
Real Estate Investment Trusts, with their nice income yields, continue to be popular with investors. Avrex Money has compiled and ranked a complete list of all the Canadian REITs on the Toronto stock exchange (TSX).

Avrex Price/ Payout
Rank Company Ticker Yield AFFO Ratio REIT Sector
1 Artis REIT AX.UN 6.82% 14.66 91.7 Diversified I (Off/Ind/Ret)
2 Morguard Real Estate Inv Trust MRT.UN 5.09% 19.53 81.7 Commercial
3 First Asset Canadian REIT RIT.UN 4.67% 26.8 Fund
4 Northwest Healthcare Prop REIT NWH.UN 6.04% 16.56 94.5 Retire/Health
5 Retrocom Mid-Market REIT RMM.UN 8.17% 12.24 117.5 Retail
6 Cominar REIT CUF.UN 6.29% 15.74 93.0 Diversified I (Off/Ind/Ret)
7 Dundee International REIT DI.UN 6.93% 13.89 96.4 Commercial
8 Dundee REIT D.UN 5.81% 17.03 92.1 Office
9 Partners REIT PAR.UN 8.10% 12.34 106.0 Retail
10 Boardwalk REIT BEI.UN 3.00% 33.64 71.3 Residential
11 BTB REIT BTB.UN 8.61% 27.4 Diversified I (Off/Ind/Ret)
12 Primaris Retail REIT PMZ.UN 4.67% 21.79 93.9 Retail
13 Timbercreek Global Real Estate TGF.UN 6.41% 44.6 Fund
14 Calloway REIT CWT.UN 5.34% 18.68 89.8 Retail
15 Brookfield Canada Office Prop. BOX.UN 4.00% 24.71 92.9 Office
16 H&R Real Estate Invest. Trust HR.UN 5.90% 16.90 90.0 Diversified I (Off/Ind/Ret)
17 Pure Industrial Real Estate AAR.UN 5.94% 16.92 84.3 Industrial
18 Northern Property REIT NPR.UN 4.82% 20.49 77.5 Residential
19 RioCan Real Estate Investment REI.UN 5.14% 19.63 97.6 Diversified II (Office/Retail)
20 Allied Properties REIT AP.UN 3.88% 25.83 82.9 Office
21 Canadian Apartment Property (CAP REIT) CAR.UN 4.26% 22.55 85.1 Residential
22 REIT INDEXPLUS Income Fund IDR.UN 6.56% Fund
23 Crombie REIT CRR.UN 6.05% 16.53 98.6 Diversified II (Office/Retail)
24 InterRent REIT IIP.UN 2.60% 37.33 54.2 Residential
25 Cdn. Real Estate Investment REF.UN 3.30% 29.61 63.1 Diversified I (Off/Ind/Ret)
26 Chartwell Retirement Residence CSH.UN 4.98% 20.03 76.2 Retire/Health
27 Morguard Sunstone Real Estate MSN.UN 5.52% 178.1 Fund
28 InnVest REIT INN.UN 9.28% 51.2 Hospitality
29 Temple Hotels TPH 8.38% 86.0 Hospitality
30 KEYreit KRE.UN 9.01% 239.5 Retail
n/a Loblaw’s Choice Properties REIT CHP-UN Retail
n/a Agellan Commercial REIT ACR.UN Diversified I (Off/Ind/Ret)
n/a American Hotel Income Properties REIT LP HOT.UN Hospitality
n/a Canadian REIT Income Fund RIU.UN 4.81% Fund
n/a Connor Clark & Lunn Real Ret RRB.UN Fund
n/a Dundee Industrial REIT DIR.UN 6.08% Industrial
n/a HealthLease Properties REIT HLP.UN 7.71% Retire/Health
n/a Holloway Lodging REIT HLR.UN Hospitality
n/a Huntingdon Capital HNT Diversified I (Off/Ind/Ret)
n/a Lanesborough REIT LRT.UN Residential
n/a Middlefield Can-Global REIT RCO.UN 6.37% Fund
n/a Morguard North American REIT MRG.UN 5.13% Residential
n/a N.W. Intl Healthcare Prop.REIT MOB.UN-X 7.44% Retire/Health
n/a North American REIT NRF.UN 6.19% Fund
n/a Pure Multi-Family REIT LP RUF.U-X 7.11% Residential
n/a True North Apartment REIT TN.UN-X 7.08% Residential
n/a US Agency Mortgage-Backed REIT USM.UN Fund

Avrex Rank – Is derived based on several valuation metrics. For illustration purposes, only two of those metrics are listed in the table above. A rank of ‘n/a’ indicates that there is insufficient data for a ranking.
P/AFFO – Price per ‘Adjusted Funds From Operation’. A lower number is better for this valuation metric.
Payout Ratio – Expressed as a percentage. A lower number ‘could’ indicate a safer distribution payout.

Asset Allocation

As an individual investor, where do REITs fit within your portfolio?

The Avrex Money portfolio has 6 % invested in REITs. This consists of owning individual REITs as well as owning the following REIT Index ETFs for further diversification:

By way of comparison, large pension funds hold 9 % of their assets in real estate. Considering that many individual investors also have real estate, in the form of home ownership, I feel that the 6 % allocation to REITs is adequate.

Since REITs are not highly correlated to the movement of equities, they provide effective diversification within your portfolio. REITs are great long-term holdings in your retirement account.

[Disclaimer: The above rankings are opinions only and should not be considered investing advice. Perform your own due diligence. Contact a professional before making any investing decisions.]

Can I achieve early retirement?

We’re running in a rat-race. While there’s still a long way to go, we can see financial independence on the horizon. Many of us don’t want to work until we’re 65 years old.
We want the race to end earlier. Perhaps at age 55. Perhaps sooner.

We want to achieve financial freedom!

Financial Freedom before 65. Retire Early Retirement.

Are you doing all that you can do, in order to cross the finish line earlier?
Here are 4 things that you should consider to achieve your goal.

Income

Have you maximized your earning potential? Are there other career opportunities that you’ve been thinking of pursuing, but haven’t yet?

Savings

“Live Beneath Your Means” (LBYM)
Don’t try “Keeping up with the Joneses”
Those are two ways of phrasing the fact that you need to save money. If you want a chance at early retirement, you need to start doing this.

“But, I don’t want to be a hermit and live in poverty.”
You shouldn’t have to. Set up an automatic payment plan, whereby 10% of your paycheck is automatically deposited into an investment account. (If you still have debt, direct that 10% towards paying off your debts first. Once it’s paid off, redirect the 10% towards the investment account.) You may think that you need that 10% to live your life, but you don’t. You will learn to live without that 10%. You won’t miss it.

You can live happily in a more frugal lifestyle.
Don’t just sit there. Set up that automatic payment plan now!

Do-It-Yourself (DIY) Investing

Take an interest in your personal finances.
Remember. No one cares as much about your money as you do.

Avoid high fee Mutual Funds. Instead, purchase passive index, low fee ETFs.
I wrote a post in which I stated that the high MER fees of mutual funds can ‘steal’ 3 years of your retirement away from you. That’s a conservative estimate. Some studies estimate that you could retire 10 years earlier.

Become a Do-It-Yourself (DIY) Investor and save a huge amount of money.

Asset Allocation – Yes, you need Equities

A proper asset allocation for your risk tolerance will allow you to achieve your goals sooner.
Determine your personal asset allocation and execute your plan. For example, if you determine that your age and risk tolerance allows you to be 70% invested in equities, then ensure that you are fully invested in that amount.

Since the market crash of 2008, investors have been scared of equity markets. A fair chunk of their money has been sitting on the sidelines, in cash, avoiding the stock markets. If you want to retire early, you can’t be too conservative. Over the years, inflation and the ‘Cost of Living’ will silently eat away at your nest egg. You need to have your money working for you. If you want a chance at early financial freedom, then you’ll need to have a significant percentage of your portfolio in equities.

Don’t worry about things that you can’t control.
There is one item that you can’t control. Investment returns. This is the ‘luck’ factor.
The market will be ‘up’ in some years and ‘down’ some other years. This factor is completely out of your control. These investment returns will partially dictate where the finish line ends up for you. You can’t worry about this factor.

Instead, worry about what you can control. Pursue those factors that will allow you to reach the finish line sooner.

Financial independence and early retirement await you. Take action today.

Four US Stock Picks for 2013

Since a portion of my portfolio is active stock selections, I thought it might be fun to compare the stock selections, that I’ve been investigating, against other investors.
Financial Uproar has included me in his annual stock picking contest.

Now because we are following the returns of only four stocks over the course of a year, the results are subject to a good portion of luck. I like these contests as an educational exercise. Looking at the stock selections of others, can give an investor ideas that he may wish to investigate further.

I’ve decided to select four stocks that I hope will have strong price appreciation (growth) over the coming year. There’s hardly any dividend here to speak of.

For a contest such as this, the preference might be to select small, penny stocks, in the hopes of getting quick gains. However, I’ll make selections, using a similar manner as I would in my ‘real’ portfolio. My selections are all large cap stocks. In fact, three of the stocks are in the S&P 500 index. When the year is over, I’ll compare my results to the benchmark S&P 500, to see how I did.

Here are my 2013 stock selections.

Jabil Circuit Inc. (JBL)

– Well diversified technology company. Profits come from many divisions (including one that manufactures aluminum casing for the Apple iPhone)
– EPS growth over the past five years is almost 40%.
– Great forward looking PEG ratio.
– P/S is a miniscule 0.22

Joy Global, Inc. (JOY)

– Undervalued Industrial goods company, with a P/E of under 9.
– High increased sales quarter-to-quarter.
– Good return on Assets

Laboratory Corp. of America (LH)

– Low Price/Free Cash Flow for this medical lab company.
– At low end of it’s historical P/E range.
– Contrarian pick. Analysts hate this stock. Therefore, I like it to surprise on the upside.

Tempur Pedic International Inc. (TPX)

– High-end bedding market. Suffered large price drop in spring 2012. Price should recover.
– Waiting for Federal Trade Commission (FTC) to approve the purchase of Sealy Corporation. This could give them pricing advantages.
– Low Price/Free Cash Flow.
– Good return on Assets.

[Disclosure: The author may own securities mentioned in this post. Perform your own due diligence before investing.]

Canadian REITs – The Vanguard REIT ETF brings cost relief

In Canada, our REIT ETF choices have been limited.

The iShares REIT product is ‘the gorilla’ in this arena with Assets under management (AUM) of approximately 1.4 billion dollars. The younger BMO REIT ETF has been steadily growing, but only has about a quarter of the assets that the iShares product has.

These two companies had better look in the rear-view mirror, because Vanguard Canada now has a REIT ETF that is very enticing.

Why? The cost. This ETF has a Management Expense Ratios (MER) of only 0.35 %

Canadian REIT ETF Symbol MER Yield
Vanguard FTSE Canadian Capped REIT Index ETF VRE 0.35% t.b.a.
BMO Equal Weight REITs Index ETF ZRE 0.55% 5.41%
iShares S&P/TSX Capped REIT Index Fund XRE 0.60% 4.58%


In the past, some investors have scoffed at the price (0.60%) of the REIT ETFs and have ventured alone, selecting two or three individual company REITS to add to their portfolio. However, most investors would be better served by purchasing a REIT ETF, to provide better diversification of REIT companies.

Conclusion

The Cost advantage cannot be ignored.
The Vanguard REIT ETF started trading in Nov 2012. This ETF will gain a larger slice of the Canadian REIT ETF market, as investors discover the cost advantages of this product.

Individual REIT companies

For those investors interested in digging further, check out this link for a complete list of all the Canadian REITs on the TMX stock exchange.

The table below shows the percentage breakdown of each individual REIT that is held within each ETF. It is interesting to see how each ETF methodology weighs the individual REITs.

  Vanguard BMO iShares  
Company Ticker VRE* ZRE XRE Yield
RioCan Real Estate Investment REI.UN 16.3% 5.5% 20.7% 5.12%
H&R Real Estate Invest. Trust HR.UN 9.4% 5.3% 11.6% 5.38%
Dundee REIT D.UN 7.2% 5.3% 9.2% 6.08%
Calloway REIT CWT.UN 6.2% 5.5% 7.3% 5.48%
Boardwalk REIT BEI.UN 6.2% 5.8% 6.5% 2.98%
Brookfield Canada Office Prop. BOX.UN 12.7% 6.0%   3.94%
Cominar REIT CUF.UN 5.6% 5.0% 6.6% 6.56%
Canadian REIT Income Fund RIU.UN 5.9% 5.6%   4.98%
Cdn Apartment Prop REIT CAR.UN 5.1% 5.5% 5.9% 4.68%
Primaris Retail REIT PMZ.UN 5.2% 5.4% 5.4% 5.32%
Cdn. Real Estate Investment REF.UN     7.3% 3.58%
Allied Properties REIT AP.UN 4.0% 5.9% 4.9% 4.22%
Chartwell Seniors Housing REIT CSH.UN 3.7% 6.1% 4.6% 5.24%
Artis REIT AX.UN 3.4% 5.3% 4.6% 6.90%
Crombie REIT CRR.UN   5.6% 2.0% 5.99%
Northern Property REIT NPR.UN   5.1% 2.6% 4.98%
Morguard North American REIT MRG.UN   6.0%   5.45%
Dundee International REIT DI.UN   5.7%   7.48%
InnVest REIT INN.UN 0.8% 5.1%   9.24%
Morguard Real Estate Inv Trust MRT.UN 1.7%     5.31%
First Capital Realty Inc.   3.1%      
FirstService Corp.   1.6%      
Extendicare Inc. (US)   1.3%      
Melcor Developments Ltd.   0.4%      

[Update Dec 06, 2012: There was a buyout offer for Primaris.]

Are you invested in Mutual funds? Congratulations, you’ll now be working an additional 3 years.

[November is “Financial Literacy month”. Bloggers are participating in the “Blog for Financial Literacy” campaign by sharing their ‘best financial tip’ with their readers.]

Many investors don’t realize it, but the high Management Expense Ratios (MER) of Mutual Funds are slowly eroding their personal life savings.

Let’s compare the characteristics of the two main investment vehicles that most investors utilize. Exchange-traded Funds (ETF) versus Mutual Funds.

Exchange-traded Funds (ETF) Mutual Funds
MER fees low cost high cost
Investing style passive index based active stock selection
Assets under Management* $49 billion $773 billion (94%)

* according to the Canadian ETF Association

1. ETFs are low-cost. Mutual Funds are high-cost.

Of course there are exceptions to this. For example, we are now seeing specialized ETFs. These niche ETFs with their higher associated costs are really not suitable for most investors. Investors should stick with core ETF holdings. In the mutual fund world, there are some low-fee exceptions. I’m thinking here of TD Waterhouse’s excellent TD e-Series Funds. These low cost index funds are great for investors, with smaller portfolios, who are just starting out.

But, those are the exceptions. In general, mutual fund fees are too high.
In fact, a Morningstar report shows the following average costs for Mutual Funds.

  Canadian Equity 2.3% MER
  Canadian Fixed Income 1.3% MER

2. Investment style

Typically, mutual funds are run by a management team that makes active stock selections, in an attempt to beat the returns of an index. Several studies have shown that over the long-term, active management returns will not beat the returns of the benchmark index. The MERs are a constant drag on the manager’s performance.

As an investor, you would be considered lucky if you selected an equity fund manager who consistently exceeded the index by 2.3% (the MER fee) year after year. These studies conclude that investors would be better off investing in funds that track the index itself and save on the high cost of MER fees.

3. Assets Under Management

Wow, only 6% of these assets are invested in ETFs. The rest are in mutual funds.
Although sales in ETFs are accelerating, as more investors are learning about their benefits, the move to ETFs is not happening quick enough.

Why do the other 94% of investors continue to pay the high MER fees of mutual funds?

I see two reasons for this.

1. Hidden MER fees.

Are the 94% of investors that hold mutual funds just dumb? No.
The MER fees of mutual funds have always been somewhat hidden from the client.
For example, an investor looks at the year-end results of his equity mutual fund and sees that it went up 6.6% for the year. “That’s pretty good”, he thinks.

What he doesn’t realize is that the underlying securities that the fund is invested in, actually went up 8.9%. The remaining 2.3% was gobbled up by MER costs. Many investors simply are not aware of this hidden cost.

The Mutual Fund industry has no incentive to share this cost with you. The 2.3% MER is how they generate their profit. Your financial advisor, who sells you the mutual fund, has no incentive to share this cost with you. He may receive a front or deferred sales commission. He may also receive a 0.5% – 1.0% trailer fee for each year that you continue to hold the fund.

2. Fear. I’ll let the Experts handle it.

Even when investors are fully aware of the MER costs involved, there is another factor that is holding them back. Fear. For example, I’ve heard the following comment, “I know nothing about investing, so I’ll let the bank handle all of my investments. After all, they are the experts and they know what to do.”
There is an inherent cost in thinking like this.

There are MER fee calculators, like this one at GetSmarterAboutMoney.ca. The calculator illustrates how much of your total nest egg is lost to investment fees.


How much am I saving?
Yes, we want to be aware and quantify the amount of money that we can save.
But, I wanted to look at this from a different perspective. Time.
In other words, the money that we do save, brings us closer, in time, to the goal of financial independence.

In the next post (coming soon), you’ll see the calculation that looks at a sample case study, of an average Canadian couple, that is invested in mutual funds. Over their working lives, the couple paid off their mortgage and were excellent savers. In this scenario, they invested their savings in mutual funds and retired comfortably at the age of 64.

However, what if the couple had invested their savings in low-fee ETFs, instead of mutual funds. What would happen in this scenario?

The calculation shows that with ETFs, they would have gained 27% more money in their retirement nest egg.. That’s a lot of additional savings! Those types of savings go directly into your pocket and not towards your bank or mutual fund company.

How does this amount of savings relate to Time?

If the couple is saving 27% more money over the course of their working lives, then the calculation goes on to show that this couple could have retired at age 61, … 3 years sooner.

That’s right. These savings can literally take years off of your working lives.

Conclusion:

My Best Financial Tip.
If you want to save more money and retire sooner, avoid high MER fees.

Take action. Become a do-it-yourself (DIY) investor.
Do not let fear hold you back. It’s not that difficult. It’s not that time consuming.
Get rid of your high-cost mutual funds.
Set up a basic ETF portfolio, like the Easy ETF portfolio, or a Couch Potato portfolio.

Remember the benefit.
You’ll be able to retire much sooner!

Weekly Options – Tread carefully

[Update 2012-10-26: This trade was successful. The price of AMZN fell for most of the week, recovering on Friday, and finishing at 238.24. This was well below my strike price of 260. Result: I collected $969 in premium. :)]

Besides my regular portfolio of options, I will occasionally dabble into Weekly options. I don’t usually utilize a spread. By not capping one end of the price-profit chart, I have assumed the risk of unlimited losses.

My strategy for Weekly options is to always sell the option. (i.e. A Short Call)Options - Short Call - Price Profit Chart
I want to gain income/premium. The higher the implied volatility is, the better the payoff. The upcoming earnings announcement will pump up this volatility level even further.

Let’s look at a trade of a ‘weekly’ option that I executed today.

I sold short 3 AMZN weekly Oct 26 calls – strike 260 @ $3.23.

At the time of my trade, Amazon (AMZN) was 240.50. (It closed today at an ‘even’ 240.00) The implied volatility was 77%. Normally, this option, looking forward a month or two, would have a volatility of around 40%. Amazon reports earnings on Thurs Oct 25.

Here are some scenarios for this transaction.

1. The stock price stays below 260.
The 260 call option would be out-of-the-money and would expire worthless.
I would keep the $969 premium. (3 x 100 x 3.23).
In this scenario, the price rises no higher than 8.3% after earnings are announced.

What would happen if Amazon announces knock-them-out-of-the-park earnings?

2. The stock price jumps 9.7% to 263.23.
That happens to be the break-even point of this transaction (260 + 3.23).
I would lose the premium and the net result would be zero.

3. The stock price jumps 12.5% to 270.00.
I would lose $2,000 on this transaction.

4. The stock price jumps 16.6% to 280.00.
I would lose $5,000 on this transaction.
I would need 5 similar positive transactions to make up for this disaster scenario.

As you can see, this is very risky.

Why would I do this?
I believe that the probability of this stock finishing out-of-the-money is higher than the pricing action would indicate. i.e. I have a positive Expected Value (EV) for this trade. Likewise, I believe that the probability of the disaster scenarios happening, is far less than the pricing model indicates.

I wouldn’t recommend this ‘weekly options during earnings reports’ strategy to others. You might even be correct to call this gambling. However, I only do this occasionally. And I only do this on a small portion of my portfolio. I am comfortable with this level of risk.

Value Trap – Cut Your Stock Losses

How many of us have been caught in a “value trap”?

Prior to making stock selections, I pour over lots of fundamental variables.
I’m a value investor. I’m looking for undervalued stocks, or stocks that have fallen out of favour.

Back in 2011, I purchased Research in Motion (RIMM, RIM.TO), with the conviction that it had fallen too far and still held lots of value. However, the price of RIMM stock continued to fall. I suffered losses.

Stock Value Trap Ackbar
RIMM stock looks so cheap. It’s a Trap!

But just like Admiral Ackbar, I was able to recognize the “trap” and escape. I only held onto this stock for a few months, so the losses weren’t too bad.

Before you make a stock selection,

Research beyond the fundamentals.

– Has this company’s business changed?
– Are the company’s products still strong?
– Does this company have a moat? Is it still ahead of it’s competition?

In the case of RIMM, in hindsight, I should have realized that their products/services weren’t keeping up with the competition. I was only looking at the fundamental variables.

RIMM isn’t the only stock that I’ve fallen into a trap with.

Even if you’ve done your research, a stock can still languish for long periods of time.
The most important lesson that I’ve learned is,

“Cut your losses”

Sometimes Mr. Market doesn’t agree with you. A stock price can stay “undervalued” for quite a while. Don’t hold onto this stock forever. Sell the stock. Move on to another investment opportunity.

Eventually your research will pay off.