Happy Canada Day Everyone!

Regular programming resumes on Monday. Have a great, extra-long, weekend!

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Happy Canada Day is brought to you by Canadian Capitalist — Helping you to invest & prosper.

The Federal Government has decided against implementing a cash-for-clunkers program in Canada because car manufacturers were not willing to settle for anything that offered less than a $3,000 rebate. However, it turns out a little-known program called Retire Your Ride, funded by the Government of Canada, already offers modest cash incentives for scrapping a model year 1995 or earlier vehicle that is in running condition and has been registered and insured for at least 6 months. Depending on the province of residence, you could receive $300 in cash, discounts on commuter bicycles, transit passes and manufacturer rebates on new cars. British Columbia residents can receive an additional $750 to $1,250 on the purchase of a newer vehicle under the Scrap-It program.

It is not terribly surprising that the program does not seem to be very successful. The website notes that Retire Your Ride has so far taken 15,000 vehicles off the road out of the 4 million autos the Government says are 15 years or older. It is not hard to see the reason: the financial incentives are meager; probably less than what even a clunker can fetch in the used-car market. The success of the program thus depends on people doing the right thing when it comes to replacing their clunker. We all know how well that will work.

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The Retire Your Ride Program is brought to you by Canadian Capitalist — Helping you to invest & prosper.

Bouchard, who has had more than 70 professional golf victories over the past 20 years, says “The most important thing I teach in my lessons is that there is no one correct way to swing a club.” There are plenty of ways to get the ball in the hole, he says. “The most successful golfers combine intuition, discipline, sound fundamentals and expert advice.”

Abbott says these same attributes can be found in the portfolios of successful investors. “Most successful golfers adhere to a strategy comprised of shots they have practiced, combined with the occasional high risk, potentially high reward play,” he says.

A few tips that both men say are key for success in both golf and investing include having a game plan and sticking to it, seeking advice from experts, and staying within your comfort zone. Professional golfers will never try a shot in competition that they haven’t practiced, Bouchard says. Likewise, uncalculated and unnecessary risks are not advised when investing.

1. Save early and often
2. Get your asset allocation right
3. Diversify across and within asset classes
4. Keep your investing costs low
5. Avoid financial blunders

You can also find a transcript of the interview at the bottom of the page.

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Burton Malkiel and Charles Ellis Talk Investing is brought to you by Canadian Capitalist — Helping you to invest & prosper.

Both iShares and Claymore have announced that several of the their ETFs will start paying distributions monthly instead of quarterly. The announcements came within five days of each other earlier this month. It’s good to see the two biggest players in the ETF market pushing each other into improving their products.

Here are the ETFs that will begin paying monthly distributions starting in July:

Claymore Equal Weight Banc & Lifeco (CEW)
Claymore 1-5 Yr Laddered Government Bond (CLF)
Claymore 1-5 Yr Laddered Corporate Bond (CBO)
Claymore Advantaged Canadian Bond (CAB)
Claymore S&P/TSX CDN Preferred Share (CPD)
Claymore Balanced Income CorePortfolio (CBD)
Claymore Balanced Growth CorePortfolio (CBN)

iShares DEX All Corporate Bond (XCB)
iShares DEX Short Term Bond (XSB)
iShares DEX Universe Bond (XBB)
iShares DEX All Government Bond (XGB)
iShares DEX Long Term Bond (XLB)
iShares U.S. IG Corporate Bond (CAD-Hedged) (XIG)
iShares U.S. High Yield Bond (CAD-Hedged) (XHY)
iShares Dow Jones Canada Select Dividend (XDV)
iShares S&P/TSX Capped REIT (XRE)
iShares S&P/TSX Capped Financials (XFN)
iShares S&P/TSX Income Trust (XTR)

The press releases from both Claymore and iShares say they made this change because investment income is becoming more important to Canadians. It’s true that the new monthly schedule will improve cash flow for people who are drawing down their nest egg.

However, the new schedule may be a disadvantage for small investors who are trying to grow their portfolios with dividend reinvestment plans, DRIPs. (Many discount brokers offer this service with Canadian ETFs.) Because only full shares can be purchased with a DRIP, small investors may find that monthly distributions are smaller than the cost of a single share.

For example, suppose an ETF trading at $30 currently pays a quarterly distribution of about 1%. That would mean you’d need 100 shares in the fund — about $3,000 — to receive enough to purchase a single share with a DRIP. When the fund switches to a monthly distributions, each payout will fall to 0.33%. That means investors will need to hold about $9,000 in the fund to receive a distribution large enough to buy one share. Anyone holding less than that will receive all of their distributions in cash.

Filed under: ETFs

The Government is indicating that taxpayers whose net TFSA contributions never exceeded $5,000 can expect a penalty waiver. The excess TFSA amount penalties incurred by taxpayers who used their TFSA as a savings account and made frequent deposits and withdrawals and / or transferred their TFSA account from one bank to another by withdrawing from one and contributing to the other will be considered to be a result of reasonable error. It is not clear if taxpayers whose net TFSA contributions exceeded $5,000 are also deemed to have been genuinely confused about TFSA rules.

One wishes the financial institutions which were so eager to sign up as many TFSA accounts as possible had been a little more proactive in catching TFSA excess amount errors and warning clients that they might be running afoul of TFSA contribution rules. I wonder how many banks still have no warnings of any sort when a client tries to make a contribution to a TFSA account. When I opened an account with Ally Bank early this year, they refused to accept an initial contribution over $5,000. However, when I tried to contribute another $1.00 to my TFSA account, there were no warnings or cautions of any sort. Is it any wonder that so many Canadians have inadvertently “over contributed” to their TFSA accounts?

You can find the press release here.

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Government Waives Some TFSA Penalties is brought to you by Canadian Capitalist — Helping you to invest & prosper.

This week I got an email from a reader who is in the process of firing her advisor and becoming a Couch Potato. “I have decided it’s time to take matters into my own hands,” wrote Sarah. “I have $25,000 in mutual funds in my RRSP with my current adviser. I want to create a Couch Potato portfolio with ETFs, but I’m a little intimidated. I don’t even know how to set up a brokerage account.”

I surprised Sarah with my response: I suggested that she not open a discount brokerage account, and that she forget about ETFs for now. That’s because $25,000 is not enough to make ETFs efficient—index mutual funds are a much better option. The trading commissions Sarah would pay to buy and sell ETFs would outweigh the benefit of the lower annual fees. In fact, index mutual funds beat ETFs for most small portfolios.

I recently wrote an article in MoneySense about this issue, but I wasn’t able to go into detail about the math. Doing the calculations is important, though: choosing the wrong option can cost you a lot of money. If you’re considering your first Couch Potato portfolio and you’re not sure whether to use index funds or ETFs, here’s how to figure it out:

1. Determine the total MER of each portfolio option.

In general, ETFs have lower annual fees than index mutual funds, but the gap isn’t necessarily large, especially if you’re comparing ETFs to TD’s e-Series mutual funds. To determine the total MER of a portfolio, multiply the annual fee of each individual fund by the percentage you’ve allocated to that fund, then add them all up. For example, here are the calculations for two versions of the Global Couch Potato portfolio:

If you’re investing in only these four asset classes, the MERs are not dramatically different. The iShares version has an edge of just 0.13%.

2. Multiply the total MER by the value of your portfolio.

This step will determine your annual cost in dollar terms. We’ll use Sarah’s $25,000 portfolio value to make the comparison:

$25,000 × 0.45% with TD e-Series Funds = $112.50
$25,000 × 0.32% with iShares ETFs = $80

Turns out the difference in MERs works out to only $32.50 a year on Sarah’s portfolio. Fractions of a percent don’t add up to much in small portfolios. Had Sarah been investing $200,000, the difference between the two options would have been $260 a year and more of a concern.

3. Determine how many ETF trades you’d make annually.

At a minimum, count on making one trade per ETF each year. (If you make an annual lump-sum contribution and rebalance the portfolio at the same time, that’s as efficient as you can get.) Multiply the number of trades by the commission charged by your brokerage. For example:

4 trades with big-bank brokerage at $28.95 = $115.80
4 trades with low-cost brokerage at $9.95 = $39.80

4. Add the cost of the MER and the cost of the trades.

You need to consider both the annual MER and the trading commissions to determine the overall cost of your portfolio. Let’s compare the different versions of the Global Couch Potato portfolio at $25,000:

You’ll notice that for a $25,000 account, the total cost of maintaining the portfolio is less with the TD e-Series funds, despite the lower management fees of the ETFs. It’s a lot lower compared with the $28.95 trades, and even a few bucks less with super-cheap $9.95 trades.

5. Find the break-even point for the two options.

As your portfolio grows in size, the dollar cost of the MER goes up, but the cost of trades remains the same. That’s why ETFs are more cost-efficient in large portfolios. The trick is to find the break-even point. If your portfolio is more the break-even point, use the ETFs. If it’s lower, use the index mutual funds.

Here’s an illustration that assumes you’re comparing an ETF portfolio with a total MER that  is half that of comparable mutual funds, and that you’re making eight trades per year. In this case, let’s use a portfolio value of $75,000:

When comparing index funds with ETFs at a big-bank brokerage, $75,000 turns out to be the break-even point: the price difference between the two options is less than $7. (With the low-cost brokerage option, the break-even point is about $27,000, at which point the annual cost of the ETFs and index funds in this example is about $161.)

Keep the cost differences in perspective: in the above example, the low-cost brokerage would save you about $145 over the mutual funds, or 0.19% of a $75,000 portfolio. Those small savings come at the cost of flexibility: you can’t make monthly contributions with ETFs (unless you use Claymore’s PACC plan), and your dividends sit in cash until your annual rebalancing date.

While ETFs dominate almost every discussion of index investing (I’m guilty here, too), the fact is they are not cost-efficient for small portfolios. In Sarah’s case, at $28.95 per trade, her portfolio would have to be $86,000 before iShares ETFs were less expensive than TD e-Series Funds (assuming four trades per year). At $9.95 per trade, she would need only $35,000 to make ETFs cheaper. However, she would also be unable to make monthly contributions to each fund, something she does with her current RRSP.

There’s another factor to consider here: Sarah was nervous about even opening a discount brokerage account. With an ETF portfolio, she would need to be comfortable making her own trades, which is intimidating for many inexperienced investors. A couple of errors when entering orders would instantly wipe out any potential cost advantage of ETFs. And when investing makes you nervous, you’re liable to abandon your strategy, which is just about the worst thing you can do as a Couch Potato.

Filed under: Couch Potato basics, ETFs, Index funds

Well, don’t be too gullible, says Canadian Business’ Larry MacDonald. (Actually, he says, “don’t be too trusting,” but let’s not split hairs.)

Besides decreasing take-home pay, MacDonald’s main concern lies with the simple fact that the CPP is government-run, and government programs are often inefficient, with more attention paid to political objectives than to maximizing return on investments. You don’t say?