All posts by Financial Independence Hub

Define “Bubble”

Posted By Financial Independence Hub | February 19, 2020

By John De Goey, CFP, CIM

Special to the Financial Independence Hub

The word “bubble” is bandied about often to explain quick and often unwarranted run-ups in securities prices. If you use the word in that context in a general conversation about economics, most people will have a quick, intuitive understanding of what you’re talking about.

Interestingly, two of the most prominent financial economists have radically different definitions of the term. In fact, one of them goes so far as to suggest that the word “bubble” is itself a misnomer that is all but meaningless.

A half dozen years ago, Professors Robert Shiller of Yale and Eugene Fama of the University of Chicago shared the Nobel for their contributions to the understanding of asset pricing. Many people have since speculated that the people in Stockholm who award the prize chose to give it to the two men concurrently in order to avoid implicitly “taking a side” in the debate about what constitutes bubbles. While I respect and admire both men immensely, you need to understand that they are rivals of sorts. The Nobel people likely wanted to recognize both without getting involved in a political and sometimes dogmatic battle of wits.

For about a generation now, I’ve been using products based on Fama’s research as the primary set of core holdings for my clients. Based on a recent conversation with one of that company’s representatives, that’s about to change. Basically, the company threatened to stop working with me simply because I told them I was inclined to subscribe to Shiller’s definition of a bubble.

Irrational exuberance

I’m currently reading the third edition (2014) of Shiller’s groundbreaking book “Irrational Exuberance.” He gets straight to the point. In the preface, he writes:

Maybe the word bubble is used too carelessly. Eugene Fama certainly thinks so. Fama, the most important proponent of the “efficient markets hypothesis,” denies that speculative bubbles exist. In his 2014 Nobel lecture, Fama states that the word bubble refers to “an irrational strong price increase that implies a predictable strong decline.” If that is what bubble means, and if predictable means that we can specify the date when a bubble bursts, then I agree with him that there may be little solid evidence that bubbles exist. But that is not my definition of a bubble, for speculative markets are just not so predictable.

Obviously, it’s all fine and well for Shiller to say what a bubble isn’t, but it should be obvious that it behooves him to go on to offer what his own definition might be. He provides a concise explanation (definition?) in chapter 1:

Irrational exuberance is the psychological basis of a speculative bubble. I define a speculative bubble as a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, and, in the process, amplifies stories that might justify the price increase and brings in a larger and larger class of investors, who, despite doubts about the real value of the investment, are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement.

Basically, I agree with Shiller on both counts … that Fama’s point is fair if one’s definition implies predictability, but that Shiller’s point (and definition) is more practical. I certainly do believe that bubbles exist and I make absolutely no claim to be able to predict anything about when, how or why they will burst. Continue Reading…

A timeless investment lesson learned from coronavirus

Posted By Financial Independence Hub | February 18, 2020

LowrieFinancial.ca/unsplash

By Steve Lowrie, CFA

Special to the Financial Independence Hub

The term “novel coronavirus” is almost as new as the year itself. And yet, how quickly it has grabbed global headlines. As depicted in this 2018 timeline of media-inflamed fears, there’s nothing like a global epidemic to occupy the media’s attention. On the plus side, dramatic coverage can spur dramatic cures. But whenever this sort of viral news spreads, so too does financial uncertainty. Investors are left wondering whether they should try to dodge markets that have been exposed.

Our advice is simple: Don’t let the breaking news directly impact your investment stamina. If you’re already following an evidence-based investment strategy …

You’ve already got a globally diversified investment portfolio.
It’s already structured to capture a measure of the market’s expected long-term returns.
You’ve already accepted (at least in theory!) that tolerating a measure of this sort of risk is essential if you’d like to actually earn those expected long-term returns.
You’ve already identified how much market risk you must expect to endure to achieve your personal financial goals; you have allocated your investments accordingly.

In other words, leaving your existing portfolio exposed to the risks wrought by a widespread epidemic is part of the plan. All you need do is follow it, because …

1. ) Markets endure

Not to downplay the socioeconomic suffering coronavirus has created, but we’ve endured similar events. Each time, markets have moved on.

To illustrate, consider a globally diversified all-equity portfolio, divided equally among Canada, U.S., and non-North American holdings. The SARS epidemic may most closely resemble current events (at least so far). What if you simply bought and held this portfolio since around the time SARS hit the headlines in February 2003? Your investment would have gone up 8.9% per year. Or in dollar terms, it would have quadrupled!

Here are other examples of the same:

Epidemic	Inception Date	Annual Return (since inception)	Growth of $1 (since inception)
SARS	Feb 2003	8.9%	$4.27
Bird Flu	Jan 2005	7.0%	$2.78
Swine Flu	Jan 2009	10.6%	$3.04
Ebola	Sept 2014	6.0%	$1.37
Zika	Jan 2016	8.4%	$1.39

“Journalists who reported flights that didn’t crash or crops that didn’t fail would quickly lose their jobs. Stories about gradual improvements rarely make the front page even when they occur on a dramatic scale and impact millions of people.” — Hans Rosling (Author of Factfulness)

2.) The risk is already priced in

The latest news on coronavirus is unfolding far too fast for any one investor to react to it … but not nearly fast enough to keep up with highly efficient markets. As each new piece of news is released, markets nearly instantly reflect it in new prices. So, if you decide to sell your holdings in response to bad news, you’ll do so at a price already discounted to reflect it. In short, you’ll lock in a loss, rather than ride out the storm. Continue Reading…

Coping with the Unexpected: 4 surprise costs and how to deal with them

Posted By Financial Independence Hub | February 12, 2020

By Nat Juchems

Special to the Financial Independence Hub

Our finances can be a source of stress and frustration at the best of times. For many of us, our budgets account for our expenses for the month, with perhaps a little left over for savings and disposable income. Which can make it particularly difficult when the unexpected occurs.

There are, of course, a variety of solutions to emergency situations. However, in the heat of the moment these can lead us to the financial band-aids that solve the problem in the short term, but perhaps put us at a long-term financial disadvantage. Credit card payments, loans, and financing may well be quick fixes to stressful issues, but you may find it difficult to cope as time progresses and your circumstances change.

We’ll take a look at a handful of the most common unexpected expenses that may arise. What are some useful, intelligent financial responses to these? Are there low-cost preparatory steps you can take to fend off larger-scale consequences?

1.) Medical Expenses

There’s certainly an element of injustice in the fact that people so often go into debt as a result of illness. However, the current US health system isn’t always well designed to provide adequate care without incurring huge bills. So, in the absence of complete systemic overhaul, what are your options for unexpected healthcare?

Of course, the simple preventative answer is to take out adequate health insurance. It can be tempting to just select the plan with the lowest monthly premium, but this could find you seriously out of pocket; particularly as lower premiums are usually leveraged by higher deductibles. That said, if you can mitigate this effect by investing a little from each paycheck into a Healthcare Flexible Spending Account (FSA). The funds paid into these accounts [in the United States] are deducted from your paycheck, but are not subject to tax. The amount accumulated can then be used to help pay for deductibles, co-pays, and indeed anything not covered by insurance in the event of an emergency.

If you have been involved in an accident that was the fault of a third party, it is certainly advisable to seek assistance from personal injury lawyers. While we all want to avoid unnecessary litigation, fair compensation may be obtained in order to cover your emergency and ongoing medical expenses. This may not be an adequate short term solution, so it can also be useful to find ways to minimize your initial outlay. Attend walk-in clinics in place of large hospital emergency rooms if appropriate, look into prescriptions of generic drugs rather than brand names.

2.) Funeral Expenses

None of us like to think about the passing of ourselves or those closest to us. However, we have to accept that death is one of the few guarantees we have in life. That said, for all its inevitability, death can take us by surprise; with the costs associated with it adding additional stress to our emotional pain.

Funerals are notoriously expensive affairs. When an unexpected death occurs, we can understandably tend to opt for solutions that place the responsibilities of organization on third parties such as funeral directors. It’s worth noting that these are usually the most expensive options, and don’t usually provide us with the opportunity to do our due diligence in investigating the necessity of services which drive prices even higher.

The fact is, there is no legal requirement in any U.S. state for a funeral director to take charge of planning and executing a funeral. It is perfectly possible for you to undertake a low-priced, meaningful ceremony. Cremation is usually one of the most cost-effective methods of handling the remains of a loved one, with the cost of cremation urns certainly tending to be lower than caskets. In fact, if you donate the body to scientific study, the remains are usually cremated and returned to you free of charge.

If you are set on burying a loved one, there are certainly options which can keep costs low. Direct burial — a process which forgoes a viewing in favor of almost immediate interment — can be around the same price as cremation, and does not require the additional expenses associated with preparation of the body. Also be wary of “extras,” such as gaskets on caskets; these are ostensibly to protect the remains after burial, and can raise the price of the casket by as much as $800.

3.) Vehicle Problems

Vehicles can represent one of our more substantial investments. Not simply in the material cost of the vehicle itself, but also its maintenance and ancillary charges such as insurance and road tax. It’s no shock, then, that when something goes wrong with our vehicles, it can be a costly affair. Continue Reading…

Is using Inverse ETFs akin to Market Timing?

Posted By Financial Independence Hub | February 10, 2020

By John De Goey, CFP, CIM

Special to the Financial Independence Hub

Early in 2020, I re-positioned a meaningful portion of my clients’ equity positions into inverse products (they go up when the market goes down and down when the market goes up). Critics, colleagues, suppliers and friends have seized the opportunity to call me a “market timer.” I beg to differ.

What I am doing is putting something that might be generally described as a form of insurance in place: expressly in light of high valuations. The Shiller CAPE (a widely accepted benchmark for market valuations) for the S&P 500 is currently over 31 and has hovered between 28 and 33 for about three years now. The historical average is under 17.

Think of buying a ten-year life insurance policy when you take on a mortgage. Is that an example of “death timing? Are you buying insurance because you EXPECT to die in the ensuing decade – or simply to protect against the consequences of something terrible happening?

If you don’t die in the decade, but still have a mortgage, are you ‘stubbornly doubling down’ after having made the ‘wrong call’? If a decade were to pass and you were still breathing, was the money spent on premiums over the previous decade ‘wasted’? To hear my critics … and to extend their logic based on what they are telling me, the answers would all be an accusatory “yes” to all these questions.

Here’s my thinking as explained via metaphor:

What I’m saying/ doing The Insurance Equivalent

Inverse sleeve Term life insurance

Temporarily high valuations Temporary unfunded liability on death

Renew if still high Renew if unfunded liability persists

Cancel if no longer high Cancel if unfunded liability is paid off

Offer relief if markets tumble Offer relief if premature death

Everyone dies eventually. Markets always have major pullbacks eventually. No one knows when either is likely to happen. See the parallel? Despite all this, people are generally portrayed as being “prudent” when they buy life insurance, but “market timers” when they incorporate an inverse sleeve. I simply don’t buy it. Perhaps I should start challenging my critics, colleagues, suppliers and friends for their “reckless disregard for the substantial risk they are taking while doing nothing to manage that risk.” See what I did there?

John De Goey, CIM, CFP, FP Canada™ Fellow, is a Portfolio Manager with Toronto-based Wellington-Altus Private Wealth Inc. This blog originally appeared on the firm’s “Newswire” site on Feb. 5, 2020 and is republished on the Hub with permission.

Your fixed-income portfolio can go one-ticket with new Vanguard global bond ETF

Posted By Financial Independence Hub | February 7, 2020

By Dale Roberts, Cutthecrapinvesting

Special to the Financial Independence Hub

Vanguard recently launched the world of bonds within one ETF. The Vanguard global bond ETF ticker VGAB combines the US bond market with the global bond market. It’s a one ticket offering. You can enter that one ticker symbol and gain access to over 15,000 bonds from Canada and the US, from Europe and through Asia. The fund includes modest exposure to developing market bonds as well.

Here’s the overview in 4 simple benefits.

The key benefits or strategy here is more ‘complete’ global diversification, investment grade quality and currency hedging. The fees are very reasonable for a Global fund at .30%.

If you want to look under the hood at the individual index ETFs, here are the links.

Vanguard US Aggregate Bond ETF (CAD hedged).

Vanguard Global Bond ETF (CAD hedged).

This slide details the benefits of currency hedging with respect to volatility.

All said, for the investor it is about the volatility and risk management for the total portfolio. We’re looking for lesser correlation to Canadian, US and International stocks. That can be achieved by way of removing the Canadian home bias with respect to bond exposure. US bonds, Canadian bonds, developing market bonds and developed market bonds will each bring unique characteristics to the table.

Our friends at ModernAdvisor will suggest that developing market bonds offer greater diversification for the Canadian investor. Those bonds are in the mix, but once again, in modest fashion.