Building Wealth

For the first 30 or so years of working, saving and investing, you’ll be first in the mode of getting out of the hole (paying down debt), and then building your net worth (that’s wealth accumulation.). But don’t forget, wealth accumulation isn’t the ultimate goal. Decumulation is! (a separate category here at the Hub).

Looking in the rear-view mirror to avoid hitting something that lies ahead

Posted By Financial Independence Hub | June 8, 2020

By Noah Solomon

Special to the Financial Independence Hub

The vast majority of today’s portfolios represent a Pavlovian response to the obliging nature of markets over the past several decades. The unprecedented increase in the value of risk assets coupled with low volatility have lulled investors into a false sense of security accompanied by an “if it ain’t broke, don’t fix it” approach to portfolio construction and risk management.

Most portfolios are dependent on the next few decades mimicking the last few. Specifically, they are over-allocated towards assets that have performed well during the secular (yet unusual) goldilocks environment of the past 40 years. As is typical of human behaviour, investors are looking in a 40-year rear-view mirror to avoid hitting something that may be in front of them.

What is Normal?

The past four decades have been unusually kind to investors. Strong tailwinds of favourable demographics, low inflation, falling rates and globalization have fueled an unprecedented rise in stocks, bonds, real estate, and almost every other major asset class. While it would be nice if these conditions were the norm, the fact is that they are unique from a long-term historical perspective.

An astounding 91% of the total price appreciation of a classic 60/40 equity/bond portfolio over the past 90 years is attributable to 22 years between 1984 and 2007. This period was also an atypically strong period for real estate, representing 72% of total appreciation over the past 90 years.

Notwithstanding some painful bumps along the way, including the tech wreck of 2000-2002 and the global financial crisis of 2008, the investing experience of most people today has been a proverbial walk in the park. An entire generation of investors has never experienced anything like the 86% peak-trough decline in equities of the 1930s which resulted in two decades of lost performance. Nor has it faced anything remotely like the 25% decline in U.S. Treasury Bonds during the stagflation-plagued 1970s.

What If?

Nobody (including us) can know for sure what the future holds. However, there are strong reasons to suspect that the road ahead will be drastically different than the unusually smooth path we have been on for the past several decades. Historically high asset valuations, record corporate and sovereign debt levels, $17 trillion in negative yielding debt, the lowest capital gains taxes in U.S. history, historically high income disparity across the developed world, and a global rise in populism and protectionism all suggest that, as Dorothy stated in The Wizard of Oz, “We’re not in Kansas anymore.” Continue Reading…

Reopening after lockdown: Switching from Defense to Offense

Posted By Financial Independence Hub | June 1, 2020

By Del Chatterson

Special to the Financial Independence Hub

Do you know your Basic Defensive Interval? I was asked that question as I left a failed business venture and wandered off into the wilderness of between engagements. For entrepreneurs it’s an important question to answer, “How long can we survive without income?” For a business start-up, it’s the number of weeks or months before you get to break-even cash flow. For an operating business, it’s how long can you survive a disaster without any revenue.

For an individual, it means how long can you continue to cover your living expenses if your monthly income suddenly stops. How much cash do you have set aside to carry you through such an event? We always knew there were unpredictable economic and financial risks that we could not prevent or avoid. Maybe we maintained insurance coverage and had a contingency fund, just in case. But none of us were prepared for a global pandemic that would shut down normal business activity for two or three months. It may be six months to two years before we get back to anything approaching normal business activity.

Tactics for the next phase

We have all found a way to get through this temporary shutdown and contributed to slowing the spread of infection to allow health care workers and facilities to handle the case load. We are now entering the end of phase one of the 2020 coronavirus pandemic, we hope. Is it time to start switching from defense to offense? Caution and constant monitoring will be appropriate as businesses reopen and people go back to work, but it’s time. Continue Reading…

Slaughter on the High Seas: Time to bottom fish Cruise Line Stocks?

Posted By Financial Independence Hub | May 29, 2020

By Ian Duncan MacDonald

Special to the Financial Independence Hub

Did you ever try to defend investing in the stock market when the risk averse shouted that no one can foretell the future and investing is just a crap shoot?

The Canadian Pension Fund’s purchase of several million more shares of Royal Caribbean Cruises Ltd in the fourth quarter of 2019 is an example of our inability to foretell the future. Due to COVID-19, Royal’s shares dropped a billion dollars in the first quarter of 2020. With assets of $420 billion, our pensions are not in jeopardy, but it may well be years (perhaps decades) before Royal Caribbean share price recovers to its former glory.

“Capital value is going to fluctuate over time,” was the pension fund’s response to the hit. They are right. As long as the pension fund does not sell these depreciated shares, they will technically never take the billion-dollar hit.

Not having to sell is the joy of investing with the public’s money. The next time you lose a few thousand on your stock pick you can tell your spouse, who is questioning your investment skills, “It’s a long-term play. At least it wasn’t a billion dollars like those professionals at the Canadian Pension Fund.”

Until COVID-19, investing in cruise lines looked like the safest of investments. Every year their boats were full of more and more baby boomers with the time and money to splurge on the non-essentials of life.

The $46 billion-dollar cruise industry is dominated by Miami based Carnival Corporation (CCL/NYSE), Royal Caribbean Cruises Ltd (RCL) and Norwegian Cruise Line Holdings (NCLH). In 2019, these three gave boat rides to 80% of the 26 million cruise passengers in the world. Between them they employed 272,000 in 200 ships. These now under utilized assets are tied up at docks with only a hope that some of them might tentatively begin cruising again August 1, 2020.

Would cruise shares make a good edition to now add to your portfolio? The following chart gives you an idea of how speculative an investment they might be:

Do you find it interesting that despite the pandemic, analysts are rating all these stocks as buys and strong buys? Based on this limited data, did the pension fund choose the best one to add to their portfolio? Interestingly Royal paid a dividend in April; this appears to be the last dividend they will be paying for the foreseeable future. The other two have not paid dividends this year.

Supply 20 times more than Demand

The book values of these three companies are well ahead of their current share price, which indicates a bargain. Admittedly, “book values” are calculated by accountants and are not the same as the “market values” that might be realized if the company’s assets were liquidated. Currently, the supply for cruise ships is probably 20 times greater than the demand.

The price to earnings ratio is low confirms that the shares are not overpriced. The operating margins for the three reflects their historical sales minus the expense to realize those sales. With little new revenue now coming in, their operating margins will probably be a minus figures when more current financial information is released.

The IDM score at the bottom of the chart is a measuring stick and summary to quickly evaluate stocks. It is based on the data currently available to the public. It does not reflect the dire straights that these businesses are now in. The scores reflect those of the profitable well-run companies that these three once were just a few months ago. Normally any score over 70 indicates a very desirable stock to own. Anything over 50 is normally a safe stock purchase. (You can learn more about the IDM score at informus.ca). Continue Reading…

Are stock markets ingenious or insane?

Posted By Financial Independence Hub | May 26, 2020

Janice Gill/Unsplash

By Steve Lowrie, CFA

Special to the Financial Independence Hub

You’ve probably heard the expression, “crazy like a fox.” If you’ve ever watched a winter fox in action, you know what that means. Hunting for prey, the fox will leap around in seemingly insane gyrations until … wham! It’s scored a tasty tidbit hiding in the snow.

Has the stock market gone similarly crazy lately? Like the fabled fox, there are actually some incredibly sensible dynamics behind the market’s seemingly manic moves. Let’s cover three reasons why investors should ignore its transitory twists in pursuit of satisfying returns.

Market pricing vs. economic indicators

To the surprise of most, markets surged in April, with the US stock markets experiencing their best monthly rally since 1991 and the Canadian stock market since 2009.

So far, May isn’t looking too bad either. But why? Why would markets spring upward while the economy remains in such a deep freeze? The explanation is relatively simple, if often misunderstood:

Economic indicators are in real time. Unemployment is high right now. Government debt is piling up. Coronavirus is ravaging our personal and economic health today.
Market pricing is forward-looking. When the market is rising, it suggests there are more buyers betting that things are likely to improve than there are sellers betting on even darker days ahead. This doesn’t mean they’re correct, but relatively efficient markets often do “know” a bit more than any one of us can know on our own.

Market efficiency

This leads to another source of confusion for investors and the popular press alike:

The markets can be crazy-volatile in the near-term. Nobody actually knows what market prices are going to do next: not even the market itself. To know, we’d first need to correctly predict each new economic or other trends that might change things. Plus, we’d need to know how the market is going to react to the interplay of every force, combined. No wonder it may often feel as if the markets are disconnected from reality. Continue Reading…

Taxes and your ETFs: Don’t let withholding taxes drive the bus

Posted By Financial Independence Hub | May 25, 2020

By Dale Roberts, CuttheCrapInvesting

Special to the Financial Independence Hub

Should you pay attention to withholding taxes on dividends? What about about capital gains vs dividend income? Should tax considerations trump asset allocation and your risk tolerance level? I get many questions with respect to taxes and ETFs. I will suggest that you do not let taxation and withholding taxes on US and International dividends drive the bus.

Keep in mind that I am not a tax expert. When in doubt have a chat with your accountant or Certified Financial Planner. I form my opinion based on the study of asset allocation models. And I’ll also largely base the opinion after reading what the qualified experts have to say. I also make it a hobby to pester several portfolio managers and investment firms on a regular basis.

Should we worry about what goes where?

Taxes and ETFs and that TFSA question. A reader and friend recently asked if he should build the TFSA in the most tax-efficient manner? After all, in a TFSA we lose the withholding taxes on US and International dividends. There is often more dividend tax efficiency in taxable accounts thanks to tax credits. The most efficient account type for US stocks and US ETFs in a US dollar RRSP account.

Does that mean we should only hold our US equities in our RRSP account?

Justin Bender of the Canadian Portfolio Manager blog constructed a wonderful post on the most tax efficient ETF Portfolio. Here’s how that tax efficient portfolio looked in the end.

Of course this is ridiculous as Justin would point out. Perhaps even shading the portfolio to any great degree does not make sense as well.

Don’t let taxation drive the asset allocation bus

In the above example the tax considerations determine the asset allocation. That in turn will determine the risk level and the ‘expected’ returns for each account type. You might get tax efficiency but no total returns in your taxable account. US stocks might tank and you get negative returns for an extended period in your RRSP account. That TFSA account has a Canadian home bias that so many advisors and financial planners would deplore. We still need those Canadian and US and International equities to ‘protect’ each other.

Of course the above portfolio example does not take into account the more important retirement funding scheme. aka the financial plan. We may need the TFSA account to work just as hard as the RRSP account. On the flip side, the financial plan may call for a quicker draw down of RRSP assets so that the retiree can delay CPP and OAS. That would require an RRSP portfolio at a lower risk level. Those are greater considerations.

It’s tax free after paying withholding taxes

And after tax returns in ETFs can get tricky. Here’s a great article in Advisor’s Edge. Continue Reading…