Hello fellow personal finance readers. I go by the pen name “Teacher Man” due to the fact that I recently graduated from university and am in my second year of teaching high school. About 9 months ago my partner and I started a website called My University Money. It is aimed at helping young people (with a specific focus on post-secondary students) and just talking about financial and student lifestyle issues in general. Young & Thrifty was one of the first bloggers to really reach out to us and give us a little recognition when we were just starting off. When I read that Y & T was hitting a busy patch in life I offered to do a little staff writing for her, and she graciously accepted. Many in the investing industry have been singing the praises of the explosion in discount brokerages over the past couple of decades. The fact is that online discount brokerages which cut fees to the bone (as little as $5 per trade) have completely changed the way the investing game is played. It wasn’t so long ago that someone wanting to invest had to ring up their full service stock broker (on a rotary phone) and ask them to place their trade for an exorbitant fee (often $50-$100). Unless you were one of the big fish, your order got put on the back burner until whenever your broker got around to it. These days investors have access to real-time quotes, and a bevy of current information that even corporate investors couldn’t have dreamed of 30 years ago. This is great news for the little guy right? Uh… the jury is still out on that one.

So You Think You Can Trade?

There is no doubt that the internet and the way it levelled the information playing field (kind of), as well as its pricing structure is to most peoples’ benefit IF they practice the same investment strategies as before. Therein lies the major problem. In the past, investors looked to make sizeable investments in companies they believed had a competitive advantage and would consequently do well over time. Paying these large fees to move in and out of investment positions was a major incentive to practice buy-and-hold investing. Today, you can turn on your TV to anyone of 3-5 channels that will be spinning some sort of voodoo about the latest earnings reports, or some new cookie-cutter shaped technical analysis theory, and that makes a lot of people believe that they could be the next Goldman Sachs hedge fund manager if they watch enough of the garbage. When you combine this with the sudden ability to trade whenever, and however you want, for a cheap fee, you can do a lot more harm than good.

Trading With The Stars

Investing is not trading. People often get this confused. When people watch Wall Street movies and get caught up in the adrenaline rush (admittedly, we testosterone-driven types are most susceptible to this) of getting rich quick, they get a ridiculous view of what investing should truly be about. It seems to me that a lot of people have forgotten that the whole point of the stock market is to allocate capital to the best companies. It is the natural extension of free market ideas that the companies that have proven they can do the best with what they have (and produce something valuable) should get more money to work with, and should see their value continue to grow. Online discount brokers have greatly aided this trend where we have moved away from that ideal, into this crazy casino world where people try to make money from nothing by attempting to predict the irrationality of the markets on a minute-by-minute basis. I want to yell at these people that Wall Street has mathematical geniuses working for them that have invented automatic algorithms that are powered by state-of-the-art technology and insider information. Do you really think you can beat these guys at their own game staring at charts? People on my site are probably sick of hearing about my worship of Warren Buffett and his patient, value investing ways, but I always think that this guy is the pinnacle of what true investing should be about – not day traders looking to cash in on some made-up “momentum swing.”

The Cheap Trade Factor

Is the invention of the $5 trade a bad thing? Not if you are realistic about the markets and your strategy within them. I’m by no means a stock guru, but pretty much every single investment study out there will back me up when I say that any sort of diversified, buy-and-hold strategy will work much better than trying to ride the latest trend. It doesn’t matter if you’re a dividend investing apostle, an ETF/Index investing convert, or a value investing Buffett-ite, you will be better off than the guy who trying match wits against the sharks on Wall Street. The $5 trade has saved smart investors a ton of money. It has also majorly cut into the slim profit margins that most investors have seen over the last few years. Go ahead and look for yourself at the studies done over the past 20 years comparing active traders to people who index is boring old index funds once every month. There is an old saying in poker that if you can’t pick out the sucker in the first hour, than you’re the sucker. How do you think these hedge fund guys can make such outrageous returns? Someone has to be at the other end of them, and I know it’s not the guy sticking his money in ETFs and Index funds.

Are You Smarter Than A Hedge Fund Manager?

For years economics professors out there loved to talk about how they had come up with a magical formula for the stock market called the efficient market theory. This approach basically claimed that since everyone now had access to such good information, supply-and-demand fundamentals guaranteed that every stock was appropriately priced at any given moment. This may have had some degree of validity when people carefully considered their investments since it cost $100 a pop to buy or sell any shares at all.  I’m fairly certain that in today’s headline-driven markets it holds almost no short-term relevance at all. We are seeing more volatile markets now than ever before, and there is little doubt that this is influenced by the competition over who can produce the most extreme headline, and the ability of the do-it-yourself investor to rush to their computer and “join the heard” trying to follow whatever the latest “Mad Money” tip was . Humans have always been genetically hardwired to be bad at investing. Our risk-averse nature basically guarantees that most of us will want to buy high and sell low the majority of the time. With trades so cheap and access to accounts so easy these days, those millennia-old instincts have an instant outlet, and this is not good for many investors.

Be a Wall Street Survivor

Don’t be one of these investors that plays right into the hands of the investment industry. Even though fees are lower, investment brokerage employees are still driving yachts (albeit maybe slightly smaller ones now). When you use low-cost trading to justify a hyperactive, instinct-driven investing style, your just eating into your meagre returns (which now can’t compound over time) and buying some rich dude a new Mercedes (regardless of how you do on the actual trade). Instead, take advantage of this competitive new market and save yourself a ton of investing fees over your lifetime.

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Hi all! Here’s another great staff post from Teacher Man- here’s his intro if you want to read a little more about him: ” I go by the pen name “Teacher Man” due to the fact that I recently graduated from university and am in my second year of teaching high school.  About 9 months ago my partner and I started a website called My University Money.  It is aimed at helping young people (with a specific focus on post-secondary students) and just talking about financial and student lifestyle issues in general.”

With so many personal finance bloggers and newspaper columnists out there these days touting the benefits of index investing it’s fairly likely you have come across the term at some point. Basically, it is a deceivingly simply investing method that allows investors
to set up the equities portion of their investment portfolio in about five minutes, and then forget about it. In addition to this ease-of-use factor, this low-maintenance style of investing will actually beat out traditional mutual funds the vast majority of the time (at least 95% by most estimates). So what is this magic investment called an index fund?

An index fund is like a mutual fund in that it takes your investment dollars and spreads them out over multiple companies. Where a mutual fund will hire an “expert,” or a team of them, to pick specific companies to invest your money in, an index fund will do nothing more than invest your money equally across the whole market it is tracking.  There are now index funds that will spread your investment dollars out across the entire world market, or ones that will follow a certain stock exchange such as the NYSE, or the TSX. In other words, an index fund is a way to lock in your investment return at exactly the market average minus relatively small investment fees.

So Just How Good Are These Investment Experts?

It initially appears ridiculous to believe that the vast majority of investment experts that work in Toronto and New York cannot do better than the market average; however, the statistics don’t lie. A recent study that appeared in the New York Times looked at 452 domestic mutual funds (taken from the Morningstar database) and their performance over the last 20 years. When compared to the Standard & Poor 500-stock index (more commonly known as the S&P 500), only 13 of these mutual funds beat the average returns of the index once their fees and tax disadvantages were taken into consideration.  Those numbers are worth repeating: only 13 out of 452!

When Did The Definition of Expert Become Below Average?

There are a few factors responsible for this eye-popping statistic. One of the primary reasons many mutual funds do poorly is because their managers are extremely well paid and are slaves to the most recent quarterly reports. The tried-and-true method for being able to cash huge paycheques for as long as possible is to simply try and mimic the index itself. If an investment manager follows this strategy, they know that they will never have a period of time where they are too far below the average, and consequently they will get to keep their jobs and their yachts. The next question one might ask is, “If so many managers are just trying to be average, why do mutual funds almost always return less investment income to investors than index funds do?” That answer is actually fairly straight forward, it’s a little thing called management fees. You see those yachts that the Wall Street-types have are paid for with the dollars you invested in their mutual fund, and the subsequent returns they produced. There are all kinds of different fee structures, but 2% is fairly average in the USA, and some hedge funds with big name managers charge well over 10%. Canada actually has the absolute highest mutual fund management fees in the world – yay, we’re number one! (Y&T’s note: HA, we’re finally #1 in something!  No more underdog status!) So to recap, if most managers are simply aiming to get average results, and then charging you 2%+ to do just that, then of course they are going to give investors a much lower (2% a year makes a huge difference over long-term investing periods) rate of return than they otherwise would have gotten.

The other consideration this study focused on was the tax inefficiency associated with many of these mutual funds. Without going into too much excruciatingly boring detail, it is generally accepted that because stocks are being bought and sold constantly within
mutual funds, there are all kinds of taxes and expenses incurred that wouldn’t be under most index investing plans. When your returns are constantly being limited because of fees and taxes, they cannot compound over time, and like Einstein says, “The most
powerful force in the universe is compound interest.” That’s from the guy that created the atomic bomb! While the study concedes that owning mutual funds within a tax-advantaged account would have allowed a few more funds to slip into the “beat the index” category, the overall results would be very similar. The article goes on to state that it would be nearly impossible to predict which funds would beat the index ahead of time, so it is effectively useless to try using past results.

Efficient Market Theory

The whole idea of index investing springs from something called efficient market theory.  What this theory basically claims is that the market is perfectly efficient. This means that if you invest for long enough and make enough trades you are almost guaranteed
to return average results. It takes the whole idea of a competitive market to its logical conclusion: that whatever the price of a company currently is, that is almost exactly what it is probably worth. For investors, the logical conclusion is that you stand almost no hope of “beating the market” long-term. If you can’t control what the market will return, the only thing left to control is the fees you pay; therefore, logic dictates that those who pay the lowest fees will come out ahead over time, and probably sooner rather than later.

Criticism of Index Investing

There are definitely some holes in efficient market theory. Anyone who has looked at the stock markets at all over the last five years can tell you that there is no way they are perfectly logical. Now more than ever, markets can go soaring or fall through the basement due to a rumour, or a slightly lower-than-expected quarterly report. Many index investing converts have modified the theory to claim that while short-term markets may fluctuate illogically, in the long-term stock prices will average out because market fundamentals will ultimately bring a stock back to where it is supposed to be. Another relevant criticism is that the more people that are out there index investing, the less rational the market will become by definition. What supposedly makes the market completely efficient is the fact that there are people out there pouring over every little press release and balance sheet to determine the true value of companies. If people stop doing that, then the market ceases to be perfectly efficient. Finally, studies show that while index investors almost always do better over the long-term, talented traders (the guys who run hedge funds) do substantially better in range-bound markets where the overall index stays more-or-less the same, but certain sectors or stocks will go up or down considerably. Most people believe this will describe North American and European markets for the next few years.

Is Index Investing For You?

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The following is a guest post from the Dividend Ninja. A couple of weeks ago, Y&T mentioned she was going
back to school full-time, and was worried about not being able to write enough material while studying (which is a valid concern). She was asking for guest posts – how could I say no to a fellow Vancouverite?

A few months ago I downloaded backgammon app on my Blackberry to play when I’m really bored and don’t feel up to reading or working on the web. Of course I chose the “Expert” level since I think I’m a pretty savvy player. I also figured it would be pretty easy to beat a basic game of backgammon – especially since it’s a just a blackberry app (if it was an iphone app I’d think twice). Well beating the game wasn’t as easy as I thought! And even more difficult as I discovered, is to consistently win a number of games in a row.

So what does that have to do with the stock market? You might be surprised to find out more than you think.  Many investors approach the stock market and their investing strategies like a game of backgammon. Here’s why gambling and investing shouldn’t have anything in common, but as we often see for many investors they do.

I Feel I Can Win

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Alright, I promised that I would share the other 4 equities I bought to hold in my TFSA aka Tax Free Trading Account. With the markets plummeting these past few days, it might be a good idea to load up on some stocks you have been keeping an eye on. The volatility is back.. stocks are on sale (that’s how I like to think of it, anyway).

Like last week’s post, I had you try to guess what the equity I bought in my TFSA was. So I’ll try and do the same again this week.

I had bought a very small amount of shares of this income trust before 2011 rolled around.  With the newly added money ($5000) I put in last month, I added more shares to equal 100 shares.  When I get more money in my TFSA from my tax refund, I plan on buying more of this stock.

Alright, here goes, time to put on your thinking caps:

• This is another big dividend payer- 8.28% annual yield  (that’s $0.10333 per share per month or $1.24 per share a year)
• They didn’t decrease their payout to investors even though they converted from an income trust to a corporation (one of the few ones that didn’t).  This says a lot since the government changed the tax structure, so they are being taxed and still paying the investors the same amount.  That says a lot.

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In my limited five year foray into personal finance, I have encountered many a financial advisor. Some that work directly for the banks, some that work for wealth-building personal finance companies (usually requiring you to have lots of assets before they even take you on), and some that work for smaller financial firms.

They all seemed very nice to me, some of them more pushy than others. I share my experience with the three financial advisors when I first started my interest in personal finance in a previous post. They had varying knowledge on finance advice, it seems. It also seems very difficult to navigate the personal finance industry, it seemed that even those IN the industry didn’t seem to understand it. How I came about finding them is an interesting story too. For the most part, they found me, and not the other way around.

One financial advisor told me that he wouldn’t get any commission from my buying the mutual fund. I trusted him 100% but later on found out that a 3.45% MER was deducted from my mutual fund contribution annually. It’s really difficult to figure out who to trust with your hard earned money. Finding a financial advisor that you can really trust can be an enduring process to say the least.

You want someone who you can depend on and know that they’re not there to gouge your wallet and reap commissions and MER’s off you, but that they’re there to support you in growing your wealth and be accountable for a sagging and lack luster portfolio, if any.

Here are some tips on how to find a good financial advisor:

• Don’t choose a friend or relative or family friend- if things go sour, or you want out, you may feel obliged to stick it out with them just out of guilt.  Not taking action because of guilt= bad thing.  Unless you feel comfortable telling your friend/relative/family friend that you’re not happy with the way your money is going, I would stay away from this
• Know what type of financial advisor they are- Certain financial advisors make money from commissions when they sell you a mutual fund, and other financial advisors charge a fee for service (so you will receive non-biased information)… but usually these financial advisors deal with HUGE portfolios.
• Make sure you feel comfortable with them and can trust them... meet them in person a few times before you hand over your money for them to invest with
• Make sure they understand your short term, medium term and long range goals and help you with them (e.g. that they don’t encourage you to lock your money in an investment for five years when you know you might be needing to withdraw the money soon for a down payment).  This example should give you red flags that your advisor isn’t there for your best interests

I hope those tips help you.  Personally, I choose to go at it alone- at least if I want to blame someone, I can blame myself and I am accountable for my own actions.  No one cares more about your money than you!  I still have a small amount left with a financial advisor (because I am locked-in with said mutual fund until 2012), but I cut most of my ties with financial advisors by switching to BMO Investorline from Investors’ Group and more recently, closing one of my RRSP accounts by using the Home Buyer’s Plan.

Readers, have you had good or not so good experiences with your financial advisor? Did you end up sticking with the same advisor even though in your perspective, they weren’t handling your hard-earned money that well? If so, why?

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