Today’s blog headline (minus the suffix I added) is also the subtitle of a free new investing booklet titled If You Can by William J. Bernstein. This is a terrific and short (16 pages) document that I wholeheartedly recommend be read and absorbed by today’s millennial generation. For that matter, it should be read by just about any investor at any age.
But a warning: if you’re in the financial services industry, you’re not going to like the content. The author is a neurosurgeon who learned the hard way how to invest his own money, and has written a few books along the way. If you’re not in the financial services industry, you may be merely amused by his depiction of most full-service stock brokerages and mutual fund salespeople as the equivalent of “hardened criminals” or “self-deluded monsters.”
At the outset, Bernstein promises to lay out an investment strategy that any 7 year-old could understand and will take just 15 minutes of work per year. Yet he promises it will beat 90% of finance professionals in the long run, but still make you a millionaire over time. The formula will be no surprise to MoneySense readers familiar with the Couch Potato approach to investing in index funds or ETFs. Simply, Bernstein advocates saving 15% of one’s salary starting no later than age 25 into tax-sheltered savings plans (IRA or 401(k) in the U.S., RRSPs or Registered Pension Plans in Canada), and divvying up the money into just three mutual funds: a U.S. total stock market index fund, an international stock market index fund and a U.S. total bond market index fund.
Bernstein a big fan of Vanguard and John Bogle
In Bernstein’s view, the index funds should be supplied by the only financial services company he seems to trust: the Vanguard Group (which sells both index mutual funds and ETFs).
Bernstein is addressing young Americans just embarking on their working careers but the basic idea would apply to Canadian millennials too. Judging by recent Portfolio Makeovers we’ve run showing ETF-based Couch Potato portfolios, the equivalent mix would be 20% each of Canadian, U.S. and international equity index funds or ETFs, and 40% of a bond ETF. And as I’ve written before, don’t even wait till age 25: if you can get your parents to match your savings starting at age 18, the TFSA is the place to put in place these bedrock principals of investing.
And the 15 minutes of work? That would be an annual rebalancing exercise to get the proportions of the three or four funds back to their starting levels.
Millennials can’t count on employer pension plans
Despite this, Bernstein warns younger people that they’ll have a hard go of it because the traditional defined benefit employer pensions of previous generations probably won’t be around much longer. This is pretty much what I wrote in the Editor’s Note for the April issue of MoneySense: that we’re all forced to be our own pension managers these days.
Bernstein says the operative word in his booklet’s title is “If,” because following his simple recipe for wealth (I’d call it financial independence of course) involves a very big “if.” He lays out five hurdles. Number one is excessive spending, second is understanding the basic principles of finance and investing, third is learning and applying market history, fourth is overcoming yourself: the biggest enemy being your face in the mirror; and hurdle five is the conflicted financial industry that is supposedly there to help you with your financial goals. He goes so far as to declare, “The financial services industry wants to make you poor and stupid.” Fighting words, indeed! I might not go that far but it’s certainly a way of looking at the world.
Bernstein’s homework assignments
Bernstein assigns some “homework” to his young readers. They have to read his document twice and read a few books, starting with Thomas Stanley and William Danko’s The Millionaire Next Door and John Bogle’s Common Sense on Mutual Funds. He’s too shrewd to plug his own books but I’ll name one on his behalf that I’ve reviewed positively in the past: The Four Pillars of Investing.
The fact that Bernstein has gone out of his way to give away the booklet should tell you a lot. You can find the link for a PDF here. If you act quickly (today, May 5) you may also be able to get the Kindle version free rather than the 99 cents Amazon.com normally would charge.
To parents of millennials, I’d urge you to download and print this document and hand it over to your kids, perhaps after highlighting the passages you feel to be most relevant. You could give them the link but you know how distracted they tend to be with all the social media noise that abounds these days. Sure, they may say they want to get rich some day but to paraphrase the old saying, “We all want to go to heaven, but no one wants to die first to get there.” For millennials, saving 15% of salary is the financial equivalent of dying, which is why Bernstein titles his document “IF you can.”
What I call the “Findependence Day Model” dervived from the book is simply the combination of three things.
All three deal with cutting investment costs or brokerage costs. The first is using a discount brokerage to make your own trades, typically at $10 per transaction. The second is to take advantage of broadly diversified, tax-efficient and low-cost exchange-traded funds (ETFs), which can also be purchased at a discount brokerage.
And the third is to use a fee-for-service financial planner, that is, a planner whose services are billed either by time (usually by the hour) or by the project (as in a one-time financial plan) but NOT via annual fees levied as a percentage of client assets under management. The problem with the latter is it gets prohibitively expensive as wealth grows, unless the fees are tapered down accordingly. I recently heard from a reader complaining that a 1% fee on a $4 million portfolio cost $40,000 a year — an amount many people could live on. Clearly in such case, you should negotiate a lower fee: say 0.5% for starters, or look for another firm that will negotiate, or go the DIY route described in this blog and find a true fee-for-service planner.
What the heck does “fee-only” really mean?
Note there is much confusion over the term “fee-only.” As Preet Banerjee writes in the current issue of MoneySense — here — the term fee-only does not necessarily mean fee-for-service. All that fee-only means is that it is NOT old-time commission-based, levying commissions per transaction. In fact, commission-based is not that bad a deal, particularly if you’re a buy-and-hold investor.
Sadly, many journalists and even advisers themselves have used the term “fee-only” when they really were referring to fee-for-service. As a result of the definition used in the US NAPFA, an asset-based financial planner (like the one charging our reader 1% of a $4 million portfolio) is well within their rights to refer to themselves as “fee-only.” Fee-only can mean EITHER fee-for-service OR asset-based financial planning, rendering it almost meaningless. And mea culpa, even in the two editions of Findependence Day, I use the term fee-only when I should have used “fee-for-service.” Future editions will fix that and editions of MoneySense magazine will going forward make this distinction clear.
MoneySense’s new Fee-for-Service online directory
Because of this, we at MoneySense have revamped the previous online directory of “fee-only” planners. Click here for the new directory, or rather TWO directories: one for true fee-for-service (i.e. by hourly or project billing) and one for financial planners who are primarily asset-based (at least 60% of revenues) but who do offer clients the option of time-based or fee-for-service billing.
I might add that other aspects of the Findependence Day model have also been rolled out in MoneySense throughout the year 2013. Our Feb/March issue on RRSPs introduced the ETF All-.Stars, which will be revisited in the Feb/March 2014 issue. And our June 2013 issue introduced MoneySense’s first survey of Canada’s best discount brokerages, a second version of which will run next summer. Both features were written by MoneySense editor at large Dan Bortolotti, more about which can be found below.
For those who missed those two issues of the magazine, here’s a tip. It costs only $20 a year to subscribe to MoneySense magazine (7 issues), which also gets you free access to the web site at MoneySense.ca PLUS the iPad edition. We recently went behind a paywall (or technically a pay fence) but the iPad edition also gives you the back issues, including the ones mentioned above and in fact all the issues since I became editor starting with the June 2012 issue.
Upcoming iShares educational event in partnership with MoneySense
Finally, those in the greater Toronto area may find an event coming Saturday, November 16th of interest. Dan, mentioned above and pictured on the left, will be talking about ETFs and portfolio construction along with “Ask MoneySense” columnist and broadcaster Bruce Sellery, and various iShares ETF experts from BlackRock Canada . Dan will be taking readers through some of the concepts I’ve described above, as outlined in the book he authored for the magazine: the MoneySense Guide to the Perfect Portfolio, copies of which will be given away at the event, along with the current issue of the magazine, parking and breakfast. (more than recouping the $25 charge).
I might add that Dan is in the process of becoming a financial planner himself. He is already working with PWL Capital, whose firm is listed in the new directory as primarily asset-based. Dan himself is in the fee-for-service camp.
Details for the iShares/MoneySense event can be found here.
A belated Happy New Year to all readers and a reminder that every adult Canadian can take a big step this week towards their ultimate financial independence. I refer of course to the fact we can all contribute another $5,500 to our Tax Free Savings Accounts (TFSAs), bringing the total cumulative room to $25,500 (going back to the program’s launch in 2009). For the benefit of any American readers, Canada’s TFSA is the equivalent of the U.S. Roth plans, albeit with different rules.
In other words, if you acted at this time each year, you’d have contributed $5,000 in each of 2009, 2010, 2011 and 2012. Now that it’s 2013, the annual limit has been raised to $5,500, the first time the limit has been adjusted to accommodate inflation.
Of course, assuming you invested wisely in each of those years, your balance should by now be well north of $25,500, and in some cases may have grown past $30,000.
TFSAs a particular boon for young people
I truly believe that maximizing the TFSA is the single biggest step Canadians can take in their quest for financial freedom. As we noted in Julie Cazzin’s “Make Your Child a Millionaire” feature in the current issue of MoneySense, the TFSA is especially a boon to young people because they have such a long investment time horizon ahead of them.
Unlike RRSPs, which require earned income the prior year, an 18 year old can qualify for the full TFSA $5,500 limit this year (they may need parental assistance to come up with the money, but that’s permitted by the rules. Think of it as a tax-effective early inheritance!). Not only that, but they can contribute to TFSAs well into old age, unlike RRSPs, which end after age 71. You better believe that half a century of maximizing TFSAs and investing wisely will mean multi-millions down the road.
Do this right from the get-go and you may not even have to worry about RRSP contributions, although those in higher tax brackets should probably do both.
But how to invest wisely? For the young in particular, but also older people seeking income, I think equities are the only way to go in TFSAs, especially with interest rates being so low as they are now.
I’m all for international investing but if you already have lots of RRSP contribution room, I’d use the RRSP for US dividend-paying stocks, since the tax treaty shelters Canadians from the 15% foreign withholding tax.
Despite the “tax-free” moniker, TFSAs won’t stop you from being dinged by that tax on foreign securities. For this reason, I like TFSAs for Canadian dividend-paying stocks. Yes, I realize the dividend tax credit makes Canadian dividends a good choice for non-registered (taxable) accounts, since the tax is roughly half what it is on interest income. However, Canadian dividends also result in the annoying “gross-up” calculation come tax-time, and such phantom dividend income can ultimately hurt you on the OAS clawback. And to me, zero tax is preferable to even a “low” rate of tax, especially if you plan to reinvest those dividends.
Canadian Dividend ETFs are my choice
For all these reasons, my personal choice for TFSAs this year are Canadian dividend-paying ETFs. A year ago, when it was part of the Claymore family, I publicly stated that the iShares S&P/TSX Canadian Dividend Aristocrats Index Fund (CDZ/TSX) was a tempting choice, at least for those who already have plenty of exposure to the big Canadian banks. To be included in that index a stock has to be a common stock or income trust listed on the TSE and have increased dividends for at least five consecutive years.
This year, there is a valid new alternative from Vanguard Canada: the Vanguard FTSE Canadian High Dividend Yield Index ETF (VDY/TSX). The management fee on VDY is just 0.30%, half the 0.60% of CDZ. (MER is 0.67%, we don’t yet know what VDY’s MER will be). But keep in mind that VDY amounts to a big bet on the major banks: a whopping 59% of the ETF is in Canadian financials and in fact the top four holdings are all the big banks. CDZ has much less exposure to financials (just 21%) and minimal exposure to the big six banks in particular.
Half and half is one compromise
One way to go might be to split your contribution between both ETFs: say $2,750 in each. Remember, though, this assumes you have plenty of US and foreign stock exposure in your RRSP. Younger people for whom the TFSA comprises the lion’s share of their wealth should strive for plenty of US and foreign stock exposure through similar types of ETFs. We’ll be looking in depth at these in the next issue of MoneySense, currently in production.
How ironic that as criticism of high Canadian mutual fund fees focused on Investors Group the last week — see Do We Really Care About Fees? — Tuesday marked the first day of trading of the first six ETFs from Vanguard Canada on the TSX.
The six ETFs average fees of 0.24%, according to Vanguard Canada managing director Atul Tiwari, who briefed financial advisors at a session at the Royal York in Toronto Tuesday afternoon. That’s roughly eight times less than the MER of the average mutual fund sold in Canada, he said.
There are three ETFs providing exposure to the U.S., EAFE and Emerging Markets, plus three domestic ETFs built expressly for Canadian investors covering Canadian equities and fixed income. All six can be considered “core” ETFs for portfolio construction.
For now, there are no plans to provide Vanguard index mutual funds in Canada, Tiwari said. Distribution appears to be the challenge there.
Pictured is Charles Ellis, author of Winning the Loser’s Game, who addressed advisors with a talk similar to one he delivered to portfolio managers in November, reported in this blog here. In an interview, Ellis told me he’s personally invested mostly in Vanguard ETFs, except for a small position in Berkshire Hathaway. He also told the audience that going back a decade, he was mostly invested in Emerging Markets, a trade that worked out well until his wife said she wasn’t comfortable with the risk. He switched to large household name American blue chips and he remains happily married, he quipped.
For more details, see Vanguard Canada’s web site here.
– 61 –
As noted in my Wealthy Boomer blog here, American indexing guru and author Charles Ellis [seen in photo on left] gave Canadian money managers both a history and arithmetic lesson on Tuesday. His point in a nutshell is that annual mutual fund Management Expense Ratios (MERs) of 2.5% or so (in Canada) are “terrible” but even the investment counselling fees of 1% (plus or minus 50 basis points) are also excessive.
These numbers may seem small when expressed as a percentage of assets but Ellis said the way to look at it is as a percentage of the return generated by active managers. So even if the active manager could generate a pre-fee return of 10%, the 2.5% fee takes that down t0 7.5%, so amounts to a 25% reduction of the return: or ten times the 2.5% figure that seems so insignificant. If returns are more likely pre-fee 6 or 7%, then a 1% fee takes it down to 5 or 6%, and amounts to a 15% reduction of return, he said.
Ellis himself prefers market-cap weighted index funds or ETFs of firms like Vanguard Group (which recently set up shop in Canada.) Investors can buy the “market” for as little as 10 basis points (0.1%), which long ago was a figure that customers of money managers were accustomed to pay. But as he related in his Monday talk in Toronto, customers didn’t balk when one firm hiked it to 25 beeps, others followed suit and eventually even a full 1% didn’t seem out of line.
This cost-conscious approach consistent with Findependence Day model
None of this should surprise readers of this blog, since the Findependence Day model cuts costs to the bone by emphasizing use of discount brokerages to cut commission costs, and then implementing trades of ETFs or index funds, the fees of which will range from about 8 or 9 beeps to 55 beeps for most mainstream ETFs, and perhaps a bit more for some esoteric ones. Of course, you can also try and pick your own individual securities, although Ellis would probably call that the “loser’s game,” as per the title of his book, Winning the Loser’s Game.
The third point is that you can still benefit from good advice by engaging a fee-only financial planner who charges by the hour, month, quarter or year, or perhaps by the project (which might be a financial plan or portfolio assessment). You can also go the fee-based route but keep in mind that a 1% fee will be on top of the underlying MERs of the ETFs, which could easily run 1.5% or so. For some investors, especially buy-and-hold investors who don’t trade frequently, a traditional commission-based full-service advisor could make sense from a cost perspective, at least relative to a high-fee-based alternative.
– 61 –
For those who prefer getting their information on video, the MoneyShow has just put up a 4-minute video with me about Findependence Day, which you can access by clicking here. This was taped for MoneyShow Toronto in September, just as this web site was launched. One of the first items in the September blog archives was the talk I gave there.
Most of the themes explored in this blog are touched on in the video, including how to keep costs down while still benefiting from the advice of a professional financial planner, use of ETFs and discount brokerage, hedging the downside and other topics.
There’s a second video I’ll post shortly that describes in more detail how investors can protect themselves and hedge portfolio volatility.
– 61 —
Unlike the United States, where fee-only financial planners are ubiquitous (See NAPFA’s site here), they are a rare breed in Canada.
In fact, according to one of them, Jason Heath of Markham-based EES Financial, there are only about 150 true fee-only financial planners in all of Canada. Compare that to 75,000 who sell financial products of some kind, or to the 25,000 who call themselves financial planners, or the 18,000 who are CFPs or Certified Financial Planners.
Jason was the second half of my presentation at the MoneyShow in September. As I noted in this blog then — here — I view fee-only financial planning as one of three key strategic components underlying what I call The Findependence Day Model: the other two being use of an online discount brokerage and making exchange-traded funds or ETFs the core of a portfolio.
How DIY investors can avoid doing it TO themselves
Earlier this week in my Wealthy Boomer blog — here — I described a TD Waterhouse survey on discount brokerage use and emotions. I noted that while DIY (Do It Yourself) investors may think they can go it alone, at least in bull markets, in these kinds of violently volatile markets, it’s as likely they will do it TO themselves. A fee-only or even fee-based advisor will likely more than pay for themselves just by acting as a sober second opinion and restraining the self-directed investor from succumbing to emotion-laden decisions at what may ultimately prove to be the worst possible time.
But fee-only planners do a lot more than just pick investment funds. Heath’s list includes tax planning and preparation, insurance needs analysis, estate planning and settlement, retirement planning and negotiating or advocating on behalf of clients.
In short, fee-only planners can help reduce both investment costs and taxes. As I argue in the other blog, no matter how knowledgeable a self-directed or DIY investor is, it’s extremely hard to overcome the emotions inherent in participating in today’s financial markets.
Fee-only is not an interchangeable term with fee-based
I think we’re in for several years of turbulent or sideways markets. If you can’t find a fee-only planner it shouldn’t be difficult to find at least a fee-based one. Remember, the latter charge a percentage of portfolio assets, typically between 0.75% and 1.5% a year. By contrast, a fee-only planner or advisor charges by the hour, monthly or year, or by the project: such as designing a financial plan or conducting a comprehensive portfolio analysis.
Scrutinize this web site as the months go by and you should be able to identify some of the country’s better fee-only planners with whom I’m familiar. Heath is certainly one of them. You may be able to find a video interview I conducted with him when we originally launched Findependence Day.
– 61 –
I’ll be talking about financial independence at the Toronto MoneyShow late Thursday afternoon this week: details here. In addition to describing the three key strategies underlying Findependence Day, I’ll be giving my view of the economy and markets in view of several books I’ve read late this summer: John Mauldin’s Endgame, Gary Shilling’s The Age of Deleveraging, Mark Steyn’s After America, The Little Book of Sideways Markets and a few others.
I’ll be describing how investors can prepare for flat markets and minimal growth by cutting costs through the use of discount brokerages and buying certain exchange-traded funds (ETFs), but still getting guidance from fee-based (or better yet, fee-only) financial planners. I’ll also look a bit at how ETFs can be used to hedge against market volatility.
The second half of the talk features a fee-only planner, Jason Heath of EES Financial, who also writes articles for the Financial Post.
The session is at 5:15 pm and the show is at the Metro Toronto Convention Center.
After, I’ll be selling (and signing) copies of Findependence Day: for just $10/copy since I’ll be passing on the savings on postage and handling.
After the talk, I’ll publish the text on this blog.
– 62 –