June 2020 Update

Investing takes patience, vision, and reflection.

Patience, because more often than not, there is no “quick money”. There isn’t a big score to find, so the best way is to invest frequently, steadily, and build up your capital over time.

Vision, because an investor has to have a goal, to know where they are going. My investment goals are not the same as your investment goals – I may have three kids, a dog, and a pool, and only need $2,000 a month to live because my spouse makes more than me and we live in a lost cost of living area. Conversely, I may have no kids, a spouse who makes less than me, prefer to drive high end automobiles, and live in a high cost of living area, so I need $6,000 a month to live. Everybody’s vision of where they need to be is different.

And finally, investing requires reflection. One must always be reviewing the portfolio—but not obsessively—to ensure that they are still on the path they started out on. More important: they must ensure that the path they started out on is still the right path to be on. Life changes, and as such, your vision should change. It is only with reflection—on your investment results, and your investment needs—that you can determine how well, or poorly, you are doing as an investor.

The first two items I have been doing fairly well at. While I have not published a portfolio update in nine months (the last being in my September 2019 update), I have been patiently investing my cash, and my vision has not changed. But what I have failed to do is monitor and reflect on my portfolio. This is even more important now, given the current state of the world, and the economy. But part of publishing a portfolio update is that it forces me to reflect on how the portfolio is doing, and the results of my investment decisions. And that brings us to today…how have things been going?

As to be expected, the first half of 2020 has been abysmal:

Monthly Performance Summary as of June 2020

The COVID-19 issues in February and March sent the markets into a tailspin, and it has taken me four months to get the total portfolio returns back to a point where I am exceeding my benchmark: June 2020 had a 2.2% return vs. the benchmark 1.5% return. Things look even worse when reviewing the trailing twelve month returns:

TTM Performance Summary as of June 2020

The benchmark has been beating me handily, with total fund hovering around a 5.0% loss for the 12 months ending June 2020, vs. the benchmark yielding a 3.0% gain during the same period. The biggest laggard is my tax free account, with the biggest drag being High Liner Foods which is sitting at -47%. High Liner has been having a hard time recovering since they cut their dividend earlier this year.

However, total fund income is only one dimension of measuring performance. First and foremost, I am a dividend investor—nay, a dividend gangster! My focus is on passive income, so regardless of how well I am doing from an overall returns perspective against the benchmark, what I really care about is how well my passive income is doing against the benchmark. Put another way: have my investment decisions for the total fund beat, or been beaten by, the passive returns if I had only invested in the benchmark?

Income TTM Variance Percentage as of June 2020

Looking at the trailing twelve months, I have beaten the benchmark, and that is the true measure of success. So for every $100 I would have made in the benchmark, my own portfolio made $117 (+17%), over the past twelve months. Reviewing the past year, every month I have beaten the benchmark on a trailing twelve month basis.

The only other item of reflection is my asset mix:

Total Fund Mix as of June 2020

As of mid-year, I am still overweight in equities, and all other asset classes are well below target. With that in mind, over the next few months my focus will be on investing in Vanguard’s VRE.TO REIT to increase my exposure to that asset class.

In summary:

  • Total fund performance has lagged the benchmark on a trailing twelve month measure
  • Over the same period, total fund passive income has exceeded the benchmark by 17%
  • The total fund is still underweight in the fixed income and real estate asset classes

Even with the sub-optimal allocation and the current state of the economy, given that passive income is still exceeding the benchmark—even with the dividend cut of High Liner Foods and CAE Inc. (discussed here)—I’d consider the past nine months a success.

Onwards and upwards!


Staying on the FIRE Path

One of the greatest challenges of investing is keeping the long-term plan in sight. If you are like many investors who are on the FIRE path, then you are probably reading blogs on a regular basis, watching financial TV shows, listening to podcasts, etc., to keep abreast of things. Constantly submersing yourself in media is a recipe for the fear of missing out (or “FOMO” as the kids call it these days). However, keeping your long-term goal in view will help you to properly avoid these fears and keep you on the FIRE path.

Over the past few years I’ve seen a number of hot topics, and seen a lot of people make quick money. Two key areas that have constantly crossed my path have been bitcoin (or any coin or ICO based off of blockchain or some derivative), and marijuana stocks. I have read about many folks making tonnes of money off of bitcoin, and when I overheard someone who works at my local cafeteria talking about it—and how she leaves her computer on all the time to mine bitcoin—I knew that bitcoin had hit the mainstream.

Many of my friends also ask me about marijuana stocks. I personally know of at least one person who made over 100x her money by buying penny stocks in the marijuana sector a few years ago, and those stocks are north of $5.00. If you buy for $0.10 and sell for $5.00 you’ve made a 4,900% (yes, four thousand nine hundred percent). To rub salt in my FOMO wounds, she put the money in her tax-free account, which means she walked away with not having to pay any capital gains taxes.

My view is that folks who make tonnes of money off of early trends/hype such as bitcoin or marijuana are either incredibly patient, have a very strong stomach for the potential of losing money, or are incredibly stupid. Of course, one view is that you should always have “play money” for your investments. E.g. if you say that you’ll spend $100/year on any stock you want, you can probably have some fun playing with penny stocks or bitcoin. Heck, you may make a hell of a lot of money. However, for the most part I see a lot of people being sucked into hype because they do fear missing out on the next big thing, on the next “dot com” craze, or some other fad.

For myself, I have a long-term plan, and to support that goal I’ve got several goals and sub-goals, to help keep me on track. Of late, one of my tactical goals is to improve my asset mix. As I mentioned in my previous quarterly update, my focus over the next six months will be to increase my real estate exposure, which is just over 10%, a far cry from my nominal target of 20%. I consider myself disciplined in that I have an investment strategy at hand that forces me to avoid things like bitcoin and marijuana stocks (however, I have been toying lately with allocating 0.10% of my portfolio towards “fun stocks”, which would open me to up being able to invest in anything just for kicks).

However, even when ignoring hype stocks, by my listening to podcasts, reading, and compiling The Dividend Gangster dividend list, I have been exposed to several interesting companies. For example, one company which recently caught my eye is MTY Food Group Inc. (covered in my July 20, 2018 dividend update). The company recently agreed to purchase sweetFrog Premium Frozen Yogurt. The firm also has a fairly solid (albeit short) dividend history with some consistent increases, and depending on the valuation model it is may be considered undervalued. Seeing companies like this ignites a FOMO reaction, and makes me wonder if I should buy some shares of MTY to get in on the ground floor before it shoots up even higher in value, or makes its next dividend increase.

But it is times like this when discipline and keeping your eyes on the long-term goal—sticking to your plan—is most important. I could certainly go out and buy some MTY next week when I make my bi-weekly stock/ETF purchases, and buying it would certainly satisfy the itch of adding another company to my portfolio, and a potentially strong dividend player at that. When I look back at other companies I could have purchased “for a steal” (e.g. I was originally looking at Lassonde when it was $100/share, and it is now north of $200; or Canadian Tire at $90 and it is now north of $160) but didn’t bother, I am reminded of opportunities I missed out on. That said, purchasing common equity would push me further away from my tactical goal of re-balancing the portfolio by building my real estate exposure.

The simple reality is that capital (for most of us, that means plain old money) is a limited resource. To quote one of my professors, strategy is the “allocation of scarce resources”. Within that context, strategy in investing is the allocation of scarce capital, i.e. the money you have to spend. There is only so much money to go around. And when I view my portfolio in that context, the need to balance my portfolio to reduce overall risk by sticking to my target allocation outweighs the need to scratch the investing itch by finding a new company to add to my holdings.

So, when friends and peers ask me about a hype stock (bitcoin, marijuana), or even a non-hype stock (should I buy some BMO for my portfolio?), my first question back to them is, “What are your long-term goals?” If a stock—hype or otherwise—makes sense to add to a portfolio, by all means, do so. But only if it makes sense. Buying to follow the crowd because you’re sacred of not making the quick money is one of the furthest things form investing strategy I can think of.

Onwards and upwards!


Leaving Money on the Table

I spent Sunday helping out my brother in organizing his finances. He joined a major Canadian corporation a little over 11 months ago, and is approaching the point of vesting for his defined contribution pension plan. Within this context, vesting means that his employer will start matching any pension contributions he makes, subject to certain rules and maximums. This is a very common investment vehicle available to Canadians: many companies do not have Defined Benefit (DB) pension plans anymore, opting to provide Defined Contribution (DC) pensions instead. As an incentive for employees to save towards retirement, companies that offer DC plans often provide a “match”. A “match” is a provision wherein the employer will match any contributions an employee makes, subject to certain conditions. For example, one company I know of offers this match structure:

  • Match 100% for the first 2% of contributions
  • Match 50% for the next 2% of contributions
  • Match 25% for the next 2% contributions

In the above, the “2% of contributions” means 2% of the employee’s salary. A more concrete example would be as follows: Assume an individual makes $40,000/year, and wishes to maximize her employer match. The numbers would add up like so:

Employee contribution %

Employee contribution $

Employer match %

Employer match $

2.0%

$800

100.0%

$800

2.0%

$800

50.0%

$400

2.0%

$800

25.0%

$200

As you can see above, the employee contributed $2,400 of their salary, but the employer contributed $1,400. This means that the employee received an instant 58% return for doing nothing! This is quite literally free money: your employer is giving you an instant top-up as incentive to save for your own retirement. Let’s take the example a little further: assume someone starts working at age 30, works for 35 years to age 65, and maximizes their contributions every year. Moreover, assume they get a 1% raise every year. If we plot this example over the duration of the person’s employment, the difference—while still a 58% gain—is even more pronounced.

By the end of 35 years, the employee would have contributed $103,000 on their own, if they had contributed 6% of their salary. But, thanks to the employer match, their effective contribution was $164,000! They have received an additional $61,000 all for doing nothing.

However, when an individual contributes to a plan such as the above, they don’t just save the money; they typically invest in mutual funds which are made available to them through the DC plan. We can modify the above graph to show the theoretical balance at retirement, assuming 2%, 4%, and 6% returns on the investments.

Again, there was a 58% gain when you compare the Employee only to the Employee and Employer Match:

Employee Only

Employee + Employer

2% returns

$146,188.44

$231,464.99

4% returns

$194,337.71

$307,701.37

6% returns

$322,391.14

$510,452.58

The astonishing thing is that many people don’t take advantage of the employer match that is offered in their pension plans (here is an interesting read from the Financial Post). This means that there are people who are literally giving up free money. Often some people say that the reason they don’t do this is that they can’t afford to contribute money to their company sponsored pension plan, because that means that they will have less money paycheque to paycheque. To that, I have a couple of comments:

  • If you are truly living paycheque to paycheque, then there are more systematic issues at hand that you need to look at; you really need to sit down and plan out a proper budget for yourself.
  • You really can’t afford not to take advantage of a pension plan: if you don’t save now, then you will ultimately have to work longer later.
  • Contributing to your pension plan is a tax-advantageous activity: meaning that if you wish to contribute $500 to your DC pension plan, your effective contribution is lower because your taxes will be lower; I will be writing about this in a future blog post.

So there really is no reason not to contribute. Imagine this: you are walking home and there is a fork in the road to go around a building. Both roads from the fork lead you to the same place at the opposite end of the building. From your vantage point, you can see a $20.00 bill lying on the ground up ahead on the road to the right, and on the road to the left, you can’t see any money lying around. Would you take the fork to the left? Of course not, you would be foolishly ignoring money that was just lying around. Your pension is the same: don’t take the road of no contributions, but take full advantage of the free money your employer is willing to give you.

Onwards and upwards!


Minimizing investment friction

Over the years, I have started to pay more attention to friction in my portfolio, which I define as any charges, fees, or penalties, which ultimately deter from my earning potential. When I am making decisions to buy/hold/sell investments, there are three primary types of friction I pay attention to, and try to avoid: Tax Friction, Rounding Friction, and Commission Friction.

1. Tax Friction

Taxes are a reality, and ultimately the tax man (or woman!) always gets his (her) due. In Canada, there are three key types of taxes to pay attention to with your investments. The first, is the capital gains tax, which is applied on any capital gains (i.e. profits) from your investments when you sell them. Following this, is taxes on dividend income; and finally, there are taxes on interest income.

There are a number of ways to reduce tax friction with your investments. The most obvious one, is to keep your investments in a tax free account; in Canada, this would be your TFSA, otherwise known as a tax free savings account. Any capital gains, dividends, or interest, you receive in the TFSA are received tax free. The reason for this is that any contributions you make to a TFSA (i.e. money or investments transferred into the TFSA) are made from after tax dollars, so you have already been taxed on the inflows to the account. The one downside to using a TFSA is that you cannot use capital losses incurred in the TFSA to offset capital gains outside of your TFSA.

The second vehicle at your disposal is to keep your investments in a tax deferred account, e.g. your RRSP. Similar to your TFSA, any gains, dividends, or interest, or not taxed in the account (well, not immediately; see the second key difference below). Moreover, any losses cannot be used to offset gains outside of the RRSP. That being said, there are two key differences between a TFSA and an RRSP. The first difference is that contributions to your RRSP lower your taxable income in the year in which you make the contribution1. As an example, say your salary in 2016 is $45,000, and you contribute $5,000 to your RRSP. This lowers your taxable income to $40,000, which means that your income tax for the year is on $40,000, not $45,000. Taking this even further, if you review the marginal tax rates for your province, you may actually move yourself into a lower tax bracket. In the example we just cited, in the province of Ontario, at $45,000 your marginal tax rate is 9.15%, but at $40,000 your marginal tax rate is 4.05%!

The second difference is that you are taxed when you take money out of the RRSP. The theory is that when you take the money out however, you will already be in a lower tax bracket. So while you may be in a $45,000 tax bracket today, when you take the money out when you retire, you will likely be in a lower tax bracket. Again, by forcing yourself into a lower bracket, you are ultimately paying less tax (and keeping more money in your pocket!).

The third way to reduce taxes is to leverage your capital losses against your capital gains. This option is only available to you in a non-registered account (e.g. not a TFSA and not an RRSP). With this reduction, you reduce the amount of tax you pay on your gains by your losses in that year. For example, if you sell a stock for a profit of $10,000, and you sell another stock at a loss of $4,000, you will only pay tax on $10,000 -$4,000 = $6,000. In general this applies provided you claim the gain and loss in the same reporting period (or carry forward any losses and/or gains to future years); seek advise from a tax professional for details.

2. Rounding friction

Rounding friction is exactly what it sounds like: losses due to rounding. As an example, assume we are able to trade stocks with no commissions, and with no tax friction (e.g. in our TFSA). For our example, say there are two companies, A and B, and we wish to sell company A and purchase company B, because the yield on B is higher:

Line # Company A Company B Notes
A # shares 100 20
B share price $12.34 $59.80
C total value $1,234.00 $1,196.00
D dividend yield 5.00% 5.10%
E dividend $ $61.70 $61.00

After we have completed all of our trades, our absolute dollar return is less even though Company B is the higher yielding stock. The reason for this is that we cannot trade fractional shares. When we sold Company A and took the proceeds of $1,234.00, the proceeds divided by the price of Company B would have had fractional shares: $1,234.00 ÷ $59.80 = 20.635 shares. But, since we can only trade in whole shares, we lost out on 0.635 shares. Even if we take into account the residual cash from selling Company A (i.e. the cash leftover from the trade), our net value is still less. Note that this is only in Year 1, however in subsequent years your net dividend income would still be lower as well with Company B due to the loss of 0.635 shares.

Line # Company A Company B Notes
A # shares 100 20
B share price $12.34 $59.80
C total value $1,234.00 $1,196.00
D dividend yield 5.00% 5.10%
E dividend $ $61.70 $61.00
F Cash in Lieu n/a $38.00
G Net Value $1,295.70 $1,295.00

The only way to get around this is to either luck out and fund companies where the net proceeds of the first will exactly pay for the net cost of the second, or to purchase fractional shares. Luckily, there are ways to perform the latter. If one uses Optional Cash Purchases for companies that allow it, you can purchase any number of shares, and the the total shares purchased will be exactly equal to the amount of capital divided by the going price for the shares.

3. Commission Friction

The most common type of friction, and often one of the hardest to avoid, is friction caused by commissions on your trades. As investors we are all familiar with commissions, and they are a cost of doing business when investing.

Other than choosing a (discount) brokerage which has very low commissions (Personally I use BMO InvestorLine, which charges $9.95/trade), to my knowledge there are really only two ways to get around commission friction.

The first, is to use Optional Cash Purchases for those companies that allow it, and that do not charge commissions on OCPs. Not all companies that offer OCPs do so commission free. For example, the McDonald’s OCP program charges $6.00 per share, whereas the Emera OCP program does not.

The only other way to reduce commission friction is to trade in larger quantities of stock, thereby reducing the average commission. For example, if you purchases 100 shares of a stock at $9.95 commission, your average commission per share is only $0.0995. But if you were to purchase only 50 shares, your average commission would be $0.1990. While you are not completely eliminating the commission, you are reducing it on an average basis.

Onward and Upward!
-pmp
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1 This isn’t exactly true. See a tax professional, but you can may be able to defer your contributions to a later year, hence reducing taxes in a later year.