Straight Talk Investing

This Chapter was last updated on  Feb 10, 2024.

Unless they are good stock pickers, self-directed equity investors without a good fee-based or fee-only advisor should read the sub Chapters in Ch 5, to assist them in their equity strategy.

Until the mid 2000s most equity strategies focused on achieving double digit yearly gains, which were easy in the go-go 1990s. Then, 15 -30% annual returns were fairly common. The glory years were fueled by the great demographic bulge of baby boomers both: creating demand for equities by shovelling money into their pensions,  U. S. 401ks and RRSPs, thereby bidding up equity prices; and also by favourable world-wide economic growth, resulting in solid profit growth for most good companies. 

But sadly, the great demographic bulge of boomers are now starting to retire, so the “good old days” may be over, but too many of our popular investing strategies refuse to acknowledge the new demographic reality. One very good investing philosophy, which is attuned to the new reality, is dividend investing.

My Newsletter at StraightTalkInvesting.ca features  a well diversified portfolio of 20 Dividend Achievers (and often a few REITs) as one component our equity recommendations, typically for at least one half of an investor’s allocation to equities. (The other component is comprised of  momentum/ growth ETFs for the more aggressive (risky) part of our equity portfolio; typically no more than one-half).

Chapter 5.4  Index ETFs; “Lazy”, “Sleepy”, and “Couch-Potato” portfolios of Equities.

Because the hidden MER charges in equity mutual funds are often 1.5% – 2.5% per year, a number of well meaning journalists and bloggers have recently begun to promote the advantages of lower-cost index equity ETFs.  Exchange Traded Funds (ETFs) are a newish (and better) cousin to mutual funds, and many (but not all) are “index” funds, in which the manager simply picks all of the stocks in one of the several published “indices” (or baskets of “similar” stocks).  A well-used Canadian benchmark is the TSX Composite Index, which represents the whole TSX, and is widely considered to be an appropriate benchmark for the whole Cdn stock market.  Such “passive” or index funds are recommended by many bloggers, instead of “actively managed” mutual funds (and some ETFs), in which the fund manager “actively” attempts to select “good” stocks for the fund, because most index-ETFs have much lower MER charges than most active mutual funds – in one case as low as .05%. So far, so good.

The “lazy,” “sleepy” and “couch-potato” index-only-portfolio advocates all choose and publish a handful of “broadly based” index ETFs or Index Mutual Funds to hold “forever”.  (This is the basis for their names). They thereby enable their followers to be identically or similarly invested.

These blog advocates correctly point out that most mutual fund managers do not consistently beat an “appropriately” chosen “benchmark”, or index. But the misguided conclusion they draw is as follows: “if most professional mangers of mutual funds can’t beat an index consistently, any non-professional retail investor also has a low probability of doing so”; and the theory goes, “the best we non-pros can hope for is to mimic an index, get mediocre results, and forget vainly trying to beat our chosen benchmark or index”.

The potato-zealots call this the “science of numbers”.  But their theory only has merit if one compares couch-potato performance to the long term performance of broadly based Mutual Funds held forever, which will have poor performance because of the hidden 2% MER charge which kills their performance, and because of the other reasons set forth in Ch 5.5. The couch potato theory of “mediocrity is best” breaks down in comparison to any good dividend portfolio, or any good ETF picker who can successfully pick good narrower sector/ industry specific ETFs, — (like high-tech at certain times; or country specific funds) — based on their recent price increases/ price momentum, and who then hold them for only 3 months, or for so long as they out-perform.  (See the next chapter).

The potato theory “worked” to some extent in the 1990s when all funds went up by double digits most years; but to my mind these potato-worshipers are unnecessarily limiting their arsenal, for the reasons set forth in the last and next Chapter. They are stuck in the glory years of the 1990s, when the baby boomers were creating demand for, and causing price increases in equities, and driving up almost all equities, almost all of the time. It takes a rising tide like the 90s to lift all broad indexes, but the index-zealots refuse to believe that the go-go 90s, and the glory years are probably behind us.

The proof is that these couch-potato portfolios have achieved a very modest rate of return on the equity part of their portfolios for over a decade.

Another huge problem with the potato-zealots is that they tend not to clearly differentiate between Equities and Income-Generating  investments, so as to allow an older investor (or one with a different risk-tolerance) to easily modify their portfolios from the ones chosen by these 20 and 30-somethings, who are the biggest couch potato advocates. 

Worse yet, the potatoes all stupidly still advocate government bond ETFs for most of their income allocation. GICs pay better than governments bonds, and bonds will lose money as interest rates rise from their present crazy-low level. But sadly, the potatoes are zealously stuck on never changing their investments, no matter how extraordinary the interest rate environment. Why? Good question; probably because they worship the first advocate of Index Investing, Vanguard’s index fund salesman Jack Bogle (an American), who wrote the Potato Bible.  Moreover, Vanguard only sold mutual funds, and now ETFs, and the Potato Bible therefore ignores GICs, which should be one pillar for most life-veterans. They also ignore: MICs, REITs, and  dividend achievers. For the potato gospellers, these investments must be ignored in their zealous devotion to Potato worship/and the investments Jack Bogle sold.

That said, the one advantage of the “couch-potato” portfolios is that they are free to copycat. These portfolios are typically re-balanced every 3 months, with an investor selling a portion of those ETF funds that have increased in value, and buying more of those that have fallen, to get back into balance. (This would take no more than an hour or two, 4 times a year).

Chapter 5.5    Dale Rathgeber’s ”Momentum ETFs, Plus Dividends Strategy”

As noted above, in Ch 5.4, I believe, like the couch potatoes, that index ETFs are a very good building block for up to one halfof the equity portion of most portfolios. Apart from the at least one-half of my equities devoted to dividend payors, I like and use equity ETFs extensively, but not exclusively, like the index-only portfolio advocates. I believe that the index zealots have unecessarily imposed a rule on themselves that they will never invest in a Sector or country specific ETF, or dividend paying stocks, and thereby stupidly limit themselves to a few broad based index ETFs, including bond fund ETFs, which will lose money as interest rates rise, and which they MUST HOLD FOREVER, REGARDLESS OF POOR PERFORMANCE.

In their rigid dogmatism, many index–only advocates have wrongly converted, “most mutual funds don’t consistently beat an index” (which is true), into “NO SMART INVESTOR CAN EVER CONSISTENTLY BEAT AN INDEX,” (which I know to be untrue, and which my Newsletter has done since 2002). See Appendix 5.5 for the full academic discussion of how and why.

See also my year by year returns since 2002 in the Chapter called “the Newsletter,  which have averaged 11% per year, compared to the couch potatoes and their very modest returns, with more losses to follow when interest rates rise, and their bond ETFs plummet.

Part of the reason for the good performance of my Newsletter was that we cashed out of our equities every Sept and Oct to miss the typical autumn market meltdown, which tends to happen 70% of the time.  But the bigger reason for our success was the “ price momentum” aspect of our Newsletter Strategy. Index-only potato worshipers won’t admit this fact; but in many circumstances a smart investor can easily find soaring Index equity ETFs in certain industry-sectors, (like tech at certain times, or country-specific-funds with recent solid gains/price momentum), which upward price momentum is likely to continue for at least the next 3 months.

How do we do this even though the majority of  potato advocates say that it is impossible?  Read Appendix 5.5 closely.  But in short, our economy and markets continually move in cycles, and narrow industrial or country-specific cycles — (and the sector ETF funds that invest in them) — tend not to reverse their cycles suddenly, and dramatically over the next 3 months.  For the riskiest (non dividend) momentum component of our equity portfolio, we  invest in ETFs for 3 months at a time, based on their  performance in the preceding 3 months.  Investing based on momentum thereby tilts the odds in our favour, because we can pick the sector funds that are out-performing in any investment cycle, and then sell our hot ETFs when they turn lukewarm or go cold. 

Although most fund managers are not allowed to invest outside of their chosen industry or country;  we can, (and do); and that is one reason for why so few mutual-fund managers do well from one calendar year to the next. But we are not as limited as one particular fund manager, and we are allowed to find the out-performing ETF funds, from various different industries or countries, from time to time; we then only stick with them for 3 months (or longer, until they turn luke-warm or cold).  To borrow a sports/probability/coaching analogy;  for up to 1/2 of our equity portfolio, we are like a hockey coach using a “hot goalie” in the playoffs; come next season, we may well have chosen a different starting goalie. That is our “secret”.

Moreover, most of the index buy and holders say that transaction costs with a momentum strategy are too high — that is no longer true with deep discount brokers charging $5 -$10 per trade.

So, the studies that say that last year’s “hot”  funds do not stay hot for another whole 2 calendar years are both true, and irrelevant to what we do.   We don’t pick “last year’s” hot ETF funds, and we don’t necessarily keep our ETFs for “years”. These studies are always cited by the “buy and hold/ignore” advisors who do not like paperwork that we generate 4 times per year.

That said, Momentum investing isn’t always a perfect predictor of future 3 month performance; some trends do uncharacteristically reverse abruptly. Momentum doesn’t always pick all of the future winners all of the time. But it does predict most of them, most of the time. Although we have picked a few dogs, our stars have typically outshone our dogs by a wide enough margin that momentum has been a very successful strategy for us — 11%, per year since 2002.

The “tricky” part of momentum investing is to identify, and stay away from, certain types of funds, like hedge-funds, leveraged funds, and some fund managers who have a history of such wild short-term fluctuations that they should be avoided. This is where I think I add value; by knowing which wild-swingers to avoid. That said, I believe that others could, and probably do replicate my results.  I don’t claim to be the most brilliant investor in the universe; and I didn’t invent Momentum Investing or Autumn Abstinence. All I have done was to weave these pro-active, sensible probability strategies into a format which works to keep transaction costs down. Recall again that momentum ETFs represent no more than one half of our equity portfolio, with at least one other half devoted to less risky dividend payors, as per Ch 5.3.

At my StraightTalkInvesting Newsletter, we do a portfolio review with significant equity fund changes in early May, February, and again at the end of October. Investors should also “fall-out” of their non dividend stocks for the treacherous months of Sept/Oct. The downside of this strategy is that one must do an hour or two of transactions 4 times per year.  My buy recommendations are clearly stated,  such as “buy this ETF for 10% of your ETF portfolio, and sell that ETF, etc”; and I never use vague weasel-words.  Momentum selections comprise up to one-half of our recommended equity portfolio. The other part of our equity selections are dividend achievers, which are held for as long as they perform — typically a few years.  See chapter 5.3 for how and why dividend achievers are important. 

Moreover, I always invest 100% of my family’s portfolio in exactly the same manner advocated in each newsletter.

You can sign-up for an introductory 2-issue subscription for $50, including GST.  To receive a trial subscription, send a cheque payable to Dale Rathgeber at 44 Coopers Heights, Airdrie Ab T4B 2S1. Please put your email address on the cheque, and give us the name of your broker, so that we can be assured that you have a discount broker who will not charge you exorbitant fees for implementing our strategy. (See the list of good discount brokers in Chapter 2.1; note again that if you need to switch to a discount broker, they will do all of the paperwork, and that you need not confront your present broker or advisor). The regular subscription price is $400.

Chapter 6:  Niche Equity Investing topics that deserve to be discussed summarily; Leverage; The “Smith” maneuver; Options; Annuities; Hedge funds; Tax shelters; and Charitable Super-Write-offs.

This grab-bag of topics, which will be of interest only to “keeners,  is mentioned here for the sake of achieving comprehensive completeness in this manual. These topics are discussed as several sub-Appendices to Chapter 6, at the very end of the manual.

THE END OF THE MAIN PART OF THIS MANUAL

The main part of this manual is now complete, and many investors will conveniently skip or skim anything more, except for retirement planning in Appendix 1.1, unless they were keenly interested in the topics discussed summarily in the manual, but dealt with in more detail in an Appendix. The various detailed appendices follow below.

My hope is that you save and plan well, and that your plan and investments both: provide for a long retirement; and also allow you to sleep well.

Dale Rathgeber, BA.(82), JD (1985).   All copyright and proprietary rights reserved by the author; short extracts may be copied without permission.

APPENDIX   to CHAPTER 1.1;      Free Canadian Retirement Income Calculator.

The further away you are from retirement, (ie 20 – 25 years) the more “rough” your data and goals can be, and/or the less anxiety you can feel about glossing-over this step for a few more years. That is, if you are less than 40 (or perhaps 45), you can probably get away with “ballparking” your projections. The closer you are to retirement, the more precise your data and Plan should be.

Computers are great for generating  a decent set of retirement calculations, and your “how-much-is- enough to retire?” number (or sets of #s). Accordingly, I believe that you can now conveniently ignore all of the “How Much is Enough?” and “Can I afford to Retire” Books and Moneysense articles — (and their esoteric debates about whether a 4% “draw-down” rate is more prudent than 5%) — because the best retirement planning method now available, for anyone who can use the internet, is to spend at least a few hours with some sophisticated retirement planning software, to ensure that you are “on track”; (and if not, how you can get back “on-track”). For example, the “good” software calculates your CPP and Old Age Security benefits for you, and uncomplicates what was formerly a minefield in Planning-the-Old-fashioned way.  If you are many years from retirement you can use the Government of Canada’s free “Canadian Retirement Income Calculator”, but it isn’t good on tax and isn’t good enough for your post retirement drawdown plan.

Before you launch into plugging numbers into any  program, in order to get it to perform its “magic”, you need to do some leg-work to plug realistic data into the program. Otherwise you risk a “garbage-in/garbage-out” projection of how much you need, and when you can retire.

Keep in mind that the whole process of retirement planning is an exercise in probability forecasting, — which is a fancy way of describing fortune-telling, or predicting the future. You will never definitively “know” (with exact certainty) your:  exact date of death, or future rate return, or inflation; but that should not stop you from doing the best you can with realistic projections. Otherwise, you increase the risk that you will retire too early, based on what you want to achieve, and/or increase the risk that you will spend too much and thereby run out of money in your retirement.

Unless you are uber-wealthy, you can never completely eliminate these risks, but with careful planning you can reduce their probability to a low enough level to allow you to sleep at night.

Some silly commentators say that “the future is unknown; therefore all planning is a waste of time”. I disagree, and appreciate the anxiety-reducing comfort of thinking that I will “probably be OK”, based on a realistic Plan. Sound-sleep is one of the main reasons for undertaking this retirement-planning process, and for reviewing it periodically on your road to retirement, — (and indeed throughout your retirement), in order to modify your spending if need be.

Making a Retirement Plan is not a one session job. It is a process that needs to be reviewed and revised as life unfolds. To make your initial How-much-is-enough Number(s)/retirement-date-Plan, you will probably need a few sessions using the software in order to realize that you may need to do some further preliminary leg-work on budgeting (or on your employer pension) to get the software to work for your unique hopes and dreams.

You also need to “dream-build” with your spouse, — (ie, do we down-size our house/ do we buy a second property in Arizona?) — and re-do your calculations a few times to see what you would need to do differently to get “on-track” for your unique goals.

Many people would also benefit from doing 2 or 3 sets of calculations based on different goal lifestyles: ie, one for a luxury-retirement; one for the bare necessities; and one or more for something in between.

The main piece of information that you will need prior to generating anything meaningful from any software is your present budget, and how much of your present level of expenses will either: (1) fall away in your retirement, — (i.e. mortgage, expenses relating to children, etc); or (2)  perhaps increase — (i.e. we want to travel the world in five-star luxury).

Many 5-minute “quick and dirty” computer plans assume that you will “need” 70% of your pre-retirement income when you leave work. This 70% rule of thumb is dangerous  – because for many people 70% is “too much” (post mortgage and kids); and for many others 70% is not enough. – (especially for those who have eliminated their mortgage and kids’ costs, and now wish to take up 5-star golf holidays and cruises). Again, to get a reasonable Plan, you need to do some work on it, probably over a few sessions.

Also, don’t forget to add in a yearly contingency into your budget of at least a few thousand dollars for: house repairs, replacement vehicles and appliances, and any travel expenses, and  possibly a huge one-time contingency for a second property purchase, net of any down-sizing proceeds from your present house.

You should use today’s dollars, and their buying power, and the program will automatically take inflation into account.

Free Government of Canada’s Retirement Income Calculator

If you are using the free government calculator you need to make a plan for each spouse. You must therefor convert your retirement budget from after-tax dollars to pre-tax dollars, and to divide your budget # in half if you are married, before you make that conversion. To help you figure out how many pre-tax dollars you will need, you can use any one of hundreds of tax calculators on the web. Fidelity has one at Fidelity.ca/education/investment/Tax Centre. To use it, you need to work “backwards” and guestimate how many pre tax dollars you will need to fund your after tax budget, and press calculate to see what your net after tax income is as a result of your guestimates. (Remember, if you are married, you divide your budget in half, and do calculations for each of you and your spouse, if you are using the Government’s calculator). Ten or twelve rounds of backwards guestimating should do it. (Anyone finding a better website that does not require all this effort is asked to disclose it for the next edition).

You are now ready to achieve a set of retirement projections in the free government of Canada’s free Retirement Income Calculator— (which will also automatically tell you whether you are on track, and if not, a Plan for how much you need to save each year to get on track)– based on: various realistic rates of return on your investments, and post-retirement spending levels. To get there, you will use and “play with” the variables  to get one or more sets of “how much-is-enough?” plans using their inputs, which are quite intuitive. (But again, remember to do separate calculations for each spouse to properly deal with taxes, CPP, and OAS).

A big unknown is the blank for your “income required to age ____”  (which is a euphemism for your anticipated age of death). Using too low an end-age increases your “longevity risk” (that you will outlive your money). Therefore, planning for a long life of 90 or more is safer; (although many people who plan to 85 say that, “ if, and when they turn 85, they can ‘get-by’ on OAS and CPP, with zero remaining savings, because most travel and expensive fun is over”). There is some merit to this point; it all depends on how much “longevity-risk” you wish to take on. (Actuaries say that: at age 60, a man will typically live to 80; women to 84.  At age 75: a man will typically live to 85; a woman to 87). More importantly, if you are married, you can generally feel safer with lower end-dates, because the probability of both spouses reaching age 88 is only about 8%. You could drive yourself crazy trying to pick the “right” number; just know that as you progress through your retirement, you may need to reduce your expenditures, (and re-do your plan), if longevity seems to be smiling upon you.

Tweaking your return estimates, or inflation, by even a percentage point or two, and changing your anticipated retirement date or anticipated death by a year or two, all result in astonishing changes in the projections. Using any rate-of-return number above 6 percent is pure folly.  More realistic projections would be based on 5%, unless you invest only or primarily in ultra-safe GICs and bonds, — in which case 3% or 2% is prudent.

Remember again that planning conservatively tends to result in pleasant surprises; planning aggressively tends to result in unpleasant surprises.

The free program will show you the effects of inflation over time, by adjusting your spending upwards over time. It will also show you how many dollars you will have left at your anticipated death. You need not worry about your spouse’s needs if you have done a separate calculation for them; but if your combined nest-eggs at death are not what you would like for your other heirs, you need to re-calibrate either your spending needs or retirement age.

After you get a plan that is satifactory, your input data and the resulting data and graphs are are now officially a “formal Retirement Plan”.

A useful exercise is to do a second series of “fallback” calculations based on a few lower anticipated rates of return, and to match these up with your various “bare-necessities,” “luxury” and “middle-of-the road” retirement spending plans.

Note also, that if you are either planning on downsizing your house, and/or buying a second property in the Sun-belt or a cottage, don’t forget to adjust your non-registered assets accordingly. Do not include the purchase amount in “other non-registered assets”. This would be a huge, and possibly life-style-changing mistake. Another mistake would be planning to retire with a mortgage that you neglect to include in your post-retirement budget.

As a second-check on the validity of your “how much is enough number(s)?”,  you should compare your annual pre tax spending needs, with 4 or 5% of your projected total assets at retirement. If your annual pre-tax needs are more than 4 or 5% of your total portfolio at retirement, something is probably amiss in your projections. If you can’t make them align with this “draw-down-rule-of-thumb” from old-school planning, you may need to hire a fee-only (hourly) financial planner.

Lastly, after your Plan/Series of Projections comes into being, you need to periodically review and revise your inputted data as you move through life to account for, (and adjust your savings for): your actual rates of return; and any financial surprises that life throws you; — (such as an inheritance, divorce, or an unexpected major expenditure), — together with any goal changes as you move along life’s journey toward, and indeed throughout your retirement – at which time spending patterns may need to be lowered, or hopefully adjusted upward after pleasant surprises! This is what “experts” mean when they say that Retirement Planning is a “process”, and not a one-shot deal.

The remaider of the Appendices appear in Part 4.