Sunday, 17 July 2016

All banks or 1 bank portfolio

Recently I had somewhat of a reunion with old friends from way back in the day, it must have been close to 2 years since us 3 had a chance to sit down and just chat.  Eventually the topic of money, investments, RRSP, RESPs, etc came up.  Well both have been aware of my financial blog and one of them has been hearing of my speeches of money for I would say 4 plus years now.  My constant ramblings back in the olden days mostly consisted of the evil Mutual Fund MER.  Well to shorten the story, he took an investment course and the instructor even had worse things to say about Fees, Life Insurance, Investments, mutual funds, etc.  It literally opened his eyes, short of acknowledging my ramblings all those years, he has switched.  Well not completely switched.  "No more new money into mutual funds" was his final statement.  He's almost there.  He asked me if I am out of mutual funds, I answered completely.  He's almost switched over, he's shocked about fees.  Self directed accounts is all he has now.  I've explained my rational of dividend investing among other topics like technical investing (50 day Moving average, 200 day moving average, P/E ratios, etc).  Baby steps, baby steps.  If my ramblings open the eyes of someone in my circle and they save money, then I will keep rambling.

Onto my 2nd buddy.  Let's just say he works at a big 5 bank and leave it at that.  His major holding is guess what, a big 5 bank.  Now the question to me was, he has had contributions to his big holding for many years now and it has performed for him.

Before we get into this analysis,  I want to disclose that I own 4 holdings in the banks.  Bank of Montreal, Royal Bank, TD Bank, and Laurentian Bank.  And as consistent with my previous articles, I own enough shares to drip 1 share with the exception of TD, which I drip 2 shares every dividend payment.

Canadian Banks are unique that they operate in an oligopoly, where the sheer scale of them makes it hard for any new entrants into this sector of the economy.  This could be described as a moat in my forever stocks post.  The Canadian banks have many revenue streams, personal / business lending, investment banking (discount brokerages), wealth management, and auto, life, property insurance.  The banks have many years of growth over the years and have provided regular dividend increases.

Now some numbers, I will compare the 10 year, 5 year performances for CIBC, Coke Cola, and Enbridge.  I will compare this to the TSX performance for the same period.

On June 30 for the years 2016, 2011, and 2006 for CIBC, the stock price listed on yahoo finance is $46.74, $60.45, and $97.04  This gives CIBC a 5 year gain of 68%, a 10 year gain of 107%.

On June 30 for the years 2016, 2011, and 2006 for Coke Cola , the stock price listed on yahoo finance is $16.02, $29.02, and $45.33  This gives Coke Cola a 5 year gain of 56%, a 10 year gain of 182%.

On June 30 for the years 2016, 2011, and 2006 for Enbridge, the stock price listed on yahoo finance is $12.33, $26.87 and $54.73  This gives Enbridge a 5 year gain of 104%, a 10 year gain of 343%.

On June 30 for the years 2016, 2011, and 2006 for the TSX, the price as listed on TMX money is 11,612 and 13,300 and 14,04  This gives the TSX a 5 year gain of 5%, a 10 year gain of 21%.

Investors have bought bank stocks thinking they provide the best returns so why not put my life savings  and invest it into 1 bank or only 5 banks.  This means if you have life savings of $600,000 you will buy only CIBC or split it 5 ways into all the banks hoping for the best returns.  Now the 5 year and 10 year numbers I've gotten show that CIBC destroys the TSX which is the benchmark for all investors to beat.  The 10 year for the TSX is 21% while CIBC clocks in at 107%.  It isn't a fair contest.  But if you wanted the best returns, why not put $600,000 into Enbridge, their 10 year is 343% which triples CIBC's stellar decade.  But no one would ever dream about just buying Enbridge.  Same holds true for Coke Cola.

Now to avoid diversification by buying only 1 bank or only the banking industry is just dangerous.  Granted, the canadian Banking industry is well regulated but the 2008-2009 financial crisis showed that banks can fail.  They failed in the U.S. and can fail in Canada.  There is still risk.  There are too many what ifs.  What if the housing bubble bursts, what if the global economy slows, what if interest rates are rise too fast.  What if.

Studies have shown that to get proper diversification you need 18 stocks across 18 different industries to be properly diversified.  Owning just 1 or just 5 stocks seems super risky.

Mutual funds have been saying it since the beginning of time.  Past performances do not guarantee future performances.  So to answer my 2nd buddy's question.  Yes it is risky to only own 1 bank stock or even own just bank stocks.  But if there is an employer matching to your contribution then some of the risk is taken away but there is still risk.

As a shareholder, I hope bank stocks keep generating solid returns and raise their dividend but I would never bet my entire portfolio on 1 stock or 1 industry.  That's why I diversify with telecoms, large consumer discretionary stocks, food stocks, chemical stocks, REITS, cigarettes, etc.  This type of portfolio will hold up better in a downturn then 1 stock or 1 industry.

Monday, 11 July 2016

RRSP Bashing

I am sure at any BBQ, any brunch, heck even a good old poker game with the guys can generate conversations regarding money.  One particular topic that I have engaged in a few times this year already are anti-RRSP or RRSP bashers.  Yes, you are correct, there are more than I care to share, numbers of people who do not and will not ever, open an RRSP account.  They say they have to pay all that tax back.  They'd rather just spend that money now and have absolutely not a penny in savings except what they have in their savings or checking account.  I ask them what happens when you get to around 58 or 59 years old, and your salary is at $80,000 a year, what happens when you stop working for medical or some other reason.  Where is that $80,000 or even $50,000 a year going to come from for the next 10 years?  They say, it will work itself out.  Seniors living in poverty is not an idea I enjoy. Neither does the government, that is why they have given us RRSPs.

Anti-RRSP individuals will complain about how you can't use the lucrative dividend tax credit or how contributing to an RRSP would turn a tax free windfall into taxable income when taken out of the RRSP.  Also mentioned is how the 50% reduction in capital gains tax is lost.

This type of ideology stays alive, they can only think of the tax they have to pay rather than take the time to understand how RRSPs work.

So here will be a basic, simple example of how RRSPs work, this could be the last time but I doubt that, as RRSP bashers will always be out there.

Let's look at a simple example.

Assume an individual has saved $10,000 for the year and she's wondering whether she should invest it inside an RRSP or in a non-registered account, or worse, just spend it on something like the mortgage (this could lead to the house poor post I've done before).  We will assume her marginal tax rate is 40% and regardless of which account she chooses to invest in, that that stock triples in 20 years.

Would she be better off in a registered or non-registered account?

Before we get an answer to this question, the tax refund needs to be looked at.  Assume her employer deducts taxes from her pay cheque.  If she contributes $10,000 to her RRSP, she will receive a $4,000 tax refund, so that $10,000 RRSP contribution wouldn't actually cost her $10,000, it would cost her just $6,000 ($10,000 minus the $4,000 refund).

Stated another way, if her marginal tax rate was 40% then $10,000 inside an RRSP (which is pretax dollars) is equal to $6,000 in a non-registered account (which contain after tax dollars)

Now we can use these numbers to do a fair comparison.

First, investing inside the RRSP, the $10,000 would grow 3 times in 20 years to $30,000.  If she sells the stock and withdraws the money, she will pay $12,000 of income tax (40% of $30,000) and be left with $18,000 net.

Now, investing outside the RRSP, the $6,000 would grow 3 times in 20 years to $18,000.  If she sells the stock and withdraws the money, she will pay capital gains tax of 20% (half of 40%) on the $12,000 which is the difference between her purchase price ($6,000) and sell price ($18,000).  After deducting $2,400 in income tax, she is left with $15,600 net.

Winner winner chicken dinner.  RRSPs win.  The return in the RRSP setup is better.  Notice that the difference between the RRSP and the non-registered totals ($18,000 versus $15,600) is equal to the capital gains tax ($2,400).  Far from losing the 50% capital gains reduction, the RRSP avoids capital gains entirely.

With an RRSP, the only tax is on withdrawals.  Bashers love to complain about the tax on withdrawals because it looks so large, but really its just the original tax they deferred plus growth of that tax over time.  As the example above shows, even after pay tax on withdrawals, the RRSP investor still wins.  If an investor's marginal tax rate is lower in retirement, the benefits of the RRSP are ever greater, go ahead, try the withdraws at 30%, and watch how much tax you all be saving on withdrawing $50,000 or $60,000 a year.

You will soon see that the RRSP Bashers are really bashing their own head with the money they are losing in tax savings.

Sunday, 3 July 2016

Forever stocks

Forever stocks.  My take on forever stocks.

I'll start with with a Warren Buffet quote, " Our favourite holding period is forever"

Forever stocks are stocks you can buy and hold forever, that is how strong they are, you do not need to worry about their performance, they will come out in the end forever, they will go down but in the long term (forever perhaps), they will outshine most things in the stock market and even beyond.

Let me introduce my criteria for picking forever stocks.  It's not as hard as you think.  There are a lot of other factors and criteria out there in the selection process but here are 2 very easy initial screeners that anyone can use.

1. Increasing dividend payouts

2. Moats

The first indicator which I have touched on in past blogs is easier than you think.  My go to place to see dividend payouts and to see if they have increased over the years is Yahoo.  That is correct, a simple yahoo search is 1 minute away.  The path is simple, go to, then to yahoo finance, then type in your ticker.  click look up, click historical prices and then finally dividends.  It will show a perfect shap shot of the dividend payouts.  Now increasing dividend payments is not enough to show what a forever stock should be.

Moat is exactly what you may think.  A moat around a castle, making it hard for an enemy to breach the castle wall.  In investing language, it means either an economic, brand, or management moat.  A company needs to protect itself from competition.  A moat makes it harder for another company to steal your earnings that you have worked so hard for. An economic moat means that it would be hard for a company to encroach on your earnings simply because it would be economically hard for them to match or exceed what you have done so far.  A brand moat would be simply the name of the company, that is so recognized that it can succeed simply on brand recognition.  Management moat would indicate that management has been able to succeed no matter what conditions the environment can throw at them.

One example that I can show you how it works is Coca Cola.  Yes that old soft drink that is at war with Pepsi.  Coke Cola has the ability to thrive for 100 years or in our case, forever.  It's a simple business that is big, and I mean big, globally in fact.  This is the economic moat, this business will not excite most people but it's stock price will rise with profits.  If someone was to challenge them, Coke Cola will simply buy them out with their deep pockets.  Economic moat.  The distribution network for Coke Cola is so vast that it encompasses almost the entire world.  Most North Americans will probably never of heard of the 3,500 different drinks under the Coke label but tishe main brand, the iconic red can, Coke Cola is a brand moat all it self.  Management has kept the profits and the business running with dividend increases for 50 years now.  Check it out on yahoo, it's true.

So with the these moats and dividend increases, it's no wonder you can consider Coke Cola a forever stock.

Disclosure: I own Coke Cola shares.