The Equal-Weight ETFs from BMO

Market-Cap Weighted or Equal-Weighted ETFs?

First Published: ADawnJournal.com May 30, 2010

Buying exchange-traded funds in Canada got much easier thanks to BMO Financial Group and the release of eight different ETFs that are equal-weighted and three that are currency-hedged. These two different types of ETFs are part of a key strategy by the Bank of Montreal to help set itself apart from ETFs that are put out by iShares and Vanguard, which currently dominate the market.

The currency strategy uses hedging to hedge foreign funds back into the Canadian dollar and this has actually been used quite a bit by iShares and Criterion Investments, which focuses only on currency hedging. However, that is not what is putting the Bank of Montreal in the papers these days; equal-weighting is.

Critics of ETFs say that market-cap weighted funds created high concentrations of large-cap stocks that are often over-valued. When the large-cap stocks get more and more overvalued, there is a greater weighting on them in the fund and that creates a higher risk for investors who put their money into the ETF. However, according to BMO, equal-weighting prevents this and therefore makes investing safer for ETF investors. How it works is if the top 10 stocks on the TSX represent 40 percent of the market cap of the index, equal-weighting puts every stock at the same weight no matter how large or small the market cap. That means that if there are 50 stocks on an ETF, each stock has a two percent weight within the stock.

However, BMO is not the only ones who offer the equal-weighted ETFs. Claymore Investments also offer them and the company states that it helps investors avoid overweighting overvalued stocks and underweighting undervalued stocks. Critics of the ETF state that often happens, as we have said, with ETFs that are not equal-weighted.

Exchange-traded funds are often looked at as a safe investment for many investors because with these you are not trying to beat the market, but instead just mirror the index. Too many times investors want to beat the stock market and that leads many of them down a road to ruin. With exchange-traded funds, even those that are not equal-weighted, there is a much safer path to go down. No, you do not make as much with these funds but if you can diversify your portfolio with them you help the hedge your bets in case the market takes a downturn.

It is very important that you do not put all your eggs in one basket. Now, with the equal-weighted ETF from banks and companies like Bank of Montreal and Claymore Investments, it is possible to make the safe investment of an ETF even safer for investors. You can expect that in the coming years, many investors will be putting their money into the equal-weighted ETFs instead of risking it in mad-cap investments that could cost the investor everything they have

What Are Mutual Funds? Advantages and Disadvantages of Mutual Funds

Mutual Funds 101: Part 1

First Published: ADawnJournal.com May 30, 2010

The following is an Excerpt from my first book Invest Now. Invest Now is jam-packed with timely information and timeless advice for the beginning Canadian investor. Invest Now covers a broad range of topics including Internet Scams. To purchase a copy, visit Chapters Indigo or click here to buy online – Invest Now: A Canadian’s Guide to Investing

Mutual Funds: The First-Time Investor’s Friend

If you had a friend who was very knowledgeable in the stock market, you would definitely want him to manage your stock investments. What if this friend agreed to do everything for a small fee? Wouldn’t you hire him? A mutual fund is just like this hypothetical friend. A mutual fund is a collection of investment products, such as stocks, bonds, T-bills, and so on. Mutual fund companies collect money from investors and hire professionals to manage your money. These professionals are called fund managers. When you buy a mutual fund, you buy a portion of the fund (or a portion of what the funds hold altogether).

Why Are Mutual Funds Suitable for First-Time Investors?

You need years of experience, lots of money, intensive knowledge, and various tools to pick an individual stock. A mutual fund does all that for you while keeping risk to a minimum. It’s no wonder that mutual funds’ assets are skyrocketing with the speed of a space shuttle.

To pick the most suitable funds for you, you need to know a few things. Let me start with the advantages of mutual funds; you can use these advantages to overcome obstacles you will face as a first-time investor.

Advantages of Mutual Funds

Low Minimums and PAC

Low minimums are the best feature mutual funds offer. Have you heard your friends saying they don’t have enough money to invest, and that’s why they never save? If you are using same excuse, put it aside. Most mutual funds will let you start with as little as $500, and some will let you start with just $100. If you agree to let fund companies take money out of your bank account systematically—either monthly, weekly, biweekly, quarterly, semi-annually or annually, you can start with as little as $25. This convenient option is a good one for those who can’t put in one lump-sum payment to start with. You will not find this type of convenience investing in stocks and bonds. The above-mentioned feature is called PAC (pre-authorized checking), AIP (automatic investment plan) or SIP (systematic investment plan). I will use PAC in this book, because PAC is widely used and recognized.

PAC is nothing but systematically investing your money with a financial institution. One great advantage of having PAC is that it gives you the power of dollar-cost averaging.

Dollar-cost average simply refers to the averaging of your cost per share or per unit. Suppose you are running a PAC for $25 monthly on the 15th of each month. Your mutual fund unit price will not be the same on the 15th of each month. But you will be adding the same $25 each month. If unit price goes up, you will be buying fewer units. If unit price goes down, you will be buying more units. Running a PAC year after year and calculating your average cost per share after a few years will prompt gains. Research has shown that if you do dollar-cost averaging, you end up buying more units rather than spending one set lump sum.

Dollar-cost averaging on stocks or bonds will cost you a lot of money, with transaction fees every time you buy. But you can do a dollar-cost average on mutual funds without additional cost or transaction fees. Just run a PAC, and you are good to go. This feature is very suitable for first-time investors.

Professional Management

Choosing an individual stock or bond can be an enormous task for new investors. All the research and decision-making can be daunting. Everyday investors don’t have the tools or resources to make a prudent decision. When you buy mutual funds, you are buying the expertise and service of the group of professionals who manage those funds. Each group consists of a fund manager and a few analysts. This group is responsible for doing all the research and for deciding when and what to buy and sell. Basically, everything is done by the fund manager and his team. You don’t have to spend days and nights analyzing stocks and monitoring your portfolio. Remember, these professionals cost you money, but I will discuss how to keep your costs minimal.

Diversification and Convenience

Whether you are a stock or a mutual-fund investor, it is very important to diversify. The old saying “Don’t put all your eggs in one basket” still applies. Diversification reduces your risk by spreading your money across different companies, countries and types of assets. A mutual fund is lot more diversified than a stock or a bond, because a typical fund holds 20 to 50 stocks or a mixture of stocks, bonds, T-bills and so on. I will share my own simple diversification strategy a little later.

Diversification can be a headache if you invest in stocks or bonds. You need to do lots of trading, and you have to keep track all of your portfolios constantly. If you don’t mind the complex task of managing your own portfolio and enjoy doing it, that’s fine. But such an endeavour would require a lot of effort for first-time investors as they pick different types of investment products and attempt to manage them. A mutual fund gives you exposure throughout the world with diversification and convenience—nothing needed from your side.

Regulation

When I first started investing, a junior mining company’s stock was going through the roof. This ten-cent stock was trading at close to two dollars, and rumour was it would reach five dollars soon. I started dreaming of becoming a millionaire in couple of weeks and had already made some plans to retire in the Bahamas the next month.

My emotions ran high; I did not hesitate to invest a few thousand dollars. My investment went up for one day. Starting the second day, my investment started to fall, and after one week my investment was down to four hundred dollars. Basically, I lost all my money. In a mutual fund, it is unlikely that you will lose your money overnight. In the financial world, nothing is guaranteed, but a mutual fund offers a better degree of protection than stocks due to stringent rules and regulations. Mutual funds are highly regulated, ensuring how funds are managed and how investors are informed.

A few points on mutual funds are worth mentioning

A mutual-fund company does not physically hold its assets. A third party, called the custodian, holds securities on behalf of the fund company. If the fund company is in trouble, your money is protected. Fund managers can’t just walk out with your money. The custodian can be either a bank or a trust company.

Fund companies need approval from unit holders to make any significant change. Also, any change in the fund’s investment objective has to be approved by unit holders.

Fund companies have to disclose the fund’s holdings on a regular basis.

Fund companies have to disclose the fund’s unit value regularly.

Fund companies need to publish procedures for the purchase and sale of funds.

Remember, these rules are in place to provide you some degree of safety. No investment is guaranteed, and any investment can decline in value.

Liquidity

Mutual funds are very easy to sell and buy. Your money is not tied up for any specified terms or years. Keep in mind that, except for money-market funds, you will incur an early redemption fee if you redeem your fund within the first sixty days of purchase. Consult your mutual-fund prospectus to find out more.

Transaction Cost

Mutual funds offer another convenient feature. Suppose you want to buy a few Canadian stocks and a couple of international stocks to start your investment. You will be spending the following if you are buying stocks:

(Assume trading cost per transaction is $29)

Three Canadian stocks trading on TSX = 3 × $29 = $87 CAD

Two American stocks trading on NYSE = 2 × $29 = $58 US

Imagine your cost in buying on the European and Asian exchanges. Selling would be equally expensive. You can avoid all these costs if you buy mutual funds. However, you do pay on mutual funds, and I will explain how in a moment.

Disadvantages of Mutual Funds

Nothing in life comes without disadvantages. Now that we have discussed the pros of mutual funds, let’s go over the cons.

Fees and Expenses

When you buy mutual funds, you pay fees to compensate companies for doing all the work. These fees are called management-expense ratios (MERs). Depending on what type of load (front load, back load or low load) you buy, you might pay commission and redemption fees. I will discuss MERs and load a little later in order to show you how to keep your cost minimal.

No Insurance

The Canadian Deposit Insurance Corporation (CDIC) does not insure mutual funds the way it insures bank accounts, loans and so on. Keep in mind that other investments, such as stocks or bonds, are not insured by the CDIC either.

Loss of Controls

Fund managers, not mutual fund holders, make the decisions on a fund’s portfolio. When you buy mutual funds, you give up your authority and abide by the fund company’s decisions.

Trading Limitations

Stocks can be traded as many times as you want throughout the day (North American markets are open from 9:30 a.m. to 4:00 p.m., Monday through Friday). Mutual funds are priced only once a day, after the markets close. Regardless of how many times you buy or sell in a day, you will get only one price for that day. It does not change every second, like stocks.

Cash Holding

Mutual funds need to hold large amounts of cash to pay for redemptions (when someone is selling). Had this cash been invested, you would have made money on this cash. In other words, investors lose growth potential on that cash portion.

Mutual funds carry some other disadvantages, but these are the most important ones.

Next, let’s discuss the fees and expenses you pay when you buy mutual funds. Fees and expenses are very important to know, as such information allows you to cut costs by investing carefully. You need to do that to become a successful investor.

How To Handle Your Mortgage In A Divorce

Divorce and Mortgage

Short of getting married, buying a house with your partner for life (or intended partner for life) is possibly the most concrete commitment you can make to them. In fact, as marriages frequently end in divorce within ten years, and the average amortization period for a mortgage is considerably longer, it could be said that it is in many ways a bigger commitment. Regardless, joining together to buy a house which you will share as a couple is a big move, and bigger still if you are joint account holders on the mortgage. An even bigger move is if you divorce while you are still paying off the mortgage – creating conditions for some of the most unpleasant times of your life, if you do not both swiftly resolve to conduct the entire process with maturity and dignity.

When a couple divorce, there is always a question over the marital home. Will it simply be sold with the couple splitting the money equally or according to a ratio of their choice? Will one partner buy out the other? It is for both of you to decide. It may be that one partner wants a clean breakaway and intends to leave the area, in which case the only thing that remains is whether the remaining partner wishes to stay in the house and can meet the full mortgage payment. It is important at an early stage to consult your mortgage agent in order to find out exactly how it affects your specific mortgage.

There may be some justification for applying for a new mortgage – whether this be for the purposes of buying out your spouse’s half of the equity in the house or in order to search for a new home. If this is the case then it is important to take account of the fact that there will be some changed data on the new application and that you are unlikely to have the same borrowing power as an individual that you did as a couple. Indeed, it is often worth involving the mortgage in discussions between lawyers if the divorce is to be conducted with the help of legal representation. This can help to divide it fairly and equally.

It is also worth taking into account that debt taken out in joint names will affect the credit scoring of both parties. Sorting out the issue of the mortgage is in this case all the more important, as acrimony over a divorce can be multiplied if one partner is considered to be behaving in any way that is injurious to the other. Although the marriage may have come to an end – potentially a very unpleasant end – the couple who are separating will usually have bought the house together at a time when they were very much in love, and its sale, or even departure from it by one of the parties can cause a great deal of heartache. It is sensible in this case to be businesslike although not insensitive, and making things easier will include smoothing out any financial issues – in which the divorce must be considered a priority.

Mutual Fund Fees and Expenses

Mutual Funds 101: Part 3 – Last Part

The following is an Excerpt from my first book Invest Now. Invest Now is jam-packed with timely information and timeless advice for the beginning Canadian investor. Invest Now covers a broad range of topics including Internet Scams. To purchase a copy, visit Chapters Indigo or click here to buy online – Invest Now: A Canadian’s Guide to Investing

What Are Fees and Expenses?

Mutual funds would be an unbeatable investment vehicle if there were no fees. But without charging fees, fund companies would not be able to give you all these options. Many financial gurus and critics would tell you to avoid mutual funds because of these fees and expenses, but I beg to differ. I think it’s better to pay fees than to lose all your money. When you buy stocks, you pay to do that-and then pay again to sell. In mutual funds, things are different. You pay your fund company every day for as long as you hold the fund. So if you calculate the cost of a thousand dollars’ worth of investments in both stocks and mutual funds for ten years, your cost for mutual funds will definitely be higher.

Let’s look at these examples:

$1000 in mutual funds:

A 3% MER would cost $1000 × 3%, which equals $30 a year.

The 10-year cost is $30 × 10, which equals $300.

$1000 in stocks:

Standard trading fees to buy = $29

Standard trading fees to sell = $29

Total cost in 10 years = $58

Buying stocks looks good in the above example—if your stocks make money. Compared to losing your money in stocks, you would not mind paying fees to buy mutual funds instead. I invest in both mutual funds and stocks. In last 10+ years, a couple of my stocks have evaporated almost overnight. I lost money in mutual funds too, but the margins were very slim. I have never lost my whole investment in mutual funds. If you know any investors, ask them how many times they lost money in stocks and how many times they lost money in mutual funds. You will get the obvious answers. Try it!

Beware of and Avoid Mutual Fund Fees and Expenses

It is time to explain the fees and expenses associated with mutual funds. An educated investor, who knows how these costs and expenses occur, should be able to reduce overall costs significantly, thus achieving higher return.

MER

This is the major cost of holding a mutual fund. MER stands for management expense ratio. The MER measures a fund’s total expenses for a financial year. A MER calculates a fund’s expenses by the fund’s average assets. The MER is expressed as a percentage of the fund’s total net assets. If you break down the MER, you will get

MER = (M + ER) × GST

The M stands for “management fees.” The M is the big chunk of the MER. This is where fund companies make money. Management fees cover compensations to dealers, sales and marketing costs, corporate expenses, portfolio-management cost, investment research cost and so on.

The ER stands for “expense ratio.” Expense ratios include administrative costs, such as regulatory costs (provincial and federal), client services and administrative costs, custodian fees, fund-reporting costs (annual report, prospectus and so on), audit and legal costs, technology costs and so on.

GST: Yes, you pay tax again when you invest your already-taxed dollars.

The MER can be found in a fund’s prospectus and on the Internet. Also, you can call your fund company to obtain the MER. It is important that your funds do not have a skyrocketing MER. Always pick a fund with a reasonable MER—not more than 2.5%. You can actually shop around for a certain type of fund and pick one with a lower MER. I will discuss index funds shortly, which have a low MER compared to regular mutual funds.

The MER Mystery

New investors will be puzzled when they do not see costs, mainly MERs, coming out of their investments up front. It’s not on your statement, not on your receipts, not on your confirmation slips … not anywhere. Does that mean that fund companies are not charging you MER fees? Are they giving you everything for free?

No, not at all. You see, fund companies came up with this brilliant way to charge you invisibly every day. The MER comes off a fund’s NAV (or net asset value—the fund’s price per unit) every day, so you don’t see it. That’s why it is important to hold a fund with a reasonable MER: in the long run, you don’t want to evaporate your money by paying a high MER. Usually, Canadian funds have a lower MER than specialty funds (which we will discuss later), and specialty funds have a higher MER than foreign funds.

Huge MER gaps can exist. A Canadian equity fund at one fund company can have a 2% MER, and the same type of Canadian equity fund at another fund company can have a 3% MER. A higher MER does not necessarily mean a higher rate of return.

Let me give you a simple example of how you pay MERs invisibly. Suppose your fund’s actual unit price is $10.05 for any given day before adding any expenses or MERs. Now your fund company will add their daily cost to $10.05 and will charge you $10.30 (assuming cost for one day is $0.25). You will never see the actual value $10.05 anywhere. Investors will see $10.30, and this is what the fund company will publish on their Web site or in the newspaper as the NAV for that day. I wish fund companies would disclose MERs visibly, but it does not look like that will happen any time soon. That’s why you absolutely must do your homework before you invest anywhere.

Loads

Mutual funds come in a confusing variety of packages: front-end load, back-end load, low load, or even no-load. Let’s clarify these.

Front-end load: When you buy this load, you pay your dealer’s commission up front. Commissions can run from 0% to 5%. If you are buying $1000 worth of funds with a 5% commission, your dealer is receiving $50, and only $950 is getting invested. With this option, you don’t pay any charges or fees when you redeem your funds. Always buy front-end funds at 0% commission, so you invest the full amount. This option is also known as initial service charge, or ISC.

Back-end load: When you buy this load, you are agreeing to stick to your fund for a few years (usually seven), and if you withdraw before passing those years, you will get hit by redemption fees. Redemption fees decline every year until they no longer exist at all. If you have always wondered why your broker or dealer always wants you to hook up with back-end funds, it’s because these funds give them a flat up-front commission (usually 5%) from the fund company. Who eventually pays this commission? It’s you. Buying back-end means you have to stick to the fund for many years, or pay redemption fees, just to compensate your fund company for that commission. Your goal is to stay away from back-end load. Back-end load is also known as rear-end load, deferred sales charge (DSC) and so on.

Low-load: This one is a kind of back-end load with reduced commitment lengths (usually three years) and reduced redemption fees as well. Also stay away from this load.

No-load: This is just a 0% version of a front-end load. But make sure the MER is not higher than other loads, in which case this is a good option.

Trailer Fees

Fund companies pay your broker or dealer trailer fees as long as you hold the fund. Trailer fees are already in the MER. Trailer fees are service commission fees, meaning your dealer or broker should keep funds on track, answer your questions, service your accounts and so on. Generally, front-end funds pay 1%, and back-end funds pay 0.5% trailer fees.

Turnover Ratio

The turnover ratio tells you how actively your fund manager is trading. Lots of trading can be expensive. The higher the turnover ratio, the more expensive the fund is. For an open account, a high turnover ratio can translate into high tax bills. You should be able to find this information in your mutual-fund prospectus.

The Prospectus: Your Mutual-Fund Bible

I have described some of the fees and expenses involved with buying a mutual fund. There might be more fees and expenses, along with other risks. A successful investor is an educated investor who researches fees, expenses, and risks. Remember, an emotional decision will not make you a successful investor. Plenty of tools out there can help you with your research, and this book will show you those tools.

The prospectus is a powerful tool that will help you a lot with your research. A prospectus is a selling document published by fund companies. By law, this has to be distributed to you as an investor. This document, which looks like a magazine, must explain a fund’s objectives, holdings, performance, risks, fees, expenses and so on. In plain words, it must provide full and true disclosure of all the important stuff you need to know to make an informed and educated decision. You can obtain this document by calling your fund company, or you can download a copy on your fund company’s Web site for free.

Always read the prospectus carefully and thoroughly. Dissect all the information it provides and then reread key information, such as risks and costs.

Miscellaneous

– Pick funds with a reasonable MER. Be extra-cautious not to pick a fund with more than a 2.5% MER. The same types of funds can have different MERs at different fund companies. If my fund company charges me a higher MER for the same kind of fund, there had better be some explanations justifying that higher MER.

– The MER is shown annually and calculated daily. The NAV you are paying for each unit already includes the MER; you do not pay the MER separately.

– The NAV, or net asset value, is what you pay for your funds. In mutual funds, you buy one unit or one share, just like one stock or one bond. The NAV equals the fund’s assets minus the fund’s liabilities. Fund companies price their funds every business day after markets close. The NAV is what you see in the newspaper or on Web sites in the Fund Prices section.

– Fund companies pay your broker, dealer, or discount brokerage trailer fees as long as you hold your funds.

The Trailer Chart

Load Type Fund Companies Pay

Front-load Up to 1% annually

Back-load Up to 0.5% annually

Low-load Pays same as back-load at

first, but later changes to front-load

·   At www.sedar.com, you can find documents submitted by public companies and mutual-fund companies. You will be able to access mutual fund prospectuses, annual reports, financial statements and so on. This is a good place to start your research. Check this site whenever you need to look for a document and you don’t want to wait for the paper version to arrive in the mail.

Compound Interest Basics

The Idea of Compounding

Compound interest is something consumers hate. With compound interest, not only are you charged interest on the principle, which is the money you borrow, but you are charged interest on the interest. The interest compounds on itself, making you pay more and it is something most people could do without.

Compound interest has actually been with humanity for quite awhile, dating back 2,000 years to the days of the Roman Empire. Back then, compound interest was regarded as the worst type of usury and it was condemned under Roman law. As well, the Qur’an and the Bible both contain references to compound interest. In the Qur’an it says “O ye who believe. Devour not usury, double and quadrupling. Observe your duty to Allah, that ye may be successful.” In the Bible, there is a reference to it in Leviticus 25:36-37 which reads “Take no usury or interest from him; but fear your god, that your brother may live with you. You shall not lend him your money for usury, nor lend him your food at a profit.”

In 1613, Richard Witt wrote Arithmetical Questions, which is considered a landmark book on compound interested. Completely devoted to the subject of compound interest, it was in sharp contrast to other books because most devoted only a chapter to the concept.

Enough about the history of compound interest though, how does it work? Well, if you take out a loan that has interest compounded on a monthly basis then it will work like this:

The loan is for $1,000 and you have one percent interest per month, which means that at the end month one you owe $1,010, and at the end of the second month you owe $1,111 and so on. So, the interest from month two is being added to the principle you owe, plus the interest you owe from month one. Naturally, this can quickly get out of control, especially when you are dealing with very high interest rates.

Most people prefer to see interest as a yearly percentage and for this reason many governments force banks and other financial institutions to disclose the equivalent total interest for the year. So, for one percent interest per month, the annual percentage rate would be 12.68 percent. This prevents people from being misled into thinking they are only paying one percent interest on their principle.

Compound interest should not be confused with simple interest, which is interest that is not compounded on top of it. Sadly, simple interest is not used very often. Compound interest is used quite a bit in finance and economics and if you have a credit card, you are paying with compound interest.

It is important to look at the laws dealing with usury to ensure that you are not becoming a victim of it through compounding interest. You want to ensure that when you get a loan, you are not going to be paying interest on interest to a degree that could cause you to default on the loan itself.