Tag Archive for: finances

Greater Fool Theory

Speculating in the stock market is very risky. The predicate is the Greater Fool Theory. This form of speculation requires no information or at best information based on unscientific methods of divining movements in the prices of stocks. This theory explains those buy long or sell short transactions that are initiated by someone regardless of current quoted market price for a stock who believes that there is a greater fool somewhere who will take him out of his position at a price that will produce a profit for him. No deep analysis is required.

A key question for anyone who enters the market: are you an investor or a speculator?

I am an investor. The following information comes from The Theory of Investment Value by John Burr Williams:

The Market for a Single Stock. Both wise men and foolish will trade in the market, but no one group by itself will set the price. Nor will it matter what the majority, however overwhelming, may think; for the last owner, and he alone, will set the price. The marginal opinion will determine market price.

Investors and Speculators. So far we have discussed a stock market for investors only. Bull or bear a man may be, and still be an investor rather than a speculator, so long as he looks to dividends rather than to price changes to justify the cost of his stock. There exists another large class of traders, however, made up of speculators, whose business it is to buy and sell for changes in price alone. To these speculators dividends are inconsequential because they hold for too short a time to receive many dividends.

To gain by speculation, a speculator must be able to foresee price changes. Since price changes coincide with changes in marginal opinion, he must in the last analysis be able to foresee changes in opinion. Successful speculation consists in just this. It requires no knowledge of intrinsic value as such, but only of what people are going to believe intrinsic value to be. Now opinion, when it changes, need not change for the right; it may change for the wrong, and the probability of a change for the wrong is about as great as of a change for the right. If opinion were not found in part on current dividends and changes therein, there would be nothing to prevent price and value from drifting miles apart.

How to foretell changes in opinion is the heart of the problem of speculation, just as how to foretell changes in dividends is the heart of the problem of investment.

Since opinion is made by the news, the task of forecasting opinion resolves itself into the task of forecasting the news. There are two ways to do this: either to cheat in the matter, or to study the forces at work.

Cheating has been outlawed, so far as can be, by the Securities Act of 1934, which tries to prevent insiders from gaining by foreknowledge of dividend changes, earnings statements, contracts let, etc., and requires these insiders to refund all short-term profits in their own stock to the treasury of their company. … In having access to this inside information, officers and directors have a most unfair advantage over the host of ordinary stockholders. Only stupidity or indifference, on the one hand, or great scrupulousness or recklessness on the other hand, can prevent insiders from getting rich in the market, and all that the law itself can really do is to advertise the ethics of the problem.

No one man can hope to be an expert in everything, and if he ventures to speculate outside his own special field he takes the chance of finding that he has bet not with but against the experts, for which impudence he must pay dearly.


I came across an interesting example related to the important first few years of a portfolio’s performance for folks who plan to retire early.

The scenario takes an individual with a $750,000 portfolio. The objective is to take $35,000 every year for 30 years, adjusted for inflation, from this portfolio. The portfolio contains a 75% weighting in a stock index fund and a 25% weighting in a bond index fund.

How much impact does bad timing have for this individual? The chart below shows what happened if the individual started in 1973 (red line), 1974 (blue line) or 1975 (green line). The chart was developed using historical returns over that time period. Overall market conditions and inflation affected all three about the same. The chance of making the portfolio last for 30 years depended heavily on what happened to the stock market in the first few years.

Something to take into account when planning to retire. Green is good.

Green is Good


10 Best Stocks of the Past Decade

Investing in the stock market is always challenging. I manage my own portfolio and I am relatively pleased with the performance over the past ten years.

But what were the best 10 stocks to hold over the last decade? Microsoft was not one of them. The list will surprise you. All of these stocks came from the U.S. exchanges. Rate of return is from January 1, 1996.

Total average return for these ten stocks over ten years? 8,240% with a total annualized return of 55.6%.

Handy information if you decide to go back in time and make a few investments.

My holdings are primarily in stocks and bonds. I hold very little in the way of mutual funds. The dirty dozen of Canadian mutual funds is an interesting list. Herein are the ten worst Canadian mutual fund performers of the past decade (as of July 2006). Hopefully you did not invest in any of these funds.

  • AGF Managed Futures: MER of 4.11 with -14.57%
  • AIC World Equity: MER of 2.43 with 2.11%
  • BMO International Equity: MER of 2.49 with 0.67%
  • CI Global Bond: MER of 2.06 with 1.94%
  • CIBC Far East Prosperity: MER of 2.87 with -0.98%
  • Investors Pacific International: MER of 2.87 with -1.92%
  • National Bank Global Bond: MER of 2.11 with 1.7%
  • PH&N U.S. Equity: MER of 1.15 with 2.05%
  • RBC U.S. Mid-Cap Equity: MER of 2.13 with 2.18%
  • Scotia Global Growth: MER of 2.56 with 1.11%
  • TD U.S. Equity: MER of 2.47 with 1.89%
  • Trimark Discovery: MER of 2.91 with -0.69%

I highlighted the Management Expense Ratio (MER) so that you can see how much the fund managers got paid for the performance of the fund.

How Much Is Enough?

I spent some time going through our finances over the week-end. And doing some refinement of our retirement plan.

Retirement planning is an interesting exercise as there are many scenarios that need to be analyzed. How much income is needed in retirement? How many years will an income be required? How much capital needs to be accumulated? What is the safest rate of withdrawal?

I have spent a fair amount of time going through the analysis. And I came across some interesting data points in my research. A starting point for me was to answer a basic question: how much is enough?

One way to approach that question is to look at various income levels. In other words, how much money do most people live on. The answer is surprising.

According to Statistics Canada, there were 23,408,890 individuals that declared some form of income. 2,323,290 made less than $5,000 in 2004. 19,297,350 made between $5,000 and $75,000. Only 791,580 people made more than $100,000 in 2004.

Expressed as a percentage:

  • 10 percent of Canadians earned less than $5,000 in 2004
  • 82 percent of Canadians earned between $5,000 and $75,000
  • 3 percent of Canadians earned more than $100,000
  • 0.48 percent of Canadians earned more than $250,000

In Ontario, average household income for families of 2 persons or more was $67,100 in 2002. This pdf report on the state of Canadian Family Finances is an interesting read.

So, assuming that you wanted to retire today with an average income of $67,100, and assuming that a government pension would provide about $12,000 then you would need a capital base of $1,100,000 to produce about $55,000 per year. Of course we would have to factor in inflation and maybe a Monte Carlo Simulation or two.

If you really want to go crazy on financial analysis, this website is a must see. I think I will just keep working.

Retirement Confidence

As I am starting to get closer to the retirement window, I am spending a lot more time looking at our retirement plan. The obvious question is how much will we need to live well in our retirement years and the obvious problem to solve is saving enough money and investing it well to become financially independent at the target age for retirement.

The Employee Benefit Research Institute conducts a Retirement Confidence Survey each year. And the results for 2006 are really quite alarming. Although the data is sourced from the United States, Canadians are generally in the same mode: spend now and worry about saving later.

According to the survey, more than two-thirds of workers — and more than half of those 55 or over — have less than $50,000 saved for retirement.

Only 64 percent are currently saving, a percentage that’s held fairly steady since 2002. Half of American workers say they thought they would need less than 70 percent of their pre-retirement income to live comfortably in retirement, another naively optimistic assumption.

Only 42 percent of workers say they or their spouses have taken the time to do a retirement needs calculation, and 8 percent of those said they guessed.

Only 39 percent of workers think they need to accumulate at least $500,000 for retirement, and 30 percent say they can make do with less than $250,000, an amount that invested at 5 percent would generate only $12,500 a year.

The Motley Fool has an interesting article called Prepare for a Gruesome Retirement. And they offer some resources to help prepare for retirement. Another good site for resource material is Choose To Save.

Family and Finances

My oldest son was home for the week-end. We spent time watching Battlestar Galactica 2.5, taking in Stranger Than Fiction, playing Gears of War and we both played as part of a worship team for a church on Sunday.

I spent the remainder of the time working through the finances. I had to call time on my Mac for my personal financial management. I could not get Quicken for Mac to do what I wanted it to do. I loaded up Quicken 2007 XG on my Vista PC, exported the Quicken data file from the Mac, imported into the PC version and made the requisite updates.

I love the Mac platform. It is what a computing environment should be: well designed and easy to use. However, there is no comparison between the Quicken software on the two platforms. Quicken for the Mac is a dog’s breakfast. The worst software experience I have endured in a long time.

I really wanted it to work. And I gave it my best shot.

Issues? First off, the Mac version is not Canadianized. You have to use the U.S. product and set the country preference to Canada. Which is okay except that not one Canadian financial institution is online with this version. Instead of downloading transactions directly to Quicken, you have to launch a browser, login, download an export file, import the export file, and go through transaction by transaction. Yuk.

Getting the investment portfolio updated is just as bad.

By comparison the Windows version is a delight to use. I have no idea why the software is not the same from a functionality perspective on the two platforms. It is quite staggering the difference in capabilities.

Quicken on the PC is just a far better experience. Much more usable and more capable.

Retirement Planning

I received a number of emails asking for resources on retirement planning.

The web offers extensive resources on retirement planning. My favourite online planning tool is BMO’s Investorline retirement planner. You will need an active account to use the tool. The other major banks and insurance companies offer similar tools. Diane McCurdy, author of How Much is Enough?, offers an online tool here. Even the government of Canada has an online planning tool. I keep going back to Investorline.

I have read over 50 books on retirement planning. From Bach’s Smart Couples Finish Rich, to Eisenberg’s The Number, there is no shortage of books to help you pull together a plan.

If you are relatively new to planning and investing, Bach is a pretty good bet. He offers a Canadian version of his financial planning books.

The Number

The National Post has been writing a series on the Boomer effect. In today’s paper they cover needs at retirement.

Basically, there are three ways to get a high-level snapshot of what you might need to fund your retirement:

1. Take your retirement age and add two decimal places. The result is an approximate amount per year for each $100,000 invested. For example, at age 55, you would receive $5,500 per year for each $100,000 invested in retirement savings.

2. The twenty times method. Determine your required annual income at retirement, subtract your pension and multiply by 20. The result is the investment capital required in retirement. For example, if you need $80,000 per year in retirement and your pension will provide $30,000 per year, you have a gap of $50,000. To fund that gap, multiply by 20. A mere $1 million will look after the difference.

3. Quick and dirty method is to take your invested assets and multiply by 0.04. This provides how much investment income you can expect each year. Add in other income sources, such as your pension, and you will gain a picture of your ability to spend in retirement.

Obviously, a defined pension plan can really help. Otherwise, the investment required to fund a reasonable retirement is pretty substantial. I would not want a pool of capital less than $1 million. But it looks like Boomers are poorly prepared.

A recent study by BMO Financial Group found that only 28% of Boomers have investments worth $100,000 or more. One in five have no savings at all. 73% still carry debt.