Investoid

A lot of the bloggers on my blogroll post periodic (or quasi-periodic) updates on their networth. Typically the networth calculations is straightforward:

Personal Assets - Liabilities = Networth

Assets would include investments, cash, homes, cars, and other long term assets. Liabilities would be things like credit card debt, mortgages, car loans, etc. The Middle Class Millionaire has decided to calculate his networth differently. His calculations produces some interesting results (see his post and the subsequent discussion).

I think it’s great that these people are focused on increasing their portfolio size to reach their investment and life goals, and that they are measuring their current status to ensure they are on track. However, from an investment perspective most of them do not seem to be keeping solid track of their investment returns versus overall portfolio growth.

What’s the difference? Investment returns are increases in the portfolio size due to higher asset prices or returns on investment (ie. dividends or other distributions). They ignore cash infusions and disbursements, to provide an accurate measurement of an asset’s return. Typically, the holding period return formula is used.

Why does this matter? After all, most people will evaluate the performance of their individual stocks or funds a fair bit, particularly in relation to their initial purchase price. But it’s important to measure your portfolio’s performance over time, not just at an individual asset but at an aggregate level. Also, you will be measuring the performance of your assets from the same point in time, rather than from the time of purchase. This is helpful when analyzing asset allocation as well as diversification. Furthermore, people who are saving for retirement may get a slightly skewed view of how their assets are doing if they look at how much their portfolio is growing in total size, but ignore the holding period return.

I think some people tend to avoid doing this because it can get a little complicated. You need to track what happens each time you buy and sell an asset, and account for the changes over each interval. It becomes especially tricky if you want to evaluate holding period returns at an arbitrary granularity - say analyze your monthly returns then roll that up into quarterly or semi-annual returns.

Nonetheless, I think it’s worth putting the time into ensuring that your portfolio is on track investment wise. I’ve looked at using a portfolio management software program like this for my own bookkeeping. If anyone has experience with a good - and preferably cheap or free - software (online or offline) system that allows you to input transactions and then calculate arbitrary time-period returns, let me know.

The second Canadian tour of personal is set to commence on May 7. The Money Diva is hosting this go around. I look forward to reading the articles from participating blogs, as there was some pretty good posts last time. This time I will comment about some of the posts on this blog, instead of just leaving comments on the particpants’ blogs.

For more information, visit the Money Diva’s site or go here.

Chris Masse over at Midas Oracle pinged my story on prediction exchanges from yesterday. He has added some corrections and expansions on my thoughts.

Thanks Chris for the link and comments on my article.

I’ve been interested in prediction exchanges for the past couple of years. Quite simply, prediction exchanges are markets whereby the market players buy and sell event-driven futures contracts. These contracts are typically valued between 0 and 100. If the event occurs in the affirmative, then the contract is worth 100 at expiry, otherwise it is worth 0. They trade at values in between these extremes prior to their expiration.

These markets have gained some mainstream media attention, mostly for their supposed quality of predictions (some believe that the value of such contracts prior to an event is a better indicator of the probability of the event occurring over other methods such as sample polling). They have also gained some notoriety for their use as sport-betting mechanisms, since they allow people to make wagers with each other rather than have to pay a bookie a hefty middle-man fee. As a result the US frowns upon many of the current markets out there, due to their heavy sports orientation.

There are two both real money and play money prediction exchanges in existence. Chris Masse’s site is a comprehensive information portal on prediction exchanges, including a listing of the major markets in existence, which include:

• InTrade, a market that focuses on current events and some financial market outcomes.
• HedgeStreet, a US-only market that currently focuses on housing and economic derivatives (and was bought by the CBOE)

Both markets make their money off of trading fees, which are typically charged to those that accept prices rather than dictate them. InTrade also has contract expiry fees, meaning the party for whom the contract expired as expected, they will be charged a percentage of the amount they receive.

I think prediction exchanges have great potential for individual investors. These markets can come up with innovative contracts that you could use to hedge against other positions, or just contracts that you will have a knowledge advantage in (or at the very least you can reasonably assume to have the same level of knowledge as the other market players). Some are just for fun (for example, you can wager on whether Conrad Black will be found guilty of some or all charges), while others are serious (like the ones tied to the end of year Federal Funds rate).

There are some very interesting short-term contracts available. For instance, I like InTrade’s end of day contracts for whether the Dow (and other major indices) will close higher or lower than the previous day. I think day traders could do very well with this contract.

These markets are in their infancy, and with that comes some major risks:

• Many of the contracts have very light volume, so pricing and liquidity are major concerns. Even the most liquid contracts can have large spreads at any given point in time (upwards of 4 or 5 points). Furthermore, the amounts traded in dollar volume is pretty low, ranging from a few hundred dollars to a few hundred thousand dollars over the life of the contracts.
• None of the markets are regulated in Canada yet, so you run the risk of the government trying to clamp down on their use by its citizens. Even in the States HedgeStreet is the only money-based prediction exchange at the moment.
• The available types of contracts is small right now, and is controlled by the exchanges. Ideally, you will be able to create your own contracts and see if others are willing to trade them. Some of the play-money exchanges do this, but none of the real money ones do.
• Volatility is quite high, partially due to the nature of the underlying events and partially due to the lack of sophistication in the markets. For instance, the daily higher/lower contract can swing violently towards the end of a trading day if the Dow is close to even. This means you can make a killing if you guess correctly, or lose a fortune if you guess wrongly. As more tools come out to analyze the pricing movements and tie them into the underlying market data, this will be somewhat mitigated (and if you’re the first to do it, you’ll be way ahead of the game and create a fortune).

Overall prediction markets are quite an interesting phenomena that regular investors should be watching. As they mature, they will present new investment opportunities for you, which should be evaluated in the overall context of your portfolio allocation. If you’re interested in following the happenings of prediction markets, I recommend subscribing to the Midas Oracle blog.

The Bank of Montreal (BMO: TSX) has reported over $350M in losses related to energy trading. Seems like they took heavy losses on natural gas speculation. This will likely cut their quarterly earnings by at least a third. The stock has dropped about 2.3% at the opening on this news.

While I’m not a day trader, I do like to pick up good stocks on weakness when news like this breaks. Some of these losses are unrealized, so the cash losses are lower than what is being reported. Overall I like the bank stocks, and think that if you like BMO then this is a good opportunity to pick some up. It’s not my favourite bank stock (I like National and Scotia better), but it’s definitely worth taking a look at today if you’re looking to add banks to your portfolio.

I logged into GlobeInvestor this evening and started typing in some of my quotes, only to find that the system has a new interface. The new look has a mix of additional features and cool AJAX components. The highlights of the new features are:

• Some measures of the intra-day stock strength
• A snapshot of the financials for the past three years
• A listing of competitors, along with a synopsis of market data for the stock
• An overview of analyst estimates and recommendations

The new look is very clean and responsive to updates, mostly thanks to the javascript used. Alas, the updated interface is only for the main page - while the subpages mostly have the look and feel of the new template, they are not upgraded in any way.

Overall I’m pretty impressed with the new look and the information that they’ve brought to the main quote page in a dashboard view format. I still use Yahoo! (Canada) Finance for looking at multiple stocks in a portfolio view, because I find it’s easier to customize the information displayed in table format. But I dislike the limited information available for Canadian stocks, and what info that is available has been reduced in the past year. Thus, if you want to get a great overall picture on a particular stock, you will enjoy the new GlobeInvestor interface. I particularly find the competitors section to be a great addition, something the Yahoo! (US) Finance has had for US-listed companies for some time.

Note: this was not a paid review.

Well, within a week of considering buying a place we have now purchased a home. I can’t believe that we moved that fast, but the more time we spent on the buy/rent analysis and the overall market/economy analysis we did we decided that the time was right.

Given the major increases in house prices in Alberta, our options were to:

1. Buy a condominium, either in a high rise downtown or a low rise near family (likely price: $250-310K)
2. Buy a detached home, entry level ($330-375K)
3. Buy a 1/2 duplex unit ($280-370K)
4. Buy a detached home, one step up ($400-430K)

In terms of appeal, the most expensive option was in line with what we had in mind for ‘our house’. This would have meant picking up a fairly large mortgage, but one that would be approved without hesitation by any lender. However, I don’t believe in the 30% ‘GDS rule’ (gross debt service ratio, read Million Dollar journey for all the lingo details). Gross income is a meaningless number, unless you can pay our bills with your tax dollars somehow (please contact me if you know how, I’ll give you half of mine!). A 30% GDS rule implies that for a $100K earning family with a 35% marginal tax rate that you should be spending nearly half of your net income on your house. That doesn’t leave much for transportation, food, yet alone any quality of life things you enjoy. If you max out the GDS rule, you’re nearly working solely to pay for your house, once you factor out the other essentials. That doesn’t sound like fun to me.

Nonetheless, the most price appreciation has happened at the lower end of homes since first time buyers have flooded the market and are trying to get whatever they can. The low end (particularly condos and duplexes) has been historically a good leading indicator of the overall housing market. Thus we weren’t really interested on being part of the rise up and down.

So, we didn’t want a $400K+ house, we didn’t want a condo, duplex, or entry level detached home. What does that leave us?

In the end we decided to look at entry level detached homes with basement suites. There is an incredible demand for additional rental housing right now, and prices have skyrocketed in the past 6-12 months. By renting out a portion of our home, we get to keep our overall housing costs roughly where they are today (20% of net income), while being able to build up our equity. This means we get to keep our current lifestyle, more or less.

We ended up getting a 1170 st foot bungalow with a separate entrance for the basement suite. The suite has 2 bedrooms and 5 appliances. The home went on the market 4 days ago and was listed at $340K. The seller had decided to consider multiple offers simultaneously, so all interested buyers had their Realtors present their offers today one after the other. We knew that there were going to be at least 3 other offers, with the possibility of more. This guaranteed a sale price above list value.

We determined our maximum price using a cash flow analysis based on what the top and bottom could currently rent for. After discussing with our Realtor, we decided to go slightly below this value as he was confident he could ensure that as long as the top offer was not higher than our maximum, we would be able to get the house.

Sure enough, an additional bid was faxed in that was higher than ours. However, our Realtor had made a convincing case and the sellers allowed us to match the offer.

On top of the cash flow analysis, we used scenario analysis to determine the affordability of our mortgage in the worst case (Alberta’s economy tanks, people start leaving en masse a la 1982). We could still pay the mortgage, eat and get to work even if only one of us was working for a period of time and we had no other way to pay for our monthly expenses. Since one of us is in an extremely recession proof job, we feel we are prepared to ride out any economic downtown, which eventually would cycle again (unless inexpensive alternative energies make oil/gas permanently irrelevant).

Conversely, in the best case (strong steady growth continues, population increases), both rent and equity prices will continue to go higher. In this case we will be paying down our mortgage on an accelerated basis thanks to the rent increases, and will also have unrealized capital gains.

Either way, I’ve had a crash course in residential real estate buying (I have had experience on the commercial side before), and in boom-time buying. When I participated in buying commercial real estate in 2004/2005, we had months to analyze and negotiate. Now deals are done in as little as a day.

I’m sure I’m in for a lot more education in the coming months as we prepare to take possession as well.

My wife and I have been unexpectedly thrust into the real estate frenzy in Alberta. We were given three months notice from our place today, as the owner is looking to sell, as her returns on capital will be higher with the money in hand than renting the place, given the current housing prices. I don’t blame her, and her analysis makes a strong case for us to continue renting, since renting prices are once again below the equivalent housing costs.

However, rent has been increasing dramatically in Alberta right now, and barring some rent controls (which the Alberta gov’t is looking into), rents will likely catch up to housing costs once again given current growth trends.

As I’ve stated before, I think Alberta’s housing boom has been driven by a mixture of fundamentals and speculation, the proportion of which is extremely hard to determine given the data available. In the past I’ve been slightly bearish about the future prospects for home prices, but have been proven wrong so and continue to be as we approach the peak buying season.

Future housing princes in Alberta essentially boils down to energy prices, so as long as cold fusion or another cost effective alternative energy source isn’t discovered tomorrow, things will not drop immediately. There are risks that China’s economy could face a hard landing (they had another 4% correction yesterday, amid fears of the enormous number of newly minted equity investors. Oil summarily dropped in sympathy), which would directly affect world energy demands.

Another interesting aspect is the high amount of debt lenders are willing to give to consumers. We were preauthorized for over $600K without any documentation (although there was a credit check), which makes me wonder how many people are taking as high of mortgages as possible.

In the end, we are leaning towards buying a home, one that has a basement suite so we can partially recoup our mortgage payments. We are looking for something that we can afford even with no renters, and in the extreme case only one of us has a job (although we’d be eating KD every day in that scenario).

This is a huge undertaking and has come about in the past 72 hours, but we know that we must act quickly and smartly. Any house in our range that’s half decent will have multiple offers on it, so we must be prepared to pay higher than asking price, or go after a home with issues and fix it up. We have some houses to look at tonight and if there’s one we like we will have to put an offer on it within 48 hours or it’s likely gone.

I am getting a crash course in home buying the hard way. It’s definitely not the way I expected to learn, but you never know what life will throw at you.

A reader commented on my Save Half Spend Half Principle and asked me what I do to make extra income. I thought this was a good question, so I decided to post in detail about it.

To make extra income, my wife and I have simply done extra work (simple, ain’t it?). This work has fallen into two categories:

• Additional work inside our areas of expertise
• Started an unrelated business that we both worked in

My AdSense revenue is minute, so I can’t include this blog.

I’m in software so I’ve taken on various consulting jobs outside of my regular job. I have been doing this with direct payment to myself, so I haven’t taken advantage of the tax benefits of doing this through a business, but I am in the process of changing that. My wife has taken extra jobs in her field as well from time to time. Since I have the lighter workload in my full-time job, I’ve been able to take on more. In my field I have made a network both in my city and internationally using the internet, while my wife has also done a combination of in person and online jobs.

These extra jobs are nice in the sense that they are flexible and entirely up to us to determine what level of work is reasonable for us and we can change it as our lives change. We try and keep our jobs short-term, so we’re not locked into something that will kill us to finish if our circumstances change, or if we’ve just had enough extra work for awhile.

As for the business route, we started a travel agency together in 2005. It was a great experience, particularly for my wife since she didn’t have any business background. We have learned a great deal and have made some fairly decent revenue on a person-hour basis. Like the outside jobs, we were able to make this a fairly flexible business where we took on clients as we wanted. This allowed us to be relatively selective with our client base, since we weren’t depending on the income for our livelihoods. Not only did this enable us to provide highly satisfying customer service, we rarely had to deal with customers who ate up an inordinate amount of time once we knew what to look for in a prospect. Unlike some businesses, this one was highly labour intensive, which means we got out of it what we were willing to put into it. After nearly two years we have decided to sell our business and plan on doing so in the summer.

In my opinion there are few shortcuts to achieving extra income - you need to be willing to work hard to get it. I’m not a big fan of trying to develop ‘passive income’ streams, at least not any of the ones that are touted by ‘get rich quick’ schemes. It’s important to spend your working time smartly though. I don’t want this to become a business blog so I won’t go into much detail, but suffice it to say you need to think about:

• Maximizing your revenue in terms of time. Whether you’re in a service or product industry, think about what types of net income you can generate per hour doing what you want to do.
• Establish your value. You need to determine what you are knowledgeable in that is of value, then work hard on establishing yourself in that area. Once you do, you’ll spend less time on sales and marketing yourself/your product, and more time on generating income. For instance, we focused on group destination weddings once we had done one and built up a strong referral program from satisfied customers.

While not all of the work has been completely enjoyable, we are both becoming experienced enough that we can begin to focus on doing extra work within our fields that we are more interested in. After all, getting paid to do something that you think is fun or enjoyable is the best work of all.

Disclosure: I hold a position in ADV.

I’ve been following The Money Diva’s quest for understanding dividend stocks, and have been also looking to add more dividend paying stocks to my retirement portfolio. Thus I made a new screen using my trial version of ChartSmart and set up a new screen to look for stocks whose dividend has increased or remained steady the past few years, while at the same time has some undervalued features to it. One of the stocks that stood out for me was Addenda Capital (ADV: TSX).

Company Analysis

• ADV is an investment management firm specializing in the active management of fixed-income portfolios. While this typically involves bonds and the like, the company does utilize leverage and derivatives in some investment strategies.
• In terms of assets under management, the company’s customer base is 66% pension funds, 15% mutual funds, 11% insurance companies, 7% endowment funds and only 1% private clients. All its clients are Canadian, with the vast majority in Quebec.
• ADV has over $28 billion in assets under management, with revenues of around $36 million.
• The senior management team has a solid track record, with a mix of founding members and external experience. The company uses a clear evaluation process to meet its client’s investment objectives.

Financial Analysis

• Revenues increased 9.6% last fiscal year, while EPS was up 13%. All of its growth has been organic.
• The company currently has a $1.32/shr dividend (based on the current quarterly dividend price), which is a 5.48% yield based on the April 16 closing price.
• The company has a great history of dividends and dividend increases. The dividend on common shares increased 19.6% last year and increased 64% last year.
• The company has a high payout ratio and has stated that it is targeting a payout ratio of approximately 90% going forward. While the company has increased dividends on a quarterly basis in the past, management has indicated that future increases will be on an annual basis.
• Employee bonus compensation is tied directly to EBITDA margins, which is a somewhat unusual measure but seems appropriate for this company. Management holds about 20% of the outstanding shares.

Stock Analysis

• The company has five analysts following it with an average rating of hold.
• According to TD Newcrest, the company has a strong history of above-market performance relative to the relevant bond benchmark indices.
• CIBC Wood Gundy rates the stock as ‘market perform’ as of Jan 30, with a 12 month target price of $30. It was downgraded as a result of the runup in the price to $27, but the price has since come back down to about $24. The analyst sees the company as a solid firm, but sees only modest 5-8% growth in the coming 1-2 years.
• The company announced on March 15 a buyback program for up to 10% of its outstanding shares. The company does not have a record of actually buying back shares.

Risk Analysis

• The company’s main risk pertains to capital market risk tolerance by its clients. For instance, if pension funds begin to have a higher risk appetite, or otherwise believe that more exotic investments will provide better risk-adjusted returns (eg. Hedge funds, real estate, etc.), then they may shift funds away from fixed investments. This is somewhat mitigated by the exotic investments the company uses in some of its pooled funds.
• The other main risks are performance & interest rates. If the company’s team is unable to maintain its strong performance, clients may divert their funds elsewhere. Rising interest rates would negatively affect their investment returns, although their clients would likely see broad-based declines in their fixed income assets, and thus relative performance will be even more important.

I believe ADV is an excellent long term investment that will provide strong dividends for the foreseeable future. If the company continues to grow I could see it gaining a wider audience and its price increase until its dividend yield is more in line with other financial companies (3-4%), although it may always carry a discount due to its relative small size in the financial sector and its largely Quebec focus.