In recent years the number of ETFs in the market has increased considerably.  People are investing in them, but do they really understand what it is that they are buyiing into?  As I sit down with prospects, I find that the answer to that question is mostly "No".

What is an ETF? An ETF is basically an open-ended mutual fund, in the sense that it is a basket of securities purchased by the ETF sponsoring financial institution.  The basket is divided into ETF units, and each unit is representative of the basket, in the same manner that mutual fund units are representative of the investment positions of the mutual fund.

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Here are six things I think anyone who is three to five years away from retirement must do.  These are based on my experience in working with my clients, and do not include the traditional replies including up-dating your financial plan and your wills and power of attorney. 

1.  Renegotiate your mortgage (if you have one) and get the biggest unsecured line of credit the banks will give you.
It is common knowledge that over 50% of retirees have mortgages or credit lines secured against their homes.  That’s just the way it is – we wish it wasn’t but wishing doesn’t make it go away.

I recommend all retires increase their access to credit before they retire.  Don’t mis-understand me.  I don’t mean for you to actually use the facilities and get into debt if you don’t have any or further into debt if you have some.  I mean that you should have the option to borrow if the need arises.  That’s what a credit line is – it is an option to borrow.  If you did not use the credit line, there would be nothing to pay back.  

Investorline is the Bank of Montreal's on-line trading platform.  Having your accounts on this platform gives you access to BMO's research - the same research that it's advisors use in order to make portfolio decisions and advise clients - of course mixed with their own experience of the markets (which is really what you buy when you hire an advisor).

Recently, (which means I don't know exactly when) BMO launched an additional service on it's Investorline platform: Advice Direct, which is a fee based service enabling on-line investors to talk to a human being presumably qualified to offer advice.  An excellent marketing strategy, and very forward thinking of the Bank, but will it do the job?

I bet you’ve noticed the prices at the pump! It’s pretty crazy.  Two days ago I heard an analyst on 680 News saying that there was no reason for gas prices to have escalated at the pump.  He’s got me all fired up – I don’t believe the guy knows what’s going on in the world.

Crude oil prices have been moving up silently for the past few weeks, the sudden jump is because of a few reasons that won’t be going away in a hurry.  Here they are:

The TFSA is probably the most under-utilized investment tool that I have ever come across.  The trouble with these accounts is that they are called "savings accounts".  Really they should be called "investment accounts".  Ninety nine percent of the people I sit down with think that they should put their saving in a TFSA and earn whatever the bank decides to pay as interest, when really the most aggressive investment positions should be going into these accounts.

The TFSA operated pretty much in the same manner as an RRSP except that it doesn’t have the tax break attached to it.  So you contribute to a TFSA with after tax dollars.  You contribute to an RRSP with before tax dollars and these dollars become exempt from taxation.

A lot of times things happen in the market because the majority sentiment makes them happen.  Imagine this scenario:

A young artist is happy that his art is beginning to sell.  He has just been commissioned to do a portrait for the Mayor on the 3rd anniversary of his office.  He and his girlfriend go out for dinner to celebrate; they start talking about how soon they will be able to qualify for a mortgage and buy a house.  As they're walking toward the restaurant they look at the news stands with large headlines about how things are bad in Europe, China isn't picking up and the US unemployment numbers are still too high to signal a recovery.  They start feeling worried.  Maybe they should wait a bit about getting the house, if the recession hits his income will surely be affected as people cut down on artwork first.  

They get to the restaurant and are still talking, and they decide to be more careful with the money they have. The restaurant owner comes by smiling: "Congratulations! I hear you are doing a painting for the Mayor" he says, "are you celebrating with some champagne this evening?" The couple look at each other and pass a knowing glance.  The young artist turns to the restaurant owner and says "we hear that things are pretty bad in the economy, and there might be another recession coming soon, so we've decided to cut down on spending; we will just have a glass of wine each to celebrate".  

The restaurant owner hears this and starts feeling uncomfortable.  He goes to his office and calls his broker, "cancel that order I placed to buy those shares I wanted.  I hear that things are pretty bad and we are heading to another recession, I want to keep as much cash in hand as possible, and don't want to risk losing money again", then he calls his wife and says "honey, I think we should cancel that trip we were going to take this year, I hear things are pretty bad in the economy we should conserve our resources and ride this out".  His wife is disappointed and she calls the travel agency to cancel - you got it the message spreads like a virus.  

In the final transmission, the Mayor calls the young artist and cancels the commissioning of the portrait.  He says "sorry young man, I hear things are likely to get rough, we will talk about this portrait when things are better". The young artist hangs up the phone in despair and turns to his girlfriend "remember what we were talking about? It's starting to happen already; that was the Mayor, he just canceled the portrait".

See how we contribute to the downward spiral?  In the same way we also contribute to the upward spiral.  Feeling better about how things are is the first step towards recovery and then the manifestation of it follows.

As an advisor who's done the rounds for over 20 years, here are a few things to watch out for:

1. Over-diversification - yes, there is such a thing, and it can really hurt you.  If you're so well diversified that none of your investment positions have any umph you're not going to make any money in either the short or the long-run.  Diversification is a tool for spreading the risk in anyone investment over many.  I personally find it really frustrating when I sit down with clients and find that the largest stock holding in their mutual funds is less than 1% of a stock.  So if this stock went up or went down, would it matter?  of course not.

2. Overlapping investments in mutual funds - A lot of times clients own the same stocks in different mutual funds, so when they think they are diversified, in reality they are not.  I don't think you need to own too many mutual funds in one portfolio.  The only reason you should add a fund is if you are trying to emphasize a particular sector of the economy or a particular geography of the world, or companies in particular growth cycles.  Your advisor should be able to tell you the reason for each mutual fund position.

3. Basing mutual fund choices on MERs - Many investors and advisors shy away from mutual funds that carry high MERs. They see this as reducing the direct return to the client.  My view on this is a bit different.  I don't believe in completely ignoring MERs however, pay attention to what the MER applies to.  It is the cost of running the mutual fund, and in most cases staff salaries constitute almost 60% of the cost.  Seriously, would you want the people who command the lowest salaries in the financial industry to manage your money for you?  How good do you think they are at what they do?  And if they are good people with good reps, how much of their time is being spent on managing the mutual fund if the fees they charge to the mutual fund is well below the market value of their time.  Would you pick the cheapest heart surgeon to perform your heart transplant?

4. Rebalancing - this is a process by which you mindlessly sell investments that are making money and buy the one that are under-performing.  Typically, rebalancing is conducted in a closed universe, which means that there are a finite number of investment choices included in the exercise.  I don't think that rebalancing ought to be conducted at regular intervals with complete disregard to what is happening in the markets.  Moreover, I don't believe in rebalancing using a finite universe of investments.  I believe that investment choices should be continuously added and/or truncated as times dictate.

5. Investing in Balanced funds - By definition a balanced fund incorporates equal parts of fixed income and equity.  Typically, when equities or stocks move up, bonds or fixed income securities move down: they are inversely related.  This means that the return on a balanced fund would theoretically be a flat line.  And it mostly is.  I am sure that there are advisors out there who can make a case for these investments, I'm just not one of them.

6. Investing for yield rather than total return - in terminology, yield and return are two very different things.  Sadly, most advisors do not make the distinction between the two - and without this clarification most clients use the terms interchangeably.  Total return over a defined period of time includes income and capital gains, where as yield is current income in ratio to current price.  At different stages in the life of an investor they are investing for growth while building their investments and on income when they are drawing on their investments.  I find that financial lingo helps to confuse the issue rather than to simplify it.

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