In Your Best Interest. W. H. (Hank) Cunningham
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significant material on ETFs to this edition.
This book is entitled In Your Best Interest for good reason. The investment business fails most individual investors by selling them products inappropriate for their circumstances. The basic tenets of fixed-income investing remain the same:
1 Keep what you start with.
2 Earn a return on it.
What else has happened since the second edition is that I joined Odlum Brown Limited as their fixed-income strategist. Odlum’s history began in 1923, and in my opinion, it is one of the finest brokerage houses in Canada. Based in Vancouver, they focus on research and strategy for their individual clients. They do not underwrite securities nor do they trade as principal. Thus, they offer objective investment advice, untainted by the natural conflicts of dealing with underwriting products. I am very proud to be associated with them.
This is not an “I told you so” book. The principles I espouse here are applicable at any stage of an economic or market cycle. Investors have learned that they cannot rely solely on equity markets for their retirement needs. The principles of preservation of capital and returns on that capital have returned to the forefront of investing, and as retirement draws nearer, investors are starting to realize that fixed-income investments should constitute a healthy percentage of their portfolios. The principles explained in this book may be applied at any time and in any investment cycle, by investors of any age. I could have written this in the middle of the bubble and it would have carried the same message: individual investors, by adopting and employing simple principles, can produce solid returns via investing in high-quality individual fixed-income securities. What this equity-market volatility has underscored is the need for investors to invest their savings in the different categories of investments appropriate to their ages and circumstances. This mixture of investments is more commonly labelled the “asset mix.” The most common categories in which to invest your money are bank deposits (cash), treasury bills, common equities (stocks), real estate, GICs, and bonds. Within each category, you can deploy your money in different ways. Within common equities, for example, you could invest in solid, dividend-paying banks and utilities or in aggressive, high-growth, high-risk technology stocks. In the bond market, you could buy Canada Savings Bonds, corporate bonds, or high-yield or “junk” bonds.
Generally, the younger you are, the more you will invest in equities and real estate. As you age and enter your peak savings years, with an empty nest and no mortgage, your thoughts begin to move toward building an adequate retirement pot to provide you with enough income. This is the time when your asset mix should become more skewed to individual fixed-income securities whose income stream and future value are known, away from the more volatile and unpredictable equity securities. You will still have some equities, but they will more than likely be conservative, dividend-paying ones. This is not a time for fixed-income mutual funds or ETFs, as their future value and income level are uncertain. But more on this later.
Accentuating the importance of this asset mix is demography. The baby boom is in or entering its peak earnings years. As people age and their assets grow, they want more personal attention and individualized solutions for their investment needs. This partly explains why mutual funds are falling from favour and why there has been a marked growth in individually managed portfolios, investment counsellors, and in self-directed individual portfolios. Simply put, mutual funds or ETFs cannot differentiate one investor from another and thus cannot offer any specific solutions. Recent scandals have further increased investors’ distrust.
One analogy from a book about demographics and the financial markets[1] explains that mutual funds of today are akin to the cheap beer of university days. While we may drink less today, we want the beer to be high quality, or perhaps we now prefer a fine wine. Translating this to investment terms, we become fussier and desire individually managed portfolios and more personal attention. This analogy is particularly appropriate for the fixed-income markets, where bond mutual funds or ETFs are just not appropriate for retirement planning in that returns, income, and future values are all uncertain.
I will show you how to achieve solid, certain returns by focusing on a specific strategy and on specific securities. The laddering strategy involves investing monies in fixed-income investments of different but evenly spaced maturities. This strategy has stood the test of time, and it will continue to do so. It has outperformed, and will continue to outperform, the majority of bond mutual funds whose managers charge too much for merely average performance. The laddered approach takes the guesswork out of the direction of interest rates and allows investors to own individual fixed-income securities with a defined income stream and a known future value. In addition, there are very valuable, retail-investor-friendly investment products called zero coupon or “strip” bonds that are excellent retirement planning tools; they provide investors with the precise future nominal value of their money. These strip bonds, when combined with the laddered approach, are ideal for RRSPs. I have also come to the view that real return bonds (RRBs) deserve to be included in your RRSPs. Currently, however, RRBs are very expensive and I do not recommend them. There is a section devoted to an analysis of these bonds in Chapter 5.
For taxable income needs, I again recommend the laddered approach, but using interest-bearing provincial and corporate bonds for their higher yield. Mutual bond funds and ETFs, you may have noticed, are not part of this strategy. In this edition, I have expanded the product section considerably, added a chapter on preferred shares, included an updated analysis of online fixed-income trading, and have expanded many portions, including bond market transparency. Exchange Traded Funds (ETFs) have proliferated in the past two years, offering investors far more cost-effective choices in fixed-income markets. I have included an in-depth discussion of the fixed-income ETF choices facing investors.
By demystifying the fixed-income market and by educating you in all of its aspects, I will show you how to meet your income and retirement needs and make the retail fixed-income market less expensive, less formidable, more accessible, and more efficient. In other words, I want to make you wealthier. That could mean increasing your net worth and your income, making your retirement portfolio bigger, or allowing you to retire sooner. To accomplish this, I will examine the bond market, what it is, how it functions, and explain the various individual products. As well, I will point out sound strategies to follow that have worked for others.
The prime reason I am in this business is to make my individual investors better off by offering them excellent advice. A high percentage of investment advisors (IAs), however, merely sell products and do not focus on their clients’ needs. Thus, it is in your best interest to not only learn about the fixed-income markets and how they work but also to select an IA who can help you to satisfy your needs. Even without finding the right IA, you can still do it yourself using an online bond-trading account. (Later in the book I have included an analysis of available sites.) After reading this book, you will be able to buy and sell individual bonds, know how to choose the appropriate ones, how to build your own portfolio, and where you can find a good IA.
The following sections are included in the book: what the bond market is, how it functions, the various products, how to use this market profitably, winning strategies, how to find and choose an IA, the mathematics of bonds, the concept of duration, how to forecast interest rates, bonds for the speculator, retirement planning (RRSPs and RRIFs), reinvestment risk, preferred shares and bond mutual funds, and GICs versus individual fixed-income products. There are separate chapters for zero coupon bonds and for the laddered approach, as they represent the cornerstones for your retirement needs. In addition, there is an expanded section on real return bonds (RRBs) and an expanded products chapter, separating conventional bonds from structured products. As an added bonus, you will know which way bond prices go when interest rates fall! I should point out here that all the various terms that are explained within the body of the book are also defined in the glossary located on page 223 at the end of the book.
Someone asked me the other day about how the bond market worked. I have been asked that question countless times, but this time, without a lot of forethought, I blurted out: “It is all about relationships.” After I said it, I realized that I had tripped over the most concise and accurate description of how the bond market actually functions: relationships. Your success