Mar 212017
 

I’ve been getting a lot of similar questions lately. What are bonds? Why should I care? Why are you wasting your time on this silly moose website?

I’ll answer some of those questions. Turn on the thinking part of your brain…. now… and here we go with bonds!

Not that kind of bond

Not that kind of bond

What is a bond?

A debt issued to some entity where YOU act as the issuer and collect interest. (You loan money and they eventually give it back plus some extra)

 

Wait what?

You give the government or a corporation some money, say $1000, and they promise to pay you interest, say 6%, over a specified time frame, say two years. At the end of the two years you’ll get your $1000 back plus $60 interest for a total of $1060.

Bonds are issued by governments and corporations to gain access to cold hard cash for various long term projects like World War II. Corporations prefer bonds over direct bank loans because bonds offer more flexibility. Banks are strict on what you spend their money on and won’t give you anything more till you pay back the first loan.

Governments typically don’t take loans from banks and thus will normally issue bonds to raise cash or cover a deficit. Alternatively the government can just print more money but that’ll weaken the currency on the open market and thus weaken the country.

 

How is this different from a GIC? Also, what’s a GIC?

A Guaranteed Investment Certificate(GIC) is an investment sold by a bank that provides a guaranteed return over a specified time frame.

GICs are normally issued by banks, not corporations or governments, and as the name implies is guaranteed. The word guarantee is a strong statement, but these banks have been pretty reliable these past few centuries. Bond values can change over time(more on that later) and thus their value is not guaranteed. A bond can also be SOLD at any time whereas a GIC is completely locked up for its duration.

 

Why should I buy bonds?

You’ve probably heard that people need 30% bonds and 70% stocks. There are reasons for that:

  1. Diversification – During wild market fluctuations bonds will normally do the opposite of stocks and owning both will make your portfolio less volatile. Some bond funds during the 2008 crash gained 11% while stocks fell 20%
  2. Stability – Bond prices may rise and fall slightly but they are seriously more stable than stocks. Check out the graph below.
  3. Income – Cash payouts from bonds remain fairly constant even if the bond price dances all over the place. Most bonds payout twice a year and can be used as a reliable source of passive retirement income.
Stocks vs Bonds

Stocks in Red vs Bonds in Blue. Bonds are low risk low reward which is a good thing

Ok I’m convinced, how do I buy bonds?

The easiest way to buy individual bonds is through your brokerage. Questrade offers zero commissions on bond trades. You will normally call the bond department of the brokerage to place an order. Government bonds can be purchased through the Government of Canada website. They’ll even mail you a fancy bond certificate! (Update: Canada Savings Bonds are being discontinued in November 2017. Dangit)

 

How else do I buy bonds?

ETFs – You guessed it, bonds also come in ETFs! With a bond ETF you can buy a small fraction of 1000 different bonds at once rather than a single bond. You can buy them just like a stock through your brokerage and can easily target a bond market, like government or corporate.

Vanguard’s Canadian Aggregate Bond ETF holds 770 different bonds, mostly government, it has an annual dividend (or distribution as they call it with bonds) of 3.3% which is paid monthly.

 

What else should I know?

  • Relationship between bonds and interest rates – Maybe you’ve heard that such a relationship exists. Well it does. And to put it simply, if the government reduces interest rates, bond prices go up, and vice versa. It’s an INVERSE relationship and one of the main reasons bond prices fluctuate.
  • Relationship between bonds and stocks – You should know this already, typically bonds will fall (slightly) when stocks rise and vice versa. Another INVERSE relationship.
  • Bond strategy – Infiltrate the Russian compound and steal the intel without alerting the guards…. wait…. wrong Bond again.
  • Bond strategy – Bonds are your safety net. A conservative profile will be mostly bonds. If you’re under 30 you should hold about 15% in bonds, gradually increasing that to at least 60% at the start of retirement. Thus if the market crashes you’ll at least retain some of your capital within the bonds.

 

Why would interest rates matter?

It will make sense with an example. Let’s say you buy a bond at $1000 paying 5%. You will eventually get back a total of $1050. But the next day interest rates rise to 10%. You decide to sell your first bond and buy a new one that gives 10%. Unfortunately you can’t find a chump to buy your sissy 5% bond when they can just as easily walk across the street and get 10%. The only solution is to lower your selling price to artificially give a 10% return.

You manage to sell your $1000 bond for $954.55. Had you kept it you would have earned $50, but the new owner will earn $95.45 ($50 plus your discount of $45.45) which is 10% of $954.55. Summarized below:

5% interest 10% interest (new owner) Difference
Value at purchase $1000 $954.55  -$45.45
Value at maturity $1050 $1050
Total interest $50 $95.45 +$45.45

 

Whoever issued the bond pays the exact same no matter who owns it. But as you can see the $45 was transferred between owners because of the interest rate change.

There! You’re now smarter! You can smugly talk about interest rates affecting your investments!

 

Oct 152016
 

 

Be sure to read Part 1 before continuing

What to hold in a frozen investment account:

Remember that in your frozen account there is no rebalancing, no buying, no selling, no withdraw. You can take no action until you return to Canada and unfreeze. Good thing you are read this before you leave Canada and it’s not too late! Your ideal frozen funds should have these characteristics:

  • No dividends
  • No re-balancing required
  • Steady, reliable growth
  • Low fees
  • Allocations: 15% Canadian equity, 40% US equity,  25% International equity, and 20% bonds

If you are under thirty I’d normally suggest 10% in bonds, but since you can’t re-balance it’s best to give your slower growing bonds a head start. In a few years your entire portfolio will be higher(probably), but the bonds will have grown at a slower pace, reducing their share of the total. Ideally that 20% will be closer to 10% or 15% where it belongs. (and yes that will keep shrinking, but there’s really nothing we can do about it if your account is frozen for ten years or longer).

I’ve come up with two options: One single balanced fund, or a set of three or four stable ETFs. Amix of both will also work well:

Continue reading »

Sep 202015
 

So you own a few ETFs and you’re ready to optimize your accounts. Especially you rich chumps and chumpettes with taxable accounts! Well swap ETFs are a crazy scheme with the primary benefit being tax savings. I mean, what’s with these governments! How dare they use our hard earned money to pay for roads, schools, and fundamental basic services! Even the so called “Tax Free Savings Account” is subject to some foreign withholding taxes.

Never fear, your crazy uncle has a scheme for those taxes!

 


Get to the point! What’s a swap ETF?

Well let me break it down for you wizards. A swap ETF essentially turns dividends or interest income into capital gains. Why would you want that? Because foreign dividends and interest are taxed at your full income tax rate, meanwhile capital gains are only half that. If you make over $138,586 your federal tax rates will be like so: Continue reading »

Sep 082015
 
Color Legend

IN THIS POST, click to jump ahead:

Why use RBC Mutual Funds?

My employer offers contribution matching up to 3% into a group RSP with RBC. Within it I am restricted to owning GICs and RBC mutual funds. If you’ve done any of your own research or read some of my other pages you know that I am not a fan of mutual funds. At first I thought I could just open my own RRSP elsewhere and contribute there, but in doing so I’d give up the 3% salary contribution match.

Second idea. What if I just transferred any contributions from my RBC account into my other RRSP biweekly as they came? Turns out RBC charges $50 to transfer funds, and it will take 2-4 weeks to transfer. Biweekly transfers would cost me $1200/year. Monthly transfers would cost $600/year. And that doesn’t include the opportunity cost of keeping that money out of the market for up to a month.

My RRSP has upwards of 38 years to appreciate(since I’m only 27 right now), so an annual or even bi-annual transfer is almost certainly in my future. The promise of even marginal gains(<0.5%) using ETFs or index funds will make a huge difference over time. In fact here is a quick calculation:

  • $10,000 at 10% compounded 38 years = $374,043
  • $10,000 at 9.8% compounded 38 years = $349,051
  • Difference in return = 0.2%. Difference in cash = $24,992

Compounding interest is a magical thing!

I can’t just let the money sit there and rot away until I accumulate enough to justify a $50 transfer. It’s time to take a close critical look at what my options are. Continue reading »