Preparing To Invest: Read Some Books!

For many of us, the web has become an important learning tool. Search engines have made it wonderfully easy to find information on specific topics. But to me, the web, with no promise that content has been edited or is correct and complete, is not a great tool for getting comprehensive information on broad topics, which is exactly what you want as you prepare to invest.

There is also the question of how the site stays in business. For most, it means selling advertising, which raises issues of conflict of interest. For instance, can I trust a review of credit cards to be fair if the site also runs ads for certain credit card companies? How do I know that a comparison of brokerages is not biased when I see ads for banks running on the site?

The use of hyperlinks on web sites, while at the very core of what makes the web great, means that users can read about whatever pages they like on a site. But it also means that they will probably read only what they like. So structuring information on a broad topic is very difficult.

Newspapers and magazines have similar issues, and also need to constantly generate new content. It does not matter if there are not any new and useful ideas to write about--staying in business for them means writing new articles.

There are plenty of other learning methods, each with their own issues, like learning from chats with friends, or from TV.

To me, the best learning tools are books. Here's why I think so:

• Content is structured: Unless this book was written and edited carelessly, the content is presented in a logical progression. Focus is given to points that are important in the context of the broader topic. Articles on the web and in magazines and newspapers lose this context.
  
• Content is comprehensive: To many people, investing means buying stocks. I'm always surprised by how many people do not understand or consider bonds or other asset classes like real estate. A good investing book will teach you about the different asset classes and how they may (or may not) fit into your portfolio. Articles from other sources mainly focus on one point (usually stocks) and are not as able as books to present information in the context of the full spectrum of investing options.
  
• Once the book is in your hands, the sale is complete. Unless you've picked up a book that is trying to sell you another product, the content is not as influenced by advertisers.

To be sure, there are some books out there that are real stinkers--books written to evangelize the latest mania, to sell another product, short-sighted books, and just plain bad advice books. But all these problems also exist in the pages of non-books, without the positive points that books enjoy.

There is still a place for non-books, especially for doing quick research into specific topics or getting the beat of current trends. But while you are building a foundation of knowledge as you prepare to invest, go read some books!

More Increases To Vanguard ETF Expense Ratios

It looks like the expense ratios on many of Vanguard's ETFs have changed recently. It wasn't that long ago that the expense ratio for VWO was raised by 0.02%.

Some other Vanguard ETFs of interest to Canadians have changed in the last few weeks:

• Vanguard's Total Stock Market ETF (VTI) has raised its expense ratio from 0.07% to 0.09% as of 04/29/2009.
• The expense ratio for the Vanguard Europe Pacific ETF (VEA) was raised from 0.15% to 0.16% on 04/24/2009
• All of their bond ETFs now have an expense ratio of 0.14%

Vanguard's expense ratios are still very low, but I hope this trend doesn't continue.

When to Buy a Currency Hedged Fund

Many international index funds have a version that is currency hedged as well as one that is not. For instance, in the TD e-series funds, there are non-hedged and hedged versions of the TD US Index and TD International Index funds. These funds can have drastically different performance numbers when the Canadian dollar fluctuates against the native currency or currencies of the companies in the index. Here are they yearly performance numbers for those TD funds.

Fund	2003	2004	2005	2006	2007	2008
TD U.S. Index	4.5	2.2	1.7	14.7	-11.1	-21.7
TD U.S. Index Currency Neutral	30.0	11.1	3.3	14.0	3.1	-39.0
TD International Index	13.4	10.9	10.2	25.5	-6.0	-27.9
TD International Index Currency Neutral	21.7	11.1	27.8	16.6	3.4	-42.2

Notice how in certain years, the performance of a fund's hedged (currency neutral) version can be quite different from the performance of the non-hedged version. This is because of currency fluctuations (tracking error also plays a part). In the case of the US index, the currency fluctuation is between the CAD and the USD, and in the International index, it is between the CAD and the various currencies in the international index.

Let's take a look at currency movements from 2003 to 2008:

So the currency neutral versions of the funds did better in years when the Canadian dollar rose against the US dollar. The non-hedged versions did better in years when the Canadian dollar fell versus the US dollar. Note that it is the change in the exchange rate and not the actual value of the exchange rate that affects returns.

Ideally, then, you want to buy the currency neutral version in years when the Canadian dollar is low, hoping to cash in when the CAD rises. Similarly, you want to buy the non-hedged version when the Canadian dollar is high, to take advantage of when the CAD falls.

Of course, timing such a move is pretty difficult, but we can look at historical data to get some idea of what could be considered a high or low Canadian dollar. Here is a chart of exchange rate data beginning in 1971 and ending May 2009:

I won't claim to know where the USD/CAD exchange rate will go, but this chart tells us that during this period, 1.00 CAD = 1 USD was pretty high, and around 1.00 CAD = 0.70 USD was pretty low. Again, I am not saying that this is how things will be in the future.

Using these numbers as a guide, we could perhaps set a rule to buy the currency hedged versions of the funds when 1.00 CAD is under 0.80 USD and buy the non-hedged version when 1.00 CAD is above 0.80 USD.

I can't guarantee that this will work in the future, but looking at the historical numbers, this appears to be a reasonable idea. There maybe other factors that would discourage this kind of thinking. For instance, you might not want to have two versions of the same index because of transaction costs or perhaps your currency hedged fund costs a lot more than your non-hedged version.

Also note that I've looked only at the CAD versus USD exchange rate. In international funds, you should consider the native currencies in the fund.

Another consideration: I am assuming that the investor wants to keep his/her investments in Canadian dollars. If you are open to holding the fund in US dollars, for example the TD U.S. Index ($US) (TDB952) instead of the TD US. Index Currency Neutral fund (TDB904), the fund in native dollars usually performs better than the one hedged in CAD due to tracking error. However, I think that the observations on currency fluctuations still holds.

And finally: Since currency movements are not predictable, and seem to even out over long periods, the choice between hedged or non-hedged funds probably isn't that important for the long term buy-and-hold investor, which is why this post is filed under the Noise tag.

Note: All chart graphics used in this post are © 2009 by Prof. Werner Antweiler, University of British Columbia, Vancouver BC, Canada and were generated using the tool at http://fx.sauder.ubc.ca/plot.html.