Clippings 2017

Recommended reading, economic debates, predictions and opinions.
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NormR
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Re: Clippings 2017

Post by NormR » 02 Nov 2017 23:38

ghariton wrote:
02 Nov 2017 14:32
Take the CAPE ratio, which has been above its average over 90% of the time for the past 30 years.
Is that an arithmetic average? A geometric average? It sure as hell can't be the median, or any other meaningful use of the word "average".
A hyperbolic average? I got tripped up by that one recently.

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Spousal Loans and TFSAs

Post by Park » 04 Nov 2017 10:40

http://cawidgets.morningstar.ca/Article ... &id=833324

"Spousal loans: Your spouse can give or lend you money for a TFSA contribution. This amount, together with any contributions made from your own resources, cannot exceed your contribution limit. Loaned or gifted amounts can grow tax-free within your TFSA, and may be withdrawn free of tax. However, if you were to reinvest any of this capital in a non-registered account, it would become taxable under the general income-attribution rules. It's better to use this money for a non-investment purpose, such as a major purchase or to pay down a mortgage. The bottom line is that, if you use money from your spouse to make a TFSA contribution, avoid reinvesting any withdrawn amounts in another, taxable account."

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Small Cap Effect

Post by Park » 08 Nov 2017 08:43

http://beta.morningstar.com/videos/8304 ... ffect.html

"we have seen a number of holes poked in the argument that small caps should writ large produce superior risk-adjusted returns. Part of this has to do with the fact that the small-cap effect tends to be concentrated in the very smallest of the small-cap names, microcaps. Most of that boost that that whole cohort is getting is from the very riskiest of risky names, these are lottery ticket-type stocks. The other phenomenon that was discovered subsequently was that the small firm effect at least historically had been concentrated in the month of January, and half of that effect that took place in January was focused on the first five trading days of the year.
Now any sort of calendar-year basis or event-driven intuition as a justification, the foundation for real legitimate risk premia is somewhat shaky. What you've also seen over time is that the small-cap effect empirically has apparently just diminished if not disappeared entirely. You see that, in the relative performance since the early 1980s of the Russell 1000 benchmark, which encompasses large- and mid-cap stocks versus the Russell 2000 benchmark, which is one of the most widely followed indexes of small-cap stocks, what you've seen is that from the point of view of those two benchmarks, the small-cap effect really has failed to materialize in any sort of significant investible way."

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Re: Clippings 2017

Post by Arby » 08 Nov 2017 14:15

After reading the snippet posted by Park on the small cap effect, I questioned the benefit of my 10% allocation to US small caps ETFs. But on reading the entire article, the author says there is a small cap benefit for some ETF's:
...it's important to understand some of the other criteria that are informing the index methodology. Most notably in the small-cap space, it's important to understand whether or not there are any screens, any potential sort of constraints with respect to liquidity and how also rebalancing the portfolio is handled. If you look at for example the S&P 600 SmallCap Index, what that index does, which is distinct from its peers, is it screens potential stocks to be included in the portfolio for profitability. It effectively acts as a quality screen. What you see is that when you screen small caps for quality, screening out the junkier names, keeping only the higher quality names, those that tend to be more profitable, have sounder balance sheets, is that all of a sudden you almost breathe the small-cap premium back to life. It reappears by getting rid of sort of long left tail of junky stocks.

...Our two most highly rated small-cap U.S. equity ETFs are the Vanguard Small-Cap ETF, VB, and the iShares Core S&P Small Cap ETF, IJR.

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Re: Clippings 2017

Post by Taggart » 08 Nov 2017 15:38

Arby wrote:
08 Nov 2017 14:15

If you look at for example the S&P 600 SmallCap Index, what that index does, which is distinct from its peers, is it screens potential stocks to be included in the portfolio for profitability. It effectively acts as a quality screen. What you see is that when you screen small caps for quality, screening out the junkier names, keeping only the higher quality names, those that tend to be more profitable, have sounder balance sheets, is that all of a sudden you almost breathe the small-cap premium back to life. It reappears by getting rid of sort of long left tail of junky stocks.
Seems like most everyone including myself wants the higher quality stocks. I look upon it as a contrarian indicator. Only problem is I know my personal limits and I can't take advantage of it myself using individual equities and I'm not interested in anything outside of the cheaper broad based indexes.

Perhaps times have changed, but maybe I should rename this thread clippings 1973. :)

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Re: Clippings 2017

Post by ig17 » 08 Nov 2017 20:01

Arby wrote:
08 Nov 2017 14:15
After reading the snippet posted by Park on the small cap effect, I questioned the benefit of my 10% allocation to US small caps ETFs. But on reading the entire article, the author says there is a small cap benefit for some ETF's:
...it's important to understand some of the other criteria that are informing the index methodology. Most notably in the small-cap space, it's important to understand whether or not there are any screens, any potential sort of constraints with respect to liquidity and how also rebalancing the portfolio is handled. If you look at for example the S&P 600 SmallCap Index, what that index does, which is distinct from its peers, is it screens potential stocks to be included in the portfolio for profitability. It effectively acts as a quality screen. What you see is that when you screen small caps for quality, screening out the junkier names, keeping only the higher quality names, those that tend to be more profitable, have sounder balance sheets, is that all of a sudden you almost breathe the small-cap premium back to life. It reappears by getting rid of sort of long left tail of junky stocks.

...Our two most highly rated small-cap U.S. equity ETFs are the Vanguard Small-Cap ETF, VB, and the iShares Core S&P Small Cap ETF, IJR.
Morningstar article failed to cite the source of the underlined insight. It comes from 2015 paper by Asness, Frazzini et al.

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Re: Clippings 2017

Post by Park » 09 Nov 2017 09:20

http://www.morningstar.com/news/market- ... inues.html

"Japan's Nikkei topped 23,000 for the first time since January 1992"

Stocks for the long run can truly be for the long run.

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Re: Clippings 2017

Post by Taggart » 09 Nov 2017 15:26

Park wrote:
09 Nov 2017 09:20
http://www.morningstar.com/news/market- ... inues.html

"Japan's Nikkei topped 23,000 for the first time since January 1992"

Stocks for the long run can truly be for the long run.
Yes, Park but 23000 in 1992, is still a heck of a long way from the all time high of the Nikkei at 38916 reached in December 1989. Compared to countries like Japan and some of the other countries in continental Europe, North Americans have been absolutely spoiled in their respective stock markets. Imagine having to live with negative total real returns over fifty to seventy years. I can't.

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Re: Clippings 2017

Post by AltaRed » 09 Nov 2017 16:04

Nor any adjustment for inflation... other than what the index yield has been to mitigate it some, and for ex-Japanese investors, no accounting for currency changes. What was the yen worth vis-a-vis the loonie in 1992?
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Re: Clippings 2017

Post by Park » 12 Nov 2017 23:24

https://www.safalniveshak.com/interview ... an-housel/

Interview with Morgan Housel


"My entire net worth is a house, a checking account, and the Vanguard Total Stock Market Index"


"My broad philosophy is that investors are their own worst enemies, and the real key to good investing over time has little to do with the investments you pick and lots to do with how you manage your behavior...To me the evidence is overwhelming that if you spend 10% of your investing energy on picking a portfolio and the other 90% on focusing on keeping your emotions in check, putting market volatility into proper context and doing everything you can to take a long-term view, you’ll end up doing better than the majority of investors."


When you look back at your own investment mistakes, were there any common elements of themes?

"Overconfidence...But everyone, no matter how they invest, must fight overconfidence. It’s pervasive and is probably the second-largest cause of investing regret, after ignorance."


Okay, what’s the behavioural mistake with the biggest impact that’s the least understood or noticed?

"How people think about fees are probably the least-noticed bias."


How can an investor improve the quality of his/her decision making? Does maintaining a journal help? What has been your experience in improving your own decision making over the years?

"Even if you don’t have a financial advisor I think it’s important for all investors to bounce their ideas off trusted advisors — friends, mentors, family, whatever."


Anyways, if you had just two-minutes to advise someone wanting to get into investing, what would your advice be? What are the biggest pitfalls he/she must be aware of?

"Keep it simple. Don’t try to be a hero. Compounding takes a lot of time. Volatility is the cost of admission for high long-term returns."


What are the most important qualities an investor needs to survive the complexity of the financial markets?

"I think it’s a combination of humility and a fine-tuned bullshit detector. You need humility to prevent yourself from overcomplicating investing more than it needs to be and taking risks greater than you’re able to handle. And you need a fine-tuned bullshit detector to protect yourself from the swarms of sales pitches and get-rich-quick schemes that plague the industry."

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Re: Clippings 2017

Post by kcowan » 13 Nov 2017 09:01

Park wrote:
12 Nov 2017 23:24
...And you need a fine-tuned bullshit detector to protect yourself from the swarms of sales pitches and get-rich-quick schemes that plague the industry."
Yes. And a good BS detector will help you far beyond the investment industry. :thumbsup:
For the fun of it...Keith

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Value Investing

Post by Park » 15 Nov 2017 02:45

Why value investing works better at the stock level than the sector/country/regional level.

https://blog.thinknewfound.com/2017/11/ ... al-equity/

"A quantitative value investor will try to identify the stocks exhibiting value characteristics (e.g. low P/E, P/B, P/S, et cetera) and then buy a large enough basket of them where the aggregate value signal remains strong, but there is sufficient diversification to limit idiosyncratic risk...for regional bets based upon valuation, there is not much to diversify: you’re effectively making one, big single bet.

First, in the traditional value factor, the dividing line is the characteristic in question: i.e. “cheapness.” All the stocks we buy are, by definition, relatively cheap. In the U.S. versus International case, both sides include both cheap and expensive stocks. We’re trying to express a valuation-driven trade but using very muddied instruments to do it.

Second, we’re using a dividing line that introduces a confounding risk factor. For the value factor, we generally expect both the cheap and the expensive portfolios to share similar characteristics...In the case of U.S. versus International, not only do we not expect the two baskets to share similar characteristics, but the construction of the trade ensures it.

valuation-driven market timing is really, really hard...Except – maybe – in the case where we’re seeing historically absurd, never-before-seen measures."

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Re: Clippings 2017

Post by Park » 17 Nov 2017 08:24

Why price/book may not have worked recently:

"adopting a value tilt using Price/Book has not produced the outperformance predicted in the academic research for the last 20+ years.

There are a couple of arguments as to why this has happened. First, as previously mentioned, when you put a huge amount of capital behind a factor, and when that capital tends to be permanent (sticking with the factor through ups and downs), that factor should lose some or all of its effectiveness. Second, share buybacks have become more common as time has gone by. When a company buys back shares, it reduces both its market capitalization (by reducing shares outstanding) and its book value (since either cash is subtracted to buy the shares or debt is added). The net result of this is a higher Price/Book ratio. This can have the effect of making a company look less attractive from a valuation standpoint, even though it is engaging in behavior that is beneficial to shareholders.

This combination of significant permanent capital tied to the Price/Book and the accounting basis for the reduction in its effectiveness has led to a transition."

https://www.validea.com/blog/the-most-h ... ng-factor/

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Bond Index Funds

Post by Park » 18 Nov 2017 22:56

http://beta.morningstar.com/articles/83 ... d-etf.html

"There is a solid case for investing in a broad, market-cap-weighted bond index, but it isn't as strong as it is for stocks. Market-cap weighting reflects the composition of the fixed-income market, taking advantage of the market's collective view at a low cost. But in contrast to the stock market, many participants in the bond market are not primarily focused on maximizing return. For example, banks and foreign governments hold U.S. Treasuries as a safe place to park their cash, often regardless of the interest rates. Additionally, issuers' financing activities have a significant impact on the composition of the bond market...Bond-indexing is generally more difficult than equity-indexing because of the bond market's sheer size encompassing a vast pool of securities, which in turn prohibits full replication of indexes. It is also more expensive to trade bonds than stocks."

https://www.kiplinger.com/article/inves ... funds.html

"A company’s stock market value is influenced slightly by how many shares it issues. But the much bigger factor is how popular the stock is with investors...Bonds are different. Yes, they rise and fall in price, but not nearly as much as stocks do. The price of an investment-grade bond typically doesn’t deviate much from the price on the day it was issued. That means the most important factor in its market value, and thus its weighting in an index fund, is the size of a particular issue."

The last link doesn't look like it's working well.

http://srt.morningstar.com/newsp/cmsAco ... ctCode=mle

"Even an index fund like Schwab Total Bond Index currently has a turnover rate of 74% (compared to only 2% for Schwab Total Stock Index). ... According to our data, the turnover ratio of the average domestic-bond fund was recently 159%, nearly one-and-a-half times the norm for diversified domestic-stock funds."

One of the advantages of index funds is low turnover resulting in low costs. That's definitely true for stock index funds. The link above states that it's still true for bond index funds compared to bond nonindex funds, but less so. So one of the advantages of indexing is muted, when it comes to bonds.

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Re: Clippings 2017

Post by ghariton » 19 Nov 2017 14:08

Park

Thank you for all the good clippings.

As regards index funds for bonds, I must say that I don't see them as nearly as advantageous as index funds for equities.

I think that I can get a better handle on riskiness for bonds than for equities. Basically, I see three risks with a bond: (1) Default risk (2) Market risk, also known as interest rate risk, if I sell prior to maturity or want to replace the bond (3) Liquidity risk, in case I need my money in a hurry; also if I'm worried about the spreads when I buy or sell.

I'm not sure investing in a bond index helps much with the last two. Market risk tends to affect all bonds of a given duration (and convexity) in similar ways, so diversifying across bonds of a given duration is unlikely to help. Similarly, when liquidity dries up, it tends to dry up for all bonds, except possible U.S. Treasuries.

Maybe investing in a bond index fund will help diversify away default risk. But if I have any faith in the credit rating agencies (a big "if", I know), then I can handle a lot of the default risk by picking from the six main grades of bonds available. I suppose that, even within a given grade, there could be benefits from diversification, but I suspect that those would be small.

Contrast that with the risk associated with equities, where a whole lot of factors can influence the performance, and where I just can't get my head successfully around grouping them into a small number of factors that I can use to define a portfolio (despite the current popularity of factor investing). Here, it seems to me, diversification really does bring big benefits, and an index fund makes sense.

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Re: Clippings 2017

Post by Shakespeare » 19 Nov 2017 14:20

The main benefit of broad bond funds/etfs is better pricing. The retail investor gets scrod by the bond desk.
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Re: Clippings 2017

Post by longinvest » 19 Nov 2017 14:33

I agree on the difficulty for a retail investor to obtain a good price.

But, there's also simplicity. I get to hold over 800 bonds of various maturities using a single ETF (VAB). For ultimate simplicity, one could even DRIP it (I don't; I reinvest distributions into my portfolio's lagging asset). I also index RRBs (ZRR), even though the ETF only holds 8 issues. With the ETF, I could buy as little as a single unit which would currently cost less than $18 (ZRR) with no commission at my discount broker. It wouldn't be possible, without an ETF or mutual fund, to invest $18 into an RRB, let alone into 8 different RRBs!

Also, 8 RRBs would be double the total number of positions (stock and bond ETFs) in my portfolio. So, no thank you! I'm not interested in holding individual bonds. I'll let other more adventurous investors take their chances at not being fleeced by their bond desk. :wink:
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Re: Clippings 2017

Post by Park » 19 Nov 2017 16:52

https://www.canadianportfoliomanagerblo ... o-part-ii/

" I tend to build a ladder of GICs for many of my clients, and combine them with a tax-efficient bond ETF (like BXF or ZDB), for rebalancing purposes and unexpected calls on capital from clients."

This is from the Justin Bender's blog. I have no connection to him, except that I read his blog. IMO, the above statement is sensible advice.

http://www.bankofcanada.ca/rates/intere ... ian-bonds/

Government of Canada 5 year bond is yielding 1.68%. That doesn't include the costs of buying it.

https://www.ratehub.ca/gics?gclid=EAIaI ... gIlr_D_BwE

You can get a 5 year nonregistered GIC at 2.75%. That does include the costs of buying it.

His point about a tax efficient bond fund is well taken. One has to watch for tax inefficient premium bonds in bond funds; this won't be a problem in tax advantaged accounts.

https://www.bmo.com/gam/ca/advisor/prod ... file%2FZDB

ZDB is BMO discount bond index ETF. Yield of 2.05% and an MER of 0.15%. 37% federal, 35% provincial and 27% corporate. Weighted average duration of 7.44 years. That doesn't include the costs to buy and sell it.

Why not substitute a HISA for a tax efficient bond ETF? If it's CDIC insured, you should have the same credit risk as a government of Canada bond. Minimal liquidity risk. No interest rate risk. No tax inefficiency of premium bonds. No costs to buy or sell. Cash is a reasonably good inflation hedge, compared to other assets:

https://personal.vanguard.com/pdf/icruih.pdf

https://www.highinterestsavings.ca/chart/

The above link shows the best HISA rate is 2.50%. The higher rates may be short lived promotional rates. So to keep the highest rate, you may have to move your money around. Still, Canadian Tire Bank is at 1.50%.

With a HISA, you are taking more income risk, as short term interest rates are more volatile than long term rates.

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Re: Clippings 2017

Post by big easy » 19 Nov 2017 17:23

Why not substitute a HISA for a tax efficient bond ETF? If it's CDIC insured, you should have the same credit risk as a government of Canada bond. Minimal liquidity risk. No interest rate risk. No tax inefficiency of premium bonds. No costs to buy or sell. Cash is a reasonably good inflation hedge, compared to other assets:
It's a good question. One reason is the CDIC limit of $100,000 and another reason might be the inconvenience of having to open accounts and shuffle money around chasing the highest yield. Also, If a HISA provider fails, then one has to wait to get their money back. Having said that, it certainly looks like a viable alternative, especially if one believes in higher rates/inflation ahead. On the flip side, if rates fall and HISA rates follow, then there is the opportunity cost of not having locked in for a longer term.
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Re: Clippings 2017

Post by longinvest » 19 Nov 2017 18:12

HISAs and GICs are cash investments. As such, their value doesn't fluctuate, unlike bonds which have a fluctuating market value.

Some investors prefer cash instruments over bonds. Good for them.

Me, I'll stick with total-market index bond ETFs. And I won't concentrate my investments into discount bonds, chasing tax advantages. I'm not seeking to maximize returns. I'm seeking to match average market returns minus a tiny fee and a hopefully small tracking error.

I'll let more adventurous investors try to beat the bond market.
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Re: Clippings 2017

Post by patriot1 » 19 Nov 2017 18:28

longinvest wrote:
19 Nov 2017 18:12
HISAs and GICs are cash investments. As such, their value doesn't fluctuate, unlike bonds which have a fluctuating market value.
The value of a GIC fluctuates just like a bond with the same coupon and maturity. You just aren't able to sell it.
Last edited by patriot1 on 19 Nov 2017 18:32, edited 1 time in total.

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Re: Clippings 2017

Post by Park » 19 Nov 2017 18:32

big easy wrote:
19 Nov 2017 17:23
Why not substitute a HISA for a tax efficient bond ETF? If it's CDIC insured, you should have the same credit risk as a government of Canada bond. Minimal liquidity risk. No interest rate risk. No tax inefficiency of premium bonds. No costs to buy or sell. Cash is a reasonably good inflation hedge, compared to other assets:
It's a good question. One reason is the CDIC limit of $100,000 and another reason might be the inconvenience of having to open accounts and shuffle money around chasing the highest yield. Also, If a HISA provider fails, then one has to wait to get their money back. Having said that, it certainly looks like a viable alternative, especially if one believes in higher rates/inflation ahead. On the flip side, if rates fall and HISA rates follow, then there is the opportunity cost of not having locked in for a longer term.
http://cawidgets.morningstar.ca/Article ... ture=en-CA

"CDIC will reimburse insured deposits up to $100,000 -- principal and interest combined -- for each of the seven insurance categories (deposits held in one name, more than one name, a RRIF, an RRSP, a TFSA, a trust and for paying taxes on mortgaged properties). Foreign-currency GICs or deposits with terms of five or more years aren't protected...In the event of a failure, access to your account will no longer be available. But CDIC will aim to reimburse savings, chequing, joint and mortgage tax accounts within three business days. For deposits in trusts, the organization will inform broker-trustees about the process to reimburse insured deposits. Within seven business days of receiving wire/transfer payment information, CDIC will remit payment to broker-trustees. For registered deposits, CDIC will hold them for several days while it works with the Canada Revenue Agency to ensure they remain tax-sheltered. CDIC will then contact these depositors to inform them of next steps."

If an HISA provider fails, based on the above, you shouldn't have to wait too long. The $100K limit may be a problem for some. That might result in the need to have accounts at different HISA providers. As for the income risk of a HISA, there's no way of getting around of that.

About trying to beat the bond market, I don't look at it that way. Usually, individual investors are at a disadvantage compared to institutional investors. An example would be buying and selling bonds. But there are a few areas in finance where individual investors have an advantage. GICs and HISAs are two such areas. One month government of Canada Treasury bills are yielding 0.85%; compare that to HISAs.

https://www.pimco.ca/en-ca/insights/vie ... lang=en-ca

From PIMCO (2013),

"cash and short-term bonds are the only asset classes that have reliably delivered low to negative correlations with risk assets, especially during times of market stress."

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Re: Clippings 2017

Post by longinvest » 19 Nov 2017 18:36

patriot1 wrote:
19 Nov 2017 18:28
longinvest wrote:
19 Nov 2017 18:12
HISAs and GICs are cash investments. As such, their value doesn't fluctuate, unlike bonds which have a fluctuating market value.
The value of a GIC fluctuates just like a bond with the same coupon. You just aren't able to sell it.
As far as I understand, the value doesn't fluctuate.

This becomes clearer when a holder dies and GICs are redeemed at par, or when a holder agreed to pay a penalty to redeem an "uncashable" GIC early. There's no case when the bank will agree to pay more than face value, even if interest rates have gone down and bonds of similar maturity are trading at a premium.
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Re: Clippings 2017

Post by AltaRed » 19 Nov 2017 18:41

Technically it does. Outside of an estate crystallization, if you have to sell it in the very thin, virtually non-existent, secondary market in an act of desparation, you'll be hammered. We were given the option of 'maturing' the GIC or selling it in the secondary market when distributing the esate and RBC said maturing the GICs for a $100 admin fee each would be a lot safer than the deep discounts in the secondary market.
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Re: Clippings 2017

Post by longinvest » 19 Nov 2017 18:43

Park wrote:
19 Nov 2017 18:32
About trying to beat the bond market, I don't look at it that way. Usually, individual investors are at a disadvantage compared to institutional investors. An example would be buying and selling bonds. But there are a few areas in finance where individual investors have an advantage. GICs and HISAs are two such areas. One month government of Canada Treasury bills are yielding 0.85%; compare that to HISAs.
I invest into the total bond market; I don't concentrate my investments into short-term bonds.

Lower short-term yields are actually a very good thing for my bond ETFs; they inflate the value of bonds at the time they're sold by the ETFs (one year prior to maturity). Yippee!
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