Emma’s ex-husband gave their two twenty-something sons a $30,000 down payment. She thinks that was a big mistake.

Four years ago, at the age of 24, Jonas Knight decided to buy his first house. Prices had been shooting up in his home town of Maple Ridge, a suburb of Vancouver, and he felt that if he didn’t get in the market soon, he never would. Problem was, like many young Canadians, he couldn’t afford even a basic starter home.

To help ease the burden, his brother Derek, 21, agreed to go halfers (we’ve changed their names to protect their privacy). Derek would own half the house and pay half the mortgage, and Jonas would live in it and rent part of it out to friends. But even then, they didn’t have enough to make the down payment on the $420,000 wood-frame house they were eyeing. So they turned to mom and dad. The brothers made separate pleas to their parents, who are divorced. Their dad, Russell, said yes, agreeing to give them $15,000 each for the down payment. Their mom, Emma, said no.

Which parent did the right thing? It’s a question I just can’t get out of my head—perhaps because my husband and I recently purchased our second home and I’m eight months pregnant. I know how tough it is for young home buyers, and 20 or 30 years from now, when my son buys his first home, I could face the same request. To help me make up my mind, I decided to research the arguments for and against helping your kids buy their first home.

Your kids have it tougher

Quite quickly I came across the most compelling argument in favour of helping your kids: Houses are much less affordable now than they were when you bought your first home. Canadian households earn $35,000 more today than a generation ago. But that’s before you factor in the rising cost of living, known as inflation. Once you do, you find that the typical Canadian household makes about the same as in 1980.

But home prices sure aren’t the same as they were back then. Even after accounting for inflation, the average Canadian home now costs dramatically more than in 1980. If you were looking to buy an average-priced Canadian home back then and you earned an average income, you would have to save every penny you made for 1.9 years to completely pay it off. But if you earned an average income today and wanted to buy the same home, you’d have to save for 4.4 years.

Mixing family and money

At this point I was pretty convinced: only cold-hearted parents would refuse to help out their kids. But then I talked to Karin Mizgala, CEO of MoneyCoaches Canada, a national network of fee-only financial professionals.

She told me there are strong reasons not to help an adult child get into the property market. “If money weren’t an object and life were perfect, I’d say don’t do it,” says Mizgala. “Mixing family and money has the potential for disastrous family dynamics.” She warns that setting up a “parental bank” could create a sense of entitlement and expectation. “This can be very dangerous to a child’s financial and overall maturity.”

Still, she did suggest a compromise: Instead of giving your kids the money, you could loan it to them. “But you have to write a formal agreement and put everything in writing,” says Mizgala. “That way your expectations are clear, your child doesn’t feel beholden to you, and they continue to develop their own sense of independence.”

Tied to the home

There’s one more argument against giving your kids the money, and this one I learned from Emma. You’ll recall that she refused to give her two sons Jonas and Derek any money for their down payment. And she’s still not sure her ex-husband did the right thing by giving them the money. You see, since buying the house, her sons, who run their own construction business, have run into some hard times. To help them make their mortgage payments, Emma and her new husband have hired them on at their standard rate to do home renovations for them.

Emma sees her sons, both not yet 30, stressing out about making their payments and she can’t help wondering if they were too young to buy a home. “Their mortgage is like a ball and chain,” she says. They can’t travel, change professions, or even save for another big purchase.

Mizgala agrees this can be a problem. By jump-starting your kids into home ownership, you may not be doing them a favour. “Check your own motives for helping,” Mizgala says. “We live in a culture where not owning draws criticism and judgment. That kind of guilt can play on a parent.” Asking your kids to spend a few years saving up a bigger down payment before they buy helps to ensure they’ll be ready for the responsibility of home ownership when they do.

After considering both Mizgala’s arguments and the genuine struggle that young people have to go through to buy, my husband and I have decided that when the time comes, we will help our boy—but we’ll loan him the money at prime, not give it to him. We believe that by structuring our financial contribution as a low-interest family mortgage, and not as a gift, we’ll help him stay fiscally responsible. And that’s a lesson that will keep on giving, even after his starter home has come and gone.

Some stores make it a chore to return unwanted items, while others roll out the red carpet. These retailers make returns and exchanges a breeze.

Chapters/Indigo: Bought a book you don’t like? If it’s a novel designated by Indigo CEO Heather Reisman as a “guaranteed read,” you can return your purchase in any condition with a receipt for a full refund.

Costco: Technically, this big box retailer’s policy says you have 30 days to bring back your purchase, but Costco members know that you won’t be hassled if you bring your items back up to a year later. Electronics must be returned within 90 days—still three times longer than the standard return period.

Home Depot: Customers have a generous 90-day period to return an unwanted item—and you don’t even need the receipt. Just bring the debit or credit card you used to make the purchase and Home Depot will credit your account.

Mountain Equipment Co-op: If you’re not satisfied with this outdoor retailer’s gear, you can get a cash refund within 30 days. However, we know members who have exchanged worn-out items up to 7 years after the item was purchased. The co-op’s guarantee even covers staff recommendations: If an employee advises you to purchase something and you don’t like it, just take it back.

Toys “R” Us: This toy retailer has a 90-day return period (45 days for certain electronic items, monitors and breast pumps), giving Junior lots of time to contemplate whether he really likes his birthday gift.

Wal-Mart: You have 90 days to return an item. If you don’t have a receipt, you can still do the return, but the refund will be placed on a Wal-Mart cash card.

(Originally published in MoneySense Magazine November 2011)

While all of these new ETFs can make the investment process seem overwhelming, they also offer investors the ability to fully customize their portfolios. To find out how you can harness the power of specialty and niche ETFs read on, and we’ll fill you in on what this next generation of ETFs offers and how you can use them in your portfolio.

What’s your weight?

The earliest ETFs followed well-known benchmarks, such as the S&P 500 in the U.S. and the S&P/TSX 60 in Canada. These major market indexes include only the largest and most frequently traded companies, and each company’s weight in the index is based on its market capitalization. (The “market cap” is found by multiplying a corporation’s stock price by the number of shares outstanding.) Most of today’s ETFs still follow these “cap-weighted” indexes.

“Cap-weighted ETFs are the easiest and cheapest to manage,” says Dan Bortolotti, author of The MoneySense Guide to the Perfect Portfolio. “Unless a company is added or deleted from the index, the fund doesn’t need to make any changes to the portfolio. That low turnover also makes them extremely tax-efficient.”

However, there is one problem with capweighted indexes: they may become dominated by a small number of very large companies. For example, a popular cap-weighted ETF that tracks the Canadian financial sector includes 26 stocks, but it is dominated by just three names: Royal Bank, TD and Scotiabank account for more than half of the index.

The concern with cap-weighted funds is that a few individual stocks could become dramatically overvalued and leave the index vulnerable to a bubble. “One only has to look at Nortel to understand the potential dangers,” says Mark Yamada, president and CEO of PÜR Investing, a firm that specializes in constructing ETF portfolios. Nortel alone made up more than one third of the S&P/ TSX Composite Index in mid-2000. During the dot-com craze of the 1990s, stock prices for technology companies soared and the tech sector went from 5% of the S&P 500 to almost 30%. Then the bubble burst and cap-weighted funds plummeted.

“For that reason, many cap-weighted indexes now impose a limit on the weight any individual company can carry,” explains Yamada. This cap is usually 10% for broadmarket indexes and 25% for sector ETFs.

A fundamental solution

In part to address some of the drawbacks of cap-weighted indexes, a number of alternative index structures have since sprung up. Among the most popular are equal and fundamentally weighted indexes.

Equal weighted indexes assign the same weight—or importance—to every stock. This helps avoid the heavy concentration of large companies that can occur in cap-weighted indexes when stock prices rise. The strategy works particularly well in sector ETFs that often hold only a small number of stocks. But this strategy also requires more turnover than cap-weighted funds and, as a result, can mean higher transaction costs.

Another alternative is the fundamentally weighted index, which breaks the link between a company’s stock price and its weight in the fund. Rather than relying on market capitalization, fundamentally weighted indexes assign proportions based on a company’s fundamentals, such as its dividend payout, free cash flow, book value and total sales. Fundamental indexes (which go by the trade name RAFI, for Research Affiliates Fundamental Index) tend to measure a company’s footprint in the economy, rather than its footprint in the stock market.

“These alternative weighting styles can result in higher returns, but these indexes do take on more risk,” explains Richard Ferri, author of The ETF Book and founder of Portfolio Solutions, a U.S.-based low-cost investment firm. “If you choose to go with an alternative weighting—either fundamental or equal—you’re really deciding to put different risks in your portfolio.”

For instance, fundamental indexes tend to move money away from growth stocks and into value stocks. “Buying a fundamentally weighted fund is really a decision to make a play on value investing,” says Ferri. “When you move into value investing, you’re taking on a riskier proposition.” That’s because value stocks are usually made up of companies in struggling industries or sectors that have lower growth rates. “This equates to more risk, and more risk should mean a better return, all things being equal.”

Equal weighted indexes, on the other hand, give less influence to large-cap companies and more to small and mid-sized companies. “We know that small and midcap companies carry more risk, as these are the companies with fewer products, and they aren’t as globally diversified,” says Ferri. For that reason, equal weighted funds should also offer potentially higher long-term returns. “If you don’t understand these additional risks you may end up making the wrong move at the wrong time, and that usually means losing money,” says Ferri.

You should also realize that in general, fees tend to be a bit higher for equal and fundamentally weighted indexes. “Capweighted funds almost always have the lowest fees and the least turnover,” explains Yamada. In addition, while cap-weighted ETFs usually come close to matching the returns of their benchmarks, alternative indexes are harder to track, and the ETFs may not always deliver what they promise.

This doesn’t mean you shouldn’t consider equal or fundamentally weighted indexes, however. After all, they do offer potentially higher returns. You just need to understand what it is that you’re buying, so you’re prepared for how they respond to different market conditions.

A new breed of ETFs

One reason for the explosion of exchangetraded funds in recent years is that there is only space for so many broad-market products. Most of the growth in the marketplace in the last few years has been in specialty or sector funds that fill in the gaps.

Some specialty ETFs passively track a benchmark, but they use embedded strategies that select stocks with certain characteristics, such as high dividend yields. Others follow investments other than stocks. There are ETFs that follow all of the major currency indexes, as well as ETFs following the price of commodities such as oil, natural gas, gold, silver, wheat, sugar and corn.

Sector ETFs, on the other hand, focus on a single economic sector, such as real estate, energy, health care or financials—or even a sub-sector such as the Canadian oil sands. They have fewer holdings and thus may be more volatile than the overall market. Investors may choose specialty or sector ETFs when they believe a particular strategy or industry will perform better than the overall market over a period of time. These ETFs let you use an active strategy or make a sector play while spreading your money over the whole sector you’re betting on.

Both specialty and sector ETFs are typically more expensive than broad-based funds. But for investors with larger portfolios— say $300,000 and up—they can be a great way to add more diversification, or to attempt to gain an advantage in the market. “One reason to introduce sector ETFs into your portfolio is because you’re underrepresented in a particular sector,” says Yamada. For instance, technology and health-care companies are all but absent from Canada. Add a U.S. or global sector ETF and you’ll increase your portfolio’s exposure to these important industries. “Remember, you can get as sophisticated as you want,” says Yamada, “but you have to assess your level of comfort, and you need to understand the product: both the risks it adds and how it impacts your portfolio.”

ETFs that act like mutual funds

A fairly recent innovation in the exchangetraded fund marketplace is the introduction of ETFs that have fund managers who actively pick stocks. In the mutual fund world, this kind of active management is the norm, but it’s still unusual in the ETF space. Of the $40 billion invested in Canadian ETFs, only about $1 billion is in actively managed ETFs.

A drawback to active ETFs is their higher costs. One of the primary reasons traditional ETFs gained popularity was their low expense ratios, but many active ETFs charge fees that are just as high as mutual funds.

Still, there is one type of active ETF that has become extremely popular with investors: funds that use covered call strategies. These ETFs buy a portfolio of stocks and then sell call options to generate additional income. (A call option gives the buyer the right to buy a stock at a specified price at any time before the expiration date.) The management fees for these funds are often quite low (0.65% or so), but there will be transaction costs that eat into your returns.

More ETF facts

How risky are derivatives?

A growing number of ETFs use derivatives to get exposure to the stock, bond or commodity markets, rather than holding those assets directly. For example, some ETFs use a derivative called a swap, which tracks an index indirectly, but perfectly and cheaply. “Not having to buy and sell the underlying asset makes them far more tax-efficient,” says Mark Yamada of PÜR Investing. All the gains are tax-deferred until you sell the ETF. However, there is a small risk the counterparty will default. Commodity ETFs may use futures contracts when holding the asset directly is impractical. Yamada says these ETFs are not nearly as tax-efficient, and they may have significant fees

Watch your costs

Not all ETFs have low fees any more. Before 2005, the average ETF expense ratio was 0.40%. Since then the average MER has jumped to 0.60%, with some new funds charging more than 1%. Since you also pay commissions and bid-ask spreads, it’s especially important that you minimize costs.

Leveraged and inverse ETFs

Leveraged ETFs magnify gains in the indexes they track, in the same way that buying a stock on margin can amplify a surge in price. But they also increase losses.

If you invest in a leveraged ETF that rises or falls at double the rate of its underlying index, and that index rises by 1% on a given day, then your fund will rise by 2%. If the index falls 1%, your fund will drop by 2%. But watch out: because of the way they behave, if the index drops by 2%, then rises by 2%, you’ll end up with less than you started.

Inverse ETFs move in the opposite direction of the markets so you can profit when an index goes down. “These are not buy-and-hold funds,” says Yamada. They are usually best left to professional investors.

(Originally published in MoneySense magazine, December/January 2012)