Bestselling Author Derek Foster on Canada’s Banks and Why Investors Learned the Wrong Lessons From the Financial Crisis

Fool contributor Robert Baillieul talks shop with Canada’s “youngest retiree.”

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Derek Foster is Canada’s youngest retiree. After building a portfolio of high-quality dividend-paying stocks, he was able to leave the rat race at the age of 34. Today, Derek is the author of several bestselling books, including Stop Working, Here’s How You Can!, Money for Nothing, and Your Stocks for Free, and The Idiot Millionaire.

In part 2 of my interview with Derek, we discuss the lessons he learned from the financial crisis, Canadian banks as investments today, and the biggest mistake investors have made following the Great Recession. Below is the transcript of our conversation; it has been lightly edited for clarity. (Click here to read part 1.)

Robert Baillieul: We’re approaching the five-year anniversary of the collapse of Lehman Brothers. What was your big takeaway from the financial crisis?

Derek Foster: The big takeaway I learned is that I’m kind of an idiot. I used to think I knew what would happen with the markets, but now I realize that I don’t. So I don’t even try to speculate what’s going to happen about whether they’re going to go up or down — because I’m not smart enough to know that.

I just feel that if I buy a company like Coca-Cola or Tim Horton’s people are going to keep consuming their products in ever greater amounts over time. The dividends will go up and I’ll keep cashing my cheques and living off the money. It’s no more complicated than that.

Baillieul: Did the financial crisis change your view on investing in financial institutions like Bank of Nova Scotia (TSX: BNS, NYSE: BNS) or Bank of Montreal (TSX: BMO, NYSE: BMO)?

Foster: Yeah, that’s a really good point, actually. First of all, another thing that I learned was that financial companies are kind of like a black box.

So a perfect example, I owned some shares of Bank of America before. [It had] a long history of increasing dividends, and was a strong bank. I think it was the biggest or the second-biggest bank in the U.S. at one point in time. And it’s impossible — even if you really know the companies — to know what they have on their balance sheet. If they have a bunch of outstanding mortgages, how many of them are actually going to get paid? So one takeaway is that financial companies are generally a black box. It’s really hard to understand what’s under the hood.

Having said that, not only did the Canadian banks do well, but it really focused me how the whole banking system works in Canada and made me really appreciate why our banks have been such stellar performers for decades — look at the way the market is structured.

Let’s say you go out and buy a house, 25% of that is insured by CMHC [Canada Mortgage and Housing Corporation] and essentially the taxpayer. So essentially the banks don’t have to worry about it. In other words, house prices could plunge 25% before the banks would actually start losing their own money. I think that little built-in legislative protection gives our banks a huge leg up over banks in other parts of the world.

Baillieul: Just speaking from my own experience working inside the financial industry, I had a challenging time wrapping my head around the entire operation. I couldn’t imagine how an outside investor could figure it out.

Foster: I think Warren Buffett bought General Re in 1999 or 2000 and they had a bunch of derivative contracts when the market was pretty benign. He had 20,000 derivative contracts outstanding that had to gradually wind down. And this is from probably the best or the smartest investor in the world in a seemingly calm market and it took him five or six years to unwind this and half a billion dollars in losses. So if Buffett can’t do it than I don’t know who can, really.

Having said that, I generally think the Canadian banks are really good. You do have to take it on some degree of faith. But I still think the Canadian banks have been good and I think they will continue to be good, given the whole structure of the industry.

Baillieul: There’s always talk about housing bubbles and a consumer spending slowdown, or over-indebted consumers in Canada. Are you worried about the effects this could have on the banking industry?

Foster: I’m really not smart enough to know, so it’s kind of a waste of time to worry about it.

Having said that, my wife and I sold our house. We did it because we wanted to go traveling around North America. We had a choice of whether we should rent it out or sell it and cash in our chips. At the time it seemed like a good move. So far it’s worked out well because our returns in the stock market have been better than house prices, which have sort of flat-lined. If I go on MLS and take a look today, it’s basically in the same ballpark as where we sold it for. So I’m happy about that.

I have no idea what’s going to happen to the housing market. It looks as though our housing market is overvalued, but I don’t expect real estate Armageddon anytime soon. And because of the CMHC, I don’t think it’s going to massively hit the banks or decrease their volumes, so they’ll do well over time.

Baillieul: Do you think the investment community or regular investors have learned much five years after the financial crisis?

Foster: I think people have learned the wrong lessons. I still get people who say the stock market is too risky, don’t buy stocks, yada yada. It’s a terrible thing to watch your portfolio go down 50% or whatever. I don’t know the exact percentages of the decline. And the last time that that really happened was ’73 or ’74 — at least with the U.S. market.

But I think people have learned the wrong lesson. The feeling I get, and I don’t work in the industry, but a lot of people still have their money stuck in GICs earnings 2% or something and that’s a terrible lesson to be learned. But I still think that over the long term, quality companies are going to do really, really well. People will continue to drink coffee or what they always do and they’ll keep making money. The Coca-Colas and the Johnson & Johnsons — you name it.

Coming up next
With Warren Buffett venturing into the oil sands, I ask Derek if he’s digging for value in the energy industry too. You can learn more about him on his website here.

For a specific stock idea …
If you’re looking for a specific stock idea, The Motley Fool Canada’s senior investment analyst has identified his “Top Canadian Small Cap for 2013 — and Beyond” in a new research report. You can instantly access the report — and see the ticker — by simply clicking here now.

Disclosure: Robert Baillieul has no positions in any of the stocks mentioned in this article.

The Motley Fool owns shares of Bank of America and Johnson & Johnson.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

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