Tuesday, August 8, 2017

Create the Retirement You Really Want

Most retirement books focus strongly on finances and investing, but in Create the Retirement You Really Want, Clay Gillespie looks at a wide range of retirement issues from figuring out what you want to do during retirement to leaving a legacy. Readers are likely to find some topics relevant to improving their own retirements.

The book is a mix of standard non-fiction style writing and story-style using hypothetical retirees. Thankfully, the stories get to the points quickly rather than trying to be good fiction. I found this worked well. I would not have had the patience to read longer fictional parts.

I was surprised the book contained so little about investing. The hypothetical retirees deal with an advisor who offers three portfolio possibilities with targeted real returns of 2%, 3%, and 4% per year. Apart from varying the allocation to stocks, there was little mention of how these returns would be achieved. I thought it would at least have made sense to discuss the importance of keeping costs low. Canadians who pay 2.5% or more per year for their mutual funds can only dream of earning a compound average annual return of 4% above inflation for decades.

The topics covered included figuring out your dreams for what you’ll do during retirement, what it will cost, health, wills, events that derail your plans, cottages, and family bickering over inheritances. I particularly liked the discussions of cottages and inheritances. I’ve heard accountants and advisors warn about problems in these areas, but Gillespie illustrated the potential complexities and conflicts well.

One part of the discussion of inheritances surprised me: “giving back and leaving an inheritance is always important to retirees.” I know many people who’ve said they have no intention of leaving money behind. Either Gillespie is saying that people tend to change their minds as they age, or perhaps he only advises wealthy people who end up leaving inheritances.

The author shows a better understanding of inflation than some advisors. “When most people think about returns, they think only in nominal terms. They forget inflation. But inflation is very real, and retirees feel the impact more than any other group because they often live on fixed incomes. Real return is the number that people should really focus on.”

Gillespie believes that “an initial withdrawal rate of 5.5 percent is sustainable if you have the proper retirement income strategy in place.” I’m skeptical that an income strategy will make much difference. This sounds a lot like a claim to be able to beat the market. The right withdrawal rate depends on age, asset allocation, portfolio costs, and willingness to reduce spending if market returns disappoint.

The book contains some plugs for financial advisors. One is included with some statistics: “Only 29% [of Canadians] use the services of a financial advisor (even though investors who use an advisor are more confident and optimistic about their financial futures).” Of course, the implied causality here is questionable. Having lot of money makes people “confident and optimistic about their financial futures.” Also, financial advisors seek out people with a lot of money, and those with a lot of money are more likely to find a good advisor. The root cause of the correlation between financial optimism and using an advisor is having a lot of money.

While many financial advisors push their clients to leverage their portfolios, Gillespie believes it’s a mistake to avoid paying off debt in favour of saving for retirement. He gets full marks for this in my opinion. The best plan involves getting total debt down to a manageable level while you’re relatively young and then keep it dropping while simultaneously building savings. Gillespie says “good debt and bad debt is just splitting hairs,” a point I’ve made before.

“It’s always a good idea to exhaust your non-registered funds before dipping into your registered savings.” I don’t think this is always true. Between retirement and age 71, it can make sense to make an RRSP withdrawal in a low-income year where the withdrawal would be untaxed or taxed at a very low rate. Figuring out when this makes sense can be tricky, though.

In one section a hypothetical couple derail their carefully constructed retirement plan to follow the advice of a do-it-yourself (DIY) investing brother-in-law. This section paints DIY investing as chasing risky biotech stocks. There certainly are people like this who try to draw others into their risky strategies, but DIY investing can also mean low-cost diversified investing.

Advice we hear frequently is not to put money in the stock market if we’ll need it within 5 years. Gillespie has an interesting way of saying something similar: “Always invest based upon when you want your money back.”

Overall I found this book useful for its treatment of a wide range of retirement issues. However, its main purpose seems to be to drive home the point that you need a financial advisor to steer you. Of course, the challenge for most of us is trying to find a quality advisor, particularly for those with modest portfolios.

Friday, August 4, 2017

Short Takes: Mortgage Delinquencies, Stupid Investments, and more

Here are my posts for the past two weeks:

The Behavior Gap

You Can’t Have Your Sears Cake and Eat it Too

Here are some short takes and some weekend reading:

Estate administrator Scott Terrio explains why today’s low mortgage delinquency rate means almost nothing in predicting future mortgage delinquencies.

Freakonomics Radio has a very interesting investment podcast called “The Stupidest Thing You can Do With Your Money.”

The Blunt Bean Counter explains the Liberal government’s new tax proposals for private corporations. He says “the impact of these proposals is potentially massive,” and “I don't think most small business owners have any idea what is about to hit them.”

Financial Services Commission of Ontario explains how to protect yourself when renting a car. Many of us have had that moment of doubt about whether to pay for the rental company’s insurance coverage that often increases the rental cost by 50% or more. This article explains how to get coverage with your credit card or your current auto insurance policy.

Canadian Couch Potato uses his latest podcast to examine MoneySense’s role in advancing index investing in Canada and to disagree with Warren Buffett and John Bogle on international investing.

Boomer and Echo explain why you shouldn’t get mortgage life insurance. Don’t miss a comment by Travis spelling out post-claim underwriting and how it can cost you.

Thursday, August 3, 2017

You Can’t Have Your Sears Cake and Eat it Too

It’s well known that Sears Canada has been having financial trouble for some time. As often happens in these situations, the Sears defined benefit pension plan is underfunded. According to Steven G. Kelman, “Ill-advised government policies” have resulted in former employees getting only “81% of the commuted value of their defined benefit pensions.” What we have here is a tension between trying to keep companies afloat and keeping pension plans fully funded.

It’s easy to decide today that Sears should never have been allowed to delay properly funding their pension plan. But, if Sears had been forced to fully fund the plan sooner, they would have gone bankrupt sooner. If we go back to a time when there was still hope to save Sears, few people would have agreed to force Sears into bankruptcy over their pension funding. But allowing sick companies to let their pension obligations slide inevitably leads to some bankrupt companies with underfunded pensions.

We can agree that it’s unfortunate that some Sears employees won’t get their pensions. But back when Sears was still limping along, who would have decided to force them into bankruptcy and sacrifice jobs to make sure that pensions are topped up? I’m not suggesting that current jobs are necessarily more important than future pensions. But, those who focus solely on pensions need to understand that they are advocating killing off sick companies sooner.

One suggested solution is Kelman’s assertion that “governments, in my opinion, should kick in the shortfalls to make the Sears former employees and others in similar predicaments whole.” This sounds perfect until we realize that governments pay for nothing; taxpayers foot the bill. There’s no free lunch. Why should taxpayers make good on the promises of failed companies?

Another idea to protect pensioners is to put them ahead of other creditors when a company gets into financial trouble. But, then who would want to be a creditor? Any company that has an underfunded pension would have serious trouble getting credit, which would drive them into bankruptcy sooner. I’m not saying this is the wrong approach, but advocates of this idea must acknowledge that it will drive more companies into bankruptcy.

If we’re going to demand that no pension plan ever be underfunded, we have to be prepared to accept that this will bring some companies to financial ruin sooner, and will break some companies that might have survived if they had a little more time to turn around. We have to choose between pensioners and current workers. We can’t have our cake and eat it too.

Monday, July 24, 2017

The Behavior Gap

The title of certified financial planner Carl Richards’ book The Behavior Gap refers to the gap between “what we should do and what we actually do” when it comes to financial decisions. The book identifies a great many of the mistakes we make, and almost all readers who are honest with themselves will identify with some of the mistakes.

Richards is well known for his napkin drawings, and there are plenty of them in this book. One says that the cost of your mistakes rises with your level of overconfidence. “Overconfidence is a very serious problem. If you don’t think it affects you, that’s probably because you’re overconfident.”

We know we shouldn’t buy high and sell low, but “we make investing decisions based on how we feel rather than what we know. Falling stocks scare us; rising stocks attract us.”

In a drawing offering investment advice, Richards says the chance that a fund will stink rises with its expense ratio. He offers more advice when he says our decisions about how much of our company’s stock to hold should be based on principles of diversification rather than “our feelings about what’s going to happen.”

On the subject of stock mania, Richards tells the story of how during the tech bubble in 1999, he resisted “the temptation to buy technology stocks” initially but eventually gave in and lost money. It’s the last people in before the bubble bursts who get hurt the most.

Richards believes that financial planning begins with life planning. “Find out who you are and what you want. Then you can stop wasting your life energy and your money on stuff that doesn’t matter to you—and start making financial decisions that will get you to your true goals.”

If we take action based on the latest news, we’re likely to do the wrong thing. “Try going on a media fast.” “When thoughts about the market arise, let them go. Go for a bike ride.”

I was surprised to see a financial planner write that “Financial plans are worthless.” However, he followed that up with “but the process of financial planning is vital.” A single static financial plan will become obsolete as life takes a few unexpected turns. Plans need to adapt.

We’re used to being told not to make overly rosy assumptions, but “pessimistic assumptions often discourage people from doing anything to improve their outlook.” I’ve known people who buy lottery tickets because they see winning as the only way to improve their lives. They just don’t understand or believe in the power of saving small amounts regularly.

“While making wise decisions about how you invest your money is important, it doesn’t have nearly the impact of working hard and saving more.” I’m all for encouraging people to save more, but a low-cost index investor could easily end up with twice as much money each month in retirement as someone who spends an investing lifetime chasing the latest hot mutual fund. This seems at least comparable in value to saving more money each month.

In one section, Richards describes so accurately the mood in a company whose stock is soaring that it seemed like he was talking about my employer back in the late 1990s. People had “visions of early retirement,” and they knew they “should sell some of the shares,” but they hung on anyway. Many of my colleagues saw 7-figure paper valuations evaporate.

I recall asking colleagues whether they would buy back the company’s shares if they were converted to cash right now. This only caused one of my colleagues to sell. I sold too few shares myself. Richards calls this the “Overnight Test” and asks if your portfolio went to cash overnight and you wouldn’t rebuild the same portfolio today, “what changes would you make,” and “why aren’t you making them now?”

“What makes us feel safe may be at odds with the numbers.” I’ve learned this truth when it comes to retirement. My wife and I need different things to feel it’s safe to retire. For me, it’s a set of spreadsheets that analyze all the numbers in a dozen different ways. I’d just be guessing about what would put my wife at ease.

We’ve heard that simple solutions are best when it comes to finances, such as saving diligently and choosing low-cost diversified investments. “We often resist simple solutions because they require us to change our behavior.” “We’d rather look for a magic bullet: something to save us from the day-to-day grind of simply doing the work that needs doing.” “It’s much easier to entertain ourselves with the fantasy of finding an investment that will give us a fantastic return than to save a little bit more money each month. But in the end, the fantasy will fail us.” Well said.

This book is both entertaining and helpful for readers prepared to admit to themselves that they’re guilty of some of the mistakes that create this “behavior gap.”

Friday, July 21, 2017

Short Takes: Reality Check for Novice Investors and Retirement Planning

Here are my posts for the past two weeks:

Are We Saving or Investing?

The Four Pillars of Investing

The Dangers of Personifying the Stock Market

Things get quiet in the middle of summer, but I still have a couple of short takes:

Dan Bortolotti warns novice index investors that the bull market can’t last forever. When markets inevitably stumble, active managers will be quick to claim they could outperform during bear markets, even though the evidence doesn’t back up that claim.

Potato shows how to answer the question of whether you’re on track for retirement by going through an example case. As he shows, you can never know for sure that you’ll get the retirement you want, but you can find out if you’re way off.