Friday, April 21, 2017

The Stock Market Only Goes Up

Here’s a chart of the S&P 500 total return for the past 8 years:

The only conclusion my lizard brain can draw is that the stock market only goes up. In Daniel Kahneman’s terms from his great book Thinking Fast and Slow (my review here), my brain’s “System 2” knows that the stock market may crash in the future, but my automatic “System 1” is sure the stock market will keep going up forever.

As my human capital dwindles, I get closer to the age where I should be shifting some of my portfolio into safer investments than stocks. I’ve done this by building up a cash reserve, but perhaps it’s not as big as it should be at this point. It’s very hard to shake the feeling that I’m losing out by not having this cash in stocks right now. My System 2 has determined that I should have some fixed-income investments just in case stocks begin a large drop. But my System 1 resisted hitting the sell button.

Younger investors have bigger concerns. Those who have been investing for 8 years or less can’t be certain they have the stomach for the risk level of their portfolios. A huge risk for investors is that they will lose their nerve in a market downturn and sell out near the worst possible time. It’s hard to know what you can handle unless you have lived through a crash of the type that we had in 2008-2009 and back when the dot-com bubble burst.

We can be sure that a market crash will come eventually, but I have no idea when it will arrive. It’s possible that today’s stock level is the lowest it will ever be in the future. It’s also possible that stocks will get cut in half from today’s level. Most likely, we’ll get something in between.

Don’t let your lizard brain blind you to the very real possibility that stock prices will drop significantly from today’s levels. Try to invest your money with a mindset somewhere between fear and euphoria.

Friday, April 14, 2017

Short Takes: Mortgage Rates and Credit Scores, Bond Confusion, and more

I was on vacation for most of the past two weeks and managed only one post about debt:

Managing Debt

Here are some short takes and some weekend reading:

Canadian Mortgage Trends explains recent changes to how your credit score affects your mortgage interest rate. It certainly makes sense to charge more when the risk of default is higher, but I’m not sure that credit scores are a very good measure or default risk. But maybe they’re the best we’ve got.

Canadian Couch Potato tries to clear up a common point of confusion about bonds: the fact that higher interest rates mean lower bond prices.

Where Does All My Money Go interviews Sandra Foster, an expert on personal finance and estate planning.

Big Cajun Man takes on the common misconception that a Tax-Free Savings Account can only hold cash like a regular savings account.

Boomer and Echo calls for an overhaul of the finance industry.

My Own Advisor considers the possibility of trying harder for financial independence and an earlier retirement.

Monday, April 3, 2017

Managing Debt

Debt is a big part of modern life. The high cost of university leads to student debt, and sky-high real estate has many Canadians in large mortgages. And that’s just the kinds of debt that most easily justified. Then we have the growing lines of credit and credit card balances that come from failing to save up for the cars, clothes, electronics, restaurant meals, and home upgrades we want.

Finance Blog Zone asked bloggers for their takes on how to manage debt. I read through them all and found 7 of them that caught my eye either because I found the ideas interesting or because I disagreed. Here’s my take on their takes.

Brave New Life

Brave New Life says “College debt and a home mortgage are the only two acceptable debts. Ever.” And for emphasis: “No debt for cars.” There may be narrow circumstances when other forms of debt make sense, but this is an excellent starting position. Too often when I try to tell people that borrowing for a car is a bad idea, their reaction is “that’s great, but is it better to get a car loan or a lease?”

Andrew Hallam

Instead of the usual boring debt advice, Andrew Hallam does a great job of stirring emotions. “Declare war against [debt],” “Crush the debt with the smallest outstanding balance” to “frighten your other debts,” and “Then go after your next smallest debt and ruthlessly obliterate it.” He even suggests taping the carcasses to a cupboard for inspiration. Reading this almost made me wish I had a debt to kill.

Fitz Villafuerte

Fitz says “Focus on how to make more money, rather than wasting time in worrying about how to pay your debt.” Unfortunately, for people with debt-building personalities, earning more money just leads to ever-higher spending and more debt. For those with very low incomes, earning more money can be the right answer. But too many people blame their overspending on their supposedly inadequate incomes. There’s nothing wrong with trying to earn more money, but examining spending is necessary.

Celebrating Financial Freedom

Dr. Jason Cabler attacks the mindset of seeing debt as inevitable: “too many people believe that debt is just a normal part of life, but it doesn’t have to be.” Getting too comfortable with debt is a bad idea. It’s better to see debt-freeness as the normal life state.

Bert Martinez

“Money is an emotion. Debt is an emotion too. How you feel is more important than what you know.” I don’t know what this means or how it can help someone. It’s true that there are a lot of emotions tied up in money and debt, but that doesn’t help me understand Bert’s advice.

J. Money

J. Money says debt problems can be the result of habits. “The best thing that got my money straight was taking a 40 day ‘no spend’ challenge.” This changed his habits and “I didn’t realize how often I’d go shopping when I was bored!” This is some practical advice for people to try instead of just telling them to stop overspending.

Leslie O’Connor

“Don’t look at debt as ‘the enemy’ or ‘a disease’. It is just one small factor in your overall, long-term financial growth.” This works for people who handle their finances well. But for those with debt problems, telling them it’s not a big deal is terrible advice. Andrew Hallam’s advice to declare war is a much better idea.

To close, I’ll stick with something I wrote once before: Debt is a crushing burden that weighs down people’s lives and dreams.

Friday, March 31, 2017

Short Takes: Car Loans, Big Spenders, and more

Here are my posts for the past two weeks:

Pension Rip-off

Tangerine Credit Card Changes

The Undoing Project

Here are some short takes and some weekend reading:

Preet Banerjee reports that “car loans have quietly emerged as one of the major risks to Canadians’ household finances.” He goes on to give a practical example of how to get off the treadmill of car debt.

Kurt Rosentreter has some entertaining tough words for high-income people living it up. Apparently, he deals with a lot of boomers with big incomes who handle their money as badly as anyone else.

Finance Blog Zone has a long list of bloggers discussing how to manage debt (including yours truly). Seven of them caught my eye either because I found the ideas interesting or because I disagreed. I may write about the details next week.

Tom Bradley at Steadyhand tells you who your best friend is when you’re worried about the markets.

The Blunt Bean Counter explains the budget’s measures aimed at professionals who use work-in-progress deductions and use private corporations.

Canadian Couch Potato takes a look at some new mutual funds from TD that hold broadly diversified index ETFs in percentages that change based on active investment decisions. While this is interesting news, I’ll stick with indexing that includes as little human discretion as I can achieve.

Robb Engen explains why he doesn’t invest in non-registered accounts. The dominant reason most people avoid non-registered accounts is that they never use up all their TFSA and RRSP room. In some cases, people have investments that aren’t allowed in TFSAs and RRSPs. In other cases, people have income too low to bother with an RRSP, but somehow managed to fill their TFSA. A commonly used reason is the desire to take advantage of the dividend tax credit. However, in most cases, this is misguided and people would be better off using their TFSA.

Big Cajun Man applauds rule changes that make it easier to apply for the disability tax credit.

My Own Advisor interviews Sean Cooper, author of Burn Your Mortgage.

Million Dollar Journey discusses how to deal with big banks trying to sell you products you don’t need and refusing to help you index your portfolio to reduce MER costs. He observes that if his “friend can reduce his portfolio drag from 2% to 1%, it can lead to a 30% larger portfolio after 30 years.” I assume this is just using the estimate of 1% for 30 years adding up to 30%. The actual increase is 35% taking into account compounding effects.

Wednesday, March 29, 2017

Pension Rip-off

A friend of mine who is collecting a defined-benefit pension had a complaint I’d never heard before. He is convinced he’s being ripped off because his pension benefits only go up by inflation each year, but the plan’s assets go up faster than inflation. I know this isn’t right, but it took a while to think of a good way to explain why.

Let’s start with the analogy of a mortgage. Suppose you have a 5-year mortgage with an annual interest rate of 3%. Even though your unpaid balance is supposed to go up by 3% each year, your payments stay the same for the full 5 years. Does this mean the bank is getting ripped off? Not likely. Banks know a thing or two about coming out ahead.

The truth is that your flat monthly mortgage payments are calculated to take into account the 3% interest on the declining mortgage balance. If your payments increased by 3% each year, your starting payment would be a lot lower. But banks are smart enough to know that they shouldn’t expect you to be able to keep up with ever-rising payments.

The situation with pension benefits is similar. Suppose the value of your pension starting at age 55 is $1 million. Based on an assumed 4.1% real return, mortality tables from the Society of Actuaries, and ignoring any coordination with CPP, your CPI-indexed pension benefit would be $5363/month. However, if you wanted your benefits to rise by 4.1% above inflation each year, your starting benefits for a $1 million pension would be only $3010/month.

But why would anyone want such rising benefits? By age 95, the benefits would be worth nearly 5 times more after factoring in inflation. This makes little sense. It’s better to receive more now instead of getting ever more money into old age.

The short answer to the question of whether my friend is getting ripped off is no, he isn’t. The 4.1% real return earned by the pension assets are what allow him to get a higher starting pension amount.