Friday, September 12, 2014

Short Takes: CPP Costs, Peter Lynch’s Advice, and more

I wrote one post this week tackling a clever argument in favour of the current model of mutual funds paying embedded commissions to financial advisors:

Embedded Commissions: Mutual Funds vs. Cars

Here are some short takes and some weekend reading:

Andrew Coyne explains that the cost of running the Canada Pension Plan has ballooned to over $2 billion per year. Much of the higher cost is going to bloated administration and external management fees. It seems that CPP is heading towards the same high-cost structure that most Canadian mutual funds use. Almost all mutual funds fail to recoup their costs in the form of higher returns, and there is little reason to believe CPP will be any different.

Rick Ferri explains why Peter Lynch gave bad advice in his classic book One Up Wall Street. I really enjoyed this book many years ago, and it played a part in propelling me into life as a stock-picker. I’d be wealthier now if I had never read it.

James Osborne is a CFP with an interesting observation about what it takes to become financially independent.

Potato explains why RRSPs are better than non-registered accounts, even for people with defined-benefit pension plans. However, he advocates investing in a TFSA first.

Million Dollar Journey explains that even definied-benefit pension plans have risks and suggests a specific strategy for how to deal with those risks.

Big Cajun Man reports that you may be able to turn the recent credit card security breach at Home Depot into free credit monitoring for a year.

Boomer and Echo say it’s not a question of if but when Canada bans embedded commissions and brings in a best interests standard for financial advisors.

Tuesday, September 9, 2014

Embedded Commissions: Mutual Funds vs. Cars

A very clever argument used by those who want to maintain the current embedded commission model for financial advisors goes as follows:
When you buy a car, you don’t demand to know the size of the salesperson’s commission. So, why would you demand to know the commission your financial advisor gets?
Most other arguments the mutual fund industry uses are easily refuted (see Tom Bradley’s excellent article on this subject). However, this car analogy rings true at first. I don’t worry about how much commission the car salesperson gets. It’s the total price of the car that matters to me.

The problem here is that the analogy isn’t an exact fit. For example, almost everyone is aware that car salesperson commissions come out of the car price. Many investors don’t know how their financial advisor gets paid. But the differences run deeper.

Let’s imagine a fictitious world where car ownership more closely matches mutual fund ownership. Suppose that instead of paying car salespeople from the car’s price, car companies sneak out in the middle of each night and siphon a few dollars of gasoline from all the cars they’ve ever sold. The car companies resell this gas to pay salespeople commissions and their own salaries. Many car owners aren’t aware that gas siphoning goes on, and even when they hear about it, they don’t believe it’s happening to them.

All this may sound absurd, but it is a close analogy to how most mutual funds work. The management company takes cash out of the funds each day to cover all costs including financial advisor commissions. There are some mutual funds that don’t pay financial advisor commissions, but most do in Canada.

In this fictitious world, it would be perfectly reasonable for car buyers to ask salespeople whether they are paid from surreptitiously-siphoned gas. They might also ask whether salespeople recommend cars based on their cut of the gas siphoning.

Getting back to the real world, it’s true that mutual fund investors should be concerned primarily with total costs rather than just their financial advisor’s cut. But, in most cases, investors’ only contact is with their advisors, and mutual fund companies are paying advisors to make them insensitive to the total fees of the mutual funds they recommend. The problem is not just the hidden costs of financial advice, but the inflated costs not associated with advisors.

If we cut off the flow of money from mutual fund companies to advisors, this will remove the incentive of advisors to choose expensive mutual funds for their clients. This will force more mutual fund companies to compete on costs, which will be very good for investors.

Friday, September 5, 2014

Short Takes: Eliminating Embedded Commissions, Productive Procrastination, and more

My only post this week described some less well-known RRSP strategies:

RRSP Strategies (

Here are some short takes and some weekend reading:

Tom Bradley at Steadyhand explains the arguments against eliminating embedded commissions for financial advisors and then demolishes these arguments.

Gail Vaz-Oxlade suggests fighting your impulse control issues with a productive form of procrastination.

Big Cajun Man is having trouble getting money out of an RESP for his daughter’s schooling, but that hasn’t stopped the bank representative from trying to upsell him on high-margin bank services.

My Own Advisor offers a primer on opening a brokerage account.

Wednesday, September 3, 2014

RRSP Strategies

I liked Preet Banerjee’s recent book Stop Over-Thinking Your Money so much that I decided to read his older book RRSPs: 41 Strategies Canadians Need to Know about our Country’s Greatest Tax-Planning Tool. I thought I knew a fair bit about RRSPs, but Banerjee managed to teach me a few things.

If you decide to read this one, keep in mind that it is 6 years old and that some RRSP rules have changed. As far as strategies go, the biggest change in that time has been the introduction of the TFSA.

The 41 strategies are aimed at a wide range of investors. The earlier ones tend to be for beginners, and the later ones are more advanced. Banerjee’s command of RRSP rules and strategies make it worthwhile to read this book with the caveat that you should confirm that anything you plan to use hasn’t changed since 2008.

The following are some points that were interesting or new to me. Be sure to check that the rules haven’t changed.

If you hold your mortgage in your RRSP and fail to make payments, a mortgage trustee can initiate a power of sale to protect your RRSP. This means your own RRSP would take away your house!

Individual Pension Plans (IPPs) are completely new to me. Apparently they are a way for high-income Canadians to shelter more of their income than is possible with RRSPs alone. The rules for IPPs seemed to have changed in 2011, so I’m not sure of their status now.

If you plan to make RRSP withdrawals between ages 65 and 71, you may prefer to convert the RRSP to a RRIF before you’re forced to at age 71. The reason is that minimum RRIF withdrawals are considered pension income, but RRSP withdrawals are not, and there is a $2000 pension income credit.

For those still working past age 71, an interesting strategy is to make an over-contribution to an RRSP in December of the year you turn 71. The part of this over-contribution above $2000 will be penalized at 1% for the month, but you can then take the RRSP deduction the next year.

Some of the more advanced strategies involving leverage come in the last two sections. There are quite a few moving parts, and Banerjee is careful to point out that these strategies are not suitable for everyone. I found them useful to open my thoughts to a wider range of possible approaches to growing RRSP savings. I’ll likely stick to a simple plan, but I like to understand other ideas to see what I might be missing.

Overall, I’m glad I read this book if for no other reason than to remind me that there is almost always more to learn about RRSP rules and strategies.

Friday, August 29, 2014

Short Takes: Closet Indexing, Rent vs. Buy Calculators, and more

Here are my posts for this week:

Leverage Quiz

When Genius Failed

Here are some short takes and some weekend reading:

Jason Zweig give a clear explanation of why fund managers tend to make their portfolios match the index fairly closely even if their investors would prefer bolder moves.

Potato reviews several rent vs. buy calculators. He takes a much deeper look than writers of most such review posts and actually explains what’s wrong with some of them.

Tim Stobbs explains his approach to early retirement in an interesting interview. His approach sounds very sensible. The one thing that concerns me in declaring my own financial independence is the possibility that when my health eventually declines somewhat, my expenses will rise. I might need to pay someone to mow my lawn, shovel snow, or clean eavestroughs. I may have more direct expenses such as physiotherapy. For this reason, I think early retirement enthusiasts should add a buffer to their current spending to account for possibly needing to spend a little more in their 60s than they do in their 40s. There will obviously be increased spending due to inflation, but I’m talking about more spending in real terms (after accounting for inflation). The dream of early retirement can still be very real, but it might be sensible to delay it by a year or two to create a buffer.

My Own Advisor lists some Canadian dividend stocks to buy and mostly forget. While I don’t believe any investor with a concentrated portfolio can afford to just forget about a stock, it can be okay to not pay much attention if you’re sufficiently diversified.

Big Cajun Man complains that he thought public education was free. Back to school costs prove otherwise.

Million Dollar Journey has begun net worth updates for Sean Cooper. Sean’s frugality and drive for income should put most readers to shame.