Wednesday, May 25, 2016

Dangers of Using the Rich as Role Models

A recent story at Market Watch discussed the fact that rich people often diversify their investments poorly. Not mentioned is the fact that many people get rich through concentrated bets. But that’s a bad reason to do the same.

There are good reasons to look to successful people to see what they do well. However, using successful people as role models isn’t always a good idea.

A common way for investors to get rich is to make an extremely risky concentrated bet and get very lucky. However, for each person who takes a wild chance and gets rich, there have to be many more who take wild chances and lose almost everything.

It’s hardly surprising that people who get rich taking big chances would have a tendency to continue to take big chances. Others who try to copy this behaviour are likely to lose badly. If the rich role model was simply lucky, the next person probably won’t be lucky. If the rich role model succeeded through genuine skill, the next person probably doesn’t have the necessary skills.

I’m not saying we shouldn’t pay attention to what successful people do. What I am saying is the we have to examine whether copying a successful person’s actions is likely to work for us.

Friday, May 20, 2016

Short Takes: Fort McMurray Disaster, Financial Frauds, and more

Larry MacDonald did a great job of capturing my investment philosophy in his “Me and My Money” column in the Globe and Mail. Check it out if you want to see details about my portfolio and why I invest that way. You’ll also find out that “James” is actually my middle name.

Here are my posts for the past two weeks:

What will happen to the Canadian Dollar?

Credit Card Q&A

Here are some short takes and some weekend reading:

Don Forgeron, president and CEO of the Insurance Bureau of Canada, says that cities should stop building in disaster-prone areas. Finally, someone has a sensible take on the Fort McMurray disaster. Of course, we need a humanitarian response immediately after this disaster, but now it’s time to look for root causes. This is a case of the inevitable masquerading as the unexpected. We can’t expect individuals living in Fort McMurray and similar places to understand the risks, but there are experts who do understand the risks and their knowledge isn’t translating into communities taking adequate precautions.

Financial Mentor has a comprehensive and interesting list of financial frauds to avoid.

Andrew Hallam takes on the common investor question: “does it matters what currency your ETF is listed in?”

Preet Banerjee discusses socially responsible investing and robo-advice with ModernAdvisor CEO Navid Boostani.

Insureye has an interesting infographic showing who owns whom among car and house insurance companies.

Big Cajun Man lays out what you need to do to get Apple Pay. Personally, I’m not looking for ways to make paying for stuff easier. Cash and credit cards work fine for me for now. No doubt I’ll eventually move to newer technologies, but I’m definitely not someone looking to be on the bleeding edge of payments, even though I do some work in this area.

My Own Advisor explains the taxation of U.S. Master Limited Partnerships. This type of thing is somewhere around fifth or sixth on my list of reasons for switching to index investing.

Marie at Boomer and Echo discusses the sharing economy and the fact that she rents out one of her condo storage spaces that she doesn’t need. This made me think of the possibility of a retired person with only one car renting storage in half of a two-car garage. Then I thought about the possibility that a renter would store weapons, drugs, or something alive. So much for that idea. It’s one thing to rent out a condo storage space, but quite another to bring other people’s stuff into your home.

The Blunt Bean Counter brings in an expert to explain the laws around severance and termination costs. This is told from the point of view of the employer, but employees may find it interesting as well.

Monday, May 16, 2016

What Will Happen to the Canadian Dollar?

One of the most common questions I get is “what will happen to the Canadian dollar?” Canadians are particularly concerned with the exchange rate between Canadian and U.S. dollars. Many planned sunny vacations this past winter were canceled or shortened due to our low dollar. So, what will happen with future exchange rates?

Currency exchange rates are determined in the largest market in the world, called the foreign exchange market. Here large international banks exchange trillions of dollars worth of various currencies every day. The tiniest mispricings or inefficiencies could be exploited by savvy participants for billions of dollars per year.

Suppose a talking head on television predicts a rise in the Canadian dollar. Let’s dig into what this prediction means. To begin with, if everyone else agreed with the talking head, then they would seek to profit by buying Canadian dollars immediately. This would cause the dollar to rise immediately.

So, a huge number of banks and other speculators necessarily disagree with our talking head’s prediction. This should make you wonder why you should listen to a talking head if people betting trillions of dollars every day disagree with him. The current exchange rate strikes a balanced price among huge currency traders. It’s hard to see why we should trust the talking head more than people betting real money.

So much for the logical part of all this. Let’s get to the more emotional parts. The talking head looks important. He has a nice suit and tie and looks smart and confident. He’s probably very likeable too. Maybe he’s the kind of guy who could get you to go $100k above the price limit you planned for buying a house.

It’s very hard to look at a confident, likeable person and say “He’s full of it. He has no idea if what he’s saying is true or not. If he really knew anything, he’d be making billions himself in currency markets instead of talking on television.”

It’s also hard to ignore people who have been “right” in the past. The Canadian dollar only goes up or down (or rarely stays flat), so it’s very likely that a talking head could be right a few times by chance alone. If you make 20 predictions randomly, you’re likely to get 3 in a row right somewhere along the way.

Another thing that makes it hard to ignore the talking head is that we care about the future of the Canadian dollar. Knowing what will happen would bring important advantages. It’s hard to ignore someone who says he’s going to tell us what we need to know.

Yet another thing that keeps us tuned into the talking head is that we feel it must be possible to work hard enough to predict what will happen. Our hindsight bias makes us think that past movements in the dollar were predictable when they really weren’t at the time. With this hindsight bias, why wouldn’t we think that someone could predict where the Canadian dollar is going in the coming months?

We need to embrace the fact that we’ll never know whether the dollar will go up or down. The only practical plan is to conduct your life in a way that you’ll be okay no matter which way the dollar heads. For some people, this may mean making investments denominated in U.S. dollars.

When I’m asked what I think will happen to the dollar, I usually give some shortened version of these thoughts, and most of the time my arguments simply bounce off. A few people have accepted this logic, and fewer disagree. Most simply move on to the next person and ask “what do you think will happen to the dollar?”

Thursday, May 12, 2016

Credit Card Q&A

I recently answered credit card questions for a couple of young people. This reminded me that nothing is obvious until someone explains it to you. Financially savvy readers can take these questions as a reminder to start with the basics whenever helping people with their finances.

Here is my recollection of the questions and my answers.

Q: If I’ve built up a balance on my credit card over time, how much am I allowed to pay each month above the minimum payment?

A: You can pay off your entire balance any time you want. In fact, this is a very good idea if you have the money available. While you have a balance owing, the credit card company charges you interest on each item from the moment you make the purchase. Once you break this cycle and pay off your entire bill on time each month, you stop paying any interest, even though there is a delay from purchase until your monthly payment is due. It can take a few months of paying off your bill in full to get off the interest treadmill, though. I’ve even had to stop using a credit card for a couple of months to break the interest cycle.

Q: If I cancel my credit card, can I apply for a better card right away?

A: You’re allowed to have multiple credit cards at once. So, you can apply for the better card right away and cancel the old card when it is convenient. Once you have the new card you can use it for new purchases while you break the interest cycle on the old card.

A possible barrier to having multiple credit cards is if the available balances are too high. A new credit card issuer may not want to give you another card if you already have a huge credit limit available on your existing cards. I get bothered to increase my credit card limits frequently, but I hold the limits to about triple the most I’ve spent in a month.

Q: Can we change the subject?

A: Soon. Too many people get off on the wrong foot with credit cards. They think of their credit limit as available money to spend. The goal should be to pay off your entire balance owing every month and never pay interest.

How about those Raptors?

Friday, May 6, 2016

Short Takes: Air Miles Problems, Return Predictions, and more

Here are my posts for the past two weeks:

A Financial Product I’d Like to See

Safe Stocks

Reader Question: Changing Asset Allocation

Here are some short takes and some weekend reading:

Potato explains in detail the problems with Air Miles and how they’ve effectively expired already. This post captures the problems generally with almost all forms of loyalty points and miles.

Barry Ritholtz cracked me up with his take on McKinsey’s predictions for global investment returns.

Canadian Couch Potato answers a tricky reader question about when and how to switch from an index portfolio of TD e-Series funds to an ETF-based portfolio.

The Fraser Institute issued a report explaining how the rates of return people get on their CPP contributions is lower the younger you are because contribution rates have risen over the years. The media release I received said “Canadians born after 1971 will receive meager 2.1 per cent rate of return.” However, this is misleading. That is a real rate of return, meaning a return after subtracting out inflation. The actual report is much clearer on this point. A 2.1% return sounds dismal, but 2.1% above inflation is actually more than most people will get from their other investments.

Preet Banerjee interviews Andrew Graham, CEO of Borrowell, in his latest podcast.

Boomer and Echo offer 11 different model portfolios, some using ETFs and others using index mutual funds from various Canadian providers.

Big Cajun Man takes a look at the enormous changes that will come with self-driving cars.

Million Dollar Journey offers some income-splitting ideas for couples. I use many of these techniques myself.

My Own Advisor interviews an index investor who is approaching retirement age.