Monday, March 27, 2017

Tangerine Credit Card Changes

Following quickly on the heels of adding new account fees, Tangerine is now making some less than friendly changes to their credit card.

The most important change to me is that they are increasing the foreign exchange fee from 1.5% to 2.5%. So, using this credit card is going to cost me more when I travel, primarily in the U.S.

The change that’s likely to annoy more customers is reducing credit-card rewards. Currently, certain categories of transactions get 2% cash back and the rest get 1%. The rest will now get only 0.5%.

Of course, we’d all be better off if there was no such thing as credit-card rewards and retailers were charged less to accept credit card payments. But I’m not holding my breath.

A slew of other fees that affect those who handle credit poorly are going up as well.

I still find Tangerine products to be better than most of what I can get at the big banks, but future fee increases could change that.

Wednesday, March 22, 2017

The Undoing Project

People make certain systematic errors in their judgments. We’d like to think this is only true of others, but it’s true of us as well. Even brilliant people who are experts in their fields make certain types of predictable mistakes. Michael Lewis’s book The Undoing Project traces the lives and work of Daniel Kahneman and Amos Tversky whose joint work “created the field of behavioral economics.” This book gives an interesting account of the two men’s lives and a gives fascinating insight into their results.

With most examples of the types of judgment mistakes people tend to make, I had to admit that I’m susceptible to the same mistakes. I’d like to think that understanding these tendencies will help me avoid some future mistakes, but I’m not sure it will help as much as I hope. The current “powerful trend to mistrust human intuition and defer to algorithms” is sensible.

Most of the time, the automatic judgments our brains make work very well for us. But when they don’t work well, it’s hard to stop making mistakes. It’s easier to understand this problem when it’s our eyes that make the mistake. Consider the Müller-Lyer optical illusion.

The two horizontal lines are the same length, but the bottom one looks shorter. After we measure and convince ourselves that they’re the same length, our eyes continue to tell us the bottom line is shorter. We can’t turn off the automatic wrong answer our eyes give. So it is with certain types of judgments our brains make. A key insight by Kahnemen and Tversky was that people “weren’t just making random mistakes ... they were doing something systematically wrong.”

An example of a common mistake comes from the “Linda story.”
“Linda is 31 years old, single, outspoken and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations.”
The question Kahneman and Tversky asked was “which of the following alternatives is more probable?”
“Linda is a bank teller.
Linda is a bank teller and is active in the feminist movement.”
85% of subjects chose the second option, even though logic dictates that it can’t be more likely than the first option because the second is a subset of the first. Even when they changed the question to make it clear that the first option doesn’t mean that Linda is “NOT active in the feminist movement,” subjects still favoured the second option. Graduate students with training in logic and statistics made this mistake. Even doctors made this type of mistake.

The book also contains plenty of the humour we’ve come to expect from Michael Lewis. Tversky was once told by an English statistician that “I don’t usually like Jews but I like you.” His reply was “I usually like Englishmen, but I don’t like you.”

Another example came from the way Tversky didn’t worry about the many demands for his time: “The nice thing about things that are urgent is that if you wait long enough they aren’t urgent anymore.”

In an odd definition of “winning,” Tversky’s wife once had to take her eldest son to an emergency room because “He had won a contest with his brother to see who could stick a cucumber farther up his own nose.”

Asked “if their work fit into the new and growing field of artificial intelligence,” Tversky replied “We study natural stupidity instead of artificial intelligence.”

Kahneman and Tversky faced a lot of opposition from economists. One economist’s paper opened with “The agent of economic theory is rational, selfish, and his tastes do not change.” That may make it easier to build theory, but it doesn’t sound much like actual people. But economists clung to this view that people were rational even in the face of mounting evidence from Kahneman and Tversky.

In this battle over whether people are rational, Kahneman and Tversky even reached back to a paper written in 1738 by Daniel Bernoulli (English translation here). Bernoulli offered a model of financial decision-making that we now call utility theory. He believed that people should treat a doubling of one’s net worth as just as good as halving it is bad, even though the dollar amounts won and lost are different.

Tversky wrote that “Bernoulli sought to account a bit better than simple calculations of expected value for how people actually behaved.” I’ve read the translation and I see no evidence this is true. My reading of Bernoulli’s paper was that he sought to model rational choices, not the irrational choices people actually make. I went into more detail on this subject a few years ago.

In explaining Bernoulli’s theory, Lewis writes “The marginal value of the dollars you give up to buy fire insurance on your house is less than the marginal value of the dollars you lose if your house burns down—which is why even though insurance is, strictly speaking, a stupid bet, you buy it.”

Just because fire insurance on a house has a negative expectation, it isn’t a “stupid bet.” I don’t know if this misunderstanding is just Lewis’ or if it is Kahneman and Tversky’s as well. It is irrational to accept a 50/50 bet to either double your net worth plus a dollar or lose everything, even though it has a positive expectation of 50 cents. Bernoulli’s theory isn’t a perfect model of rational decision-making, but it is far better than simple expectation.

All that said, Kahneman and Tversky’s prospect theory is an excellent model of how people actually make decisions, which is clearly different from a purely rational method.

Overall, I found this book up to Lewis’ usual high standard. It gives very accessible insight into Kahneman and Tversky’s work and gives interesting accounts of their lives and collaboration. Anyone who enjoys this book should consider reading Kahneman’s Thinking Fast and Slow.

Friday, March 17, 2017

Short Takes: Honest Fund Disclosure, Juicing Returns, and more

Here are my posts for the past two weeks:

Recognition Points Update

Tangerine Adds Some New Fees

Retirement Spending Plan Question

Balance Transfer Offer

The Case for Delaying CPP and OAS to Age 70

Here are some short takes and some weekend reading:

Jason Zweig brings us the best mutual fund disclosure ever. Brutal honesty can be hilarious.

Larry Swedroe explains how mutual fund families use IPOs to juice the returns of new funds. He also shows how they shift returns from one fund to another with front-running: “A large fund family with a small-cap fund has the small-cap fund buy shares of stocks with a low market cap and limited liquidity. Other funds in the same family then pile in, buying more shares. The limited supply of stock allows the large fund family to drive up prices with relatively small purchases by each fund. The returns of the new fund then look great.”

Canadian Couch Potato uses his latest podcast to explain why active share have little predictive power for fund returns and takes a shot at Gordon Pape’s poor investment advice.

The Reformed Broker points out that U.S. household wealth grew by a staggering $40 trillion during Obama’s presidency. That’s quite a jump considering how his political enemies have had some success painting his financial impact as a negative. Of course, presidents have only a limited impact on the growth of wealth, even if they tend to get the credit or blame.

Retire Happy has a very clear explanation of the difference between a TFSA beneficiary and a TFSA successor holder. It pays to understand this difference.

Tim Cestnick describes an interesting trick to decide after the federal budget is announced whether to realize capital gains at the 50% inclusion rate that existed before the budget.

Squawkfox reports that 39% of Canadians don’t understand the benefits of paying more than the minimum credit card payment. She uses her engaging style to explain the benefits of paying more than the minimum.

Big Cajun Man has some tax tips including the fact that CRA offers auto-fill now. I was skeptical at first, but I’ve heard from others that it works well.

Boomer and Echo explain why a 4-minute portfolio is tough to beat.

My Own Advisor updates his progress on his 2017 financial goals. I really like his first goal: “Do not to incur any new debt.” He says this goal goes without saying, but it’s an important reminder for his readers. It only goes without saying for those who’ve already figured out how bad debt can be. More naive readers might find this goal enlightening.

The Blunt Bean Counter explains the tax consequences of borrowing from or lending to your small business.

Million Dollar Journey updates us on Frugal Trader’s progress to building enough portfolio income to make his family financially independent.

Wednesday, March 15, 2017

The Case for Delaying CPP and OAS to Age 70

There are good reasons why some people start collecting CPP and OAS benefits as early as possible. However, many people start collecting CPP and OAS early for emotional reasons that don’t hold up under scrutiny. The main reason to delay benefits until age 70 is simple enough: most of us need to plan for the possibility of a long life.

Let’s start with some basics about CPP and OAS payments. Old Age Security (OAS) can start anywhere from age 65 to 70. Most Canadians at age 65 are eligible for the maximum pension (currently $578.53/month and rising with inflation). However, waiting until age 70 gives the payments a 36% boost (0.6% for each month of delay). A 70-year old just starting OAS today would get $786.80/month.

Canada Pension Plan (CPP) benefits are more complex to calculate. Doug Runchey has a great description of how to calculate your CPP pension. The biggest CPP retirement pension a 65-year old can collect today is $1114.17/month, rising with inflation. However, the average is $644.35/month. Whatever amount you’re entitled to, you’re allowed to start payments as early as age 60 or as late as age 70. The penalty for starting at age 60 is a 36% reduction, and the benefit for waiting from 65 to 70 is a 42% boost. So, the maximum payment at age 60 is $713.07/month, and the maximum starting at age 70 is $1582.12/month. That’s quite a big difference.

One technicality about CPP is that delaying benefits from age 60 to 65 can reduce your calculated pension a little if you’re not working past age 60 because you’ll have more years with no CPP contributions. (There is a special “dropout” that allows you to not count the years from 65 to 70.) So, depending on your exact circumstances, the dramatic difference between CPP at age 60 and at age 70 can be a little smaller than I showed, but it doesn’t affect the rest of the discussion much.

There are some good reasons to start collecting CPP and OAS as soon as possible. If you have much lower than normal life expectancy for any reason, it makes sense to collect some money while you’re still alive. If you have no savings and you plan to live only on just the total of your pensions (including the lower CPP and OAS payments that come from taking them early), then it makes no sense to delay CPP and OAS.

Suppose you have a normal life expectancy and have at least enough savings to be able to make it to age 70 without collecting CPP or OAS. This means that if you calculate the boosted payments you’ll get from CPP and OAS at age 70, your savings will cover withdrawals of at least this amount for the years from when you retire until you’re 70. So, you have a real choice: take CPP and OAS sooner or later?

There are some strong emotional reasons to take CPP and OAS sooner. One is that we discount the future too much. Another is that we sometimes use the fact that CPP is available at age 60 to justify retiring at 60, whether we have enough savings or not. Yet another is that it’s psychologically hard to spend down one’s savings, and as Frederick Vettese explained, you’ll have to do that faster if you delay CPP and OAS.

I’ve heard people try to justify taking CPP at age 60 saying that they want to have some money to spend while they’re still young enough to enjoy it. However, they could just spend more from their savings to achieve this. If delaying CPP and OAS to age 70 has a net benefit, then doing so will allow you to spend a little more during your early years of retirement than if you took CPP and OAS as early as possible.

We only need to consider one dominant fact to see that delaying CPP and OAS is a big win: you might live a long life. The scenario that puts the most strain on your finances is living a long time. If your financial plan works for a long life, then you won’t have financial trouble if you don’t live so long.

If you do live a long time, you’ll get the most value from CPP and OAS if you wait until age 70 to get larger payments. Knowing that you’ll be better covered after age 85 with big CPP and OAS payments makes it possible to spend more early on. The problem with longevity risk is that we are forced to plan for living to 95 even if we expect to only live to 85. The great thing about large CPP and OAS payments is that they keep growing with inflation as long as you live. This eliminates part of your longevity risk.

If you live a long life, the math overwhelmingly supports taking CPP and OAS at age 70. Doing so makes it possible to spend more in your 60s than you could do safely if you take CPP and OAS early. But what if you don’t live long? You’re still better off delaying CPP and OAS. You don’t know in advance that you won’t live long, so you’re still forced to plan for the possibility of a long life.

You may see some analyses with detailed calculations to decide when to take CPP and OAS. These often use normal life expectancy to make the choice. These analyses just aren’t relevant to most of us because we have to plan for the possibility of a long life. An exception is if you’re wealthy enough that you plan to under-spend your assets and longevity risk matters little.

In many financial decisions, the truth is in the numbers, but only when you get all the facts right. If you get a fact wrong, such as not planning for the possibility of a long life, the math gives you an answer that is exactly wrong. It pays to think clearly about the gift of high CPP and OAS payments you can get by waiting until you’re 70 to collect.

Monday, March 13, 2017

Balance Transfer Offer

I have a credit card that I don’t use much any more because I get more cash back on another card. I recently got an offer related to my little-used card by paper mail:

“Save on interest - pay only 0.99% on balance transfers” “for up to 12 months”

I normally just throw away junk like this, but I decided to scan the page. Toward the bottom, my eye caught the following line:

“A fee of 3% of the balance amount you are transferring applies.”

Just how dumb are they hoping I am? This looks like at least 3.99% interest annually to me. More likely, they’re hoping to reach the inattentive and desperate.

I decided to read the 25 lines of fine print on the back. In addition to the usual stuff about how they’d jack up my interest rate if miss my payments, I saw the following:

“Please refer to sections 10, 11, 12, 13 and 14 in your Cardholder Agreement for details on calculation of interest and the application of payments.”

There just has to be a story behind something this cagey. After reading more than just the sections referenced, I think I have the story. After I make a balance transfer from another credit card, suppose I make a normal purchase on this credit card. It turns out that the balance transfer is treated like a cash advance. If I make a payment, the payment goes against interest first, then the balance transfer, and new purchases last. So, until I pay off the entire balance transfer, interest at a high rate accumulates on any new purchases.

So, if you choose to make a balance transfer, be sure to put your credit card in a cool, dry place and don’t use it until the balance transfer is completely paid off.

No matter how bad your financial situation gets, there’s always someone there to profit from dragging you down further.