Monday, December 11, 2017

Biggest Mistakes Retirees Make with Their Investments

I was reading an interesting article by Jason Heath titled Here are the six biggest mistakes retirees make with their investments. It made me think, but one of my thoughts isn’t what you might expect.

I don’t want to pick on Jason because he’s a good guy who provides solid information in his articles. Like other Certified Financial Planners, Jason works primarily with wealthy people. Now, the definition of wealthy is different in each person’s mind. A person with a million dollars in investible assets might say the threshold of wealthy is $3 million. Someone with $3 million might say the threshold is $10 million. However, the typical Canadian would call the clients of CFPs wealthy.

Jason’s thoughtful list of the most common mistakes he sees is based on his client base and not the typical Canadian. To be fair, it’s unlikely Jason wrote his own headline, and it’s the headline that I think is wrong.

Here are a few of the biggest financial mistakes Canadian retirees have made:

Saved very little money.

Carried debt into retirement.

“Bought” RRSPs at the bank a few times, but cashed them out years ago.

For those of us who have built significant savings before retirement, I highly recommend Jason’s article to see if you’re guilty of some common mistakes. Maybe you’ll learn something profitable.

Friday, December 8, 2017

Short Takes: Shorting Bitcoin, Financial Survival, and more

Here are my posts for the past two weeks:

Finance for Normal People

Should You Delay Taking CPP and OAS?

Leaving a Spouse to Pick up the Pieces

Here are some short takes and some weekend reading:

New securities will make it possible to short bitcoin. This is very tempting, but I have to consider the possibility that some government or major set of banks might choose to back bitcoin. I certainly don’t think this is likely, but it’s enough to stop me from shorting bitcoin.

Jason Zweig interviewed Peter L. Bernstein. An important quote: “Survival is the only road to riches. You should try to maximize return only if losses would not threaten your survival and if you have a compelling future need for the extra gains you might earn.”

John Bogle offers 7 rules of successful investing.

Dan Bortolotti answers a question about fees for moving assets out of a brokerage. Will the new online brokerage cover these fees?

Ted Rechtshaffen explains “two major [conflicts of interest] that every consumer should be aware of, and I believe regulators should focus on”: one for financial advisors and the other for insurance brokers.

Big Cajun Man is looking into how much he can save in taxes with pension income splitting.

Monday, December 4, 2017

Leaving a Spouse to Pick up the Pieces

I’ve been helping an elderly relative sort out her finances and other matters since her husband died. I’ll call them Carol and Bob. This experience has made it very clear to me that both spouses need to at least be able to locate a record of account numbers and institutions, including banks, insurance companies, and utilities.

For the first year or so after Bob’s death, a friend of Carol’s tried to help. They found a few paper bank statements, and wandered into branches asking for help locating all accounts. They were ultimately able to find several accounts and were able to get some of Bob’s accounts into Carol’s name.

By the time I took over, I still had to get one of Bob’s TFSAs into Carol’s name, cancel some of Bob’s monthly automatic bank account payments, and get titles on the house and car fixed. It’s been months now and this is still ongoing.

Of course, there have been many other things to sort out, but the most painful tasks involve doing battle with large organizations like banks, insurance companies, and the government.

One outstanding item is a joint investment account at BMO Nesbitt Burns. The only records I have show it holding about $40k a year before Bob’s death. I have no record of its contents being transferred anywhere, but Carol isn’t getting any more account statements mailed to her. After a frustrating series of calls to BMO Nesbitt Burns, I found out they consolidated small accounts into a lower-service arm of the company. After that the trail went cold and all promises to call back with information have been broken. So, either Bob cleaned out this account shortly before he died, or it still exists somewhere but only has online statements. It’s very frustrating that BMO Nesbitt Burns is unwilling to tell Carol whether the account still exists. Given Carol’s modest income and bank account balances, she could really use the money.

A lot of pain could have been avoided if Bob had either made Carol pay attention to the finances, or had at least left an up-to-date list of institutions, account numbers, and other contact information.

Friday, December 1, 2017

Should You Delay Taking CPP and OAS?

The default age to start collecting Canada Pension Plan (CPP) payments is 65. However, you can start anywhere from age 60 to 70. Less well known is that you can delay collecting Old Age Security (OAS) payments until age 70 as well. There are incentives for delaying these payments, and it’s not easy to decide whether to take lower payments early or wait for larger payments. Here I do an analysis that helped me make up my mind.


Let’s start with OAS because it’s simpler. The default starting age is 65. However, your payments increase by 0.6% for each month you delay starting to take OAS before age 70. So, if you wait until age 70, you’ll get $1.36 for every dollar you would have received when starting at 65.

It’s important to understand that these amounts are indexed to inflation. Some people mistakenly believe that someone starting to collect at age 65 would have his payments catch up to the amounts received by someone taking OAS at age 70. This is not true.

Consider the example of twins Alice and Carol. Alice plan to take OAS at age 65 and Carol plans to wait until she is 70. Suppose Alice will initially receive $600 per month, and by the time she gets to 70, inflation indexing will increase her payments to $700. At the same time Alice is getting $700, Carol’s payments will be

$700 x 1.36 = $952 per month.

For the rest of their lives, Carol will always get 36% larger payments than Alice will get. This compensates Carol for receiving nothing for 5 years.

If we ignore income taxes for the moment, we can calculate the return Carol gets on her “investment” of 5 unpaid years. This return depends on how long Carol lives. The longer she collects the larger payments, the better her investment looks. A chart below (after the discussion of CPP) shows the rate of return Carol gets depending on her age of death.

A complicating factor is income taxes. If your income is high enough, some or all of OAS payments get clawed back. People with high enough incomes that they are subject to a clawback require a more complex analysis. However, the more income you have, the less important the relatively small OAS payments are to you. For our purposes here, I assume that you will not be subject to any clawing back.

Another complicating factor for low-income people is the Guaranteed Income Supplement (GIS). My analyses here don’t apply to someone whose income is low enough to collect the GIS.


The CPP case is similar to OAS, but with more complications. The default age to take CPP payments is 65, but you’re allowed to start taking payments at age 60. The price is a 0.6% reduction for each month you start early. This means that you get 64 cents on the dollar if you start at 60.

You can delay taking CPP past age 65 as well. For each month you delay from 65 to 70, your payments increase by 0.7%. So, you get 142 cents on the dollar if you wait until age 70. Similar to OAS, all these amounts are indexed to inflation. If you start early, you never catch up. The boost in monthly payments from delaying the start of CPP is permanent.

A complication with CPP is that your payments depend on your history of paying into the system. There are complex dropout rules where you don’t have to count years where your income was low. I looked at two scenarios:

CPP Scenario 1: You worked steadily enough from age 18 to 60 that you get no advantage from any dropouts, and you can drop out all the years from age 60 to 70 that you don’t work.

CPP Scenario 2: You had 7 or more years with no income from age 18 to 60 and you didn’t work past age 60. You couldn’t use any of the other special dropout rules, such as looking after children under 7.

The following chart shows the real return (the return after subtracting inflation) from delaying CPP from age 60 to 70 depending on your age at death. It also shows the real return of delaying OAS from age 65 to 70.


CPP scenario 1 is close to a best-case for delaying payments. It can get a little better if you work past 65 and use those years to replace some lower-income years. CPP scenario 2 is close to a worst case. It can be made worse if some of the special dropouts are relevant to you, but most people fall somewhere between these two scenarios.

To understand this chart, it’s important to have a sense of what levels of real returns are high and low. Historically, 5% or 6% was what a diversified 100% stock portfolio with no costs received. More realistically from today’s high stock and bond valuations, even a 4% real return is high for a disciplined do-it-yourself investor who incurs very low costs and is 100% invested in stocks. If there is a fixed-income component, this drops to 3%. Those who have a non-fiduciary financial advisor and pay mutual fund MERs might hope for 1% to 2%. Anyone whose accounts get churned will get less, whether this churning comes from impulsive client decisions or unethical advisor actions.

Armed with this information, we see from the chart that delaying CPP and OAS doesn’t look good if you don’t make it to age 80. But they look very good at 90, and fantastic if you make it to 100.

But we don’t know how long we’ll live. So, it seems we’re no closer to an answer. I focus on making it to 100 for the simple reason that I know I’ll have enough money if I die young. It’s the possibility of living long that limits my spending today.

I have enough savings to fill the gap before I’m 70. In fact, having a definite age where significant new income arrives makes it easier to plan for a portion of my portfolio to last until I’m exactly 70. Guaranteed real returns over 5% look excellent to me, so I’ll be delaying CPP and OAS to age 70.


I don’t want to work until I’m 70.

Neither do I. I don’t even plan to work until I’m 60. You don’t have to start collecting CPP the day you stop working. As long as you have the savings to last until you’re 70, you can delay taking CPP and OAS.

I want to spend some money while I’m young enough to enjoy it.

Me too. In fact, delaying CPP and OAS helps me spend more money today. By making my future income more certain, I can safely spend more of my savings before I turn 70.

Won’t a higher CPP payment mean I’d get a smaller CPP survivor pension?

The total of your CPP payments and a survivor’s pension are subject to a maximum. However, the calculation makes adjustments to nullify the effects of taking CPP early or late. See Doug Runchey’s explanation of CPP survivor benefits for all the gory details.

I read that taxes and the desire to leave an inheritance can affect this decision in many ways.

That’s true. But it’s mostly true for the rich. Skilled financial planners mostly deal with wealthy people and write about their concerns. These are the people who are trying to figure out how they can spend $11,000 per month instead of just $10,000. People who have to get by on less have simpler choices to make.

The thought of dying before age 70 and getting nothing for all my CPP pay deductions drives me insane.

Try to focus on the fact that if you live long enough, the government will pay you more than they expected.

Everyone in my family dies young.

If you’re absolutely certain you won’t live to old age—so certain you have no intention of planning for it at all—then take CPP and OAS early. However, if you think living past 85 is a possibility, consider delaying CPP and OAS.

A bird in the hand is worth two in the bush.

We’re wired to make decisions that are good in the short term. Fortunately, a sequence of good short- to medium-term decisions usually leads to acceptable long-term results. However, CPP and OAS are cases where our tendency to take money now often doesn’t lead to the best long-term outcome.


It’s certainly not the case that all people should delay CPP and OAS until they’re 70. However, many who take CPP and OAS as early as possible would be better off waiting for larger payments.

Monday, November 27, 2017

Finance for Normal People

Standard financial theory treats us as though we are all perfectly rational people who make no mistakes in maximizing our utilitarian benefits with each of our financial choices. In reality, we’re emotional creatures who have desires outside of utilitarian needs. We have limited time and ability to evaluate choices, and we make lots of mistakes.

Many books have been written about how people fail to make the best rational choices. What sets Meir Statman’s Finance for Normal People apart is his attempt to unify real human nature into a realistic theory of finance.

“We want three kinds of benefits—utilitarian, expressive, and emotional—from all products and services, including financial products and services.” We’re used to focusing on utilitarian benefits such as maximizing portfolio returns. However, we also seek “the expressive benefit of high social status, as by a hedge fund; and the emotional benefits of exhilaration, as by a successful initial public offering.”

Sometimes we make cognitive and emotional errors, but this is distinct from seeking expressive or emotional benefits. Feeling good has value. It is perfectly sensible to add up utilitarian, expressive, and emotional benefits when making a choice. It’s a cognitive error when we misjudge benefits.

For example, it’s sensible for a wealthy person to say “I have more money than I need, and I don’t mind sacrificing some returns when I pick my own stocks.” For almost all people, it becomes a cognitive error when we believe that our own stock picks will beat the market. “Investors who believe they can pick winning stocks are regularly oblivious to their losing records, recording wins as evidence confirming their stock-picking skills but neglecting to record losses as disconfirming evidence.”

Because we have limited time and attention, we use cognitive and emotional shortcuts to make decisions. This works well most of the time. “Cognitive and emotional shortcuts turn into errors when they take us far from our best choices.” Keep in mind that “best choice” is defined in terms of all types of benefits: utilitarian, expressive, and emotional.

One type of cognitive error we make is called a “framing error.” Stock traders who “frame the trading race as between them and the market” are making an error. “Traders possessing human-behavior and financial-facts knowledge frame trading correctly as against traders on the other side of the trades—the likely buyers of what they sell and likely sellers of what they buy.”

In everyday language, we use “rational” to mean roughly the same as “smart.” “Financial economists, however, use the term more narrowly” to refer to people who “want only utilitarian benefits from investments.” While there is no utilitarian benefit from buying your date a rose, it is perfectly rational in the everyday sense of the word.

Statman criticises those who advise us “to set emotions aside when we are making financial choices, and use reason alone.” He says that “we cannot set emotions aside,” and that “emotional shortcuts complement reason.” I think this apparent disagreement is mostly semantic. I suspect both sides would agree that it makes sense to think carefully about big financial decisions and avoid making a snap emotional choice. Those with less technical knowledge in behavioural finance than Statman has might compress this advice to “keep emotions out of it.”

Even optimism can lead to emotional errors. “Optimism enhances our daily life as we contemplate an enjoyable future, but optimism has downsides.” A study of Finns found that “Optimism can lead to excessive debt loads.”

On the question of whether financial advisers help investors avoid cognitive and emotional errors, Statman says “Evidence indicates that financial advisers improved the financial behavior and well-being of both working and retired people.” I scanned the four papers he references that offer evidence of financial adviser benefits. I suspect that the benefits are greatest for those with enough money to get advice from a fiduciary. Those getting “suitable” advice likely benefit less, if at all.

In an example of understatement, Statman says that many firms, including “banks, hotels, health clubs, mutual fund companies, and credit card companies” “choose to exploit their customers’ errors, such as by hiding information or shrouding it.” A good example of this is the 7-page confusing investment account statements I get that bury mandatory disclosures about fees near the end.

All is not lost. “We are susceptible to cognitive and emotional errors, yet can correct them by human-behavior and financial-facts knowledge.” So admitting we make mistakes and understanding them can help us make better choices in the future.

“Expected-utility theory and prospect theory are two theories that assess happiness and predict choices. Expected-utility theory was introduced by mathematician Daniel Bernoulli.” My assessment of Bernoulli’s paper is that he was not trying to predict choices. He was saying how people should make choices, not how they actually do make choices. It may be that later economists incorrectly claimed that people actually make choices based on expected-utility theory, but I’ve seen no evidence that we should pin this on Bernoulli.

We’d like to think we’re not susceptible to trying to keep up the Joneses, but a study showed that lottery winners “increased visible assets, such as houses, cars, and motorcycles,” and this caused a “rise in subsequent bankruptcies among the close neighbors of these winners.”

I won’t repeat discussions of parts of this book I’ve discussed before about the dividend puzzle, portfolio optimization, and the annuity puzzle.

In a discussion of sustainable spending in retirement, Statman claims that “Older people in developed countries reduce their spending substantially starting at about age seventy and accelerating afterwards.” The reason, he says, is “physical limitations make them less able to spend, such as on travel, and because they are less inclined to spend for personal reasons.” He points to Fred Vettese’s work to justify leaving out what I think is the dominant reason retired people begin spending less: they overspent in their first few years of retirement. I wrote a critique of Vettese’s arguments in a previous article.

When investing, we seek more than just utilitarian benefits; we also seek expressive and emotional benefits such as “holding socially responsible mutual funds, the prestige of hedge funds, and the thrill of trading.” Unfortunately, investments with high expressive and emotional benefits “tend to be associated with high prices and low expected returns.”

Cognitive and emotional errors hurt our returns as well. Some examples are the “belief that stocks of admired companies are likely to yield higher returns than stocks of spurned companies, and that frequent trading is likely to yield higher returns than rarer trading.”

Statman goes through 5 possible explanations for the higher “factor” returns of value stocks and small-cap stocks. The first three explanations come from standard financial theory, and the final two come from behavioural financial theory. He concludes that behavioural financial theory explanations are more likely: “the evidence favors the emotional-errors and wants hypotheses over the data-mining, risk, and cognitive-errors hypotheses.”

To the growing list of investing “factors” such as value stocks and small-cap stocks, Statman adds some possible behavioural factors. One example is that stocks that rank low on social responsibility likely having higher returns.

In a discussion of three forms of the efficient market hypothesis (EMH), it struck me that the definitions seem to be based mostly on access to information and whether it is possible to profit from it with short-term trading. However, the best example of an investor who defies the EMH, Warren Buffett, made his billions with long-term investment. His advantage seemed to have less to do with having exclusive information and more to do with being better able to analyze how a company’s culture and strategy will play out over the long term.

Overall, I found this book to be very helpful at taking what I’ve learned elsewhere about human behaviours and mistakes and putting them in a useful context and framework. Our expressive and emotional needs aren’t mistakes; the mistakes come when we over- or under-value them. Statman says “I hope you see yourself in this book and learn to identify your wants, correct your errors, and improve your financial behavior.”