Friday, July 25, 2014

Short Takes: Psychology Undermines Returns, Reward Cards, and more

Here are my posts for this week:

A Saver’s View of RRSP and TFSA Room

Stuff Tax

Here are some short takes and some weekend reading:

Daniel Solin has some clear explanations of what drives people to make poor investing decisions. I can definitely see my younger self in many of the bad choices driven by psychology that he describes.

Gail Vaz-Oxlade has some sensible things to say about reward credit cards. Her reasonable advice contrasts sharply with the barrage of breathless blog posts about the latest and greatest reward cards from bloggers who make commissions from getting people to sign up for new cards.

Canadian Couch Potato takes a look at iShares’ core ETFs and gives an interesting explanation of why two seemingly very similar ETFs have different MERs.

Million Dollar Journey lays out his plans to build a portfolio to fully cover his living expenses. I’m in this process as well.

Big Cajun Man explains the difference between disability insurance and critical illness insurance. He doesn’t see why you would need both. My goal has been to build up enough savings that I don’t need either type of insurance because I’ve become self-insured.

7 comments:

  1. A noble goal to be self-insured, less premiums to pay, and the ones you do go to a very good company (you). Thanks for the mention.

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  2. MDJ's article misses a big point. His expenses are aftertax, but his portfolio income stream is pre-tax. He needs a portfolio of ~$2M to meet his expenses. Also, his expense calculations look low (e.g., he'll never have another car payment, ever).

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    1. @Anonymous: Good points. Depending on his mix of RRSP/TFSA/non-registered savings and whether his assets are split with his wife, he may not pay very much tax at all. His expenses may be high in some areas as well, such as life insurance premiums no longer needed once he has enough savings. I don't really believe people can predict their spending two decades or more into the future. Presumably, as he approaches his goal he will adjust it as necessary.

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    2. Exactly. 2 out of the 3 sources (RRSP/NRS) are taxable at either income or dividend or CG rates. Assuming a 0% rate when it's more likely to be in the 20-30% range leaves a sizeable gap.

      Look forward to your take on a similar investment income vs budget. I think that a statement of cashflows (i.e., cashflows from operations, investment, financing) is a good model to start from. This balances the income statement against other sources and uses of cash. As long as it nets out to zero or positive, then the cashflows from sources and sinks are all accounted and the plan is viable over time.

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    3. @Anonymous: I think your estimate of 20% to 30% taxes is very high in Frugal Trader's case. Let's suppose that he and his wife each need $30,000 per year to spend. As a guess, let's say that $5000 each comes from some combination of TFSA, non-registered capital, or capital gains deduction. This leaves $25,000 of income each. The tax rate on this income would be very low, particularly after they turn 65.

      You can make a plan that works today, but I think spending needs and desires can change significantly as we age. The younger you are when you declare financial independence, the larger the buffer you need in your plan.

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    4. OK...but that's $10K in income that has no tax? Not sure I follow the logic; TFSAs don't magically replenish unless you have additional savings and the capital only lasts so long if you have a fixed or rising withdrawal rate. The big assumption is that TFSA capital is sufficiently large so that a $5K annual drawdown is less than the growth rate on the remaining capital.

      With a more realistic $35K each to account for the missing vehicles noted above, the tax rates are verging on 20% for the average rate and well above for the marginal rate.

      Source: http://www.ey.com/ca/en/services/tax/tax-calculators-2014-personal-tax

      Anyway, I think we're close in our assumptions, but I'm taking a more conservative set of assumptions.

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    5. @Anonymous: There are 3 different sources of spending that will not be taxed: 1) TFSA withdrawals, 2) original principal in non-registered accounts, and 3) half of capital gains in non-registered accounts. It is these 3 things together that I'm guessing might add up to $10k/year in FT's case. The calculator you point to only uses the basic personal exemption. At a minimum, Canadians in most provinces get tax credits for their property taxes. There are additional credits for kids. After age 65 there is a senior's credit. So, I doubt FT and his wife will pay much tax.

      All that said, I have no problem with taking a conservative approach. I just don't think FT is far off the mark with his numbers.

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