Friday, May 30, 2014

Short Takes: TFSA Misconceptions, Nest Egg Needed for Retirement, and more

Here are my posts for this week:

Rockin’ Your RRSP

CPP at Age 60 Anchors Canadians’ Thinking

Here are some short takes and some weekend reading:

Boomer and Echo have an excellent quiz on TFSAs that illustrates misconceptions with example scenarios. You’ll notice a pattern in the true/false answers after a while.

Million Dollar Journey says you won’t need as much money to retire as you think. I’d say it all comes down to how much you intend to spend. I’ve known people who can’t seem to get by on less than $10,000 take home per month, and I’ve known others who could comfortably get by on just CPP and OAS.

The Blunt Bean Counter explains the tax implications of using a corporation to hold your investments.

Potato looks at rules of thumb for the cost of house maintenance. It’s a tricky area, but one thing I’d bet is true is that maintaining a house is more expensive than most people realize.

Canadian Couch Potato tells the story of one investor’s journey to inner peace. I’ve certainly found index investing to be much less worrisome than stock picking.

My Own Advisor lays out his priorities for found money such as tax refunds.

Big Cajun Man gets into a debate on debt. Both sides take extreme positions, but if you have to choose one extreme, you’re better off being deathly afraid of debt.

Wednesday, May 28, 2014

CPP at Age 60 Anchors Canadians’ Thinking

The option to take CPP starting at age 60 is not serving most Canadians well. Most people who have no defined-benefit pension do not have enough savings to retire comfortably when they turn 60. But since people know that CPP can start at 60, this creates an anchor in their minds for when they want to retire.

The maximum CPP benefit for those starting at age 60 is about $8000 per year. Most Canadians will get quite a bit less than this. For a single person hoping for a modest $36,000 per year income in retirement, CPP isn’t adding much. This leaves at least a $28,000 per year shortfall until age 65, and once OAS kicks in, about a $21,000 per year shortfall thereafter. Covering this shortfall requires savings in the range of half a million dollars or more. I think I just heard some readers say “HA!” at the thought of having half a million dollars saved.

The problem is that the lure of not having to work any more is powerful. But for the typical Canadian, discussing CPP at age 60 just brings false hope. Combine this false hope with some fuzzy thinking about the numbers and many Canadians take the retirement plunge at age 60 even though they are ill-prepared financially.

I tend to favour giving people the choice to make their own decisions. But I can’t help but think that typical Canadians would have more realistic retirement expectations if they couldn’t start their CPP benefits until age 65 or later.

Monday, May 26, 2014

Rockin’ Your RRSP

Bruce Sellery’s book The Moolala Guide to Rockin’ Your RRSP takes a fresh approach to motivating people to save money. Saving and investing can be scary and boring, and requires self-sacrifice. Sellery’s five easy steps are aimed at helping those who feel overwhelmed by the process.

This book contains many of the technical facts people should know about RRSPs, but these get slipped in while Sellery is telling some entertaining stories that explain his five-step process. The first step is the most important: find a reason for saving that has meaning for you. Sellery’s answer is adventure, but everyone has their own reason they find motivating. In the remaining steps, Sellery remains keenly aware of the emotional reasons why people don’t follow through on their savings plans.

My biggest criticism of this book is that it tends to steer people to their banks to open RRSPs. Saving money in bank mutual funds with sky-high MERs is better than not saving at all, but there are better options. The book mentions some other choices, but I would like to have seen more discussion of the importance of keeping fees low.

In the nitpick category, when 30 years of 2% inflation increases prices by 81%, this is not the same as “your purchasing power would decline by 2% every year, or 81% over thirty years.” In fact, purchasing power declines only 45%. This type of basic error undermines confidence in other numerical parts of the book.

Sellery’s “Rule of $20” implicitly advocates a 5% starting withdrawal rate from savings when you retire. With the length of today’s retirements, even a 4% withdrawal rate is somewhat aggressive for portfolios with ultra-low fees. For people invested in expensive mutual funds, a 3% withdrawal rate is more realistic.

In an inspired effort to get past procrastination, Sellery says that whether your reason for not getting started saving in an RRSP is fear of looking foolish, boredom with thinking about money, lack of discipline, or lack of time, it’s not likely to change so there’s no point in waiting for it to change. You might as well get started.

Overall, this book is well-suited to people who feel overwhelmed by the process of learning how to save money in RRSPs. Those who are already on their way may still benefit from the ideas on how to create good habits and stay engaged.

Friday, May 23, 2014

Short Takes: Lottery Losers, Differing ETF Yields, and more

Here are my posts for this week:

A Radical Idea about Asset Allocation for Novice Investors

What to do about the Impending Stock Market Crash

Here are some short takes and some weekend reading:

Do These Look Even? has a take on lotteries that is one of the best I’ve read.

Canadian Couch Potato explains why Canadian and U.S. versions of ETFs that hold exactly the same assets have very different dividend yields.

Big Cajun Man does a few spreadsheet calculations to show just how devastating a high MER is to long-term portfolio growth.

Potato agrees with Rob Carrick in broad strokes on the rent vs. buy debate, but he disagrees on some of the details on how much you save by renting and how much more money renter’s need to add to their long-term savings. The most important message to get across is that your parents’ advice to buy a house may not be the best idea in today’s real estate market. Once you accept this point, Potato goes to the next level of working out the numbers.

The Blunt Bean Counter points out the folly of going the DIY route on all your tax and accounting matters. I’m a big fan of DIY, but the several situations Mark describes are clearly cases where I’d seek expert advice.

My Own Advisor draws a lot of reader feedback when he discusses how he feels about his debt.

Million Dollar Journey explains the new government rules imposed on issuers of prepaid credit cards. Some of the worst abuses have been curbed, but there is still room for issuers to apply unreasonable charges. Maintenance fees can’t start until after the first year, but it’s hard to understand why they exist at all. The financial institution holds the money without having to pay any interest, and maintenance isn’t much more than storing a few kilobytes in a database.

Wednesday, May 21, 2014

What to do about the Impending Stock Market Crash

A stock market crash of 20% or more is coming. We all know it. Of course, it might not happen until the stock market triples first. So what do we do about it? It’s hard to believe that the right thing to do is nothing at all.

From 2008 June 18 to 2009 March 9, the S&P/TSX Composite Index of Canadian stocks dropped by almost 50% (counting dividends). By simply selling at the beginning of this period and buying back at the end, anyone could have doubled the number of shares he or she owned. A market timer could have beaten a buy-and-hold strategy by almost 100%!

All the available evidence says that nobody can reliably predict the beginning or end of a stock market crash. The problem with guessing wrong is that you’re left on the sidelines watching stock prices rise without you. All available evidence says that you should stick with a good investment plan and just ride out stock market crashes.

I’ve known people who accept that the most profitable long-term plan is to ignore the possibility of stock market crashes. Yet they still pay attention to confident talking heads on television who offer meaningless predictions about stock prices.

More baffling to me is exchanges I have with people that go something like the following:

Investor: “Do you think stocks are overvalued? Is it time to get out?”

Me: “I have no useful insight into the near-term future of stock prices. I don’t believe anyone else does either.”

Investor: “Yes, I know that. But what do you think will happen? Maybe interest rates will go up soon?”

This ability for otherwise intelligent people to believe completely contradictory ideas is strange.

In any case, I’ve cast my lot with an investment strategy that makes no attempt to predict stock market crashes at all. I believe I’m on the side of the evidence, but I don’t expect this position to become very crowded with typical investors.

Tuesday, May 20, 2014

A Radical Idea about Asset Allocation for Novice Investors

There is no shortage of advice out there on how to find the right balance between the asset allocation that makes people comfortable (low volatility, but low return), and the asset allocation that makes people money (high return, but high volatility). I’m going to suggest a possible different approach for novice investors.

Disclaimer: I do not recommend the following strategy in any way. These are just ideas to chew on. Think for yourself.

Because high returns and high volatility go hand-in-hand, we’re advised to seek the most risk we can handle while still able to stick to an investment plan and sleep well at night. The most nervous investors end up with low returns either because they have few risky investments or because they bail out of their risky investments at the worst possible time.

Even not so nervous investors can have these types of problems. Toss in some unreasonably high mutual fund MERs, and the end result is that their long-term savings grow to less than half of their potential by the time they retire. What if novice investors were to work on their tolerance for volatility when they’re young?

Imagine a 20-something, Dan, who just started a new full-time job and is still living at home. Dan starts saving 20% of his take-home pay in an RRSP or TFSA as long-term savings. He also saves money in a savings account for short-term desires, such as first and last month’s rent for when he moves out, a used car, and extra payments against his student loan.

What if Dan ignored all the asset allocation advice and just invested all his long-term savings in a Canadian stock exchange-traded fund (ETF) such as VCN or XIU? In addition to seeking the high returns from stocks, Dan would be seeking experience with stock volatility. He’ll have lots of time to change his asset allocation once his savings grow to $25,000 or $50,000.

We could even teach Dan to cheer every time his ETF dropped in price because he knows he’ll be able to buy even more units with his savings. With any luck, Dan would experience at least one significant drop in stocks prices in the few years it takes him to build up $25,000 or $50,000. This might help him calmly choose a higher-reward asset allocation for the long term and comfortably ride out the inevitable downturns over the decades.

Humans are adaptable, especially when they are young. Instead of treating our tolerance for risk as a fixed trait we carry around for our whole lives, what if we tried to teach young people to build a greater tolerance for uneven portfolio returns and stay focused on long-term goals with any savings designated for the long term?

Friday, May 16, 2014

Short Takes: Sobering Thoughts on Leverage, Debunking a Mutual Fund Myth, and more

I managed only one post this week where I examine how the number of stocks you own affects the returns you can expect:

The Cost of Portfolio Concentration

Here are some short takes and some weekend reading:

Tom Bradley at Steadyhand has some sobering thoughts for those contemplating borrowing to invest.

Andrew Hallam debunks the claim that actively-managed funds are less risky than index funds.

Canadian Couch Potato reports that Vanguard Canada is coming out with some new global ETFs that give some interesting new choices to Canadian investors who prefer not to trade in U.S. dollars.

The Blunt Bean Counter answers readers’ questions about rental properties.

Big Cajun Man has something on his mind that he thinks will solve all his problems. Try to guess what it is. He may be right.

Wednesday, May 14, 2014

The Cost of Portfolio Concentration

An oft-quoted statistic is that you only need about 20 stocks to make a well-diversified portfolio. Here I attempt to quantify the benefit of diversification. The result is that losses due to portfolio concentration are still quite high at only 20 stocks.

Meir Statman wrote a useful paper called How Many Stocks Make a Diversified Portfolio? In it he gives a table showing portfolio volatility values for varying number of stocks in the portfolio. The data is based on the portfolio having equally-weighted stocks.

From this table we can simulate a 30-year portfolio to see how much more volatility drag there is on returns for concentrated portfolios. I assumed that an investor would start with a lump sum and invest for 30 years. I set the starting lump sum so that a portfolio owning all stocks would finish at $1 million. The following chart shows how smaller numbers of stocks fared.


I call the difference between a portfolio of all stocks and a more concentrated portfolio the portfolio “concentration gap.” We see from the chart that the gap at 20 stocks is about $140,000, which I’d call quite significant.

So, why do so many people think that 20 of fewer stocks make sense? The answer is that they believe they can pick winning stocks. All of the above analysis is based on a random selection of stocks. If you can choose above-average stocks, then you can overcome the concentration gap. Of course, the vast majority of investors (but not quite all) who believe they are great stock-pickers are actually deluded.

The main takeaway from this article is that it isn’t good enough to have some stock-picking skill. You need enough skill to jump the concentration gap. If you have the talent and energy to find 20 above-average stocks, you need to be able to overcome the concentration gap and any other costs you incur that index investors would not incur.

Friday, May 9, 2014

Short Takes: Risky Bonds and more

Here are my posts for this week:

Why Don’t More Bank Machines Give out $50 Bills?

The Power of Saving When You Invest Well

Here are some short takes and some weekend reading:

Tom Bradley at Steadyhand warns about the shift to riskier bonds in bond funds.

Los Angeles Times reports disturbing practices at Wells Fargo. It sounds like an unpleasant place to bank and an even worse place to work.

My Own Advisor thinks the fact that pension funds and insurance companies are willing to buy Canada’s new 50-year bonds could be a sign that big investors know that growth could be low for a long time to come. That’s one possibility. Another is that nobody really knows what will happen in the long term.

Canadian Couch Potato reviews William Bernstein’s short book If You Can: How Millennials Can Get Rich Slowly.

Big Cajun Man asks whether you’d be willing to work less to avoid surtaxes on high income earners. I’d be willing to work less for less pay, but tax advantages would be just a bonus. More free time would be my goal. Several extra weeks of vacation would be wonderful.

Million Dollar Journey reviewed the book Moolala Guide to Rockin’ Your RRSP. He’s also giving away two free copies of the book.

Thursday, May 8, 2014

The Power of Saving When You Invest Well

We all know that the point of investing is to grow your savings. But how much benefit do we actually get from saving and investing well? Here I try to quantify this benefit.

For any analysis of this kind to make sense, we have to think in terms of inflation-adjusted dollars. So, instead of talking about dollars, let’s talk about saving and spending baskets of goods. When the government comes up with inflation figures, they are basing them on the price of a standardized basket of goods.

Imagine a hypothetical saver Sarah who begins saving at age 25. She saves some number of “baskets” per year, and she increases this number steadily until she is saving triple this amount per year by the time she is 50. The actual number of dollars she saves at age 50 will be more than triple what she saved at age 25, but the number of baskets of goods she could buy with the saved money triples. Sarah’s saving level then stays steady from age 50 to 65. Then she begins drawing her “baskets” steadily in retirement until she runs out of money at age 90.

If Sarah has invested well, the total number of baskets she spends in retirement will be more than the amount she saved. But how much more will it be? This depends on the returns she got in her investments. The following chart shows how many baskets Sarah got to spend for each basket she saved.


The horizontal axis shows Sarah’s return above inflation. So, if inflation averages 3% and her investments average 6%, Sarah beat inflation by 1.06/1.03-1=2.9%.

To make sense of this chart, let’s start with a return above inflation of 0%. This means Sarah’s investments just covered inflation and nothing more. It makes sense that in this case, the number of baskets Sarah gets to spend will exactly match the number she saved. So the ratio of spending to saving is 1.

However, for higher returns, things look better. Personally, I’m hoping to make 4% or 5% above inflation. I’m not counting on this, just hoping. If Sarah got this much, she’d get to spend between 3.3 and 4.5 baskets of goods for each basket she saved. This sounds like a very good deal.

However, if Sarah owns balanced funds with MERs in the 2.5% range, she could easily end up with average returns of only 1% above inflation. In this case, Sarah would only get to spend 1.3 baskets for each basket she saved.

This shows the importance of minimizing costs and avoiding behavioural mistakes that drag down your average returns. Of course, you have to save some money in the first place to get any benefit from investing.

Monday, May 5, 2014

Why Don’t More Bank Machines Give Out $50 Bills?

The average income in Canada works out to a little less than $1000 per week. Take off some deductions and you’re still left with enough $20 bills to choke most wallets. I realize that most people don’t want to carry a week’s take-home pay around in cash, but those who choose to do so should be able to do it without bursting their wallets.

Many people prefer to make all their purchases with credit and debit cards. That’s fine. To each his or her own. For those of us who prefer to make some cash purchases, it would be nice to be able to get a few $50 bills from bank machines.

There was a time when it was more difficult to spend fifties and hundreds, but this was always overstated. It’s fairly rare to have a problem with fifties now, but you need to hold a couple of twenties just in case. I’ve never had a large retailer or grocery store even bat an eye at a fifty or hundred dollar bill.

It’s possible to get cash in the denominations you want from a teller, but this is inconvenient. I’d be happy if bank machines defaulted to giving me the first $120 to $200 in twenties and the rest in fifties. I’m told that there are some bank machines that give fifties, but I’ve never received anything but twenties from a BMO bank machine.

A further annoyance is that on those rare occasions when I want more than $500, I have to make two separate withdrawals and get hit with two withdrawal fees of a dollar each. Even paying a dollar for every withdrawal, I’m better off than if I pay for some banking package. But this fee annoyance is making me think more about getting a Tangerine chequing account.

It’s hard to tell to what extent banks are trying to steer people toward plastic transactions instead of using cash, and to what extent they are just reacting to people’s choice to use less cash. No doubt some people would be annoyed to receive a fifty from a bank machine. But these people probably take out money in smaller amounts anyway. So, I’m thinking that my idea to give the first $120 to $200 in twenties and the rest in fifties might work reasonably well.

Friday, May 2, 2014

Short Takes: Empty Claims of Outperformance, Some Bad Advice, and more

Here are my posts for this week:

The Downside of Naked Put Options

Anti-Rebalancing

Here are some short takes and some weekend reading:

Andrew Hallam finds that a mutual fund company that claims to have outperformed the market actually didn’t fare all that well.

Gail Vaz-Oxlade stomps some bad advice she found at two popular web sites.

Preet Banerjee explains defined-benefit pension plans in his vlog.

Big Cajun Man didn’t find much good news when he checked into whether students can claim moving expenses on income taxes.

My Own Advisor updates his progress toward his 2014 financial goals. I’m pleased to see that he is on track while avoiding taking on any new debt.

The Blunt Bean Counter has a new look or his blog, and he promises more humour and sarcasm.