Wednesday, April 29, 2015

Spinning the TFSA Increase

I’m not strongly for or against the TFSA limit increase announced in the latest federal budget (pdf here). However, the attempted spin in the budget document makes me laugh.

As Larry MacDonald observed, the budget writers tried to counter the idea that a TSFA increase mainly benefits the rich by saying “about 60 per cent of the individuals contributing the maximum amount to their TFSAs had incomes of less than $60,000.”

The first thing to observe here is that being rich is only indirectly about income. It’s really about how much money you have. I’d rather have a million dollars and an income of $50,000 than be in the hole a million dollars and have an income of $100,000. The truth is that the people who will benefit the most from a TFSA increase are those who already have significant non-registered assets, regardless of their incomes.

Even if we look at wealth in terms of income, I expect that my wife and I will likely each have incomes under $60,000 in retirement. But we’ll also get to spend some TFSA withdrawals and some of the capital from our non-registered accounts. We’ll have a great retirement, but will still fit under the $60,000 figure from the budget quote.

The TFSA increase makes little difference to those who are very wealthy; the main beneficiaries will be those with upper middle class incomes and those with enough assets that they’ve already maxed out their TFSAs and RRSPs (which tend to be older people).

So, it’s true that the TFSA increase mainly benefits those who are fairly well off. But this doesn’t make it a bad idea. Who says that all government measures have to benefit only the poor? Surely we can have different measures that help different groups. The first few thousand dollars of TFSA room certainly benefit poorer people who are better off not saving in an RRSP.

If pressed for my opinion, I’d have to say that I think we didn’t need the TFSA increase, but I don’t feel strongly about this. What bother me most are nonsense arguments for or against the TFSA increase.

Monday, April 27, 2015

Money: Master the Game

Tony Robbins is well-known as a motivator and it shows in his personal finance book Money: Master the Game. Readers who just want financial facts and advice will be frustrated that the vast majority of the over 600 pages are devoted to motivation of many types. Given the sad state of most people’s personal finances, maybe what they really need is a master motivator to get them to save more and spend less.

The chapter I found most interesting was devoted to expert opinions on the amazing technologies we can expect to improve our lives in the coming decades. This later blended into an appeal to contribute to some of Robbins’ charities.

Robbins defends his motivational writing style saying “knowing information is not the same as owning it and following through.” However, I’ll confine the bulk of this book review to the personal finance aspects.

The centerpiece of this book is an asset allocation called the “All Seasons” portfolio devised by Ray Dalio. Here are the asset classes and percentages:

30% stocks
40% long-term U.S. bonds
15% intermediate U.S. bonds
7.5% gold
7.5% commodities

The first thing to notice is that the largest allocation is to long-term bonds. Robbins focuses heavily on the high-return and low-risk performance of this portfolio during the 30 years from 1984 to 2013. U.S. interest rates have fallen like a rock during that period. As long as the next 30 years bring us interest rates that continue to fall dramatically to minus 10% or thereabouts, long-term bonds should keep performing well.

In case it wasn’t obvious, that was sarcasm. I have no idea if interest rates are rising any time soon, but I’ll go out on a limb saying that interest rates can’t drop in the next 30 years as much as they dropped in the last 30 years. This All Seasons portfolio looks overly conservative and overly fitted to the past 3 decades.

Robbins makes a strong pitch for using annuities to deal with longevity risk. Although he acknowledges that “variable annuities are invariably bad” and other types of annuities are often loaded with fees. “Most variable annuities should come with more warnings than a Viagra commercial.” Robbins helped to set up his own annuity provider. I’ll wait for some expert opinions before deciding that his annuities are better than the rest.

A common theme in the book is that most investors are best off in index funds. However, Robbins seems to contradict himself when he talks about methods of finding low-risk high-reward investments.

Interspersed among the motivational speeches were a number of good quotes and pieces of advice. One example is Elliot Weissbluth saying “The largest financial institutions are set up to make a profit for themselves, not their clients.”

Some revelations for retail investors: “chasing returns never works,” and “nobody beats the market long-term,” “except for a few ‘unicorns’” whose “doors are closed to new investors.”

Robbins gives a good characterization of typical mutual funds: “imagine someone comes to you with the following investment opportunity: he wants you to put up 100% of the capital and take 100% of the risk, and if it makes money, he wants 60% or more of the upside ... and if you lose, he still gets paid.”

In one example, Robbins says a woman named Angela could draw a retirement income of $34,000 per year from initial savings of $640,000. It’s hard to see how this greater than 5% withdrawal rate could be safe if Angela expects to increase her spending by inflation each year.

One quote I quite liked because it’s something I tell my sons: “it’s not what you earn that matters, it’s what you keep.”

Robbins is a fan of getting financial advice, but only from “fiduciary advisors.” This is a good short-form for emphasizing the importance of fiduciaries.

Robbins believes it isn’t possible to spend only on the things you absolutely need. He says we should have a “dream bucket.” This is a place to put a fixed fraction of your income to spend in ways that make you happy in the short term. This sounds like a good idea. It allows you to enjoy yourself in a way where the “fun” spending is controlled.

The book contains transcripts of interviews with several well-known investors. Asked about investing advice for the masses, Warren Buffett said “it’s so simple ... indexing is the way to go.” When activist investor Carl Icahn bought a big block of Netflix shares, he soothed their fears explaining the Icahn rule: “Anybody who makes me eight hundred million in three months, I don’t punch them in the mouth.”

Overall, because I was not particularly interested in the motivational aspects of this book, I found it frustrating trying to get to the parts I cared about. However, maybe Robbins is right that most people need this style of motivation to generate excitement and drive them to action.

Friday, April 24, 2015

Short Takes: Breaking a Mortgage, Buying Low, and more

Here are my posts for the past two weeks:

Pay Down Your Mortgage or Invest?

Do Dividend Haters Exist?

Here are some short takes and some weekend reading:

Preet Banerjee does an excellent job of simplifying the explanation of the cost of breaking a mortgage in his latest Drawing Conclusions video.

Scott Ronalds at Steadyhand makes an interesting case for buying into Steadyhand’s weakest recent performer as a way to buy low and sell high.

Justin Bender does a thorough analysis of the all-in costs of ETFs of international stocks.

Mrs. January wrote an amusing open letter to Rogers.

Larry MacDonald summarizes the federal budget.

The Blunt Bean Counter explains the importance of both spouses using the same accountant for income taxes.

Robb Engen at Boomer and Echo explains why he now focuses on total returns rather than just dividends for his future retirement income. I think this is a good idea, but one example cited is risky. If you could guarantee a 5% real return every year for 30 years and you knew you’d live for exactly 30 years, then you could draw a $90,000 per year income (rising with inflation) from starting savings of $1.45 million. However, returns in the early years may be lower than 5% real, you may live longer than 30 years, and average compound returns over 30 years may be below 5% real. The safe withdrawal amount in this case is much less than $90,000.

Big Cajun Man has some tongue-in-cheek advice for finding the right tax-preparer.

My Own Advisor adds some of his own silver and bronze rules after the golden rule of personal finance.

Wednesday, April 22, 2015

Do Dividend Haters Exist?

I’ve encountered the phrase “dividend hater” a few times now, and it got me wondering whether dividend haters actually exist. I’d have to say I’ve never met any but, like beauty, it’s all in the eye of the beholder.

My investing philosophy is simple enough. I value each after-tax dollar equally, whether it comes from dividends, capital gains, or interest. I know a great many people who think the same way. To be a dividend hater, I’d say that an investor would have to value after-tax dividend dollars below dollars from other sources. I’ve never heard of people like this, but I suppose they might exist.

However, I have heard of several people who value after-tax dividend dollars more than after-tax dollars from capital gains or interest. Perhaps these people should be called capital gains haters or interest haters.

I encountered the phrase “dividend hater” most recently in some tortured logic saying that it is a myth that stock prices drop by the amount of a paid dividend. I won’t bother to explain the obvious fact that the value of a company drops after it pays a dividend other than to point to Investopedia’s clear explanation.

One amusing part of the attempt to dispel this “myth” about dividends lowering a company’s value is the following scenario: “A company earns $1/share and sells for $10/share. Now, if that company distributed a $10 special cash dividend, it will not trade at $0.”

Under what conditions would a company trade for only $10/share if it has $10/share in the bank and earns $1/share each year? If investors expect the $1/share earnings to continue, then the stock price would be much higher than $10.

I suppose that investors might believe that conditions will change and the company’s future profits will be zero. If the company also has nothing to sell in a breakup, then it would indeed sell for $0 after paying the $10/share dividend.

Another possibility is that the company did not have $10/share in cash and went into debt to pay the dividend. If we assume the company was valued properly at $10/share before the dividend, then the lender that provided the cash for the dividend was a fool who won’t get all of his money back and has essentially made a gift to shareholders. The amount of the gift would be whatever share price the company has after paying the dividend.

I’ve still yet to encounter a true dividend hater, but no doubt the label will continue to be used. I’m content to value all my after-tax return dollars equally.

Monday, April 13, 2015

Pay Down Your Mortgage or Invest?

The many arguments you can find online about whether it’s best to pay down your mortgage or invest tend to gloss over the most important considerations. The answer isn’t in detailed calculations of returns based on assumptions that are just guesses. The truth is that if your income remains stable, you’ll do fine with either approach. The real answer comes when considering problem scenarios.

All investment choices should balance two needs: (1) capturing wonderful returns through good times, and (2) surviving bad times. If you just average out the good and bad times and project future returns based on some middle-of-the-road assumptions, you might be taking on too much risk.

One possible future for you is that you will always have a job when you want one and enjoy ever-increasing pay until you choose to retire. Here is another possible scenario:

– The stock market crashes and stays low for 5 years.
– Shortly after the crash, you lose your job.
– It takes you 6 months to find another job.
– The new job pays only two-thirds of your former salary.
– Your salary never recovers to its previous inflation-adjusted level.

If you knew this was a possibility for your future, would you pay off your mortgage or invest? When I was younger, my response to this possibility was to buy a less expensive house than banks told me I could afford, and I maintained emergency savings. By having a lower mortgage, I would still have been able to afford my mortgage payments on a lower salary. The emergency savings would have supported me during a period of unemployment.

What should people do now if they already have a large mortgage? Well, when you consider the negative scenario above, one good response is to build some emergency savings. Another good response is to pay off the mortgage aggressively until the principal is down low enough that a smaller salary could handle the payments. Once the mortgage principal is down, you can start building retirement savings.

Personally, I think it’s better to rent or buy a less expensive house from the start so you can begin to invest right away. But if you’re already stuck with a huge mortgage, you have to consider a safer path. This safer path may result in smaller future savings if the bad scenario never happens, but that’s no reason to ignore bad possibilities.

In the end, each person needs to find his or her own balance between surviving bad times and reaping returns during good times. But my experience has been that most people just deny that bad scenarios are even a real possibility for them.

Friday, April 10, 2015

Short Takes: Ben Graham on Indexing, Future Bond Returns, and more

Here are my posts for this week:

Making Momentum Work for Your Savings

Business Success is not the same as Investor Success

Here are some short takes and some weekend reading:

Jason Zweig explains that despite the claims of some value investors, Benjamin Graham believed in index funds.

Canadian Couch Potato gives us some clear thinking about bond returns over the past couple of decades.

Tom Bradley at Steadyhand explains why soft landings for overheated markets are not likely. Hard landings are more the norm.

Preet Banerjee has another of his popular videos, this time explaining the recent increase in CMHC premiums.

The Blunt Bean Counter explains the 2014 changes to the T1135 foreign reporting form.

Justin Bender explains how to report your U.S.-listed ETFs on the T1135 tax form.

Big Cajun Man warns that if you buy lottery tickets with a credit card, it may be treated as a cash advance and have associated extra costs.

My Own Advisor updates his progress on his 2015 personal financial goals. I’m always happy to see an explicit goal of not creating any new debt.

Boomer and Echo are no fans of the Rich Dad Poor Dad real estate seminars.

Wednesday, April 8, 2015

Business Success is not the same as Investor Success

My recent post about stock-picking drew a thoughtful anonymous comment explaining the reader’s trouble with indexing. Here is the (lightly edited) comment:
“Indexing is counter-intuitive. Doesn't it seem reasonable that if you bought the companies in the S&P 500, then sold off high flying market darlings and poorly-managed businesses, and used the proceeds to double up on the best run companies that you would beat the market? The evidence is no; professional managers who spend 40+ hours a week doing just this cannot consistently beat the index. What gives?”
Let’s start with the high-flying stocks. Nothing is flying as high as Apple right now. I have no idea if Apple is currently a good buy, but no doubt some people think it’s destined to drop. Let’s go back to 2000 when Apple was also on good run. Anyone who excluded Apple from their portfolio then would have missed out on a 25 times increase in its stock price. The truth is we can’t be sure if a high flyer will fly higher or crash.

As for the businesses that aren’t doing well, their stock prices are usually low as a result. Even a terrible business may be a good investment if the market is too pessimistic about the stock. In fact, value investors seek out stocks where other investors have driven its price too low.

Stock-pickers need to consider more than a company’s business prospects. They need to consider the current price. A business’s success or failure does not necessarily reflect how investors will fare. What matters are the business’s prospects compared to its current price. It is this type of analysis that is very difficult to do better than investment professionals.

It’s always possible to look into the past and see which stocks you wish you hadn’t owned. But when we look at today’s stocks without the benefit of hindsight, it’s far from obvious which stocks will be the stinkers.

Tuesday, April 7, 2015

Making Momentum Work for Your Savings

Most of us have heard the advice to pay yourself first. Having your savings come off your pay before you see it is a painless way to save consistently. I have an idea to take this a step further to automate the saving of pay increases and bonuses.

Consider the example of a single 30-year old, Jen, who earns $65,000 per year. Every two weeks, Jen’s take-home pay is $1830 until October when CPP and EI contributions end, and then she takes home $2000. She hasn’t been saving any money and wants to start.

Jen could get her employer to split her paycheque so that a fixed percentage of her take-home pay goes to savings. Another possibility would be for Jen to have $1700 directed to her chequing account, and the balance directed to savings. This has the advantage that her spending is constant all year and the savings level changes when CPP and EI deductions end for her in October.

Another effect of this approach is that her raise next year will get diverted entirely into savings; she won’t see any difference in her level of spending money. In addition, any bonuses added to her regular paycheque will go entirely to savings.

Eventually, inflation will erode the value of Jen’s biweekly $1700 for spending, and she can go back to her employer to have this amount increased. But this is something she will have to take action to do. By default, raises turn into more savings; momentum becomes Jen’s friend.

There are people who won’t be able to use this idea. Highly variable income is a problem, and some savings plans may not be set up to take variable amounts in this way. But for those who can automate their savings with this idea, momentum becomes a driver for increased savings.

Friday, April 3, 2015

Short Takes: Estimating Future Returns, Capital Gains Exchange Rates, and more

Here are my posts for this week:

Getting Fired

Vanguard Shifts to Alternative Strategies

April Fools? Not Really

Here are some short takes and some weekend reading:

Larry Swedroe gives brief and clear description of 10 common investor mistakes along with some realistic estimates of future investment returns.

The Blunt Bean Counter explains CRA’s position on how to handle exchange rates for capital gains, dividends, and income. I was pleased to find that the way I do my taxes is acceptable to CRA. Whenever I make a trade in U.S. dollars in a non-registered account, I enter the amounts in a spreadsheet along with that day’s exchange rate from the Bank of Canada currency converter. For dividends and interest income, I just use the average exchange rate for the whole year.

Big Cajun Man has a cautionary tale about a bank’s mistakes when setting up a student line of credit.

My Own Advisor has a guest post with interesting takes on some of the crazy things people say about money.

Boomer and Echo liked the One-Page Financial Plan and is giving away a copy.

Thursday, April 2, 2015

April Fools? Not Really

My previous post about Vanguard’s seeming departure from index funds was written to seem like an April Fools’ joke, but it wasn’t. All this information came from their SEC filing for the Vanguard Alternative Strategies Fund. Vanguard will still have their familiar index funds, but their lineup will also include this much more “exciting” fund.

Wednesday, April 1, 2015

Vanguard Shifts to Alternative Strategies

The long-time pillar of index investing, Vanguard, has decided to embrace alternative strategies with a new Vanguard Alternative Strategies Fund. In this departure from the mission of founder and retired CEO, John C. Bogle, Vanguard plans to short equities, trade currencies, and trade in commodity-linked investments.

While Vanguard is known for rock-bottom fees like 0.05% per year, the new fund is expected to cost a whopping 1.10% every year. This is cheaper than some competing alternative strategies funds, but is very pricey for Vanguard. Over 25 years, this amounts to a total cost of 24%.

Some of the other strategies Vanguard intends to use include trading in options, foreign currency exchange forward contracts, commodity futures, Treasury futures, and swaps. This new direction will no doubt come as a shock to some long-term Vanguard investors.