Monday, August 21, 2017

Email Replies

Reader feedback is the best part of writing my blog. But some of the email I get is less welcome. Here is another installment of replies to emails I usually ignore.

Dear Brenton,

Thank you so much for the chance to register for your lucrative trader service. Your list of 15 triple-digit winners in just 8 months is indeed impressive. If you had started with $10,000 and let it ride through these great picks, you’d now have 736 million dollars! But, I’m puzzled. Now that you’re so wealthy, why do you need me to pay when I register?




Dear Melanie,

I’m so glad that my blog passed the test to join your publishing partners network. One of the tricks I use to keep quality up is that I never run advertorials. If I were to start publishing the “customized and relevant content” you provide, I’m afraid that my blog would then drop below your standards. It seems we’re caught in a catch-22.




Dear Robert, Reed, Michael, Joon, Brian, Craig, and many others,

Thank you for the many invitations to join your class action lawsuits. I have indeed suffered losses related to the companies you mentioned. However, my losses aren’t related to trading shares in these companies. I’ve lost time from my life dealing with the flood of class-action-related emails. Thank you for limiting my time losses by marking the emails with “IMPORTANT” and “ALERT”. This helped greatly in determining quickly that the emails were unimportant.



Friday, August 18, 2017

Short Takes: Begging the Fed, Asset Classes, and more

I managed only one post in the past two weeks:

Create the Retirement You Really Want

Here are some short takes and some weekend reading:

Tom Bradley at Steadyhand has a funny and accurate take on a letter from bondholders trying to avoid losses on poor investments by warning the U.S. Fed not to raise interest rates too fast.

Preet Banerjee comes back from an extended hiatus to explain asset classes in his latest video.

Big Cajun Man found that all of his credit card limits counted against the size of mortgage he could get.

Salman Ahmed at Steadyhand has some suggested questions for the guy who brags he earned a 30% return last year.

Potato says the advisor vs. adviser distinction is a meaningless distraction from finding good financial advice.

Tuesday, August 8, 2017

Create the Retirement You Really Want

Most retirement books focus strongly on finances and investing, but in Create the Retirement You Really Want, Clay Gillespie looks at a wide range of retirement issues from figuring out what you want to do during retirement to leaving a legacy. Readers are likely to find some topics relevant to improving their own retirements.

The book is a mix of standard non-fiction style writing and story-style using hypothetical retirees. Thankfully, the stories get to the points quickly rather than trying to be good fiction. I found this worked well. I would not have had the patience to read longer fictional parts.

I was surprised the book contained so little about investing. The hypothetical retirees deal with an advisor who offers three portfolio possibilities with targeted real returns of 2%, 3%, and 4% per year. Apart from varying the allocation to stocks, there was little mention of how these returns would be achieved. I thought it would at least have made sense to discuss the importance of keeping costs low. Canadians who pay 2.5% or more per year for their mutual funds can only dream of earning a compound average annual return of 4% above inflation for decades.

The topics covered included figuring out your dreams for what you’ll do during retirement, what it will cost, health, wills, events that derail your plans, cottages, and family bickering over inheritances. I particularly liked the discussions of cottages and inheritances. I’ve heard accountants and advisors warn about problems in these areas, but Gillespie illustrated the potential complexities and conflicts well.

One part of the discussion of inheritances surprised me: “giving back and leaving an inheritance is always important to retirees.” I know many people who’ve said they have no intention of leaving money behind. Either Gillespie is saying that people tend to change their minds as they age, or perhaps he only advises wealthy people who end up leaving inheritances.

The author shows a better understanding of inflation than some advisors. “When most people think about returns, they think only in nominal terms. They forget inflation. But inflation is very real, and retirees feel the impact more than any other group because they often live on fixed incomes. Real return is the number that people should really focus on.”

Gillespie believes that “an initial withdrawal rate of 5.5 percent is sustainable if you have the proper retirement income strategy in place.” I’m skeptical that an income strategy will make much difference. This sounds a lot like a claim to be able to beat the market. The right withdrawal rate depends on age, asset allocation, portfolio costs, and willingness to reduce spending if market returns disappoint.

The book contains some plugs for financial advisors. One is included with some statistics: “Only 29% [of Canadians] use the services of a financial advisor (even though investors who use an advisor are more confident and optimistic about their financial futures).” Of course, the implied causality here is questionable. Having lot of money makes people “confident and optimistic about their financial futures.” Also, financial advisors seek out people with a lot of money, and those with a lot of money are more likely to find a good advisor. The root cause of the correlation between financial optimism and using an advisor is having a lot of money.

While many financial advisors push their clients to leverage their portfolios, Gillespie believes it’s a mistake to avoid paying off debt in favour of saving for retirement. He gets full marks for this in my opinion. The best plan involves getting total debt down to a manageable level while you’re relatively young and then keep it dropping while simultaneously building savings. Gillespie says “good debt and bad debt is just splitting hairs,” a point I’ve made before.

“It’s always a good idea to exhaust your non-registered funds before dipping into your registered savings.” I don’t think this is always true. Between retirement and age 71, it can make sense to make an RRSP withdrawal in a low-income year where the withdrawal would be untaxed or taxed at a very low rate. Figuring out when this makes sense can be tricky, though.

In one section a hypothetical couple derail their carefully constructed retirement plan to follow the advice of a do-it-yourself (DIY) investing brother-in-law. This section paints DIY investing as chasing risky biotech stocks. There certainly are people like this who try to draw others into their risky strategies, but DIY investing can also mean low-cost diversified investing.

Advice we hear frequently is not to put money in the stock market if we’ll need it within 5 years. Gillespie has an interesting way of saying something similar: “Always invest based upon when you want your money back.”

Overall I found this book useful for its treatment of a wide range of retirement issues. However, its main purpose seems to be to drive home the point that you need a financial advisor to steer you. Of course, the challenge for most of us is trying to find a quality advisor, particularly for those with modest portfolios.

Friday, August 4, 2017

Short Takes: Mortgage Delinquencies, Stupid Investments, and more

Here are my posts for the past two weeks:

The Behavior Gap

You Can’t Have Your Sears Cake and Eat it Too

Here are some short takes and some weekend reading:

Estate administrator Scott Terrio explains why today’s low mortgage delinquency rate means almost nothing in predicting future mortgage delinquencies.

Freakonomics Radio has a very interesting investment podcast called “The Stupidest Thing You can Do With Your Money.”

The Blunt Bean Counter explains the Liberal government’s new tax proposals for private corporations. He says “the impact of these proposals is potentially massive,” and “I don't think most small business owners have any idea what is about to hit them.”

Financial Services Commission of Ontario explains how to protect yourself when renting a car. Many of us have had that moment of doubt about whether to pay for the rental company’s insurance coverage that often increases the rental cost by 50% or more. This article explains how to get coverage with your credit card or your current auto insurance policy.

Canadian Couch Potato uses his latest podcast to examine MoneySense’s role in advancing index investing in Canada and to disagree with Warren Buffett and John Bogle on international investing.

Boomer and Echo explain why you shouldn’t get mortgage life insurance. Don’t miss a comment by Travis spelling out post-claim underwriting and how it can cost you.

Thursday, August 3, 2017

You Can’t Have Your Sears Cake and Eat it Too

It’s well known that Sears Canada has been having financial trouble for some time. As often happens in these situations, the Sears defined benefit pension plan is underfunded. According to Steven G. Kelman, “Ill-advised government policies” have resulted in former employees getting only “81% of the commuted value of their defined benefit pensions.” What we have here is a tension between trying to keep companies afloat and keeping pension plans fully funded.

It’s easy to decide today that Sears should never have been allowed to delay properly funding their pension plan. But, if Sears had been forced to fully fund the plan sooner, they would have gone bankrupt sooner. If we go back to a time when there was still hope to save Sears, few people would have agreed to force Sears into bankruptcy over their pension funding. But allowing sick companies to let their pension obligations slide inevitably leads to some bankrupt companies with underfunded pensions.

We can agree that it’s unfortunate that some Sears employees won’t get their pensions. But back when Sears was still limping along, who would have decided to force them into bankruptcy and sacrifice jobs to make sure that pensions are topped up? I’m not suggesting that current jobs are necessarily more important than future pensions. But, those who focus solely on pensions need to understand that they are advocating killing off sick companies sooner.

One suggested solution is Kelman’s assertion that “governments, in my opinion, should kick in the shortfalls to make the Sears former employees and others in similar predicaments whole.” This sounds perfect until we realize that governments pay for nothing; taxpayers foot the bill. There’s no free lunch. Why should taxpayers make good on the promises of failed companies?

Another idea to protect pensioners is to put them ahead of other creditors when a company gets into financial trouble. But, then who would want to be a creditor? Any company that has an underfunded pension would have serious trouble getting credit, which would drive them into bankruptcy sooner. I’m not saying this is the wrong approach, but advocates of this idea must acknowledge that it will drive more companies into bankruptcy.

If we’re going to demand that no pension plan ever be underfunded, we have to be prepared to accept that this will bring some companies to financial ruin sooner, and will break some companies that might have survived if they had a little more time to turn around. We have to choose between pensioners and current workers. We can’t have our cake and eat it too.

Monday, July 24, 2017

The Behavior Gap

The title of certified financial planner Carl Richards’ book The Behavior Gap refers to the gap between “what we should do and what we actually do” when it comes to financial decisions. The book identifies a great many of the mistakes we make, and almost all readers who are honest with themselves will identify with some of the mistakes.

Richards is well known for his napkin drawings, and there are plenty of them in this book. One says that the cost of your mistakes rises with your level of overconfidence. “Overconfidence is a very serious problem. If you don’t think it affects you, that’s probably because you’re overconfident.”

We know we shouldn’t buy high and sell low, but “we make investing decisions based on how we feel rather than what we know. Falling stocks scare us; rising stocks attract us.”

In a drawing offering investment advice, Richards says the chance that a fund will stink rises with its expense ratio. He offers more advice when he says our decisions about how much of our company’s stock to hold should be based on principles of diversification rather than “our feelings about what’s going to happen.”

On the subject of stock mania, Richards tells the story of how during the tech bubble in 1999, he resisted “the temptation to buy technology stocks” initially but eventually gave in and lost money. It’s the last people in before the bubble bursts who get hurt the most.

Richards believes that financial planning begins with life planning. “Find out who you are and what you want. Then you can stop wasting your life energy and your money on stuff that doesn’t matter to you—and start making financial decisions that will get you to your true goals.”

If we take action based on the latest news, we’re likely to do the wrong thing. “Try going on a media fast.” “When thoughts about the market arise, let them go. Go for a bike ride.”

I was surprised to see a financial planner write that “Financial plans are worthless.” However, he followed that up with “but the process of financial planning is vital.” A single static financial plan will become obsolete as life takes a few unexpected turns. Plans need to adapt.

We’re used to being told not to make overly rosy assumptions, but “pessimistic assumptions often discourage people from doing anything to improve their outlook.” I’ve known people who buy lottery tickets because they see winning as the only way to improve their lives. They just don’t understand or believe in the power of saving small amounts regularly.

“While making wise decisions about how you invest your money is important, it doesn’t have nearly the impact of working hard and saving more.” I’m all for encouraging people to save more, but a low-cost index investor could easily end up with twice as much money each month in retirement as someone who spends an investing lifetime chasing the latest hot mutual fund. This seems at least comparable in value to saving more money each month.

In one section, Richards describes so accurately the mood in a company whose stock is soaring that it seemed like he was talking about my employer back in the late 1990s. People had “visions of early retirement,” and they knew they “should sell some of the shares,” but they hung on anyway. Many of my colleagues saw 7-figure paper valuations evaporate.

I recall asking colleagues whether they would buy back the company’s shares if they were converted to cash right now. This only caused one of my colleagues to sell. I sold too few shares myself. Richards calls this the “Overnight Test” and asks if your portfolio went to cash overnight and you wouldn’t rebuild the same portfolio today, “what changes would you make,” and “why aren’t you making them now?”

“What makes us feel safe may be at odds with the numbers.” I’ve learned this truth when it comes to retirement. My wife and I need different things to feel it’s safe to retire. For me, it’s a set of spreadsheets that analyze all the numbers in a dozen different ways. I’d just be guessing about what would put my wife at ease.

We’ve heard that simple solutions are best when it comes to finances, such as saving diligently and choosing low-cost diversified investments. “We often resist simple solutions because they require us to change our behavior.” “We’d rather look for a magic bullet: something to save us from the day-to-day grind of simply doing the work that needs doing.” “It’s much easier to entertain ourselves with the fantasy of finding an investment that will give us a fantastic return than to save a little bit more money each month. But in the end, the fantasy will fail us.” Well said.

This book is both entertaining and helpful for readers prepared to admit to themselves that they’re guilty of some of the mistakes that create this “behavior gap.”

Friday, July 21, 2017

Short Takes: Reality Check for Novice Investors and Retirement Planning

Here are my posts for the past two weeks:

Are We Saving or Investing?

The Four Pillars of Investing

The Dangers of Personifying the Stock Market

Things get quiet in the middle of summer, but I still have a couple of short takes:

Dan Bortolotti warns novice index investors that the bull market can’t last forever. When markets inevitably stumble, active managers will be quick to claim they could outperform during bear markets, even though the evidence doesn’t back up that claim.

Potato shows how to answer the question of whether you’re on track for retirement by going through an example case. As he shows, you can never know for sure that you’ll get the retirement you want, but you can find out if you’re way off.

Thursday, July 20, 2017

The Dangers of Personifying the Stock Market

Most people understand that the stock market reflects the collective actions of all stock traders, but we often personify the market, talking about it as though it has its own free will. This can lead to investing errors.

When we say that “stock markets struggled this week,” we don’t literally mean that there exists some sentient entity called the “market” that has the desire to rise, but was unable to do so this week. But thinking of it this way can create the illusion that you have only a single foe when you trade stocks.

It can also create the illusion that we can all somehow succeed against the market. When someone says that some past market event was easily predictable, such as the 8-year recovery from the 2008-2009 crash, many would agree. But it can’t be true. If we all knew stocks would rise so much, then buyers would have driven prices up right away.

When we see the stock market as the collective action of all buyers and sellers, it becomes clear that there had to be a lot of uncertainty among traders 8 years ago because stock prices just rose slowly instead of jumping all the way back up immediately. In fact, we must always be in a state where most traders are uncertain, because, if they weren’t, stock prices always shift up or down until they were uncertain.

If you’re trying to beat the market by getting higher than market returns, your real opponents are all the other stock traders, not just some single entity. Traders can’t all be winners. For every dollar of market outperformance, there has to be a dollar of underperformance.

So, when you try to beat the market, you have to ask yourself whose trading dollars you expect to take. Even worse, because almost all trading is done by professional investors these days, you need to ask yourself which investment pros’ dollars you expect to take.

None of this proves that you can’t beat the market. But it does show that the deck is stacked against anyone who tries, particularly after factoring in the costs associated with trying to beat the market.

Monday, July 17, 2017

The Four Pillars of Investing

While reading William J. Bernstein’s book The Four Pillars of Investing, I was unsure of how to summarize it. After finishing I’d say that it aims to give readers the right knowledge and expectations to become successful do-it-yourself investors. Without a solid grounding in each of the four pillars, investors are at risk of making expensive mistakes.

The first pillar, called “theory,” is less intimidating than it sounds. It teaches the link between risk and reward and that “high previous returns usually indicate low future returns, and low past returns usually mean high future returns.” This is particularly true of stocks because they show more mean reversion than you’d expect just from randomness.

We tend to think of money market funds as safe, but they get their returns in part from commercial paper that “does occasionally default.” There is no excess return without some risk.

Bernstein explains the Gordon equation, which states that the market return is equal to dividend yield plus the rate of dividend growth. He goes on to explain that to this we have to add the rate of stock buybacks and subtract the rate of new share issuance. One point I’d add is that companies can make their dividend growth appear higher for a few years by increasing the proportion of earnings they pay out in dividends. For this reason, one might substitute earnings growth for dividend growth. But this has its own problems for companies that game their earnings accounting.

An amusing bit was using Trump Casinos as an example of a business with a high risk of defaulting on loans. I doubt Bernstein had any idea that years after writing it, his book would come to seem political.

It’s not hard to see what Bernstein thinks of active management when he refers to a mutual fund’s advisory fees as “what the chimps get paid.” He also says “It should be painfully apparent by now that most of the investment industry is engaged in nonproductive work.” He sums up his arguments with “Stock picking and market timing are expensive, risky, and ultimately futile exercises. Harness the power of the market by owning all of it—that is, by indexing.”

Because of the possibility of high inflation, the author believes that “Long-duration bonds are generally a sucker’s bet.”

The second pillar is the history of investing. The main purpose of this pillar is to teach readers that market bubbles and crashes happen fairly regularly, and we need to keep our wits about us and stick to a plan. As George Santayana said, “Those who cannot remember the past are condemned to repeat it.”

I’ve written before about Bernstein’s distinction between investing and saving, and I won’t say any more about it here.

I enjoyed a joke at the expense of the company “Yahoo!” where Bernstein asked if the name is an interjection “or was it simply a noun, meant to describe the company’s shareholders.”

The third pillar is the psychology of investing. People consistently make many types of investing mistakes. The first step in avoiding these mistakes is to understand them.

Some examples of mistakes are assuming “that the immediate past is predictive of the long-term future,” and our search for patterns that aren’t there. “The pricing of stocks and bonds at both the individual and market level is random: there are no patterns.”

Another mistake is seeking status through the types of investments you use. “Wealthy investors should realize that they are the cash cows of the investment industry and that most of the exclusive investment vehicles available to them—separate accounts, hedge funds, limited partnerships, and the like—are designed to bleed them with commissions, transaction costs, and other fees.”

The fourth pillar is the business of investing. This pillar is a warning about the financial industry. “The stockbroker services his clients in the same way that Bonnie and Clyde serviced banks.” “Under no circumstances should you have anything to do with a ‘full service’ brokerage firm.”

Most mutual-fund companies aren’t much better: “The primary business of most mutual-fund companies is collecting assets, not managing money.”

The sections of the book on the four pillars are strong, but the “assembling the four pillars” section isn’t as strong. A couple of the reasons for this aren’t Bernstein’s fault: the discussion of specific investments is getting dated and is too U.S.-centric for a Canadian like me.

My main criticism is that he ends up building portfolios that are too complex. For most people, the potential benefit of slicing up portfolios into ETFs or funds based on market caps, growth/value, geography, and other factors is too small to justify the extra work. No doubt some people could manage all this well, but many investors would make mistakes and end up spending too much on commissions, spreads, higher MERs, and realized taxes. Simpler is usually better.

The short section on investing with children is excellent. He advocates buying index funds for children, letting them watch the ups and downs once each quarter, and letting them spend some dividends. I tried to do something similar for my sons, but mostly failed. Bernstein’s approach would have been better.

Bernstein is very positive about an approach to investing called value averaging. It doesn’t work. I’ve discussed why here and here, and described some experiments I ran here.

The subsection on rebalancing places a lot of emphasis on which method gives the highest returns. This can be misleading for investors. When you own many stock funds based on various factors, rebalancing can give a small boost in returns. However, most investors just rebalance between stocks and bonds. The purpose in this case is to control volatility, not boost returns.

Overall, I found this to be an excellent book for steering investors toward making good decisions about the things they can control, and remaining calm about the things they can’t control. Readers who get through the whole book are likely to become better investors.

Wednesday, July 12, 2017

Are We Saving or Investing?

When we buy shares in a company, are we saving or investing? Most of the world would call this investing, but William J. Bernstein disagrees. In his excellent book The Four Pillars of Investing, he explains why he calls this saving:

“When you and I purchase shares of stock or a mutual fund, we are not investing. After all, the money we pay for our shares does not go to the companies, but, instead, to the previous owner of the shares. In economic terms, we are not investing; we are saving.”

He continues

“Only when we purchase shares at a so-called ‘initial public offering’ (IPO) are we actually providing capital for the acquisition of personnel, plant, and equipment. Only then are we truly investing.”

It’s certainly important to make a distinction between a simple change of ownership of shares and a company getting new money to run its operations. But I find the terms Bernstein uses very unsatisfying.

When I commit money to my trading account with the intent to leave it there for a long time, I am saving. When I choose to convert cash to shares, I’m not saving again. The word most people use for this activity is “investing.” If we wish to make the distinction Bernstein is making, then I think “trading” is a better word than “saving.”

But even this doesn’t describe the situation fully. It’s true that the net actions of buyer and seller provide no new capital to the company. But the buyer has aligned his economic outcome to the fate of the company. The buyer’s viewpoint is that he has invested in the company and the seller has withdrawn his investment, even if the company doesn’t see it this way.

The most troubling part of this semantic game is that it gives an opening for obnoxious types to derail any type of investment discussion with “actually, you’re not investing at all.” It’s amazing how often people in a narrow technical field think they can police the meaning of a word that has one meaning in the technical field and another well-established meaning among the broader public.

The point Bernstein was leading up to in his book is that IPOs have historically been poor investments, on average. So, investors would do well to avoid IPOs altogether. This is a good point to make, but we need better terms when discussing the distinction between IPOs and the secondary market than investing/saving.

Friday, July 7, 2017

Short Takes: Macroeconomics, Unlocking Phones, and more

Here are my posts for the past two weeks:

Payday Loan Information

Are Payday Loan Users Victims?

Enough: True Measures of Money, Business, and Life

Arguments Against Index Investing

Here are some short takes and some weekend reading:

Preet Banerjee interviews Luke Kawa, a Bloomberg reporter, to talk about macroeconomics. It was good to get some buzzwords explained, but this interview didn’t change the feeling I’ve had for some time that macroeconomics is wild guesswork.

Big Cajun Man reports that new CRTC rules will eliminate phone unlocking fees on 2017 December 1. He uses the example of Bell’s policies to show how onerous these fees can be.

Canadian Couch Potato reports on new index ETFs from Royal Bank.

Boomer and Echo ask whether your assets under management are really being managed.

Thursday, July 6, 2017

Arguments Against Index Investing

I’m accustomed to reading arguments against index investing. The valid ones tend to point out that few index investors actually stick to their plans. The “other” arguments make less sense but get repeated frequently anyway. Jack Mintz managed to bring a great many of these less sensible arguments together in a recent short article. Here I examine Mintz’s claims.

“What happens if the day comes that the entire stock market becomes solely made up of passive investors?”

This won’t happen. We’re not close to it now. If we ever got close enough to 100% index investing, active stock picking would become profitable.

“The lure of sharply reduced investment fees has enticed millions of investors to shift their portfolios to passive investments.”

Calling low fees a “lure” implies that index investors can expect to get caught somehow. Mintz offers nothing to back this up.

“There are problems with all this passivity.”

I got to the end of the article without seeing anything to back up this vague claim of problems index investors can supposedly expect.

“Much of the argument in favour of passive investment is based on the presumed failure of active funds to provide superior pre-tax returns on a consistent basis compared to index funds.”

The failure of active funds to keep up with index funds is extremely well studied and documented. There is nothing “presumed” about it.

“But passive investment works when market prices convey all the information about a security.”

The implication here is that passive investment doesn’t work when market prices don’t convey all the information about a security. This isn’t true. The fact that the average index investor gets higher returns than the average active investor is based on simple arithmetic, not some variant of the Efficient Market Hypothesis. Only a small minority of active investors can outperform the index. The more efficient the market is, the tinier the minority of active investors who can outperform the index over the long term.

“In the presence of informational inefficiency, there is value to research and hiring advisers.”

The vast majority of trading is done by investment professionals. They can’t all beat the index. After factoring in costs, only a small minority can beat the index over the long run. Average investors have no idea which advisors will help them outperform. Trying to guess this correctly is as hard as being a superior stock-picker.

“Passive investors freeload on active investors in the presence of informational inefficiencies. Through their research, active investors will reallocate capital from poorer-performing to better-performing assets, thereby increasing the overall value of an index, making passive investors better off too.”

This is true, but it’s an argument in favour of index investing, not against it. The work of active investors sets good prices that index investors enjoy. Perhaps we’re supposed to be embarrassed to be considered freeloaders. I think active money managers can be considered freeloaders for the huge fees they charge for a service that consistently produces poor outcomes for investors.

“It’s obvious that relying only on an index is absurd.”

So far we’re being lured, we have problems, we’re freeloaders, and now we’re behaving absurdly. Flinging around such characterizations is easier than making a logical argument.

“Nortel made up 36 per cent of the TSX in 2000 and went bust a few years later. Meanwhile, funds based on an index will often end up holding many unprofitable firms.”

On the other hand, index investors rode Nortel on the way up, and they own many profitable firms. The implication here is that active managers avoided Nortel’s implosion (as a group, they didn’t), and they can avoid companies that will be unprofitable in the future (as a group, they can’t).

“When the U.K. ended embedded commissions, the result was that lower-wealth investors would not or could not pay for advice, leaving them less well-prepared for retirement.”

Lower-wealth investors in Canada are already very poorly served. Most of the time, salespeople sell them expensive mutual funds without providing meaningful advice. Quality financial advisors are almost exclusively available to investors with substantial portfolios.

“Instead of favouring passive investing over active investing, policy should instead remove barriers that make financial planning costly. Ottawa charges GST on financial-management fees.”

It’s not clear to me that removing the GST from financial-management fees would lower investors’ costs. Costs are unreasonably high now. What would stop fund companies from raising fees to fill the GST gap? If you think of the GST as an extra cost for investors, you probably want to remove it. If you think of the GST as taking a slice of fees away from fund companies and advisors, then you probably want to keep it (unless you work for a fund company or advisor).

“Fans of ETFs and the companies that market the funds insist that active investing can never beat passive investing, since no human can consistently outperform the market.”

Few people claim that no human can consistently outperform the market. After all, most of us have heard of Warren Buffett. What index investors claim is that the average index investor gets higher returns than the average active investor after factoring in fees.

“The overwhelming number of studies that test the difference between active and passive funds are deficient in some respects.”

To back up this claim, Mintz cites nitpicks about benchmarks and observes that some studies found that active management beat passive in certain time-frames or under other circumstances. The truth is that the overwhelming majority of studies clearly back up the simple arithmetic argument that active managers as a group cannot beat indexes.

It’s hard to know the real motivation of those who make arguments like this. One plausible guess is that while the arguments are easy to refute, they give advisors something convincing to say to their clients in a one-on-one setting with nobody there to offer counterarguments.

One point to be clear about here is that active investing is not the enemy. For one thing, active investors help to set good prices. Investors’ real enemy is high costs. In the U.S., Vanguard offers active mutual funds with low costs. These funds serve investors well.

The best criticism of index investing is that so many investors fail to stick to their plan. Some bail out when stock prices fall. Others tinker so much with their allocations that they’re effectively market timers. Some are poorly diversified.

The passive versus active debate isn’t going away any time soon. There are too many people who make their livings from expensive mutual funds to expect them to just give up.

Wednesday, July 5, 2017

Enough: True Measures of Money, Business, and Life

John Bogle thinks there should be more to investment management and business in general than maximizing profit. In his distinguished career, he has put his money where his mouth is by creating a structure for Vanguard that strongly incents employees to minimize investor costs. In his book Enough: True Measures of Money, Business, and Life, Bogle describes Vanguard’s history and explains his business philosophy.

The book opens with the story of Joseph Heller being told that a hedge fund manager “had made more money in one day than Heller had earned from his wildly popular novel Catch-22 over its entire history. Heller responds, ‘Yes, but I have something he will never have ... enough.’” Bogle believes there are more important goals once you have enough money.

Vanguard began amid a business dispute and it was “barred from assuming responsibility for investment management and marketing.” This proved to be a happy result for investors because it helped make Vanguard the investor-friendly organization it is today. Vanguard eliminated the need for investment management by forming “the world’s first index mutual fund.” Without marketing, it converted “to a no-load, sales-charge-free marketing system.”

Keeping investor costs low is very important to Bogle. “On balance, the financial system subtracts value from our society.” He doesn’t want to add to this problem. He also shares Charlie Munger’s “concerns about the flood of young talent into a field [fund management] that inevitably subtracts so much value from society.” “Today, if fund managers can claim to be wizards at anything, it is in extracting money from investors.”

Some investors have a hard time accepting low-cost index investing approach that Bogle advocates because it seems too simple. But Bogle says that “Financial institutions operate by a kind of reverse Occam’s razor. They have a large incentive to favor the complex and costly over the simple and cheap, quite the opposite of what most investors need and ought to want.”

Canadians may be surprised to learn that Bogle is leery of ETFs: “I have serious questions about the rampant trading of most ETFs.” While Vanguard offers low-cost mutual funds, they are not available to Canadians, and we tend to look to ETFs for low costs. Bogle does “admire the use of broad market index ETFs that are held for the long term.”

Fans of diversifying with commodities will get only blunt words from Bogle. “Commodities have no internal rate of return. Their prices are based on supply and demand. That is why they are considered speculations, and rank speculations at that.”

Bogle worries that professions, including financial services, that should be worthy of trust are being undermined by profit motives. “Profession by profession, the old values are clearly being undermined. ... Unchecked market forces not only constitute a strong challenge to society’s traditional trust in our professions, but in some cases these forces have totally overwhelmed normative standards of professional conduct, developed over centuries.” “Over the past half-century-plus, the fund business has turned from stewardship to salesmanship.”

Bogle is critical of the practice of paying CEOs with stock options. This drives short-term thinking, but measuring “CEO performance should be based on the long-term building of intrinsic value.”

Convincing people to pursue more than just money can be a tall order. He quotes Descartes on this point: “A man is incapable of comprehending any argument that interferes with his revenue.”

Bogle sacrificed a great deal of personal wealth when he created Vanguard to strongly incent its employees to keep costs low. “In comparison to nearly all, if not all, of my peers in this business, I am something of a financial failure.” But he is “doing just fine, thank you.” He has enough and measures his success with a different yardstick.

Tuesday, July 4, 2017

Are Payday Loan Users Victims?

In a recent post about payday loans, reader Paul had the following (lightly edited) comment:

“You know I used to feel sorry for people who get caught up in this money cycle. But when most people would rather just watch Dancing with the Stars or an insane reality program and not spend 30 seconds on improving any aspect of their financial lives, I just can’t.

“One’s financial problems seem to always be ‘someone else’s or some fat cat banker’s fault.’ No one is responsible for themselves anymore. For the poor who struggle to make ends meet and this is the only option, yes I agree that is bad; for the rest, you get what you deserve if you can't pay for that non-essential ‘toy’ or latest iPhone you purchased you just had to have.”

There definitely are many people who deserve Paul’s criticism. But many who get caught up in a vicious payday loan cycle had plenty of help getting there. When I’m asked to referee a dispute, I like to say that we shouldn’t overlook the possibility that everyone is wrong.

Before looking at the causes of debt troubles, it’s important to recognize that on a pragmatic level, it doesn’t matter whose fault it is that you’re stuck in debt. If nobody else will help you, then you have to help yourself. So, don’t take any part of the rest of this post as an excuse to throw up your hands and declare your debt troubles to be someone else’s fault; that won’t help you.

Most of us start off young and clueless about money. It’s easy to begin a descent into debt trouble without realizing the path you’re on. These people aren’t blaming others for their problems because they don’t know they’re in trouble yet. As they begin to recognize the signs of trouble, they react in different ways. Some take positive actions to climb out of their financial hole and some blame others, but many just bury their heads in the sand for as long as possible pretending nothing is wrong.

The financial industry has great skill when it comes to promoting debt and helping people maintain their lifestyles while building debt. When your debt is split across multiple credit cards, lines of credit, car loans, and a re-advanceable mortgage, it’s very easy to lose track of whether your debt is rising from one month to the next.

If tobacco companies were to hire attractive 21-year olds to give free cigarettes to kids on their 18th birthdays, parents would riot. We react much less to banks hiring attractive people to push credit card applications on young adults. However, for many debtors, getting into a vicious payday loan cycle is the end of a descent that began with mishandling a first credit card.

Student loans are no help in teaching people to avoid debt. Tuitions have risen so high that it’s very difficult to get an education without a loan. Starting your adult life owing $20,000 normalizes being in debt. How could it hurt to add another $1000 on a credit card? At this point, the debt cycle is well established.

Any time I’m inclined to judge debtors harshly, I wonder what effect today’s debt-pushing machine would have had on me. I was turned down for student loans because I went to school in a different province, and fortunately for me, being in debt didn't seem like a normal state when I was young. If I were growing up today, I probably would be able to get student loans. Without the strong push I got toward frugality, perhaps I might have got an early taste for a more expensive lifestyle.

When it comes to Canadians’ debt problems, there’s a lot of blame to go around. But we can’t wait for banks, universities, and government to grow a heart and stop contributing to the debt cycle. The only person you can count on to get you out of a debt spiral is you.

Monday, June 26, 2017

Payday Loan Information

The Financial Consumer Agency of Canada (FCAC) has a page providing information about payday loans that has drawn criticism from some personal finance experts. The main problem I see is that FCAC didn’t include enough summary of the dangers of payday loans in the first few sentences. Lower down on the page, there is solid information about dangers.

When you’re trying to help people, it’s vitally important to set the tone for your message very early. Many people won’t read past the title of an article. Others will read only the first couple of sentences. In most cases, only a small fraction of readers will make it to the end. The failing of FCAC’s payday loan page is the tone it sets in its short introductory section.

Some would want FCAC to use strong language to warn Canadians away from payday loans. However, the Government of Canada has to be careful about sticking to facts. They can’t publish a diatribe against a legal industry.

Below is my suggestion for a few small edits to the beginning of the page to change the tone and hint at some good material that appears lower on the page.

“A payday loan is a short-term loan [with a high fee and interest rate]. You can borrow up to $1,500. You must pay the loan back from your next paycheque [or face more fees, interest, and possibly collections, lawsuits, property seizure, and wage garnishment].”

I’m tempted to add “Almost all personal finance experts advise against taking out payday loans” as long as there is some data to back up such a claim.

It can be tricky to set the proper tone while sticking to facts with solid backing. I think FCAC has done this for the small minority of readers who will read their whole page. They need to get the tone right for readers who will only read the first few lines.

Friday, June 23, 2017

Short Takes: Fear on Wall Street, Home Affordability, and more

The Blunt Bean Counter is giving away copies of his book Let’s Get Blunt about Your Financial Affairs. To enter the draw, just complete a short confidential survey about how “on track” your retirement plans are. To maintain confidentiality, there’s a separate link to the draw at the end of the survey. He’s a friend, so I took this short survey myself. You can go directly to the survey here and see his write up about it here.

Here are my posts for the past two weeks:

The Index Revolution

Experienced Investors and Novices

Here are some short takes and some weekend reading:

The Reformed Broker asks “If stocks keep going up, why isn’t anyone celebrating?” A couple of other good quotes: “This may be the first bull market in history that featured layoffs on Wall Street” and “The stock market is now 35% passive and 65% terrified.”

Squawkfox has some sensible advice about whether you can afford to buy a home. She even has a spreadsheet to help you work out the number for your unique situation. Sharp-eyed readers will notice a big difference between her rule of thumb that “a mortgage should not exceed 3X your annual income” and the much more relaxed “stress test” limits required by the government. Squawkfox says you should ignore how much the bank says you can borrow and figure out what you can really afford.

A Wealth of Common Sense lists the things the market does not care about. The only one I’m not sure about is the “passive vs. active debate.” It seems that every time someone asks how I invest and I explain that I rarely trade, the market moves in some way that trips one of my rebalance thresholds and I end up making a couple of trades. But seriously, the market doesn’t care about you or me at all. A bonus from A Wealth of Common Sense: some amusing money manager clich├ęs.

Dan Bortolotti talks with Tom Bradley of Steadyhand Investment Funds to discuss what they agree and disagree about in their index and non-index (undex) approaches to investing.

Mr. Money Mustache suggests preparing for the next recession now while times are still good. Some amusing bits: auto loans are the worst “outside of mortgaging your shins to a loan shark to afford tonight’s cocaine,” and the car is a “bank-financed gas-powered racing sofa.”

Jim Yih at Retire Happy has some great advice on how to handle an inheritance. Combine the fact that so many people handle windfalls poorly with the fact that they’ll be grieving, and it’s no wonder they need to take special care with an inheritance.

The Blunt Bean Counter discusses how to avoid family strife by discussing your will with your family. It seems that almost all parents believe that after their death their children will get along well, but serious conflicts over inherited property are common.

Thursday, June 22, 2017

Experienced Investors and Novices

It’s common to hear that certain types of risky investments are not for novices. Some will take this to mean that such investments are good for experienced investors. This isn’t necessarily the case.

A recent example of this type of advice is an article warning investors about quadruple-leveraged ETFs:
“Investing in even modestly levered funds is a potentially dangerous proposition for inexperienced investors.”
This quote is true, but some readers may conclude that these leveraged ETFs are safe if you’re an experienced investor. It’s worth reminding ourselves of a simple truth: if two investors buy the same investment for the same price on the same day, and they sell it for the same price on the same later day, they will get the same return. The more experienced investor won’t somehow get a better result. To perform better than novices, experienced investors must do something different from novices.

Quadruple-leveraged ETFs are usually a bad idea for investors no matter their experience level. No doubt there are ways to handle them that are less damaging than other ways, but don’t let overconfidence drive you to poor choices. Saying they’re not for novices is almost a form of advertising to draw in investors wanting to think they’re sophisticated enough to handle them.

Most of us would likely see through a pitch like “Leveraged ETFs aren’t for novices, but a smart person like you could make a killing.” But subtler forms of the same pitch for different types of risky investments do work on some of us who seek the status of investing in sophisticated products.

Wednesday, June 14, 2017

The Index Revolution

Charles D. Ellis draws on his distinguished 50-year career in investing to make a very strong case for indexing in his recent book The Index Revolution: Why Investors Should Join it Now. He acknowledges that collectively professionals used to be able to use intelligence, discipline, and early access to information to beat the market, but that this is no longer true today. His arguments are clear and thorough.

We might wonder whether the modern failure of investment professionals is a sign that past professionals were smarter. Ellis explains that this is not the case. In the 1960s, “Active investment managers were competing against two kinds of easy-to-beat competitors. Ninety percent of trading on the New York Stock Exchange was done by individual investors. Some were day traders ... [and] others were mostly doctors, lawyers, or businessmen.”

“Fifty years later, the share of trading by individuals has been overwhelmed by institutional and high-speed machine trading to over 98 percent.” “In a profound irony, the collective excellence of active professional investors has made it almost impossible for almost any of them to succeed.” “The specter of underperformance that now haunts active investing will not go away.”

Ellis says there are 4 big reasons for indexing today: “(1) the stock markets have changed extraordinarily over the past 50 years; (2) indexing outperforms active investing; (3) index funds are low cost; and (4) indexing investment operations enables you as an investor to focus on the policy decisions that are so important for each investor’s long-term investment success.”

Active managers saw the threat of index funds early on. In 1977, posters appeared in “the offices of investment management companies nationwide depicting Uncle Sam stamping ‘Un-American’ on computer printouts and the words ‘Help Stamp Out Index Funds. Index Funds are Un-American.’”

Interestingly, despite the threat from low-cost index funds, the cost of active management soared over the decades. Up to the 1970s, “explicit fees were low, typically one-tenth of 1 percent per year.” Clients seemed to believe that active managers could overcome much larger costs. “As a strategy consultant to investment managers from 1972 to 2000, I witnessed this process of explaining fee increases many times and never observed a negative reaction by the clients of any manager.”

High fees are tolerated in part because “nobody ever actually pays the managers’ fees by signing a check for hundreds of thousands of dollars. Fees are conveniently and quietly deducted by the manager from the assets being managed. Out of sight, out of mind.”

Ellis isn’t a fan of “Smart Beta” factor investing. “If a factor works, investors will notice, move in on it, and reduce or even eliminate the real risk-adjusted advantage seen previously by earlier investors.”

Although much of the book is focused on the U.S., Ellis has some advice for non-U.S. investors when it comes to stock asset allocation: “Investors based in New Zealand or Spain or Canada should be comfortable investing more than half of their investments outside their smaller home markets.”

Ellis advises young people to focus on owning stocks more than bonds because assets outside your portfolio such as “home, future income, and future Social Security benefits can all be thought of as close to stable value fixed-income equivalents.” Personally, I think future income for most people is riskier than they realize, but I still agree with Ellis that young people should ignore stock market price moves and own stocks.

I highly recommend this book. It is likely to help those who know little about index investing the most. Those who pursue active investing should read this book and be able to explain clearly why Ellis’ arguments don’t apply to them. Those who index their investments but need a refresher on why they should stay the course can benefit as well.

Friday, June 9, 2017

Short Takes: Forgery at Banks, Investing Heroes, and more

Here are my posts for the past two weeks:

High Housing Costs vs. Avocado Toast

Against the Gods

Here are some short takes and some weekend reading:

If forgery by banks is as widespread as this CBC article makes it out to be, we have much bigger concerns than whether banks are up-selling us.

Phil Huber has a very interesting take on the unsung heroes of investing.

Patrick O’Shaughnessy interviewed David Chilton in this interesting podcast.

Because Money interviewed Preet Banerjee who shared several interesting findings from research in finance. One question he answered was why mutual fund companies have so many mutual funds. It turns out that it helps them capture performance-chasing clients.

Robb Engen has some blunt words to describe the state of financial advice for people of modest means.

Tom Bradley at Steadyhand says it is during calm times like we’re experiencing now that we have to plan how we’ll react to the inevitable downturn. It’s hard to get people to pay attention to a message like this during good times, but now is the right time to decide how to react to market losses.

Big Cajun Man says he hasn’t had much success trying to maintain a budget. Many others would say the same thing. At the very least, if you track your spending accurately, you will naturally cut back in areas where you see unreasonably high spending.

The Blunt Bean Counter explains how hang-ups we have talking about money and death combine to form a “virtual tsunami of taboos” about creating and discussing wills.

Million Dollar Journey compares the cost of owning a global ex-Canada ETF such as VXC or XAW to the cost of owning 3 slightly cheaper ETFs that collectively own the same stocks. The focus here is on ETFs that trade in Canadian dollars rather than U.S.-dollar ETFs that offer potentially higher savings for more effort.

Monday, June 5, 2017

Against The Gods

Our modern understanding of financial risk is built upon work that reaches back thousands of years. Peter L. Bernstein traces this history in his interesting book Against the Gods: The Remarkable Story of Risk. Bernstein avoids overly technical material and looks at the historical figures who made meaningful contributions to the way we think about risk today.

The book begins with ancient forms of gambling and early attempts to understand probabilities. It then covers Daniel Bernoulli’s early attempt to model rational financial decision-making when outcomes are uncertain. Bernstein frequently criticizes Bernoulli’s work as being a poor model of how people actually make choices. But, as I’ve explained before, I see no evidence that Bernoulli was trying to model human behaviour. He was modeling how we should make decisions, not how we actually make decisions.

When Bernstein makes it to Gauss’ contribution, he observes that “The normal distribution forms the core of most systems of risk management,” and “Impressive evidence exists to support the case that changes in stock prices are normally distributed.” But readers of Benoit Mandelbrot and Nassim Taleb needn’t get too excited. Bernstein later explains that when we look at a chart of the sizes of monthly changes in stock prices, there are too many large changes at the edge of the chart and that “A normal curve would not have those untidy bulges.” He concludes “At the extremes, the market is not a random walk.”

In further evidence that stock prices aren’t completely random, Bernstein cites a study of the S&P 500 from 1926 to 1993 by Reichenstein and Dorsett. If stock price changes were independent from year to year, then the variance of multi-year returns would grow linearly with the number of years. However, “the variance of three-year returns was only 2.7 times the variance of annual returns; the variance of eight-year returns was only 5.6 times the variance of annual returns.” This means that good periods tend to be followed by below average years, and bad periods tend to be followed by above-average years.

One comment I couldn’t follow was the assertion that if the market were fully rational, “At any level of risk, all investors would earn the same rate of return.” Is this some mathematical consequence of rational behaviour in the markets even when investors have rational levels of risk aversion, or is Bernstein asserting that risk aversion is irrational? The latter is clearly not true. It is perfectly rational for me to reject a double-or-nothing bet for everything I own. Even if I’m offered an extra $10,000 if I win, I’m still being rational to reject the bet even though it has a positive expectation of $5000.

Even though this book was written in 1996, Bernstein seemed to anticipate the financial meltdown of 2008-2009. “Mortgage-backed securities are complex, volatile, and much too risky for amateur investors to play around with.” They also proved to be too complex for professionals to handle safely.

An unfortunate typo in a discussion of the Fibonacci sequence is likely to leave some readers confused. Bernstein tries to make the point that the ratio of successive terms starting at 5 always begins 0.6... .  Unfortunately, the text says these ratios are always 0.625, which works for 5/8, but fails for 8/13, 13/21, etc.

Overall, I found this book entertaining and enlightening, although it has such breadth that I’m guessing experts could find much to criticize. It is definitely worth reading.

Wednesday, May 31, 2017

High Housing Costs vs. Avocado Toast

By now just about everyone has heard how wealthy Australian Tim Gurner admonished young people for wasting money on avocado toast while they complain about high housing costs. This has led to a predictable backlash. It seems that avocado toast is easy to mock. As is usually the case, neither side of this “debate” is entirely right or wrong.

It’s tough that rents and house prices are so high today. No matter how frugal people are in all other areas of spending, rents and mortgages are still painfully expensive. But wasting money in other areas doesn’t help.

David Chilton once wrote that people most underestimate the costs of “(1) cars; (2) dining out; and (3) little things.” Rather than literally discussing avocado toast, we should look at it as a stand-in for “little things.”

The cost of little things adds up quickly. Most of us have little idea how much we spend on our habits. For most of us it’s easily hundreds of dollars per month. I’d be willing to bet that if most people were asked to guess their total spending on little things, they’d guess less than half the correct figure. I’d like to think I’d do better, but maybe I wouldn’t.

I recall asking one of my sons how he managed to spend $1000 in one month at university. He wasn’t sure. When we checked his debit records, the answer was “a little bit at a time.” He had more than 50 transactions, none of which was over $40. This was enough of an eye-opener for him that he cut way back.

Some people say that cutting back on lattes and avocado toast will never make enough of a difference to put a dent in the high cost of rents and mortgages. This depends on how much you spend on little things. And unless you have actually tracked your spending for a while to know how much you really spend, you can’t be sure that little things don’t matter.

Other people argue that we shouldn’t be forced to give up every little indulgence in life just to be able to afford a place to live. There is truth in this. Maybe the odd latte isn’t a problem. But is this really all of your habitual spending on small things? I know I spend small amounts on many different things.

Suggesting cutting back on small purchases causes some people to immediately imagine the one type of small purchase they most enjoy and declare they’re not giving it up. This reminds me of asking a hoarder to get rid of some stuff. Instead of looking around for things he didn’t need any more, one hoarder I knew would sit and think of the one thing he most wanted to keep and would angrily declare he wasn’t going to get rid of it.

We need to avoid being like the hoarder who wouldn’t even examine his possessions. If high rent or mortgage payments are a problem in your life, one way to ease the pressure is to examine all areas of spending for things where you’re not getting much value for your money. Don’t make the mistake of ignoring small purchases. Many of us have enough small purchases in a month that they add up to real money.

Friday, May 26, 2017

Short Takes: Responsible Investing, Securities Regulation, and more

Here are my posts for the past two weeks:

Replying to Emails I Usually Ignore

Bad Surveys

Pay Yourself First?

Here are some short takes and some weekend reading:

Canadian Couch Potato discusses socially responsible investing with specialist Tim Nash. It sounds like it’s not possible to fully exclude companies with objectionable practices. Rather you end up with a tilt away from the practices you don’t like and possibly toward greener companies. In a later part of the podcast CCP delivers repeated beatings to Ted Seides over his attempt to explain away his crushing loss on a bet with Warren Buffett.

Preet Banerjee interviews Professor Anita Anand to discuss securities regulation in Canada and what needs to change to better protect investors.

The Blunt Bean Counter compares Canada’s CPP/OAS pension system to Social Security in the U.S.

Robb Engen shares his obsessions with saving money.

Big Cajun Man lays out the 5 steps to getting an RDSP.

Million Dollar Journey lays out a very simple index investing guide for Americans. He mentions an equally simple indexing approach for Canadians as well.

Thursday, May 25, 2017

Pay Yourself First?

“Pay yourself first” is some great advice to help people save money. If you have any trouble with money, as most people do, there are a number of ways to improve your finances including paying yourself first, tracking your spending, and budgeting. Even though I think these things are important, I don’t do them myself.

The idea of paying yourself first was popularized by David Chilton in his first Wealthy Barber book. When your pay hits your bank account, the idea is to set aside some chosen percentage for savings before you begin paying the month’s bills and start spending any money on wants. Most people who wait until the end of the month to save whatever is left end up saving nothing.

However, my wife and I have saved over 50% of our take-home pay for several years now by using the dangerous save-whatever-is-left method. We don’t bother to smooth out our expenses with equal billing plans and paying monthly for insurance and other things. We don’t spread out big expenses like home repairs either. As a result, our savings rate varies wildly from month to month. But by the end of the year, our saving percentage is always high.

I see many people who desperately need to start budgeting, tracking their spending, and paying themselves first. But I don’t often come across people with high saving rates who don’t really try very hard.

It feels strange to advise people to do things I don’t do myself, but that’s exactly what I do. I would never recommend most of the details of my money habits to anyone. The end result of saving money without building debt is worthwhile, but different people need different methods to achieve this result.

Wednesday, May 17, 2017

Bad Surveys

Yet another survey concludes that people are pretty dull when it comes to finances. This time it’s the Teachers Insurance and Annuity Association (TIAA) Institute who asked just over a thousand Americans 28 financial questions. The respondents didn’t do very well. But sometimes, it’s the designers of the study who are dull.

A Wall Street Journal article quotes one of the survey’s 28 questions:

There’s a 50/50 chance that Malik’s car will need engine repairs within the next six months which would cost $1,000. At the same time, there is a 10% chance that he will need to replace the air conditioning unit in his house, which would cost $4,000. Which poses the greater financial risk for Malik?

Anyone mathematically inclined sees instantly that the expected cost is $500 for the engine and $400 for the air conditioner. But the question is which potential repair “poses the greater financial risk for Malik?”

In the field of assessing threats and vulnerabilities, “risk” is defined as the product of probability and the amount of loss. This is the same as the expected value of the loss. Based on this definition, we would choose the engine as the greater risk.

In finance, we usually use standard deviation as the measure of “risk.” For the engine the standard deviation is $500, and for the air conditioner the standard deviation is $1200. Few people would do this exact calculation, but they may understand it intuitively. A 10% chance of a $4000 cost seems riskier than a 50% chance of a $1000 cost, and the math backs up this feeling. Based on this definition we would choose the air conditioner as the greater risk.

In case the argument based on standard deviation isn’t compelling enough, imagine that we replace the potential air conditioner cost with a 0.1% chance of losing $400,000. This is still an expected loss of $400. However, faced with a 50% chance of losing $1000 and a 0.1% chance of losing $400,000, reasonable people would focus more on the potential huge loss.

But the word “risk” isn’t owned by any one technical field. The everyday use of “risk” is imprecise and doesn’t conform exactly to either of the technical definitions.

Some people might look at this question and decide that it’s reasonable to be able to absorb a $1000 loss into their short-term finances, but $4000 would put them into a cycle of high-interest debt and digging out would take time. In this scenario, the air conditioner is the greater risk.

Another way of looking at this question is that engines will cost $1000 per year in repairs and air conditioners will cost $4000 every 5 years or so. So, engines are more expensive, and even though the word “risk” isn’t a good fit, a person who thinks about the question this way would choose the engine as more risky.

As it turns out, the survey designers think the correct answer is that the engine is riskier because its expected cost is higher. I wonder how many knowledgeable respondents understood expected cost but chose the air conditioner anyway because of their view of what “risk” means. I could easily have chosen the air conditioner had I participated in the study.

I agree that most people know too little about personal finances, but in this case, the study designers seem unable to ask clear questions.

Tuesday, May 16, 2017

Replying to Emails I Usually Ignore

I enjoy feedback from my readers discussing the topics covered in my posts, even when they’re critical of my ideas. However, I get other email as well. Here is another installment of replies to emails that I usually ignore.

Dear Andrew,

Thank you for kind words about my “content related to money.” You remind me of book publishers who see their jobs as trying to sell white bricks. I see you have quite a list of different ways to connect your client to topics that appear to be of interest to readers. If I ever decide it would be funny to subject my readers to dreck, I’ll contact you.




Dear Julia,

Thanks you for yet another chance to share in the profits of duping people into losing their money in forex trading. After careful investigation, I’ve determined that I still have a conscience. Better luck next time.




Dear Jessica,

Thank you for your offer to place sponsored guest advertorials on my website along with your requirements that they not be labeled as “sponsored”, “guest”, or “advertorial”. Your offer to cover administration fees of posting sounds generous. You’ll find that my administration costs are somewhat lower than those of the City of Toronto.



Friday, May 12, 2017

Short Takes: Bogus Research, Dumb Things We Do, and more

Here are my posts for the past two weeks:


Becoming a Millionaire

Should You Invest or Pay Down Your Mortgage?

Here are some short takes and some weekend reading:

Kewei Hou, Chen Xue, and Lu Zhang say that “The anomalies literature is infested with widespread p-hacking.” In plain English, they investigated hundreds of claimed ways to beat the market and found that almost everyone was full of it. For those who know a little bit about statistical testing, the one-paragraph abstract of their paper is worth a read. If correct, the paper is devastating to a huge area of investment research into market-beating anomalies.

Meir Statman says it’s possible to make better investment decisions if we recognize that our tendencies sometimes push us in the wrong direction. It’s interesting that he says “Normal people are not irrational.” I’ve seen this statement elsewhere from other thoughtful writers. I can say with certainty that I am sometimes irrational, and I see others act irrationally as well. Perhaps experts use a different definition of “irrational” than I use. Another possibility is that they are simply avoiding the term because people react badly to being told they are irrational. The language Statman uses is gentle and much more likely to help people make positive changes.

Canadian Couch Potato explains why you should probably own some bonds, even though bond yields are very low right now. Curiously, I found myself nodding in agreement as I read, even though I don’t follow this advice myself. Keep in mind that I lived through the dot-com bust and the 2008-2009 financial meltdown with an all-stock portfolio without flinching.

Andrew Hallam reproduces an excellent article by Mark Dowie, “The Best Investment Advice You’ll Never Get.”

Preet Banerjee had an interesting discussion with Dan Hallett, Vice-President and Principal at HighView Financial Group. The big news is that Preet seems to have changed his name to Preset.

Big Cajun Man explains that some low-income families don’t bother applying for the Disability Tax Credit mistakenly thinking it won’t help them. But it leads to being able to open an RDSP and getting some free government money.

Boomer and Echo explains how CDIC would protect deposits if Home Capital goes bankrupt. It seems that once CDIC steps in, depositors get access to their money in a few days. What’s not clear is how long depositors could be left without access to their money prior to CDIC stepping in. I’m interested in how long depositors have been left without access to their deposits in past bankruptcies, but haven’t found any useful information yet.

Thursday, May 11, 2017

Fintech in Canada

“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” ― Adam Smith
Fintech holds the promise of greatly reducing the cost of financial services for Canadians. Our big banks have little choice but to keep costs high because they have a lot of capital tied up in real estate, they have a lot of employees to pay, and most importantly, they have shareholders demanding ever-growing profits. Operating primarily online, lean fintech companies give us the hope of reduced banking fees, better interest rates, and other benefits. But it’s important to understand the motivations of fintech companies.

People like John Bogle who founded Vanguard are rare. Instead of enriching himself, he created an investment company that serves the interests of its customers. He even had the foresight to create a legal structure that created strong incentives to benefit customers instead of pitting them against Vanguard’s management.

Fintech companies are not structured this way. They seek to make money. The best way to make money fast in fintech is to attract as many customers as possible and then sell the company to one of the big banks. Not all fintech companies have this plan, but many do. After acquiring a fintech firm, the big bank will do its best to squeeze more profits from its newly purchased customers without losing their loyalty to the original fintech firm. It’s a tricky balancing act but make no mistake: this is why big banks buy fintech firms.

A longer fintech plan is to actually operate the fintech company and make money from its profits over time. Even here, though, the company’s long-term dreams would be to get closer to the kind of profitability that the big banks enjoy. The path to these profits is to start off with very customer-friendly practices to get a loyal customer base, and later try to squeeze more profits from these customers. Whether or not a fintech company seeks to get sold to a big bank, the endgame is similar: whoever owns the fintech company will try to extract more money from customers.

None of this is really different from the rest of our economy; companies seek profits. But bank customers who understand what is going on can predict how to get less expensive banking. You have to be willing to change banks. It’s not enough to jump once from a big bank to a fintech firm. You need to be prepared to leave one fintech firm for another that makes a better offer.

I’ve gone through this myself first leaving a big bank for Tangerine. Since then Tangerine has been whittling away at credit card rewards and the interest rate they pay. They have even resorted to teaser interest rates to try to compete using advertising without actually paying competitive interest rates on deposits. This has driven me over to EQ Bank.

It’s not my intention to promote one financial firm over another here. Every time I see a good deal at an online bank, I expect to have to pay attention to whether they make negative changes. I expect to have to change banks yet again. I won’t be more loyal to a bank than it is to me.

My hope is that more and more fintech firms will keep popping up to the point where the big banks can’t keep buying them all. If the marketplace becomes diverse enough that there is meaningful competition, maybe some new banks will actually decide that treating customers well is in their long-term interests. Until then, expect to have to change banks whenever your current bank’s offerings deteriorate.

Should You Invest or Pay Down Your Mortgage?

“It is better to be vaguely right than exactly wrong.” ― Carveth Read.
In a good example of how you should be careful where you go for financial advice on the internet, the blog Money After Graduation attempted to tackle a reader question about whether to save money or pay down a mortgage. The analysis and conclusion are not useful.

Ordinarily I applaud those who pull out their math skills to answer questions, but in this case, crucial factors were missed. The article simplified the reader’s question by assuming that TFSA investments would provide a tax-free return of exactly 5% each year, that the mortgage interest rate would stay less than 3%, and that nothing bad would happen in the reader’s life.

With these assumptions, there is no need for the article’s detailed calculations. We can see that 5% is more than 3%, so investing will beat paying down the mortgage. No need for any further analysis, unless there are problems with the assumptions, like the possibility of stock market crashes, poor health, and lost jobs.

I would hope that most people already know that investing in stocks and bonds is likely to give higher returns than a mortgage interest rate. The other factors to consider have to do with risk. Mortgage debt is a form of leverage. There are limits to how much leverage it makes sense to take on.

If there were no uncertainty in life, we could all get rich borrowing as much as possible at a modest interest rate and earning a higher return in the stock market. Market returns would cover the interest on the debt and more. But the stock market is volatile, and people get sick and lose their jobs.

If you have too much leverage, losing your job during a stock market crash could ultimately lead to losing your house too. This may sound unlikely, but losing your home would be so devastating that it’s a more important consideration than whether investments usually earn higher returns than mortgage interest rates.

The exact amount of leverage that makes sense for you depends on several factors including your age, health, income, job security, and how easily you could find another job. Unfortunately, people often overestimate their job security. One reason seems to be that the thought of losing our jobs is so scary that the only way to get through the day is to believe that our jobs are secure.

Most people understand these things to some degree. Big debts make people nervous, and they feel better when they can pay down their debts. We may not be able to figure out our optimum leverage level, but we often recognize too much leverage when we see it.

Not to pile on, but the Mortgage After Graduation article also contains the following quote: “Even at 1%, cash in the bank is better for your net worth than mortgage pre-payments simply because cash will earn a compounding return and mortgage pre-payments won’t.” This is wrong. Pre-payments on your mortgage have a compounding effect on your net worth. Cash earning 1% interest will not outperform a mortgage pre-payment. Of course, this doesn’t mean we shouldn’t hold some cash. The purpose of holding cash is to prepare for an emergency or other cash needs that arise, not to act as a better investment than paying down your mortgage.

Getting back to the question of what to do with some savings, I see 4 main possibilities: invest, add to an emergency fund, pay down the mortgage, or pay down some other debt. Which one is correct depends on the details of the person’s financial life. The general order is to eliminate high interest debt, build an emergency fund, pay down the mortgage until you get to a sensible level of leverage, and finally invest. Deciding what to do can be difficult, but thinking in this way offers a chance to be vaguely right instead of exactly wrong.

Wednesday, May 10, 2017

Becoming a Millionaire

I recently saw a tweet with a chart showing how much money you need to save each day to become a millionaire at age 65. This was one of those motivational things designed to get young people to start saving. For just two bucks a day, supposedly a 20-year old could become a millionaire in 45 years. I applaud the part of this that tries to get millennials to save money, but two bucks a day won’t make anyone a millionaire.

The implicit assumption in the chart was that we can get a 12% annual return from investments. This is just a dream. With a balanced portfolio and slightly lower than average investment fees, the typical investor could reasonably hope for a 5% annual return.

But this is ignoring inflation. In 45 years, cash might have only one-quarter of its current spending power. When people imagine becoming millionaires, do they really mean to have only the spending power of a quarter million dollars today?

To become a millionaire in today’s dollars, we need to focus on real returns, which are investment returns after subtracting out inflation. Typical investors could hope to get a 2% annual real return. We should also plan to have the amount we save increase by inflation each year.

The following table shows how return assumptions can make a big difference in how much you need to save.

Table: Daily Savings to Become a Millionaire by Age 65

Age 12% Return 5% Return 2% Real Return
20 $1.91 $16.74 $37.73
25 $3.37 $22.13 $44.91
30 $5.99 $29.60 $54.26
35 $10.72 $40.24 $66.87
40 $19.41 $56.02 $84.69
45 $35.92 $80.86 $111.65
50 $69.42 $123.90 $156.87
55 $147.46 $212.56 $247.75

As we can see, the daily savings needed by a 20-year old change radically when we change the return assumptions. Don’t be too discouraged by these numbers, though. You’ll likely get raises during your working life that exceed inflation. So, your capacity to save will likely increase with time.

The important thing is to get into the saving habit now even if the amounts are small. This will give you a head start in building greater savings when you’re older. Those who build too much debt may find they’ll run out of time to dig out of debt and build the savings they’ll need when they’re older.

Wednesday, May 3, 2017


As imperfect humans, we often don’t have the time, skills, or information necessary to make good decisions. In their fascinating book, Nudge, Richard H. Thaler and Cass R. Sunstein show the many ways we can help people make better choices about health, investments, and many other areas without taking away their freedom to make any choice they want.

One simple example concerns default choices for company retirement plans. Often, if workers take no action, they don’t get enrolled in a company retirement plan. In such a case, an alarming number of workers fail to accept the free money a company offers in matching any contributions workers make to their retirement funds. However, when a company automatically enrolls workers (meaning they would have to take some action to avoid being enrolled), far more workers end up in the retirement plan. It seems that when we are faced with choices, we often just don’t choose.

The authors call themselves libertarian paternalists. The “libertarian” part means that they don’t want to restrict people’s freedom of choice. The “paternalist” part means they want to set up the circumstances under which we make our choices in such a way that we are nudged toward options that are in our best interests.

The authors show clever ways that make it easier for us to save more money, invest better, and improve other types of choices. When it comes to saving more money, a successful method is to time increases in your saving rate to coincide with raises. This way, you see no decrease in take-home pay that makes you not want to save more.

As an example of how we can be influenced easily, “forty thousand people [were] asked a simple question: Do you intend to buy a new car in the next six months? The very question increased purchase rates by 35%.” Most of us probably believe that while others may be susceptible to such things, we’re not. We’re wrong.

In another example of influencing you without taking away your freedom of choice, “Suppose the thermostat in your home was programmed to tell you the cost per hour of lowering the temperature a few degrees during the heat wave.” Making costs visible definitely drives behaviour.

The authors have an interesting take on the problems of either saving too little or too much money. “The costs of saving too little are greater than the costs of saving too much.” Spending more is easy enough, but “coping in the opposite direction is less pleasant.” This argues for adding some buffer to your savings. Unfortunately, those who are already saving too much will embrace such advice, and those who are saving too little will ignore it.

Owning too much of one stock is very risky, but for some reason, we tend to be blind to the risk of holding stock in our employers. An alarming statistic: “five million Americans have more than 60 percent of their retirement savings in company stock.” This is reckless, but I can’t be too critical; my own percentage was higher during the late 1990s. I took an insane risk and came out okay.

On the subject of mortgage brokers, “after controlling for risk and other factors,” “Loans made by mortgage brokers are more expensive than those made by direct lenders by about $600.” This surprised me. I thought the selling point of mortgage brokers is that they can extract good deals from banks that more than make up for the broker’s fee. Apparently not.

The book has a few funny parts as well. In a discussion of alerting users to excess energy consumption, the authors suggest a device that makes “annoying sounds, such as cuts from ABBA’s Gold: Greatest Hits.” Another suggestion is to allow motorcycle users to ride without a helmet only if they have signed up to be organ donors.

Overall, I highly recommend this book. Whether you agree with their proposals or not, the book contains very thoughtful discussions of many areas where we might help people make better choices.