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 clichés.

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.

Friday, April 28, 2017

Short Takes: Billionaire Spies, Flight Bump Compensation, and more

Here are my posts for the past two weeks:

The Stock Market Only Goes Up

Victory Lap Retirement

Here are some short takes and some weekend reading:

Preet Banerjee interviews investor, spy, billionaire, and holder of 11 honorary doctorates, Stephen Jarislowsky. As an added bonus, Preet uses his latest Drawing Conclusions video to show us what kind of income you need to be able to afford rents in various cities across Canada.

Million Dollar Journey looks into how much compensation you’re entitled to if you get bumped from a flight.

Canadian Couch Potato uses his latest podcast to answer questions about the role of bonds in today’s portfolios.

The Blunt Bean Counter reports from the tax-hell trenches about financial institutions sending incorrect capital gains reports to their clients.

Big Cajun Man reports on an unfortunate side-effect of the Federal Civil Service’s inability to pay its own workers properly. Workers are afraid to make any changes to their pay which means they’re avoiding automated charity donations.

Tuesday, April 25, 2017

Victory Lap Retirement

Mike Drak and Jonathan Chevreau argue that the traditional approach to retirement where you work full-time until some magic day where you fully stop working makes no sense. In their book Victory Lap Retirement, they say we should add another phase of life between full-time work and full-stop retirement where you work part-time doing something you find spiritually satisfying. Another strong theme of the book is trying to persuade readers to quit the job they’ve grown to hate.

Mixed in with the notion of a victory lap of part-time work is the idea of financial independence. It obviously takes some resources to be able to afford to quit full-time work. The authors suggest entering a victory lap after achieving financial independence, but their definition of this term differs from mine: “the point where your basic (non-discretionary) living expenses are covered by your passive (non-work) income.”

As a young adult, I lived very frugally. I know my wife and I could get by if we spent about half of what we spend now. That would be enough to cover our basic needs. But I don’t want to live that way. And I certainly didn’t consider myself financially independent when I had enough money to cover just basic needs for the rest of my life.

The working definition of financial independence that I use is having enough money to cover my current expenses (rising with inflation) until the end of a long life. This is quite different from only being able to cover basic expenses.

It seems far too easy for people who hate their jobs to use this definition of financial independence to justify quitting their jobs and entering their victory lap. Unfortunately, if they jump ship too early, this may be a victory lap spent scrambling to earn enough money to make life tolerable.

The authors encourage the reader to “Reduce your material needs and adopt a more frugal lifestyle.” This is great advice. However, don’t make the mistake of planning to be more frugal after you quit your job. The time to be frugal is during the entire time you’re working full-time. That way you’ll build more savings and make part-time work more realistic sooner. Failing that, at least live frugally for a few months before quitting your job to prove that you and your family can live on less.

In my opinion, the best part of the book is a short section called “The Trap.” It explains how you can start in an exciting job paying more than you need initially, and end up trapped in a job you grow to hate but can’t quit because you’ve become too dependent on a fat income. I’ve tried to explain this to young people to encourage them to save more money, but I’ve had little success. The authors do a much better job explaining this problem than I ever did.

The authors discuss many advantages of working longer including the claim that “Numerous studies have shown that mortality rates improve with an older retirement age.” However, every study of this type I’ve looked at has only shown correlation, not causation. It seems likely to me that sick people tend to retire younger or get laid off younger. That could be the entire explanation for why those who retire younger have poorer health outcomes. There may be no health advantage at all to working longer.

The authors offer seven “eternal truths” of financial independence. Six of these seven make a lot of sense. But “buy a home and pay it off as soon as possible” can end badly in Canadian real estate today. Prices in Vancouver and Toronto are sky-high and banks are willing to lend people more than 5 times their gross income. I’m not against home ownership, but the price has to be reasonable. Overstretching can leave you buried in debt for decades, and possibly lead to bankruptcy. If a home is too expensive, you are likely far better off renting a nice place and building long-term savings.

The authors write that once you own your home free and clear, “For the rest of your days, you’ll be able to live rent-free.” This is misleading. Homeowners pay for property taxes, upkeep, house insurance, and utilities. These can easily add up to nearly the cost of renting a house. Toss in the opportunity cost on the capital tied up in the house and renting can be a huge financial victory.

To be clear, I’m not against owning a home. I own a home. I do this because the extra cost is worth it to me, not because I’ve deluded myself that owning a home today is better financially than renting. There is no reason to believe that the huge real estate gains that baby boomers enjoyed over their lives will get replayed for millennials.

As further evidence that people should consider leaving the job they hate, the authors quote palliative care nurse Bronnie Ware, who explains that people on their deathbeds don’t wish they’d earned more money during their lives. However, I’ve had some relatives who have run out of money and wished they had more. It’s a terrible thing to outlive your money.

Before reading the book, I had assumed that both authors had reached financial independence (in the stronger sense of covering current spending levels indefinitely) before they left full-time work. However, Chevreau had “enough money in the bank to take an extended sabbatical ... and he was (and is) blessed by a wife who continued to work full-time. Mike’s situation was similar.”

I don’t want to be too critical here; this book contains a lot of useful information about how to have a happy retirement. But it also contains a strong element of “we did it and you can too.” It must be nice to be able to quit your job and follow your dreams while your spouse works. I’m not sure this qualifies the authors to encourage sole breadwinners to quit full-time work and trust that everything will turn out okay.

I think the notion of a victory lap has some merit, but make sure you’ll really be okay if your part-time income proves to be very modest. Not everyone does the type of work that lends itself to taking on a few clients part-time, and not everyone has a spouse continuing to work full-time. I think this book is worth a read, but be careful not to let your dream of a victory lap turn into a financial nightmare.

Friday, April 21, 2017

The Stock Market Only Goes Up

Here’s a chart of the S&P 500 total return for the past 8 years:

The only conclusion my lizard brain can draw is that the stock market only goes up. In Daniel Kahneman’s terms from his great book Thinking Fast and Slow (my review here), my brain’s “System 2” knows that the stock market may crash in the future, but my automatic “System 1” is sure the stock market will keep going up forever.

As my human capital dwindles, I get closer to the age where I should be shifting some of my portfolio into safer investments than stocks. I’ve done this by building up a cash reserve, but perhaps it’s not as big as it should be at this point. It’s very hard to shake the feeling that I’m losing out by not having this cash in stocks right now. My System 2 has determined that I should have some fixed-income investments just in case stocks begin a large drop. But my System 1 resisted hitting the sell button.

Younger investors have bigger concerns. Those who have been investing for 8 years or less can’t be certain they have the stomach for the risk level of their portfolios. A huge risk for investors is that they will lose their nerve in a market downturn and sell out near the worst possible time. It’s hard to know what you can handle unless you have lived through a crash of the type that we had in 2008-2009 and back when the dot-com bubble burst.

We can be sure that a market crash will come eventually, but I have no idea when it will arrive. It’s possible that today’s stock level is the lowest it will ever be in the future. It’s also possible that stocks will get cut in half from today’s level. Most likely, we’ll get something in between.

Don’t let your lizard brain blind you to the very real possibility that stock prices will drop significantly from today’s levels. Try to invest your money with a mindset somewhere between fear and euphoria.

Friday, April 14, 2017

Short Takes: Mortgage Rates and Credit Scores, Bond Confusion, and more

I was on vacation for most of the past two weeks and managed only one post about debt:

Managing Debt

Here are some short takes and some weekend reading:

Canadian Mortgage Trends explains recent changes to how your credit score affects your mortgage interest rate. It certainly makes sense to charge more when the risk of default is higher, but I’m not sure that credit scores are a very good measure or default risk. But maybe they’re the best we’ve got.

Canadian Couch Potato tries to clear up a common point of confusion about bonds: the fact that higher interest rates mean lower bond prices.

Where Does All My Money Go interviews Sandra Foster, an expert on personal finance and estate planning.

Big Cajun Man takes on the common misconception that a Tax-Free Savings Account can only hold cash like a regular savings account.

Boomer and Echo calls for an overhaul of the finance industry.

My Own Advisor considers the possibility of trying harder for financial independence and an earlier retirement.

Monday, April 3, 2017

Managing Debt

Debt is a big part of modern life. The high cost of university leads to student debt, and sky-high real estate has many Canadians in large mortgages. And that’s just the kinds of debt that most easily justified. Then we have the growing lines of credit and credit card balances that come from failing to save up for the cars, clothes, electronics, restaurant meals, and home upgrades we want.

Finance Blog Zone asked bloggers for their takes on how to manage debt. I read through them all and found 7 of them that caught my eye either because I found the ideas interesting or because I disagreed. Here’s my take on their takes.

Brave New Life

Brave New Life says “College debt and a home mortgage are the only two acceptable debts. Ever.” And for emphasis: “No debt for cars.” There may be narrow circumstances when other forms of debt make sense, but this is an excellent starting position. Too often when I try to tell people that borrowing for a car is a bad idea, their reaction is “that’s great, but is it better to get a car loan or a lease?”

Andrew Hallam

Instead of the usual boring debt advice, Andrew Hallam does a great job of stirring emotions. “Declare war against [debt],” “Crush the debt with the smallest outstanding balance” to “frighten your other debts,” and “Then go after your next smallest debt and ruthlessly obliterate it.” He even suggests taping the carcasses to a cupboard for inspiration. Reading this almost made me wish I had a debt to kill.

Fitz Villafuerte

Fitz says “Focus on how to make more money, rather than wasting time in worrying about how to pay your debt.” Unfortunately, for people with debt-building personalities, earning more money just leads to ever-higher spending and more debt. For those with very low incomes, earning more money can be the right answer. But too many people blame their overspending on their supposedly inadequate incomes. There’s nothing wrong with trying to earn more money, but examining spending is necessary.

Celebrating Financial Freedom

Dr. Jason Cabler attacks the mindset of seeing debt as inevitable: “too many people believe that debt is just a normal part of life, but it doesn’t have to be.” Getting too comfortable with debt is a bad idea. It’s better to see debt-freeness as the normal life state.

Bert Martinez

“Money is an emotion. Debt is an emotion too. How you feel is more important than what you know.” I don’t know what this means or how it can help someone. It’s true that there are a lot of emotions tied up in money and debt, but that doesn’t help me understand Bert’s advice.

J. Money

J. Money says debt problems can be the result of habits. “The best thing that got my money straight was taking a 40 day ‘no spend’ challenge.” This changed his habits and “I didn’t realize how often I’d go shopping when I was bored!” This is some practical advice for people to try instead of just telling them to stop overspending.

Leslie O’Connor

“Don’t look at debt as ‘the enemy’ or ‘a disease’. It is just one small factor in your overall, long-term financial growth.” This works for people who handle their finances well. But for those with debt problems, telling them it’s not a big deal is terrible advice. Andrew Hallam’s advice to declare war is a much better idea.

To close, I’ll stick with something I wrote once before: Debt is a crushing burden that weighs down people’s lives and dreams.

Friday, March 31, 2017

Short Takes: Car Loans, Big Spenders, and more

Here are my posts for the past two weeks:

Pension Rip-off

Tangerine Credit Card Changes

The Undoing Project

Here are some short takes and some weekend reading:

Preet Banerjee reports that “car loans have quietly emerged as one of the major risks to Canadians’ household finances.” He goes on to give a practical example of how to get off the treadmill of car debt.

Kurt Rosentreter has some entertaining tough words for high-income people living it up. Apparently, he deals with a lot of boomers with big incomes who handle their money as badly as anyone else.

Finance Blog Zone has a long list of bloggers discussing how to manage debt (including yours truly). Seven of them caught my eye either because I found the ideas interesting or because I disagreed. I may write about the details next week.

Tom Bradley at Steadyhand tells you who your best friend is when you’re worried about the markets.

The Blunt Bean Counter explains the budget’s measures aimed at professionals who use work-in-progress deductions and use private corporations.

Canadian Couch Potato takes a look at some new mutual funds from TD that hold broadly diversified index ETFs in percentages that change based on active investment decisions. While this is interesting news, I’ll stick with indexing that includes as little human discretion as I can achieve.

Robb Engen explains why he doesn’t invest in non-registered accounts. The dominant reason most people avoid non-registered accounts is that they never use up all their TFSA and RRSP room. In some cases, people have investments that aren’t allowed in TFSAs and RRSPs. In other cases, people have income too low to bother with an RRSP, but somehow managed to fill their TFSA. A commonly used reason is the desire to take advantage of the dividend tax credit. However, in most cases, this is misguided and people would be better off using their TFSA.

Big Cajun Man applauds rule changes that make it easier to apply for the disability tax credit.

My Own Advisor interviews Sean Cooper, author of Burn Your Mortgage.

Million Dollar Journey discusses how to deal with big banks trying to sell you products you don’t need and refusing to help you index your portfolio to reduce MER costs. He observes that if his “friend can reduce his portfolio drag from 2% to 1%, it can lead to a 30% larger portfolio after 30 years.” I assume this is just using the estimate of 1% for 30 years adding up to 30%. The actual increase is 35% taking into account compounding effects.

Wednesday, March 29, 2017

Pension Rip-off

A friend of mine who is collecting a defined-benefit pension had a complaint I’d never heard before. He is convinced he’s being ripped off because his pension benefits only go up by inflation each year, but the plan’s assets go up faster than inflation. I know this isn’t right, but it took a while to think of a good way to explain why.

Let’s start with the analogy of a mortgage. Suppose you have a 5-year mortgage with an annual interest rate of 3%. Even though your unpaid balance is supposed to go up by 3% each year, your payments stay the same for the full 5 years. Does this mean the bank is getting ripped off? Not likely. Banks know a thing or two about coming out ahead.

The truth is that your flat monthly mortgage payments are calculated to take into account the 3% interest on the declining mortgage balance. If your payments increased by 3% each year, your starting payment would be a lot lower. But banks are smart enough to know that they shouldn’t expect you to be able to keep up with ever-rising payments.

The situation with pension benefits is similar. Suppose the value of your pension starting at age 55 is $1 million. Based on an assumed 4.1% real return, mortality tables from the Society of Actuaries, and ignoring any coordination with CPP, your CPI-indexed pension benefit would be $5363/month. However, if you wanted your benefits to rise by 4.1% above inflation each year, your starting benefits for a $1 million pension would be only $3010/month.

But why would anyone want such rising benefits? By age 95, the benefits would be worth nearly 5 times more after factoring in inflation. This makes little sense. It’s better to receive more now instead of getting ever more money into old age.

The short answer to the question of whether my friend is getting ripped off is no, he isn’t. The 4.1% real return earned by the pension assets are what allow him to get a higher starting pension amount.

Monday, March 27, 2017

Tangerine Credit Card Changes

Following quickly on the heels of adding new account fees, Tangerine is now making some less than friendly changes to their credit card.

The most important change to me is that they are increasing the foreign exchange fee from 1.5% to 2.5%. So, using this credit card is going to cost me more when I travel, primarily in the U.S.

The change that’s likely to annoy more customers is reducing credit-card rewards. Currently, certain categories of transactions get 2% cash back and the rest get 1%. The rest will now get only 0.5%.

Of course, we’d all be better off if there was no such thing as credit-card rewards and retailers were charged less to accept credit card payments. But I’m not holding my breath.

A slew of other fees that affect those who handle credit poorly are going up as well.

I still find Tangerine products to be better than most of what I can get at the big banks, but future fee increases could change that.

Wednesday, March 22, 2017

The Undoing Project

People make certain systematic errors in their judgments. We’d like to think this is only true of others, but it’s true of us as well. Even brilliant people who are experts in their fields make certain types of predictable mistakes. Michael Lewis’s book The Undoing Project traces the lives and work of Daniel Kahneman and Amos Tversky whose joint work “created the field of behavioral economics.” This book gives an interesting account of the two men’s lives and a gives fascinating insight into their results.

With most examples of the types of judgment mistakes people tend to make, I had to admit that I’m susceptible to the same mistakes. I’d like to think that understanding these tendencies will help me avoid some future mistakes, but I’m not sure it will help as much as I hope. The current “powerful trend to mistrust human intuition and defer to algorithms” is sensible.

Most of the time, the automatic judgments our brains make work very well for us. But when they don’t work well, it’s hard to stop making mistakes. It’s easier to understand this problem when it’s our eyes that make the mistake. Consider the Müller-Lyer optical illusion.

The two horizontal lines are the same length, but the bottom one looks shorter. After we measure and convince ourselves that they’re the same length, our eyes continue to tell us the bottom line is shorter. We can’t turn off the automatic wrong answer our eyes give. So it is with certain types of judgments our brains make. A key insight by Kahnemen and Tversky was that people “weren’t just making random mistakes ... they were doing something systematically wrong.”

An example of a common mistake comes from the “Linda story.”
“Linda is 31 years old, single, outspoken and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations.”
The question Kahneman and Tversky asked was “which of the following alternatives is more probable?”
“Linda is a bank teller.
Linda is a bank teller and is active in the feminist movement.”
85% of subjects chose the second option, even though logic dictates that it can’t be more likely than the first option because the second is a subset of the first. Even when they changed the question to make it clear that the first option doesn’t mean that Linda is “NOT active in the feminist movement,” subjects still favoured the second option. Graduate students with training in logic and statistics made this mistake. Even doctors made this type of mistake.

The book also contains plenty of the humour we’ve come to expect from Michael Lewis. Tversky was once told by an English statistician that “I don’t usually like Jews but I like you.” His reply was “I usually like Englishmen, but I don’t like you.”

Another example came from the way Tversky didn’t worry about the many demands for his time: “The nice thing about things that are urgent is that if you wait long enough they aren’t urgent anymore.”

In an odd definition of “winning,” Tversky’s wife once had to take her eldest son to an emergency room because “He had won a contest with his brother to see who could stick a cucumber farther up his own nose.”

Asked “if their work fit into the new and growing field of artificial intelligence,” Tversky replied “We study natural stupidity instead of artificial intelligence.”

Kahneman and Tversky faced a lot of opposition from economists. One economist’s paper opened with “The agent of economic theory is rational, selfish, and his tastes do not change.” That may make it easier to build theory, but it doesn’t sound much like actual people. But economists clung to this view that people were rational even in the face of mounting evidence from Kahneman and Tversky.

In this battle over whether people are rational, Kahneman and Tversky even reached back to a paper written in 1738 by Daniel Bernoulli (English translation here). Bernoulli offered a model of financial decision-making that we now call utility theory. He believed that people should treat a doubling of one’s net worth as just as good as halving it is bad, even though the dollar amounts won and lost are different.

Tversky wrote that “Bernoulli sought to account a bit better than simple calculations of expected value for how people actually behaved.” I’ve read the translation and I see no evidence this is true. My reading of Bernoulli’s paper was that he sought to model rational choices, not the irrational choices people actually make. I went into more detail on this subject a few years ago.

In explaining Bernoulli’s theory, Lewis writes “The marginal value of the dollars you give up to buy fire insurance on your house is less than the marginal value of the dollars you lose if your house burns down—which is why even though insurance is, strictly speaking, a stupid bet, you buy it.”

Just because fire insurance on a house has a negative expectation, it isn’t a “stupid bet.” I don’t know if this misunderstanding is just Lewis’ or if it is Kahneman and Tversky’s as well. It is irrational to accept a 50/50 bet to either double your net worth plus a dollar or lose everything, even though it has a positive expectation of 50 cents. Bernoulli’s theory isn’t a perfect model of rational decision-making, but it is far better than simple expectation.

All that said, Kahneman and Tversky’s prospect theory is an excellent model of how people actually make decisions, which is clearly different from a purely rational method.

Overall, I found this book up to Lewis’ usual high standard. It gives very accessible insight into Kahneman and Tversky’s work and gives interesting accounts of their lives and collaboration. Anyone who enjoys this book should consider reading Kahneman’s Thinking Fast and Slow.

Friday, March 17, 2017

Short Takes: Honest Fund Disclosure, Juicing Returns, and more

Here are my posts for the past two weeks:

Recognition Points Update

Tangerine Adds Some New Fees

Retirement Spending Plan Question

Balance Transfer Offer

The Case for Delaying CPP and OAS to Age 70

Here are some short takes and some weekend reading:

Jason Zweig brings us the best mutual fund disclosure ever. Brutal honesty can be hilarious.

Larry Swedroe explains how mutual fund families use IPOs to juice the returns of new funds. He also shows how they shift returns from one fund to another with front-running: “A large fund family with a small-cap fund has the small-cap fund buy shares of stocks with a low market cap and limited liquidity. Other funds in the same family then pile in, buying more shares. The limited supply of stock allows the large fund family to drive up prices with relatively small purchases by each fund. The returns of the new fund then look great.”

Canadian Couch Potato uses his latest podcast to explain why active share have little predictive power for fund returns and takes a shot at Gordon Pape’s poor investment advice.

The Reformed Broker points out that U.S. household wealth grew by a staggering $40 trillion during Obama’s presidency. That’s quite a jump considering how his political enemies have had some success painting his financial impact as a negative. Of course, presidents have only a limited impact on the growth of wealth, even if they tend to get the credit or blame.

Retire Happy has a very clear explanation of the difference between a TFSA beneficiary and a TFSA successor holder. It pays to understand this difference.

Tim Cestnick describes an interesting trick to decide after the federal budget is announced whether to realize capital gains at the 50% inclusion rate that existed before the budget.

Squawkfox reports that 39% of Canadians don’t understand the benefits of paying more than the minimum credit card payment. She uses her engaging style to explain the benefits of paying more than the minimum.

Big Cajun Man has some tax tips including the fact that CRA offers auto-fill now. I was skeptical at first, but I’ve heard from others that it works well.

Boomer and Echo explain why a 4-minute portfolio is tough to beat.

My Own Advisor updates his progress on his 2017 financial goals. I really like his first goal: “Do not to incur any new debt.” He says this goal goes without saying, but it’s an important reminder for his readers. It only goes without saying for those who’ve already figured out how bad debt can be. More naive readers might find this goal enlightening.

The Blunt Bean Counter explains the tax consequences of borrowing from or lending to your small business.

Million Dollar Journey updates us on Frugal Trader’s progress to building enough portfolio income to make his family financially independent.

Wednesday, March 15, 2017

The Case for Delaying CPP and OAS to Age 70

There are good reasons why some people start collecting CPP and OAS benefits as early as possible. However, many people start collecting CPP and OAS early for emotional reasons that don’t hold up under scrutiny. The main reason to delay benefits until age 70 is simple enough: most of us need to plan for the possibility of a long life.

Let’s start with some basics about CPP and OAS payments. Old Age Security (OAS) can start anywhere from age 65 to 70. Most Canadians at age 65 are eligible for the maximum pension (currently $578.53/month and rising with inflation). However, waiting until age 70 gives the payments a 36% boost (0.6% for each month of delay). A 70-year old just starting OAS today would get $786.80/month.

Canada Pension Plan (CPP) benefits are more complex to calculate. Doug Runchey has a great description of how to calculate your CPP pension. The biggest CPP retirement pension a 65-year old can collect today is $1114.17/month, rising with inflation. However, the average is $644.35/month. Whatever amount you’re entitled to, you’re allowed to start payments as early as age 60 or as late as age 70. The penalty for starting at age 60 is a 36% reduction, and the benefit for waiting from 65 to 70 is a 42% boost. So, the maximum payment at age 60 is $713.07/month, and the maximum starting at age 70 is $1582.12/month. That’s quite a big difference.

One technicality about CPP is that delaying benefits from age 60 to 65 can reduce your calculated pension a little if you’re not working past age 60 because you’ll have more years with no CPP contributions. (There is a special “dropout” that allows you to not count the years from 65 to 70.) So, depending on your exact circumstances, the dramatic difference between CPP at age 60 and at age 70 can be a little smaller than I showed, but it doesn’t affect the rest of the discussion much.

There are some good reasons to start collecting CPP and OAS as soon as possible. If you have much lower than normal life expectancy for any reason, it makes sense to collect some money while you’re still alive. If you have no savings and you plan to live only on just the total of your pensions (including the lower CPP and OAS payments that come from taking them early), then it makes no sense to delay CPP and OAS.

Suppose you have a normal life expectancy and have at least enough savings to be able to make it to age 70 without collecting CPP or OAS. This means that if you calculate the boosted payments you’ll get from CPP and OAS at age 70, your savings will cover withdrawals of at least this amount for the years from when you retire until you’re 70. So, you have a real choice: take CPP and OAS sooner or later?

There are some strong emotional reasons to take CPP and OAS sooner. One is that we discount the future too much. Another is that we sometimes use the fact that CPP is available at age 60 to justify retiring at 60, whether we have enough savings or not. Yet another is that it’s psychologically hard to spend down one’s savings, and as Frederick Vettese explained, you’ll have to do that faster if you delay CPP and OAS.

I’ve heard people try to justify taking CPP at age 60 saying that they want to have some money to spend while they’re still young enough to enjoy it. However, they could just spend more from their savings to achieve this. If delaying CPP and OAS to age 70 has a net benefit, then doing so will allow you to spend a little more during your early years of retirement than if you took CPP and OAS as early as possible.

We only need to consider one dominant fact to see that delaying CPP and OAS is a big win: you might live a long life. The scenario that puts the most strain on your finances is living a long time. If your financial plan works for a long life, then you won’t have financial trouble if you don’t live so long.

If you do live a long time, you’ll get the most value from CPP and OAS if you wait until age 70 to get larger payments. Knowing that you’ll be better covered after age 85 with big CPP and OAS payments makes it possible to spend more early on. The problem with longevity risk is that we are forced to plan for living to 95 even if we expect to only live to 85. The great thing about large CPP and OAS payments is that they keep growing with inflation as long as you live. This eliminates part of your longevity risk.

If you live a long life, the math overwhelmingly supports taking CPP and OAS at age 70. Doing so makes it possible to spend more in your 60s than you could do safely if you take CPP and OAS early. But what if you don’t live long? You’re still better off delaying CPP and OAS. You don’t know in advance that you won’t live long, so you’re still forced to plan for the possibility of a long life.

You may see some analyses with detailed calculations to decide when to take CPP and OAS. These often use normal life expectancy to make the choice. These analyses just aren’t relevant to most of us because we have to plan for the possibility of a long life. An exception is if you’re wealthy enough that you plan to under-spend your assets and longevity risk matters little.

In many financial decisions, the truth is in the numbers, but only when you get all the facts right. If you get a fact wrong, such as not planning for the possibility of a long life, the math gives you an answer that is exactly wrong. It pays to think clearly about the gift of high CPP and OAS payments you can get by waiting until you’re 70 to collect.

Monday, March 13, 2017

Balance Transfer Offer

I have a credit card that I don’t use much any more because I get more cash back on another card. I recently got an offer related to my little-used card by paper mail:

“Save on interest - pay only 0.99% on balance transfers” “for up to 12 months”

I normally just throw away junk like this, but I decided to scan the page. Toward the bottom, my eye caught the following line:

“A fee of 3% of the balance amount you are transferring applies.”

Just how dumb are they hoping I am? This looks like at least 3.99% interest annually to me. More likely, they’re hoping to reach the inattentive and desperate.

I decided to read the 25 lines of fine print on the back. In addition to the usual stuff about how they’d jack up my interest rate if miss my payments, I saw the following:

“Please refer to sections 10, 11, 12, 13 and 14 in your Cardholder Agreement for details on calculation of interest and the application of payments.”

There just has to be a story behind something this cagey. After reading more than just the sections referenced, I think I have the story. After I make a balance transfer from another credit card, suppose I make a normal purchase on this credit card. It turns out that the balance transfer is treated like a cash advance. If I make a payment, the payment goes against interest first, then the balance transfer, and new purchases last. So, until I pay off the entire balance transfer, interest at a high rate accumulates on any new purchases.

So, if you choose to make a balance transfer, be sure to put your credit card in a cool, dry place and don’t use it until the balance transfer is completely paid off.

No matter how bad your financial situation gets, there’s always someone there to profit from dragging you down further.

Thursday, March 9, 2017

Retirement Spending Plan Question

Reader P.H. asked me a challenging question about drawing down TFSAs, RRSPs, and non-registered accounts during retirement. Here is a lightly-edited version of the question:

Over the RRSP season I had the same conversation with both my father and father in law about RRSP withdrawals. It was over which account they should tap first, their RRSP or non-registered (everyone agreed to leave TFSA until they end and to max it out forever.)

I understood that non-registered accounts should be used up first and then RRSP so that you pay less in investment taxes over time. They think they should draw out RRSP money first or even draw extra money they don’t need immediately and invest it in non-registered account so they pay less income tax over time. I tried to explain that they would have more money if they waited, but both were concerned about the 50% income tax their estate/heirs would have to pay when they died.

After some back of the envelope calculations I think we are both right. I think they would have more money for themselves to use if they did RRSP last, but they could leave a larger inheritance if they took out extra withdrawals and invested it in a non-registered account.

So, my conclusion to them was that if they wanted to make the most out of their money for their own use then leave it in the RRSP, but if they plan to leave an inheritance then they can take extra out earlier.

Does this make sense?

Love the blog.

First off, I’m glad you enjoy the blog.

I’ve thought a lot about this type of question, and I don’t claim to have a definitive answer that covers all situations. I’m not even completely sure about my own situation yet.

In all the simulations I’ve done, going with the order non-registered, RRSP/RRIF, and finally TFSA has been either optimal or not too far off optimal. But I don’t claim to have looked at all possible financial situations people find themselves in during retirement.

There are so many variables involved, including the amounts you have in each type of account, other income you have, your year-to-year cash flow needs, and whether you are married. Other important factors that you can’t know are how long you and your spouse will live and what future changes the government will make to the tax system.

A change that seems likely at some point is to take into account TFSAs when giving out government benefits. I don’t think Canadians would be too pleased to see people with massive TFSAs collect GIS and other government money intended for low-income seniors.

A strategy I’ve read in a few places is to “top up” your current tax bracket. For example, in Ontario, the marginal tax rate on income below $42,201 is 20.05%. If your income is a little below this level, this strategy would have you withdraw enough from your RRSP/RRIF to top up this bracket. If you’re going to withdraw early from your RRSP/RRIF, then this makes some sense, but it doesn’t answer the question of whether you should be making such withdrawals early at all.

The father and father-in-law in P.H.’s question both focus on the large tax bill from their RRSP/RRIFs when they die. This is understandable, but may not give the correct conclusion. It’s often the case that you can withdraw RRSP/RRIF funds at a lower tax rate today than you’ll pay later on with a huge withdrawal at death.

But comparing tax rates isn’t the only thing you should consider. There is value in deferring taxes on investment gains as long as possible. Let’s consider an example to illustrate this point.

John is 65 and is currently in a 30% marginal tax bracket. He is considering withdrawing $5000 from his RRSP, even though he doesn’t need the money today. His TFSA contribution room is fully used, and so the $3500 remaining after tax would be invested in a non-registered account.

Suppose that John will live to age 90 and earn pre-tax investment returns of 7% per year. If the money stayed in his RRSP, it would grow to $27,137. Assuming John lives in Ontario and would be pushed into the top marginal rate at death, his heirs would get $12,610 resulting from the original $5000.

In the non-registered account option, suppose that yearly taxes would reduce the growth rate to about 6% per year. Further, he would pay capital gains taxes at death. The final amount going to John’s heirs works out to $11,938. In this example, John was slightly better off leaving the money in the RRSP.

In reality, the calculation would be more complex than this because a higher RRSP balance would actually lead to larger RRIF withdrawals each year. So, the $5000 would not actually stay in the account until John dies. Also, if John had any TFSA room available to hold part of an RRSP withdrawal, the comparison changes.

As for P.H.’s split conclusion about one strategy being better for the retiree and the other better for the heirs, I suspect this just because heirs benefit when retirees spend less. A true comparison comes when we hold retiree spending constant. Keep in mind that forced RRIF withdrawals do not have to be spent; they can be saved in either a TFSA or non-registered account. So, spending the RRSP/RRIF last doesn’t mean the higher forced RRIF withdrawals must be spent.

This whole area can get quite complex. For myself, I’m going with the idea that I don’t have to get the best answer, just a good one. My core plan is to spend non-registered money first, RRSPs second, and TFSAs last unless I get new information. However, I can see the logic of making early RRSP withdrawals if I can get the money out close to tax-free in a year where my income is very low, particularly if I have TFSA room to hold some of the withdrawal.