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.