Short Takes: Empty Return Promises, Asset Allocation ETFs, and more

I came across yet another case of a furious investor whose advisor had promised a minimum return, but the portfolio lost money.  There is a lot wrong with this picture.  On the client side, they often believe that advisors have some meaningful level of control over returns and that advisors can somehow steer around bear markets, which is nonsense.  Advisors can choose a risk level.  The only way to guarantee a (low) return is to take little or no risk.  On the advisor side, I can only assume that many advisors are under so much pressure to land clients that they make promises they know they can’t keep unless they get lucky.  All the while, the management above these advisors know full well what is going on.

Here are my posts for the past four weeks:

Giving With a Warm Hand

The Case for Delaying OAS has Improved

Here are some short takes and some weekend reading:

Robb Engen at Boomer and Echo sings the praises of Vanguard Canada’s Asset Allocation ETFs.  Owning these ETFs is a great way to invest.  If only investors could focus on how many ETF units they own instead of the day-to-day price quote.

Squawkfox warns us about the downside of rewards programs.  “Canadians should be wary of loyalty programs — not enticed by them.”

New research shows that happiness increases for incomes up to $500,000 instead of only $75,000 as previously believed.  In this case, what I find interesting is how widespread the news of the $75,000 limit on happiness travelled.  Because most people make less than $75,000 per year, we tend to like the news that richer people aren’t happier, and news outlets make more money when they report news we like.  This is why I tend to be suspicious when a news story tells me something I’m happy to hear.

Justin Bender explains foreign withholding taxes on emerging markets ETFs.

The Case for Delaying OAS Payments has Improved

Canadians who collect Old Age Security (OAS) now get a 10% increase in benefits when they reach age 75.  The amount of the increase isn’t huge, but it’s better than nothing.  A side effect of this increase is that it makes delaying OAS benefits past age 65 a little more compelling.

The standard age for starting OAS benefits is 65, but you can delay them for up to 5 years in return for a 0.6% increase in benefits for each month you delay.  So, the maximum increase is 36% if you take OAS at 70.

A strategy some retirees use when it comes to the Canada Pension Plan (CPP) and OAS is to take them as early as possible and invest the money.  They hope to outperform the CPP and OAS increases they would get if they delayed starting their benefits.  In a previous post I looked at how well their investments would have to perform for this strategy to win.  Here I update the OAS analysis to take into account the 10% OAS increase at age 75.

This analysis is only relevant for those who have enough other income or savings to live on if they delay OAS.  Others with no significant savings and insufficient other income have little choice but to take OAS at 65.

OAS payments are indexed to price inflation, and the increases before you start collecting are also indexed to price inflation.  So, the returns that come from delaying OAS are “real” returns, meaning that they are above inflation.  An investment that earns a 5% real return when inflation is 3% has a nominal return of (1.05)(1.03)-1=8.15%.

In many ways, the OAS rules are much simpler than they are for CPP, but two things are more complex: the OAS clawback and OAS-linked benefits.  For those retirees fortunate enough to have high incomes, OAS is clawed back at the rate of 15% of income over a certain threshold.  This complicates the decision of when to take OAS.  Low-income retirees may be eligible for other benefits once they start collecting OAS.  These factors are outside the scope of my analysis here.

A One-Month Delay Example

Suppose you’re deciding whether to take OAS at age 65 or wait one more month.  For the one month delay, the OAS rules say you’d get an additional 0.6%.  So, for the cost of one missed payment, you’d get 0.6% more until you reach 75.  After that, you’d be getting 0.66% more.  

For a planning age of 100, the real return from this delay is a little over 7%.  So, your investments would have to average 7% plus inflation to keep up if you chose to take OAS right away and invest the money.

All the One-Month Delays

The following chart shows the real return of delaying OAS each month for a range of retirement planning ages, based on the assumption that the OAS clawback and delaying additional benefits don’t apply.  The returns are slightly higher than they were before CPP payments rose 10% at age 75.

The case for delaying OAS isn’t nearly as compelling as it is for delaying CPP.  However, those with a retirement planning age of 100 get real returns above 4% for delaying all the way to age 70.  I plan to wait until I’m 70 to take OAS.

For a retirement planning age of 90, delaying OAS to 68 or 69 makes sense.  However, those whose health is poor enough that they plan to age 80 or less should just take OAS at 65.

Giving with a Warm Hand

I expect to be leaving an inheritance to my sons, and I’d rather give them some of it while I’m alive instead of waiting until after both my wife and I have passed away.  As the expression goes, I’d like to give some of the money with a warm hand instead of a cold one.

I have no intention of sacrificing my own retirement happiness by giving away too much, but the roaring bull market since I retired in mid-2017 has made some giving possible.  Back then I thought stock prices were somewhat elevated, and I included a market decline in my investment projections to protect against adverse sequence-of-returns risk.

Happily for me, a large market decline never happened.  In fact, the markets kept roaring for the most part.  As it turned out, I could have retired a few years earlier.  A large market decline in the near future is still one of several possibilities, but the gap between our spending and the money available is now large enough that we are quite safe.  

Our lifestyle has ramped up a little over time, but not nearly as much as the stock market has risen.  We just aren’t interested in expensive toys.  Owning a second house or a third car just seems like extra work.  Our idea of fun travel is to go somewhere with nice hiking trails.

So, we have the capacity to help our sons with money, but there is another consideration: what is best for them?  I’m no expert in the negative effects of giving large sums of money to young people, but I’m thinking it makes sense to ease into giving.

This is where the new First Home Savings Account (FHSA) is convenient for us.  Our plan is to have our sons open FHSAs, and we’ll contribute the maximum over the next 5 years.  This will give them an extra tax refund each year, and if they choose to buy a house at some point, they can use the FHSA assets tax-free as part of their down payment.  If they don’t buy a house, they can just shift the FHSA contents into their RRSPs without using up any RRSP room.

This FHSA plan is just the beginning of a journey that I expect to enjoy a lot more than hoarding money I don’t need to be handed over after my death.  My sons will benefit more from getting some money now instead of waiting until they’re on the verge of retiring themselves.

Short Takes: Rental Real Estate, Example TFSA Uses, and more

I’ve lost count of the number of real estate agents and mortgage brokers in Canada and the U.S. who’ve told me that right now is a fantastic time to buy a rental property.  Usually, they don’t own any rental properties themselves and have no plans to buy one now, but they’re sure that it would be a great time for me to buy.

When I say that I’m not interested in using my capital to buy the part-time job of being a landlord, they tell me to hire a management company.  When I tell them I’ve heard from landlords that management companies soak up most or all of the profit from being a landlord, they usually give up on me.

I guess my message here is that I’ve found a fairly short path to ending an uninvited sales pitch about real estate.  You’re welcome.

Here are some short takes and some weekend reading:

Robb Engen shows that TFSAs can be very useful for smoothing out life’s financial bumps without creating a big tax bill.  This gives you time for the necessary next step of restoring TFSA savings.  RRSPs don’t work as well for this purpose.

Andrew Hallam has some news for people who think we’re living through especially bad times for our finances.

Morningstar says Canadians shouldn’t be in a hurry to buy a house.  The reasoning makes sense to me, but I find it hard to believe that these things can be predicted with any certainty.

Short Takes: Behavioural Economics, Monty Hall, and more

I find behavioural economics and other aspects of psychology interesting, but I often get lost between a study’s results and the conclusions people draw from these results.  A good example is the oft-repeated fact that most people believe they are above-average drivers.  I have no doubt that a large majority of people will consistently report that they are above-average drivers.  However, the tidy conclusion that these people are overconfident isn’t obvious to me.

There is no single measure of the quality of a driver.  Imagine two brothers where one believes that it is crucial to observe the speed limit at all times, and the other believes it is prudent to always stay up with the flow of traffic to minimize relative speeds.  These standards of driving skill are in conflict, and each brother judges the other to be a poor driver.  Each brother believes he is the better driver based in part on his view of what makes a driver good.

It may be that both brothers are overconfident as well, but we can’t necessarily draw this conclusion from the fact that each brother believes he is better than the other.  In the general case, it’s hard to say whether a high fraction of people think they are above-average drivers primarily because of differences in the standards they apply or primarily because of overconfidence.

This was just a single example, but I find such gaps come up often between a study’s results and the conclusion people draw from those results.

Here are some short takes and some weekend reading:

Annie Duke has a plausible explanation of why people can’t learn to get the Monty Hall problem right but pigeons can.

Andrew Hallam looks at the mutual fund with “the best performance record of all American mutual funds” and makes a surprising comparison.

Squawkfox helps you control your spending with ideas from behavioural science.

Justin Bender explains the two levels of foreign withholding taxes on dividends from international equity ETFs.