Friday, October 11, 2019

Short Takes: Student Bankruptcies, Early RRSP Withdrawals, and more

Here are my posts for the past two weeks:

The Latte Factor


Here are some short takes and some weekend reading:

Doug Hoyes and Ted Michalos make a strong case that students are being treated unfairly by preventing them from including their student loans in bankruptcies for 7 years after leaving school. In addition to their other good points, they explain why removing this rule wouldn’t allow students to have bankruptcies of convenience shortly after graduating. One troubling part of the information they bring forward is the fact that university tuition has been rising much faster than inflation for a very long time. What we need is an inquiry into why schooling is so expensive and what unnecessary costs can be stripped out. If they’re anything like any of our levels of government, universities have far too much office staff and administration that contribute little to necessary functions.

Jason Heath goes through some reasons for early RRSP withdrawals. He runs through some of the numbers to show there are situations where you’re better off not deferring RRSP withdrawals as long as possible.

Cross-Border Experts recommend that Canadians own U.S. properties through cross-border trusts to avoid expensive and time-consuming probate.

Steve Garganis says you can prevent someone from fraudulently getting a mortgage on your home by taking out a secured line of credit you have no intention of using. I’d be interested in the opinions of other experts on how effective this would be.

Robb Engen at Boomer and Echo argues that passive investing is not a bubble. He’s right about this, but it’s certainly possible for popular ETFs to contribute to a bubble in the same way that active investing can contribute to a bubble. It’s possible for a narrow ETF that becomes popular to cause a bubble in some asset class. However, narrow ETFs aren’t really passive investing. As a passive investor in broad index ETFs who buys and holds for the long run, I’m not worried about causing bubbles.

Big Cajun Man sees media confusion over the difference between debt and deficit. “Debt” is how much your life sucks. “Deficit” is how fast your life is getting worse.

Monday, October 7, 2019


Smart people who analyze different investment strategies often talk about correlations. Investments have correlations that are high, low, positive, or negative. This can all sound impressive, but as I’ll show, any conclusions we draw based on correlations can be suspect.

In the investment world, correlation is a measure of how asset returns move together. A positive correlation means two assets tend to give good returns together and bad returns together. A negative correlation means they tend to move in opposite directions. A zero correlation means the direction of one investment doesn’t tell you anything about the direction of the other investment.

It’s impossible to know the correlation of two investments exactly. All you can do is measure their correlation over a period of time. We then just assume the correlation will remain the same into the future.

To show the problem with this approach, I simulated two streams of monthly investment returns. The distributions I chose had zero correlation. Then I measured the rolling 10-year correlations of the two investments. Here are the results.

As we can see, the measured correlations aren’t particularly close to zero much of the time. The range was -11% to +24%. The fact that the correlations tended to be positive was just a coincidence; when I ran it a few more times, sometimes the correlations tended to be negative.

So, even though the correlation of the distributions I used was zero, the measured correlations from sequences of outputs varied considerably. So, analysts combing through investment returns could easily think the correlation between two investments is 20% when it is really zero.

Even more disturbing is that much mathematical analysis of investing assumes that returns follow the normal distribution (technically the lognormal distribution). However, there is strong evidence that the tails of return distributions follow power laws rather than the normal curve. This means that the standard deviation is infinite, and that correlations (in the way they are usually calculated) don’t exist.

These unsettling facts are the main reason why an analysis might calculate the optimum leverage for a portfolio to be 300%, when the real answer is more like 0% or 25%.

This doesn’t mean that any investment analysis that discusses correlations is automatically wrong. All mathematical analyses use models, and all models fail to match the real world in one way or another. The challenge is to figure out when the math gives the right answers and when it doesn’t.

Only a small minority of investors are comfortable using the math described in this article. However, among those who are comfortable with this math, only a small minority understand the errors in the models they use and how they cast doubt on their conclusions.

Tuesday, October 1, 2019

The Latte Factor

The first step to improving your finances is to spend less than you earn. But a great many people never seem to find the motivation to take this first step. The Latte Factor by David Bach and John David Mann aims to help readers find this motivation. It’s a short, easy read that many young people might find compelling.

The book is the story of a young woman whose finances are a disaster, and she gets some good advice from an unexpected source. Even without the financial lessons for readers, the story works well enough to keep the pages turning.

The first two of the book’s main messages are familiar to readers of financial advice: “Pay yourself first” and “Don’t budget—make it automatic.” The idea is that your savings should come off your pay first rather than waiting to see what’s left over after life’s expenses.

The final main message is “Live rich now.” The idea is to find a way to live the life you want now instead of waiting until some magical future time when you’ll have more money. It’s often the case that the things we truly want in life don’t cost too much money, and we can have them if we give up other things that are less important, like eating out and expensive coffee.

Some might think that this book is little more than a diatribe against expensive lattes. It isn’t. “It’s not about your coffee. The latte factor is a metaphor. It could be anything you spend extra money on that you could do happily without. Cigarettes. A candy bar. Fancy cocktails. Anything.”

One part of the book had me objecting initially. “When you rent, you are letting life happen to you. When you own, you take a hand in directing the events of your life.” With housing so expensive now relative to rents in many places, telling young people to extend themselves on a mortgage isn’t good advice. However, the philosophy of owning makes sense in other contexts such as cars and stocks.

Overall, I recommend this book for anyone whose finances are in poor shape and needs ideas for improving them. The lessons are described clearly, and the story form makes them easy to digest.

Friday, September 27, 2019

Short Takes: Canadian vs. U.S. ETFs, Real Estate, and more

Here are my posts for the past two weeks:

More Buyers than Sellers

STANDUP to the Financial Services Industry

Here are some short takes and some weekend reading:

Justin Bender looks at when it makes sense to own the all-in-one ETF VEQT and when it makes sense to hold two separate ETFs VCN and VT. I answered a similar question in a recent post, but was considering replacing VEQT with all 4 of its components.

Preet Banerjee has Ben Rabidoux back on his Mostly Money podcast for an update on Canadian real estate.

Ellen Roseman reboots her blog with the story of a broken Apple Watch.

Big Cajun Man looks at the financial part of a marriage preparation course.

Thursday, September 19, 2019

STANDUP to the Financial Services Industry

John J. De Goey doesn’t mince words in his book STANDUP to the Financial Services Industry. He says you should be “protecting yourself from well-intentioned but oblivious advisors.” In addition to pointing out the current problems with financial advice, he paints a picture of what it should be. He also offers an extensive list of questions to ask your financial advisor. Although parts of the book appear hastily written, the main message comes through loud and clear: we pay too much for advice that is often based on “facts” that have been proven untrue.

Critics of financial advisors often paint them as villains, but De Goey says “Advisors might be better seen as unwitting accomplice intermediaries between some sophisticated corporations and trusting Canadian consumers.” So, your advisor may not be a bad person, but he or she works for people who know Canadians are getting a raw deal.

While there is reasonable debate about the value of financial advice, there is little doubt that mutual fund managers add far less value than they cost. The mutual fund “manufacturers pretend to reliably add value, and the advisors pretend to be able to reliably identify the ones who do so.”

De Goey says that advisors who want to do a better job for their clients by using cheaper products get gagged. IIROC Rule 29.7 (1) f) says that advisors can’t publish material that “is detrimental to the interests of the public, the Corporation or its Dealer Members.” This rule is applied liberally to suppress publications that criticise expensive mutual funds.

The author sees parallels between the financial services industry and the tobacco industry decades ago. The message that tobacco is harmful was suppressed in ways similar to the way that criticism of expensive investments is suppressed today.

“Currently, many advisors and clients presume that high product cost is immaterial,” and “most clients don’t understand how or how much advisors are paid.”

Advisors cling to easily refuted narratives like “Embedded compensation doesn’t cause advisor bias,” “active management consistently adds value,” “I’m a good fund picker,” and “I’m a good market timer.” This makes them “card-carrying and founding members of the fictional Society of Cognitive Dissonance.”

There were quite a few parts of the book that were harder to parse than they should be. I’ll point out three mistakes that aren’t too hard to fix, but a few other parts were harder to follow.

“It is not four times as much work to deal with one $1 million client as it is to deal with four clients with $250,000 each.” One instance of “four” needs to go.

“Someone ought to run a test to see what advisors would recommend if they had to choose between active mutual funds that pay an embedded commission and passive funds that do not.” This is the status quo. He meant to test a new scenario where the commissions are attached to the passive products. The purpose was to show that although many advisors express a belief in active management, they actually just follow commissions.

“What percent of actively managed funds survive to celebrate a 10-year anniversary?” “See if you can get your advisor to hazard a guess. Most will say something like 15% or 20%. The actual number is closer to 40%.” This initial question should be what fraction of funds don’t make it to 10 years.

In one section, De Goey gives some quotes he’s heard from advisors. One quote is “They don’t have any debt except for a mortgage and some student loans.” His amusing reply: “I’m a vegan except for bacon-wrapped steak.”

In conclusion, this book gives a valuable insider view of what’s wrong in the financial services industry. I recommend it to anyone who has a financial advisor, and especially to financial advisors themselves.