Friday, January 18, 2019

Short Takes: John Bogle Leaves A Great Legacy

Here are my posts for the past two weeks:

The Ages of the Investor

Skating Where the Puck Was

Firing Male Brokers and Financial Advisors

Here are some short takes and some weekend reading:

John Bogle, who founded Vanguard and revolutionized retirement savings, dies at 89. It’s hard to overstate the profound impact Bogle had on investing for the little guy. Without him, it’s plausible that index investing would still be a niche area and would cost 1% or more per year. His idea was to create a mutual fund company owned by the funds themselves where employee bonuses are tied to how low the fund costs are compared to their competition. This drove costs way down to sensible levels. Personally, I save the cost of a few vacations per year because of Bogle.

Mastercard to stop letting companies automatically bill you after free trials. This sounds like a positive step. We’ll see how things go in the implementation.

The Blunt Bean Counter provides us a simple tool for organizing your estate and making it easier for your family and executors to pick up the pieces. I really wish some of my late family members had filled out a form like this.

Tom Bradley at Steadyhand couldn’t bring himself to pick some hot stocks in response to a media request. Instead he explains the benefits of rebalancing your portfolio by shifting from hot assets to colder ones. This is a better bet than chasing the latest hot investment.

Robb Engen at Boomer and Echo has an interesting story of potlatch ceremonies and suggests we modernize it to reduce the amount of useless stuff in our lives.

Canadian Couch Potato gives the 2018 returns for his various model portfolios. It wasn’t as bad as it seemed.

Wednesday, January 16, 2019

Firing Male Brokers and Financial Advisors

The article Consider Firing Your Male Broker by Investment Advisor Representative Blair duQuesnay in the New York Times has generated a firestorm of comments. Most readers didn’t like the obvious sexism, but I’m more concerned about the muddled reasoning.

The article says research shows women investors outperform men, and therefore, you should choose a female financial advisor or broker. This reasoning presupposes that financial advisors and brokers are focused on the performance of their clients’ portfolios. This is far from the truth.

Most financial advisors and brokers are salespeople who sell what their employers tell them to sell. Typically, they either don’t know or don’t care that what they’re selling isn’t good for their clients. The fact that so many advisors invest their own money the same way they invest their clients’ money shows they don’t have bad intentions.

Even those advisors and brokers who know they’re hurting their clients didn’t necessarily start out this way. But they started to figure out that what they’re told to sell isn’t helping their clients, and they either lived with this knowledge or eventually quit. Some of those who quit go on to get higher designations and work in different environments with more autonomy so they can do a better job for their clients. Unfortunately for investors, this type of advisor typically takes only higher net worth clients.

If a new rule outlawed all male financial advisors and brokers, after a few years of hiring and employee turnover, the typical female advisor would either not know or not care that what they’re selling isn’t good for their clients. Large financial institutions run their operations to get profitable behaviour from their employees whether they’re women or men.

We might then ask whether women should run the financial institutions. The filtering process for high-powered positions in big companies is much more severe than it is for becoming a financial advisor or broker. The only people who move high up on the corporate ladder are those willing to run the company profitably. This applies equally to male and female executives. Whether there is sexism or not during the climb up the corporate ladder, you can bet that those who reach the highest rungs are focused on profits.

In the end, this article isn’t helping investors choose a better advisor, and it isn’t shaping a better path forward for the financial industry. But if investors accept its message, it might help some female financial advisors and brokers meet their sales targets.

Monday, January 14, 2019

Skating Where the Puck Was

Diversifying your portfolio reduces volatility and improves compound average returns. Portfolio theorists dream of finding risky asset classes with low correlation to known risky asset classes. However, author William J. Bernstein argues that correlations between asset classes have been rising. He explains why this is so in his book Skating Where the Puck Was: The Correlation Game in a Flat World, the second book of his four part Investing for Adults series.

One of the side effects of rising correlations is that everything tends to crash at once. We are moving toward “a cohort of nearly identically behaving asset class drones.” “When everyone owns the same set of risky asset classes, the correlations among them will trend inevitably toward 1.0.”

Bernstein asks “Will things really get that bad?” The surprising answer is “We are, in fact, already there; further, it’s always been that bad. Yes, international REITs were a wonderful diversifying asset, but the ordinary globally oriented investor, and even most extraordinary ones, did not have access to them before 2000. Ditto commodities before 1990 or, for that matter, foreign stocks before 1975.” “Diversification opportunities available to ordinary investors were never as good as they appeared to be in hindsight.”

There is some good news, though. “Short-term and long-term risk are indeed two very different things.” Bernstein gives data showing that monthly returns show high correlation, but 5-year returns show much lower correlation. So, your asset classes tend to crash together, but if you wait long enough, their returns tend to drift apart and give some diversification benefit.

In the past, early investors in new asset classes benefited from diversification, but those who pile in later are “skating where the puck was.” It’s necessarily the case that as many investors buy into an asset class, its correlations with other asset classes rise.

My takeaway from this book is that I can’t avoid market crashes that affect most of my portfolio. I’m best off to live on safe liquid assets and wait out any market declines in the rest of my portfolio.

Thursday, January 10, 2019

The Ages of the Investor

Different stages of life call for different investing approaches and the need for transitioning from one stage to the next. William J. Bernstein addresses this challenge in his short book The Ages of the Investor: A Critical Look at Life-cycle Investing, the first book in his four part Investing for Adults series. His suggested method of transitioning toward retirement is very sudden.

Bernstein splits life-cycle investing into opening moves, middle game, and endgame. When you’re young, he suggests taking on as much risk as you can handle. Because this book is aimed at “investing adults,” he presumes the reader knows that stock picking and market timing are losing strategies. So, in this context, “risk” means compensated risk that comes with higher expected returns and comes mainly from stocks. Young investors are best off taking as much risk as they can handle without losing their nerve and selling out when stocks hit a difficult patch. “The young investor’s first encounter with a significant market decline serves mainly to ascertain her true risk tolerance.”

The book covers the life-cycle investing approach promoted by Ayres and Nalebuff that has young investors taking on 2:1 leverage using margin investing or call options on stock indexes. Bernstein lists some problems with this approach but leaves out the most serious problem: your ability to save in the future (and even to avoid withdrawing from savings) is highly risky. Losing your job during a stock market crash could completely wipe out leveraged savings.

An alternative to leverage is stock market investing using factor tilts. I tend to be skeptical that factor tilts will give future results that match past apparent success. Perhaps a slight tilt to small value stocks is sensible, but there is nothing wrong with an unleveraged position in low-cost stock indexes.

Because a mortgage is like a “negative bond,” it’s best to “Pay the damned thing off” rather than own bonds at the same time as holding a mortgage.

Bernstein portrays value averaging (VA) as an alternative to dollar-cost averaging (DCA) and describes VA as “a clever technique pioneered by Michael Edelson.” Value averaging doesn’t work. The main problems are 1) the return calculations supporting VA ignore opportunity costs of cash on the sidelines and interest on borrowed money, and 2) VA can lead to unsafe levels of leverage. I did some experiments to examine actual VA returns if we modify the strategy to eliminate these problems.

As you near retirement (the “endgame”), Bernstein suggests splitting your portfolio into two parts, a “liability matching portfolio” (LMP), and a “risk portfolio.” The idea is that the LMP contains completely safe assets that cover your basic needs for the rest of your life. The challenge is to create a LMP free from inflation risk, longevity risk, and counterparty risk (insurance company bankruptcy).

After examining several LMP approaches that all have risks, Bernstein chooses a ladder of inflation-protected bonds as the best option. This means Real-Return Bonds (RRBs) in Canada and Treasury Inflation-Protected Securities (TIPS) in the U.S. The challenge I see here is that we still have longevity risk. How many years of RRBs are safe?

During the middle game of your investing life “If, at any point, a bull market pushes your portfolio over the LMP “magic number” of 20 to 25 times your annual cash-flow needs beyond Social Security and pensions, you’ve won the investing game. Why keep playing? Start bailing.” The author calls for a sudden sell off of risky assets to buy the LMP. Then any new savings can be invested as riskily as you like.

This LMP idea would be more appealing if it handled longevity risk. How do I know that 20 to 25 times my annual spending needs is enough? If an investor bails out into a LMP in her 50s anticipating working to 65, but loses her job, the LMP is suddenly not enough for a longer retirement.

One side note most Canadians would agree with: the U.S. has “a dysfunctional health-care system and an inadequate safety net.”

On the subject of safe spending from a portfolio: “Below the age of 65, a 2% spending rate is bulletproof, 3% is probably safe, and 4% is taking chances. Above 5%, you’re taking an increasingly serious risk of dying poor. (For each five years above 65, add perhaps half a percentage point to those numbers.)”

It has become popular to plan for reduced spending throughout retirement. I’ve written many times about flaws in this idea. Bernstein takes this further by explaining why we might want to spend more in the future, even in inflation-adjusted terms. “Worker productivity, wages, and per capita GDP all grow at a real rate of about 2% per year. So will your expectations. Would you be happy with a 1960s standard of living? When everyone else has or will soon have an iPad, could you stand to live without one?”

Overall, I recommend this book for its critical thinking about life-cycle investing. However, I take issue with some of the specific recommendations.

Friday, January 4, 2019

Short Takes: All-in-one ETFs, Bankruptcy, and more

I managed only one post in the past two weeks:

Rational Expectations

Here are some short takes and some weekend reading:

Canadian Couch Potato reviews iShares’ new all-in-one ETF portfolios and compares them to similar ETFs from Vanguard.

Doug Hoyes makes sense of some Canadian debt statistics. One of his conclusions: “I fully expect our Homeowners’ Bankruptcy Index to rise, dramatically.”

Preet Banerjee interviews Melissa Leong, author of the new book Happy Go Money: Spend Smart, Save Right and Enjoy Life.

Big Cajun Man got into the spirit of the holidays with 12 days of Christmas debt.

Robb Engen at Boomer and Echo implores us to stop giving markets our attention.