Monday, November 23, 2020

The Capitalist Code

Ben Stein has an interesting short book called The Capitalist Code: It Can Save Your Life and Make You Very Rich.  He aims it mostly at young people as a combination of financial advice and a defense of capitalism.

The advice part of the book is essentially to save some money to invest in stocks as a way to hitch a ride on the incredible wealth generation capitalism provides.  He says that when “we hook up our lives to the mighty engine of capitalism,” we’re generating wealth to deal with the wide array of uncertainties in life.

On the subject of employment, Stein “will always advise working at one loves,” and “we might as well be prisoners as work in jobs we loathe.”  I agree with this to an extent, but we have to meet the world halfway.  If all the people who love painting landscapes tried to make a living at it, 99% would starve.  You have to choose among jobs that have some hope of paying enough money to live.

To those who might doubt the benefits of capitalism, Stein says “When your professors and your schoolmates tell you that capitalism as we see it in the United States of America right now is an evil exploitive system, they’re lying.  When they tell you that you’re being consistently ripped off by Wall Street, they’re lying and they’re hurting you.”

Stein points to Elizabeth Warren as an example of a professor who is wrong about capitalism.  I think the truth is somewhere between their points of view.  Capitalism works, but we can afford to carve out a small part of the wealth to protect the less fortunate.  The catch is deciding how much wealth to dedicate to the needy.  In my view, the U.S. is crazy to allow severe medical problems to bankrupt some of their citizens.  They also need to deal with some corporations that have become so large that their effects are anti-capitalistic.

Overall, this book is worth a read.  Stein gives solid advice for young people and offers an interesting defense of capitalism at a time when many are singing the praises of socialism.

Saturday, November 21, 2020

CPP Timing: A Case Study

There are many factors that can affect your decision on whether to take CPP at age 60 or 70 or somewhere in between.  Here I do a case study of my family’s CPP timing choice.

Both my wife and I are retired in our 50s and had periods of low CPP contributions because of child-rearing and several years of self-employment.  So, neither of us is in line for maximum CPP benefits.  If we both take CPP at age 60, our combined annual benefits will be $11,206 (based on inflation assumptions described below).  

The “standard” age to take CPP is 65.  If you take it early, your benefits are reduced by 0.6% for each month early.  This is a 36% reduction if you take CPP at 60.  If you wait past 65, your benefits increase by 0.7% for each month you wait.  This is a 42% increase if you wait until you’re 70.

However, there are other complications.  If you take CPP past age 60, any months of low CPP contributions between 60 and 65 count against you unless you can drop them out under a complex set of dropout rules.  If my wife and I take CPP past age 65, we won’t be able to use any dropouts for the months from 60 to 65, so we’ll get the largest benefits reduction possible for making no CPP contributions from 60 to 65.  Fortunately, CPP rules don’t penalize Canadians any further if they have no contributions from 65 to 70.

Another less well-known complication is that before you take CPP, your benefits rise based on wage inflation.  But after your CPP benefits start, the payments rise by inflation in the Consumer Price Index (CPI).  Over the long term, wage inflation has been higher than CPI inflation.  So, when you start taking CPP benefits, you lock in lower benefit inflation.

In this case study, I’ve assumed 2% CPI inflation and 3% wage inflation.  These assumptions along with the CPP rules and our contributions history led to our annual benefits of $11,206 if we take CPP at 60.

If we wait until we’re 70, our combined annual CPP benefits will be $29,901.  However, don’t compare this directly to the figure at age 60 because they are 10 years apart.  If we take CPP at 60, it will grow with CPI inflation for those 10 years.  The following table shows our annual CPP benefits in the two scenarios: early CPP at 60 and late CPP at 70.

Age    Early CPP    Late CPP              
Age    Early CPP    Late CPP
 60    $11,206   
 75    $15,081   $33,013
 61    $11,430   
 76    $15,383   $33,674
 62    $11,658   
 77    $15,690   $34,347
 63    $11,891   
 78    $16,004   $35,034
 64    $12,129   
 79    $16,324   $35,735
 65    $12,372   
 80    $16,651   $36,449
 66    $12,619   
 81    $16,984   $37,178
 67    $12,872   
 82    $17,324   $37,922
 68    $13,129   
 83    $17,670   $38,680
 69    $13,392   
 84    $18,023   $39,454
 70    $13,660   $29,901
 85    $18,384   $40,243
 71    $13,933   $30,499
 86    $18,752   $41,048
 72    $14,211   $31,109
 87    $19,127   $41,869
 73    $14,496   $31,731
 88    $19,509   $42,706
 74    $14,785   $32,366
 89    $19,899   $43,560

It would certainly feel good to start collecting CPP benefits when we’re 60, but by the time we’re 70, we’d never notice that our payments could have been 119% higher.  That’s why we plan to wait until we’re 70 for our CPP benefits.

A good question at this point is what we’ll do in our 60s without those payments.  We’ve already begun dipping into our RRSPs, and we’ll continue this through our 60s.  We’re happy to spend some of our savings early in exchange for much larger CPP benefits later.

To see why we’ll make this tradeoff, focus on our financial position at age 70.  The choice is to have either small CPP benefits and more savings or large CPP benefits and less savings.  The math says we’re better off with more guaranteed income indexed to inflation than we are to have more savings invested in risky assets.  In fact, when we do an analysis of how much we can safely spend, the decision to take CPP at 70 instead of 60 increases our safe spending level.  It seems counterintuitive, but we can spend more safely now in our 50s because of the decision to delay CPP to age 70.

You might wonder whether you could invest the smaller CPP payments in your 60s to do better than delaying CPP benefits.  In our case, if we live to 90, our investment return would have to beat CPI inflation by an average of 6.3% per year.  If we choose to manage our savings to make sure we have enough to make it all the way to 100 years old, the breakeven return rises to 7.4% above inflation.  There is no way we can be confident of such high investment returns, particularly because much of our assets would be in taxable accounts.  My planning assumption is that our stocks will beat inflation by 4% minus taxes and other costs.  It’s clear that delaying CPP to 70 is the better strategy.

What if the government changes the rules?  That’s certainly a possibility.  The government could choose to cap CPP benefits in the future, which would be bad for those who take CPP at 70.  The government could also bring in wealth taxes, which would be bad for those who take CPP at 60.  If the government ever becomes desperate enough to take away retiree benefits or charge wealth taxes on people who aren’t very rich, I suspect we’ll have much bigger problems than whether we took CPP at 60 or 70.

Although taking CPP at 70 is the right choice for us, there are some good reasons for others to take CPP early.  One reason is if you just don’t have enough savings to get through your 60s.  But, just not wanting to spend any savings isn’t a sound reason.  Another reason is if you’re in poor health and don’t expect to live long.  But just fearing you might die young isn’t a sound reason.  If you’re so sure you won’t make it to age 80 that you’d be willing to spend down all your savings before 80, then taking CPP at 60 is likely for you.  There are other narrow reasons to take CPP early that are mainly due to technical rules about taxes and certain government benefits.

The final conclusion is clear.  We’re better off delaying the start of CPP benefits despite the strong emotional reasons for taking them early.

Friday, November 20, 2020

Short Takes: MLM Cults, CPP Timing, and more

You might have noticed I’ve written quite a few book reviews lately.  The books I had on hold at the library were taking a long time to become available (maybe because of the pandemic), so I put more books on hold.  But then they started showing up in bunches.  I’m barely staying ahead of the return dates.  You can expect more reviews in the coming weeks as several of the books I have out now are about money.

Here are my posts for the past two weeks:

Bond Quiz

Value Averaging

Mom and Dad, We Need to Talk

Napkin Finance

Here are some short takes and some weekend reading:

Preet Banerjee
interviews Multi-Level Marketing “survivor” David Pride who needed 3 years of therapy to de-program his brain when he left.  I know there’s a cult aspect to many MLM schemes but had no idea it was this powerful.

Mark Burgess has a sensible take on when to start your CPP.  He also points out the conflict of interest financial advisors have when they advise on CPP timing.

Justin Bender explains the details of the new iShares sustainable investing ETFs in his latest video.

Boomer and Echo
says that health and dental insurance aren’t really insurance.  I agree.  Instead of capping benefits at $10,000 per year, real insurance would cover anything over $10,000. 

Big Cajun Man
got his credit card company to forgive the interest that came from accidentally paying late.

Wednesday, November 18, 2020

Napkin Finance

When it comes to money and finances, it seems like everything we learn is more complicated than we hoped.  The book Napkin Finance: Build Your Wealth in 30 Seconds or Less by Tina Hay offers very short overviews of a wide range of financial topics.  The format is appealing in some ways, but it’s an American book and much of the content isn’t relevant to Canadians.

The book covers a wide range of financial topics, including compound interest, credit, investing, college costs, retirement, taxes, GDP, and Bitcoin.  Each begins with the image of a napkin with drawings overviewing the subject.  Then there are a couple of pages with further explanations.  The format felt gimmicky at first, but it grew on me.  Before people can understand the many details and subtleties of an area, they want a quick understandable overview for context.

The book contains lots of humour to help hold readers interest.  One of my favourites was “A hedge fund is a fee structure in search of a strategy.”

In most cases, it’s obvious when subjects are only relevant in the U.S., such as discussions of 401(k)s, 529 plans, and Social Security.  However, when Hay calls advisor fees “moderate” and mutual fund fees “comparatively low,” it may not be obvious to some readers that she’s definitely not talking about Canada.

For the most part, the explanations are very good.  One part I particularly liked: “Investors waste a lot of energy (and money) trying to guess when a bull market is ending so they can sell, or guess when a bear market is ending, so they can buy.  The reality is, no one can predict those turning points consistently.  Most investors do a lot better by just holding on through bull and bear markets.”

One subject area explanation I didn’t think much of was “Risk vs. Reward.”  The pyramid from low risk to high risk includes savings accounts, bonds, stock, start-ups, and cryptocurrency.  With the risk-reward trade-off, reward refers to expected returns, not possible returns.  Stocks have higher expected returns than bonds.  However, when we get to cryptocurrencies, there’s no reason to believe that expected returns are higher than those for stocks.  It’s not sensible for investors to move from stocks to cryptocurrencies because they are willing to accept more risk in exchange for a higher expected return.

If we ever get a Canadian version of Napkin Finance, I’d likely recommend it to my readers.  However, this U.S. version could mislead readers looking for basic information about financial topics.

Monday, November 16, 2020

Mom and Dad, We Need to Talk

I wasn’t sure what to expect from Cameron Huddleston’s book Mom and Dad, We Need to Tak: How to Have Essential Conversations with Your Parents about Their Finances, but I was pleasantly surprised.  It’s well written and contains lots of practical advice about the steps we need to take to make it easier to help our parents as they age.  The book is U.S.-centric, so some of the more detailed advice is less useful to Canadians, but is still well worth a read.

A common theme throughout the book is that some steps with helping your parents need to begin long before they need help.  I’ve been in the position of rooting through a house full of papers trying to figure out what accounts there are and what bills need to be paid.  I can only imagine how much worse the experience would have been if I didn’t have a power of attorney document prepared in advance.

It’s tempting to decide that there’s no need to do anything right now because your parent or parents are fine.  However, when the time comes that they need help, you’ll need to know about their various accounts, and you’ll need to have power of attorney.  However, wills and power of attorney documents have to be set up while your parents are still competent.  As for their financial accounts, you’ll want them to at least tell you which banks and insurance companies you’ll need to contact.  The more information you have, the less you’ll need to play the role of “forensic accountant.”  In my case, I almost missed an account with about $40,000 in it.  Maybe there are others I did miss.  I’ll never know.

Huddleston covers many of the reasons your parents may resist talking about their finances with you.  They may consider money a taboo topic.  They may be worried about losing their independence and don’t want to think about aging and death.  They might be embarrassed about their finances, or they may think you’re just sniffing around for an inheritance.  The book covers a wide range of ways of moving forward despite resistance.

An interesting piece of advice is to make sure you and your siblings are on the same page before approaching your parents.  You won’t get very far with a discussion about finances or moving out of a house your parents can’t manage any more if your siblings are fighting you.

In one of the book's many examples, “Jason” used the 2008-2009 recession to broach the subject of finances with his mother.  He asked whether “she had been speaking to anyone about her retirement funds and if she had moved any of her holdings into a safe harbor type of situation to prevent any negative fallout from the market crash.”  This shows the importance of knowing what you’re talking about yourself before trying to help your parents.  Jason has bought into the myth that financial advisors can steer around market crashes.  He was advising his mother to sell out of stocks after they had already fallen to lock in her losses.

Another important subject for discussing with your parents is scams.  Huddleston gives a good list of red flags for scams including fees to collect winnings, calls from government agencies, emergency calls from grandkids, free lunches, and high-return investments with no risks.

Hudleston advises being careful about reverse mortgages because “deceptive marketing is common.”  The book contains no further information other than a reference to a Consumer Financial Protection Bureau (CFPB) document.  I found the following: “since January 2012 American Advisors Group’s advertisements misrepresented that consumers could not lose their home and that they would have the right to stay in their home for the rest of their lives. The company also falsely told potential customers that they would have no monthly payments and that with a reverse mortgage they would be able to pay off all debts. In fact, consumers with a reverse mortgage still have payments and can default and lose their home if they fail to comply with the loan terms. These terms require, among other things, paying property taxes, making homeowner’s insurance payments, and paying for property maintenance.”

Overall, I recommend this book to get useful information about making a very difficult time easier.  It’s hard to see your parents or other relatives decline with age, but the experience can be a whole lot worse without proper preparation.  Wills and powers of attorney need to be in place in advance.  Siblings need to come to agreement, and you and your parents need to make realistic plans about either aging in place or moving somewhere more manageable.