Friday, January 31, 2014

Short Takes: Youth Football, Diversification Still Works, and more

I had a full week of posts:

Treating Your Entire Portfolio like a RRIF in Retirement

A Portfolio with 3 Different Returns

Stocks for the Long Run

Retirement Spending Experiment

You can follow me on Twitter now (@MJonMoney). Here are some short takes and some weekend reading:

The Atlantic has a very thoughtful (and likely controversial) take on youth football. The money in professional football blinds us to the damage young men do to themselves seeking a slice of the pie. Some of the same concerns carry over to youth hockey and basketball, both of which are more violent (and physically damaging) than they were when I was young.

Canadian Couch Potato has a very interesting way of showing that diversification works, despite what some say.

Andrew Hallam shows that some major RBC actively-managed mutual funds don’t fare well when their 10-year returns are compared to benchmarks.

Big Cajun Man says that if you haven’t started saving for retirement by the time you have your first colonoscopy, it’s probably too late. Thanks for that :-)

My Own Advisor says you really do need a million dollars to retire well.

Million Dollar Journey has the story of a 34-year old who crossed the million-dollar mark.

Thursday, January 30, 2014

Retirement Spending Experiment

I decided to run an experiment to test a retirement spending strategy (described here) on actual stock returns over the past 100 years. The goal of the experiment is to see how well the spending strategy balances the need for stable income against the need to adapt spending to portfolio gains and losses.

Along with the retirement spending strategy, I gave a spreadsheet to calculate the yearly spending amounts. My experiments used the default values in the spreadsheet (a 4% real return on an all-stock portfolio, low investment costs, target longevity of 100, and 5 years of spending kept in safe investments, among other assumptions).

I used inflation-adjusted stock returns in the U.S. from 1913 to the present to simulate seventy 30-year portfolios for an investor retiring at age 60. The spreadsheet calculations set yearly retirement spending for a 60-year old at 4.17% of total retirement savings. This percentage rises to 9.74% by age 89.

I chose a starting portfolio value so that monthly spending starts at $5000. After that, the execution of the spending strategy and investment returns dictate how spending changes over time. In addition to the spreadsheet percentages, I used some filtering. Each year, the spending level changes by only 30% of the change dictated by the spreadsheet percentages. So, if spending is scheduled to drop from $5000 to $4900, I only drop it to $4970. This smoothes out the short-term bumps.

You can think of this experiment having 70 different people all retiring at age 60, but in different years from 1913 to 1982. Each retiree has a different experience due to different investment returns. Here are the experimental results:

U.S. stocks have averaged more than 4% returns above inflation, which is the reason for the general upward trend in the monthly spending. The worst case scenario had spending drop to $2766 per month. I thought this might be related to the 1929 stock crash and the depression, but it isn’t. The worst case scenario began with the 60-year old retiree in 1966. By the time this retiree hit age 76 in 1982, spending had dropped by 45%.

It turns out that the 5 years of spending held in safe investments is what saved the investor who retired just before the 1929 crash. This retiree weathered the storm reasonably well before the huge stock rebounds in 1933 and 1935.

The best results came for the 1942 retiree. By age 90, this retiree saw spending more than quadruple. It would probably be more desirable for this retiree to spend more earlier on, but we can’t know when the stock market will give such great riches.

Overall, I’m pleased with these results. There seems to be a good balance between safety and the desire to be able to spend as much as possible. I can’t say that I’m prepared to follow this strategy myself yet; I doubt that I’ll make a final decision until the time comes to actually retire.

Wednesday, January 29, 2014

Stocks for the Long Run

Jeremy Siegel’s book Stocks for the Long Run is in its fifth edition and has so much fascinating information for investors that keeping this review to a reasonable length is a challenge. A major theme running throughout the book is how different stocks look in a long-term view versus a short-term view. Despite Siegel’s deep analysis, this book is very accessible for readers with an interest in investing.

In the Foreword, Peter Bernstein asserts that “stocks must remain ‘the best investment for all those seeking steady, long-term gains’ or our system will come to an end, and with a bang, not a whimper.” Early in the first chapter, Siegel shows a remarkable chart of U.S. asset class returns adjusted for inflation over 210 years. A dollar in stocks grew to over $700,000 from 1802 to 2012 (even after subtracting out inflation). In contrast, bonds grew to only $1800 and gold to a measly $4.52.

The swings in stocks feel large when you live through them, but on a 210-year chart, stock gains look steady and relentless. “Since World War II ... the longest it has ever taken an investor to recover an original investment in the stock market (including reinvested dividends) was the five-year, eight-month period from August 2000 through April 2006.”

The conventional wisdom is that stocks are riskier than bonds. This is true in the short-term, but Siegel shows that for holding periods of 20 years or longer, real stock returns have been less volatile than bond returns! And unlike bonds, “stocks have never given investors a negative real return over a 20-year horizon.”

It’s normal for risks to steady out somewhat over time, but this happens for stocks faster than random chance would predict “because of the mean reversion of equity returns.” In contrast, bond returns steady our more slowly than random chance predicts, which means that bonds show “mean aversion.” So, over long holding periods, stocks offer higher expected returns and lower volatility than bonds, which makes a strong case for owning stocks.

For the rest of this review, I’ll discuss some of the many interesting parts of the book.

On geographic diversification

“Some argue that the increased correlation between the world’s stock markets reduces or even eliminates the incentive to diversify one’s portfolio.” However, “correlations are usually calculated over relatively short periods of time,” and long-term correlations are “significantly lower.” If you’re more interested in the state of your portfolio in a couple of decades than next month or next year, geographic diversification looks valuable.

Retirement age

“Who will produce the goods and services that the [longer-living] retirees will consume”? “If the developed world must rely solely on its own population to produce these goods, then the age that people will be able to retire must increase significantly.”

How can stocks rise faster than the economy?

“The reason that total return grows faster than stock wealth is because investors consume most of the dividends paid by stocks.”

Stock returns of other countries

Some say that the rise of the U.S. to dominate the world is the reason for the impressive history of U.S. stock returns, and that we cannot expect the same in the future for the U.S. or most other countries. In fact, since 1900, U.S. real stock returns have trailed those of Australia and South Africa. There are a total of 12 countries with over a century of real returns over 4% per year, and the world average is over 5% per year.

Efficient frontiers

If you don’t care about expected returns and just want to choose an asset allocation between stocks and bonds that minimizes risk, the result depends greatly on the holding period you consider. For 1-year returns, you get the lowest risk with 13% in stocks. However, for 30-year returns you get the lowest risk with 68% stocks.

Biased P/E ratios

“The traditional way of calculating the P/E of an index or a portfolio is by adding the earnings of each firm in the index and dividing this sum into the total market value of the index.” When some firms report large losses, we can get a “very distorted view of the index’s valuation.” Stock prices can’t go below zero. “Losses in one firm do not cancel the profits of another firm. Equity holders have unique rights to the profits of firms, unsullied by the losses in others.” So, beware of P/E measures of the entire stock market.

Value premium

With charts of stock prices from 1957 to 2012 broken out by quintiles of P/E ratio levels, Siegel shows the existence of a value premium for stocks. However, John Bogle found no evidence for a value premium when looking at returns from 1948 to 2008. Could the slightly different measurement periods be the explanation for the difference of opinion, or is there something else to this?

Investing based on economic growth

“There is a negative correlation between economic growth and stock returns, and this finding extends not only to those countries in the developed world but also to those in the developing world.” The chart showing poor returns in China is striking.

Inflation protection with stocks

“Since stocks are claims on the earnings of real assets—assets whose value is intrinsically related to the price of the goods and services they produce—one should expect that their long-term returns will not be harmed by inflation.”

Republicans vs. Democrats

“The stock market has actually done better under Democrats than Republicans.”

Technical analysis (charting)

A quote from Benjamin Graham: “A moment’s thought will show that there can be no such thing as a scientific prediction of economic events under human control. The very ‘dependability’ of such a prediction will cause human actions which will invalidate it. Hence, thoughtful chartists admit that continued success is dependent upon keeping the successful method known to only a few people.”

The January effect

It’s well known that for some reason, small-cap stocks have performed amazingly well in January for many decades. “Perhaps all the publicity about the January effect has motivated investors and traders to take advantage of this calendar anomaly, since the effect has largely disappeared since 1994.”

Berkshire Hathaway

Berkshire has beaten the S&P 500 by an average of “more than 10 percentage points per year” from 1972 to 2012. “The probability that this return was achieved by chance is less than one in a billion.”

Hindsight bias

Selective memory causes us to regret not acting on past hunches. “Hindsight plays tricks in our minds. We forget the doubts we had when we made the decision not to buy. Hindsight can distort our past experiences and affect our judgment, encouraging us to play hunches and try to outsmart other investors.”


This book has remarkably few typos. One small error occurs in an example of futures markets on page 277 where the figure 1410 should be 1710.


This book is very clearly written and offers powerful evidence for the advantages of investing in stocks. I highly recommend it to investors.

Tuesday, January 28, 2014

A Portfolio with 3 Different Returns

The Canadian Securities Administrators (CSA) are making changes to reporting rules on client portfolio statements. Among the changes is the requirement to report clients’ yearly returns in dollar-weighted terms (also called the internal rate of return (IRR)). This gives clients a better idea of how their portfolios have performed, but opens the door to the amusing possibility of multiple return values.

For an accessible explanation of the difference between time-weighted and dollar-weighted returns, see Neil Jensen’s excellent article. More mathematically-inclined readers can see Wikipedia’s internal rate of return (IRR) page.

Dollar-weighted returns are a great idea because they give more weight to the returns you get when you have more money invested. After all, the return you get on a few dollars is much less important than the return you get on millions. However, dollar-weighted returns can have some mathematical quirks in rare circumstances. One of those rare quirks is that there can be more than one correct return value.

Here is the most plausible scenario that I could concoct that gives multiple returns:

Start of year portfolio value: $200,000.

Mar. 1: Portfolio jumps to $303,000. Client withdraws $300,000.

May 1: Client withdraws $2000.

July 1: Client withdraws $1000.

Nov. 1: Client deposits $301,000.

End of year: A poor final two months leaves a portfolio value of $198,000.

If you add up the cash flows into and out of the account, you’ll see that a 0% return fits the data. However, a return of 10% every 2 months also fits the data. Even stranger is that a return of -10% every two months fits the data as well!

Compounding these returns to a full year, the client statement could show -46.9%, 0%, or +77.2%. No one of these returns is any more correct than the others.

On a practical level, this isn’t a big problem. When the return is ambiguous, it means that the cash flows were so unusual that the return isn’t very meaningful anyway. And we could just make up a simple rule about which return to show, or when to show no return at all.

Monday, January 27, 2014

Treating Your Entire Portfolio like a RRIF in Retirement

Tax rules for RRIFs require you to withdraw a percentage each year that depends on your age. One thought for choosing how much to spend from your entire portfolio in retirement is to use the same table of RRIF percentages.  This idea makes sense to me, but I chose to work out my own percentages.

A while back I proposed a possible retirement income strategy where you set aside a fixed number of years of spending somewhere safe (like a high-interest savings account (HISA)) and invest the rest of your savings with the same portfolio allocations you had before retirement. The strategy calls for using your current portfolio balance to choose a spending level.

To determine the amount you can spend, you would assume a fixed investment return and calculate the yearly spending level that would deplete the portfolio by some fixed age. Then if your portfolio either gets higher or lower returns than expected, your spending level would increase or decrease. The HISA savings serve to smooth spending levels somewhat. Further smoothing of spending could be done with some filtering.

If we just focus on yearly spending amounts rather than trying to adapt monthly, what we end up with is a table of spending percentages similar to the RRIF percentages. I created a spreadsheet to calculate the yearly spending percentages as well as the percentage of savings that would be held in a HISA. To edit this spreadsheet, you need to go to the “File” menu and “Make a copy”.

Spreadsheet Inputs

The inputs in the spreadsheet are highlighted in yellow. You need to choose an asset allocation (excluding the HISA) and the expected real return for each asset class. “Real return” means the return after subtracting out inflation. Beware of choosing high returns; the higher they are, the greater the risk of your portfolio returns coming up short and leaving you spending too much early on in retirement.

Another very important input is the fees you pay for owning each asset class. I’ve listed 0.12% for stocks because I pay 0.11% in MERs and another 0.01% in commissions and spreads each year. However, few investors have a portfolio with such low costs.

Other inputs are the real return of the HISA, number of years of spending saved in the HISA, your target life expectancy, and your minimum expected remaining life. This last input only starts to affect spending levels late in life. If your target life expectancy is 100, but set the minimum remaining life to 10 years, then spending percentages will stop rising at age 90 in an effort to preserve capital.

Spreadsheet Results

The results appear down the left side of the spreadsheet. It shows, for each age, what percentage of the total savings should be in the HISA, and what percentage of the total savings (including the HISA) you can spend each year. Although, the table starts at age 18, the most useful part begins further down the left side at more realistic retirement ages.

The idea is that at the start of each year you would shift portfolio assets into the HISA to match the target percentage. Then you’d withdraw the target spending amount from the HISA during the rest of the year. You might want to add some filtering to the spending levels to avoid sudden changes from one year to the next, but such filtering is not included in the spreadsheet.

It might seem that this spending strategy has you spending more money later in retirement because the percentages rise with age. The idea is that if your portfolio’s return exactly matches expectations, your total savings will drop (due to your spending) by exactly the right amount to keep your yearly spending the same from one year to the next.

If you try to use such a retirement spending strategy, it’s important not to double-dip. If you are spending dividends or interest from your portfolio, that counts as part of the spending allocation for the year. If you are spending forced RRIF withdrawals, the RRIF assets count as part of your portfolio and the withdrawals count as spending. Don’t forget that you may not actually be able to spend all your withdrawals because of income taxes.

This retirement spending strategy can be conservative or aggressive depending on the inputs you choose. The default inputs have a 65-year old spending 4.43% of savings during the year. However, if we reduce the target life expectancy from 100 to 85, drop the years of HISA savings to 3, and increase real stock return to 6%, that percentage jumps to 7.37%. If, instead, we extend life expectancy to 110, increase HISA years of savings to 10, and drop real stock returns to 3%, the spending percentage for a 65-year old drops to 3.14%.

I can’t tell you what spreadsheet inputs give a good balance between safety and living a decent life in retirement. This will depend on your ability to adjust your lifestyle, your other income streams from CPP, pensions, or annuities, and other factors. As always, you can’t follow anything here blindly; think for yourself.

Friday, January 24, 2014

Short Takes: Cult of Home Ownership, Mutual Fund Fee Battles, and more

For those who haven’t noticed, you can now follow me on Twitter (@MJonMoney). I had a full week of posts:

How to Rack Up a $7000 Tax Bill on Excess TFSA Contributions

Evaluating My 2013 Economic Predictions

Liar’s Poker

Long-Term TFSA Penalties

Last week’s post on the financial side of replacing old toilets got a mention in Carrick on Money.

Here are some short takes and some weekend reading:

Rob Carrick says that more young people are abandoning the cult of home ownership.

Boomer and Echo take on the Investment Funds Institute of Canada (IFIC) over mutual fund fees.

Tom Bradley at Steadyhand looks at the reasons why ETFs have not been taking off as fast as he thought they would, despite the fact that “for the most part ETFs are a better option than high-cost mutual funds that do little more than shadow the index.”

SquawkFox says that her drive to fill her RRSP has less to do with rational judgement and more to do with fear of cat food.

Canadian Capitalist updated his analysis of currency-neutral S&P 500 index funds. As I explained in a past post, I don’t believe that currency hedging truly produces a currency-neutral fund because fluctuations in the U.S. dollar don’t fully carry over to fluctuations in the value of U.S. companies. A so-called currency-neutral S&P 500 fund is actually a peculiar mix of owning large-cap U.S. stocks along with a partial side bet on the Canadian dollar advancing relative to the U.S. dollar.

The Blunt Bean Counter discusses property you may not have thought about for your will: reproductive assets such as sperm and ova.

Preet Banerjee’s new book Stop Over-Thinking Your Money is now available in dead-tree format as well as a number of digital formats. I think he’s written a great financial book for the masses.

Big Cajun Man runs down the RDSP (Registered Disability Savings Plan) offerings at the big banks.

My Own Advisor lists his financial goals for 2014. The last one warms my heart: “Do not incur any new debt in the process.” More people need to add this to their list of goals.

Thursday, January 23, 2014

Long-Term TFSA Penalties

It’s possible for a combination of TFSA over-contributions and investment losses to lead to tax penalties that go on for years. Here I give the most plausible scenario I can think of that produces tax penalties that grow to six figures.

Our fictitious hero, Kevin, just got an inheritance, and he’s got big investment plans. He just got a hot tip on a gold-mining company where a friend of a friend works. If this tip pans out, he’ll be set for life.

But Kevin doesn’t want to have to pay any capital gains taxes. He’s never had a TFSA before, but he knows that the gains in a TFSA can be withdrawn tax-free. As of 2014, Kevin has $31,000 worth of TFSA room available, but this is nowhere near enough to shelter his inheritance of a little over five times that amount.

Kevin misunderstands the TFSA limit rules and thinks they are similar to the $100,000 limit on CDIC protection on bank account deposits where you can just spread your money to different banks. So Kevin goes out and opens five TFSA accounts at five different discount brokers, and he deposits $31,000 into each one. Each deposit on its own is allowed, but the TFSA limit applies to all his TFSAs together. So, Kevin doesn’t realize that he’s made a $124,000 over-contribution.

As of January 2014, the 1% per month over-contribution penalty begins. Not realizing the train-wreck that awaits him, Kevin uses all of his TFSA deposits to buy shares in the gold-mining company. He’s ready to watch the riches roll in.

By June, the stock hasn’t done much, but some questions start to surface about the company’s gold claims. The stock starts to drop, but Kevin hangs on. By December the worst has been confirmed: this is a full-on Bre-X (except that nobody falls out of a helicopter). The stock has dropped by over 99%, and Kevin only has a total of $1000 worth of stock left in his 5 accounts.

Just when Kevin thought things couldn’t be worse, his so-called friend explains the TFSA rules and points out that Kevin’s over-contribution of $124,000 creates a tax penalty of 1% per month for a total of $14,880 for 2014. (Everyone knows that if it weren’t for messengers, nothing bad would ever happen).

Once he understands the TFSA tax penalty, Kevin immediately sells all is stock and withdraws the contents of all the TFSAs. His TFSAs are now completely empty, but that doesn’t stop the bleeding. He still has an over-contribution of $123,000.

In January of 2015, Kevin gets another $5500 in TFSA room which leaves his over-contribution at $117,500. But the TFSAs are empty. He can’t make a withdrawal, and his 2015 tax penalty comes to $14,100.

In fact, assuming 2% per year inflation that increases TFSA room over the years, Kevin won’t build up enough TFSA room to eliminate the over-contribution until 2033! The total tax penalty over the years adds up to $152,040. This is just slightly less than the $154,000 that he lost on the gold-mining stock.

I’d like to think that cooler heads would prevail, and CRA would waive all penalties from 2015 on. But it would be better if there were some explicit rule in place to prevent over-contribution penalties when TFSA contents are empty.

Wednesday, January 22, 2014

Liar’s Poker

Michael Lewis’s classic book Liar’s Poker is much more like a novel about life at Salomon Brothers than a finance book. However, along with the compelling story and the humour, he manages to mix in some financial lessons. The overriding lesson is how little regard Wall Street firms have for their customers.

Summing up the attitude towards customers is “if it was a good deal, the bankers kept it for themselves; if it was a bad deal, they’d try to sell it to their customers.” To encourage one group of bond traders to sell more, they were blasted from a loudspeaker: “C’mon, people, we’re not selling truth!”

Salomon made a lot of money from mortgage trading at a time when sleepy thrift banks were transforming. At one point, the typical thrift manager “became America’s biggest bond trader. He was also America’s worst bond trader. He was the market’s fool.”

Success wasn’t necessarily glamorous. One very successful analyst was so hounded day and night for his opinions that “he regularly nipped into a bathroom stall during midday lulls and slept on the toilet.”

One exchange shines a humourous light on ethics: “‘I thought you spoke French,’ he said. ‘No, that was just on my résumé,’ I said.”

One financial lesson I learned was the purpose of splitting a collection of mortgages into tranches. In the early days of mortgage bonds, they were hard to sell because potential buyers didn’t like the uncertain maturities; homeowners sometimes pay off their mortgages early. The idea with tranches is that all payments initially go only to the first tranche investors. “Not until the first tranche holders were entirely paid off did the second tranche investors receive any payments.” Finally, the third tranche gets paid. “One could say with some degree of certainty that the maturity of the first tranche would be no more than five years, that the maturity of the second tranche would fall somewhere between seven and fifteen years, and that the third tranche would be between fifteen and thirty years.” More certainty lead to more buyers.

If you enjoy novels and like reading about money, Liar’s Poker is a great combination.

Tuesday, January 21, 2014

Evaluating My 2013 Economic Predictions

To start the year I made some random economic predictions that I have no confidence in myself. Let’s see how well I pin the tail on the donkey.

1. Interest rates will go up a little.

Fail. The Bank of Canada target rate stayed at 1% for yet another year.

Score: -1

2. Housing prices will come down a little.

Fail. According to the Teranet - National Bank Composite House Price Index, house prices in Canada rose an average of 3.81%.

Score: -1

3. Canadian and U.S. stock markets will have an above average year.

Success. Libra Investments have a spreadsheet of historical investment returns. This year’s return of 13% on the TSX composite is above the 10.8% average since 1970. The U.S. S&P 500 was up 29.6% including dividends (measured in U.S. dollars).

Score: +1

4. Bonds will have a below average year.

Success. The Libra Investments spreadsheet says that Canadian bonds dropped 1.2%, clearly a below-average year.

Score: +1

5. The 2013 U.S. government deficit will be less than the 2012 deficit.

Success. The U.S. government 2013 deficit was $680 billion, substantially less than $1.1 trillion for 2012. This was known to be a very likely outcome, though. I’ll only take a tiny bit of credit on this one.

Score: +0.01

6. Berkshire Hathaway will have a strong year.

Success. Berkshire A-class shares went from US$134,060 to US$177,900, an increase of 32.7%, which is higher than the S&P 500’s increase of 32.3%.

Score: +1

Total Score: +1.01 (out of a possible range of -6 to +6)

So, my overall score is a little above middling this year. I made no concentrated bets on these predictions. You shouldn’t have either.

With a little luck, I could just as easily have made a bunch of predictions that all turned out to be right. But these would have been just as worthless as the predictions I did make because you can’t know in advance if I’m going to be right or not. If I do get my predictions all right one year, I’d have to find a way to leverage publicity quickly before my next year’s predictions prove to be half wrong.

The important lesson here is to avoid paying attention to others’ predictions. It’s normal to be swayed by confident people, but it’s important to remember that their predictions are usually just random.

Monday, January 20, 2014

How to Rack Up a $7000 Tax Bill on Excess TFSA Contributions

There is a scary scenario that can arise with TFSA over-contributions where you can’t stop tax penalties from building up for an entire year. It involves a situation where your TFSA investments lose money. I’ve hunted through the Income Tax Act for a clause that deals with this case, but found none.

The scenario is best explained with a fictitious example. Ted was a big fan of Apple. When TFSAs first came on the scene, he made the maximum $5000 contribution in March of 2009 and put it all in Apple stock. Each January since then (including 2014), he has made a maximum contribution and bought Apple stock. His account now holds C$68,400 worth of stock.

Ted’s success with Apple gave him the confidence to try his hand at more active trading. He decided to open a TFSA at a different discount brokerage offering better active trader tools. He then withdrew his money from the first account and deposited it into his new account.

At this point, readers knowledgeable about TFSAs will realize that Ted has made a TFSA over-contribution of $68,400. However, Ted didn’t know this. Now he begins picking some stocks and buying shares. For the first few days, he doesn’t trade much, but his pace starts to quicken. He isn’t too bad at picking stocks, but commissions and spreads are eating him alive.

By the end of March 2014, some bad luck leaves Ted’s account balance at $8400, a loss of $60,000! Then Ted gets some bad news: he has been carrying a TFSA over-contribution of $68,400 for 3 months. The 1% tax each month will cost Ted $2052. But this is just the beginning of his troubles.

Ted immediately withdraws the remaining accounts assets ($8400). However, this still leaves an over-contribution of $60,000. But the account is empty. Ted has no other TFSAs to withdraw from to solve this problem. All he can do is wait for new TFSA contribution room next year to reduce his over-contribution.  The remaining 9 months of 2014 cost him 9% of $60,000, or $5400. In January 2015, his over-contribution disappears.  The total penalty is $7452.

It could be that CRA would use its discretion to waive penalties in such a case. And it could be that discount brokerages have safeguards to prevent people from making such a large over-contribution. But the fact remains that under the TFSA rules as I’ve read them, you can accrue taxes on over-contributions even when your TFSAs are all empty.

Friday, January 17, 2014

Short Takes: ISPs Manipulating Data Caps, Death of Long-Term Thinking, and more

Support for my Friday Short Takes feature is stronger than I thought. Several people came forward to comment on the blog or send me email asking that I keep it going. And it wasn’t just the various bloggers whose posts I comment on! So, Short Takes live to see another day.

I had a full week of posts:

2013 Update of My Personal Portfolio Returns History

Currency Exposure is Partly an Illusion

Crashing Another Stock-Picking Contest

Literally Flushing Money Away

Here are some short takes and some weekend reading:

Michael Geist explains how internet service providers are boosting revenues by manipulating data caps to create a two-tiered internet that favours certain content.

Morgan Housel at the Motley Fool wrote a very funny obituary for long-term thinking. Despite my past annoyance with The Motley Fool, I think Housel’s piece is great.

Preet Banerjee interviews Bruce Sellery about his new RRSP book. Sellery is a very energetic guy.

Canadian Couch Potato explains how a falling Canadian dollar affects ETFs of U.S. stocks. Many investors get confused by this.

Boomer and Echo explain the right way to think about how your investments are performing.

The Blunt Bean Counter is tired of the cold and discusses the business and income tax aspects of golf.

Big Cajun Man says now that CPP and EI deductions have begun again, he’s making plans for what to do with the extra income when the deductions stop part-way through the year.

My Own Advisor expects to increase his dividend income from $7600 in 2013 to $9000 in 2014.

Thursday, January 16, 2014

Literally Flushing Money Away

How much money can you save replacing an old high-flow toilet with modern low-flow toilets? My house is old enough that we still have toilets that use about 13 liters per flush1 instead of the modern standard of 6 liters or less.

(I bet some readers landed here hoping to catch me using “literally” incorrectly. Maybe they have caught me. I’m literally flushing away something I have to pay for (water), but I’m not literally flushing coins or bills. It’s an important debate to have while I’m somewhere else.)

New dual-flush toilets use either 6 liters or 3.8 liters per flush depending on whether it is a big or small flush. This makes the water savings either 7 liters or 9.2 liters per flush. In my limited experience, low-flow toilets need more second flushes than my old toilets require. Combining this with the fact that small flushes are more frequent, I’ll call the savings an average of 8 liters per flush.

For my 4-person family, I estimate that we flush about 20 times per day on weekends and holidays (116 days per year), and about 12 times per day for the remaining 249 days per year. At 8 liters per flush, the savings add up to 42,464 liters or about 42 cubic meters per year.

With the exciting sewer surcharge of over 100%, I pay $3.25 per cubic meter of water. So my estimated savings on 42 cubic meters is $136.50 per year. Given the uncertainties in the water-saving estimates, we should probably say that the savings are between $100 and $200 per year.

The cost for me to replace 3 toilets is probably about $1000 for the toilets and the inevitable extra parts or replacement of a broken tool. Oh yeah, and I have to include whatever value I place on my labour for this type of work.

Overall, the payback time is in the 7-15 year range. That’s not fast enough to get me excited. I’d have to believe that the cost of water will rise faster than inflation, which seems likely. Another motivator is doing my part to protect our environment. It will take a burst of enthusiasm to overcome my natural laziness on this one.

1 Trying to find out how much water my toilets flush took a little while. They have no convenient markings of liters or gallons per flush. So, I was reduced to the ancient volume trick of length X width X height. The tank length and width were easy (46 cm X 16 cm). I had to actually watch a flush to see how far the water dropped (16 cm). But when the tank hit its low point, the bowl was still filling. So I had to estimate the volume of water to refill part of the bowl (20 cm X 16 cm X 6 cm). Then subtracting an estimate of the volume of stuff (technical term) in the tank, and using 1000 cubic cm per liter gave an estimate of 13 liters per flush. That’ll make you think twice about reading future footnotes.

Wednesday, January 15, 2014

Crashing Another Stock-Picking Contest

I like to crash stock-picking contests by entering the returns of my personal portfolio. I include all of my stock investments – no cherry-picking. Last year I showed how I had well above-average results in each of 4 years of contests among one group of bloggers. However, this isn’t much of a reflection on me because my portfolio is mostly indexed; it’s the collective results of the other bloggers that was sub-par.

A commenter on my post last year (Robb at Boomer and Echo) observed that if I had entered a different 2012 stock-picking contest run by Financial Uproar, I would have come in last place. In fact, the average results were 20.7% ahead of my real-money portfolio. I decided to take a peek again this year to see if they have more magic.

For 2013, Financial Uproar’s stock-pickers got an average return of 21.6%. However, my real-money return for 2013 was 26.7%. So, we have a mean reversion of 4.1%1. I’m in fifth place out of 14 entries. This still doesn’t come close to making up for last year’s results, but we’ll see what happens in future years if they keep up with their contest.

1 It might seem that this should be 5.1%, but the right way to compute the compound difference is (1+0.216)/(1+0.267)-1=-4.1%.

Tuesday, January 14, 2014

Currency Exposure is Partly an Illusion

When Canadians own U.S. assets, they usually think they are exposed to U.S. dollar fluctuations. This is only partly true. Our tendency to think of dollars as an absolute measure of value muddies the water.

Let’s choose a very simple fictitious example to help illustrate these ideas. Sandy bought 100 shares of a U.S. stock ETF trading at US$100 per share at the start of a year when the Canadian and U.S. dollars were at parity. So, her investment started out with a value of C$10,000.

By the end of the year, the ETF shares rose in value to US$120, and the U.S. dollar finished the year worth C$1.10. Sandy’s 100 shares are now worth US$12,000, or C$13,200. We would normally say that the ETF rose 20%, and Sandy made an extra 10% on the U.S. dollar for a total (compounded) return of 32% when measured in Canadian dollars.

Based on this example, it appears that Sandy’s investment had full exposure to the relative value of U.S. and Canadian dollars, but this isn’t the case. Her real exposure is only partial. This becomes clear when we shake off the notion that dollars are an absolute measure of value.

We need to look at what happened as the U.S. dollar rose relative to the Canadian dollar. Suppose the reason for this change was that the U.S. dollar rose against most of the world’s currencies. This means that some of the U.S. businesses owned by the ETF saw the value of their foreign revenues drop when measured in U.S. dollars. They also saw the value of some of their foreign assets fall in value. If the U.S. dollar hadn’t dropped, some U.S. businesses would have had higher revenues and asset values when measured in U.S. dollars. This means some of the stock prices would have been higher (again measured in U.S. dollars). So, if the U.S. dollar hadn’t risen, perhaps the ETF return would have been 23% instead of 20%. The net effect of all this is that Sandy’s exposure to the U.S. dollar was only partial.

It’s important to remember that when you buy stocks, you own slices of businesses, not dollars. Changes in the value of U.S. dollars do not translate 100% into the same changes in the value of U.S. businesses. This may seem to be the case over the short-term, but over the long-term, businesses have a complex set of exposures to the currencies of the world.

This lesson becomes even clearer when we look at an ETF such as VXUS which is bought and sold in U.S. dollars, but holds stocks of non-U.S. companies. It makes little sense to believe that the value of VXUS has a 100% exposure to the U.S. dollar just because it is traded in U.S. dollars.

Understanding all this, Canadian Couch Potato’s explanation of how a falling Canadian dollar affects U.S. equity ETFs makes perfect sense. Whether your ETF of U.S. stocks is traded in Canadian or U.S. dollars, what you own is a slice of a set of businesses, and your currency exposure is exactly the same in each case (unless the Canadian version includes currency hedging).

If we can’t use dollars as an absolute measure of value, what can we use? The best answer for most Canadians is to use the Consumer Price Index (CPI). This is basically the Canadian dollar adjusted for inflation in the prices of a basket of goods most of us need to buy. For Canadians who spend a lot of time in the U.S., some blend of inflation-adjusted Canadian and U.S. dollars would make sense.

Monday, January 13, 2014

2013 Update of My Personal Portfolio Returns History

2013 would have been a great year in the stock market if I were retired. Unfortunately, I’m paying higher prices for the stocks I continue to add to my portfolio. However you look at it, 2013 was a roaring year for the stock market. My overall internal rate of return (IRR) was 26.74%.

So how does this compare to a benchmark return? My portfolio is almost completely indexed; the only exception is that I still own some Berkshire Hathaway stock. I chose the Vanguard ETF of U.S. value stocks (ticker: VTV) as an appropriate benchmark for Berkshire. If I had invested in VTV instead of Berkshire, my 2013 IRR would have been 25.92%.

This makes the difference between my return and the benchmark return, called my alpha1, 0.66%. So owning Berkshire worked out well for me this year. Here is my full history of personal and benchmark returns since I started investing in equities in 1995:

My compound average alpha over this 19-year period is 3.59% per year. Some may wonder why I would give up stock picking in favour of indexing. After all, at this pace it would take me only 20 years to build a portfolio double the size that the index would give me. The answer lies in the 1999 results. My spectacular 192% return in 1999 was a wild ride taking insane risks that happened to pay off. If we leave out 1999, my compound average alpha drops to a loss of 1.10% per year. Focusing on the years where I was most serious about studying stocks (2000-2008), my alpha was a loss of 4.75% per year. I don’t believe I have any stock-picking skill.

My chart above shows nominal returns (no adjustment for inflation). Investors should think in terms of real returns where we subtract out the effect of inflation. What matters is how your purchasing power changes, not how your number of dollars changes. My compound average real return is 8.42% per year. If this were sustainable, I would be far past the point of financial independence for my family. However, if we drop out 1999, my compound average real return drops to 2.73%. So, I continue to work not only because I enjoy what I do, but because I have a lot of mouths to feed.

I’m still very comfortable with my decision to become a mostly index investor. I expect that I’ll eventually sell off the Berkshire stock and go 100% with indexing. I’m also hopeful that my mix of Canadian, U.S., and international stocks will generate at least a compound average 4% real return over the next 25 years. We shall see.

1 Some readers will know that CAPM defines alpha in terms of risk-adjusted return rather than a simple comparison to a benchmark. I’m using “alpha” in the simpler (but related) sense here. Others will notice that subtracting the benchmark return (25.92%) from my return (26.74%) gives 0.82%, not 0.66%. This is not the right way to take a percentage difference in this case. To get the added return that would compound with 25.92% to give 26.74%, we compute (1+0.2674)/(1+0.2592)-1=0.66%.

Friday, January 10, 2014

Short Takes: Preet’s New Book and Podcast, Hooking Kids on Investing, and more

I’m reconsidering the usefulness of my Friday short takes. When I have something substantive to say about someone else’s article, I’m thinking of just writing a full article on the subject instead of collecting together several links and a few thoughts. If you have any opinion on this, feel free to comment on this post. I’ll make a decision next week.

I had a full week of posts:

Stop Over-Thinking Your Money

It’s Time that Renting Got a Little Respect

Common Sense on Mutual Funds

A Chance to Mouth Off

Here’s some weekend reading:

Preet Banerjee’s new book Stop Over-Thinking Your Money is out, and he interviewed me for his podcast, all in one week!

Andrew Hallam has a very interesting hook for getting kids interested in investing.

SquawkFox reviews Preet’s new book Stop Over-Thinking Your Money.

Potato has had it with Bell and is considering a jump to Primus for a home phone. I’m interested in feedback about customer experience with Primus home phones (regular land line as opposed to VOIP).

Canadian Couch Potato is tinkering with his model portfolios. A theme is a shift toward more Vanguard ETFs. All my ETFs are from Vanguard now. But I’m still holding on stubbornly to some shares in Berkshire Hathaway.

The Blunt Bean Counter says that the advantage of paying yourself dividends instead of salary from a private corporation has “been virtually eliminated.”

My Own Advisor takes a look at how well he did with his 2013 financial predictions and humbly admits that “I am no better at predications than anyone else.”

Million Dollar Journey lists its most popular articles of 2013.

Krystal Yee decided to shift her extra mortgage payments to higher retirement saving. This is a slightly higher risk and higher (expected) reward path. I hope it works out for her.

Big Cajun Man suggests working out how much higher your mortgage payment would be if interest rates jumped up, and then try making extra principal payments to match this increase as a stress-test of your finances.

Thursday, January 9, 2014

A Chance to Mouth Off

It was my pleasure to be a guest on Preet Banerjee’s Mostly Money Mostly Canadian podcast this week. If you’re looking for entertainment value, at one point I managed to connect investing to Charles Barkley. Many thanks to Preet for taking the time to talk to me.

A big welcome to those who’ve landed here for the first time after listening to the podcast. (I’m in a good mood; welcome to everyone else too.) Every week I write somewhere between one and five articles on any subject to do with money. I tend to focus on personal finance rather than macroeconomic issues, and I use mathematical analysis to (ironically) simplify things as much as possible.

My biggest benefit from writing this blog is interaction with readers. I’m always happy to learn something new about how the financial world works. The best ways to ask a question or speak your mind are to leave a comment on one of my posts (scroll to the bottom of the relevant post) or use Twitter where I’m @MJonMoney.

Down the right side of each blog page you’ll find a search bar, a list of popular posts, and then a full blog archive where you can browse article titles all the way back to 2007. Here are a few recent posts:

It’s Time that Renting got a Little Respect

Which Takes a Bigger Bite from Your TFSA: Income Taxes or Mutual Fund Fees?

Employer Matching in Group RRSPs

For the record, I discussed the 25-year effect of a 2.5% management expense ratio (what I call the MERQ) during the podcast and said that it would consume more than half your savings. The actual total loss is 46%, not quite half. My estimating abilities failed me.

Whether you like to join the conversation or just read a few posts, I’m always happy to have more readers. Welcome.

Wednesday, January 8, 2014

Common Sense on Mutual Funds

I wish I had read John Bogle’s book Common Sense on Mutual Funds when the first edition came out in 1999. I might have saved myself a lot of the time and money I wasted trying to beat the stock market. Instead I’ve read Bogle’s updated 10th anniversary edition long after I accepted the wisdom of trying to capture market returns at the lowest cost possible. If any readers are finding their commitment to indexing being poisoned by thoughts of purportedly market-beating strategies, this book is a great antidote.

Bogle amasses overwhelming evidence of the mutual fund industry’s failure to help investors capture anything close to the full returns of the market. He lays out so much statistical evidence to back up his case that the reader could benefit from notes at the bottom of pages such as “if you’re already convinced of the current point, skip ahead 10 pages.”

The book isn’t just a litany of complaints, though. Bogle lays out his ideas of how a fund company should be run. These aren’t just idle opinions. Bogle founded the Vanguard Group in 1974 and built it into a massive fund company run based on his ideals. By the standards of most mutual fund companies, Vanguard isn’t very successful at making its managers rich. But by Bogle’s standards of serving the interests of fund investors, Vanguard is wildly successful.

Prior to reading this book, I spent a lot of time agonizing over which index ETFs I should own. The conclusion I ultimately settled on in each case was one of Vanguard’s funds (some in Canada and some in the U.S.). Now I feel even better about these choices. My only lingering concern is that I don’t know if Vanguard Canada is run based on the same principles as Vanguard in the U.S.

For the rest of this book review, I’ll pick out a few parts of the book that I found particularly interesting.

Real Returns

“Nominal returns are unadjusted for inflation. Real returns are corrected for inflation and are thus a more accurate reflection of the growth in an investor’s purchasing power. Because the goal of investing is to accumulate real wealth—an enhanced ability to pay for goods and services—the ultimate focus of the long-term investor must be on real, not nominal, returns.”

Stocks vs. Bonds

“The data make clear that, if risk is the chance of failing to earn a real return over the long term, bonds have carried a higher risk than stocks.”

Mutual Fund Industry “Creativity”

“In this exceedingly creative industry, we will no doubt witness the development of countless new short-term strategies, each with an alluring but ultimately vacant promise that hyperactive short-term management of a long-term portfolio can generate better results than a sensible buy-and-hold approach.”

Fund Selection

“The key to fund selection is to focus not on future return—which the investor cannot control—but on risk, cost, and time—all of which the investor can control.” Bogle quotes Nobel Laureate in Economics, William F. Sharpe as saying that when it comes to funds, “The first thing to look at is the expense ratio.”

Balanced Portfolios

The most widely accepted definition of a balanced portfolio is a 50/50 split between stocks and bonds. However, Bogle defines balanced as “two-thirds in stocks, one-third in bonds.”

Older Investor Asset Allocation

In the first edition of the book (in 1999 when stock markets were booming), Bogle recommended a 50/50 asset allocation for older investors living off their savings. In the 2010 update (just after stock markets had crashed), Bogle changed his mind to recommend “that an investor’s bond position should be equal to his or her age.” Imagine an investor who was 65 at the time of reading the book’s first edition. This investor’s stock allocation suffered through two massive declines, and then Bogle recommends that he or she should sell off some stocks in 2010. Could it be that even the great John Bogle isn’t immune to giving advice that amounts to buy high and sell low?

International Investing

“Foreign funds may reduce a portfolio’s volatility, but their economic and currency risks may reduce returns by a still larger amount.” Bogle recommends “limiting international investments to a maximum of 20 percent of a global equity portfolio.” Bogle wrote this for an American audience. It’s generally accepted that Canadians must diversify out of Canada. But the question is whether it is necessary to go beyond Canada and the U.S. My current allocation to stocks outside of Canada and the U.S. is about 27%, which is higher than Bogle’s recommended 20% maximum.


Indexing is “the triumph of experience over hope.”

Mutual Fund Manager Market Timing

When it comes to mutual fund cash reserves, some argue that “smart managers, recognizing that a market decline lies in prospect, can reduce stock holdings.” Unfortunately, “quite the reverse is true. Funds tend to hold large amounts of cash at market lows and small amounts at market highs.”

Index Funds with High Expense Ratios

“When a representative of [an index fund charging 0.95%] was asked how such a confiscatory fee could be justified, he responded ‘It’s a cash cow.’”

Exchange-Traded Funds (ETFs)

Bogle says that ETFs have “ill served fund investors” because there are too many narrowly focused funds and are traded too much. When it comes to owning broad index ETFs for the long term, he does “endorse such a strategy.” But “buy-and-hold investors are conspicuous by their absence from the ETF scene.” Unfortunately, most Canadians can’t invest in U.S. mutual funds, so we have no choice but to use ETFs if we want to hold U.S. funds.

Disappearing Mutual Funds

“How investors can invest for the long term in an industry in which the majority of funds endure only for the short term is an interesting question.”

Reversion to the Mean

“Reversion toward the market mean is the dominant factor in long-term mutual-fund returns.” This is a big part of the reason why looking at past mutual fund returns is mostly futile.

Value Stocks

Over 60 years ending in 2008, growth and value funds had very close to the same average return. While value funds caught up significantly from 2001 to 2008, Bogle is not convinced that a value premium exists.

Dollar-Weighted Returns

When mutual funds report their returns, they use time-weighted returns, which are based on an investor who buys into a fund at the start of the reporting period and holds all the way through without buying more or selling. Dollar-weighted returns take into account the assets in the fund; they tell us what return the average dollar invested in the fund experienced. Unfortunately, when a mutual fund advertises good past returns, investors pile in and the fund usually subsequently cools off just when it has more assets under management. So, dollar-weighted returns tend to be lower than time-weighted returns.

To illustrate the difference in return calculations, Bogle gives an example that I can’t figure out: a “fund’s assets were $1 million at the start of the year, growing to $1.3 million by year-end, reflecting the 30 percent return. Then, on the last day of the year, investors suddenly recognized that its 30 percent gain was pretty remarkable, so they immediately invested $10 million in the fund. In this obviously extreme case, the dollar-weighted return is just 4.9 percent.”

In this example, the internal rate of return (IRR) is still 30%. Perhaps Bogle is using some measure other than IRR for the dollar-weighted return? Or perhaps the example is explained incorrectly? If the 30% return happened all in the first half of the year and the second half of the year had a 0% return, and if the $10 million was invested mid-year, the IRR works out to 5.05%, which isn’t too far from Bogle’s claimed 4.9%.

Fund Management

“No longer is the prudent, disciplined stewardship of fund portfolios the core function around which all others are satellite. Rather, the distribution of shares through aggressive advertising and selling techniques has become the industry’s core function.” I have tended to take for granted that a mutual fund’s main goal is to grow assets under management. However, the cost of this function actually harms the returns of existing investors.

“The mutual fund industry ... is now just another consumer products business. ... Investors are no longer fund owners; they have become mere fund customers.”

A quote from Goldman Sachs: “Managing money is not the true business of the money management industry. Rather, it is gathering and retaining assets.”

Hyperactive Trading

To combat “casino-like trading” Bogle advocates a “five-cent tax on each share of stock traded.” Such a tax would cost me less than 0.01% of my portfolio per year, but would make a huge difference for anyone trading frequently.

Compounding Fees

Bogle makes the point that even when fees sound like a small percentage, they compound over time to significant costs. Quoting Arthur Levitt: “a 1 percent fee will reduce an ending account balance by 17 percent over 10 years.” Bogle continues, “the 2-plus percent all-in cost for the average equity fund would reduce the amount of capital accumulated by about 24 percent over 10 years, and 39 percent over 25 years.” By my calculations, the three account balance reduction percentages should be 9.5%, 18.1%, and 39.3%, respectively. The only way I can make sense of this is if Levitt’s “1 percent” is actually 1.9%, and Bogle’s “2-plus percent” means 2.7%.

Vanguard’s Structure

With traditional mutual fund companies, shareholders own the mutual funds and have a board of directors who are supposed to appoint and control a management company to run the fund. Unfortunately, these boards of directors are usually ineffective and the management company tends to control everything, including their own pay. “A dollar in profits for the management company is a dollar less for mutual fund shareholders.” This makes it very clear that shareholders and managers have misaligned interests.

With Vanguard, shareholders own the mutual funds, and the funds own the management company. As a result, Vanguard “manages its own affairs on an at-cost basis.”

Vanguard employees are paid a percentage of the amount of money they save their shareholders compared to the fees charged by Vanguard’s largest competitors. “In 1998 alone, ... more than $3 billion of value was added to our clients’ returns.” The share of this that goes to Vanguard employees “can amount to as much as 30 percent” of their annual compensation.


Few investors will take the time to read the over 600 pages of this book, but the payoff for doing so is potentially huge. Investors give away a large percentage of their returns in fees and most don’t even realize it. Taking the time to understand Bogle’s teachings would more than double the investment retirement income for many Canadians.

Tuesday, January 7, 2014

It’s Time that Renting Got a Little Respect

I like owning a house. I’ve become very accustomed to the freedom and autonomy that come from not having a landlord. But I can’t pretend that owning my house is the best move from a purely financial point of view any more.

My current home would sell for about 2.5 times what I paid for it. Even factoring in inflation, its value has gone up over 70% in real terms. So homeownership has worked out well for me. But that’s in the past. What about the future?

I don’t know what will happen to house prices, but if we look at the likely range of possibilities, the future looks very unlikely to match the past couple of decades. Interest rates are at historic lows and Canadians are deep in debt. I’d have to be delusional to think that my home is likely to increase another 70% above inflation. It’s not impossible, but hardly likely.

I have little doubt that I’d be better off financially to sell my house and rent. So far my wife and I have decided to leave this money on the table and continue to own. However, how should I advise my sons?

My sons have grown up in a world where they and most of their friends grew up in homes owned by their parents. To some extent, having to rent instead of own seems like failing.

When we think of owning vs. renting, we tend to imagine a spacious house with room for a family vs. a cramped apartment. It doesn’t have to be this way. It’s possible to rent a nice house. The rent might seem high, but it will compare favourably to the combination of property taxes, mortgage payment, and house maintenance costs. The comparison looks even better for renting when you factor in the possibility of interest rate increases.

For anyone who buys into the idea that renting isn’t failing, the next step is to actually save the money you’re not spending on a home. I tell my sons that once they get full-time work, they should put 20% of their take-home pay into long-term savings. By “long-term,” I don’t mean “until you want to go on vacation or buy a car.” You need additional savings for these purposes. Long-term means you have no planned use for the money. You may keep it all the way to retirement, or use it to fund a career change in 20 years, or some other far off purpose.

If a young person can’t sock away 20% of take-home pay, then there is a problem. Either make more money or spend less. Perhaps renting a nice big house isn’t in the cards yet. Rent an apartment or share a place with a friend.

My main point here is that it is possible to live a financially prudent life while renting. In fact, while house prices remain so high relative to incomes, renting along with prudent saving may be the preferred route for young people today. I have no problem with people who choose to own a home, but renting a home can be for winners, not just failures.

Monday, January 6, 2014

Stop Over-Thinking Your Money

Most people believe that doing well with personal finance and investing is complicated. Preet Banerjee shows why this isn’t true in his new book, Stop Over-Thinking Your Money: The Five Simple Rules of Financial Success. He says that while it can be a lot of work to get an A+ in how you handle your money, you can get an easy A with his 5 rules, and right now “most people are somewhere near a C–”. (Disclosure: Preet is a friend of mine. However, as my long-time readers have likely figured out, I say what I really think, even if it involves criticizing a friend’s work or praising a foe’s work.)

The book is written in a conversational style that’s very easy to read. Banerjee explains that while the money rules are easy to understand, they can be challenging to follow the way that it can be challenging to stick with healthy eating and exercising. But the good news is that “getting physically fit is much harder than getting financially fit.” Financially, you only need “discipline for a short time, because once you get started down the right path, it gets easier.”

Banerjee has what I call a good sense of scale. He knows which mistakes have a small cost and which have a large cost. If you don’t save, “who cares about the difference in taxation of dividends and capital gains in your portfolio? What portfolio?” With his 5 rules, Banerjee focuses on the actions that give the biggest return. If a financial choice has only a modest impact, he says you should only worry about that if you’re going for your A+. When you’re focusing on your A first, things get much simpler.

For the rest of this review, I’ll pick out a few parts of the book I found particularly interesting.

Life Insurance Underwriting

Most books that discuss life insurance don’t even mention the critical issue of the time of underwriting; Banerjee leads with it. Mortgage life insurance typically gets underwritten at the time of the claim. That’s a fancy way of saying that they wait until you die to check your mortgage insurance application to see if you qualify for life insurance. What good is life insurance if you don’t know if it will pay?


Banerjee recommends that you “have a few hundred dollars (or more) in cash stored in a safe place in your home” to “buy necessities if there is a natural disaster that knocks out the ability to pay ... with debit and credit cards.” That’s one I hadn’t thought about before.

Financial Fire Drill

“Pretend you lost your job today and you won’t find work again until the end of the year.” Banerjee doesn’t want you to just imagine this scenario; he wants you to live it for a few months. Except for things that are difficult to cut for just a few months, he wants you to try living for a while as though you must cut way back on expenses.

Real After-Tax Interest

Banerjee goes through an example to show that today’s interest rates on savings aren’t much different from what they were in 1980 after you deduct taxes and inflation. This directly contradicts claims by others that savers fared better in the past when interest rates were high.

The Right Way to Think about Borrowing

“Think of borrowing money as negotiating a pay-cut with your future self.”

Passive vs. Active Investing

“Most people are better off in a low-cost, passively managed portfolio.” However, “the good news is that [portfolio cost] doesn’t matter if you’re just starting out.”

“How you set up your investments when you have a large portfolio is phenomenally important. How you set up your investments when you have a small portfolio is phenomenally unimportant. How much you contribute is what you need to focus on first.”

Financial Advice

Banerjee believes that most people need financial advice, but not just about their investments. He gives the clearest description I’ve seen of the different models for how funds charge you money and how financial advisors are compensated.

His description of the advantage of being able to write off the cost of a fee-based advisor leaves out the added taxes on the higher investment returns. He says he will clarify this point in a future version of the book.


Overall, I highly recommend this book as a way to get the message out that running your personal finances well can be simple. People would do well to make sure that they deserve an A based on Banerjee’s rules.

Friday, January 3, 2014

Short Takes: Estate Tax Loopholes, Reversion to the Mean, and more

I managed a few posts during the holidays, including my (late) jump into Twitter as @MJonMoney:

Your Unused TFSA and RRSP Contribution Room is Shrinking!

Dragged Kicking and Screaming

Study Distracts from Message about High CEO Pay

Things have picked up a little compared to last week. Here’s some weekend reading:

Loopholes in the U.S. tax code has allowed the wealthiest Americans to save over $100 billion in gift taxes and estate taxes since the year 2000. These loopholes “make the estate tax system essentially voluntary”. Thanks to the Stingy Investor for pointing me to this one.

Canadian Couch Potato reports on another active investment strategy that showed promise initially and then floundered. So often these strategies succumb to reversion to the mean, eventually. And that’s when high investment costs show themselves.

Big Cajun Man lists his most read posts from 2013.

Million Dollar Journey gives an end-of-year net worth update. Of particular interest to me was Frugal Trader’s reporting of the internal rate of return (IRR) in a couple of his accounts. He did very well on Canadian and U.S. stocks. I’d be interested to see the IRR of his entire investment portfolio. This is something I calculate and publish for my own portfolio each year, but I haven’t seen other bloggers do this.

Thursday, January 2, 2014

Study Distracts from Message about High CEO Pay

Yet again, the Canadian Centre for Policy Alternatives released a study of CEO Pay in Canada that misleads readers. A quote:
“Just as most Canadians are wrapping up lunch break on the first official work day of the year — 1:11 p.m. on January 2 — the average of the 100 highest paid CEOs will have already pocketed what it takes the average Canadian an entire year to earn. All in a day’s work.”
If you thought that meant that the average Canadian CEO earns in about 4 hours what the average worker earns all year, you’re mistaken, but I don’t blame you. In reality, the average CEO pay is 171 times higher, which means that it takes CEOs about a day and a half to earn what the average worker earns in a year. The idea is that the CEO was paid for Jan. 1 as well.

I don’t see the point of being unclear about this. CEO pay is extreme enough that there is no need to make it look worse. Perhaps the mention of “January 2” was meant to add some clarity, but it doesn’t help much. Only more mathematically curious readers would figure this out from the pay ratio of 171.

I have no problem with CEOs who are genuinely worth the money they are paid. Too often, though, the company’s board of directors aren’t doing their jobs properly. The board is supposed to represent stockholders and negotiate for a good CEO at a reasonable price. This doesn’t work well when the CEO controls the board and gets friends elected to it.