Monday, July 28, 2014

Stock Markets Only Go Up?

Stock indexes in Canada have risen so steadily for the past year that the part of my brain that is no good for investing is convinced that everything is different now and stock markets only go up. Let’s let that part of my brain think some more.

Now that my stocks will beat inflation by 25% or so every year, I can throw the 4% rule out the window and go with a 20% rule. My current savings can produce way more than enough income to cover my lifestyle. So, I can declare myself financially independent and ramp up my spending by a factor of four or so.

Believe it or not, many people really talked this way during the tech bubble of the late 1990s: “as long as I can make 15% or 20% a year on my stocks, I can retire soon …”.

That’s a nice daydream, but my more rational side needs to take over. A stock market correction is coming. It may come soon or it may come after markets rise another 50%, but it is coming. The future holds many small corrections and the occasional larger one. I can reasonably hope for lumpy returns that beat inflation on average by a modest margin. As long as I keep my costs low, the 4% rule is as high as I should go.

Friday, July 25, 2014

Short Takes: Psychology Undermines Returns and more

Here are my posts for this week:

A Saver’s View of RRSP and TFSA Room

Stuff Tax

Here are some short takes and some weekend reading:

Daniel Solin has some clear explanations of what drives people to make poor investing decisions. I can definitely see my younger self in many of the bad choices driven by psychology that he describes.

Canadian Couch Potato takes a look at iShares’ core ETFs and gives an interesting explanation of why two seemingly very similar ETFs have different MERs.

Million Dollar Journey lays out his plans to build a portfolio to fully cover his living expenses. I’m in this process as well.

Big Cajun Man explains the difference between disability insurance and critical illness insurance. He doesn’t see why you would need both. My goal has been to build up enough savings that I don’t need either type of insurance because I’ve become self-insured.

Thursday, July 24, 2014

Stuff Tax

No, I’m suggesting that the world should stuff taxes. I’m thinking about the many costs of owning great piles of stuff. We’ve heard of lotteries as a tax on those who can’t or won’t do math. Those who own too many possessions pay a stuff tax.

I’m not focusing here on things you truly need and use, like a bed. I’m thinking of the things you own but don’t use at all or at least often enough to justify owning them. Some good examples of large items are under-used boats and camping trailers. In the medium size category is furniture we don’t need. Among smaller items are a thousand books that will never be read again and a hundred pairs of shoes.

Here are some different types of stuff taxes:

1. Initial purchase price. The financial drag begins with buying an item in the first place.

2. A larger, more expensive home. If you have enough excess stuff, you need a bigger house to hold it all.

3. Higher house insurance premiums. If the replacement cost of your stuff exceeds the typical thresholds set by your insurance company, you may have to pay a higher premium.

4. Higher moving costs. The more your stuff weighs, the more you pay to move it all.

5. Lost time due to searching. The more stuff you have, the more time you spend sifting through it all to find the thing you want at a particular moment.

6. Lost time due to tidying. The more stuff you have, the more time it takes to clean up for company or during spring cleaning.

No doubt readers could name many other costs that come with owning more stuff.

Given my take on owning too much stuff, you might think that I’m the one in my immediate family who just owns things that matter. In fact, I think I’m probably worst by this measure. I’ve improved greatly over the past decade or so, but I still have a long way to go. The battle rages on.

Wednesday, July 23, 2014

A Saver’s View of RRSP and TFSA Room

We hear many stories of people who seem completely unconcerned about building up great piles of debt. However, there are savers at the other end of the spectrum who handle money far differently. My own tendency toward saving shows up in how I feel about RRSP and TFSA room.

Looming in just over 5 months (at the start of 2015) is more contribution room in my retirement accounts. This is a good thing. Contributions reduce my taxes over the long run. However, to me it doesn’t feel entirely good. It feels like a debt. It feels like I owe money to my retirement savings accounts. It should be satisfying to max out my contribution room, but what I usually feel is just relief that only lasts until the start of the next calendar year.

It’s not that I gnaw my fingernails with worry. I’m generally happy, and there isn’t much that keeps me awake at night. But RRSP and TFSA room feels like an obligation. When I had mortgage debt, the feeling of obligation was much stronger, but the feeling of having to top up my retirement savings accounts is similar.

I’m not looking for sympathy here – I live a great life and my finances are in very good shape. My point is that spenders and savers have very different emotional responses to money matters. My feelings about contribution room may not apply to all savers, but I doubt they are unique.

Friday, July 18, 2014

Short Takes: New Advisor Disclosure Rules, Investment Fee Questions, and more

Here are my posts for this week:

Does the Value Premium Exist?

The Glass Ceiling

Here are some short takes and some weekend reading:

Preet Banerjee explains new disclosure rules for financial advisors that will come into force in 2016 including dollar amounts of fees. He predicts that Canadians will be “shocked” at how much their investment advice costs. I hope so.

Tom Bradley at Steadyhand answers a list of questions about investment fees. Investors would do well to get their own advisors to answer this list of questions.

Big Cajun Man reviews William Bernstein’s short but very good book If You Can.

Million Dollar Journey says you should think twice before getting a mortgage with one of the big banks.

My Own Advisor is a fan of staycations. I like to spend some vacation time around home in the summer, but once it gets cold, I like to travel somewhere warm.

Wednesday, July 16, 2014

The Glass Ceiling

“Glass ceiling” refers to the invisible barrier that holds women back from rising in management. I’ve read many opinions on this subject, some sensible and some less so. Recent remarks by Sherry Cooper, outgoing Bank of Montreal chief economist, paint a picture of a corporate environment that differs sharply with my own experience.

Coopers remarks are from an article based on her CBC interview. Here is part of what she had to say:
“No one ever considered I could be in training for a C-suite job in the bank.”

“It’s not that I aspired to be a CEO. It’s just that I was never even considered in that role.”
To me, these remarks paint a picture of many high-level bank employees working hard, doing their best for the bank, and waiting to get noticed. Maybe Cooper didn’t mean them this way, but I know many people who think corporate environments work this way. My experience has been much different.

I’ve spent most of my career in high-tech reporting to high-level management. But I was a technical person and not in management myself. So, I got to observe CEOs interact with their direct reports without getting caught up in the fray very much myself.

I would characterize the climb to the top as a bunch of intelligent psychopaths playing an adult high-stakes version of king-of-the-mountain. I’m not just saying this for effect. Let me explain.

I use the word “psychopath” to mean a personality type I saw frequently. These are people who are indifferent to the happiness or suffering of others. They don’t enjoy hurting people. As a matter of fact, they seem not to notice or understand the feelings of others. They can scream at someone and then be baffled when that person leaves crying. There were others who did seem to understand others’ feelings, but they used this knowledge to manipulate rather than to create a pleasant work environment.

King-of-the-mountain is a child’s game where one child climbs to the top of a mountain of snow and declares loudly that he, usually a boy, is the king of the mountain. Then many other children begin climbing the mountain to first shove the king off and then shove each other off. Hilarity and concussions ensue.

When I hear someone complain about not being considered for promotion, I imagine a child standing beside the mountain of snow waiting to be acclaimed as king while the other children are violently throwing each other down.

Of course, the adult version of king-of-the-mountain is much more subtle than the child’s version. There certainly are frantic periods where executives get fired. But mostly there is relative calm where everyone is lining up their strategies to get each other fired. Some CEOs will fire potential rivals, but mostly they try to keep everyone in line with the promise of excessive bonuses and stock options.

I have some sympathy for low- and middle-level employees who get passed over for promotion for unfair reasons. This can happen due to gender bias, racial bias, or a whole host of reasons that affect both men and women. However, those aspiring to a top-level position need to roll up their sleeves and join the rest of the mostly anti-social executives in their slug-fest.

Monday, July 14, 2014

Does the Value Premium Exist?

Many investors take it as fact that small-cap stocks earn higher long-term returns than large-cap stocks, and that value stocks earn higher long-term returns than growth stocks. This belief originates with work by Fama and French on their 3-factor model of stock returns. The evidence that a small-cap premium exists is compelling, but not so for the value premium. Whether or not these premiums exist affects the choice of ETFs for an indexed portfolio.

John Bogle discussed growth vs. value stocks in the final third of an excellent speech in 2001. In it he observes that the Fama and French conclusions are based on stock market data from 1963 to 1990. It turns out that the size and even the existence of a value premium is period dependent.

Bogle extended the period of study to 1937-2000 and found the average annual compound returns to be 11.8% for growth stocks and 11.9% for value stocks, hardly a significant edge. You may ask what happened from 2001 to 2013. According to Standard and Poors, value stocks won by a little over half a percent per year. So, there was no statistically significant value premium in U.S. stocks from 1937 to 2013.

There certainly were periods where either value or growth stocks had a large advantage. However, unless an investor can predict whether a given future period will favour growth or value stocks, these swings are of no use.

Some might object that investors like Warren Buffett proved that value stocks are superior. This is a different situation altogether. Bogle, Fama, and French are comparing all value stocks to all growth stocks. But Buffett sought to own only those stocks he believed would outperform. Value investing through stock-picking is very different from an index strategy where the investor chooses to own all value stocks.

Implications for index ETF portfolios

In my own portfolio, I’ve chosen not to tilt toward either value stocks or growth stocks. I do have a modest tilt to small-cap stocks over large-cap stocks. I prefer Vanguard Canada’s fund VCN over the iShares fund XIU because VCN contains some small-cap stocks.

In the U.S., I prefer Vanguard’s VTI, which represents the entire U.S. stock market, over funds that hold just the S&P 500. In addition, I own some of Vanguard’s VB fund, which holds U.S. small caps, to add an extra small-cap tilt.

As always, I don’t think anyone should follow my choices blindly; think for yourself. That said, hopefully this discussion of how I bet my own money carries more weight than some pundit’s “investing ideas.” Comments and constructive criticism are most welcome. There is too much at stake when investing to ignore useful ideas.

Friday, July 11, 2014

Short Takes: Unsustainable Income Funds, Bonds – Ontario vs. Italy, and more

Here is my only post for this week:

Target-Benefit Pension Plans: Pros and Cons

Here are some short takes and some weekend reading:

Dan Hallett names monthly income funds that have unsustainable payouts. Many such funds have already cut their payouts. Some retirees want high monthly income so badly that they look past obvious signs that not only will their income not rise with inflation but will get cut even in nominal terms.

Tom Bradley at Steadyhand compares bonds from Ontario and Italy. Unfortunately, Ontario doesn’t come out too well.

Sandy Martin takes Advocis to task for implausible claims about what will happen if advisor compensation is banned. “You know what banning embedded commissions will do? It’ll end the illusion that advisors on the commission system are anything more than salespeople.

Rob Carrick explains the necessary evil of repeatedly negotiating package costs for television, internet, home phone, and wireless.

Canadian Couch Potato profiles Vanguard’s new All-World ex Canada ETF (VXC). It looks a little expensive for RRSPs and TFSAs. The MER is about 0.3%, but there are also some added withholding taxes that amount to about 0.45%. He also explains that he will be making some changes to his blog’s look as well as using a new subscription service to replace Feedburner. This makes me nervous because it seems that I will likely have to do something similar myself (shudder).

Big Cajun Man got caught by a subtle difference between insurance companies about how they apply the rule that they only pay for one pair of glasses every two years.

My Own Advisor reviews a very short but excellent book by William Bernstein called If You Can: How Millennials Can Get Rich Slowly.

Tesla Motors announced that they hit the 1 GWh supercharging milestone. I wasn’t even aware that this supercharging network existed. They seem to be pressing close to the point where electric cars are practical for typical consumers.

Thursday, July 10, 2014

Target-Benefit Pension Plans: Pros and Cons

The C.D. Howe Institute issued a report on Target-Benefit Pension Plans that explains how they differ from traditional Defined-Benefit (DB) and Defined-Contribution (DC) plans. Target-benefit plans solve a number of the problems with DB and DC plans, but they have some serious challenges as well.

Defined-Benefit (DB) pension plans push all of the risk onto employers who have to provide predictable benefits. Employers must shoulder the risk that investments may perform poorly, forcing them to make large contributions.

One problem with some DB plans is that they use unrealistic assumptions about future returns to reduce today’s contributions. This can lead to chronic under-funding. Another problem with some DB plans is they use unrealistic actuarial information. Effectively, they assume people will die younger than they actually will. This leads more under-funding problems.

Defined-Contribution (DC) pension plans push the risk from employers to employees. The employers know exactly how much they will have to contribute each year, but employees cannot predict how their savings will grow, and certainly cannot predict their future pension payments.

Even worse, DC plans create a risk that wasn’t present with DB plans: longevity risk. A given employee cannot predict how long he or she will live and must either underspend or take a chance on not living past the average lifespan. With DB plans, this risk gets diversified away, but with DC plans, employees must choose between frugality early in retirement or potentially running out of money late in retirement.

Target-Benefit Plans eliminate many of the disadvantages of DB and DC plans. Employer contributions are predictable within certain ranges. Whether benefits rise by more or less than inflation is determined by how well investments perform. So, employees take on some risk, but longevity risk is eliminated.

A big concern for Target-Benefit Plans is potential influence by employers or employees on how plans are run. If competent, well-meaning people choose investments and choose actuarial tables, then Target-Benefit Plans look like a great solution to difficult problems.

However, employers and employees would have strong motivations to influence how these new pension plans are run. If an employer can get the pension plan to use unrealistically high investment return assumptions, the pension plan will be chronically underfunded. This saves the employer a lot of money, and employee benefits will fail to keep up with inflation. Similarly, employees could get benefits rising faster than inflation if investment return assumptions are too low.

Another way employers and employees could influence the pension plan is through actuarial assumptions. Employers would prefer to assume we all die as young as possible to reduce the size of their contributions, and leave employees with benefits trailing inflation. Employees would prefer to use actuarial tables that assume long lives to increase required employers contributions and increase employee benefits.

Another risk is the growth of expensive administration for the pension plan. With DB plans, expensive administration leads directly to employers having to make larger contributions. With Target-Benefit Plans, the cost of bloated administration comes out of employee benefits. Usually, employers are in a better position to control administrative costs than employees are.

I don’t think it is overly difficult for competent independent people to handle investment return assumptions and actuarial tables fairly. The problem is that there are billions of dollars at stake, and employers and employees will be very strongly motivated to influence how Target-Benefit Plans are run.

Friday, July 4, 2014

Short Takes: Costly CPP Active Investing and more

Here are my posts for this week:

Norbert’s Gambit Catch at BMO InvestorLine

The Pension Debate

People seem to be writing less during the summer months, but here are a few short takes and some weekend reading:

Andrew Coyne explains that the CPP switched from passive investing to active investing in 2007. Investment costs are approaching 1% of assets per year. This is disturbing. Whether CPP returns beat benchmarks or not, those who collect their share of the hundreds of millions in fees are strongly motivated to continue this active approach.

Big Cajun Man has three financial rules of thumb to help keep you out of debt.

The Blunt Bean Counter explains RRIFs.

Thursday, July 3, 2014

The Pension Debate

I’ve read many articles on the debate over whether we need an improved pension system, and I’ve noticed some patterns. The two sides rarely address each other’s issues.

Arguments for Change

Supporters of change usually point to the alarming number of Canadians who save little and are headed to a dismal retirement where their standard of living will drop significantly. They rightly point out that the only remedy is forced savings. They call for an expansion of CPP or support Ontario’s plans to create a new pension system. Either option leads to higher payroll taxes as a form of forced savings.

Status Quo Side

Supporters of the status quo say that Canadians are doing just fine with their retirement savings. They say that the average level of retirement savings among Canadians is quite healthy. They observe that few retired Canadians live in poverty. They say that forced saving would just reduce voluntary saving.

Who is right?

These two arguments seem to contradict each other, but they don’t. Average savings levels are quite good. However, the average includes those with substantial savings along with those with little or no savings. So, it’s possible for the average to be good and still have many people with inadequate retirement savings.

The statements about many Canadians facing a big drop in their standard of living in retirement and few retirees living in poverty don’t really contradict each other either. Most Canadians facing a big drop in their standard of living will still have an income above the poverty line.

The claim that forced saving would just reduce voluntary saving appears to be at odds with the claim that forced saving would help people. But there really isn’t a contradiction here either. It’s true that people who are saving some money now for retirement would likely save less voluntarily if they were forced to save more in a government-run plan. However, those who save nothing now can’t save any less voluntarily; they would benefit from forced saving.

Entrenched Interests

If it were possible to aim a new savings plan only at those who save little or nothing now, there would be little opposition. However, with expanded government retirement savings plans, everyone who works would contribute more involuntarily. This would take a significant bite out of voluntary savings. The money management industry would face a big drop in assets under management and a corresponding drop in total income. This is their real concern.


I think we would be better served if the two sides of this debate were to directly address each other’s issues instead of talking past each other. We’re weighing the benefit of forced saving for those who don’t save voluntarily against the reduced choices for those who are already saving enough. I suspect that many who struggle with how to invest their RRSPs would welcome forced savings in a government plan, but others prefer to handle their own money.

Wednesday, July 2, 2014

Norbert’s Gambit Catch at BMO InvestorLine

My most recent currency exchange using the Norbert Gambit seemed to go off without a hitch. I bought Royal Bank shares in Canada with Canadian dollars and then sold Royal Bank shares in the U.S. to get U.S. dollars. Two weeks later, all looked fine. But I was eventually hit with an interest charge.

Here is the sequence of events. I made the trades one day, and the trades settled three business days later. But it wasn’t until one business day (3 calendar days) after settling that InvestorLine’s systems wiped out the positive number of shares on the Canadian side of my account and the negative number of shares on the U.S. side. So far, so good.

However, InvestorLine’s system decided that I was short the U.S. shares for the three calendar days it took to flatten the positive and negative numbers of shares. At 21% interest, shorting for three days produced a charge of over US$90. The worst part, though, is that interest charges don’t show up in my account until about the 21st of each month. In this case, the interest charge appeared over 4 weeks after I made the trades.

When I called InvestorLine, the representative immediately said he’d reverse the charge. But this isn’t good enough in my opinion. I noticed the charge mainly because my account showed a negative amount of cash. If I had looked a few days later after receiving some dividends, I might not have noticed at all.

When I asked what went wrong and whether I could expect such interest charges again (this happened once before, but I thought it was an isolated mistake), the representative told me that this was a limitation of their system. If I “ever try this again,” I’ll have to call again to get the interest charge reversed.

I’ve heard from many readers that they do currency exchange with Royal bank stock and other stocks without any problems. I’d suggest that these readers go back and check for interest charges up to a month or so after the trades. If any readers go back to check, please let me know your results.