Friday, September 26, 2014

Short Takes: Happiness Lessons from Frugality, Free Credit Monitoring, and more

Here are my posts for this week:

The Empowered Investor

Changing RRIF Withdrawal Rates

Here are some short takes and some weekend reading:

Mr. Money Mustache tells an inspiring story of embracing challenges in living a frugal life instead of complaining and living an expensive lifestyle.

Financial Crooks gives a detailed account of what to expect if you sign up for an Equifax Premier Account provided by Home Depot for their customers who made credit card purchases during the “hacking period.”

Daniel Solin debunks 8 common investing myths. This is a rare list-type article that is truly worth reading.

Million Dollar Journey has some advice for people making investment choices within their group RRSPs at work.

The Blunt Bean Counter explains the complex rules surrounding whether you are eligible for the $800,000 capital gains exemption when you sell shares in your small business.

Big Cajun Man reports that TD now has the capability for their credit card customers to make purchases with their Near-Field-Communication-enabled smart phones. He says “They keep making it easier and easier to spend your money.” However, I get the feeling he doesn’t think this is a good thing.

My Own Advisor reviews the book Wealthing Like Rabbits. This sounds like a book to add to my reading list.

Thursday, September 25, 2014

Changing RRIF Withdrawal Rates

In a recent report Rethinking RRIF Withdrawals, York University Professor Moshe Milevsky makes a strong case for reducing the forced RRIF withdrawal percentages. But what should individual retirees do in the face of a government that won’t reduce the size of these forced withdrawals?

People are living longer and guaranteed returns after inflation are lower than they were years ago when the RRIF withdrawal percentages were set. By leaving the withdrawal percentages too high, the government is encouraging people to overspend in retirement and risk being left with too little to live on in their old age.

Milevsky looked at the other side of this debate as well:
“Of course, defenders of the status quo (and certainly those interested in maximizing tax revenue) might argue that [Required Minimum Distributions] are “red herrings” since retirees are not required to consume the withdrawn funds (but merely to withdraw them from the tax-protected shelter of the registered account).”
It’s true that this argument does not give a good reason to leave withdrawal rates as they are. Too many people do spend their entire RRIF withdrawals not understanding the risks they take. This is a good enough reason to reduce the mandatory percentages.

However, what should individual retirees do if the government won’t act? The answer is that they should determine for themselves their safe spending rate and save any RRIF withdrawals that are above this safe spending level. The fact that retirees can protect themselves in this way does not mean the government shouldn’t act. It just means that in a situation that isn’t ideal, retirees are left to protect themselves by spending less than their entire mandatory RRIF withdrawals.

It’s possible for both sides to be wrong in a debate. The government can be wrong for not reducing forced RRIF withdrawals, and retirees who know better but just throw up their hands and spend their entire withdrawals can be wrong as well. It’s the retirees who don’t understand the risks they are taking who concern me the most.

Tuesday, September 23, 2014

The Empowered Investor

If you look back at your investing efforts to date and wonder where you went wrong, portfolio manager Keith Matthews’s book The Empowered Investor will explain it to you in such clear terms that you’ll wonder why you couldn’t figure it out on your own. I wish I’d read this book before I made my share of investing mistakes.

Matthews begins with the common investing pitfalls that trip up so many of us, and then explains the conflicts of interest in financial services before moving onto describing the “empowered” way to invest that involves diversification and indexing. This may seem like familiar territory, but Matthews make his case convincingly in an easy-to-read style.

The final sections of the book cover the approach to indexing used by Dimensional Fund Advisors. You can’t buy these funds directly but have to work through a financial advisor to invest in them. For those who wish to work with an advisor, this can be a cheaper option that usually gives you better advice than you’d get from the typical mutual fund salesperson. Those who prefer to build their own portfolios can use low-cost index ETFs. The first 7 chapters of the book are directly relevant to both groups, and the final few chapters are still food for thought for do-it-yourselfers.

The author’s portfolio management firm makes no secret of the fact that exposure of this book benefits their client business. However, I believe this book will benefit readers whether they become clients or not. I am not receiving any kind of payment for this review. As usual, I write what I really think.

The remainder of this review covers a few details of the book that I found interesting for one reason or another.

The author says that safe withdrawal rates are age-dependent: “For 60-, 65-, and 70-year-olds, ... conservative amounts to withdraw each year are 3%, 4%, and 5%, respectively.” Too often I hear early retirement enthusiasts refer to the “4% rule.” This is not a safe enough starting withdrawal rate for someone expecting a very long remaining life.

“The financial industry wants you to believe that it can successfully predict future market outcomes. ... The truth is that no one can predict future asset prices. Making major portfolio bets on these predictions is one of the most dangerous things an investor can do.” Well said.

“The investment industry actively markets performance when selling its products. Investors are unfortunately all too willing to buy into this devil’s dance.” Even huge pensions funds can’t predict which investment managers will outperform in the future.

Matthews discusses some new research into the “Direct Profitability Premium,” which is a proposed new factor of investment returns like value stocks and small-cap stocks. If this factor catches on, I wonder if companies will try to game their accounting to show higher direct profitability to attract more investors.

“A qualified, independent, fee-based advisor does not depend on commissions or sales fees and is able to offer unbiased advice and recommend the best tools in the marketplace.” I agree that this is a better model than commissions from mutual funds, but the size of the fee matters. Even a 1% per year fee will consume more than one-quarter of your investment after 30 years.

Overall, I highly recommend this book.

Friday, September 19, 2014

Short Takes: Portfolio Simplification, Used Cars, and more

I wrote one post this week taking another look at whether the value premium exists:

Does the Value Premium Exist? Redux

Here are some short takes and some weekend reading:

Scott Ronalds at Steadyhand has declared September 19th to be National Portfolio Simplification Day. I come out quite well on his list of questions. “Do you own a long list of investments?” Nope – four ETFs and one stock. “Do you have a Strategic Asset Mix?” Yup – I’ve chosen fixed percentages for the ETFs and use threshold rebalancing when new contributions aren’t enough to keep percentages in line. I’m not adding to the shares in the one stock. “Take a close look at your costs.” My MERs, TERs, foreign withholding taxes, commissions, and spreads add up to less than 0.2% per year.

Preet Banerjee says that the traditional gap between the prices of new and used cars has been narrowing. The games that car manufacturers play with interest rates and incentives can make comparisons difficult. The important question to me is what the price is if I walk in with a bag of 20-dollar bills. This makes it easier to compare prices of new and used cars.

Canadian Couch Potato reports that the main Canadian ETF providers are paying attention to the hidden drag of foreign withholding taxes.

The Blunt Bean Counter explains the complex new world of reporting foreign assets on a T1135 tax form. I sure hope investments in RRSPs continue to be excluded from reporting.

Potato pokes holes in some stories promoting real-estate ownership.

My Own Advisor breaks down the components of a Management Expense Ratio (MER) as well as other expenses not included in the MER. An important takeaway is that “management fee” and MER are not the same thing.

Big Cajun Man is finding that text books are chewing up huge amounts of his RESP savings.

Million Dollar Journey has begun tracking the net worths of a few new people. The latest report is on a couple who seem destined to arrive at millionaire status quickly with a total family income of $284,500.

Thursday, September 18, 2014

Does the Value Premium Exist? Redux

A couple of months ago I wrote about John Bogle’s doubts that stocks have a persistent value premium. I’ve since persuaded myself that Bogle defines value stocks differently from other researchers. It seems that a value premium has persisted for some time. I’m not certain that it will exist into the future in a form that can be captured in returns after costs, but I’ve decided to modify my portfolio on the premise that I might be able to capture a value premium.

I had owned the Vanguard exchange-traded fund VB, which holds U.S. small cap stocks. Vanguard also offers two ETFs that split small cap stocks into value stocks (VBR) and growth stocks (VBK). I’ve sold my VB and bought VBR. This isn’t exactly a huge change in my portfolio, but it is the biggest change I’ve made in some time apart from adding new money.

I was adding a block of new money and did a currency exchange using the Norbert Gambit. By making the change from VB to VBR at the same time, I saved a few transactions.

Over the past decade, U.S. small cap growth stocks (VBK) have actually outperformed small cap value stocks (VBR) by 1.5% per year. So, I’m lucky to have split the difference by owning VB instead of VBR before now. Here’s hoping that VBR gives the higher returns in the coming decades.

Friday, September 12, 2014

Short Takes: CPP Costs, Peter Lynch’s Advice, and more

I wrote one post this week tackling a clever argument in favour of the current model of mutual funds paying embedded commissions to financial advisors:

Embedded Commissions: Mutual Funds vs. Cars

Here are some short takes and some weekend reading:

Andrew Coyne explains that the cost of running the Canada Pension Plan has ballooned to over $2 billion per year. Much of the higher cost is going to bloated administration and external management fees. It seems that CPP is heading towards the same high-cost structure that most Canadian mutual funds use. Almost all mutual funds fail to recoup their costs in the form of higher returns, and there is little reason to believe CPP will be any different.

Rick Ferri explained why Peter Lynch gave bad advice in his classic book One Up Wall Street. I really enjoyed this book many years ago, and it played a part in propelling me into life as a stock-picker. I’d be wealthier now if I had never read it.

James Osborne is a CFP with an interesting observation about what it takes to become financially independent.

Potato explains why RRSPs are better than non-registered accounts, even for people with defined-benefit pension plans. However, he advocates investing in a TFSA first.

Million Dollar Journey explains that even defined-benefit pension plans have risks and suggests a specific strategy for how to deal with those risks.

Big Cajun Man reports that you may be able to turn the recent credit card security breach at Home Depot into free credit monitoring for a year.

Boomer and Echo say it’s not a question of if but when Canada bans embedded commissions and brings in a best interests standard for financial advisors.

Tuesday, September 9, 2014

Embedded Commissions: Mutual Funds vs. Cars

A very clever argument used by those who want to maintain the current embedded commission model for financial advisors goes as follows:
When you buy a car, you don’t demand to know the size of the salesperson’s commission. So, why would you demand to know the commission your financial advisor gets?
Most other arguments the mutual fund industry uses are easily refuted (see Tom Bradley’s excellent article on this subject). However, this car analogy rings true at first. I don’t worry about how much commission the car salesperson gets. It’s the total price of the car that matters to me.

The problem here is that the analogy isn’t an exact fit. For example, almost everyone is aware that car salesperson commissions come out of the car price. Many investors don’t know how their financial advisor gets paid. But the differences run deeper.

Let’s imagine a fictitious world where car ownership more closely matches mutual fund ownership. Suppose that instead of paying car salespeople from the car’s price, car companies sneak out in the middle of each night and siphon a few dollars of gasoline from all the cars they’ve ever sold. The car companies resell this gas to pay salespeople commissions and their own salaries. Many car owners aren’t aware that gas siphoning goes on, and even when they hear about it, they don’t believe it’s happening to them.

All this may sound absurd, but it is a close analogy to how most mutual funds work. The management company takes cash out of the funds each day to cover all costs including financial advisor commissions. There are some mutual funds that don’t pay financial advisor commissions, but most do in Canada.

In this fictitious world, it would be perfectly reasonable for car buyers to ask salespeople whether they are paid from surreptitiously-siphoned gas. They might also ask whether salespeople recommend cars based on their cut of the gas siphoning.

Getting back to the real world, it’s true that mutual fund investors should be concerned primarily with total costs rather than just their financial advisor’s cut. But, in most cases, investors’ only contact is with their advisors, and mutual fund companies are paying advisors to make them insensitive to the total fees of the mutual funds they recommend. The problem is not just the hidden costs of financial advice, but the inflated costs not associated with advisors.

If we cut off the flow of money from mutual fund companies to advisors, this will remove the incentive of advisors to choose expensive mutual funds for their clients. This will force more mutual fund companies to compete on costs, which will be very good for investors.

Friday, September 5, 2014

Short Takes: Eliminating Embedded Commissions and more

My only post this week described some less well-known RRSP strategies:

RRSP Strategies

Here are some short takes and some weekend reading:

Tom Bradley at Steadyhand explains the arguments against eliminating embedded commissions for financial advisors and then demolishes these arguments.

Big Cajun Man is having trouble getting money out of an RESP for his daughter’s schooling, but that hasn’t stopped the bank representative from trying to upsell him on high-margin bank services.

My Own Advisor offers a primer on opening a brokerage account.

Wednesday, September 3, 2014

RRSP Strategies

I liked Preet Banerjee’s recent book Stop Over-Thinking Your Money so much that I decided to read his older book RRSPs: 41 Strategies Canadians Need to Know about our Country’s Greatest Tax-Planning Tool. I thought I knew a fair bit about RRSPs, but Banerjee managed to teach me a few things.

If you decide to read this one, keep in mind that it is 6 years old and that some RRSP rules have changed. As far as strategies go, the biggest change in that time has been the introduction of the TFSA.

The 41 strategies are aimed at a wide range of investors. The earlier ones tend to be for beginners, and the later ones are more advanced. Banerjee’s command of RRSP rules and strategies make it worthwhile to read this book with the caveat that you should confirm that anything you plan to use hasn’t changed since 2008.

The following are some points that were interesting or new to me. Be sure to check that the rules haven’t changed.

If you hold your mortgage in your RRSP and fail to make payments, a mortgage trustee can initiate a power of sale to protect your RRSP. This means your own RRSP would take away your house!

Individual Pension Plans (IPPs) are completely new to me. Apparently they are a way for high-income Canadians to shelter more of their income than is possible with RRSPs alone. The rules for IPPs seemed to have changed in 2011, so I’m not sure of their status now.

If you plan to make RRSP withdrawals between ages 65 and 71, you may prefer to convert the RRSP to a RRIF before you’re forced to at age 71. The reason is that minimum RRIF withdrawals are considered pension income, but RRSP withdrawals are not, and there is a $2000 pension income credit.

For those still working past age 71, an interesting strategy is to make an over-contribution to an RRSP in December of the year you turn 71. The part of this over-contribution above $2000 will be penalized at 1% for the month, but you can then take the RRSP deduction the next year.

Some of the more advanced strategies involving leverage come in the last two sections. There are quite a few moving parts, and Banerjee is careful to point out that these strategies are not suitable for everyone. I found them useful to open my thoughts to a wider range of possible approaches to growing RRSP savings. I’ll likely stick to a simple plan, but I like to understand other ideas to see what I might be missing.

Overall, I’m glad I read this book if for no other reason than to remind me that there is almost always more to learn about RRSP rules and strategies.