Tuesday, May 26, 2015

Climate Change Mutual Funds

Creators of mutual funds and exchange-traded funds (ETFs) are always looking for new fund ideas that will attract investors. I have an idea for climate change funds.

Suppose that two funds were to hold assets likely to be affected by climate change, such as ocean-front properties. The “scientists’ fund” would short such properties on the theory that they will go down in value as ocean levels rise. The “deniers’ fund” would buy such real estate on the theory that it will be fine and is likely underpriced on fears of rising oceans. No doubt there are many other types of financial assets whose value would be affected by climate change.

So, instead of sitting in a bar and arguing about whether climate change is real, people would be able to get some real skin in the game by risking their own money.

Monday, May 25, 2015

“I Don’t Pay Any Fees”

I was struck recently with how hard it is to get across a simple message about investing sensibly. A friend, Carl (not his real name), mentioned that he needs to get his investments organized, but isn’t sure how to proceed. He asked me what I thought.

I began with the simple ideas of not trading too much, choosing a sensible mix of stocks and safer investments, and avoiding fees. Carl immediately volunteered that he didn’t pay any fees. I countered a little too quickly and forcefully with “yes, you do.”

After I explained that a percentage of Carl’s portfolio gets taken out in fees every year, Carl remembered that he was told that a small fee came out of his returns. I tried to explain that this fee comes out even if his investments lose money and that over decades these fees can eat up one-third or even half of his money. But Carl was skeptical.

Unable to persuade Carl that fees are a big deal, I didn’t have much hope with the rest. I tried to explain that all of his investments ultimately amount to some mix of mostly stocks, bonds, and cash. Carl wasn’t sure if he owned any stocks. He listed a few marketing names for types of accounts and funds at a couple of financial institutions. He was skeptical of my claim that these accounts and funds in turn just hold stocks, bonds, and cash. Somehow, the marketing from financial institutions makes it all seem much more elaborate.

Carl is a smart guy. He even works in a somewhat financial area. But the things I was saying didn’t resonate with him. I don’t think Carl thought the things I was saying were wrong; he just thought they weren’t relevant to his situation.

I find this is a common problem. There are many writers and speakers who have clearly explained the main mistakes typical unsophisticated investors make, but their messages will often just bounce off because they sound irrelevant to people who think “I don’t pay any fees.”

Friday, May 22, 2015

Short Takes: Robo-Conflicts of Interest, Home-Country Bias, and more

Here are my posts for the past two weeks:

New Bank Fee Strategy

The New RRIF Minimum Withdrawals are Designed for 3% Returns

Here are some short takes and some weekend reading:

David Pett explains how robo-advisors are drifting away from low costs and away from serving their clients’ interests.

Dan Bortolotti explains why having some (but not too much) home-country bias in your stock allocation makes sense.

The Blunt Bean Counter takes on the interesting question of whether shareholders can be independent contractors for their own companies.

Boomer and Echo explain how your financial decisions amount to a battle between your present and future self.

My Own Advisor is giving away a copy of the book The One-Page Financial Plan.

Big Cajun Man suggests some financial questions to ask on a first date to decide whether you should run for the hills.

Million Dollar Journey explains the basics of TFSAs.

Wednesday, May 20, 2015

The New RRIF Minimum Withdrawals are Designed for 3% Returns

Some time ago I showed that the magic RRIF minimum withdrawal percentages for each age were designed to give the same income each year if your RRIF earned a 6% return. The latest federal budget proposes to change these percentages to make minimum RRIF withdrawals smaller. So, I decided to repeat my previous analysis. You can find the new percentages in Table A5.2 of the budget document.

For a starting RRIF balance of $500,000, the following chart shows the yearly minimum withdrawals for 7 different cases of constant portfolio returns ranging from 0% to 6% per year.

As we can see, the RRIF income remains closest to constant for a little over 20 years when the investment return is 3% per year. So, the change is essentially dropping return expectations from 6% to 3%. Another more subtle change was to delay by about one year the age where RRIF income starts dropping off.

Note that you can think of these return percentages in either nominal or real terms. This means you can think of the return as either 3% or inflation plus 3%. For the case where you want your RRIF income to stay level in dollar terms, you need to earn 3%. If you want your RRIF income to have constant purchasing power, you need to earn inflation plus 3%.

Overall, I think this is a sensible change. The old minimum RRIF withdrawals caused retirees to spend too much of their income. Savvy retirees just saved part of their RRIF withdrawals for the future, but too many just spent their withdrawals not understanding that they were overspending.

Thursday, May 14, 2015

New Bank Fee Strategy

Canada’s big banks have been creating new types of fees and increasing the size of existing fees lately. But this all shows little imagination. The banks need to think more creatively about increasing profits.

It’s common for bank customers with chequing accounts to have to pay a fee of a dollar or so for each withdrawal beyond some maximum number of withdrawals each month. I think of it as getting dollared to death one little cut at a time.

What if the banks counted the deduction of the dollar service charge as a withdrawal as well? This would create another dollar service fee and another withdrawal. And then there would be another fee and withdrawal and so on. Depending on the speed of the banks’ computers, this could add up after a while.

Critics might say that this would lead to an infinite number of charges, but I’m sure bank representatives could explain that this isn’t true. The charges would stop once the account is drained or the overdraft protection is exhausted. Then the customer could show up at the bank with a loonie to end the chain of service charges.

Okay, that’s enough sarcasm. It should be obvious that I’m annoyed by all the new service charges. Most of my withdrawals require no human interaction. It’s hard to see why I should be charged anything close to a dollar for a few computers to do their work. That’s why I made the move to Tangerine.

Friday, May 8, 2015

Short Takes: Mortgage-Breaking Penalties, Ridiculous Trucks, and more

Here are my posts for the past two weeks:

Money: Master the Game

Spinning the TFSA Increase

TFSA Limit Increase and Long-Term Cut

Replies to Emails I Usually Ignore

Here are some short takes and some weekend reading:

Robert McLister is calling on the federal government to force lenders to clarify the rules for penalties for breaking a mortgage. He explains that the calculators banks make available are unusable by most borrowers.

Mr. Money Mustache takes a run at men who own ridiculous trucks.

Tom Bradley at Steadyhand adds some context to the latest fee increases from Canada’s big banks.

Dan Hallett explains why covered calls are not free money.

Big Cajun Man has a picture of one way he saves money and asks if he is being frugal or cheap.

The Blunt Bean Counter explains the advantages of RRSPs over TFSAs.

Boomer and Echo say we need to get over the thinking that it’s hard to switch banks.

My Own Advisor says that with the TFSA limit increase everybody wins. I’m guessing that he’s trying to be controversial, but this is not literally true. Some people can’t use the higher limit but will have to pay their share of the make-up taxes (or lower government benefits) to cover the lost tax revenue from TFSAs.

Thursday, May 7, 2015

Replies to Emails I Usually Ignore

The best part about running this blog is the feedback I get from readers. Learning about finances has definitely been a two-way street. However, I get a lot of less useful messages that I usually ignore. Today I respond to a few of them.

Dear Melissa,

Thank you for your query about what form of paid article I’d like. When my son was 3 and I knew he didn’t want to wear a sweater, I’d ask him if he wanted to wear his red sweater or his blue sweater. This stopped working when he was 4. Also, I’m older than 3. I’ll pass on using your advertising as content on my blog.




Dear Wilson,

I was relieved to learn that the content on my blog is relevant to the web site you are promoting. I was afraid that I’d been wasting my time and my readers’ time with content that was misaligned with your advertising efforts. I’ll sleep better now.




Dear Julia,

Thank you for yet another opportunity to partner with your company that tries to draw unsuspecting people into forex trading. Perhaps you should advertise forex as low-risk. If you can count on a return of minus 100%, it makes financial planning simpler.



Wednesday, May 6, 2015

TFSA Limit Increase and Long-Term Cut

A reader, Garth, suggested a good topic for an article: “I would love to see you do an article on what the Time Value of Money will do to unused and future TFSA contribution room now that it is no longer indexed to inflation.” Most people aren’t good at understanding the long-term effects of inflation. Let’s look at how TFSAs will be affected.

To start with, the reports of how people can use TFSAs to build up million-dollar portfolios are highly misleading. For example, if 25-year old Sandy socks away $10,000 in her TFSA every January for the next 40 years and makes a 7% return, she would end up with $2.1 million that she can withdraw tax-free.

However, if inflation is 3% per year, the value of money will be less than one-third of what it is today. The purchasing power of Sandy’s money will be only about $650,000 in today’s dollars. This will put Sandy in a good financial position, but she won’t be a multimillionaire by today’s standards. Even low levels of inflation build up significantly over time.

In fact, at 3% inflation, it would have taken only 20 years for the TFSA limit to reach $10,000 per year under the old rules. So, in 2 decades or so, this so-called TFSA limit increase will start to look like a TFSA cut. Older Canadians will benefit from a higher TFSA limit now, but younger Canadians will eventually need the $10,000 limit to be raised to counter the effects of inflation.

Turning our attention to unused TFSA contribution room, inflation is a kind of leak in your available room. Any unused room is a fixed dollar amount that doesn’t rise with inflation. This isn’t a consequence of removing the indexing of the TFSA limit; it was true before the change and it’s still true now. When you invest TFSA contributions your returns tend to counter inflation, but unused room declines a little in value every year.

Whenever you think of money over long periods of time, it’s important to account for inflation. If we do this properly, it changes the discussion of the TFSA limit change in important ways.