Friday, April 29, 2016

Safe Stocks

In recent months I’ve encountered more investors than usual who see Canadian big bank stocks as safe investments. I guess the most recent one was one too many for me. I don’t believe that there is such thing as a safe stock, and as stable as Canadian banks have been, this applies to their stocks as well.

Investors in Canadian banks have been rewarded with decades of stable dividends and fairly consistently rising stock prices. This may continue or it may not. The pressure of new online banks that don’t have the costs of physical branches may bite deeply into big bank profits. This isn’t a prediction. It’s just one possible future. I don’t know what will happen to big bank share prices or dividends.

Investing substantially all of your investments in two or three bank stocks may feel safe, but it isn’t. I’m not saying to avoid bank stocks entirely. Approximately 7% of my portfolio is invested in Canadian big bank stocks indirectly through Vanguard’s exchange-traded fund VCN. But this is a far cry from investing 80% or more of your portfolio in banks.

Diversification is your friend. Many investors feel safe invested in big bank stocks, but they aren’t really safe.

Wednesday, April 27, 2016

A Financial Product I’d Like to See

When I retire I’d like to be able to invest in a fund holding a low-cost index of the world’s stocks that addresses longevity risk. The idea is that it would be like a low-cost annuity based on stock returns rather than bond returns.

The easiest way to describe this idea is first as a simple tontine structure. Imagine a large number of 65-year old women each placing $100,000 into a fund and the money gets invested in a low-cost index of the world’s stocks. Each month the fund sells some fraction of the shares and divides the money among the surviving women.

The dollar value of shares the fund sells would be chosen based on expected stock market returns and mortality expectations. The payouts would be calculated so that if these expectations turn out exactly right, then the monthly payments would rise exactly with inflation. However, the actual monthly payments would be based on actual stock returns and the actual number of surviving women. No money would go to the estates of women who die; this is the trade-off to get higher payments while still alive.

In a real fund of this type, we’d actually open the fund up to different deposit amounts, different ages, men, and couples. We could even introduce the option of payments to an estate after an early death (in exchange for lower payments while alive). We’d need to have actuarial rules to choose fair payout levels. We’d also need rules for how to adjust payment levels if longevity statistics change over time.

Another possible approach to this type of product is to have an insurance company take on the longevity risk rather than having a tontine structure based on actual mortality. The insurance company would essentially promise to deliver a certain number of shares (or more likely the cash value of the shares) each month. The payment levels would be determined by stock market returns and expected mortality statistics (actual mortality numbers would not affect payments).

All these details can be worked out by people skilled at actuarial math. The main thing I want is to get investment returns based on stock investments along with the higher payments that come from eliminating longevity risk.

I wouldn’t put all my money in such an investment, but I would put in a substantial amount when I retire. I’d then maintain a cash cushion to deal with stock market volatility, and I’d keep some fraction of my portfolio to manage on my own. I might also buy a standard simple annuity to serve as a bond-like version of this type of new investment.

Saturday, April 23, 2016

Short Takes: Self-Driving Cars, Mortgage Complaints, and more

Here are my posts for the past two weeks:

Phishing for Phools

How Much Do You Have to Learn to be a Good Investor?

Replies to Emails I usually Ignore

4 Reasons to Pay Cash for Cars

Here are some short takes and some weekend reading:

Mr. Money Mustache describes his cross-country road trip in a Tesla that drove itself. He also takes a look at how this technology will transform our world.

Canadian Mortgage Trends explains the top three complaints people have about their mortgages.

Canadian Couch Potato offers some clear thinking about target date funds.

Big Cajun Man has some ideas for tricking yourself into saving some money.

Potato looks at the risks and rewards of the “hot potato” investing strategy. It’s not for me but it does illustrate how tempting such strategies can look.

Boomer and Echo give a detailed example of one way to draw an income from your savings in retirement.

My Own Advisor asks what your car says about you. To me cars are nothing more than a form of transportation that say nothing about me or anyone else.

Wednesday, April 20, 2016

4 Reasons to Pay Cash for Cars

I’ve long advocated paying cash for cars. This idea is completely foreign to many, but the advantages are compelling.

You’ll buy a more reasonably-priced car

It’s harder to hand over cash you’ve saved than it is to agree to future payments. Car salespeople are experts at spinning the numbers to steer you into a lease with payments that seem low. But you’re still giving away a huge pile of money when you total up the payments and future penalties. It’s much easier to understand what you’re really paying when save up for a car. And you’re much more likely to make a reasonable choice of car instead of burying yourself in debt.

Get a better deal

Buying a car is stressful and the salespeople have information advantages over you. When you’re paying cash, there are fewer ways to trick you. Car loans can seem cheap, but the reality of paying for many years may not be in the front of your mind. Things get worse with leases if the contract has clauses that will very likely have you paying penalties when you return the car.

0% financing doesn’t exist

We love to get things for free. But when a dealership offers either 0% financing or cash back, that’s an admission that the financing is not 0%. If there is no cash back alternative to the 0% financing, the car’s advertised price is still inflated. The truth is that the financing rate will be higher than your mortgage rate, but that won’t be obvious at all as your head swims in numbers.

Get off the debt treadmill

If you save up to buy a car you avoid debt. Once you’ve bought the car you can start saving a little each month towards your next car. Instead of being on a negative debt treadmill, possibly owing more than your car is worth, you get into a positive pattern. It feels good not to have car payment obligations.

Monday, April 18, 2016

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 Grant,

I just had a thought about your stock analyzer. Right now you want me to use my blog to help you sell access to it. But I think you can make much more money another way. Just hear me out. Suppose you just take your own money and invest it based on your stock analyzer’s recommendations? As you say, you can “make 5 to 15% in stock returns every month.” I know it’s a big departure from your current strategy, but it sounds way easier than trying to sign a bunch of people up to use it for a few dollars each. Enjoy your soon to be abundant wealth.

You’re welcome,



Dear Mat,

I would love to publish your ad disguised as “an article about trading financial derivatives.” Unfortunately, it doesn’t quite fit the theme of my blog. If I ever start up a blog about the fastest way to get rid of money, I’ll contact you.




Dear George,

Thank you for the one-week stock market forecast. I decided to wait until the week was over to see if you were right. Looking past all the double-talk taking both sides, your forecast did have somewhat of a coherent prediction, but it turned out to be all wrong. It’s enough to undermine my faith in forecasters.



Thursday, April 14, 2016

How Much Do You Have to Learn to be a Good Investor?

In one sense, you need to know almost nothing to be a good investor. However, in another sense, you need to learn quite a lot.

The recipe for investing better than almost all other investors over the long run can be dead simple. Buy three low-cost index ETFs and rebalance mechanically based on some fixed rules. Within reason, these fixed rules don’t matter much as long as they remain fixed. We could teach this to a 12-year old.

Where you need deep knowledge is to avoid screwing up the simple investing recipe. Imagine yourself balancing on a wobble board following this simple investing recipe and trying not to fall over. Unfortunately, most of the financial industry is trying to knock you off.

First we have the never-ending media reports about an impending market crash. These are designed to turn you into a market timer. All the evidence says you are most likely to get out of the market at the wrong time, but the articles calling for a crash are very scary and convincing. More money is lost being out of the market than has been saved avoiding crashes, but that brings little comfort as you feel yourself falling off your wobble board.

Next there’s the lure of expensive mutual funds with the promise of star managers getting you higher returns and steering you clear of big losses. Of course, they can’t do these things, but the appeals to greed and fear are often enough to knock you off balance. Over the years you give away one-third or more of your savings waiting for the out-sized returns that never come.

Then there’s the lure of choosing your own stocks. When the world tells you you’re smart enough to beat other investors, your ego can’t resist. Steady media stories about “5 hot stocks” keep you off balance. Trading against the best in the world rarely works out well, but you remember your winners. Somehow, though, your portfolio never grows the way you hoped it would.

Banks, insurance companies, fund companies, and brokerages can’t make money unless they take it from you. So, they do their best to keep you off balance. Their messages can be extremely persuasive. It takes a lot of investing knowledge to tune out all this noise, stick to the simple plan, and stay balanced.

Monday, April 11, 2016

Phishing for Phools

We’ve been taught that the invisible hand of the free market brings unintended social benefits. However, Nobel Prize-winning economists George Akerlof and Robert Shiller explain that we get more than just social benefits in their book Phishing for Phools: The Economics of Manipulation and Deception. Necessary parts of the market equilibrium are “tricks and traps.” The authors explain these ideas in a surprisingly easy read.

“The free market system exploits our weaknesses automatically.” If one seller of unhealthy baked goods wasn’t there to catch us at our weakest moments, another would step into the void. The authors go through many examples of markets where we get “phished for phools” including cars, houses, credit cards, prescription drugs, tobacco, alcohol, and junk bonds. They make a strong case that phishing is a major part of our free markets.

One interesting example of phishing is the way that credit cards affect us. Studies “show that credit cards get you to spend ... quite a bit more” compared to using cash. When retailers and credit card companies battle over the fees retailers have to pay to accept credit cards, these two groups are battling over the spoils of our overspending.

“Free markets make people free to choose. But they also make them free to phish, and free to be phished.” Our “competitive markets by their very nature spawn deception and trickery, as a result of the same profit motives that give us our prosperity.” As a result, “phishing for phools is not some occasional nuisance. It is all over the place.”

The authors argue that “economists’ understanding of markets systematically excludes [trickery and deception].” As a result, “modern economics inherently fails to grapple with deception and trickery.”

I have often argued that we need effective government to police our markets for monopolistic behaviour, misleading advertising, and externalities. I can now add that we need government to help even when we make our own choices with our eyes open. I see no other way to deal with our obesity epidemic. The challenge is to find a way for government to do what is necessary (and no more) for a reasonable cost.

I highly recommend this book to anyone with an interest in economics, even if you find other economics books boring. This book is written to be understood rather than written to impress.

Saturday, April 9, 2016

Short Takes: Investing Overconfidence, Market Averages, and more

Here are my posts for the past two weeks:

Should We Plan to Spend Less as We Age in Retirement?

Bonds vs. an Annuity in Retirement

Revisiting the 4 Percent Rule
The Essential Retirement Guide: A Contrarian’s Perspective

Here are some short takes and some weekend reading:

Gary Belsky explains why we think we’re better investors than we are. This article gives some of the clearest explanations I’ve seen about how we screw up investing.

Boomer and Echo bring us some expert takes on why index investing doesn’t mean settling for average returns. I may be biased in liking this article because I was quoted.

Tom Bradley at Steadyhand gives an important lesson in where investors should focus their attention.

The Blunt Bean Counter gives his take on the 2016 federal budget.

Big Cajun Man explains why he doesn’t trust anyone claiming to show him how to get rich.

My Own Advisor lays out how he plans to invest during retirement. Having an indexed pension certainly makes a big difference.

Wednesday, April 6, 2016

The Essential Retirement Guide: A Contrarian’s Perspective

We all hear the steady drumbeat of fear-mongering about a retirement crisis and how we need to save more for retirement. Actuary Frederick Vettese aims to be a voice of reason with his book The Essential Retirement Guide: A Contrarian’s Perspective. He says we’re not nearly as badly off as banks and insurance companies would have us believe.

I learned quite a bit about a wide range of financial aspects of retirement from this book. One example is that long-term care insurance is a bad deal for almost everyone. Another is the frightening fact that as we age our ability to manage our finances deteriorates, but our confidence in our abilities increases. So, we’re unlikely to seek help when we most need it. There were also some important parts of the book I disagreed with.

Vettese begins the Preface pointing a U.S. study showing that 88% of people over 85 have some financial or housing assets. He presents this as evidence that people are doing reasonably well in their retirements. I looked up the study and found that while 12% had no assets at all, another 11% had less than $10,000. So, nearly one-quarter of the elderly have almost nothing. That doesn’t sound overly positive to me.

The early chapters make a very strong case that the usual rule of thumb that you need 70% as much income in retirement as you had while working is just too high for those with above-average incomes. I know this applies to me. I won’t need anywhere near 70% of my current income when I retire.

People with very low incomes may need nearly 100% of their incomes in retirement, but that will be covered by CPP/OAS/GIS. For people with higher incomes, Vettese explains that an income target of 50% is more realistic to maintain the same standard of living heading into retirement.

When it comes to choosing a wealth target you’ll need before retiring, Vettese asks “if the wealth target were higher than the cost of an annuity, then why take the risk of managing your own money?” The answer that he seems to miss is inflation risk. The short-term risk of inflation running up seems small, but are you prepared to gamble that it will never happen for the rest of your life? Insurance companies don’t like offering inflation-indexed annuities because “inflation might take off again.” Why should we ignore this risk?

Underpinning Vettese’s calculations of how much money you need to retire is his belief that because people spend less as they age, we can assume that retirement spending “does not have to be indexed to inflation.” In a previous article I explained why we should assume a much smaller spending decline than the amount of inflation. It’s hard to tell how big a reduction in spending over decades of retirement is actually baked into his calculations. This is because CPP and OAS are indexed, and one of the notes in the Appendices seems to imply that he included some indexing in the annuity calculations.

Two other parts of the book that I discussed in earlier articles are the interesting comparison of a bond portfolio to an annuity and the chapter on revisiting the 4 percent rule.

“By eliminating unhealthy behaviors,” such as smoking, drinking, eating poorly, inactivity, and being stressed, “you can restore 7.5 years of lost life expectancy.” The remarkable part of this is that “you can gain back up to 9.8 years of healthy life expectancy.” So, living a healthy life leads to a longer life but actually cuts down on the number of unhealthy years you’re likely to live.

In a chapter on savings rates, Vettese makes a good case that your average saving rate doesn’t have to be as high as you might think. I think they have to be a little higher than he says because it doesn’t make sense to ignore inflation in retirement. However, there is another reason to pick a higher savings rate. For a young person starting out, there are likely to be good and bad times financially. You have to save more during the good times because your savings rate will drop or even go negative in bad times.

The author makes some predictions that seem to make sense. He says that interest rates will stay low for a long time mainly because of demographics. Large numbers of people getting older are driving the demand for bonds. Another prediction concerns annuities. He says the trend away from defined-benefit pension plans is causing plan sponsors to buy annuities to de-risk these plans. He says it will take about 5 years for annuity demand to drop off and for annuity prices to fall.

In a chapter called “Carpe Diem,” Vettese argues that your 60s are the best time to take advantage of your health and spend some money doing fun things while you can. He points out the health problems that will come later and the pressures that dominate earlier decades of life. Not coincidentally, he’s in his early 60s himself. I think a 50-year old could easily make the same case for spending in one’s 50s. The same applies to people in their 40s, 30s, and 20s. I see this chapter as little more than trying to justify spending today. The truth is that we need balanced spending across all ages. No one age should be favoured. And at any age, we should be looking for ways to enjoy life that don’t take a lot of money.

Overall, I’m glad I read this book. Even though I disagreed with some parts, it gave me some new and useful ways of thinking about retirement. I recommend it mainly to people with above average incomes who have no defined benefit pensions.

Monday, April 4, 2016

Revisiting the 4 Percent Rule

Many people have opinions about William Bengen’s 4% rule for annual retirement spending. William Bernstein said that 2% is “secure as possible,” 3% is “probably safe,” 4% is “taking real risks,” and at 5% “you had better like cat food.” However, Frederick Vettese says 5% is “relatively safe” and that 6% or 7% “might not be outlandish.” Here I examine Vettese’s reasoning for these conclusions in the chapter “Revisiting the 4 Percent Rule” of his book The Essential Retirement Guide.

Bengen’s original 4% rule is based on a fictitious retiree with no spending flexibility at all. Upon retiring, the retiree chooses a yearly spending dollar amount and increases it by the cost of living each year without regard to how his or her portfolio performs. Bengen tried to figure out what percentage of your starting nest egg would give a safe spending level. Using historical U.S. stock and bond returns, he came up with 4%.  This inflexible approach is how he calculated his safe initial spending percentage, but he was clear that a real retiree may choose to increase or decrease spending in the face of a portfolio that is declining severely or growing wildly.

So, if you start with a million dollars when you retire, spending $40,000 per year rising with inflation is probably safe for about 30 years. Keep in mind that in the second and all subsequent years, you aren’t necessarily spending 4% of your portfolio each year. If your portfolio performs well, you may be spending less than 4% of what you have left, but more likely you will be spending more than 4%.

Vettese chose to interpret “4% rule” differently. He assumes that you would spend 4% of whatever is left of your portfolio each year. This implies that you are quite flexible in how much you spend. It also implies that you could never run out of money because you never spend all of it. I’ll distinguish these two approaches calling Bengen’s the “initial 4% rule” and Vettese’s the “4% each year rule.”

A major problem with the 4% each year rule is that it takes no account of your age. As your remaining life expectancy diminishes, it makes sense to be able to spend increasing percentages of your savings. With one retirement spending strategy I worked out, the percentage of your portfolio you spend is 4.17% at age 60, 4.43% at age 65, 6.17% at age 80, and continues to rise. The actual dollar amounts don’t necessarily rise, though. Your portfolio is unlikely to keep up with these ever-rising percentages, so each year you’ve spending a higher percentage of a shrinking inflation-adjusted portfolio balance. The percentages are chosen so that if your portfolio performs as expected, the yearly inflation-adjusted spending amounts remain constant.

Vettese goes on to run Monte Carlo simulations of a 5% each year rule from age 65 to 80. He assumes you’d buy an annuity at age 80. Based on these simulations he concludes that this approach is “on the right track.” The implication is that we can compare this 5% each year rule to Bengen’s initial 4% rule. But this is an apples to oranges comparison. With Bengen’s rule, unless your portfolio outperforms, you’re withdrawing more than 4% each year because his 4% refers to the starting portfolio size. In fact, Vettese may have you spending less than Bengen after the first few years.

Comparing Vettese’s 5% each year rule to my retirement strategy discussed above, I actually have you spending an average of 5.07% during the years from age 65 to 80. So, Vettese hasn’t given you an extra 1% to spend. What he’s done is boost the amount you spend in your 60s at the expense of what you can spend thereafter.

An unfortunate artifact of the 5% each year rule to age 80 is what happens after buying the annuity. An 80-year old male can buy an annuity that pays out over 9% per year. Even if the payments are indexed by 2% each year to partially offset inflation, the starting payout is still over 7%. But with Vettese’s plan, you only get to spend 5% at age 79. His simulations have you scrimping in your late 70s so you can live larger after turning 80.

Overall, just comparing the percentages (4% and 5%) in the two rules is highly misleading. The only time it makes sense is in the first year of retirement when Vettese has you spending more than Bengen does. After that, the comparison is more complex.