Friday, December 22, 2017

Short Takes: Illusion of Wealth, Bankruptcy Stories, and more

I managed only one post in the past two weeks:

Biggest Mistakes Retirees Make with Their Investments

Here are some short takes and some weekend reading:

Robb Engen explains one of the many predictable errors we make: the illusion of wealth.

Preet Banerjee interviews Scott Terrio about the ins and outs of consumer proposals and bankruptcy. Scott has some crazy stories of how far people can get into debt.

Canadian Couch Potato discusses robo-advisors with Professor Pauline Shum-Nolan. One of the themes is the fact that current robo-advisors aren’t very adaptable to the desires of clients in the types of stocks included in portfolios. I’m of two minds about this. On one hand, it’s good to give people what they want. On the other hand, when most of us act on our ideas about investing, it costs us money.

Big Cajun Man appeals to people to apply for the Disability Tax Credit (DTC). There is a lot of money at stake.

Monday, December 11, 2017

Biggest Mistakes Retirees Make with Their Investments

I was reading an interesting article by Jason Heath titled Here are the six biggest mistakes retirees make with their investments. It made me think, but one of my thoughts isn’t what you might expect.

I don’t want to pick on Jason because he’s a good guy who provides solid information in his articles. Like other Certified Financial Planners, Jason works primarily with wealthy people. Now, the definition of wealthy is different in each person’s mind. A person with a million dollars in investible assets might say the threshold of wealthy is $3 million. Someone with $3 million might say the threshold is $10 million. However, the typical Canadian would call the clients of CFPs wealthy.

Jason’s thoughtful list of the most common mistakes he sees is based on his client base and not the typical Canadian. To be fair, it’s unlikely Jason wrote his own headline, and it’s the headline that I think is wrong.

Here are a few of the biggest financial mistakes Canadian retirees have made:

Saved very little money.

Carried debt into retirement.

“Bought” RRSPs at the bank a few times, but cashed them out years ago.

For those of us who have built significant savings before retirement, I highly recommend Jason’s article to see if you’re guilty of some common mistakes. Maybe you’ll learn something profitable.

Friday, December 8, 2017

Short Takes: Shorting Bitcoin, Financial Survival, and more

Here are my posts for the past two weeks:

Finance for Normal People

Should You Delay Taking CPP and OAS?

Leaving a Spouse to Pick up the Pieces

Here are some short takes and some weekend reading:

New securities will make it possible to short bitcoin. This is very tempting, but I have to consider the possibility that some government or major set of banks might choose to back bitcoin. I certainly don’t think this is likely, but it’s enough to stop me from shorting bitcoin.

Jason Zweig interviewed Peter L. Bernstein. An important quote: “Survival is the only road to riches. You should try to maximize return only if losses would not threaten your survival and if you have a compelling future need for the extra gains you might earn.”

John Bogle offers 7 rules of successful investing.

Dan Bortolotti answers a question about fees for moving assets out of a brokerage. Will the new online brokerage cover these fees?

Ted Rechtshaffen explains “two major [conflicts of interest] that every consumer should be aware of, and I believe regulators should focus on”: one for financial advisors and the other for insurance brokers.

Big Cajun Man is looking into how much he can save in taxes with pension income splitting.

Monday, December 4, 2017

Leaving a Spouse to Pick up the Pieces

I’ve been helping an elderly relative sort out her finances and other matters since her husband died. I’ll call them Carol and Bob. This experience has made it very clear to me that both spouses need to at least be able to locate a record of account numbers and institutions, including banks, insurance companies, and utilities.

For the first year or so after Bob’s death, a friend of Carol’s tried to help. They found a few paper bank statements, and wandered into branches asking for help locating all accounts. They were ultimately able to find several accounts and were able to get some of Bob’s accounts into Carol’s name.

By the time I took over, I still had to get one of Bob’s TFSAs into Carol’s name, cancel some of Bob’s monthly automatic bank account payments, and get titles on the house and car fixed. It’s been months now and this is still ongoing.

Of course, there have been many other things to sort out, but the most painful tasks involve doing battle with large organizations like banks, insurance companies, and the government.

One outstanding item is a joint investment account at BMO Nesbitt Burns. The only records I have show it holding about $40k a year before Bob’s death. I have no record of its contents being transferred anywhere, but Carol isn’t getting any more account statements mailed to her. After a frustrating series of calls to BMO Nesbitt Burns, I found out they consolidated small accounts into a lower-service arm of the company. After that the trail went cold and all promises to call back with information have been broken. So, either Bob cleaned out this account shortly before he died, or it still exists somewhere but only has online statements. It’s very frustrating that BMO Nesbitt Burns is unwilling to tell Carol whether the account still exists. Given Carol’s modest income and bank account balances, she could really use the money.

Update: A helpful reader who works at BMO put me in touch with a manager at BMO Nesbitt Burns who tracked down what happened to the account (it went to another bank).  This story ends happily.

A lot of pain could have been avoided if Bob had either made Carol pay attention to the finances, or had at least left an up-to-date list of institutions, account numbers, and other contact information.

Friday, December 1, 2017

Should You Delay Taking CPP and OAS?

The default age to start collecting Canada Pension Plan (CPP) payments is 65. However, you can start anywhere from age 60 to 70. Less well known is that you can delay collecting Old Age Security (OAS) payments until age 70 as well. There are incentives for delaying these payments, and it’s not easy to decide whether to take lower payments early or wait for larger payments. Here I do an analysis that helped me make up my mind.


Let’s start with OAS because it’s simpler. The default starting age is 65. However, your payments increase by 0.6% for each month you delay starting to take OAS before age 70. So, if you wait until age 70, you’ll get $1.36 for every dollar you would have received when starting at 65.

It’s important to understand that these amounts are indexed to inflation. Some people mistakenly believe that someone starting to collect at age 65 would have his payments catch up to the amounts received by someone taking OAS at age 70. This is not true.

Consider the example of twins Alice and Carol. Alice plans to take OAS at age 65 and Carol plans to wait until she is 70. Suppose Alice will initially receive $600 per month, and by the time she gets to 70, inflation indexing will increase her payments to $700. At the same time Alice is getting $700, Carol’s payments will be

$700 x 1.36 = $952 per month.

For the rest of their lives, Carol will always get 36% larger payments than Alice will get. This compensates Carol for receiving nothing for 5 years.

If we ignore income taxes for the moment, we can calculate the return Carol gets on her “investment” of 5 unpaid years. This return depends on how long Carol lives. The longer she collects the larger payments, the better her investment looks. A chart below (after the discussion of CPP) shows the rate of return Carol gets depending on her age of death.

A complicating factor is income taxes. If your income is high enough, some or all of OAS payments get clawed back. People with high enough incomes that they are subject to a clawback require a more complex analysis. However, the more income you have, the less important the relatively small OAS payments are to you. For our purposes here, I assume that you will not be subject to any clawing back.

Another complicating factor for low-income people is the Guaranteed Income Supplement (GIS). My analyses here don’t apply to someone whose income is low enough to collect the GIS.


The CPP case is similar to OAS, but with more complications. The default age to take CPP payments is 65, but you’re allowed to start taking payments at age 60. The price is a 0.6% reduction for each month you start early. This means that you get 64 cents on the dollar if you start at 60.

You can delay taking CPP past age 65 as well. For each month you delay from 65 to 70, your payments increase by 0.7%. So, you get 142 cents on the dollar if you wait until age 70. (In reality, the increase is likely to be a little more than this because before you take CPP, it rises with general wages rather than inflation.)  Similar to OAS, all these amounts are indexed to inflation. If you start early, you never catch up. The boost in monthly payments from delaying the start of CPP is permanent.

A complication with CPP is that your payments depend on your history of paying into the system. There are complex dropout rules where you don’t have to count years where your income was low. I looked at two scenarios:

CPP Scenario 1: You worked steadily enough from age 18 to 60 that you get no advantage from any dropouts (except the special dropout for the years from 65 to 70), and you can drop out all the years from age 60 to 70 that you don’t work.

CPP Scenario 2: You had 7 or more years with no income from age 18 to 60 and you didn’t work past age 60. You couldn’t use any of the other special dropout rules, such as looking after children under 7.

The following chart shows the real return (the return after subtracting inflation) from delaying CPP from age 60 to 70 depending on your age at death. It also shows the real return of delaying OAS from age 65 to 70.


CPP scenario 1 is close to a best-case for delaying payments. It can get a little better if you work past 65 and use those years to replace some lower-income years. CPP scenario 2 is close to a worst case. It can be made worse if some of the special dropouts are relevant to you, but most people fall somewhere between these two scenarios.

To understand this chart, it’s important to have a sense of what levels of real returns are high and low. Historically, 5% or 6% was what a diversified 100% stock portfolio with no costs received. More realistically from today’s high stock and bond valuations, even a 4% real return is high for a disciplined do-it-yourself investor who incurs very low costs and is 100% invested in stocks. If there is a fixed-income component, this drops to 3%. Those who have a non-fiduciary financial advisor and pay mutual fund MERs might hope for 1% to 2%. Anyone whose accounts get churned will get less, whether this churning comes from impulsive client decisions or unethical advisor actions.

Armed with this information, we see from the chart that delaying CPP and OAS doesn’t look good if you don’t make it to age 80. But they look very good at 90, and fantastic if you make it to 100.

But we don’t know how long we’ll live. So, it seems we’re no closer to an answer. I focus on making it to 100 for the simple reason that I know I’ll have enough money if I die young. It’s the possibility of living long that limits my spending today.

I have enough savings to fill the gap before I’m 70. In fact, having a definite age where significant new income arrives makes it easier to plan for a portion of my portfolio to last until I’m exactly 70. Guaranteed real returns over 5% look excellent to me, so I’ll be delaying CPP and OAS to age 70.


I don’t want to work until I’m 70.

Neither do I. I don’t even plan to work until I’m 60. You don’t have to start collecting CPP the day you stop working. As long as you have the savings to last until you’re 70, you can delay taking CPP and OAS.

I want to spend some money while I’m young enough to enjoy it.

Me too. In fact, delaying CPP and OAS helps me spend more money today. By making my future income more certain, I can safely spend more of my savings before I turn 70.

Won’t a higher CPP payment mean I’d get a smaller CPP survivor pension?

The total of your CPP payments and a survivor’s pension are subject to a maximum. However, the calculation makes adjustments to nullify the effects of taking CPP early or late. See Doug Runchey’s explanation of CPP survivor benefits for all the gory details.

I read that taxes and the desire to leave an inheritance can affect this decision in many ways.

That’s true. But it’s mostly true for the rich. Skilled financial planners mostly deal with wealthy people and write about their concerns. These are the people who are trying to figure out how they can spend $11,000 per month instead of just $10,000. People who have to get by on less have simpler choices to make.

The thought of dying before age 70 and getting nothing for all my CPP pay deductions drives me insane.

Try to focus on the fact that if you live long enough, the government will pay you more than they expected.

Everyone in my family dies young.

If you’re absolutely certain you won’t live to old age—so certain you have no intention of planning for it at all—then take CPP and OAS early. However, if you think living past 85 is a possibility, consider delaying CPP and OAS.

A bird in the hand is worth two in the bush.

We’re wired to make decisions that are good in the short term. Fortunately, a sequence of good short- to medium-term decisions usually leads to acceptable long-term results. However, CPP and OAS are cases where our tendency to take money now often doesn’t lead to the best long-term outcome.


It’s certainly not the case that all people should delay CPP and OAS until they’re 70. However, many who take CPP and OAS as early as possible would be better off waiting for larger payments.

Monday, November 27, 2017

Finance for Normal People

Standard financial theory treats us as though we are all perfectly rational people who make no mistakes in maximizing our utilitarian benefits with each of our financial choices. In reality, we’re emotional creatures who have desires outside of utilitarian needs. We have limited time and ability to evaluate choices, and we make lots of mistakes.

Many books have been written about how people fail to make the best rational choices. What sets Meir Statman’s Finance for Normal People apart is his attempt to unify real human nature into a realistic theory of finance.

“We want three kinds of benefits—utilitarian, expressive, and emotional—from all products and services, including financial products and services.” We’re used to focusing on utilitarian benefits such as maximizing portfolio returns. However, we also seek “the expressive benefit of high social status, as by a hedge fund; and the emotional benefits of exhilaration, as by a successful initial public offering.”

Sometimes we make cognitive and emotional errors, but this is distinct from seeking expressive or emotional benefits. Feeling good has value. It is perfectly sensible to add up utilitarian, expressive, and emotional benefits when making a choice. It’s a cognitive error when we misjudge benefits.

For example, it’s sensible for a wealthy person to say “I have more money than I need, and I don’t mind sacrificing some returns when I pick my own stocks.” For almost all people, it becomes a cognitive error when we believe that our own stock picks will beat the market. “Investors who believe they can pick winning stocks are regularly oblivious to their losing records, recording wins as evidence confirming their stock-picking skills but neglecting to record losses as disconfirming evidence.”

Because we have limited time and attention, we use cognitive and emotional shortcuts to make decisions. This works well most of the time. “Cognitive and emotional shortcuts turn into errors when they take us far from our best choices.” Keep in mind that “best choice” is defined in terms of all types of benefits: utilitarian, expressive, and emotional.

One type of cognitive error we make is called a “framing error.” Stock traders who “frame the trading race as between them and the market” are making an error. “Traders possessing human-behavior and financial-facts knowledge frame trading correctly as against traders on the other side of the trades—the likely buyers of what they sell and likely sellers of what they buy.”

In everyday language, we use “rational” to mean roughly the same as “smart.” “Financial economists, however, use the term more narrowly” to refer to people who “want only utilitarian benefits from investments.” While there is no utilitarian benefit from buying your date a rose, it is perfectly rational in the everyday sense of the word.

Statman criticises those who advise us “to set emotions aside when we are making financial choices, and use reason alone.” He says that “we cannot set emotions aside,” and that “emotional shortcuts complement reason.” I think this apparent disagreement is mostly semantic. I suspect both sides would agree that it makes sense to think carefully about big financial decisions and avoid making a snap emotional choice. Those with less technical knowledge in behavioural finance than Statman has might compress this advice to “keep emotions out of it.”

Even optimism can lead to emotional errors. “Optimism enhances our daily life as we contemplate an enjoyable future, but optimism has downsides.” A study of Finns found that “Optimism can lead to excessive debt loads.”

On the question of whether financial advisers help investors avoid cognitive and emotional errors, Statman says “Evidence indicates that financial advisers improved the financial behavior and well-being of both working and retired people.” I scanned the four papers he references that offer evidence of financial adviser benefits. I suspect that the benefits are greatest for those with enough money to get advice from a fiduciary. Those getting “suitable” advice likely benefit less, if at all.

In an example of understatement, Statman says that many firms, including “banks, hotels, health clubs, mutual fund companies, and credit card companies” “choose to exploit their customers’ errors, such as by hiding information or shrouding it.” A good example of this is the 7-page confusing investment account statements I get that bury mandatory disclosures about fees near the end.

All is not lost. “We are susceptible to cognitive and emotional errors, yet can correct them by human-behavior and financial-facts knowledge.” So admitting we make mistakes and understanding them can help us make better choices in the future.

“Expected-utility theory and prospect theory are two theories that assess happiness and predict choices. Expected-utility theory was introduced by mathematician Daniel Bernoulli.” My assessment of Bernoulli’s paper is that he was not trying to predict choices. He was saying how people should make choices, not how they actually do make choices. It may be that later economists incorrectly claimed that people actually make choices based on expected-utility theory, but I’ve seen no evidence that we should pin this on Bernoulli.

We’d like to think we’re not susceptible to trying to keep up the Joneses, but a study showed that lottery winners “increased visible assets, such as houses, cars, and motorcycles,” and this caused a “rise in subsequent bankruptcies among the close neighbors of these winners.”

I won’t repeat discussions of parts of this book I’ve discussed before about the dividend puzzle, portfolio optimization, and the annuity puzzle.

In a discussion of sustainable spending in retirement, Statman claims that “Older people in developed countries reduce their spending substantially starting at about age seventy and accelerating afterwards.” The reason, he says, is “physical limitations make them less able to spend, such as on travel, and because they are less inclined to spend for personal reasons.” He points to Fred Vettese’s work to justify leaving out what I think is the dominant reason retired people begin spending less: they overspent in their first few years of retirement. I wrote a critique of Vettese’s arguments in a previous article.

When investing, we seek more than just utilitarian benefits; we also seek expressive and emotional benefits such as “holding socially responsible mutual funds, the prestige of hedge funds, and the thrill of trading.” Unfortunately, investments with high expressive and emotional benefits “tend to be associated with high prices and low expected returns.”

Cognitive and emotional errors hurt our returns as well. Some examples are the “belief that stocks of admired companies are likely to yield higher returns than stocks of spurned companies, and that frequent trading is likely to yield higher returns than rarer trading.”

Statman goes through 5 possible explanations for the higher “factor” returns of value stocks and small-cap stocks. The first three explanations come from standard financial theory, and the final two come from behavioural financial theory. He concludes that behavioural financial theory explanations are more likely: “the evidence favors the emotional-errors and wants hypotheses over the data-mining, risk, and cognitive-errors hypotheses.”

To the growing list of investing “factors” such as value stocks and small-cap stocks, Statman adds some possible behavioural factors. One example is that stocks that rank low on social responsibility likely having higher returns.

In a discussion of three forms of the efficient market hypothesis (EMH), it struck me that the definitions seem to be based mostly on access to information and whether it is possible to profit from it with short-term trading. However, the best example of an investor who defies the EMH, Warren Buffett, made his billions with long-term investment. His advantage seemed to have less to do with having exclusive information and more to do with being better able to analyze how a company’s culture and strategy will play out over the long term.

Overall, I found this book to be very helpful at taking what I’ve learned elsewhere about human behaviours and mistakes and putting them in a useful context and framework. Our expressive and emotional needs aren’t mistakes; the mistakes come when we over- or under-value them. Statman says “I hope you see yourself in this book and learn to identify your wants, correct your errors, and improve your financial behavior.”

Friday, November 24, 2017

Short Takes: Driving Undercover in Uber and Lyft, and more

Before launching into this biweekly roundup, our friend the Blunt Bean Counter played a role in a BDO Canada survey of business owners and non-business owners about retirement and wealth. Here are some of their findings:
  1. Business owners plan more for retirement than non-business owners but feel less on track.
  2. Almost one-third of business owners plan to work part-time after retirement – compared to 12 percent of the general population.
  3. More than one in three business owners plans to retire in the next five years.
  4. Financial support for children was more common among the business owners than among non-business owners.

Here are my posts for the past two weeks:

The Dividend Puzzle

Portfolio Optimization

The Annuity Puzzle

The High Cost of Paying Property Insurance Monthly 

Here are some short takes and some weekend reading:

Mr. Money Mustache describes his experience driving for Uber and Lyft. He has a number of suggestions for making the system exploit drivers less.

Canadian Couch Potato interviews Nobel Prize winning professor of economics, Robert J. Shiller. I found Shiller’s remarks on real estate to be particularly interesting.

CBC Marketplace reports that car dealerships push long-term loans and disguise “negative equity,” which means the debt that results from owing more on your car loan than your car is worth.

Jason Zweig explains that not all index funds are run well and sometimes investors suffer.

Garth Turner found a real estate agent who makes it sound like the mortgage rule changes will make you lose money.

Big Cajun Man found that while he was ill, he let parts of his personal finances slide.

The Blunt Bean Counter explains how Canadian CPP/OAS and U.S. Social Security are harmonized with a “Totalization Agreement” between the two countries. See the first post on this topic as well.

Boomer and Echo review Dollars and Sense by Dan Ariely and Jeff Kreisler. It’s worth taking a chance on any book written by Ariely.

Wednesday, November 22, 2017

The High Cost of Paying Property Insurance Monthly

Update: An anonymous commenter says that when a down payment is charged on property insurance, contrary to what our insurance agent told us, monthly payments end after 10 months and not 12.  The article has been updated accordingly.

Recently, I was helping a family member switch property insurance companies. The last thing to arrange was paying the premium. The insurance agent was steering us toward monthly payments instead of paying for the full year in advance.

At first I was just going to dismiss the idea of paying monthly, but I decided to ask the agent what interest rate they charged. I think his exact words were “there is a 4% service fee.”

For the purposes of this article, I’ll scale all the numbers to an annual insurance premium of $1200 to keep the math simple. I took the insurance agent to mean that they take the $1200 premium, add 4% to get $1248, and divide by 12 to get $104 as the monthly premium. This turns out to be only partially correct.  In addition to the monthly charges, the insurance company wanted a $200 “down payment.”

This is where the uncertainty comes in.  Although we were told the payments would last for 12 months, it seems plausible that our agent was wrong and that they would end after 10 months.

So, the $1200 premium led to a total of $1448 in payments if paid monthly for 12 months. After doing some figuring, I said “that service fee of 4% is more like 4% per month.” The agent’s reply was a simple “yes.” Needless to say, we just paid the full annual amount of $1200.

Later on when I had time for more accurate calculations, I worked out the internal rate of return on these payments to be 3.58% per month, which compounds to 52.6% per year!

However, if the payments were only going to last for 10 months, then the total paid would be $1240, and the annual interest rate charged would be 9%.  It's misleading to characterize 9% interest as “a 4% service fee,” but this is a long way from charging over 50%.

I recommend trying to find out the total of all payments you'll make when paying monthly and compare this total to the annual premium.  This will give you some idea of the cost of paying monthly.

Tuesday, November 21, 2017

The Annuity Puzzle

A big challenge in retirement is spending enough to be happy without running out of money. The main problem is not knowing how long you’ll live. This is called “longevity risk.” We are forced to plan for a long life whether we’ll live long or not.

One way to eliminate longevity risk is with an annuity. The idea is to hand your money over to an insurance company, who then promises to pay you monthly, even if you live much longer than they expect.

According to Meir Statman in his book Finance for Normal People, “people are reluctant to annuitize, a reluctance we know as the ‘annuity puzzle.’” Statman identifies a number of “behavioral impediments to annuitization.”

We are averse to “transparent dips in capital.” Seeing your portfolio take a big drop hurts, even knowing that you’ll get lifetime income in return. Also, the “money illusion” makes “a lump sum of $100,000 seem larger than its equivalent as a $500 monthly annuity payment.”

“Availability errors deter people from annuitizing further because images of outliving life expectancy are not as readily available to people as images of many kinds of death that might befall them soon after they sign an annuity contract.” Regret aversion is also involved because of the possibility “their heirs would receive only pennies on the annuity dollar.”

Finally, we get to the easiest-to-understand reason for avoiding annuities: they have a “smell of death.”

All these behavioural reasons that people avoid annuities sound perfectly plausible. However, there are also rational utilitarian reasons for avoiding the annuities available to people.

First, let’s consider a simple fixed payout life annuity. The return on such annuities is a mixture of long-term bond rates, mortality credits, and embedded fees. This forces people who prefer the higher expected returns of stock investments to give them up to get mortality credits. One good solution might be to take just your bond allocation and buy an annuity if the embedded fees aren’t too high. But, it can be quite reasonable to prefer to keep a significant allocation to stocks.

There are annuities available whose variable payouts are related to stock investments. However, the investment fees buried inside these products are extremely high.

If we had an annuity option that resembled a well-run shared-risk pension plan, then it would certainly make sense for people to use it to get the advantage of mortality credits. Until this is available, expect this annuity puzzle to persist.

Monday, November 20, 2017

Portfolio Optimization

Deciding what percentage of your portfolio to allocate to bonds, domestic stocks, foreign stocks, etc. can be challenging. Any attempt to optimize this allocation is necessarily based on assumptions. It’s dangerous to blindly follow optimized allocation percentages without examining the assumptions built into the optimization process.

In his book Finance for Normal People, Meir Statman tells the story of investment consultants choosing asset allocation percentages for a large U.S. public pension fund. The consultants used Harry Markowitz’s mean-variance portfolio theory to calculate an optimal portfolio for the pension fund. But then they modified all the percentages.

Statman’s explanation for why the consultants changed the percentages is that the managers of the pension fund wanted more than the “utilitarian benefits of higher expected return”; they wanted “expressive and emotional benefits, including the benefits of conformity to the portfolio conventions of this pension fund and similar pension funds.”

Statman may be correct in this assessment, but there is another reason for rejecting the recommended percentages from mean-variance portfolio theory. This reason is based on strictly utilitarian benefits and not expressive or emotional benefits.

The basis for mean-variance portfolio theory is that investment returns follow what is called a lognormal distribution. This model does a decent job for most of the range of possible investment returns, but it vastly underestimates the chances of extreme events. Unfortunately, making sure you can survive extreme events is a very important part of portfolio allocation.

If returns really conformed to mean-variance portfolio theory, then rational investors would be using a lot of leverage (investing with borrowed money). To compensate for the tendency of mean-variance portfolio theory to recommend risky portfolios, we usually choose a low value for the standard deviation of portfolio returns we can tolerate. This helps but isn’t a perfect solution.

There are other stable distributions that do a better job of modeling extreme investment returns. Unfortunately, they are harder to work with. In fact, their standard deviations are infinite.

Statman may be right that the primary reason why people deviate from portfolios optimized by mean-variance portfolio theory is that they seek expressive and emotional benefits. However, trying to protect portfolios against extreme events is another good reason.

Tuesday, November 14, 2017

The Dividend Puzzle

The strong preference many investors have for dividends over capital gains is known among economists as the “dividend puzzle.” Meir Statman offers a solution to this puzzle in his book Finance for Normal People.

Statman says that many investors incorrectly “frame the capital of a stock as a fruit tree and dividends as its fruit. In that frame, collecting dividends and spending them does not diminish the capital of the stock any more than picking fruits off a tree and consuming them diminishes its size.”

“Rational investors know the correct frame for dividends and capital. They know that $1,000 in ‘homemade’ dividends from the sale of shares is identical in substance to $1,000 from a cashed dividend check, even if different in form, and they care about their total wealth, not its form.” Because the “price of shares of a company declines when a company pays dividends,” “payments of dividends do not affect the total wealth of investors.”

All that said, dividends do offer some advantages when we consider “expressive and emotional benefits” rather than just utilitarian benefits.


“Young investors bolster their self-control by setting separate mental accounts for income, including salary and dividends, and capital, including stocks. They add a rule—‘spend income but don’t dip into capital.’” Investors who create homemade dividends are more likely to succumb to temptation and “turn a 3 percent homemade dividend into a 30 percent homemade dividend.”

Sticking to a rule of not spending capital “also benefits older investors who draw money from their portfolios for retirement expenses and worry that self-control lapses would turn” their intended 3% home dividend into larger withdrawals.

Mental prohibitions against spending capital are so strong that when a company is forced to suspend its dividend, some shareholders living off dividends do “not even contemplate creating homemade dividends by selling [some] shares.”

Hindsight, Regret, and Pride

“Compare John, who buys a laptop computer for $1,399 with dividends received today from shares of his stock, to Jane, who buys the same laptop today with $1,399 homemade dividends from the sale of shares of the same stock.”

If the stock later goes up, Jane will feel regret for not having waited to sell, but John won’t feel this regret. Of course, if the stock later drops, Jane would feel pride for selling when she did, and John won’t feel this pride. “Consistent with loss aversion in prospect theory,” Jane would feel regret stronger than she would feel pride. So, on balance, John comes out ahead.


There is another emotional advantage to dividends that comes from the way that capital gains are framed with and without an associated dividend. This topic is somewhat technical, and so I’ll leave it to those who choose to read Statman’s book.

So, even though rational investors focus on total returns rather than over-valuing dividends, normal investors get some expressive and emotional advantages from dividends.

Friday, November 10, 2017

Short Takes: Amazon Nonsense, Extended Warranties, and more

I managed only one post in the past two weeks, a review of two books:

The Smartest Investment Book and Portfolio

Here are some short takes and some weekend reading:

Tom Bradley at Steadyhand is almost as cynical as I am about Amazon’s long, drawn-out “search” for a second headquarters location. I hope this whole PR event backfires for Amazon. In another article he discusses the elements of academic behavioural economics that he sees in practice.

Squawkfox has some sensible advice about extended warranties.

Gordon Pape shares important things you should know about traveling to Florida for the winter. His advice on this subject is far superior to his investment advice.

Big Cajun Man clarifies some of the rules surrounding Registered Disability Savings Plans (RDSPs).

Friday, November 3, 2017

The Smartest Investment Book and Portfolio

There is little doubt that the vast majority of investors would be better off investing in low-cost diversified index funds than attempting to beat the market. However, the best writers explaining this fact, like Charles D. Ellis, tend to be calm and reasonable, while the loudest proponents of expensive active management say silly alarmist things like “index funds will destroy capitalism.”

One voice on the index fund side that can take on hysterical active management proponents is Daniel R. Solin. His books The Smartest Investment Book You’ll Ever Read (Canadian Edition) and The Smartest Portfolio You’ll Ever Own pull no punches. While I prefer Ellis’s style, I like Solin’s chances of holding his own in a public debate.

Solin refers to active portfolio selection as “hyperactive management.” He says “The securities industry adds costs. It subtracts value.” He devotes many pages to the numerous failings of the investment industry. While he overstates some of his points (e.g., “Nobody Can Consistently Beat The Market”), most investors would do well to assume his absolutes are correct.

The 2006 book, The Smartest Investment Book You’ll Ever Read (Canadian Edition), is starting to get a little dated, but is still very useful. Many Management Expense Ratios (MERs) for index funds are now much lower, and there are more Exchange-Traded Fund (ETF) choices than there were back then. On the positive side, this Canadian edition really does have meaningful Canadian content.

The 2011 book, The Smartest Portfolio You’ll Ever Own, covers some of the same ground as the first book, but covers new ground as well. It offers several model portfolios. One ETF-based portfolio is essentially the same as the one recommended in the first book. Another portfolio is based on index mutual funds. A third is based on Vanguard target-date funds.

Solin calls these three model portfolios the “smartest portfolios.” To distinguish a fourth model portfolio from these three, he calls it “The SuperSmart Portfolio.” This portfolio is based on ETFs and is designed to capture size and value factors based on the Fama-French three-factor model. All four portfolios are intended for Americans, so Canadians will have to try to adapt them to investment choices available to us.

Here are a few interesting quotes:

“Wall Street is not completely lacking in skill. It takes considerable skill to convince you it has an expertise that doesn’t exist and that you should pay for this nonexistent skill.”

“Just say no to: Market timing; Buying individual stocks and bonds; Actively managed mutual funds; Alternative investments; Variable annuities; Equity indexed annuities; Private equity deals; Principal-protected notes; Currency trading; Commodities trading.”

“The true secret of giving advice is, after you have honestly given it, to be perfectly indifferent whether it is taken of not and never persist in trying to set people right.—Hannah Whitall Smith”

“If you are using a broker or adviser who claims to be able to beat the market, withdraw your money and close your account.”

Toward the end of the 2011 book, Solin gives somewhat of a commercial for Dimensional Fund Advisors (DFA), and he admits to being an advisor offering their funds. However, this comes after the bulk of the book that offers advice suitable for do-it-yourself investors.

Overall, I find these books useful for giving readers the indexing side of the active vs. indexing debate. Academics might cringe at the repeated absolutes, but the impact on readers is likely to be positive.

Friday, October 27, 2017

Short Takes: Free Trials, Trailer Fees, and more

Here are my posts for the past two weeks:

Cheerleading for Home Ownership

Burn Your Mortgage

Here are some short takes and some weekend reading:

Ellen Roseman calls on credit card companies to do more to prevent “free-trial” credit card fraud. One problem I see here is that while some such offers are clearly deceptive, some aren’t as easy to identify. Another problem is the conflict of interest for credit card companies. My personal rule is that if it’s a free trial, then they don’t need my credit card number.

Tom Bradley at Steadyhand says that even though the battle over banning trailer fees rages on, the writing is on the wall. I hope he’s right that “Trailer fees are going the way of the dodo bird.”

Big Cajun Man isn’t very happy with the amount of his charitable contributions going to overhead.

Robb Engen at Boomer and Echo monitors the progression of his human capital into financial capital.

The Blunt Bean Counter summarizes planned changes to taxing private corporations.

Thursday, October 19, 2017

Burn Your Mortgage

Many people are familiar with Sean Cooper’s story of living extremely frugally for a few years while he saved up a large down payment, bought a home, and paid off his mortgage by age 30. Cooper built on the interest in his story by writing a book called Burn Your Mortgage. I expected to like this book because I believe paying off your mortgage and any other debts is a good idea (I paid off my first mortgage by age 28). However, despite many good parts of the book, there is too much cheerleading for home ownership for me to recommend it.

A common theme throughout this book is treating rising housing prices as a permanent reality. “The last thing you want is to find yourself priced out of the market.” “It’s probably wise, if you’re in the financial position to do so, to buy now while you can still afford to.” Even though this book came out in 2017, it already has a dated feel now that home prices have been dropping in Vancouver and Toronto.

Another part of this theme of rising house prices is the claim that real estate has been a better investment than stocks. See my recent post on cheerleading for home ownership for one example. Another is a chart of home sale prices from 1980 to 2015 with the caption “Canadian real estate prices have been trending upward over the past 25 years. That’s more than we can say about the stock market over this same time.” I can’t do better than John Robertson’s image of the S&P 500 total return superimposed on Cooper’s home price chart.

The early chapters of the book cover advice on basic personal finances building up to how to save up for a down payment. One quote I particularly liked is “It’s not how much you make; it’s how much you save.” The more I see of other people’s finances, the more I realize that overspending can happen at any income level.

One section offers “25 Ways to Save Big.” This is a decent list of things that many people buy mindlessly, but each item includes a suggested amount of annual savings that just seems random. This attempt to quantify savings marred an otherwise interesting list.

Some of the advice is too superficial for readers to follow without a lot more knowledge. One example is “Carefully weigh the pros and cons of a car loan versus leasing to see what makes the most sense.” This ignores the best option: save up and pay cash for a car. Another problem is that those who just compare monthly payments might think they’re following this advice.

There are advantages and disadvantage to using the Home-Buyer’s Plan (HBP) to use RRSP assets for a down payment, but Cooper’s justification is pure FOMO: “in this crazy real estate market where home prices are rising a lot faster than wages, it’s hard to turn down a 30% risk-free return.” To start with, the HBP allows you to increase the size of your down payment with money you’ll have to pay back later; this is not the same as a 30% return. Further, it’s dangerous to make big financial decisions based on the belief that house prices will keep rising.

The second part of the book contains a lot of useful advice on the details of buying a house. Cooper even allows that “sometimes it makes sense to rent until you’re financially ready to buy a home.” More excellent advice is to “Love They Neighbour.” It’s difficult to understand how important it is to work at getting along with neighbours until you’ve had a bad neighbour. “A good neighbour can make your time at home pleasant; a bad one can make it a living nightmare.”

I was suspicious of a quote Cooper attributes to Warren Buffett: “To build true long-term wealth, you must buy and hold real estate.” This turns out to be from a list of 13 Buffett quotes that were “translated” for real estate investors. The actual Buffett quote is “Our favorite holding period is forever.” But Buffett is referring to the businesses his company owns, not real estate. This is another example of true believers in some investment approach trying to recruit Buffett as one of their own.

In a section listing the pros and cons of buying a home, one of the pros is “forced savings.” There is some truth in the idea that forced savings helps people, but as Rob Carrick once said, a home comes with “forced spending” as well. Curiously, Cooper says forced saving is good because “Most people put their mortgage ahead of all other debts.” If you’re paying off your mortgage and allowing other debts to grow, that’s not forced savings. You’re not saving anything if your net worth isn’t growing.

One section contains some good, detailed advice on choosing a real estate agent. However, along with several good ideas is the advice to “Visit their website to read testimonials.” That’s not a good idea. For some reason humans are wired to be influenced by stories, even when they are deliberately misleading. In Ontario, regulated health professionals aren’t even permitted to publish testimonials.

In a discussion of mortgages and how much you can borrow, Cooper discusses the two main debt ratios. For the gross debt service ratio, he recommends that we “aim for a GDS ratio 30% or below (up to 35% in pricey real estate markets).” For the total debt service ratio, he recommends that we “aim for a TDS ratio of 37% or below (up to 42% in high-cost cities).” This idea that it’s okay to borrow more in hot markets is nonsense. You can’t suddenly handle more debt just because houses are expensive. And hoping to get bailed out by prices continuing to rise after you buy is a bad plan.

In a section discussing the pros and cons of mortgage brokers, Cooper says they have “No cost.” This is just wrong. The broker’s fee is baked into the rate you get. Now, it could be that a mortgage broker can still get a better rate than you could negotiate yourself from a lender, but that doesn’t mean the broker has no cost. Any time it seems like someone is working for you for free, you’re probably missing something.

A good section on breaking a fixed mortgage explains how expensive this can be. Many people would be shocked to learn that it could cost $20,000 or more to break their mortgage. A statistic that surprised me is that “70% of people change their mortgage before the end of its term.” Presumably, this doesn’t always involve a huge penalty, but such penalties are common enough that home-buyers should understand this potential cost.

The book’s last section covers topics that come after you’ve bought your home such as insurance, wills, and becoming a landlord. Becoming a landlord isn’t for everyone, but those who choose this path get some useful advice from Cooper on pitfalls and good practices.

“A rental property is the ultimate solution to building long-term wealth and achieving financial freedom.” I disagree. I’ve known too many people who tried to make money this way and ended up losing a lot of time and money. It takes a certain personality type to be able to deal effectively with tenants and to negotiate with various types of contractors for repairs and upgrades. You also need to develop a keen sense of the value of real estate to buy and sell at good prices. Only a small minority of people seem to do well at being a landlord. It’s much easier to build wealth with passive investments in the stock market.

An appendix lists a number of “side hustles” to make some extra money. This list of ideas can be a good starting point for an energetic person seeking ideas. One that made me cringe, though, is “If you’re healthy, get paid to test out new drugs.” Yikes!

The best parts of the book discuss frugal living and the advice on important details of the house-buying process and becoming a landlord. However, if asked whether I’d recommend this book to my sons, I’d have to say no; they are bombarded with enough messages to buy now while they still can. I think they’re better off using price-to-rent ratios to decide when to rent and when to own.

Tuesday, October 17, 2017

Cheerleading for Home Ownership

I’ve been a happy homeowner for many years now. I prefer owning my home to renting. But I have no illusions that this is the better choice financially. Price to rent ratios today mean I’d very likely come out far ahead if I sold my house and started renting a comparable house. But I’m not going to sell because I choose to pay the price of ownership. Unfortunately, many homeowners need to believe they will win financially, and they come up with poor analyses to justify this belief.

One such example comes from Sean Cooper’s book, Burn Your Mortgage:

“Let’s say you bought a home a decade ago for $250,000, with only 10% down ($25,000). You later sold it for $400,000, making $125,000 in profit (for simplicity’s sake, we’ll ignore associated costs such as mortgage interest, mortgage insurance, property taxes and closing costs). Even though your home only went up in value by 60%, that’s a 500% return on your initial investment (down payment) of $25,000. Try finding that kind of return in the stock market!”

For accuracy’s sake, let’s sacrifice some of the simplicity of this analysis. Let’s assume your mortgage rate was 3% for the past 10 years, and you had to add CMHC insurance of $5000 to your mortgage. This gives mortgage payments of $13,060 each year on a starting mortgage balance of $230,000. After 10 years, your mortgage balance dropped to about $157,800 so that your equity was $242,200.

Let’s say your annual property taxes were $4000, total maintenance costs averaged $6000 per year, and insurance was $1000 annually. When you bought the house, the closing costs were $10,000, and when you sold it, the real estate fees and other costs totaled $20,000.

It wouldn’t be fair to stop here because you are getting the benefit of living in the house. So, we have to factor in rent. In my area, a place that would have sold for $250,000 a decade ago and is worth $400,000 today would have rented for an average of about $1500 per month over the 10 years. Let’s say the extra utilities an owner has to pay that are usually included in rent come to $2000 per year.

Grinding these numbers through a spreadsheet, we find that the internal rate or return on this investment was 8.7% per year. Somehow we went from an eye-popping 500% return to a pleasing, but down-to-earth return, despite a 60% increase in house price and 10:1 initial leverage.

What would have happened if your home’s value had only risen to $300,000? The internal rate of return would have been -1.2% per year. That’s right—even if your house appreciates by 20%, you can lose money on the investment.

Never trust simple analyses of the investment value of owning a home. The reality is almost always much worse than it appears. Having said all that, I own my home and don’t plan to sell. But I don’t own with the expectation of making a profit.

Friday, October 13, 2017

Short Takes: Income Swings, Buy vs. Rent, and more

Here are my posts for the past two weeks:

Stock-Picking Skill

Liberating Your Losers

The Success Equation

Here are some short takes and some weekend reading:

A new C.D. Howe Institute study concludes that Canadians whose incomes vary from year to year face an unfair tax penalty and that reforms are needed. I agree. My income is highly variable, and it seems unreasonable that during good years I’m incented to delay new work until January.

John Robertson gives a thoughtful and balanced discussion of whether to buy or rent a home.

Robb Engen at Boomer and Echo explains why he doesn’t hold bonds in his portfolio.

Big Cajun Man liked Doug Hoyes’ book enough to lift a few ideas from it.

Thursday, October 12, 2017

The Success Equation

Success in most endeavours is a combination of skill and luck. As Michael L. Mauboussin explains in his book The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing, we have a tendency to decide we were skillful when we succeed and unlucky when we fail. We make many other mistakes as well when it comes to recognizing the role of luck in our lives. Mauboussin teaches methods of measuring skill and luck.

Some activities involve little or no luck, such as chess or checkers. If a chess master beats me soundly at one game of chess, he or she is likely to beat me another 10 times in a row. Other activities involve to skill at all, such as roulette and lotteries, unless you count not paying as a skill. A test of “whether an activity involves skill: ask whether you can lose on purpose.” If you can lose on purpose, there must be some skill involved. Most activities, like sports, business, and investing, combine luck and skill.

It turns out that there are statistical techniques to measure the contributions of skill and luck to success. For example, using such methods we can measure the amount of luck involved in single-season records of sports teams. From most skill to least skill we have the following ranking: basketball, soccer, baseball, football, and hockey.

Even though there is so much luck in sports outcomes, fans are quick to blame their heroes for the loss of a single game. But even if you don’t make that mistake, don’t be too smug. We also attribute way to much skill to CEOs who often just get lucky, and we definitely attribute too much skill to investors who get lucky in the markets.

One study found that skill at handling day-to-day finances increases to age 53, on average, and declines thereafter. I guess that means I can expect a low, slow descent that ends with an inability to tell door-knockers to get off my property.

With activities that involve a lot of luck, like investing, “the focus must be on process” rather than on outcomes. Reinforcing poor choices just because they work out well isn’t a good path to success. A challenge with focusing on process is that you have to know a good process. Mauboussin summarizes Benjamin Graham’s approach to value investing as an example of a good process. This approach worked well in Graham’s day, but even he was no longer an advocate of his methods back in 1976. Since then, the stock market has become much more competitive requiring ever more sophisticated means of outsmarting other investors.

Not many books leave me pondering their contents after I’ve finished reading them, but this is one such book. If you want to compete in a complex area where feedback is clouded by luck, such as active investing, it pays to understand the lessons Mauboussin teaches.

Tuesday, October 10, 2017

Liberating Your Losers

Recently, Jonathan Chevreau wrote about a way to try to save money on taxes called “liberating your losers” from your RRSP. It’s no fun owning a losing investment, and when it’s in your RRSP, you don’t even get a capital loss for your taxes. Chevreau offers a way to reduce the sting. Unfortunately, it doesn’t work.

The idea is to withdraw a losing investment from your RRSP so that when it rebounds, you’ll only pay capital gains taxes on 50% of the increase. If you leave the investment in your RRSP you’d end up paying taxes on 100% of the increase when you eventually withdraw the assets from your RRSP/RRIF.

According to Chevreau’s broker friend, this makes sense “when you have had bad timing in your RRSP/RRIF investment choices; when you're confident your investment will return to its previous higher value; and if you prefer to pay tax on 50 per cent of a capital gain rather than 100 per cent of income.” The first condition just means you’ve made an investment that lost money, and the third condition is that you’d rather pay less tax.

Unless you’re Warren Buffett, the middle condition (that you’re confident the investment will rebound) requires you to hallucinate that you have investment skill that makes your judgment of the investment’s value better than the collective judgment of all other investors. If this is true, why not invest more in this investment that’s sure to rebound? The truth is that this investment is no more likely to generate future profits than any other investment you might choose in the same class. However, even if you’re right about the investment rebounding, the strategy of liberating your losers doesn’t make sense, as I’ll show.

To avoid making mistakes analyzing investments inside and outside RRSPs, it helps to think of part of your RRSP belonging to the government. If you expect to pay 40% tax on RRSP/RRIF withdrawals, then think of your RRSP as only 60% yours. Whatever gains your investments make in the future, the government will get 40%, so you might as well think of 60% of the money belonging to you and growing for you, and 40% for the government. The government bought this slice of your RRSP back when you got a tax refund on your contribution.

Thinking about the government owning a chunk of your RRSP isn’t pleasant, but it can keep you from making mistakes when thinking about different strategies. A silver lining is that the 60% of your RRSP that’s yours is completely tax-free. All the taxes you owe are taken into account by allocating 40% of your RRSP to the government.

Getting back to the strategy of liberating your losers, let’s consider an example. Suppose you invested $25,000 in XYZ stock within your RRSP a few years ago and its value has dropped to $5000. Now you’re considering liberating your losers and hoping to save on taxes. The truth is that only $15,000 of that initial investment was yours, and only $3000 is currently yours. If you withdraw your XYZ stock from your RRSP, you’ll have to pay $2000 in income taxes.

By doing this you’re actually increasing your stake in XYZ stock. Before the withdrawal, you really only owned $3000 worth of XYZ stock, and afterward you owned $5000 worth. This suggests an alternative strategy: leave the XYZ stock in your RRSP and buy $2000 worth of XYZ outside your RRSP.

Let’s name these strategies “liberate” and “buy more.”

Liberate: Withdraw $5000 worth of XYZ stock from your RRSP and pay $2000 in taxes.

Buy more: Leave the XYZ stock in your RRSP and buy $2000 more XYZ for your non-registered account.

Suppose XYZ stock doubles. Which strategy is better? In the liberate case, you own $10,000 worth of XYZ stock in your non-registered account, and you have a $5000 capital gain that will generate $1000 in taxes when you sell.

For the buy more strategy, you have $10,000 worth of XYZ in your RRSP (of which only $6000 is really yours), and you have $4000 of XYZ in your non-registered account for a total of $10,000 worth of stock. You have a $2000 capital gain that will generate $400 in taxes when you sell.

One difference between these two strategies is that you’ll pay more capital gains taxes with the liberate strategy. Another is that further gains will generate more capital gains taxes with the liberate strategy. This is what I assume Jamie Golombeck meant when Chevreau quoted him as saying “But you then lose your tax-free compounding indefinitely, which is why I don't like it.” It’s clear that the buy more strategy is superior.

But what about all the extra tax you’ll pay when you ultimately sell your XYZ stock and withdraw the money from your RRSP/RRIF? It’s true that the government will get more tax with the liberate strategy. But that’s because you invested $2000 in XYZ stock on the government’s behalf in your RRSP and it doubled. With the buy more strategy, both you and the government came out ahead. Unless you hate the government so much that you’d rather both lose than both win, I suggest just focusing on your own after-tax gains.

Does liberating your losers make sense if you’re forced to make a RRIF withdrawal, but you don’t need the money to live on? The short answer is no. In this case, the “buy more” strategy changes but is still superior to the liberate strategy if XYZ stock is going to perform better than your other investments.

The alternative to liberating XYZ stock begins by choosing $8333 worth of some other investment(s) within your RRIF that you think will perform worse than XYZ. Sell 40% of these investment(s) and buy XYZ stock with the resulting $3333. Use the remaining $5000 of the investment(s) to make an in-kind withdrawal from the RRIF. If XYZ outperforms the other investment(s), then after working through the details, you’ll find that this strategy works out better than liberating your losers.

In summary, liberating your losers is a bad idea. It only seems good when your understanding of RRSP/RRIF taxation is muddled.

Thursday, October 5, 2017

Stock-Picking Skill

When researchers talk about someone having skill at stock-picking, they are using the word “skill” differently than we’re used to. I might be impressed that a stock-picker seems very smart and knows far more than I do, but this is far from having skill in the technical sense.

To illustrate what we typically mean by “skill,” let’s consider golf. Over the years, I’ve golfed with many people whose abilities impressed me. There are dozens I’ve played with who I’d say have golf skills. Worldwide, there are millions of people who I would judge to be skillful at golf if I saw them play.

But what if we define “golf skill” differently? What if we decided that only those who have an expectation to earn more in prize money and endorsements than they spend on travel and equipment count as being skilled at golf? By this definition, I’ve never golfed with a skillful player. Worldwide, there are perhaps a few thousand players who have skill in this sense.

Does this strict definition of golf skill make sense? I suppose it makes sense for someone considering making a living at golf. But the vast majority of golfers play for fun, and there is nothing wrong with deciding that a player is skillful, even if they have no chance of making a living at it.

Getting back to stock-picking, does it make sense to call someone skilled just because I’m impressed with their knowledge and insight about stocks? The answer is no because the purpose of stock-picking is profits. I’ve never met anyone who admits that their stock-picking efforts tend to lose money but they do it anyway because it’s fun. A few such people may exist, but the vast majority of stock-pickers believe their efforts are likely to be profitable; they wouldn’t pick their own stocks otherwise.

Roughly speaking, the definition of stock-picking skill is the expectation of earning higher compound returns (after factoring in costs) than an appropriate benchmark. The word “compound” is important here because it implies a rational level of risk aversion. This is similar to the concept of risk-adjusted returns. (The way the math works out, the expected compound return is approximately equal to the median return rather than the arithmetic average return.)

A major challenge with this definition of stock-picking skill is that there is so much luck involved. Even Legg Mason Value Trust’s record of beating the S&P 500 every year for 15 years seemed certain to be skill before 3 years of substantially underperforming the market. It’s very difficult to say with any confidence that a particular stock picker has skill. Another challenge is that stock pickers can shop around for a benchmark they look good against.

A paradox of skill at stock picking is that the better everyone gets at it, the less skill there is in the world. The definition of skill at stock picking involves beating the market, which implies beating the average returns of other investors. So, you can only have skill if you’re enough better than other stock pickers.

As more and more talented stock pickers enter the field, the talent threshold for having skill rises. With each passing decade, market professionals increase their domination of trading in stock markets. Retail stock pickers are no longer much of a factor. To have skill, you need to be substantially better than the typical professional stock picker, a tall order.

There is even some doubt in the case of the great Warren Buffett. I’m satisfied that Buffett demonstrated skill over his long and hugely successful career. But does he have stock picking skill today? He has two huge forces working against him. The first is that his competition has been getting better over the decades. The second is that he’s investing so much money that he’s forced to focus on the stocks of only the largest businesses that already attract a huge amount of attention. He may still have skill, but it’s hard to be certain.

I’m satisfied that stock-picking skill must be very rare. Among professional stock pickers, skill is, at best, uncommon. Among retail investors, skill is so rare that you can safely assume that anyone you meet almost certainly doesn’t have skill, regardless of any claims they make.

Friday, September 29, 2017

Short Takes: Pension Changes, the Middle Class, and more

Here are my posts for the past two weeks:

The Wealthy Renter

What We Need on Credit Card Statements

Straight Talk on Your Money

Here are some short takes and some weekend reading:

Frederick Vettese makes the case for changing federal civil servants’ pensions to a target-benefit plan to save taxpayers a lot of money. The government could save even more money by eliminating employees they don’t need.

Andrew Coyne does some clear thinking about taxes and the middle class. He shows that when there is a raging debate, it’s possible for both sides to be very wrong.

Squawkfox explains the steps necessary to open a Registered Disability Savings Plan (RDSP). It’s work, but the substantial free government money available makes it worth the effort.

Big Cajun Man was on his best behaviour for a podcast with Doug Hoyes. He even explained how he got his nickname (but left out the profanity).

Monday, September 25, 2017

Straight Talk on Your Money

There are many writers offering financial advice to the typical Canadian, but Doug Hoyes, author of the book Straight Talk on Your Money, is a licensed insolvency trustee. He’s seen enough to have good insights into the kinds of financial mistakes we make. Unlike many writers who offer black-and-white opinions, Hoyes sees the shades of gray.

The book promises to dispel 22 financial myths that are holding us back and that “Everything you know about money is wrong.” But the contents are actually more thoughtful and nuanced than advertised. Even the section titles are somewhat out of sync with the book’s contents. One section title declares “pay yourself first” to be a myth. The rest of the section then goes on to explain that paying yourself first is a good idea unless your finances are so dire that you can’t afford to start saving immediately.

The contrast between section titles and the contents gives the book somewhat of a newspaper feel where reporters write articles and the marketing department writes headlines. But don’t be put off by this contrast. Hoyes makes many great points getting to the core of why people have financial trouble.

The book begins with an explanation that rather than being rational, we rationalize. “Your gut makes a decision, for purely emotional reasons, and then you consciously find reasons to rationalize your decision.” Admitting this is true is a good starting point for making better decisions.

Unlike much “tough love” advice, Hoyes says that your financial troubles aren’t entirely your fault. Lost jobs, illness, divorce, and other bad luck plays a role. Aggressive and deceptive lenders deserve some blame, too. “But, blame doesn’t matter.” It’s better to work on solutions.

“Starting now, refer to your credit card only as a debt card.” Debt cards don’t deserve the positive connotations of the word “credit.” When it comes to credit scores (debt scores?), “focus on your goals, not your credit score.”

Hoyes recommends diversification in a different sense than the usual investing definition. Bank accounts sometimes get frozen for various reasons, so “have a second bank account, at a different bank ... where you don’t owe any money.”

“Collection agencies almost never sue anyone.” Under most circumstances “you should never pay a collection agency.” I learned quite a bit from the section on how collections agencies operate, and how you should deal with them.

The author doesn’t like the labels “good debt” and “bad debt.” “Instead of asking yourself, ‘Is this good debt or bad debt?’ ask, ‘What’s the risk that I won’t be able to repay this debt?’”

It’s not a good idea to think of your house as an investment. “By viewing your house as a consumer good, not as an investment, you can free yourself from the need to buy the most expensive house and instead focus on what’s truly important to you.” On the subject of whether a house provides stability, Hoyes says it does, but there are also ways that a house anchors you down and keeps you from following new opportunities.

In another example of the contrast between the book’s section titles and its contents, one section title is “Budgeting is a Waste of Time.” However, the proposed alternative to budgeting seems a lot like budgeting. There is an important difference, but it’s somewhat subtle. By “budgeting” the book means the process of tracking every single expenditure, analyzing them, and making necessary changes. The suggested alternative is to identify necessary spending along with big things that are important to you and to set aside money immediately from each pay cheque into bank accounts to cover these items. Whatever is left after these important things doesn’t need to be tracked. I guess the idea is that if you run out of money for the less important things that you don’t track, you can do without them for a while. Of course, this assumes that you’d actually do without instead of just running up your credit (I mean, debt) card.

On the subject of helping your kids with a house down payment, the author has a warning: “I can tell you many stories of parents who provided the money for a down payment, and as a result the kid bought a house much bigger than he or she could reasonably afford, which caused severe financial pressure for the kid, because the cost of a house is more than just the cost of the mortgage.”

Overall, I found this to be a thoughtful book with useful insights into why we get into financial trouble. It’s potentially directly useful to readers for their own finances and useful to those who try to help others with their finances.

Wednesday, September 20, 2017

What We Need on Credit Card Statements

The most prominent parts of my credit card statements are two numbers: my money-back rewards for the current month and the total rewards I’ve received since I got the card. This gave me an idea for “improving” credit card statements.

What if the most prominent part of a statement was the total interest you’ve paid since you got the card? For many of us, that would be zero or close to zero, but for too many it would be a nauseatingly big number, perhaps a 5-figure sum.

I’d be interested to see what effect this would have on people’s credit-card spending. It would likely be a slap in the face at first, and later there would be some numbness to it, but it might help some people control unnecessary spending.

Another possible effect would be for people to spend with a different card. If seeing the total interest we’ve paid over the years is painful, it makes sense that people would avoid this pain by using a different card.

Sadly, this will very likely remain just a thought experiment. I don’t think there are any credit-card issuers who’d be willing to reduce their profits this way unless the law forced them to do so.

Monday, September 18, 2017

The Wealthy Renter

It seems that everyone wants you to buy a house: your parents, real estate firms, mortgage brokers, and even the government. Alex Avery decided to make a case for renting in his book The Wealthy Renter: How to Choose Housing That Will Make You Rich. His reasonable and balanced analysis contrasts sharply with the usual cheerleading for owning a house.

We’ve all heard people say something like “renting is just throwing money away,” or “why pay your landlord’s mortgage when you can own your own house?” This advice is based on the mistake of comparing rent to a mortgage payment. Typically, renters pay for little other than their rent – maybe a few utilities. Homeowners pay property taxes, maintenance costs, utilities, insurance, and an opportunity cost on home equity. It’s the total of all these costs that we should be comparing to rents.

Avery goes through an example of an $850,000 home and concludes that the cost for an owner to occupy the home is between $4000 and $8000 a month. The high end of this range involves some double-counting and implausibly high maintenance costs,1 but a range of $4000 to $6000 per month is quite plausible. Most people would find this range shockingly high and simply wouldn’t believe it even after seeing the logic behind it. They’d be wrong.

Some might object that homeowners can look forward to gains on the value of their home. Avery gives a series of charts showing that while house prices are up quite a bit since 1991, “Canadian house prices haven’t delivered returns anywhere near those of the Canadian stock market.”

Renting and investing the difference would have made you richer than owning the average Canadian home. However, this analysis is based on low-cost methods of investing in the stock market. For investors who pay Canada’s sky-high mutual fund costs, the gap is smaller, but still favours stocks over houses. A homeowner might proudly say that his home has tripled in value, but he forgets inflation and all the money he spent on property taxes, maintenance, and other costs.

At a time when banks will lend 5 to 7 times your gross annual salary for a mortgage, the author says “if you want to build wealth, there are much better things to spend your money on than housing. Minimizing consumption of housing is crucial to building wealth.”

In addition to comparing owning to renting, Avery gives some detailed analysis of what drives housing prices. This begins with “Buildings never go up in value,” and “Only land can go up in value.” He also analyzes the 6 biggest housing markets in Canada. Toronto house prices are at 40 times annual rents, which is very high. At first I thought this was for comparable dwellings, but I’m guessing this isn’t the case.

What has really allowed homeowners to do well, Avery explains, is leverage. Investing in a house with borrowed money amplifies returns. Of course, stock investors can use leverage too. But leverage comes with risks, whether investing in stocks or a house.

“Home buying needs to be seen for what it really is: an investment in land plus consumption of the glamorous building that has been erected on that piece of land.” This makes it clear why owning a smaller house is better for your long-term finances.

“The thought of never being able to afford a house because house prices have risen so quickly you can never catch up is irrational. So is buying a house to get into the market.”

Avery includes an excellent chapter “How Housing Can Dictate Your Career in Surprising and Unexpected Ways.” This is something I’ve tried to explain to my sons. The exciting job you start with can end up being a trap if you build a lifestyle that needs your full income. Having a huge mortgage can leave you biting your tongue at work for fear of upsetting the boss and losing your job. This is something I’ve seen many times in coworkers.

One of the claimed benefits of owning a house is the forced savings. This is true to a point. If you rent and just spend all your income, you could end up worse off than a homeowner. To get the full benefit of renting, you need to save and invest some of the money you didn’t spend on home ownership. Avery explains several ways to automate your savings.

So, why is there so much cheerleading for owning a home and almost none for renting? “The primary, and often only, beneficiaries of renting are the renters themselves.” Those who benefit from all the forced spending by homeowners are the ones who promote owning. “Renting is the more logical, cheap, flexible, and low-risk way to live.”

Overall, this book gives a very thoughtful analysis of owning versus renting. Unlike most promotion of owning, the author is not a cheerleader for renting. He acknowledges advantages and disadvantages on both sides. I recommend this book to anyone struggling with a decision of whether to buy a home or rent.

1 For the high end of the range of monthly home ownership costs, Avery starts with the asking rent for a comparable house before adding other costs. But a landlord might include allowance for some of these costs in the asking rent. The maintenance cost range goes too high as well. As Avery later explains, “The rule of thumb for maintenance costs is 2 to 5 percent of the value of the house in most markets, and lower where house prices are particularly high.” Essentially, the cost of maintaining a house doesn’t go up much just because the land under it becomes more valuable. So, 5% is an unreasonably high estimate for a house sitting on expensive land, which is the case for most $850,000 houses.

Friday, September 15, 2017

Short Takes: Mortgage Delinquencies, Indexing Distortions, and more

Here are my posts for the past two weeks:

What’s Your Income


Here are some short takes and some weekend reading:

Scott Terrio, a licensed insolvency trustee explains why low mortgage delinquency rates aren’t a good sign. He says “the low delinquency rate will catch up with the reality of Canada’s overburdened households.”

Lawrence B. Siegel explains why “indexing doesn’t distort anything.”

Reporter Sara Mojtehedzadeh went undercover working in food production for a temp agency. Her story contrasts sharply with the claims made by her employer about working conditions. Strangely, she had to collect her pay from a payday lender.

Patrick McKenzie has some interesting and authoritative advice on what to do if someone creates credit accounts in your name. These things can lead to long-lasting problems if you don’t handle them correctly. Unfortunately for Canadians, some aspects of this advice are specific to Americans. I’d be interested in comparable advice for Canadians.

The Blunt Bean Counter gives his perspective on proposed new tax rules for private corporations.

Squawkfox goes through the ways that the recent interest rate hike from the Bank of Canada can affect you. The main effects are interest rates on debt. She observes that banks aren’t usually very quick to increase the rates they pay on savings accounts and GICs. I wonder how long it will take for higher interest rates to change annuity payments.

Dan Bortolotti summarizes a study of ETF investors. It turns out that they handle their ETFs poorly for a couple of reasons.

Big Cajun Man says if you try to take some form of loan from a big bank, they’ll try to get you to open a chequing account as well.

Tuesday, September 12, 2017


Employers would like to know the secret to motivating their employees to give their best effort. According to Dan Ariely, author of Payoff: The Hidden Logic That Shapes Our Motivations, the answer to what motivates us is complex, but his research has yielded some interesting results. I find just about everything Ariely writes to be fascinating, and this short book is no exception.

The book isn’t just about what motivates us at work. Ariely also tackles our attachment to our own ideas and creations, the importance of money (and sometimes lack of importance), and the urge for symbolic immortality. In short, “this book is about what we really want out of life before we die.”

One seeming contradiction Ariely points out is that happiness and meaning often don’t go together. A marathoner is strongly motivated to run hard for hours and finds deep meaning in the effort, but it’s hard to say that a person whose face is twisted in pain is happy, at least while still running.

Some of Ariely’s experiments revealed that “the more effort people expend, the more they seem to care about their creations.” This was true even when the experimenters manipulated conditions to cause subjects to work harder to produce something of lower quality.

On the subject of whether to pay someone to do certain tasks around your house or do them yourself, Ariely says that “a little sweat equity pays us back in meaning—and that is a high return.”

We search for meaning, even after our deaths. Some of us even seek to control others from the grave. “A man named Samuel Bratt, whose wife had no doubt badgered him about his smoking, bequeathed her £333,000 under the condition that she smoke 5 cigars a day.” German poet Heinrich Heine “left his estate to [his wife] on the condition that she remarry to ensure that ‘there would be at least one man to regret my death.’”

Overall, this book is entertaining, clear, concise, and gave me useful insights into motivation.

Monday, September 11, 2017

What’s Your Income?

The raging debate over the federal government’s plan to change certain tax rules for corporations has a glaring contradiction. The government insists that the changes only affect those making more than $150,000 per year. Opponents say it’s hitting middle-class business owners. Who’s right?

Consider the example of a professional whose efforts earn $250,000 per year. This professional has a personal corporation. So, it’s actually the corporation that has an income of $250,000. The professional draws a personal income of $100,000 from the corporation, leaving what’s left after taxes within the corporation. He plans to continue drawing an income from the corporation throughout his retirement. So, what is the professional’s income?

The government would say the professional’s income is $250,000, and he uses his corporation to spread his income over his lifetime to reduce his total tax bill. Many opponents of the government’s tax plans say the professional’s income is $100,000, and he’s an example of a middle-class earner getting hit hard by unfair new tax rules.

This issue isn’t as simple as it first appears. The professional’s efforts may only earn a lot of money for a modest number of years. Taking into account many years in school and several years of struggling to build a good reputation, lifetime average earnings may be well below $250,000 per year, even after adjusting for inflation and adjusting for the typical income increases salaried employees get.

I’ll leave it to readers to decide for themselves which side they think is right.

Friday, September 1, 2017

Short Takes: Too Many Advisors and more

Here are my posts for the past two weeks:

Email Replies

Small Business

Here are some short takes and some weekend reading:

Preet Banerjee interviews John de Goey who says “there are way too many advisors in the business,” and “we could easily get rid of one-third of all advisors in Canada and not make a ripple in terms of access to advice.” I agree with this. Most financial advisors are paid for their sales effort and not for their advice. The only way to lower Canada’s unreasonably high cost of investing is to lower the total amount of money that goes to advisors and fund managers. This necessarily means there will be fewer advisors.

Jason Zweig has 19 questions to ask your financial advisor along with the “correct” answers. While this is an excellent list of questions, few advisors would have the best answers, and those who do would likely only handle wealthy clients.

Canadian Couch Potato explains the upcoming change to stock-trading settlement periods.

Boomer and Echo aren’t fans of “core and explore” investing.

Preet Banerjee explains asset allocation for investing beginners in his latest video.

Big Cajun Man describes a trick for keeping your employer from taking back some or all of a direct deposit. I’d be interested in knowing whether this trick actually works or whether banks would just track down further transactions.

Tuesday, August 29, 2017

Small Business

What do you think of when you hear “small business?” Maybe you think of a roofer who has enough work to employ three helpers. Or maybe you think of a hair-cutting place. Do you ever think of lawyers who make half a million dollars per year and incorporate themselves to defer and reduce their income taxes?

Opponents of the Trudeau government’s planned income tax changes for private corporations have been vocal lately. They have a lot to lose. The “tax planning” opportunities using private corporations are very effective at reducing taxes.

There are some good arguments on both sides of this debate, but one part of it irks me: referring to incorporated professionals as “small business.” It’s not that this is technically wrong; it’s that it’s deliberately misleading. The public has sympathy for the types of businesses they think of when they hear “small business.” This sympathy dries up quickly if we talk about highly-paid professionals reducing their income taxes.

Getting into the substance of the proposed tax changes, I think there are two parts that make a lot of sense. One is that private corporations shouldn’t be able to get income deductions for paying family members who had little or nothing to do with earning the income. The other is putting a stop to complex maneuvers designed to turn income into capital gains to cut the tax rate in half.

The merits of the changes designed to attack passive income inside a private corporation are less clear to me. Professionals hold assets in their corporations as a means of smoothing income over a lifetime. In a sense, it’s like using an RRSP to reduce income today and create an income after retirement.

Everyone should be allowed to save some money tax-free to create income in retirement (when it will be taxed). The debate is how much income we should be allowed to defer. Government employees with defined-benefit pensions get an advantage over those who use only RRSPs because the government undervalues future pensions. I certainly can’t replace 70% of my income from my RRSP savings. This means government employees get to defer more income than most of the rest of us even after taking into account their reduced RRSP room (called a pension adjustment).

Professionals using private corporations are deferring significant amounts of income as well, although working out how much they defer gets complicated when we take into account the partial tax payments they make at the corporate tax rate.

Another complication in this debate concerns doctors. Few people will cry over some lawyers and accountants leaving for greener pastures, but doctors are clearly in a different category. I don’t know what the long-terms effects of the new tax measures will have on our medical system, but I doubt the correct answer is “none.”

We need more reasoned debate on these issues. But, please don’t refer to private corporations of highly-paid professionals as “small business.”