Wednesday, May 31, 2017

High Housing Costs vs. Avocado Toast

By now just about everyone has heard how wealthy Australian Tim Gurner admonished young people for wasting money on avocado toast while they complain about high housing costs. This has led to a predictable backlash. It seems that avocado toast is easy to mock. As is usually the case, neither side of this “debate” is entirely right or wrong.

It’s tough that rents and house prices are so high today. No matter how frugal people are in all other areas of spending, rents and mortgages are still painfully expensive. But wasting money in other areas doesn’t help.

David Chilton once wrote that people most underestimate the costs of “(1) cars; (2) dining out; and (3) little things.” Rather than literally discussing avocado toast, we should look at it as a stand-in for “little things.”

The cost of little things adds up quickly. Most of us have little idea how much we spend on our habits. For most of us it’s easily hundreds of dollars per month. I’d be willing to bet that if most people were asked to guess their total spending on little things, they’d guess less than half the correct figure. I’d like to think I’d do better, but maybe I wouldn’t.

I recall asking one of my sons how he managed to spend $1000 in one month at university. He wasn’t sure. When we checked his debit records, the answer was “a little bit at a time.” He had more than 50 transactions, none of which was over $40. This was enough of an eye-opener for him that he cut way back.

Some people say that cutting back on lattes and avocado toast will never make enough of a difference to put a dent in the high cost of rents and mortgages. This depends on how much you spend on little things. And unless you have actually tracked your spending for a while to know how much you really spend, you can’t be sure that little things don’t matter.

Other people argue that we shouldn’t be forced to give up every little indulgence in life just to be able to afford a place to live. There is truth in this. Maybe the odd latte isn’t a problem. But is this really all of your habitual spending on small things? I know I spend small amounts on many different things.

Suggesting cutting back on small purchases causes some people to immediately imagine the one type of small purchase they most enjoy and declare they’re not giving it up. This reminds me of asking a hoarder to get rid of some stuff. Instead of looking around for things he didn’t need any more, one hoarder I knew would sit and think of the one thing he most wanted to keep and would angrily declare he wasn’t going to get rid of it.

We need to avoid being like the hoarder who wouldn’t even examine his possessions. If high rent or mortgage payments are a problem in your life, one way to ease the pressure is to examine all areas of spending for things where you’re not getting much value for your money. Don’t make the mistake of ignoring small purchases. Many of us have enough small purchases in a month that they add up to real money.

Friday, May 26, 2017

Short Takes: Responsible Investing, Securities Regulation, and more

Here are my posts for the past two weeks:

Replying to Emails I Usually Ignore

Bad Surveys

Pay Yourself First?

Here are some short takes and some weekend reading:

Canadian Couch Potato discusses socially responsible investing with specialist Tim Nash. It sounds like it’s not possible to fully exclude companies with objectionable practices. Rather you end up with a tilt away from the practices you don’t like and possibly toward greener companies. In a later part of the podcast CCP delivers repeated beatings to Ted Seides over his attempt to explain away his crushing loss on a bet with Warren Buffett.

Preet Banerjee interviews Professor Anita Anand to discuss securities regulation in Canada and what needs to change to better protect investors.

The Blunt Bean Counter compares Canada’s CPP/OAS pension system to Social Security in the U.S.

Robb Engen shares his obsessions with saving money.

Big Cajun Man lays out the 5 steps to getting an RDSP.

Million Dollar Journey lays out a very simple index investing guide for Americans. He mentions an equally simple indexing approach for Canadians as well.

Thursday, May 25, 2017

Pay Yourself First?

“Pay yourself first” is some great advice to help people save money. If you have any trouble with money, as most people do, there are a number of ways to improve your finances including paying yourself first, tracking your spending, and budgeting. Even though I think these things are important, I don’t do them myself.

The idea of paying yourself first was popularized by David Chilton in his first Wealthy Barber book. When your pay hits your bank account, the idea is to set aside some chosen percentage for savings before you begin paying the month’s bills and start spending any money on wants. Most people who wait until the end of the month to save whatever is left end up saving nothing.

However, my wife and I have saved over 50% of our take-home pay for several years now by using the dangerous save-whatever-is-left method. We don’t bother to smooth out our expenses with equal billing plans and paying monthly for insurance and other things. We don’t spread out big expenses like home repairs either. As a result, our savings rate varies wildly from month to month. But by the end of the year, our saving percentage is always high.

I see many people who desperately need to start budgeting, tracking their spending, and paying themselves first. But I don’t often come across people with high saving rates who don’t really try very hard.

It feels strange to advise people to do things I don’t do myself, but that’s exactly what I do. I would never recommend most of the details of my money habits to anyone. The end result of saving money without building debt is worthwhile, but different people need different methods to achieve this result.

Wednesday, May 17, 2017

Bad Surveys

Yet another survey concludes that people are pretty dull when it comes to finances. This time it’s the Teachers Insurance and Annuity Association (TIAA) Institute who asked just over a thousand Americans 28 financial questions. The respondents didn’t do very well. But sometimes, it’s the designers of the study who are dull.

A Wall Street Journal article quotes one of the survey’s 28 questions:

There’s a 50/50 chance that Malik’s car will need engine repairs within the next six months which would cost $1,000. At the same time, there is a 10% chance that he will need to replace the air conditioning unit in his house, which would cost $4,000. Which poses the greater financial risk for Malik?

Anyone mathematically inclined sees instantly that the expected cost is $500 for the engine and $400 for the air conditioner. But the question is which potential repair “poses the greater financial risk for Malik?”

In the field of assessing threats and vulnerabilities, “risk” is defined as the product of probability and the amount of loss. This is the same as the expected value of the loss. Based on this definition, we would choose the engine as the greater risk.

In finance, we usually use standard deviation as the measure of “risk.” For the engine the standard deviation is $500, and for the air conditioner the standard deviation is $1200. Few people would do this exact calculation, but they may understand it intuitively. A 10% chance of a $4000 cost seems riskier than a 50% chance of a $1000 cost, and the math backs up this feeling. Based on this definition we would choose the air conditioner as the greater risk.

In case the argument based on standard deviation isn’t compelling enough, imagine that we replace the potential air conditioner cost with a 0.1% chance of losing $400,000. This is still an expected loss of $400. However, faced with a 50% chance of losing $1000 and a 0.1% chance of losing $400,000, reasonable people would focus more on the potential huge loss.

But the word “risk” isn’t owned by any one technical field. The everyday use of “risk” is imprecise and doesn’t conform exactly to either of the technical definitions.

Some people might look at this question and decide that it’s reasonable to be able to absorb a $1000 loss into their short-term finances, but $4000 would put them into a cycle of high-interest debt and digging out would take time. In this scenario, the air conditioner is the greater risk.

Another way of looking at this question is that engines will cost $1000 per year in repairs and air conditioners will cost $4000 every 5 years or so. So, engines are more expensive, and even though the word “risk” isn’t a good fit, a person who thinks about the question this way would choose the engine as more risky.

As it turns out, the survey designers think the correct answer is that the engine is riskier because its expected cost is higher. I wonder how many knowledgeable respondents understood expected cost but chose the air conditioner anyway because of their view of what “risk” means. I could easily have chosen the air conditioner had I participated in the study.

I agree that most people know too little about personal finances, but in this case, the study designers seem unable to ask clear questions.

Tuesday, May 16, 2017

Replying to Emails I Usually Ignore

I enjoy feedback from my readers discussing the topics covered in my posts, even when they’re critical of my ideas. However, I get other email as well. Here is another installment of replies to emails that I usually ignore.

Dear Andrew,

Thank you for the kind words about my “content related to money.” You remind me of book publishers who see their jobs as trying to sell white bricks. I see you have quite a list of different ways to connect your client to topics that appear to be of interest to readers. If I ever decide it would be funny to subject my readers to dreck, I’ll contact you.




Dear Julia,

Thanks you for yet another chance to share in the profits of duping people into losing their money in forex trading. After careful investigation, I’ve determined that I still have a conscience. Better luck next time.




Dear Jessica,

Thank you for your offer to place sponsored guest advertorials on my website along with your requirements that they not be labeled as “sponsored”, “guest”, or “advertorial”. Your offer to cover administration fees of posting sounds generous. You’ll find that my administration costs are somewhat lower than those of the City of Toronto.



Friday, May 12, 2017

Short Takes: Bogus Research, Dumb Things We Do, and more

Here are my posts for the past two weeks:


Becoming a Millionaire

Should You Invest or Pay Down Your Mortgage?

Here are some short takes and some weekend reading:

Kewei Hou, Chen Xue, and Lu Zhang say that “The anomalies literature is infested with widespread p-hacking.” In plain English, they investigated hundreds of claimed ways to beat the market and found that almost everyone was full of it. For those who know a little bit about statistical testing, the one-paragraph abstract of their paper is worth a read. If correct, the paper is devastating to a huge area of investment research into market-beating anomalies.

Meir Statman says it’s possible to make better investment decisions if we recognize that our tendencies sometimes push us in the wrong direction. It’s interesting that he says “Normal people are not irrational.” I’ve seen this statement elsewhere from other thoughtful writers. I can say with certainty that I am sometimes irrational, and I see others act irrationally as well. Perhaps experts use a different definition of “irrational” than I use. Another possibility is that they are simply avoiding the term because people react badly to being told they are irrational. The language Statman uses is gentle and much more likely to help people make positive changes.

Canadian Couch Potato explains why you should probably own some bonds, even though bond yields are very low right now. Curiously, I found myself nodding in agreement as I read, even though I don’t follow this advice myself. Keep in mind that I lived through the dot-com bust and the 2008-2009 financial meltdown with an all-stock portfolio without flinching.

Andrew Hallam reproduces an excellent article by Mark Dowie, “The Best Investment Advice You’ll Never Get.”  (Web crawlers complain that this article's address is broken, but it seems to work:

Preet Banerjee had an interesting discussion with Dan Hallett, Vice-President and Principal at HighView Financial Group. The big news is that Preet seems to have changed his name to Preset.

Big Cajun Man explains that some low-income families don’t bother applying for the Disability Tax Credit mistakenly thinking it won’t help them. But it leads to being able to open an RDSP and getting some free government money.

Boomer and Echo explains how CDIC would protect deposits if Home Capital goes bankrupt. It seems that once CDIC steps in, depositors get access to their money in a few days. What’s not clear is how long depositors could be left without access to their money prior to CDIC stepping in. I’m interested in how long depositors have been left without access to their deposits in past bankruptcies, but haven’t found any useful information yet.

Thursday, May 11, 2017

Fintech in Canada

“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” ― Adam Smith
Fintech holds the promise of greatly reducing the cost of financial services for Canadians. Our big banks have little choice but to keep costs high because they have a lot of capital tied up in real estate, they have a lot of employees to pay, and most importantly, they have shareholders demanding ever-growing profits. Operating primarily online, lean fintech companies give us the hope of reduced banking fees, better interest rates, and other benefits. But it’s important to understand the motivations of fintech companies.

People like John Bogle who founded Vanguard are rare. Instead of enriching himself, he created an investment company that serves the interests of its customers. He even had the foresight to create a legal structure that created strong incentives to benefit customers instead of pitting them against Vanguard’s management.

Fintech companies are not structured this way. They seek to make money. The best way to make money fast in fintech is to attract as many customers as possible and then sell the company to one of the big banks. Not all fintech companies have this plan, but many do. After acquiring a fintech firm, the big bank will do its best to squeeze more profits from its newly purchased customers without losing their loyalty to the original fintech firm. It’s a tricky balancing act but make no mistake: this is why big banks buy fintech firms.

A longer fintech plan is to actually operate the fintech company and make money from its profits over time. Even here, though, the company’s long-term dreams would be to get closer to the kind of profitability that the big banks enjoy. The path to these profits is to start off with very customer-friendly practices to get a loyal customer base, and later try to squeeze more profits from these customers. Whether or not a fintech company seeks to get sold to a big bank, the endgame is similar: whoever owns the fintech company will try to extract more money from customers.

None of this is really different from the rest of our economy; companies seek profits. But bank customers who understand what is going on can predict how to get less expensive banking. You have to be willing to change banks. It’s not enough to jump once from a big bank to a fintech firm. You need to be prepared to leave one fintech firm for another that makes a better offer.

I’ve gone through this myself first leaving a big bank for Tangerine. Since then Tangerine has been whittling away at credit card rewards and the interest rate they pay. They have even resorted to teaser interest rates to try to compete using advertising without actually paying competitive interest rates on deposits. This has driven me over to EQ Bank.

It’s not my intention to promote one financial firm over another here. Every time I see a good deal at an online bank, I expect to have to pay attention to whether they make negative changes. I expect to have to change banks yet again. I won’t be more loyal to a bank than it is to me.

My hope is that more and more fintech firms will keep popping up to the point where the big banks can’t keep buying them all. If the marketplace becomes diverse enough that there is meaningful competition, maybe some new banks will actually decide that treating customers well is in their long-term interests. Until then, expect to have to change banks whenever your current bank’s offerings deteriorate.

Should You Invest or Pay Down Your Mortgage?

“It is better to be vaguely right than exactly wrong.” ― Carveth Read.
In a good example of how you should be careful where you go for financial advice on the internet, the blog Money After Graduation attempted to tackle a reader question about whether to save money or pay down a mortgage. The analysis and conclusion are not useful.

Ordinarily I applaud those who pull out their math skills to answer questions, but in this case, crucial factors were missed. The article simplified the reader’s question by assuming that TFSA investments would provide a tax-free return of exactly 5% each year, that the mortgage interest rate would stay less than 3%, and that nothing bad would happen in the reader’s life.

With these assumptions, there is no need for the article’s detailed calculations. We can see that 5% is more than 3%, so investing will beat paying down the mortgage. No need for any further analysis, unless there are problems with the assumptions, like the possibility of stock market crashes, poor health, and lost jobs.

I would hope that most people already know that investing in stocks and bonds is likely to give higher returns than a mortgage interest rate. The other factors to consider have to do with risk. Mortgage debt is a form of leverage. There are limits to how much leverage it makes sense to take on.

If there were no uncertainty in life, we could all get rich borrowing as much as possible at a modest interest rate and earning a higher return in the stock market. Market returns would cover the interest on the debt and more. But the stock market is volatile, and people get sick and lose their jobs.

If you have too much leverage, losing your job during a stock market crash could ultimately lead to losing your house too. This may sound unlikely, but losing your home would be so devastating that it’s a more important consideration than whether investments usually earn higher returns than mortgage interest rates.

The exact amount of leverage that makes sense for you depends on several factors including your age, health, income, job security, and how easily you could find another job. Unfortunately, people often overestimate their job security. One reason seems to be that the thought of losing our jobs is so scary that the only way to get through the day is to believe that our jobs are secure.

Most people understand these things to some degree. Big debts make people nervous, and they feel better when they can pay down their debts. We may not be able to figure out our optimum leverage level, but we often recognize too much leverage when we see it.

Not to pile on, but the Mortgage After Graduation article also contains the following quote: “Even at 1%, cash in the bank is better for your net worth than mortgage pre-payments simply because cash will earn a compounding return and mortgage pre-payments won’t.” This is wrong. Pre-payments on your mortgage have a compounding effect on your net worth. Cash earning 1% interest will not outperform a mortgage pre-payment. Of course, this doesn’t mean we shouldn’t hold some cash. The purpose of holding cash is to prepare for an emergency or other cash needs that arise, not to act as a better investment than paying down your mortgage.

Getting back to the question of what to do with some savings, I see 4 main possibilities: invest, add to an emergency fund, pay down the mortgage, or pay down some other debt. Which one is correct depends on the details of the person’s financial life. The general order is to eliminate high interest debt, build an emergency fund, pay down the mortgage until you get to a sensible level of leverage, and finally invest. Deciding what to do can be difficult, but thinking in this way offers a chance to be vaguely right instead of exactly wrong.

Wednesday, May 10, 2017

Becoming a Millionaire

I recently saw a tweet with a chart showing how much money you need to save each day to become a millionaire at age 65. This was one of those motivational things designed to get young people to start saving. For just two bucks a day, supposedly a 20-year old could become a millionaire in 45 years. I applaud the part of this that tries to get millennials to save money, but two bucks a day won’t make anyone a millionaire.

The implicit assumption in the chart was that we can get a 12% annual return from investments. This is just a dream. With a balanced portfolio and slightly lower than average investment fees, the typical investor could reasonably hope for a 5% annual return.

But this is ignoring inflation. In 45 years, cash might have only one-quarter of its current spending power. When people imagine becoming millionaires, do they really mean to have only the spending power of a quarter million dollars today?

To become a millionaire in today’s dollars, we need to focus on real returns, which are investment returns after subtracting out inflation. Typical investors could hope to get a 2% annual real return. We should also plan to have the amount we save increase by inflation each year.

The following table shows how return assumptions can make a big difference in how much you need to save.

Table: Daily Savings to Become a Millionaire by Age 65

Age 12% Return 5% Return 2% Real Return
20 $1.91 $16.74 $37.73
25 $3.37 $22.13 $44.91
30 $5.99 $29.60 $54.26
35 $10.72 $40.24 $66.87
40 $19.41 $56.02 $84.69
45 $35.92 $80.86 $111.65
50 $69.42 $123.90 $156.87
55 $147.46 $212.56 $247.75

As we can see, the daily savings needed by a 20-year old change radically when we change the return assumptions. Don’t be too discouraged by these numbers, though. You’ll likely get raises during your working life that exceed inflation. So, your capacity to save will likely increase with time.

The important thing is to get into the saving habit now even if the amounts are small. This will give you a head start in building greater savings when you’re older. Those who build too much debt may find they’ll run out of time to dig out of debt and build the savings they’ll need when they’re older.

Wednesday, May 3, 2017


As imperfect humans, we often don’t have the time, skills, or information necessary to make good decisions. In their fascinating book, Nudge, Richard H. Thaler and Cass R. Sunstein show the many ways we can help people make better choices about health, investments, and many other areas without taking away their freedom to make any choice they want.

One simple example concerns default choices for company retirement plans. Often, if workers take no action, they don’t get enrolled in a company retirement plan. In such a case, an alarming number of workers fail to accept the free money a company offers in matching any contributions workers make to their retirement funds. However, when a company automatically enrolls workers (meaning they would have to take some action to avoid being enrolled), far more workers end up in the retirement plan. It seems that when we are faced with choices, we often just don’t choose.

The authors call themselves libertarian paternalists. The “libertarian” part means that they don’t want to restrict people’s freedom of choice. The “paternalist” part means they want to set up the circumstances under which we make our choices in such a way that we are nudged toward options that are in our best interests.

The authors show clever ways that make it easier for us to save more money, invest better, and improve other types of choices. When it comes to saving more money, a successful method is to time increases in your saving rate to coincide with raises. This way, you see no decrease in take-home pay that makes you not want to save more.

As an example of how we can be influenced easily, “forty thousand people [were] asked a simple question: Do you intend to buy a new car in the next six months? The very question increased purchase rates by 35%.” Most of us probably believe that while others may be susceptible to such things, we’re not. We’re wrong.

In another example of influencing you without taking away your freedom of choice, “Suppose the thermostat in your home was programmed to tell you the cost per hour of lowering the temperature a few degrees during the heat wave.” Making costs visible definitely drives behaviour.

The authors have an interesting take on the problems of either saving too little or too much money. “The costs of saving too little are greater than the costs of saving too much.” Spending more is easy enough, but “coping in the opposite direction is less pleasant.” This argues for adding some buffer to your savings. Unfortunately, those who are already saving too much will embrace such advice, and those who are saving too little will ignore it.

Owning too much of one stock is very risky, but for some reason, we tend to be blind to the risk of holding stock in our employers. An alarming statistic: “five million Americans have more than 60 percent of their retirement savings in company stock.” This is reckless, but I can’t be too critical; my own percentage was higher during the late 1990s. I took an insane risk and came out okay.

On the subject of mortgage brokers, “after controlling for risk and other factors,” “Loans made by mortgage brokers are more expensive than those made by direct lenders by about $600.” This surprised me. I thought the selling point of mortgage brokers is that they can extract good deals from banks that more than make up for the broker’s fee. Apparently not.

The book has a few funny parts as well. In a discussion of alerting users to excess energy consumption, the authors suggest a device that makes “annoying sounds, such as cuts from ABBA’s Gold: Greatest Hits.” Another suggestion is to allow motorcycle users to ride without a helmet only if they have signed up to be organ donors.

Overall, I highly recommend this book. Whether you agree with their proposals or not, the book contains very thoughtful discussions of many areas where we might help people make better choices.