Friday, June 22, 2018

Short Takes: Asset Location, Placebo Effect, and more

Yesterday, regulators went about 10% of the way to eliminating investment industry practices that silently drain money from Canadians’ retirement savings. Maybe in a few years they’ll put a stop to another 10%. Here are my posts for the past two weeks:

The Power of Passive Investing

Blockchain and Cryptocurrency News

Exploiting Innumeracy

Here are some short takes and some weekend reading:

Justin Bender explains that “it’s your post-tax asset allocation that determines your ending portfolio value.” As I explained in a post on Asset Location Errors, there are many people who get asset location decisions wrong because they mix up pre-tax asset allocation and post-tax asset allocation. Justin does an excellent job of explaining these issues in detail with clear examples.

Scott Alexander reports on a research finding that the placebo effect seems to be just mean reversion. There seem to be a great many “results” that owe their existence to poor use of statistics.

Canadian Couch Potato interviews Ben Rabidoux who has a sensible take on real estate as an investment. CCP also discusses how hedge fund returns don’t live up to their reputation, and explains the danger of having some initial success with stock-picking.

Big Cajun Man lists his 5 best investments. The last one might help me with my sore back.

Thursday, June 21, 2018

Exploiting Innumeracy

It’s not news that governments and businesses take advantage of those who can’t or won’t do basic math. A good example is lotteries. Another recent example comes from a regulator of massage therapists, called the College of Massage Therapists of Ontario (CMTO). To justify a large increase in fees, CMTO is counting on its massage therapists being innumerate.

Annual fees for massage therapists will be going from $598 to $785, a 31% increase. In their announcement of the rising fees, the first part of CMTO’s justification is as follows.

“CMTO has not raised fees much beyond inflation in almost a decade (since 2009), while the size of our registrant base has increased by more than 40 percent.”

Most people’s eyes glaze over at the sight of numbers, but it pays to think a little. Let’s pull this statement apart. If “CMTO has not raised fees much beyond inflation in almost a decade (since 2009),” you can guess what happened in 2009. CMTO increased registration fees by 29%, which is more than a decade of inflation.

The next part is the most troubling: “while the size of our registrant base has increased by more than 40 percent.” If you don’t think much about this, it seems to make sense that you need more money to regulate more massage therapists. However, the fees are paid by an increasing number of therapists. So, even if CMTO never increased fees at all, they’d still be getting 40% more money. The 31% increase from $598 to $785 per year is on top of any increase in the number of registrants.

Here is a rewrite of the quote above removing the spin:

“Despite fee increases over the past decade that total more than double inflation, CMTO is now raising registration fees by 31% to $785 per year.”

The truth is that as the number of registrants increases, an efficient organization could have used economies of scale to control the fees paid by each registrant. But it’s not surprising that CMTO is looking for a big fee increase. C. Northcote Parkinson explained the nature of administration decades ago.

Tuesday, June 12, 2018

Blockchain and Cryptocurrency News

I’ve received 10 blockchain and cryptocurrency announcements in just the past week. To save you time, I’ve summarized them here. I’m guessing the PR firms sending the announcements might quibble with my summaries.

  1. A market for investments you should never own now plans to use blockchain to track share ownership.
  2. You can buy a service that mines cryptocurrencies for you. Try to guess whether they price the service above or below the value of the mined coins.
  3. Another cryptocurrency exchange is opening. Hopefully, it won’t get hacked like the others.
  4. Another cryptocurrency is available.
  5. Cryptocurrencies are getting hacked.
  6. There’s another cryptocurrency app.
  7. And another app.
  8. Cryptocurrency “experts” are eager to get their messages published.
  9. Bitcoin could go to $30,000 soon. Of course, it probably won’t.
  10. “Experts” predict huge increases in cryptocurrency values. Of course, they might go down instead.

Monday, June 11, 2018

The Power of Passive Investing

“Passive investing is power investing.” This line from Richard Ferri’s book The Power of Passive Investing: More Wealth with Less Work is proof that he’s far better at persuading people to use index investing than I am. Who wouldn’t want to be a power investor?

Ferri goes through the academic evidence and makes the case for passive investing to individual investors, charities and personal trusts, pension funds, and advisors. The typical individual investor will get the central ideas of this book, but it’s mainly aimed at much more knowledgeable investors.

Ferri takes dead aim at the “utter failure of active managers to deliver on their promises of market beating results while enriching themselves with fees extracted from investors who entrust money to them.”

“A fund that tracks an index may charge only 0.2 percent in annual fees compared to an active fund with the same investment objective, which may charge 1.2 percent per year.” Over 25 years, these costs grow to 4.9% and 26%, respectively. But Ferri is focused on U.S. funds. In Canada, we often pay about 2.5% per year (46% over 25 years).

Ferri estimates that “tactical asset allocation errors cost investors about 1 percent per year.” Doesn’t this mean there is someone on the other side of these trades making money at tactical asset allocation? Perhaps not depending on exactly how this cost is measured. I find I’m often left with questions about exactly how some statistics are calculated.

One section of the book quotes results from DALBAR on the eye-popping gaps between mutual fund time-weighted returns and the money-weighted returns of actual investors. I’ve written before about how DALBAR’s measure of investor underperformance is wrong. Fortunately, the rest of the evidence in this book supporting passive investing doesn’t depend on DALBAR’s results.

Ferri has some counter-intuitive advice for you: “Avoid strategies that promise to deliver excess returns and you will earn higher returns.” Investing is an area where trying harder can make things worse.

As for finding a talented active manager to handle your money, why would someone capable of beating the market need your money? “If an active manager were talented, chances are you’ve never heard of him or her, and if you did, you’d never be able to hire them.”

Ferri believes that advisors cling to active management “because they believe it’s what their clients want.” But he says “Individuals who go to an advisor aren’t looking to beat the markets. They’re looking for prudent investment advice that’s appropriate for their needs.”

“When an inexperienced person visits an advisor for advice and councel [sic], it is the responsibility of the advisor to disclose how they are paid up front.” No advisor I ever worked with passed that test.

Overall, Ferri does a strong job of presenting evidence for the superiority of passive investing, but few investors would have the patience to go through it all. More likely, Ferri will persuade a group of more knowledgeable investors, and some of them will take a simplified message about passive investing to individual investors.

Friday, June 8, 2018

Short Takes: Public Service Pensions, Bad Investor Behaviour, and more

I wrote only one post in the past two weeks, but I think it’s worth reading for anyone who understands that investing is important but would rather think about almost anything else:

How My Sons Invest

Here are some short takes and some weekend reading:

The C.D. Howe Institute explains how public service pensions are much more expensive than the federal government claims. A side effect of this fact is that government employees contribute much less than half the cost of their pensions, even though the split is supposed to be 50/50. The full report in pdf form is written to be understood by non-specialists.

Frederick Vettese points out some serious problems with the Public Service Pension Plan and how it should be fixed.

Morgan Housel “describes 20 flaws, biases, and causes of bad behavior I’ve seen pop up often when people deal with money.” The ninth one is “Attachment to social proof in a field that demands contrarian thinking to achieve above-average results.” It’s true that you can’t beat the market by following the crowd. However, it’s possible for a large group of index investors to match the market by following each other.

Tom Bradley at Steadyhand previews the likely end to our long bull market in stocks. With markets setting new records daily, it’s hard to get people to think about whether their stock allocations are too high, but that’s what they should be doing. Right now, I’m set up to weather 5 years of poor stock returns without having to sell low. This feels dopey as I watch stocks continue climbing, but it’s important to know I’ll be fine no matter what happens in the markets.

Big Cajun Man reviews Doug Hoyes’ book Straight Talk on Your Money. I reviewed this book as well (

The Blunt Bean Counter tells us about the issues he’s been seeing with his clients’ Notices of Assessment (NOA). It seems that the NOA may say you owe money when you’ve already paid, and there have been issues with alimony claims.

Wednesday, June 6, 2018

How My Sons Invest

Rather than tell people how to invest and try to cover every need and circumstance, I’m going to describe my sons’ simple but powerful investment approach. Readers can decide for themselves how suitable this approach is for them.

My sons are young adults just a few years into investing some of their savings. Working on their investments isn’t in their top 100 favourite things to do.  They have a simple plan based on do-it-yourself low-cost index investing that will beat the vast majority of other investors over time. They may modify their plan as their lives change and their assets grow, but for now they’re following the ideas described here.

Time horizon

It seems obvious to say that they have very long investing time horizon, but that’s only true for part of their money. Not all of their plans are long-term. One of them is considering buying a car. The other earns less income in the winter and needs a cash buffer. Both need a buffer in their chequing accounts and emergency savings in their high-interest savings accounts.

They only invest money they expect not to need for at least five years. Of course, we can’t predict the future exactly, and they may need money sooner than they expect, but they do their best to predict how much cash they should hold for shorter-term needs.

Another thing we should all consider is our ability to stay invested through a market crash. I told my sons that it’s not just about how much money you’ll need over the next 5 years. Just imagine that the market is crashing and your hard-earned savings are shrinking. How much money do you need to have safe in a high-interest savings account to keep your nerve and leave your investments alone while you wait for markets to recover?

It’s one thing to know intellectually that a market crash is a good thing for young people so they can buy stocks cheaply. But it’s quite another to live through a crash and try to keep your nerve. A buffer of emergency savings is a great way to feel safer.

There are some who say that having cash savings earning low interest creates a pointless opportunity cost, and that you’d make more money investing it all. However, the cost of losing your nerve and selling during a market crash is so high that it’s worth it to pay the much lower cost of having some cash savings. Another thing to consider is that being able to sleep at night is very valuable.

Account type

It makes most sense to use tax-advantaged accounts where possible. In Canada, this generally means either TFSAs or RRSPs. My sons’ incomes are low enough for now that RRSP contributions would give them only modest tax refunds, so they’re better off investing in TFSAs initially.

Neither of them is threatening to use up all his TSFA room anytime soon, so until their incomes grow, they’re likely to keep investing exclusively in TFSAs.

Where to open an account

My sons chose to open their accounts at a discount brokerage that will suit their needs when their savings are much larger. Some commentators recommend that young people choose mutual funds such as TD’s e-Series or Tangerine funds. These are fine choices for small to medium-sized accounts. My sons decided not to create a future need to change financial institutions and learn a new way to invest. Their plan is so simple that they can handle investing at a discount brokerage from the beginning.

Although my sons planned to own exchange-traded funds (ETFs), they didn’t worry much about choosing a brokerage with free ETF trading. Their plan involved very infrequent trading. They focused more on brokerage features that will suit them when their accounts become large.

Asset allocation and ETF choices

My sons chose all-stock portfolios. Although stocks are more volatile than bonds in the short term, their volatilities over 20 years or longer is almost the same. But bonds have much lower expected returns, so the only reason to choose to own bonds for the long term is to control short-term volatility. This is an important reason for holding bonds for retirees who could be hurt by short-term volatility or for anyone who might panic and sell at a bad time. My sons chose to maintain adequate cash savings to handle short term needs and to help them control any sense of panic during a market crash.

They chose a simple portfolio of one-third Canadian stocks and two-thirds U.S. and foreign stocks. Based on the size of Canada’s economy, this mix is overweight in Canadian stocks. But their spending needs will be correlated with the fate of the Canadian economy, and it seems appropriate to be somewhat overweight in Canadian stocks.

Vanguard is an investor-owned fund company with investor-friendly policies. It’s not clear how this carries over from Vanguard U.S. to Vanguard Canada, but Vanguard seems a better bet than any for-profit fund company. So, my sons chose the following allocation:

1/3 VCN (a Vanguard ETF of Canadian stocks)
2/3 VXC (a Vanguard ETF of the world’s stocks excluding Canada)

It might seem that this portfolio is just too simple. But the truth is that as long as my sons stay the course, they will get higher returns than the vast majority of other investors who get drawn into more complex strategies.


The Management Expense Ratio (MER) of VCN is 0.06%/year. It has no other significant costs to investors. VXC’s MER is 0.27%/year. However, to this we must add foreign withholding taxes on dividends. Based on Vanguard Canada’s 2017 Annual Financial Statements, this adds about 0.30%/year for a total cost to VXC investors of about 0.57%/year. The total cost of the blended portfolio works out to 0.4%/year. Over 25 years, this adds up to almost 10% (see this explanation of how costs build over 25 years).

A 10% haircut over 25 years may seem hefty, and it is, but most investors who own mutual funds pay much more than this; they just don’t realize it. The truth is that until my sons’ portfolios become large, costs aren’t critical. They will have plenty of time to find lower-cost ways to own U.S. and foreign stocks once their portfolios grow larger and include RRSPs.


Over time, ETFs pay dividends, and people add new money to their portfolios. This creates a need to buy more ETF units. VCN and VXC will grow at different rates. While my sons’ portfolios are small to medium size, they will be able to maintain their desired 1/3, 2/3 ratios for VCN and VXC by buying more of whichever ETF is below its target allocation.

However, they don’t worry about their asset allocations being off by a few thousand dollars. For an initial deposit of $3000, it’s fine to just put it all in VXC instead of buying $1000 VCN and $2000 VXC. A second deposit of $2000 could go entirely into VCN. Each time they have enough cash to invest, they just buy VCN if it’s below 1/3 of the portfolio, or buy VXC if it’s below 2/3 of the portfolio. If they ever have a very large sum to invest, say above $5000, then they’d split it into two purchases with sizes that bring the portfolio to the target allocations of 1/3 and 2/3.

It’s conceivable that VCN and VXC could grow at such different rates that they wouldn’t be able to maintain their target allocations by just buying the ETF that is below its target allocation. But this is unlikely to happen until their portfolios grow significantly. If it did happen they might have to sell some of one ETF to buy the other to get back in balance.

They don’t worry about holding some cash in their accounts. They don’t reinvest each small dividend when it arrives. For those who don’t pay commissions on ETF purchases, it’s OK to invest small sums, but it isn’t necessary. My sons just set a threshold level and invest the cash whenever it exceeds the threshold. Their current threshold is about $1500.


This very simple plan will likely work well for my sons until their incomes grow to the point where it makes sense to open RRSP accounts. Very little else would need to change at that point, though.

They would just view their combined TFSA and RRSP as a single portfolio, and maintain their overall target allocation of 1/3 VCN and 2/3 VXC. Other subtleties like accounting for future income taxes on RRSP/RRIF withdrawals and reducing portfolio costs can wait until they’re closer to retirement.