Tuesday, October 30, 2018

Retirement Income for Life

If you don’t have a defined-benefit pension, odds are you’re losing some sleep worrying about saving enough money during your working years to retire well. You might even have a retirement savings goal in mind. With all this to worry about, you probably don’t think much about how to spend that money during your retirement. Probably something like the 4% rule will be good enough, right? Well, the 4% rule is better than no plan at all, but you can do a lot better.

Frederick Vettese explains solid strategies for the “decumulation” phase of your life in his excellent book, Retirement Income for Life: Getting More Without Saving More. He starts off showing how the 4% rule can fail, and then makes a sequence of 5 enhancements that improve the decumulation strategy significantly.

The five enhancements
  1. Reducing investment fees
  2. Deferring your CPP pension to age 70
  3. Buying an annuity with about 30% of your savings
  4. Being prepared to adjust your annual spending if markets boom or crash
  5. Taking out a reverse mortgage late in life if necessary

Many people will object to some of these enhancements. There is a very good chance that whatever objections you have, Vettese discussed them in the book and explained convincingly that you’re not right. It’s no fun to be proven wrong, but the upside is getting more income out of your retirement savings.

Enhancement 1: The benefits of reducing investment fees are obvious, except for those who don’t even realize they are paying huge fees on their mutual funds.

Enhancement 2: “Only 1 percent or so of all CPP recipients postpone the start of their CPP payments until age 70,” even though doing so can be so advantageous. And Vettese jokes that he’s not sure “if they started their CPP pension late by design or accident.”

Getting people to defer their CPP payments is a tough sell, as I’ve discussed before. If you think that wanting to spend money in your 60s while you’re still young enough to enjoy it is a winning argument, I’m sorry to say that this idea doesn’t hold water for people with at least $100,000 in savings (double that for a couple). The truth is that planning to delay CPP makes it possible to spend more in your 60s safely.

The arguments for delaying CPP to age 70 apply nearly as well to delaying OAS payments to age 70. However, Vettese worries that getting people to delay CPP is a hard enough sell without asking them to delay OAS too.

Enhancement 3: Annuities are another tough sell, but the proof that they help when markets give poor returns is in Vettese’s well-explained simulations. My trouble with annuities is that the market for them seems so opaque. There is limited information available to compare payouts of standard annuity types. I’m interested in annuities whose payouts rise by 1% or 2% each year, and I’ve never found a way to get payout information online. I’ve seen elderly members of my extended family negotiate GIC rates with their banks, and still end up with rates more than 1% below what was available elsewhere. I’m afraid that will be me with annuities because I don’t know how to find the best payouts.

At one point, the author admits to being surprised when his simulations showed that delaying CPP and buying an annuity weren’t “a net drag on retirement income when investment results are good.” I’m not surprised because both enhancements shift longevity risk away from the retiree to either the government or an insurance company. The book’s simulations assume a long life where you win at life but lose at longevity risk.

Enhancement 4: The benefit of being prepared to adjust your spending is that you don’t have to leave such a huge margin of safety. “The idea behind dynamic spending is that a voluntary, controlled reduction in spending made early enough might enable you to avert a more drastic and involuntary cut later on.”

Enhancement 5: Vettese calls reverse mortgages “the nuclear option.” They’re not a core part of his plan. But if markets perform badly for many years, and you’re safety margin wasn’t enough, starting a reverse mortgage late in life can make sense.

With a reverse mortgage “You cannot be forced to move out. You do have to maintain the house, however.” These statements seem to contradict each other. If you don’t maintain the house well enough, can you be forced out? From experience, I can tell you that old people often stop maintaining a house properly once they have physical or mental problems or run short of money.

Your spending pattern

“The traditional advice for middle- and high-income earners is to shoot for a retirement income target of 70 percent of final average earnings.” The book goes through the numbers to show that this is too high for most people. In retirement, your income taxes go down, you don’t need to save any more, you probably finished off the mortgage, and your kids probably cost less. Few people need 70% of their former income to end up with the same standard of living.

Academic studies consistently show that our inflation-adjusted spending declines, on average, through retirement. Based on this finding Vettese’s simulations assume that your inflation-adjusted spending will be flat in your 60s, decline 1% each year in your 70s, decline 2% each year in your 80s, and remain flat thereafter.

It makes intuitive sense that you slow down and spend less as you get older, and academic studies support this idea. However, as I’ve argued before, I see problems with planning for your retirement spending to decline this much as you age.

My main objection is that some people start to spend less because they overspent early in retirement, and now they have no choice. I’m not saying this applies to everyone, but it does apply to a nontrivial number of people. Few people will admit to this easily, though. I had a long discussion with my neighbour about how he works part-time in retirement. It began with talk of needing something to do, but he eventually got around to admitting indirectly that he needed the money.

Vettese’s model of declining spending has your spending dropping by 26% from age 70 to 90. This is a big drop. Things like property taxes, house insurance, and house repairs won’t decline that much, so everything else has to drop by even more. I can believe that people do spend this much less, on average, but for some the decline is forced rather than a choice.

The book argues that “couples aged 75 and over either saved or gave away as cash gifts an average of 16.1 percent of their income. Couples 85 and older saved or gave away even more. Saving so much ... showed that the drop in spending had little to do with insufficient income.” This shows the problem with trying to reason with average figures. The saving and giving away of 16.1% of income is a mix of people giving away more than this, some giving away less, and some giving away none. You can’t then conclude that nobody is short of income. This just isn’t true.

A UK study reported that “most of the 80-year-old respondents said that their spending was not constrained by a lack of money.” Most is not all. The existence of people whose spending declines due to lack of money skews the study’s results.

Ideally, we’d like to base our retirement spending plans on the experiences of people who make the choices they want rather than those who are forced to spend less due to running out of money. It would be nice to go back to the academic studies and ask the researchers to remove data from people whose spending was forced to decline. Then we could see what happens when people do what they naturally want to do. If we could do this, there might still be a spending decline with age, but I’m guessing that the decline would be less than what Vettese uses in his simulations.

All that said, though, I still find the book’s 5 enhancements very interesting. I suspect that using lower spending decline percentages would make some difference, but that the enhancements still make sense.

Some good quotes

“You have to invest in stocks if you want a decent return over the long run.”

“I don’t see any good reason to adopt a stock weighting as low as 50 percent in your RRIF or RRSP, apart from wanting to avoid a lecture from your financial planner.”

“I used to do market research on my own and trade individual stocks. It was hubris to think I was smarter than the crowd.”

A salesman trying to choose the right size of fridge in a sitcom asks “How many cubic feet of food does your family consume in a week?” In figuring out whether you’ve saved enough, Vettese doesn’t want to make the same mistake and says “I’m not going to ask you how many cubic feet of money you will consume in retirement.”

Using DSCs “is one of the most odious practices a fund salesperson can perpetuate on an innocent investor.” “The salesperson might say it is for your own protection—so you don’t jump from one investment to another too often—but this is like a third-world employer saying that he locks in his migrant employees at night ‘for their own protection.’”

Online Calculator

The author generously makes a retirement income calculator available free online. This calculator never asks for your name or email address, and you get a pdf file of your results.  It tells you how much you can spend in retirement under different scenarios.  Seeing the benefit of Vettese's enhancements for my own situation is very interesting.  The first time I tried the calculator, there were a few hiccups, but they appear to have been fixed.


This is an excellent book that will challenge your preconceived ideas about retirement spending. Anyone with 6-figure or better savings will face difficult choices about how best to spend this money during retirement. Few financial advisors are knowledgeable enough to help much. This book is a good starting place for making these important decisions.

Friday, October 26, 2018

Short Takes: Securities Lending, Pot Stocks, and more

Here are my posts for the past two weeks:

Beat the Bank

Getting Even by Owning Big Business Stocks

Here are some short takes and some weekend reading:

Dan Bortolotti discusses the “catch” with zero-fee index mutual funds. Dan says “there is no catch here,” but I’d like an expert opinion on the securities-lending practices of different index mutual funds and ETFs. Who gets the interest the funds collect from short-sellers who borrow stocks? How much hidden risk is there for investors?

Dan Hallett analyzes the price levels of pot stocks.

Squawkfox explains how social media and FOMO can make you unhappy and cost you money.

The Blunt Bean Counter explains clearance certificates from CRA for a deceased person’s estate. Without one, the executor(s) could be held personally responsible for any taxes CRA comes looking for after a reassessment. This is timely for me because I’ll be filing tax returns for an estate next spring. I’m still on the fence about whether a clearance certificate is needed in my case, but now I understand the issues better.

John Robertson makes a convincing argument that we need to keep our investment plans as simple as possible.

Thursday, October 25, 2018

Getting Even by Owning Big Business Stocks

Common advice to make up for high bank fees is to buy bank stocks to get your money back in dividends. We could extend this to the big telecommunications companies as well. I decided to look at how I stand in collecting dividends from these companies vs. what I pay for their products.

On the dividend side, it’s not a good idea for your portfolio to be too concentrated. I own Canadian stocks through Vanguard’s Canada All Cap Index ETF (ticker: VCN). The part of VCN’s dividends that come from the six big banks plus Bell, Rogers, Telus, and Shaw amount to about 34 cents per share each year.

So, suppose you add up what you pay to these businesses and it comes to $1000 per year. As I write this, you’d have to own $90,800 worth of VCN to collect $1000 per year in dividends. Of course, these businesses don’t pay all of their earnings out in dividends, so you could own a little less VCN than this to have the total profits cover your costs.

You could also argue that these businesses do provide some value, and we shouldn’t say the entire $1000 is lost to insufficient competition. Prices might be only triple what they would be with meaningful competition. In the end, you might decide that $50,000 worth of VCN is enough to cover your costs deriving from our uncompetitive markets.

On the other hand, most of us will find that we give more than $1000 per year to these businesses. For the telecommunications companies, we should include mobile phone plans, home phones, cable, and internet access.

Assessing bank costs is trickier. If you haven’t figured out that there are free chequing accounts, these fees are easy enough to add up. Bank deposits are typically paid about 2% less interest than current short-term bond yields. Credit cards make almost everything more expensive whether you pay by credit card or not. Net of credit card rebates, I’m guessing I pay an extra 1% on almost everything I buy. Then there’s the cost of unreasonably high interest rates on all forms of debt.

In the end, I was surprised at how much I pay to Canada’s big, bloated, government-protected businesses. Fortunately, what I get back in dividends from these companies is a little higher. That’s good for me, but the vast majority of Canadians end up on the wrong side of this comparison.

Wednesday, October 24, 2018

Beat the Bank

It can be frustratingly difficult to get the masses to understand how important it is to control investment costs. Ex-banker Larry Bates does an excellent job of explaining what he calls Simply Successful Investing in his book Beat the Bank. Canadians who hand their savings over financial advisors at banks or elsewhere need to read this book.

Bates knows that people don’t want to become investing experts. “There are countless things about investing you don’t need to know: this book focuses on the few things you do need to know.” You don’t have to “listen to the daily tsunami of utterly useless media chatter about the financial markets.”

As a career banker, Bates understands the harm that bank mutual funds do to people’s savings. This harm became personal after a conversation with his sister. He was left embarrassed and ashamed after learning that she was taken in by his employer’s high-fee mutual funds. “Fees are stealth wealth killers.”

The book refers to “top banks, insurers, and mutual fund companies” as Bay Street, the downtown Toronto street where many of these companies are headquartered. “Bay street fees continue to quietly strip away 50 percent or more of the lifetime investment gains of millions of Canadians.” When I tell people this, they typically react with disbelief. Maybe they’ll believe it coming from a former banker.

Bates has a web site where you can get your “T-Rex score,” which is a measure of “how much of your investment return you will actually get to keep.” T-Rex is short for Total Return Efficiency Index. The catch is that you have to know what you pay in annual fees to get your T-Rex score. This is a challenge for the blissfully-ignorant investors who think they don’t pay any fees.

The book lists the T-Rex scores for many of the biggest mutual funds in Canada. The average score is a pathetic 45%. The missing 55% is what Bates calls “true fees.” “Freedom 55? I think not. More like 55 percent of your money is gone.”

The biggest mutual fund providers don’t care which of their funds you invest in, as long as they get your money. That’s why they “operate hundreds of mutual funds at any given point in time. This means the big players will almost certainly have at least some four-star and five-star ranked funds.” This is true even if the good results in a few funds are just blind luck.

According to Burton Malkiel, “A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.” Bates continues with the monkeys asking us to “imagine a mutual fund provider named Simian Fundco employs eight monkey to select stocks.” After a year, four outperform. After another year, two outperform again. After three years, one monkey has outperformed three straight years. This monkey “is anointed as Simian’s new star.” No actual skill is required to advertise a star money manager.

In a call for action, the reader is asked to “Choose One: 1. Make Bay Street Rich 2. Make Yourself Rich.” Unfortunately, most Canadian investors have unwittingly chosen option 1.

To entice readers to learn a little about investing, he distinguishes between a do-it-yourself (DIY) investor and an assemble-it-yourself (AIY) investor. DIY investors devote much of their time to following individual stocks and reading annual reports. AIY investors just choose some low-cost index funds and ignore their portfolios most of the time. The book gives examples of good index funds for building a complete AIY portfolio. By these definitions, I was a DIY investor for a while; I had a good year followed by a bad decade. Now I’m a happy AIY investor.

One barrier to becoming an AIY investor is the fear of doing something wrong when making online trades with a discount broker. Even though I’ve been doing this for almost two decades, it still makes me nervous to make 5- or 6-figure trades. I wasn’t aware that most discount brokers have practice accounts “to get familiar with buying and selling processes before you consider doing the real thing.” This sounds like a great idea to dispel fear of the unknown.

For those who still find AIY investing more than they want to take on, robo-advisors are an option that Bates includes in his definition of Simply Successful Investing. Robo-advisor fees are higher than teh MERs of low-cost index funds, but they are still far lower than typical Canadian mutual fund fees.

In a discussion of DIY investing (stock-picking), Bates tries to put stocks into categories: Blue Chip, Moderate Risk, and Speculative. However, these categories are illusory, as the author later admits. Any stock can fall to speculative status before you figure out you should sell. Nortel “is a particularly prominent and painful Canadian example.” Bates credits stock-pickers with near 100% T-Rex scores, but invisible losses from competing with pros on stock selection make stock-picking a bad choice for most investors.

“Long-term business ownership through the stock market is a bet on the continued ingenuity, dynamism, growth, and prosperity of today’s North American businesses and tomorrow’s budding entrepreneurs.” It pays to be optimistic about the future as long as you protect yourself adequately from short-term paper losses. “Today’s bonds are virtually useless at building wealth,” but they “can be highly effective at protecting wealth.”

“Canadians love ‘balanced’ mutual funds.” However, the fees are stripping away almost all of the bond returns as well as too much of the stock returns. “High-fee balanced mutual funds are conveniently lucrative for Old Bay Street and simply awful for investors.”

You’re better off being a bank owner than a customer. “If you think Bay Street banks overcharge, earn enormous profits, are protected by the government, generally get away with murder, and will continue to do so, there is a perfect way for you to address the ‘inequity.’ Include bank stocks in your portfolio. Make bank profits work for you.” This is good advice to a point, but don’t miss the book’s message about diversification. Unfortunately, many Canadians have portfolios dangerously concentrated in Canadian bank stocks.

One piece of advice I don’t agree with is to make trades at the market price. Limit orders are safer. Just pick a price a few cents worse than the current bid or ask. So, if the market says you can buy at $20, you can set a limit of $20.05. If all goes smoothly, you’ll get the $20 price. If the market price happens to run away at that moment, you’ll pay at most $20.05 per share or trade won’t execute. In addition to protecting you from major market movements, limit orders help you avoid spending more than the amount of cash you have in your account.

Among the investments Bates thinks you can safely ignore are gold, preferred shares, corporate bonds, and Bitcoin. Sounds sensible to me.

A nitpick is the two quotes about compound interest attributed to Albert Einstein. Fact checker Snopes finds this attribution “dubious” because “Einstein died in 1955, but the earliest mention we could find of this item was in a 1983 New York Times blurb.”

This book delivers on its promise to stick to the few things you need to know about investing. I highly recommend it for any Canadian who has or expects to have enough savings to invest.

Friday, October 12, 2018

Short Takes: Killing Mutual Fund Reforms, Taxing the Rich, and more

Here are my posts for the past two weeks:

Managing a GIC Ladder in Retirement

More Money for Beer and Textbooks

My House vs. My Stocks

Here are some short takes and some weekend reading:

Gordon Pape takes Doug Ford and Vic Fedeli, Ontario’s Finance Minister, to task for “dumping cold water” on Canadian Securities Administrators’ mutual fund reforms “that would significantly benefit investors.” This position “flies in the face of everything the Premier claims he stands for.”

The C.D. Howe Institute reports that the 4% increase in the top federal income tax rate didn’t produce the hoped-for $3 billion increase in tax revenues. Instead it resulted in a slight decrease in combined federal/provincial tax revenues. My own retirement made a small contribution to reducing tax revenues in the future.

Canadian Couch Potato interviews Larry Bates who is trying hard to explain to Canadians just how much of their investment gains are getting consumed in fees. Check out his “T-REX Score” calculator.

Preet Banerjee interviews Ben Rabidoux for an interesting discussion of real estate across Canada from the points of view of both owners and renters.

Robb Engen at Boomer and Echo answers questions from a reader considering borrowing money to invest. Robb does his best to offer the alternative of not borrowing, but just investing available cash from income. However, I’ve never had much success in talking people out of using leverage to buy stocks.

Wednesday, October 10, 2018

My House vs. My Stocks

My wife and I bought our house in mid-1993. We’re at the young end of the baby boom, but we bought our house when we were fairly young. As a result, we’ve lived through the huge run up in house prices older boomers have enjoyed. In 25 years, the price of our house has gone up about 160%. So, how has this compared to our investment portfolio?

Well, in that same period of time, our portfolio has had a cumulative return of 1030%. That might seem to end the comparison, but real estate is typically a leveraged investment. We paid off our home quickly, so we didn’t get much advantage from the leverage. But what if we had used leverage?

The average discounted mortgage rate over that period was about 5%. Suppose we had put 10% down and made payments on a 5% mortgage for 25 years. The Internal Rate of Return (IRR) on our investment works out to 5.8% per year or a cumulative return over the 25 years of 307%.

It might be tempting to add in a return from not having to pay rent, but it’s doubtful that the rent on a comparable house would have been more than we’ve paid in property taxes, insurance, maintenance, repairs, and upgrades.

We figured out early that it didn’t make sense to pay high mutual fund fees on our investments. If we had paid an extra 2% each year, our cumulative investment return would have been 580% instead of 1030%. This brings the 307% real estate return closer, but our investment portfolio still wins.

What’s the point of all this? Even though we owned a home during one of the best periods in history for real estate, our other investments performed better. There may be some people whose homes outperformed stocks, but far fewer than most would guess. When we think about our homes being worth a couple hundred thousand dollars more than we paid, it’s easy to forget about the costs of ownership and the long period of time it took to get that return.

Looking forward, real estate can continue to appreciate, but certainly not at the same pace it did for baby boomers. For now, young people are better off financially renting rather than owning. This is true even if they choose to rent a single-family dwelling rather than an apartment. To get full advantage of the lower cost of renting, they need to sock away some of their monthly savings to invest.

Tuesday, October 9, 2018

More Money for Beer and Textbooks

When I headed off to university, I was pretty naive about money. It’s safe to say that this is true of most kids starting post-secondary education. There are lots of ways to get yourself into financial trouble at school. This is where Kyle Prevost and Justin Bouchard come in with their book More Money for Beer and Textbooks. These authors offer Canadian students and their parents solid information that I wish I had back when I was in school.

This book isn’t purely about finances. Just because one choice is more expensive than another doesn’t necessarily make it a bad choice. The authors discuss cost differences and weigh them against other advantages and disadvantages.

They start with how much school will cost and the relative costs of being on and off campus. They also offer a number of tips on finding one or more of the scholarships and bursaries available, many of which never even have one student apply. You’re not likely to find many other books that even devote a section to partying on a budget.

Other sections include RESPs, student loans, summer jobs and part-time work, cars, credit cards, saving on textbooks, and choosing in-demand careers. Throughout, the writing style is clear and (mostly) fun. No matter how hard you try, the details of RESPs may be important, but they’re not fun.

There’s not much negative to say about this book. They made a joke about unclaimed scholarships that made a reference to taxes on lottery winnings, but Canada doesn’t tax lottery winnings. A few details about tax credits have changed since this book was printed in 2013.

The authors don’t pull any punches in their discussion of banks: “many parents are extremely confused about how any sort of registered plan is used, because bank employees and investment advisers make a lot of money on this confusion.”

Few people truly understand how expensive cars are, but these authors get it. They go over the various costs and conclude “The truth is that owning a car is an absolute money pit.” That said, though, they go on to give practical advice for those who want a car despite the costs.

Despite the fact that both authors have liberal-arts degrees, they are quite blunt about the poor job prospects for new graduates with liberal-arts degrees. “Many scholars and post-secondary institutions believe that the goal of a liberal-arts education is simply to give people a well rounded education after high school. Many students believe that the goal of a liberal-arts education should be to provide them with the skills and credentials to succeed in the job market. There is a fundamental contradiction here.”

A problem with our education system is that “More and more [teachers] swam the liberal-arts streams to get there (go ahead and walk in to an elementary school and see how many teachers there have any math background at all).” Among other problems, this leads to “an overall deficit of enthusiasm and knowledge surrounding skilled labour in our academic system.”

I recommend this book to post-secondary students and their parents. It’s a wealth of knowledge about how schools work. It will answer important questions many students never would have thought to ask.

Friday, October 5, 2018

Managing a GIC Ladder in Retirement

The following good question about managing a GIC ladder during retirement came from AT in Calgary (edited for length and privacy):

I’m 100% FIREd and have no regrets about this. After working for 30+ years, I was just done. I spent the better part of a year learning about money, and your articles have been particularly helpful.

I have put 3 years into GICs (1,2,3) and the '1' comes due 2019 May 1. Assuming I stick with the 3 year model, do I roll that one into a new 3 year GIC and then continue as before?

That seems to make sense but here is my question that I can't quite wrap my head around. If I lock it in on May 1st, then what happens if the market crashes on May 2nd? Somewhere there has to be a cash cushion for that year unless I just have to bite the bullet and draw down my registered money. What do you think?

First of all, congratulations on retiring! I know I felt great about retiring to my personal projects rather than doing what other people wanted me to do. I’m glad you like the blog. I’ve learned a lot about finances writing it.

I’ll describe how I handle the cash and GICs part of my portfolio, and you can decide for yourself whether you want to apply it to your own portfolio. I began retirement with 5 years’ worth of spending in cash and GICs, and have the rest of my portfolio in stocks. One year of cash was in a High-Interest Savings Account (HISA) at EQ Bank paying 2.3% interest. The other 4 years were in GICs of duration 1, 2, 3, and 4 years. Note that I don’t have a 5-year GIC.

During my first year of retirement, I spent the cash in the HISA. At the end of that year, my 1-year GIC came due. Because nothing bad had happened in the stock market, I rolled the GIC cash into a new 4-year GIC, and sold stocks to refill the HISA. So, I started the year with 5 years of cash and GICs, but this dwindled to 4 years before I topped it up again.

Suppose the stock market had crashed so severely that I decided to reduce my annual spending. To make this more concrete, suppose my planned annual spending from my portfolio had dropped from $50,000 to $45,000. With $50,000 in cash and $150,000 in GICs, I would only have needed to sell $25,000 worth of stocks to get to 5 years’ worth of cash plus GICs. $45,000 would then have gone into my HISA, and I’d have bought a $30,000 4-year GIC.

There are plenty of minor complications in all this. One is reducing the amount in the HISA and GICs to account for dividends in non-registered accounts that you could spend instead of reinvesting. Another is that a buying a small GIC could lead to being short of cash in the future. This is easy enough to handle by just keeping a little extra cash in your HISA. Of course, you have to stay on top of your spending level. You can’t start spending more just because there’s extra cash in the HISA.

The important part of all this is that I always have enough cash in the HISA to maintain my planned spending level until the next GIC comes due. So, I’m never in a position of having to draw down my stocks during a short-term mid-year stock market crash.

So, AT, you can compare your approach to mine and decide whether there is anything you want to change. Good luck.