Monday, March 25, 2019

Padding Retirement Savings

In the nearly two years since I retired, I’ve been asked a few times why I didn’t work longer to build a bigger nest egg so that my wife and I could live a better lifestyle in retirement. After all, I did walk away from a good salary and generous variable pay. The truth is that we’re not very interested in living lavishly, but I decided to take a look at what I passed up.

It’s not hard to see how much more money we could have had in our accounts, but this doesn’t tell us directly what kind of lifestyle we could afford. What matters is how working longer would have translated into extra spending per month during retirement.

Fortunately, I have a spreadsheet that takes all our account balances and computes the amount we can safely spend per month (after taxes), rising with inflation, until we’re 100 years old. This spreadsheet makes a number of fairly conservative assumptions about investment returns and takes into account CPP, OAS, interest, dividends, capital gains, and income taxes.

The question I decided to answer is how much more income did I need to earn during the rest of 2017 (the year I retired) for our safe spending level throughout retirement to rise by $50 per month. The answer was higher than I initially guessed: $47,100. That’s a lot of income to make a modest increase in lifestyle.

Why did it take so much income for only $50 more per month? To start with, living in Ontario, that income would have been taxed at 53.53%. So, $25,200 of it would have been consumed in taxes right away. Then our incomes would have been slightly higher throughout retirement. So, we’d have paid more taxes each year of retirement, and the OAS clawback would have been higher.

In the end, continuing to work just didn’t translate into much increase in retirement spending. That said, let me make a couple of things clear. I’m not asking anyone to feel sorry for us; we’re very happy. And I’m not calling for reductions in income taxes. I’m not sure what tax rates are best for our society, and I’m not inclined to support government policy changes just because they’re good for me.

But you have to expect individuals to make decisions in their own interests. I didn’t retire to protest high taxes. I retired because working more didn’t benefit us enough to be worthwhile. A side effect of retiring is that the government isn’t collecting anywhere close to as much income tax from me. One person doesn’t make much difference, though. Government revenues will only suffer if enough others do the same. I don’t know how many others retired young for similar reasons.

So, to answer those who asked about why I didn’t keep working, it’s because it just didn’t make enough of a difference to our retirement to compensate for the time lost. As time has passed, I’ve become more comfortable with my decision to retire. I have far too many projects on the go to worry about working 9-to-5 for someone else.

Friday, March 15, 2019

Short Takes: Home Bias, Hedge Fund Fees, and more

Here are my posts for the past two weeks:

Is FIRE Impossible for Reasonable People?

Private Equity Returns are Overstated

Here are some short takes and some weekend reading:

Robb Engen at Boomer and Echo looks for a simple way to reduce the growing home bias in his stock portfolio. This is a thoughtful post that respects the importance of keeping investments simple. Robb seeks a lower home bias than I’ve chosen. I have my reasons for maintaining a bias for countries where I expect to be spending money, but I can’t say my level of home bias is better than Robb’s plan for a lower level.

Nick Maggiulli shows how hedge funds quickly shift client assets into their own coffers. It has nothing to do with the returns they generate and everything to do with their fee structure.

Dan Bortolotti discusses smart beta, stock return dispersion and what that means for silly pronouncements that we’re in a stock-pickers’ market, and John Bogle’s gift to investors.

Michael Batnick has a great list of 20 crazy investing facts.

Preet Banerjee explains how the shift to paying with plastic rather than cash affects our purchase decisions. Research into this area gives us ways to make it easier to save and control spending.

Big Cajun Man explains how RDSP grants differ before and after your child turns 18. He also explains the rules that make the RDSP a very long-term savings plan.

The Blunt Bean Counter explains new U.S. laws requiring ecommerce businesses to collect state sales taxes. Not that I was ever planning to start an ecommerce business, but this is another reason not to.

Wednesday, March 13, 2019

Private Equity Returns are Overstated

Many people believe that the rich and powerful have access to exclusive investments that earn higher returns than average people can get. One such category of investments that sounds impressive is private equity. However, the severe restrictions placed on private equity investors make the returns much lower than they appear.

A private equity investor is asked to commit a certain amount of money over a long period, such as seven years. However, the private equity funds don’t have to take all the money at once. The funds can demand the money on their own schedule. They also get to give the money back on their own schedule, possibly later than the seven year period.

The funds get to calculate their returns on the money they’ve collected, not the total commitment from the investor. So, as an investor, you have to keep some of your committed cash on the sidelines, or risk a demand for cash at a bad time, say 2008 or 2009 when stocks had tanked.

Personally, I would consider my return as a private equity investor to be a blend of the fund’s return and interest on the cash I had to keep on the sidelines. If there is any debate about whether private equity funds outperform stock indexes, this method of calculating returns would end it.

When I was young, I thought the rich had mysterious ways of getting higher returns than I knew how to get. I don’t believe that anymore. My first thought when I hear about some sort of exclusive investment is that someone is trying to separate me from my money. I’m happy to stick with index investing where cash inflows and outflows happen when they suit me, not some private equity fund.

Wednesday, March 6, 2019

Is FIRE Impossible for Reasonable People?

“Whether you think you can, or you think you can't―you're right.”
― Henry Ford

Retiring in your 30s or 40s seems like an impossible dream for most people. But the FIRE (Financial Independence Retire Early) movement is filled with people whose goal is to retire well before the usual retirement age. Critics say these FIRE penny-pinchers deprive themselves of any joy in their lives, and that FIRE is impossible for reasonable people. There is some truth to this, but not much.

The truth is that most adults have created a life for themselves that makes FIRE impossible without huge changes. They bought a big house far from where they work and own cars for commuting. They’ve committed almost all their income for the foreseeable future to a lifestyle they’ve chosen. No amount of eating in or other penny-pinching will make a big enough change to make FIRE possible.

That isn’t to say that smaller changes don’t help. Cutting out small amounts of spending here and there can improve your life tremendously. The key is to identify spending that isn’t bringing you happiness. But this type of change won’t shorten your working life by decades.

For FIRE to be a reality, it’s best to start before you make huge financial commitments. Instead of buying a big house far from where you work, you choose to rent or buy a modest place close to work. The savings can be huge. Reducing your commute by 25 km each way saves about $5000 per year. Renting or owning a smaller place can save much more. By avoiding building an expensive life, it’s possible to save much more of your income and build toward early financial independence.

If you’ve already built an expensive life, changing to the FIRE path requires big changes. It likely means selling your home, selling expensive cars, and moving to a modest place closer to work. Few people are willing to make these changes.

None of this means it’s wrong to buy a big house for your family in the suburbs and commute a long way to work. It’s just that this choice precludes early retirement. Life is about choices. FIRE is not impossible; it just requires the right set of choices on the most expensive things in life. However, most people tend to push big choices like houses and cars right up to the limit their income supports.

Some critics say FIRE is impossible unless you have an enormous income. This isn’t true. FIRE is certainly easier with a big income, but it’s still possible to avoid making lifestyle choices that consume most of your future income. Some incomes really are too low for FIRE, but the lower limit is well below $100k/year.

Other critics say FIRE isn’t possible in certain expensive cities. Staying in an expensive city is a choice. You’re free to do as you please. But if you’re income is too low for FIRE in downtown Toronto, then FIRE may be possible somewhere else. You may not want to find a new job and a new home, and that’s your business. But you’re then choosing the status quo over FIRE.

The truth is that most people like the idea of being financially independent and retiring early, but they’re not willing to do what it takes to get there. Instead of admitting that this is a choice they’re making, they want to deride those who seek FIRE, and declare it impossible for reasonable people. But this just isn’t true. My own path is only mildly FIRE-like. I could have retired much earlier by spending less, but didn’t. That was my choice.

Friday, March 1, 2019

Short Takes: Factor Investing, Delaying CPP, and more

Here are my posts for the past two weeks:

Your Complete Guide to a Successful and Secure Retirement

Warren Buffett on Debt

Here are some short takes and some weekend reading:

Cameron Passmore and Benjamin Felix interview Rick Ferri who explains why we don’t need to get too caught up in factor-based investing.

Boomer and Echo offer three reasons to take CPP at age 70.

John Robertson works out an RRSP meltdown scenario for someone destined to collect the GIS. These calculations are always tricky. The main message is that if your income is low, TFSAs and non-registered accounts are usually better than RRSPs.

Big Cajun Man explains when it makes sense to get a payday loan.

The Blunt Bean Counter discusses how to bridge the financial literacy gap with a spouse who has little interest in finances.

Monday, February 25, 2019

Warren Buffett on Debt

In Warren Buffett’s latest letter to shareholders, he comments on companies using debt, but his ideas carry over to personal finance as well.

We use debt sparingly. Many managers, it should be noted, will disagree with this policy, arguing that significant debt juices the returns for equity owners. And these more venturesome CEOs will be right most of the time.

At rare and unpredictable intervals, however, credit vanishes and debt becomes financially fatal. A Russian-roulette equation – usually win, occasionally die – may make financial sense for someone who gets a piece of a company’s upside but does not share in its downside. But that strategy would be madness for Berkshire. Rational people don’t risk what they have and need for what they don’t have and don’t need.

When times are good, it’s easy to make the payments on your debt; potential problems seem distant and harmless. But times can turn bad suddenly. Nearly 20 years ago, many Nortel employees with fat salaries found themselves out of work, unable to find new jobs at even a 30% pay cut. Mortgages, car payments, and lines of credit that seemed well under control became impossible to service.

Does this mean we should be putting our lives on hold and dedicating all efforts to paying off debt? No. But once you have a house and car, your total debt should decrease over time. It doesn’t make sense to keep increasing your debt every time you want a kitchen renovation or a new car.

It can be sensible to invest at the same time as having a mortgage, but balance is needed. If you split your money between extra mortgage payments and RRSP savings, you’re building to a solid future at the same time as de-risking your life. If times turn bad, you’ll be happy to have emergency savings, no car payments, and a moderate-sized mortgage.

One of my family members recently had the happy decision of what to do with a lump sum. She could have invested it all based on common advice that her expected investment return is higher than her mortgage interest rate. But she chose a middle-of-the-road approach. She paid off 30% of her mortgage, established emergency savings, and invested the rest. She’ll be fine whether the economy runs well or poorly.

Friday, February 22, 2019

Your Complete Guide to a Successful and Secure Retirement

It’s not easy to figure out the best way to handle retirement accounts once you’re no longer collecting a regular paycheque. I’ve been working on the best way to handle my own retirement, so I was quite interested to read Larry Swedroe and Kevin Grogan’s book Your Complete Guide to a Successful and Secure Retirement. I’ve appreciated the academic rigour in Swedroe’s other books, and this one proved to be more of the same.

Unfortunately for Canadians, this book is for Americans. Most of the book is relevant to Canadians as well, but detailed discussion of retirement accounts and tax laws are for Americans only. Knowing the rough mappings (IRA, RRSP) and (Roth IRA, TFSA) helps in some cases.

This book leans toward giving advice to high net worth families. It isn’t entirely this way, but some parts are clearly intended to draw in rich clients for the authors’ advisory business. That said, it’s easy enough to ignore these parts and focus on solid advice relevant to people of more modest means.

The retirement topics covered are wide-ranging, beginning with a non-financial discussion of how to handle the big life transition of retirement. “One-third of all men over 65 become depressed within one year of retirement.” Such a sobering statistic should drive near-retirees to follow the authors’ advice on “helping you change the focus from retiring from something to retiring to something.”

One of the planning errors the authors describe is underestimating your needs. “The average person will need to replace 80 percent to 90 percent of their preretirement income.” I find it doubtful that the average person needs this much income to maintain a comparable lifestyle. This is far higher than most other recommendations I’ve seen that tend to range from 50-70%.

Another planning error is that “People often assume that their tax rate will be lower than actually proves to be the case.” I’ve found people tend to overestimate their retirement tax rates. Perhaps this is a Canada-U.S. difference, or maybe it’s a wealthy vs. not so wealthy difference.

The last retirement planning error the authors list is one I’ve seen many times in my own extended family: underestimating the build-up of inflation over time. It’s sad to see an older person trying to get by on a very modest income that used to be enough before the ravages of inflation.

An interesting chapter on “The Discovery Process” showed how talented advisors would draw relevant planning information out of their clients. I think this could be useful for my wife and me. You never know where you disagree with someone before you get them to say what they think.

“As Bill Bachrach says in his book Values Based Financial Planning: not having to worry ‘about your finances is critical to having a life that excites you, nurtures those you love, and fulfills your highest aspirations.’” Having watched how financial worries shrunk the lives of some of my older family members, I agree.

“The investor should consider tailoring the portfolio to gain specific exposure to the currency in which the expenses are incurred.” This is the reason I am somewhat overweight in Canadian and U.S. stocks.

One interesting aspect of retirement planning the authors advocate is making a “Plan B.” This is pre-planning what actions you’ll take to reduce expenses if your investment returns disappoint. It was this type of planning that kept me working longer. I worked extra time at high wage instead of waiting until I’ve been retired a decade and need to find a job likely paying one-quarter my previous wage.

The authors place a lot of emphasis on Monte Carlo simulations to look at a range of different retirement outcomes you could have. This is good to a point, but these simulators usually bake in the assumptions that returns follow lognormal distributions and that annual returns are independent. “Although stock returns do not fit exactly into a normal distribution ..., a normal distribution is a close approximation.” Actual data show that normal approximations aren’t good at the extremes, and that annual return independence breaks down over decades. It’s not clear that you’re really helping yourself by seeking 95% certainty that your plan will succeed. Long-term stock returns don’t tend to be as wild as simulators assume.

The authors are more conservative with withdrawal percentages than many others are: “we recommend that at age 65 you consider withdrawing just 3 percent a year from your portfolio, adjusting that each year by the inflation rate. You could increase that to 4 percent if you have options that you would be willing and able to exercise that would cut expenses should the portfolio be severely damaged by a bear market. If you are older than 65, the safe withdrawal rate increases as the portfolio does not have to support as many years of spending. At age 70, you can increase the safe withdrawal rate to 3.5 percent; at age 75 to 4.5 percent, and at age 80 to 6 percent.”

The failure of active management is well known, and the example portfolios worked out in the book are based on passive index investing with a heavy dose of factor-based investing. After starting with a portfolio A and optimizing it into a factor-based portfolio B using historical factor returns, the authors admit that “there is no way that, in 1982, we could have predicted the allocation for Portfolio B would have produced returns so similar to the allocation for Portfolio A. We might have guessed at a similar allocation, but we cannot predict the future with anything close to that kind of accuracy. This is an admission that the optimization method used future information. Actual portfolio construction must be based on guesses. I’m skeptical that heavy use of factors in Dimensional Fund Advisors (DFA) funds offers much advantage over simpler factor tilts available with Vanguard funds at lower cost.

There are four alternative funds where the math says returns are weakly correlated with other factors. In theory, these funds offer a way to get a safer, high-yielding portfolio. In practice, they scare me: alternative lending, re-insurance, variance risk premium, and alternative risk premium.

On the subject of tax-advantaged accounts (RRSPs in Canada), take the example of Mary who is in a 25% tax bracket: “The right way to think about it is that Mary never owned 100 percent of her $1,000 investment. She owned 75 percent of it; the government owned the other 25 percent. The government let Mary invest its share of the money until she withdrew her share.” Many people have a hard time understanding that their RRSPs are not entirely their own. Consistent with this way of understanding RRSP taxes, the authors advocate focusing on after-tax asset allocation.

I had never heard this term before, but I’m currently in the “black-out” phase of investing. This means I’m retired, but not collecting any government pensions, and have no required withdrawals from RRSPs or RRIFs. It’s in this phase that it’s important for many retirees to make some RRSP withdrawals to take advantage of low tax rates on low income.

On the subject of filing for Social Security benefits (CPP and OAS in Canada), “Being alive without sufficient assets to support an acceptable lifestyle is almost unthinkable for most people. Protecting for longevity always weighs the decision towards filing as late as possible.” I agree.

On the subject of reverse mortgages, “The lender can begin the foreclosure process if you fail to pay real estate taxes or homeowner’s insurance, or allow the house to deteriorate.” Of course, it’s very common for old people to have problems maintaining a house properly. Once a lender is owed nearly as much as the house is worth, the incentive for foreclose becomes strong.

There is a very interesting section later in the book on elder abuse. “According to The True Link Report on Elder Financial Abuse 2015, the amount stolen from elders each year in the U.S. is more than $36 billion.” The authors demonstrate that preventing abuse by family members and others is challenging.

An appendix tries to scare wealthy readers into seeking an advisory firm. To go it on your own, “You need advanced knowledge of probability theory and statistics, such as correlations and the various moments of distribution (such as skewness and kurtosis).” I have knowledge of these things, but I seriously doubt I’ll ever use them in planning my own retirement.

Other questions the authors ask about your ability to plan your own retirement are far more relevant: “Do I have a strong knowledge of financial history?” “Do I have the temperament and the emotional discipline needed to adhere to a plan in the face of the many crises I will almost certainly face?”

Although I’ve tended to focus on aspects I the book I disagreed with, most of the contents are excellent. Swedroe’s opinions on any subject are always well thought out and have significant academic backing. Deviate from his recommendations at your peril.

Friday, February 15, 2019

Short Takes: Low-Income Retirees, Not for Profit Credit Counselling Debt Collectors, and more

Here are my posts for the past two weeks:

Emotional Money Choices

CPP and OAS Breakeven Ages

Here are some short takes and some weekend reading:

Preet Banerjee and Liz Mulholland appear on TVO to discuss financial realities and strategies for low-income retirees. Preet also interviewed the team from Passiv who offer a service to keep your DIY portfolio at a discount brokerage balanced for only $5 per month.

Doug Hoyes and Ted Michalos say that not-for-profit credit counselling agencies are now just debt collectors funded by lenders. I’d be happy to read a rebuttal, but they make a very compelling case.

Canadian Couch Potato gives us a new Excel spreadsheet for rebalancing portfolios of ETFs. The new feature is that it handles ETFs that consist of more than one asset class, such as the new all-in-one ETFs. This spreadsheet will certainly help DIY investors, but I prefer to use Google spreadsheets because they can look up stock prices. I just have to record changes in the number of ETF units rather than enter dollar amounts every time I want to rebalance.

Andrew Hallam makes the point that the currency an ETF trades in doesn’t affect the performance of its underlying investments. I’d go even further. If you buy Canadian stocks, you’re making less of a bet on the Canadian dollar than it seems. Same applies to buying stocks in other countries.

Wednesday, February 13, 2019

Emotional Money Choices

My wife and I are savers, and I like to think we make mostly rational financial choices. But there are a few less than rational things we do with money that make us happier. I’m not saying it’s irrational to seek happiness, but the reasons for these choices are definitely on the emotional side.

Over-saving for retirement

We saved quite a bit more than we needed to retire to the life we want. We could have quit our jobs earlier, but nagging doubts about whether we had enough drove us to work longer. It’s quite reasonable to save some extra as a buffer, particularly if you have a high-paying job and you’d make much less trying to re-enter the workforce years later. However, we went well beyond a reasonable safety buffer.

But if we hadn’t over-saved, we would have felt uncomfortable, and we likely would have reduced spending on pleasures like travel. So, given our conservative financial natures, I think we made the right choice, even if it is somewhat emotional.

Large savings account

In an attempt to balance our individual net worths, we’ve saved my wife’s income and spent from mine. A side effect of this choice is that money needs to flow from accounts I control to accounts my wife controls. When she has to ask me for money, it makes her feel a little like she’s begging and has to justify her spending.

As far as we’re both concerned, all the money we have belongs to both of us, but this feeling of being less adult remains if she has to ask me for money. So, we opened an EQ savings account that pays good interest and filled it with enough cash that she won’t have to ask for money for more than a year. We consider this cash to be part of the fixed-income part of our portfolio.

We’d probably make a little more interest if we moved some of this cash to GICs, but the trade-off is worth it to us.

Real-time safe spending level

I created a spreadsheet that calculates our safe monthly spending level using near real-time market data. It’s good to know how much you can safely spend from your portfolio, but seeing the amount change in near real-time is clearly overkill.

However, when markets start dropping enough that it becomes a subject of conversation with friends and on social media, we tend to start having those nagging doubts about whether we’re spending too much. Being able to look at the spreadsheet and see a monthly spending figure that’s still clearly above what we spend gives us peace of mind. I think we’d likely curtail spending if we didn’t have the spreadsheet.


Whether we call these choices emotional or irrational, we’ve found they make our lives better. To those with different money personalities, these choices might seem strange, but I suspect we all make some financial choices to compensate for our emotional sides.

Monday, February 4, 2019

CPP and OAS Breakeven Ages

The default age to start collecting CPP and OAS is 65, but Canadians are allowed to defer these pensions until they’re 70 in return for permanently higher payments. The internet is filled with analyses of how old you have to live to come out ahead by delaying benefits. The mistake people make is in how they use these “breakeven” ages.

Suppose you work out that your CPP breakeven age is 85. If you don’t live that long, you’ll get more if you take CPP early, and if you live longer, you’ll get more by delaying CPP to age 70. There are many factors that feed into calculating a breakeven age, including how aggressively you invest, but let’s just use age 85 as an example.

Worrying about the breakeven age only makes sense if you have enough savings to live on until at least age 70 without one or both of CPP and OAS. If you don’t have enough savings, you have little choice but to start taking government pensions before your savings run out.

We’ll assume that you do have enough savings to live until at least age 70. It’s tempting to then guess whether you’re likely to live to your breakeven age (85 in this example) and let that guess drive your decision of when to start collecting CPP. But that’s not the right way to think about this important choice.

Suppose you work out that if you knew for certain you’d live to exactly 85, you can safely start spending $50,000 per year. At $50,000 per year plus cost-of-living adjustments each year, you expect to run out of savings at 85 whether you take CPP early or late (that’s what the breakeven age means).

Of course, there’s that nagging doubt: what if you live longer? Maybe you’re not likely to live longer, but do you really want to take a chance on having no savings left at age 85? So, you decide to spend a little less than $50,000 per year.

So, now you’re savings are likely to last past age 85. But how much longer depends on when you take CPP. Delaying to age 70 makes your savings last longer than if you take CPP at 60 or 65. Suppose that by lowering your spending, your savings will last until you’re 90 if you take CPP at 60, but will last until you’re 95 if you take CPP at 70. It seems obvious now that taking CPP at age 70 is the better choice.

Looked at another way, if you decide you don’t want your money to run out until you’re 95, then delaying CPP to age 70 gives you a higher safe spending level. But this isn’t just more spending when you’re old; you get to spend more right from the beginning of your retirement. It may seem paradoxical, but choosing to delay government pensions to age 70 can make it possible to safely spend more in your 60s.

However, if your plan is to spend so much less than your safe spending level that your money will last indefinitely whether you take CPP early or late, then you’ll be leaving money to your heirs no matter how long you live. Whether you should take CPP and OAS early or late comes down to whether you want to maximize your estate for an early death or maximize it for a late death.

So, the right way to think about a CPP or OAS breakeven age is to first ask yourself if you’re willing to spend down all of your assets by your breakeven age. If not, then you’re safe spending level is highest if you delay taking CPP or OAS until you’re 70.

Friday, February 1, 2019

Short Takes: Credit Score Obsession, Joint Account Benefits, and more

Here are my posts for the past two weeks:

Happy Go Money

My Investment Return for 2018

Preet Banerjee features prominently in this week’s short takes and weekend reading:

Scott Terrio explains how trying to optimize your credit score can make your finances and your life worse. Credit scores measure your profitability to banks. You are the product, not the customer.

Joint bank accounts curb wasteful spending according to a study by the University of Notre Dame’s Mendoza College of Business. My wife and I aren’t spenders, and we’ve always found joint bank accounts about as appealing as sharing a toothbrush. But this study could partially explain why some couples are adamant that joint bank accounts are the way to go.

Preet Banerjee explains research results on what motivates us to save for retirement. It turns out many people are more interested in helping their families than helping themselves.

Preet Banerjee interviews Dr. Avni Shah who explains research into how we feel pain of payment and how it affects our willingness to spend and how much we enjoy our purchases.

Fintech is leaving too many people behind. If there were more competition in financial services, customers would be better served.

Retire Happy explains some common investment mistakes made by retirees. This is an excellent guest post by Jason Heath.

Big Cajun Man looks at how to reduce his portfolio concentration as he nears retirement.

Robb Engen at Boomer and Echo discusses whether clients will abandon robo-advisors in the next stock downturn and what the robo-advisors are doing to try to prevent loss of clients.

The Blunt Bean Counter explains how to use his estate organizer to make things easier on your heirs. I’m helping with an estate right now, and I have little confidence that we’ll be able to find all assets. It’s hard to find things if you don’t know they exist.

Blair Crawford reports a simple but effective gift card scam.

Thursday, January 24, 2019

My Investment Return for 2018

During 2018, my portfolio’s return was -4.9%, my first annual loss since 2011. So, naturally I’m firing my financial advisor and ...

Wait. I don’t have a financial advisor. And even if I did, it’s a myth that financial advisors can prevent losses. Nobody can predict short-term stock market movements. If you’re in the stock market, you’ll have losses sometimes.

I manage my own investments, and in the wake of the poor returns in 2018, I’ve sold all my stocks to cash to wait out the uncertainty ...

Wait. I didn’t do that. There is always uncertainty in markets, even if our faulty hindsight makes the past seem less risky. The fact that markets dropped in the last few months of 2018 tells us little about the near future because momentum effects are too weak.

In reality, I stuck to my chosen asset allocation which includes a mix of stock ETFs, and a mix of cash and GICs to cover 5 years of my family’s spending. I use threshold rebalancing calculated on a spreadsheet that emails me whenever I have to do any trading. The truth is that I wasn’t paying much attention to stock markets during 2018.

Each year I calculate a benchmark return to compare to my actual return. The fact that my portfolio now has a substantial cash and GIC allocation moderates both my actual and benchmark returns. For 2018 the benchmark return was -3.2%.

So, why did my portfolio do worse than the benchmark? My benchmark is based on time-weighted returns, which means it assumes no deposits or withdrawals. I calculate my actual returns with the internal rate of return (IRR) method. Shortly before the stock markets started dropping, I made a substantial deposit to my portfolio. The timing of this deposit was unlucky and not something I was able to control.

To put my 2018 loss into context, here is my cumulative real return since 1995 compared to my benchmark (“real” means after subtracting out inflation):


That little drop at the end was 2018. It’s been a bumpy ride, but I’ll take the stock market volatility to get it’s high expected returns. My compound average real returns have been 8.02%. However, I base my spending on future 4% real returns for stocks (before taxes and other costs) and 0% real returns for cash and GICs.

I should comment on my spectacularly lucky 1999. My portfolio nearly tripled when I took an insane risk that happened to pay off. I could just as easily have lost 80% that year. I’ll never knowingly do anything remotely that risky with my portfolio again.

Now that I’m retired and don’t have a regular paycheque to help keep me from worrying too much about stock market risk, I’ve got my 5 years of cash and GICs to keep me napping while stocks try to get my attention. I’d rather meet up with friends than spend any time agonizing over stock prices.

Tuesday, January 22, 2019

Happy Go Money

It’s not easy to make personal finance entertaining, but Melissa Leong succeeds in her book Happy Go Money: Spend Smart, Save Right & Enjoy Life. Some books slip in a couple of jokes near the beginning to lighten the material, but Leong’s writing is lively and fun throughout. Another thing that sets this book apart is its focus on the connections between money and happiness, often referring to scientific studies of happiness.

I don’t often laugh out loud while reading, but I did a few times with this book. Leong isn’t afraid to use some suggestive material to keep things interesting. Her discussion of compounding involves “horny rabbits” where “one rabbit bones another rabbit to make 10 more.” When her friend starts talking about insurance, “my eyes cross as I achieve boregasm.” The last chapter is called “Happy Endings.”

If you think you can’t be happy without more money, it might help to realize that many of the things that make you happy have little to do with money. “If you’re relying on something (or someone) to make you happy, you’re wasting your time and energy.”

“Stop playing the lottery. Now.” My father used to say that buying a few lottery tickets is harmless dreaming. But I suspected he was using lottery dreams to delay taking concrete steps to improve his life. He didn’t need to work harder at his business as long as a lottery win was a possibility.

Even though we know little about other people’s situations, “based on our limited information, we compare, we covet and we compete.” It’s hard to turn off our desire to keep up with the Joneses, but it may help to recognize this tendency to help keep us from competitive overspending.

Social media is a source of unhappiness as we compare our lives to what we see of others. But, “We curate our lives for social media. We filter the crap out of photos. We filter our whole lives. We crop out the unsavoury parts of our vacations. We live-tweet the music festival but not the moment when the credit card is declined at the grocery store a month later.” I do a public service in my neighbourhood by having the worst lawn. Maybe I could do something similar on social media.

We crave expensive things like cars, but Leong says the categories of spending that bring happiness are experiences, time savers, and anticipation. On time savers, the idea seems to be to factor in the value of your time whenever making financial choices.

“A report in the 2006 American Journal of Psychiatry estimates that roughly 5.8% of the U.S. population suffers from compulsive buying disorder.” I’ve always had the vague feeling that most retailers are competing to attract compulsive shoppers, and the rest of us who need a new shirt every year or two just don’t matter.

Among some exercises aimed at increasing happiness, one I found interesting was “Using your strengths in a new way.” I can see where it would feel great to find new contexts where your talents are useful.

No personal finance book can avoid the topic of budgeting. To most people, “a budget looks like restriction,” but it can give “Freedom to spend without guilt. Freedom from debating every little purchase.” When you’ve automated necessities like retirement saving, paying the mortgage, and other bills, you can spend the rest without worries.

On the subject of automated savings, I liked the analogy comparing your income to a bowl of chips. If you don’t set some aside at the beginning, “Ten minutes later, I’m daubing at crumbs with a moistened index finger.” Waiting until the end of the month to save whatever money is left won’t end well.

Lest I start to seem like a cheerleader for this book, I had to find something to criticize. “Switch to compact fluorescent light bulbs.” Fluorescents are passé; LEDs are in. “I calculate our net worth twice a year. And I like to see this number climb every time.” This is possible while your savings are small compared to new contributions. But once you’ve got substantial savings invested in stocks, you can’t smooth the ups and downs of the stock market with new contributions. It’s better to focus on the size of your new savings and debt repayment rather than what someone else will pay for your house and stocks.

The book does a decent job of explaining mutual fund costs, but the author says that if fees are high, “your fund has to perform better than average to be a worthwhile commitment of your cash.” This misleads readers into thinking the goal is to find a mutual fund that will outperform. This isn’t possible. The mutual fund industry makes a killing marketing funds that outperformed in the past by luck. But fund returns rarely look as good in subsequent years.

“When it comes to money and happiness, ... the biggest happiness killer is debt.” I couldn’t agree more. When it comes to borrowing to invest, “Make sure you understand the worst-case scenarios. What if interest rates go up on your loan? What if you lost your job or something happened where you needed the money? What if your investment tanks?” Considering the potential downside of leverage is vital, even though we’d rather focus on pretty charts showing how much money we might make.

Overall, I highly recommend this book to anyone who struggles with aspects of personal finance, which is probably 80% of us. It’s an entertaining read and can help improve both your finances and your happiness.

Friday, January 18, 2019

Short Takes: John Bogle Leaves A Great Legacy

Here are my posts for the past two weeks:

The Ages of the Investor

Skating Where the Puck Was

Firing Male Brokers and Financial Advisors

Here are some short takes and some weekend reading:

John Bogle, who founded Vanguard and revolutionized retirement savings, dies at 89. It’s hard to overstate the profound impact Bogle had on investing for the little guy. Without him, it’s plausible that index investing would still be a niche area and would cost 1% or more per year. His idea was to create a mutual fund company owned by the funds themselves where employee bonuses are tied to how low the fund costs are compared to their competition. This drove costs way down to sensible levels. Personally, I save the cost of a few vacations per year because of Bogle.

Mastercard to stop letting companies automatically bill you after free trials. This sounds like a positive step. We’ll see how things go in the implementation.

The Blunt Bean Counter provides us a simple tool for organizing your estate and making it easier for your family and executors to pick up the pieces. I really wish some of my late family members had filled out a form like this.

Tom Bradley at Steadyhand couldn’t bring himself to pick some hot stocks in response to a media request. Instead he explains the benefits of rebalancing your portfolio by shifting from hot assets to colder ones. This is a better bet than chasing the latest hot investment.

Robb Engen at Boomer and Echo has an interesting story of potlatch ceremonies and suggests we modernize it to reduce the amount of useless stuff in our lives.

Canadian Couch Potato gives the 2018 returns for his various model portfolios. It wasn’t as bad as it seemed.

Wednesday, January 16, 2019

Firing Male Brokers and Financial Advisors

The article Consider Firing Your Male Broker by Investment Advisor Representative Blair duQuesnay in the New York Times has generated a firestorm of comments. Most readers didn’t like the obvious sexism, but I’m more concerned about the muddled reasoning.

The article says research shows women investors outperform men, and therefore, you should choose a female financial advisor or broker. This reasoning presupposes that financial advisors and brokers are focused on the performance of their clients’ portfolios. This is far from the truth.

Most financial advisors and brokers are salespeople who sell what their employers tell them to sell. Typically, they either don’t know or don’t care that what they’re selling isn’t good for their clients. The fact that so many advisors invest their own money the same way they invest their clients’ money shows they don’t have bad intentions.

Even those advisors and brokers who know they’re hurting their clients didn’t necessarily start out this way. But they started to figure out that what they’re told to sell isn’t helping their clients, and they either lived with this knowledge or eventually quit. Some of those who quit go on to get higher designations and work in different environments with more autonomy so they can do a better job for their clients. Unfortunately for investors, this type of advisor typically takes only higher net worth clients.

If a new rule outlawed all male financial advisors and brokers, after a few years of hiring and employee turnover, the typical female advisor would either not know or not care that what they’re selling isn’t good for their clients. Large financial institutions run their operations to get profitable behaviour from their employees whether they’re women or men.

We might then ask whether women should run the financial institutions. The filtering process for high-powered positions in big companies is much more severe than it is for becoming a financial advisor or broker. The only people who move high up on the corporate ladder are those willing to run the company profitably. This applies equally to male and female executives. Whether there is sexism or not during the climb up the corporate ladder, you can bet that those who reach the highest rungs are focused on profits.

In the end, this article isn’t helping investors choose a better advisor, and it isn’t shaping a better path forward for the financial industry. But if investors accept its message, it might help some female financial advisors and brokers meet their sales targets.

Monday, January 14, 2019

Skating Where the Puck Was

Diversifying your portfolio reduces volatility and improves compound average returns. Portfolio theorists dream of finding risky asset classes with low correlation to known risky asset classes. However, author William J. Bernstein argues that correlations between asset classes have been rising. He explains why this is so in his book Skating Where the Puck Was: The Correlation Game in a Flat World, the second book of his four part Investing for Adults series.

One of the side effects of rising correlations is that everything tends to crash at once. We are moving toward “a cohort of nearly identically behaving asset class drones.” “When everyone owns the same set of risky asset classes, the correlations among them will trend inevitably toward 1.0.”

Bernstein asks “Will things really get that bad?” The surprising answer is “We are, in fact, already there; further, it’s always been that bad. Yes, international REITs were a wonderful diversifying asset, but the ordinary globally oriented investor, and even most extraordinary ones, did not have access to them before 2000. Ditto commodities before 1990 or, for that matter, foreign stocks before 1975.” “Diversification opportunities available to ordinary investors were never as good as they appeared to be in hindsight.”

There is some good news, though. “Short-term and long-term risk are indeed two very different things.” Bernstein gives data showing that monthly returns show high correlation, but 5-year returns show much lower correlation. So, your asset classes tend to crash together, but if you wait long enough, their returns tend to drift apart and give some diversification benefit.

In the past, early investors in new asset classes benefited from diversification, but those who pile in later are “skating where the puck was.” It’s necessarily the case that as many investors buy into an asset class, its correlations with other asset classes rise.

My takeaway from this book is that I can’t avoid market crashes that affect most of my portfolio. I’m best off to live on safe liquid assets and wait out any market declines in the rest of my portfolio.

Thursday, January 10, 2019

The Ages of the Investor

Different stages of life call for different investing approaches and the need for transitioning from one stage to the next. William J. Bernstein addresses this challenge in his short book The Ages of the Investor: A Critical Look at Life-cycle Investing, the first book in his four part Investing for Adults series. His suggested method of transitioning toward retirement is very sudden.

Bernstein splits life-cycle investing into opening moves, middle game, and endgame. When you’re young, he suggests taking on as much risk as you can handle. Because this book is aimed at “investing adults,” he presumes the reader knows that stock picking and market timing are losing strategies. So, in this context, “risk” means compensated risk that comes with higher expected returns and comes mainly from stocks. Young investors are best off taking as much risk as they can handle without losing their nerve and selling out when stocks hit a difficult patch. “The young investor’s first encounter with a significant market decline serves mainly to ascertain her true risk tolerance.”

The book covers the life-cycle investing approach promoted by Ayres and Nalebuff that has young investors taking on 2:1 leverage using margin investing or call options on stock indexes. Bernstein lists some problems with this approach but leaves out the most serious problem: your ability to save in the future (and even to avoid withdrawing from savings) is highly risky. Losing your job during a stock market crash could completely wipe out leveraged savings.

An alternative to leverage is stock market investing using factor tilts. I tend to be skeptical that factor tilts will give future results that match past apparent success. Perhaps a slight tilt to small value stocks is sensible, but there is nothing wrong with an unleveraged position in low-cost stock indexes.

Because a mortgage is like a “negative bond,” it’s best to “Pay the damned thing off” rather than own bonds at the same time as holding a mortgage.

Bernstein portrays value averaging (VA) as an alternative to dollar-cost averaging (DCA) and describes VA as “a clever technique pioneered by Michael Edelson.” Value averaging doesn’t work. The main problems are 1) the return calculations supporting VA ignore opportunity costs of cash on the sidelines and interest on borrowed money, and 2) VA can lead to unsafe levels of leverage. I did some experiments to examine actual VA returns if we modify the strategy to eliminate these problems.

As you near retirement (the “endgame”), Bernstein suggests splitting your portfolio into two parts, a “liability matching portfolio” (LMP), and a “risk portfolio.” The idea is that the LMP contains completely safe assets that cover your basic needs for the rest of your life. The challenge is to create a LMP free from inflation risk, longevity risk, and counterparty risk (insurance company bankruptcy).

After examining several LMP approaches that all have risks, Bernstein chooses a ladder of inflation-protected bonds as the best option. This means Real-Return Bonds (RRBs) in Canada and Treasury Inflation-Protected Securities (TIPS) in the U.S. The challenge I see here is that we still have longevity risk. How many years of RRBs are safe?

During the middle game of your investing life “If, at any point, a bull market pushes your portfolio over the LMP “magic number” of 20 to 25 times your annual cash-flow needs beyond Social Security and pensions, you’ve won the investing game. Why keep playing? Start bailing.” The author calls for a sudden sell off of risky assets to buy the LMP. Then any new savings can be invested as riskily as you like.

This LMP idea would be more appealing if it handled longevity risk. How do I know that 20 to 25 times my annual spending needs is enough? If an investor bails out into a LMP in her 50s anticipating working to 65, but loses her job, the LMP is suddenly not enough for a longer retirement.

One side note most Canadians would agree with: the U.S. has “a dysfunctional health-care system and an inadequate safety net.”

On the subject of safe spending from a portfolio: “Below the age of 65, a 2% spending rate is bulletproof, 3% is probably safe, and 4% is taking chances. Above 5%, you’re taking an increasingly serious risk of dying poor. (For each five years above 65, add perhaps half a percentage point to those numbers.)”

It has become popular to plan for reduced spending throughout retirement. I’ve written many times about flaws in this idea. Bernstein takes this further by explaining why we might want to spend more in the future, even in inflation-adjusted terms. “Worker productivity, wages, and per capita GDP all grow at a real rate of about 2% per year. So will your expectations. Would you be happy with a 1960s standard of living? When everyone else has or will soon have an iPad, could you stand to live without one?”

Overall, I recommend this book for its critical thinking about life-cycle investing. However, I take issue with some of the specific recommendations.

Friday, January 4, 2019

Short Takes: All-in-one ETFs, Bankruptcy, and more

I managed only one post in the past two weeks:

Rational Expectations

Here are some short takes and some weekend reading:

Canadian Couch Potato reviews iShares’ new all-in-one ETF portfolios and compares them to similar ETFs from Vanguard.

Doug Hoyes makes sense of some Canadian debt statistics. One of his conclusions: “I fully expect our Homeowners’ Bankruptcy Index to rise, dramatically.”

Preet Banerjee interviews Melissa Leong, author of the new book Happy Go Money: Spend Smart, Save Right and Enjoy Life.

Big Cajun Man got into the spirit of the holidays with 12 days of Christmas debt.

Robb Engen at Boomer and Echo implores us to stop giving markets our attention.

Thursday, January 3, 2019

Rational Expectations

It’s not easy to choose your portfolio’s asset allocation and decide how to change it as you head into retirement. William J. Bernstein discusses the many considerations that affect asset allocation decisions in his book Rational Expectations: Asset Allocation for Investing Adults, the last of four books in his Investing for Adults series.

Rather than just provide a set of model portfolios, the book includes a range of topics to help the reader choose his or her own allocation. These topics include historical asset-class returns, factor tilts, market efficiency, asset location, risk tolerance, your brain, liability matching portfolio, ETFs, rebalancing, and a lot more. You’re not left entirely on your own in building a portfolio; there are tables of recommended funds to cover the different asset classes.

To explain the intended meaning of “adult,” Bernstein says, “If the terms ‘standard deviation,’ ‘correlation,’ and ‘geometric average’ are Greek to you, or if you think you can time the market or pick stocks, then don’t buy this book.”

One quote that illustrates how Bernstein generally thinks clearly and correctly about investing is “The purpose of investing is not to simply optimize returns and make yourself rich. The purpose is to not die poor.” To this end, the author suggests that once you’ve saved enough to cover your future basic living expenses for the rest of your life, you should sell risky assets and buy government inflation-protected bonds. You can then invest any additional savings as riskily as you like.

Future stock returns are likely to be lower than they were in the past because it used to be difficult and expensive to own even a fraction of a stock index, “Prices stayed low, and the financial rewards were correspondingly high.” Further, “as societies grow wealthier, the supply and demand balance of capital shifts in favor of its consumers (companies) and away from its providers (investors).” The result is lower expected returns.

“Once you’ve arrived at a prudent asset allocation, tweaking it in one direction or the other makes relatively little difference to your long-term results.” What matters more is “your ability to stick to it through thick and thin.”

“When academics aggregate stock return data from many nations, statistically significant evidence of mean reversion appears. But since all the data come from the same time period, it’s hard to tell.” The existence of mean reversion means annual returns are correlated over time, which invalidates portfolio optimization methods that assume independence over time.

“Asset returns behave approximately lognormally,” but not exactly. A portfolio optimization technique called mean-variance optimization (MVO) assumes lognormal returns, and often gives crazy results. These crazy results come from a combination of the lognormal assumption and MVO being very sensitive to the accuracy of estimates of expected returns. Rather than use MVO, “I suggest a more profitable way to design your portfolio: stuff half the money in your mattress and lend the other half to your drug-addled nephew.”

On the subject of bonds, “sooner or later, we’re going to have an inflationary crisis, and in such an environment, long duration will be a killer.” “Bondholders of developed nations can expect to suffer permanent capital loss that equity holders will avoid.” For your fixed-income component, Bernstein recommends sticking to short-term government bonds and CDs (the U.S. equivalent of Canadian GICs). I don’t often find others who agree with the decision I made in my own portfolio to avoid corporate bonds and long-term government bonds.

Unfortunately, Bernstein has muddled ideas about asset location. He “largely” disagrees with the idea that “you should adjust downward the assets in your ... accounts by their estimated future tax exposures.” He reasons that assets are fungible, so “why should the exact stock/bond allocation of each [account] matter?”

The allocation in each account doesn’t matter. It’s the overall after-tax allocation that matters. By focusing on pre-tax asset allocation, Bernstein draws the incorrect conclusion that you should put assets that produce higher returns in accounts with lower expected tax rates. In reality, the author is mistaking tax efficiency for choosing a higher after-tax allocation to risky higher-return assets. When we hold the after-tax asset allocation constant, the supposed tax efficiency disappears.

The book quotes some interesting work by Philip Tetlock on market forecasters. The most extreme forecasts are the most wrong, but the media prefers extreme forecasts, and forecasters prefer media attention. “This sets up a positive feedback loop in which the media not only seeks out the most inaccurate forecasters but also worsens their forecasts.”

“Q. How do we know that economists have a sense of humor? A. They use decimal points.” It’s better to think clearly and make decisions that are approximately correct rather than rely too heavily on models that give precisely wrong results.

“Because threshold rebalancing tends to ‘catch’ market peaks and valleys more effectively than simple calendar rebalancing, I believe it is likely to be superior to calendar rebalancing.” I agree, but I wouldn’t recommend watching your portfolio daily in case a big market move triggers a need to rebalance. I’ve set up a spreadsheet that alerts me by email if I should rebalance my portfolio.

As for rebalancing thresholds, Bernstein gives some advice and concludes with “If you wind up rebalancing an asset class more than once per year on average, you should widen your thresholds. If you’re hardly rebalancing at all, narrow the thresholds.” The problem is that appropriate thresholds depend on portfolio size. My own work in this area may seem complex, but it factors in portfolio size, and in the end it’s just a few lines on a spreadsheet.

Overall, this is a valuable book for helping investors think about their asset allocations in sensible ways. I recommend it to anyone who meets the author’s definition of an “adult” investor.