Thursday, July 11, 2019

Estimating the Value of 0% Financing

I recently helped a family member buy a new car. She was paying cash for the car, so we had to estimate the value of the 0% financing offered to figure out a sensible price to pay for the car.

The key factors that matter for estimating the value of low financing interest rates are duration and interest rate reduction. For example, suppose financing is offered for 4 years at a rate that is 4% below a competitive interest rate. This is a total of 4x4%=16%. However, if the car will be paid off over 4 years, the average balance owing will be close to half the price of the car. So, the value of the financing is about 8%.

For this example, you can reduce the car’s MSRP by 8% as a starting point for a cash sale negotiation. This is equivalent to paying the full MSRP and taking the financing. From there you can negotiate down from the adjusted MSRP.

It was interesting to talk to multiple dealerships and take this approach. A couple just pretended they didn’t know what I was talking about. They played it initially like they never heard of financing having a cash value. The place we eventually bought the car from immediately applied a cash-back figure that represented the value of low-interest financing.

A complicating factor was that I made a mistake initially with valuing the financing. I forgot about the average balance owing being only half the price of the car. So, I initially thought the financing was twice as valuable as it really was.

In the end, the price we got appeared to be better than indicated by the somewhat confusing report we downloaded from unhaggle. It’s always hard to know if you got a good or bad deal on a car, and I’m always left feeling uneasy for a while.

I don’t have much advice for most aspects of buying a car, but there are three things I’m confident about. One is how to value low-interest financing, the second is that it’s best to buy from Phil Edmonston’s Lemon-Aid guide recommended vehicle list, and the third is that it’s best to avoid debt and pay cash for cars.

Friday, July 5, 2019

Short Takes: Paying in Home Currency, Rent vs. Own, and more

Here are my posts for the past two weeks:

Switch: How to Change Things When Change is Hard

How Fast Will Your Portfolio Shrink in Retirement?

Here are some short takes and some weekend reading:

Preet Banerjee explains why you should never accept a foreign merchant’s offer to let you pay in your home currency.

Benjamin Felix compares renting to owning a home in terms of unrecoverable costs.

Big Cajun Man can probably hear the circus music after completing another round with CRA. They’ve accepted both halves of his documentation, but not both at the same time.

Tuesday, July 2, 2019

How Fast Will Your Portfolio Shrink in Retirement?

Once you’re halfway through retirement, you’d expect about half your savings to be gone, right? This turns out this is very wrong when we don’t adjust for inflation. The return your portfolio generates causes your savings to hold steady for a while and then fall off a cliff.

I read the following quote in the second edition of Victory Lap Retirement:

“A recent Employee Benefit Research Institute study found that people in the U.S. who retired with more than $500,000 in savings still had, on average, 88 percent of it left eighteen years after retirement.”

Frederick Vettese provided further detail. This 88% figure is the median rather than the average.

This statistic was used as proof that retirees aren’t spending enough. After all, if you planned on a 35-year retirement, half the money should be gone after 18 years, right? Not even close. Below is a chart of portfolio size based on the following assumptions.

- annual portfolio return of 2% above inflation
- annual withdrawals of 4% of the starting portfolio size, rising with inflation each year
- inflation of 2.12% (the average U.S. inflation from 2001 to 2018)



So, to be on track for a 35-year retirement, your remaining portfolio 18 years into retirement should be 83% of your starting portfolio size. This is a far cry from an intuitive guess that about half the money should be left.

Still, the earlier quote said the average retiree who started with at least half a million dollars had 88% of their money left 18 years into retirement. Further, thanks to a reader named Dave who found the original EBRI study online, we know that the 88% figure is inflation-adjusted.

Here is an inflation-adjusted version of the chart above:



So, 18 years into retirement in this scenario, you’d have 57% of your money left after adjusting for inflation. But the median U.S. retiree who started retirement with at least half a million dollars has 88% of the money left after adjusting for inflation. This is so high it would seem that retirees are severely underspending in retirement.

However, we have to look at the definition of retirement used in the study:

Definition of Retirement: A primary worker is identified for each household. For couples, the spouse with higher Social Security earnings is the assigned primary worker as he/she has higher average lifetime earnings. Self-reported retirement (month and year) for the primary worker in 2014 (latest survey) is used as the retirement (month and year) for the household.

So, even if the lower income spouse still works, the couple is retired. Also, because retirement is “self-reported,” we need to consider post-retirement working income. Most people who leave an office job, but make some money part-time doing a different type of work, consider themselves retired. Another significant source of money coming in is inheritances.

All these sources of post-retirement income cause retirees to draw less from their savings in early retirement to allow larger withdrawals later when they stop earning side income. This is true even for retirees who seek the largest steady inflation-adjusted spending level they can get throughout retirement.

Another factor that increases median savings levels is that some retirees have savings is in the millions and have no intention of spending all their money. Many retirees intend to leave a legacy.

If we account for the intention to leave legacies and the fact that many retirees continue to earn some income in the early phase of retirement, the gap between actual inflation-adjusted savings 18 years into retirement (median of 88%) and recommended level (57%) would shrink. How much it would shrink is hard to guess without further data on post-retirement incomes and intentions concerning legacies.

However, median figures hide the range of outcomes. You can drown in a river whose average depth is only 4 feet. These statistics include a very large number of U.S. retirees who are overspending and will run out of money. The EBRI study says that of retirees who started with at least half a million dollars, 18 years later 12% have less than one-fifth of their money left, and 32% have less than half. These retirees are at risk of running out of money before they run out of life.

The Victory Lap Retirement book and Vettese’s article promote the idea that retirees aren’t spending enough. In fact, there is a group who don’t spend enough, and another group who spend too much. We need to find a way to direct different messages to these two groups. Unfortunately, it’s the overspending group that is most likely to take comfort from books and articles claiming that retirees don’t spend enough.

Thursday, June 27, 2019

Switch: How to Change Things When Change is Hard

In my quest to better understand how to help people manage their money better, I followed a reader’s recommendation to try a psychology book by Chip Heath and Dan Heath called Switch: How to Change Things When Change is Hard. They explain how human nature makes change difficult, and they offer techniques for overcoming these difficulties.

The book begins with the observation that “Your brain isn’t of one mind.” Kahneman called the two parts of our minds System 1 and System 2, but the Heaths prefer a different analogy: “our emotional side is an Elephant and our rational side is the Rider.” Making changes requires getting the Elephant and Rider in agreement.

We can see the tension with a personal matter such as getting out of debt. The Rider might want spend less, but the Elephant would rather go out to eat than cook. You might think that we’d only have to deal with people’s rational sides to make changes at an organizational level, but you have to appeal to people’s Elephants if you want anyone to care enough to change their behaviour. Even executives need to care about a new idea at an emotional level to move on it.

A common theme in the book is that “What looks like resistance is often a lack of clarity.” When you’re trying to get people to change their behaviour, it’s vital to be crystal clear about what they should do. Any confusion makes it easy to just slip back into familiar old patterns.

Another common theme is the “Fundamental Attribution Error.” We have a tendency “to attribute people’s behavior to the way they are rather than to the situation they are in.” We tend to declare change impossible because of people’s natures when the right prodding can lead to big changes.

Only small parts of the book are directly relevant to financial matters. In one section, the authors are positive about the “Debt Snowball Method.” This is where you pay off small debts first rather than going after the debts with the highest interest rate. The reason is a matter of motivation. Being able to cross a debt off a list provides motivation to keep going. Paying off $200 of a $5000 credit card debt leaves us at risk of giving up.

There are nine steps the authors offer for making a “switch.” Here are four of them.
  • Rather than focus on problems, look for bright spots and encourage more of what is going right.
  • Script very specific changes rather than thinking about the big picture.
  • Find a way to make people feel strongly about the needed change.
  • Shrink the change to a first step that isn’t daunting.

The authors tell compelling stories, and their writing is page-turning. My first reaction is that the book’s methods must work well, but I can’t be sure because I haven’t tried to use them yet. I think the book is worth reading because it gives readers a different way to think about motivating change in themselves and others.

Friday, June 21, 2019

Short Takes: CPP Active Management, Portfolio Rebalancing, and more

Here are my posts for the past two weeks:

Should CPP Exist?

Credit Card Hopelessness

Living Debt-Free

Here are some short takes and some weekend reading:

Andrew Coyne explains the active vs. passive management issue for the Canada Pension Plan. He also digs into discrepancies in the claimed recent outperformance.

Canadian Couch Potato explains why it’s not necessary or desirable to rebalance your portfolio more than once per year. This advice is for those who rebalance based on time. I prefer threshold rebalancing, which is rebalancing whenever my portfolio is sufficiently far from its target percentage allocations. This is really only recommended if you can automate the process. It doesn’t make sense to do all the necessary calculations every day just in case you hit a threshold. I have my portfolio spreadsheet set up to send me an email when it’s time to rebalance, so I never have to look at it.

Tom Bradley at Steadyhand reminds us to focus on what really counts in investing. Hint: it’s not the short term.

The MoneySaver Podcast interviews Dan Bortolotti, the Canadian Couch Potato. They discuss passive index investing, ETFs, Robo-Advisors, and getting started investing.

Frederick Vettese shows in one example scenario that deferring CPP to age 70 is better than buying one of the new Advanced Life Deferred Annuities (ALDAs).

The Blunt Bean Counter explains the rules for the pension income tax credit.

Friday, June 14, 2019

Living Debt-Free

Through a combination of good luck and good habits, I’ve never had a problem staying out of debt. I’ve had to work at understanding what causes others to have debt problems. This is where Shannon Lee Simmons’ book Living Debt-Free has helped me. She lays out a wide range of debt management plans that take into account human nature and the underlying reasons why people have trouble with debt. The book contains a great many stories of people Simmons helped out of debt. These stories illustrate her points well and made the book an entertaining read.

Without thinking too deeply, we might believe that making someone feel shame about being in debt would drive them to cut their spending and pay off their debts. Simmons says the opposite is true. People need to feel good about some of the choices they’ve made to generate the sustained enthusiasm necessary to spend a few years digging out of debt.

“The stronger the negative emotions connected to your debt, the more likely you are to fail at your debt-repayment plan. You’d think it would be the opposite, but it’s not.”

If you’re in debt and don’t have a handle on your finances, “It’s likely that you feel guilty or afraid when you spend money. You never really know when spending is okay or when it’s going to lead to more debt you can’t pay off.”

An interesting part of the book it the idea of “tripwires.” Simmons suggests that you examine your spending over a few months and identify all the purchases you now regret. She then wants you to look for a pattern among these purchases. Possible examples are overspending on vacations, buying things your children don’t need, or fear of missing out. She wants you to identify your tripwires so you can catch yourself before making a purchase you’ll regret later.

Simmons doesn’t believe in scaring people with how much interest they’re paying. “The problem is that using scare tactics as the sole motivating factor almost always leads to failure over the long run.” She prefers to have you find your “touchstone,” which is the non-financial reason you have for wanting to get out of debt. She offers a list of questions to answer to help identify your touchstone. Keeping your reason for wanting to get out of debt front and center in your mind will help you maintain your motivation.

The book contains a series of steps for analyzing your spending, setting a realistic spending level, and calculating your “magic amount,” which is the amount of your income you can put towards debt each month.

Simmons stresses the importance of being realistic about how much you need to spend. If you choose a spending target that’s too low, you’re just setting yourself up for failure. “People give up on their Debt Game Plan if the plan doesn’t feel doable. I’ve seen it again and again.”

“If you’re in a situation where your Magic Amount is zero and you need to reduce expenses, try to reduce Fixed Expenses first, before reducing your Spending Money.”

Simmons has specific recommendations for how to set up your bank accounts. It’s aimed at having a separate chequing account to isolate the money you can spend each month however you wish. This gives you “permission to spend that money to zero without worrying that you’re using money earmarked for bills or savings.” If you want pizza and the account has money in it, you can have the pizza. “No guilt, no shame, no worries. No debt.”

Some minor not-so-good parts of the book

There are a few references to Astrology. Perhaps these are just meant to keep the book light and fun, but they are a red flag for me. I had a family member who believed in Astrology, and she made important decisions about her life and relationships taking into account Astrological nonsense. These few references to Astrology undermined my confidence in the author.

In Simmons’ own story of digging herself out of debt, she planned to withdraw $13,000 from her RRSP and “Once I paid the tax penalty, I’d have $9,100 left.” I know many people mistakenly think of the withholding tax on RRSP withdrawals as a “penalty,” but as a CFP, Simmons should know better.

After cleaning out her RRSP, “That was it. All of my savings, gone. Poof!” It’s common for people to think of their savings and debts separately, but the RRSP withdrawal was just recognition that it had already been spent slowly over time.

The interest rate on payday loans “can be as high as 60 percent.” Try 390%, and that’s before compounding. The compounded interest rate on payday loans is about 3600%!

When you’re in a position of needing to sell investments to pay off debt, Simmons says “you don’t want to sell if you’re in a loss position.” This isn’t good logic. It’s a bad idea to sell something just because it went down, but if you need the money to pay off debt, it shouldn’t matter whether the investments are trading higher or lower than your purchase price.

In a strategy Simmons calls “Stack and Swap,” it can be a good idea to pay certain debts off first to eliminate their minimum payments to free up cash flow. She says to “pay off the [debt with the] lowest amount owing,” but this isn’t right. It’s the ratio of minimum payment to debt that matters. If the lowest debt is $1000 on a credit card with a $30 minimum payment, paying it off won’t free up much cash flow. The targeted loan has to have high payments relative to the debt amount for “Stack and Swap” to work.

In a story about a person named Lee with tax troubles, the difference between $500 and $325 is calculated as $125.

Conclusion

Overall, I found this book both entertaining and illuminating. While I don’t have debt troubles myself, I’m glad to get better insight into how to help others who do have debts. The book has some parts I didn’t like, but they weren’t central to the main themes.

Wednesday, June 12, 2019

Credit Card Hopelessness

We’ve all seen the block of text on our credit cards that says how long it will take to pay off the debt if we just make minimum payments. I suspect this disclosure doesn’t make a positive difference.

Here’s the text that appears on my latest credit card statement:

“At your current rates of interest, if you only make your Minimum Payment by its due date each month, it will take approximately 35 year(s) and 10 month(s) to repay the account balance shown on this statement.”

35 years is a depressingly long time for it to take to get out of debt. And this is for a balance of only a little over $4200. It gets longer for larger balances. I calculate that my minimum payment should be a little over $70, but it’s only $10, which doesn’t even cover interest. Perhaps as long as I keep paying my bill in full every month, my minimum payment stays at $10 so I won’t realize that the interest is actually about $70 per month.

Superficially, the mandated disclosure with the depressing message of it taking decades to get out of debt seems like it should motivate people to pay more than the minimum payment. However, I suspect it often has the opposite effect. What’s the point in trying if you can’t get out of debt for decades? You might as well give up. I don’t believe these things, but I can understand if people become hopeless about their debts.

I have a suggestion for a different disclosure:

“The amount you have to pay monthly to clear this debt in
1 year is $391,
3 years is $157,
5 years is $112.”

This disclosure is more hopeful and more useful for credit card holders. I suspect this type of message is more likely to induce people to pay more than the minimum payment. We can only know for sure by how strongly banks and credit card companies oppose it.

Monday, June 10, 2019

Should CPP Exist?

When Canada Pension Plan (CPP) expansion was first being discussed, businesses didn’t like the prospect of making larger CPP contributions on behalf of their employees. Money managers and financial advisors weren’t happy either because of the likelihood of it reducing their assets under management. This led to many negative articles about CPP. Here I look at some criticisms of CPP.

CPP is a Ponzi scheme.

No, it isn’t. Detractors only call it a Ponzi scheme to try to make it seem fraudulent and likely to collapse. CPP did begin as a scheme where worker contributions were used to pay retired workers, but it is moving away from that model as it builds assets from new contributions. CPP is on very solid footing now and is set to make its promised payments for decades to come.

We should have more individual responsibility.

That sounds good in theory, but let’s look at how that would play out in practice. Suppose we eliminated CPP, OAS, GIS, and other programs that direct money to low-income retirees. This would likely prompt a few people still working to save more, but we’d still have a very large number of people who would spend all the money that gets into their hands. Once these people become unable to work for physical or mental reasons, they’d have no money for food, clothing, or shelter.

It might be tempting to say “too bad” at this point, but there’s no way we’d want to live in a world with hundreds of thousands of starving old people begging for food on the streets across Canada. A majority of us would demand that the government step in to help these people. This would soak up massive amounts of tax money. A much better idea is forced savings in the form of CPP contributions to reduce the burden on taxpayers.

CPP should be optional.

It’s true that not everyone needs to be forced to save money for their retirement. If we could identify just those who don’t need CPP and let them opt out, then making CPP optional would work well. But that’s not what would happen. Huge numbers of people who need CPP would opt out, and we’d be left with the same problem of massive numbers of starving old people. CPP only does its job properly when it’s mandatory.

CPP management is too costly.

I have some sympathy for this one. Those who actively manage CPP investments are soaking up billions of dollars. I’m skeptical that they will outperform by enough to justify their costs over the long run. One thing is certain, though; they will be able to produce reports that paint their performance in a positive light.

Now let’s compare CPP management to the alternative: allowing people to manage more of their own savings. The returns that we get collectively on our retirement accounts are dismal. Huge fees and poor market-timing decisions are widespread. The current costs of running CPP are a bargain by comparison. Any time we talk about running CPP more efficiently, it’s important to remember how badly most people manage their own investments.

CPP returns are too low.

CPP returns are higher than most people would get managing their own money. The usual analyses that show low CPP returns are quite biased. First, they usually take the example of someone who makes the maximum contribution every year and doesn’t need any of the dropout provisions. These dropouts mean that some of one worker’s CPP contributions become benefits for another worker. A slice of contributions get redistributed. That’s the way the system works. Those who don’t use dropouts get a somewhat lower return so that others get a higher return. I think of it as most of my CPP contributions are for me, and the rest are essentially a tax.

Another misleading part of many analyses is that they don’t mention that the investment returns they calculate are real, meaning they are above inflation. There is a big difference between 2% and inflation plus 2%. Canadians whose long-term returns are inflation plus 2% are doing quite well.

CPP will be bankrupt by the time Millennials retire.

No, it won’t. This is mostly used as a scare tactic to get people to save more for their retirement so that money managers and financial advisors can have more assets under management. The increases in CPP contribution rates from 1987 to 2003 have put CPP on a stable trajectory.

Conclusion

Canadians are far better off with CPP than without it. There is room to improve how CPP is run, but eliminating this program without a similar replacement would be a disaster.

Friday, June 7, 2019

Short Takes: Free Investment Dinner, Mutual Fund Costs, and more

Here are my posts for the past two weeks:

The Next Millionaire Next Door

Thinking in Bets

Here are some short takes and some weekend reading:

Rick Ferri describes his “free dinner and retirement discussion” as a warning to others. It would have been funny except that I kept thinking about retirees who buy in and get fleeced.

Preet Banerjee gives an introduction to mutual fund costs. If you’re thinking you don’t need to worry about this because your mutual funds don’t have any fees, you need to watch the video because you’re wrong.

John Robertson looks at potential future costs with all-in-one ETFs if you want to change your asset allocation in taxable accounts as you age. This isn’t much to worry about if your RRSPs hold as much as your taxable accounts, because you can make low-cost changes just within your RRSP to change the asset allocation of your entire portfolio.

Justin Bender explains that any tax inefficiency in holding Vanguard’s asset allocation ETFs in a taxable account comes from the bond holdings rather than equities.

Thursday, June 6, 2019

Thinking in Bets

The world is an uncertain place, and according to Annie Duke, author or Thinking in Bets, we’re better off accepting that we don’t know for certain what will happen than to keep trying to guess the future. It’s better to assign probabilities to different outcomes and adjust them as necessary rather than pick an outcome and doggedly defend that choice. Individually her ideas are familiar, but taken collectively, they amount to a rational truthseeking lifestyle.

Duke is best known as a highly successful poker player, and although this isn’t a poker book, she uses a number of vivid poker stories (and many non-poker stories) to illustrate her points. She says that “all decisions are bets” because your choices lead to gains or losses of money, time, and other things that matter.

One of Duke’s early points is that we need to avoid “resulting,” which is a poker term for judging a decision by how things worked out. Walking across a highway blindfolded isn’t a good idea, even if you don’t get hit by a car.

One interesting point is about how we form beliefs. We think we hear an idea, “think about it and vet it, determining whether it is true of false,” and then “form our belief.” In reality, when we hear something we tend to believe it to be true, and “Only sometimes, later, if we have the time or the inclination, we think about it and vet it, determining whether it is, in fact, true or false.”

“Our default is to believe that what we hear and read is true.” “It doesn’t take much for any of us to believe something. And once we believe it, protecting that belief guides how we treat further information relevant to that belief.”

“Fake news isn’t meant to change minds. As we know beliefs are hard to change. The potency of fake news is that it entrenches beliefs its intended audience already has, and then amplifies them.”

So what can we do about the way we form beliefs and harden them? Among poker players, an antidote is “wanna bet?” When someone challenges us to a bet based on our beliefs, it leads us to ask ourselves many good questions: “How I know this? Where did I get this information? Who did I get it from?”

Rather than relying on others to challenge us to bets to help weed out wrong beliefs, Duke suggests “Incorporating uncertainty into the way we think about our beliefs.” Instead of believing something is 100% true, we might admit we’re only 70% sure. This makes it easier to reduce this probability in the face of new evidence instead of rejecting the evidence and doggedly sticking to the original belief. “This shifts us away from treating information that disagrees with us as a threat, as something we have to defend against, making us better able to truthseek.”

We have a tendency to believe our good outcomes are the result of our skill, and bad outcomes are the result of bad luck. This interferes with learning to improve our skills. Duke’s “learning loop” depends critically on correctly identifying both good and bad luck. To develop skill we start with a belief, take some action that amounts to a bet on that belief, view the outcome, throw out the part of the outcome due to luck, and update our belief. If all bad outcomes are bad luck, then we won’t develop skill. Failing to recognize good luck impedes learning as well. I had extraordinary good luck investing in 1999, and it took me about a decade to see that I was better off with index investing.

Our thinking about luck can slow learning in another way. Our habit of being competitive with others and thinking them lucky when they succeed impedes our ability to learn from their successes and failures.

Duke suggests forming a group of friends or colleagues committed to truthseeking and “thinking in bets.” This helped her learn to play poker at a very high level, and she sees benefits in business and other activities. She sees the failure to truthseek as a reason why some groups fail. In my experience, another big reason for business failure is self-interest. If you need to keep your job, you agree with the boss, even when you think he or she is wrong. It’s a rare employee at any level who feels free to disagree with a company’s top management.

A young Duke was told “It’s all just one long poker game.” This is “a reminder to take the long view, especially when something big happened in the last half hour.” I make a similar point when I talk about “the 1000-foot view.” I get a lot of benefit from trying to keep things in perspective. Few outcomes that seem terrible in the moment are very important in the long run.

Another important idea in the book is that when we make a choice, there are several possible outcomes. In our financial lives, this way of thinking is critical. Just because a bet has a positive expectation doesn’t mean it’s a good idea. If one of the reasonably-likely outcomes would be devastating, we should make a smaller bet or not bet at all.

Overall, I enjoyed this book for its vivid explanations and the way it tied together many familiar ideas into an action plan. Duke offers a set of tools for overcoming some of our natural tendencies to keep believing things that are wrong. Even a small improvement in this area can pay large dividends in life.

Wednesday, May 29, 2019

The Next Millionaire Next Door

Back in 1996, the book The Millionaire Next Door was wildly successful. I recall enjoying it without thinking too critically about its messages. The latest follow-up book in this millionaire series is The Next Millionaire Next Door, written mainly by Sarah Stanley Fallaw, daughter of one of the earlier book’s authors, Thomas J. Stanley. I enjoyed this book as well, but mainly for the interesting personal stories of millionaires’ journeys.

The book is based on surveys of millionaires. As with the first book, this one attempts to use the collected data to draw conclusions about how people become wealthy. This presents a number of challenges. A big challenge is that the data is all self-reported. What people say is often very different from reality. For example, when asked about investment fees, “33% of [millionaires] paid zero.” But how many just don’t know they pay fees?

Among millionaires, “luck was rated among the least important success factors, while being well-disciplined was at the very top along with integrity.” Few successful people think they were just lucky, but lots of unsuccessful people believe they had bad luck.

In another example, “marketing tactics related to homeownership had little influence on millionaires in our study.” Even if marketing tactics were wildly successful, few people would ever admit to being influenced or even be aware they were influenced.

In a different study, “only 54% of Americans could manage a $400 emergency expense.” This statistic has been widely repeated, but it seems likely that the respondents were answering a different question: “Does the thought of an unexpected $400 expense sound scary?” It’s doubtful that more than half of Americans are really less than $400 from bankruptcy.

Another challenge with drawing conclusions from data about millionaires is survivorship bias. Looking at the traits and actions of millionaires tells you nothing about how many people with the same traits and actions and failed to become millionaires. Which traits and actions lead to wealth and which are irrelevant? It’s hard to know. Some actions such as “save lots of money” seem safe to say that they help with getting rich. Others are less clear.

No doubt the authors attempted to minimize survivorship bias, but it’s hard to tell how successful they were. One conclusion that “how we feel about ourselves and our abilities related to financial matters significantly impacts net worth” seems suspicious. I would guess that causation in the reverse direction would be strong. Getting rich, even by luck, makes us confident about our financial choices.

Another example of what looks like survivorship bias is “economically successful people demonstrate an uncanny ability to select the right occupation.” And lottery winners show an uncanny ability to buy the right ticket.

“To build and maintain wealth over time, it will be necessary for you to approach all financial management—spending, saving, generating revenue, investing—in a different, more disciplined approach than anyone else around you.” This makes sense; getting rich is a competition among people, because we can’t all be rich.

“Those who do not budget or account for annual consumption categories demonstrate a lack of respect for money.” This one puzzles me. Plenty of people just naturally spend little without agonizing over details. I’ve added up my past consumption, but never budgeted or worried about categories. I definitely have respect for money.

In this period of ever-rising real estate prices, it was refreshing to read that it is dangerous to purchase “a home that requires more than three times your annual income.” Buying too much house can be a financial ball and chain.

“Too many Americans may believe that by driving a new car they are emulating economically successful people. But only 16% of millionaires drive this year’s model motor vehicle.” Doesn’t that mean millionaires buy a new car roughly every 6 years? Seems like rich people do drive new cars.

Some great advice for a young person starting a new job: “invest [your] money because one day ‘you may decide you don’t [like your job] anymore. That money will give you the independence and, more importantly, options to choose, rather than to continue working. Money isn’t about being rich. Money is about giving you choices. You are young and may not be able to see this now, but someday you will.’”

An interesting statistic: “just under one-third of millionaires reports relying on a financial professionals to make investment-related decisions.” Financial advisors seek out wealthy people, but catch them less often than I would have guessed.

Overall, I enjoyed this book because it is filled with entertaining personal stories written by wealthy people. What’s much less clear is whether the book’s conclusions form a useful blueprint for seeking wealth.

Friday, May 24, 2019

Short Takes: Beliefs and Decision-Making, Fake News, and more

Here are my posts for the past two weeks:

Reader Question about Bucket Investing Plan in Retirement

Should You Withdraw the Commuted Value of Your Defined-Benefit Pension?

The Cost of Longevity Risk

Here are some short takes and some weekend reading:

Annie Duke gives a fascinating talk on how we form beliefs and make decisions. I hope understanding these issues will help me make better decisions in the future. However, the research seems to say I’ll have minimal success.

Julian Matthews explains why we’re susceptible to fake news and what we can do about it.

Robb Engen at Boomer and Echo has made the leap to one-ticket investing using Vanguard’s 100% stocks ETF (VEQT). A huge upside with this approach is its extreme simplicity. The downside for large RRSPs is U.S. foreign withholding taxes. By holding U.S. ETFs directly in my RRSP instead of VEQT, I estimate that I save a little over $500 per year for each $100,000 in my RRSP. To save this money, I have the joy of managing multiple ETFs and doing currency exchanges using Norbert’s Gambit. Whether this extra work is worth it depends on portfolio size.

Nick Maggiulli calls out some instances of financial pornography and explains why it’s not going away any time soon.

Ellen Roseman interviews Preet Banerjee to discuss his 5 simple personal finance rules. I enjoyed his story about how his first media exposure majorly pissed off his then employer. His new venture Money Gaps sounds like an interesting way to drive more solid financial advice to those with modest portfolios. Canadian Couch Potato also interviews Preet to discuss problems in the financial advice industry and what Preet is doing to help fix these problems.

Andrew Hallam points out what he believes is an active Ponzi scheme. The promises of no monthly losses and 30% annual returns are crazy.

Canadian Couch Potato explains what can happen when you trade stocks or ETFs close to their dividend dates. The consequences are generally minor, but sometimes moving your trade date by a day can give a small tax benefit.

Tuesday, May 21, 2019

The Cost of Longevity Risk

One valuable part of CPP, OAS, and defined-benefit pensions is that they keep paying you even if you live a long life. In more technical language, these pensions take care of longevity risk. When you have to manage your own investments, you’re forced to spend conservatively in retirement in case you live long. Here we consider example cases to illustrate the cost of longevity risk.

Shawna is 65 years old and is entitled to a $1000 per month pension, indexed to inflation, for the rest of her life. She is offered the choice of keeping this pension or withdrawing its commuted value to invest in her locked-in retirement account.

To keep this example simple, we’ll assume the pension plan expects Shawna to live 20 more years, and her commuted value is calculated with a discount rate of inflation plus 1.5%. The commuted value of her pension works out to $207,436. We’ll also assume Shawna won’t have to pay any income taxes immediately as she would have to if her commuted value was too much larger.

If Shawna takes the commuted value, she is then hoping to invest her lump sum well enough to all withdrawals of at least $1000 per month, rising with inflation, for the rest of her life. If she just assumes she’ll die at 85, she only needs to generate annual returns of inflation plus 1.5%.

However, Shawna is worried she might live past 85. To be safe, she plans to make the money last for 30 years. The question then is what return does she have to get to produce $1000 per month rising with inflation for 30 years? The answer is inflation plus 4.16%.

Even with an all-stock portfolio, there is significant risk that Shawna’s portfolio won’t produce this return, on average, for 30 years. Taking the commuted value leaves Shawna with a lot more risk than if she just takes the pension.

The situation changes for a younger person. Consider Carla who is 45 and is entitled to a $1000 per month pension, rising with inflation, starting at age 65 for the rest of her life. With the same assumptions as in Shawna’s case, Carla’s commuted value is $154,015.

To make her self-generated pension last for 30 years starting at age 65, Carla needs to generate investment returns of inflation plus 2.52%. This is more realistic than Shawna’s case. Carla is still taking some risk if she takes the commuted value, particularly if she is working with an expensive advisor. But with discipline and low-cost investments, Carla has a reasonable chance of generating more income than she would get with her pension.

It’s easy to get lost in the numbers when trying to decide whether to take a pension or withdraw its commuted value. Any analysis that leaves out longevity risk is flawed.

Wednesday, May 15, 2019

Should You Withdraw the Commuted Value of Your Defined-Benefit Pension?

No. There are some exceptions, but the answer is almost always no. In fact, if a financial advisor is pushing you to pull out the commuted value of your pension, that’s a sign that you’re likely working with a bad advisor.

There is almost no chance that your advisor will choose investments that outperform a pension fund, mainly because the total fees you pay with an advisor are so much higher than the fees charged within a pension fund. Some advisors will tell you that you won’t pay any fees because the mutual funds pay the advisor. Don’t believe this. Mutual funds and advisors get paid out of your savings.

Further, defined-benefit pensions have the advantage of handling longevity risk. Pension funds can afford to pay you based on your expected life span, and they’ll keep paying if you happen to live long. With an advisor managing your money, you need to hold back on your spending in case you live long.

There are some cases where it makes sense to withdraw your pension’s commuted value. Here are a few:

1. Poor health makes you likely to die much younger than average. In this case, taking the commuted value allows you to spend more now or leave a larger legacy.

2. You’re employer’s pension plan is badly underfunded and the company is in financial difficulty. A good example of this was Nortel. The Big Cajun Man was fortunate to get the full commuted value of his Nortel pension before pension payments were cut.

3. You leave an employer long before retirement age, and the pension plan rules make the commuted value more attractive than future pension payments. It’s important to make this determination based on modest return expectations for your portfolio. The fees you’ll pay an advisor severely dampen investment returns over long periods.

I’m sure it’s possible to come up with other narrow exceptions, but you should be very wary of advisors who push hard for you to withdraw the commuted value of a defined-benefit pension. These advisors have strong incentives to increase their assets under management to get more fees. Don’t be swayed by advisors who claim they can generate big investment returns.

Monday, May 13, 2019

Reader Question about Bucket Investing Plan in Retirement

One of this blog’s readers, AT, asks the following question about his retirement bucket investing plan (lightly edited for length):

Loosely following your bucket idea, I put $25,000 in 1, 2, and 3-year GICs. A year came and went and then $25,000 plus change went back into my account. I get CPP, OAS and have activated my RIF and LIF accounts. Does it make sense to have GICs when I have these streams of income which once started, I can't just randomly stop when the market plunges? I'd like to stop them of course and live on a GIC for a year, but if I can't, are GICs any use to me?

In my own portfolio, when stocks plunge, I just rebalance rather than make an active decision to spend only from my fixed-income investments. So, to me, your dilemma just looks like a rebalancing question. If stocks go down, your planned annual spending goes down somewhat, and you end up wanting less in GICs than you have in your non-registered (taxable) account. The remedy is to own a small amount of stock in your non-registered account. One possible way to do this is to take an annual RIF or LIF withdrawal in-kind. Alternatively, you could just use cash from the withdrawals to re-buy stocks.

If you have TFSA room to hold the stocks that no longer fit in your RIF and LIF, then you won’t have any loss of tax-efficiency. If not, it is less tax-efficient to own stocks outside registered accounts, but there is no choice if you want to be holding more stock than your registered accounts can hold. At least if you buy and hold low-cost index funds, you can defer capital gains taxes.

If you’re planning to make more active decisions about whether to spend from stocks or GICs, it’s still possible to use the idea of holding stocks in a TFSA or non-registered account. However, there are so many active retirement spending strategies that it’s hard to say what asset location choices make sense without knowing more about your strategy.

So, GICs can still be of use to you as a buffer against stock market declines, as long as you’re willing to hold some stock outside your RIF and LIF.

Friday, May 10, 2019

Short Takes: Maximizing OAS, Elder Financial Abuse, and more

I wrote one post in the past two weeks:

My “Bucket Strategy” for Retirement Spending

Here are some short takes and some weekend reading:

Ted Rechtshaffen explains how to maximize the amount of OAS you’ll get to keep. This is one of the more sensible articles I’ve read about OAS deferral and clawbacks.

Ellen Roseman interviews elder law specialist Laura Tamblyn Watts about protecting seniors from financial abuse. This is a very difficult area because it’s hard to distinguish between someone who is helping a senior and someone who is stealing money from a senior. If you go too far in protecting against abuse, you make it hard to help as well.

Preet Banerjee interviews David Bach, author of the book The Latte Factor. It’s not just about lattes, but generally the power of small daily amounts of money. I had a laugh at the joke website name, Bonds are for Losers.

Big Cajun Man explains a few things to clueless car flippers.

Tuesday, April 30, 2019

My “Bucket Strategy” for Retirement Spending

I frequently get questions about the “bucket strategy” I’m using for spending my assets in retirement. I prefer not to use the term “bucket” because my strategy differs from bucket methods in important ways. In fact, my retirement spending more resembles single-portfolio strategies.

My decumulation approach involves holding 5 years’ worth of my annual spending in short-term fixed income and the rest in stocks (described in more detail in my post Cushioned Retirement Investing). Each year, I sell enough stock to replenish the fixed-income allocation.

My annual spending each year is calculated from my age and current portfolio value. As I get older, I spend a slightly higher percentage of my remaining portfolio (see the spreadsheet in my Cushioned Retirement Investing post for the exact percentages). If stocks perform well, my annual spending will rise, and if they perform poorly, my spending goes down.

Because my annual spending changes from year to year, I have to calculate how much stock to sell each year. I take my new annual spending, multiply by 5, and subtract the current value of my fixed-income investments. This is essentially a form of rebalancing that has me selling fewer stocks when they’re down and selling more when stocks are up. In rare cases when stocks crash, I might have more fixed income than 5 times my new annual spending, and I actually buy some stocks instead of selling.

Important Differences from Bucket Strategies

No active decision on which bucket to spend from

Many bucket strategies involve making an active decision about whether to spend from stocks or fixed income in a given year. This only makes sense if you believe you have the ability to time the market. I don’t. Most people (maybe all) who believe they can time the market are wrong.

No hard switches between spending from stocks and fixed income

It’s possible to devise a bucket strategy that is entirely rules-based. A simple example would be to spend for the year entirely from fixed income if stocks are more than 20% below their peak level. The idea would be to ride out stock market declines by spending from fixed income until stocks rebound. My strategy has no hard switches between spending from stocks and spending from fixed income.

Other differences from typical decumulation strategies

Predetermined spending changes based on portfolio size

Decumulation strategies often have retirees set a spending level and keep it fixed (possibly with inflation adjustment each year). If stocks perform poorly, these retirees then have to decide when to cut their spending. My strategy automatically adjusts spending level based on portfolio size. This has the advantage of guaranteeing I won’t run out of money. However, it becomes a disadvantage for any retiree who can’t or won’t spend less when stocks disappoint.

Fixed-income allocation adjusts automatically with age

Many decumulation strategies are vague about when to increase the allocation to fixed income investments in a retiree’s portfolio. My strategy uses a fixed rule to increase the percentage of fixed income each year.

No long-term bonds or corporate bonds

I get enough volatility from my heavy stock allocation. I prefer not to be open to shocks in bond markets. So, my portfolio holds no corporate bonds at all, and no government bonds of duration more than 5 years. In fact, I currently have only GICs and savings accounts.

Conclusion

My decumulation strategy is close to single-portfolio methods than it is to bucket strategies. It’s impossible to know whether my strategy will work out any better than anyone else’s. But I prefer to remove as much of my own decision-making as possible. Faced with a decision, it’s very easy to just do nothing. I have a spreadsheet that tells me what to do and when to do it.

Friday, April 26, 2019

Short Takes: Million Dollar Lattes edition

I didn’t write any posts since my last set of Short Takes, so I thought I’d start by weighing in on the furor Suze Orman stirred up when she said buying expensive coffee is “peeing $1 million down the drain.” In an effort to annoy everyone, I’m going to drive down the middle of the road.

Orman’s example using a 12% rate of return for 40 years is just plain silly. She also ignores the time value of money that makes $1 million 40 years from now much less valuable than $1 million today. But she’s not wrong that small amounts of money add up and can undermine your saving efforts.

There’s nothing wrong with buying coffee or other small things if you’re doing it thoughtfully, understanding their full cost over time. But that’s not how most people think. They just can’t imagine that such small amounts can make much difference. But they do.

Orman’s critics are right when they say that the big things in life, like houses and cars, matter the most. But they’re wrong when they say that little things can’t make a meaningful difference to your retirement.

There is no one answer to the latte question that applies to everyone. If you’ve got the money, and you want your coffee, go ahead. If you’re holding an expensive coffee and complaining that life is so expensive now and you’re not sure what you’re going to do, then the money wasted on coffee is a problem.

Here are some short takes and some weekend reading:

Robb Engen at Boomer and Echo explains why he isn’t paying off his mortgage any faster. My take on whether to pay off a mortgage faster comes down to a single question: if stocks drop 40% and you lose your job at the same time, will you be OK? I suspect Robb would hold out fine financially until he found another job. Too many people would be wiped out by that scenario.

Canadian Couch Potato answers several listener questions in his latest podcast.

Big Cajun Man is having some income tax hassles that illustrate how the extremely long delays at CRA complicate taxes even further.

Friday, April 12, 2019

Short Takes: Investment Fees, Downside Protection, and more

I wrote one post in the past two weeks:

Consumers Can’t Avoid Computer Bots

Here are some short takes and some weekend reading:

Tom Bradley at Steadyhand looks at the current landscape of investment fees. Costs aren’t dropping in all areas.

Dan Bortolotti answers a reader question about downside protection with stocks.

Big Cajun Man has some tax trouble and shows what can happen to this year’s taxes when a previous year is still in dispute.

The Blunt Bean Counter discusses the issues occupying his time this tax season.

Tuesday, April 2, 2019

Consumers Can’t Avoid Computer Bots

You may have heard some people complain that when they used online chat on some big business’s website, they were chatting with a computer bot instead of a real person. You might think this isn’t a problem for you because you don’t use chat features on websites. Think again.

The dream of big businesses is to run their customer interfaces with computers rather than employees. Most of the time I actually prefer to do things myself on a website, such as banking transactions, travel packages for my phone, and even some troubleshooting. However, there are times when we need to speak to a person to solve a problem.

After you’ve waded through phone menus, listened to music for several minutes, and finally get a person on the line, you may not really be getting human responses. Increasingly, call center employees just read computer responses off a screen. As these computer algorithms get more sophisticated, call center employees make fewer decisions on their own.

Even your local bank branch will have you interacting with computers. It’s common for bank tellers to try to upsell you on bank products. One time I happened to have a view of the teller’s computer screen when the upsell came. The exact language the teller used appeared on screen: “Hey, have you thought about opening a TFSA?” This is creepy, and it’s getting progressively more common.

With each passing year, customer-facing employees of big businesses have less discretion to make their own decisions. They can’t overrule computer decisions. For now, what they can control is what they enter into the computer. I remember pointing out a small dent in a stove being delivered to my house. The delivery person said “so you’re refusing delivery, right?” He had his finger hovering over a small touchscreen waiting for my answer. I wasn’t sure how to respond. “If you refuse delivery, they’ll send a new stove at no extra cost to you.” I was being helped to give the right response so a computer would decide to send me a new stove.

A few years ago, my bank upped the amount of cash I could withdraw per day from cash machines, but I had to do it in two transactions, and I was getting hit with two withdrawal charges of a dollar each. The branch manager reversed one of the charges, but told me she wouldn’t be able to do it again in the new year because much of her discretion was being taken away. Even branch managers have to do what computers tell them to do.

The next time you’re frustrated with an employee at a big business, remember that getting angry at the employee doesn’t help. Low-level employees have little discretion; company policies are set at headquarters and are transmitted throughout the business by computers. Be polite, stand your ground, and maybe the employee will poke the computer in such a way that you’ll get what you want.

Friday, March 29, 2019

Short Takes: Simplified Investing, Swap-Based ETFs, and more

Here are my posts for the past two weeks:

Compensating for Your Money Personality

Padding Retirement Savings

Here are some short takes and some weekend reading:

Ryan Krueger wrote a very entertaining piece drawing analogies between stock analytics and basketball analytics. He then draws the nonsensical parallel between NBA players shooting more 2-pointers and investors taking concentrated positions in a few dividend stocks. The article may not make much sense, but it’s so well written it’s worth a read.

John Robertson discusses the swipe at swap-based ETFs in the latest federal budget. I agree with his take that these swap arrangements that turned different types of income into capital gains always seemed too good to be true. The party appears to be over.

Big Cajun Man explains some positive changes to RDSPs in the latest federal government budget.

Canadian Mortgage Trends reports that the mortgage industry is unhappy with the latest federal budget. I take this as a positive sign. Too many young people are burying themselves financially by borrowing too much to buy a house. If those who profit from sales activity are unhappy, this must mean the budget won’t do much to drive more activity.

Andrew Hallam gets roped into a timeshare sales pitch and describes his experience. It takes a backbone to hold off some very persuasive salespeople, and it takes number-crunching skills to realize just how bad a deal timeshares are.

Preet Banerjee explains mutual funds and exchange-traded funds in his latest learn about investing video.

The Blunt Bean Counter has some tax tips for students.

Wednesday, March 27, 2019

Compensating for Your Money Personality

When my wife and I were young, we were very frugal. I recall walking around for over a month with the same ten-dollar bill in my pocket. We’re less frugal now but still having a hard time transitioning from workers who save to retirees who spend. Fortunately, we’ve found some ways to compensate for the aspects of our money personalities that aren’t helping us any more.

In my case, I fuss over spreadsheets that show we consistently underspend our safe monthly allowance. This gives me constant reminders that I’m no longer an 18-year old kid who doesn’t have enough money to eat lunch.

In my wife’s case, she feels the pain of every expenditure. This is particularly true if the expense seems extravagant, like eating out. To compensate for this, I pay in almost all situations where we’re together.

This wasn’t a revelation of mine; my wife knows herself well enough that she’s the one who wants me to pay. In fact, I might not even have noticed this pattern if she hadn’t pointed it out. She says thinking “it’s all free for me” helps her enjoy the moment without fretting about money.

We’ll never completely pull free of our financial natures and early-life experiences, but we’ve found some ways to compensate.

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.