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.