Wednesday, October 16, 2019

Time to Change Credit Cards

I forgot to pay off my credit card balance a few days ago. I do this roughly every 4 or 5 years. More annoying than paying some interest is that I seem to have to stop using the card for a couple of months to break the credit card interest cycle and get back in good standing. I need a useful reminder feature to help me avoid these mistakes.

My Tangerine Mastercard offers the following credit card email alerts:

  • Remaining Credit Less Than $100.00
  • Credit Card Payment Due
  • Credit Card Transactions Over $1,000.00
  • Money-Back Rewards Earned
  • Credit Card Payment Received
  • Money-Back Rewards Deposited

The alert I really want is “Your payment is due in a few business days, and we haven’t received anything yet.”

My wife tells me that her credit card offers this alert along with better cash-back rewards than I’m getting now. Maybe it’s time for me to dump my Tangerine credit card.

Friday, October 11, 2019

Short Takes: Student Bankruptcies, Early RRSP Withdrawals, and more

Here are my posts for the past two weeks:

The Latte Factor

Correlation

Here are some short takes and some weekend reading:

Doug Hoyes and Ted Michalos make a strong case that students are being treated unfairly by preventing them from including their student loans in bankruptcies for 7 years after leaving school. In addition to their other good points, they explain why removing this rule wouldn’t allow students to have bankruptcies of convenience shortly after graduating. One troubling part of the information they bring forward is the fact that university tuition has been rising much faster than inflation for a very long time. What we need is an inquiry into why schooling is so expensive and what unnecessary costs can be stripped out. If they’re anything like any of our levels of government, universities have far too much office staff and administration that contribute little to necessary functions.

Jason Heath goes through some reasons for early RRSP withdrawals. He runs through some of the numbers to show there are situations where you’re better off not deferring RRSP withdrawals as long as possible.

Cross-Border Experts recommend that Canadians own U.S. properties through cross-border trusts to avoid expensive and time-consuming probate.

Steve Garganis says you can prevent someone from fraudulently getting a mortgage on your home by taking out a secured line of credit you have no intention of using. I’d be interested in the opinions of other experts on how effective this would be.

Robb Engen at Boomer and Echo argues that passive investing is not a bubble. He’s right about this, but it’s certainly possible for popular ETFs to contribute to a bubble in the same way that active investing can contribute to a bubble. It’s possible for a narrow ETF that becomes popular to cause a bubble in some asset class. However, narrow ETFs aren’t really passive investing. As a passive investor in broad index ETFs who buys and holds for the long run, I’m not worried about causing bubbles.

Big Cajun Man sees media confusion over the difference between debt and deficit. “Debt” is how much your life sucks. “Deficit” is how fast your life is getting worse.

Monday, October 7, 2019

Correlation

Smart people who analyze different investment strategies often talk about correlations. Investments have correlations that are high, low, positive, or negative. This can all sound impressive, but as I’ll show, any conclusions we draw based on correlations can be suspect.

In the investment world, correlation is a measure of how asset returns move together. A positive correlation means two assets tend to give good returns together and bad returns together. A negative correlation means they tend to move in opposite directions. A zero correlation means the direction of one investment doesn’t tell you anything about the direction of the other investment.

It’s impossible to know the correlation of two investments exactly. All you can do is measure their correlation over a period of time. We then just assume the correlation will remain the same into the future.

To show the problem with this approach, I simulated two streams of monthly investment returns. The distributions I chose had zero correlation. Then I measured the rolling 10-year correlations of the two investments. Here are the results.


As we can see, the measured correlations aren’t particularly close to zero much of the time. The range was -11% to +24%. The fact that the correlations tended to be positive was just a coincidence; when I ran it a few more times, sometimes the correlations tended to be negative.

So, even though the correlation of the distributions I used was zero, the measured correlations from sequences of outputs varied considerably. So, analysts combing through investment returns could easily think the correlation between two investments is 20% when it is really zero.

Even more disturbing is that much mathematical analysis of investing assumes that returns follow the normal distribution (technically the lognormal distribution). However, there is strong evidence that the tails of return distributions follow power laws rather than the normal curve. This means that the standard deviation is infinite, and that correlations (in the way they are usually calculated) don’t exist.

These unsettling facts are the main reason why an analysis might calculate the optimum leverage for a portfolio to be 300%, when the real answer is more like 0% or 25%.

This doesn’t mean that any investment analysis that discusses correlations is automatically wrong. All mathematical analyses use models, and all models fail to match the real world in one way or another. The challenge is to figure out when the math gives the right answers and when it doesn’t.

Only a small minority of investors are comfortable using the math described in this article. However, among those who are comfortable with this math, only a small minority understand the errors in the models they use and how they cast doubt on their conclusions.

Tuesday, October 1, 2019

The Latte Factor

The first step to improving your finances is to spend less than you earn. But a great many people never seem to find the motivation to take this first step. The Latte Factor by David Bach and John David Mann aims to help readers find this motivation. It’s a short, easy read that many young people might find compelling.

The book is the story of a young woman whose finances are a disaster, and she gets some good advice from an unexpected source. Even without the financial lessons for readers, the story works well enough to keep the pages turning.

The first two of the book’s main messages are familiar to readers of financial advice: “Pay yourself first” and “Don’t budget—make it automatic.” The idea is that your savings should come off your pay first rather than waiting to see what’s left over after life’s expenses.

The final main message is “Live rich now.” The idea is to find a way to live the life you want now instead of waiting until some magical future time when you’ll have more money. It’s often the case that the things we truly want in life don’t cost too much money, and we can have them if we give up other things that are less important, like eating out and expensive coffee.

Some might think that this book is little more than a diatribe against expensive lattes. It isn’t. “It’s not about your coffee. The latte factor is a metaphor. It could be anything you spend extra money on that you could do happily without. Cigarettes. A candy bar. Fancy cocktails. Anything.”

One part of the book had me objecting initially. “When you rent, you are letting life happen to you. When you own, you take a hand in directing the events of your life.” With housing so expensive now relative to rents in many places, telling young people to extend themselves on a mortgage isn’t good advice. However, the philosophy of owning makes sense in other contexts such as cars and stocks.

Overall, I recommend this book for anyone whose finances are in poor shape and needs ideas for improving them. The lessons are described clearly, and the story form makes them easy to digest.