Tuesday, October 27, 2020

Owning Today’s Long-Term Bonds is Crazy

Today’s long-term bonds pay such low interest rates that it makes no sense to own them.  There is virtually no upside, and rising interest rates loom on the downside.  Warren Buffett called this “return-free risk.”  He was right.  Here I explain the problem and address objections.

As I write this, 10-year Canadian government bonds pay 0.623% interest.  If you invest $10,000, you’ll get a total of only $623 in interest over the decade, and then you’ll get your $10,000 back.  This is crazy.  Even if inflation stays at just 2%, you’ll lose $1237 in purchasing power.

Even worse are 30-year Canadian government bonds that pay 1.224% as I write this.  Your $10,000 would get a total of $3672 in interest over 3 decades.  This is a pitiful amount of interest over a full generation.  At 2% inflation, you’ll lose $1738 in purchasing power.  Even a portfolio that only beats inflation by 2% per year would gain $8113 in purchasing power over 30 years.

All investments have risk, but there has to be some potential upside to justify the risk.  Where is the upside for long-term bonds?  The only upside comes if we have sustained deflation.  It’s crazy to risk so much just in case the prices of goods and services drop steadily for the next decade or three.

Some investors mistakenly think they can always sell bonds and collect accrued interest.  That’s not how it works.  With a 30-year bond, the government is promising to pay you the tiny interest payments and give you back your principal after 3 decades.  If you want out, you have to sell your bond to someone else who will accept these terms.  You don’t get accrued interest; you get whatever another investor is willing to pay.  Counting on selling a bond is hoping for a greater fool to bail you out.  If future investors demand higher interest rates on their bonds, your bond will sell at a significant capital loss.

If the interest rate on 30-year bonds goes up over time, that’s actually bad for current bond owners, because they have to live with their lower rate instead of receiving the new rate.  If 30-year bond interest rates go up by 1%, you immediately lose 30 years of 1% interest; you can’t just sell to avoid the loss because other investors wouldn’t happily take these losses for you.

Let’s go through some objections to this argument against owning today’s long-term bonds.

1. Stocks are risky.

It’s true that stocks are risky, but I’m not suggesting that investors replace long-term bonds with stocks.  Short-term bonds and high-interest saving accounts are safer alternatives.  A decision to avoid long-term bonds doesn’t have to include a change in your asset allocation between stocks and bonds.  For anyone willing to look beyond Canada’s big banks, it’s not hard to find high-interest savings accounts paying at least 1.5% and offering CDIC protection on deposits.  If long-term bond interest rates ever return to historical norms, it’s easy to move cash from a savings account back into bonds.  So, you don’t have to live with a measly 1.5% forever.

2. Investors need to diversify.


The benefit from diversifying comes from owning assets with similar expected returns that aren’t fully correlated.  However, the expected returns of today’s bonds are dismal.  We don’t really own bonds for diversification these days.  The real reason we own bonds is to blunt the risk of stocks.  It doesn’t make sense to try to reduce portfolio risk by buying risky long-term bonds.  Flushing away part of your portfolio with long-term bonds isn’t a reasonable form of diversification.  Short-term bonds and high-interest savings accounts do a fine job of reducing portfolio volatility without adding significant interest rate risk.

3. Long-Term bonds have higher interest rates than short-term bonds.

Historically, long-term bonds rates usually have been higher than short-term rates.  Today, however, high-interest savings accounts pay more interest than long-term government bonds.  But that’s not the only consideration.  Interest rates will change over the next 30 years.  If you own short-term bonds, your returns will change too.  However, if you buy 30-year bonds, your interest rate won’t change for 3 decades.  If interest rates rise, new short-term bond rates will be higher than your old 30-year rate.  Even if long-term bond rates rise, that won’t change your interest rate.  New investors will get more interest, but your bonds will still be locked into the same low rate.

4. All durations of bonds have done very well for almost 40 years.

Interest rates peaked in 1981 and have declined steadily since then (with some bumps along the way).  Investors who bought bonds that paid high interest rates have been able to sell them at a premium because their high interest payments keep looking better as interest rates on new bonds decline.  Unless you believe interest rates can go negative to -10% or lower, the next 40 years can’t look the same.  If interest rates ever return closer to historical norms, long-term bonds will get clobbered.  

5. My favourite ETFs contain long-term bonds.

Almost all balanced funds and bond funds contain some long-term bonds.  My favourite ETF company is Vanguard because of their focus on treating investors well.  Vanguard Canada has a great lineup of asset allocation ETFs that allow investors to buy just one ETF for their whole portfolio.  Unfortunately, these asset allocation ETFs, including the new retirement income ETF called VRIF, contain long-term bonds.  I’d like these products a lot better if the only bonds they held were short term.

Concluding Remarks

Throughout history, it has made a lot of sense to own a diversified set of stocks along with government bonds of various durations.  Looking back in time, we recognize stocks bubbles, but I’ve never been sure I was in a stock market bubble while it was happening.  So, I’ve maintained my allocation to stocks through thick and thin.  But it’s not hard to see the problem with long-term bonds today.  They have plenty of downside possibilities with almost no upside.

Unfortunately, almost all simple balanced investment options for Canadians include long-term bonds.  The simplest reasonable investing solution I see for a do-it-yourself Canadian is to own Vanguard Canada’s VEQT for the stock allocation, and place the fixed income allocation in short-term government bonds or high-interest savings accounts (not from a big bank).  For those using advisors, good luck convincing your advisor that long-term bonds aren’t worth owning.

None of this is intended as investment advice.  I spend time thinking and writing about how to invest my own money.  I’ve always preferred to keep my fixed income investments liquid, and I’m more certain than ever that I don’t want to own long-term bonds.

Monday, October 26, 2020

The Elements of Investing

When it comes to what really works in investing, two of the greats are Burton Malkiel (author of A Random Walk Down Wall Street) and Charles Ellis (author of Winning the Loser’s Game).  They came together to write the short book The Elements of Investing that leaves out “complex details that tend to overwhelm normal people.”  This book is full of excellent ideas that Canadians can apply, although the most detailed advice is U.S.-centric.

The elements of investing the authors chose are save, invest in indexes, diversify, avoid blunders, and keep it simple.  We all know that saving is easier said than done.  I was pleasantly surprised at the practical ideas on saving rather than just preachiness.

“Because they center their thinking on enjoying the benefits of achieving their goals, most savers and most slim people take pleasure in the process of saving and the process of keeping trim.  They do not think in terms of deprivation.”  “You can too.”

For couples, “practice ‘double positive’ shopping”: “agree that nothing gets purchased without both of you saying yes.”

“The only sensible limit on credit card debt is zero.”  “Every month or two, go over your expenditures, including credit card charges.”  Think about whether the purchases were all equally worthwhile, or whether you could easily have done without one of two of them.

The authors consider owning a home to be part of saving.  Under normal circumstances I would agree, but housing prices in big Canadian cities have run away from rent levels.  Parts of the authors’ reasoning about owning a home doesn’t apply in Canada.  “Your bank will not let you borrow more than you can sensibly handle given your income.”  This isn’t true here.  They also point to U.S. mortgage tax deductions which don’t exist in Canada.

The second chapter gives an excellent summary of the case for index investing, without the technical detail.  The authors explain that “The average actively managed mutual fund charges about one percentage point of assets each year for managing the portfolio.”  The case is even stronger in Canada where typical costs are 2% or higher.  These costs build up over an investing lifetime to consume one-third to half of a portfolio.

I liked the explanation of why market forecasters are useless.  “For a market forecaster to be right, the consensus of all others must be wrong and the forecaster must determine in which directionup or downthe market will be moved by changes in the consensus of those same active investors.”

On the subject of asset allocation, the authors make an interesting point about bequests.  “The appropriate allocation for planning bequests should be geared to the age of the recipient, not the age of the donor.”  So, even if you’re 90, the part of your portfolio you’re leaving to your grandchildren should be in stocks.

The authors each offer separate ideas on how your portfolio should become less risky as you age.  Ellis is more aggressive, suggesting still having 30-50% in stocks at age 80.  My own plan based on maintaining 5 years of spending in fixed income is more aggressive than either author, but my plans probably aren’t suitable for most people.

The book contains specific recommendations for mutual funds and exchange-traded funds (ETFs).  Canadians can’t buy U.S. mutual funds, and most Canadians prefer to avoid the currency exchanges necessary to buy ETFs in U.S. dollars.  However, it’s not too hard to find Canadian ETFs that meet the criteria the authors laid out for choosing investments.

Overall, I found this short book contains great investment advice.  I wish I had known these things decades ago before I made many mistakes.  Life is a great teacher but the tuition is very expensive.  This book can save investors a lot of money.

Friday, October 23, 2020

Short Takes: Invisible Progress, Probate Fees, and more

This has been a week of IT fixes for me.  I’ve been fixing broken links on the blog and trying to keep the family printer/scanner working.  For a long time we’ve been able to print but not scan from my wife’s laptop.  But on my laptop, I could only scan and not print.  So we sent messages back and forth (“please print this pdf” and “here’s the scan you wanted”).  Finally, after an HP Smart app “update,” scanning stopped working for me too.  Several hours of fruitless attempts to install an updated printer driver led me to try the Windows scan app to access the scanner.  It seemed to work at first, but it produces comically large files because it thinks the paper is 23x32 inches (you can’t make this stuff up).  All this has left me planning to buy a new printer.  It seems silly to buy new hardware over a software problem, but that’s where I am.

Here are my posts for the past two weeks:

Financial Warning Signs

Variable Percentage Withdrawal: Garbage In, Garbage Out

Here are some short takes and some weekend reading:

Morgan Housel explains why progress is a yawn while disasters grab our attention.

The Blunt Bean Counter discusses pitfalls with two popular ways of trying to avoid probate fees.

Justin Bender explains (in a video) how ETF investors can take advantage of tax-loss harvesting without getting hit by CRA's superficial loss rule.  Canadian Couch Potato covered the same subject in written form.  Both are excellent sources of reliable investment information.

Boomer and Echo addresses major gaps in your retirement plan.

Doug Hoyes explains why we shouldn't obsess over our credit scores in this short video.

Big Cajun Man explains some of the rules around turning your RDSP (Registered Disability Savings Plan) into a SDSP (Specified Disability Savings Plan).

Tuesday, October 20, 2020

Variable Percentage Withdrawal: Garbage In, Garbage Out

The concept of Variable Percentage Withdrawal (VPW) for retirement spending is simple enough: you look up your age in a table that shows what percentage of your portfolio you can spend during the year.  The tricky part is calculating the percentages in the table.  Fortunately, a group of Bogleheads did the work for us.  Unfortunately, the assumptions built into their calculations make little sense.

If we knew our future portfolio returns and knew how long we’ll live, then calculating portfolio withdrawals would be as simple as calculating mortgage payments.  For example, if your returns will beat inflation by exactly 3% each year, and your $500,000 portfolio has to last 40 more years, the PMT function in a spreadsheet tells us that you can spend $21,000 per year (rising with inflation).

Instead of expressing the withdrawals in dollars, we could say to withdraw 4.2% of the portfolio in the first year.  If the remaining $479,000 in your portfolio really does earn 3% above inflation in the first year, then the next year’s inflation-adjusted $21,000 withdrawal would be 4.26% of your portfolio.  Working this way, we can build a table of withdrawal percentages each year.

Of course, market returns aren’t predictable.  Inevitably, your return will be something other than 3% above inflation.  You’ll have to decide whether to stick to the inflation-adjusted $21,000 or use the withdrawal percentages.  If you choose the percentages, then you have to be prepared for the possibility of having to cut spending.  If markets crash during your first year of retirement, and your portfolio drops 25%, your second year of spending will be only $15,300 (plus inflation), a painful cut.

A big advantage of using the percentages is that you can’t fully deplete your portfolio early.  If instead you just blindly spend $21,000 rising with inflation each year, disappointing market returns could cause you to run out of money early.

Choosing Withdrawal Percentages

One candidate for a set of retirement withdrawal percentages is the RRIF mandatory withdrawals.  These RRIF withdrawal percentages were designed to give payments that rise with inflation as long as your portfolio returns are 3% over inflation.

Unfortunately, the RRIF percentages would have a 65-year old spending only $20,000 out of a $500,000 portfolio.  Some retirees chafe at being forced to make RRIF withdrawals, but when it comes to the most we can safely spend in a year, most retirees want higher percentages.

A group of Bogleheads calculated portfolio withdrawal percentages for portfolios with different mixes of stocks and bonds.  Most people will just use the percentages they calculated, but they do provide a spreadsheet (with 16 tabs!) that shows how they came up with the percentages.

It turns out that they just assume a particular portfolio return and choose percentages that give annual retirement spending that rises exactly with inflation.  You may wonder why this takes such a large spreadsheet.  Most of the spreadsheet is for simulating their retirement plan using historical market returns.

The main assumptions behind the VPW tables are that you’ll live to 100, stocks will beat inflation by 5%, and bonds will beat inflation by 1.9%.  These figures are average global returns from 1900 to 2018 taken from the 2019 Credit Suisse Global Investment Returns Yearbook.  

So, as long as future stock and bond returns match historical averages, you’d be fine following the VPW percentages.  Of course, about half the time, returns were below these averages.  So, if you could jump randomly into the past to start your retirement, the odds that you’d face spending cuts over time is high.  

For anyone with the misfortune to jump back to 1966, portfolio spending would have dropped by half over the first 14 years of retirement.  More likely, this retiree wouldn’t have cut spending this much and would have seriously depleted the portfolio while markets were down.

The VPW percentages have no safety margin except for your presumed ability to spend far less if it becomes necessary.

Looking to the Future

But we don’t get to leap into the past to start our retirements.  We have to plan based on unknown future market returns.  How likely are returns in the next few decades to look like the average returns from the past?

30-year bonds in Canada pay less than 1.2%.  For them to beat inflation by 1.9%, we’d need to have 30 years of 0.7% deflation.  That’s not impossible, but I wouldn’t count on it.  It seems crazy to expect bonds to deliver 1.9% annual real returns in the coming decades.  Bond returns may get back to historical averages at some point, but retirees can’t expect much for some time.

Expecting 5% annual real returns from stocks may be sensible enough, as long as you have a high capacity for reducing retirement spending if it becomes necessary.  If your ability to reduce retirement spending is more limited, you need a safety margin in your assumed stock returns.  For my own retirement spending plans, I use inflation+4% for stocks (minus investment costs) and inflation+0% for bonds.

If we recalculate the VPW tables with these new assumptions, the annual withdrawal percentages drop by nearly a full percentage point.  This may not sound like much, but let’s look at an example of a 65-year old spending from a $500,000 portfolio invested 50% in stocks and 50% bonds.  The “official” VPW tables would have this retiree spending $25,000, but only $21,000 by my calculations.  It’s not hard to see who most retirees would rather believe.

Pre-Retirees


This disagreement over reasonable assumptions makes a big difference for pre-retirees deciding how much money they need to retire.  For the 65-year old in the earlier example wanting to spend $25,000 per year, the Bogleheads say to save $500,000, and I say nearly $600,000.

Clearly I could never make it as a financial advisor.  I’d be worried about protecting people from future spending cuts, and more “optimistic” advisors would scoop up all my clients by telling them what they want to hear.

Conclusion

Even when smart people develop good retirement spending tools, the results are only as good as the baked-in assumptions.  We can’t count on the high bond returns of the past, and it makes sense to have some safety margin in expected stock returns.  As with so many other calculators, if you input garbage assumptions, the results you get out will be garbage as well.

Tuesday, October 13, 2020

Financial Warning Signs

I recently saw the headline Five warning signs you are in over your head financially, by Pattie Lovett-Reid.  I saw it as an opportunity to learn more about how to help people avoid financial trouble.

Here is a summary of her list of warning signs:

  1. You are ignoring your finances.
  2. Your finances are giving you a lot of anxiety.
  3. As soon as you get paid, all of your money is spoken for, with the majority of it going to debt service.
  4. Your creditors are calling non-stop.
  5. You are borrowing from Peter to pay Paul.


I was expecting warning signs that you’re headed in a bad direction, but these seem to be signs that you’re already in serious trouble that will be difficult to fix.  In a similar vein, here are my warning signs that you’ve got health problems.

  1. Most of your blood is on the ground.
  2. You haven’t breathed in a few days.
  3. You’ve been cremated.


My point is that I was hoping for more subtle signs that your finances are heading in the wrong direction.  Catching the problem earlier makes it easier to fix.

Let’s go through some more early warning signs of potential financial problems.

You didn’t pay off all of your credit cards in full last month.

Does this mean all is lost?  Not at all.  It’s just a sign that you’re headed in the wrong direction.  If you’re on a trip and make a wrong turn, all you need to do is turn around; your trip isn’t ruined.

Suppose this is the first time you haven’t paid off your card in full.  The appropriate response is to make a plan to get it paid off.  Look for some way to reduce other spending until you’ve eliminated the credit card debt.

You don’t have any quick access to emergency funds without adding new debt.

If you don’t have an emergency fund, you’ll be fine as long as nothing bad ever happens.  Of course, bad things do happen, such as cars needing repairs, health expenses, etc.  Going further into debt for each of these problems is a formula for eventual bankruptcy.

Don’t despair if you have no emergency savings.  Just start saving a little at a time.  When you have enough of a cushion, stop adding to it.  If you ever have to dip into it, start adding to it a little at a time again.

You are about to sign a many year commitment to big payments.

This is most common when buying cars or houses that are too expensive, but there are other cases.  For example, an insurance salesperson might try to sell you on some complicated mix of life insurance and investments.  As long as you make the big monthly payments for decades, you’ll get millions in your retirement.  But what happens if you can’t make the payments at some point?  The answer is that you’ll lose the car, house, or retirement.  Make sure the payments you commit to are reasonable, even if you end up facing big changes in your life.


I’d be interested to hear about more early warning signs of personal financial trouble.  The idea is that the warning should come early enough to be able to solve the problem without too much pain.

Friday, October 9, 2020

Short Takes: Revisiting the 4% Rule, Vanguard’s new Monthly Income Fund, and more

Sharp-eyed readers might have noticed that I removed ads from my blog.  The income has been dismal for some time, and I was never really doing this for the blog income.  The deciding factor was that so many of the ads I saw on my blog were at odds with my messages.

I started writing because I wanted to learn more about investing and about personal finance in general.  With the help of readers I've made great strides, and I've been pleased to educate others while learning myself.

I wrote one post in the past two weeks:

Rebalancing When There are No Trading Fees

Here are some short takes and some weekend reading:

William Bengen, author of the original “4% rule,” revisits his work on safe retirement withdrawal rates.  (The paper appears to now be caught behind a paywall or sign-up.)  This paper is quite interesting, although it travels significantly into data-mining territory.  Here are a few things I wish he would consider in his analysis: longer retirements than 30 years, investment costs, and flexibility to reduce spending somewhat if necessary.

Canadian Couch Potato answers questions about Vanguard Canada’s new monthly income ETF with the ticker symbol VRIF.  His analysis of VRIF continues in a second post, and in the third he explains the ways VRIF is different from problematic monthly income funds.  In the last post of this series, Canadian Couch Potato explains which types of portfolios are suitable for VRIF.

John Robertson finds some problems with a proposal to try to save money unbundling all-in-one ETFs.

Justin Bender compares the gold ETFs IAU and GLD.  My favourite part came in an example with two hypothetical traders: “immediately after purchasing their shares, Wayne and Garth realize they just bought a hunk of metal that doesn’t do anything.”  I keep waiting for the world to figure out that gold’s price makes no sense compared to its value as a metal, and that the world’s major currencies are no longer backed by gold.  It’s like a huge game of hot potato where whoever is holding the gold when we all wake up loses.

The latest Rational Reminder podcast includes Jordan Tarasoff describing in detail how badly clients were treated at his previous financial advice firm.  The bad advice of the week that follows is entertaining as well.

The Blunt Bean Counter describes how to gift money to grandchildren through RESPs, TFSAs, RRSPs, and your will.

Tuesday, September 29, 2020

Rebalancing When There are No Trading Fees

Index investors usually choose some target allocation percentages for the different asset classes of stocks and bonds in their portfolios.  As markets move, these percentages can wander, so investors need to make trades to get back to their target percentages, a process called rebalancing.  Long-time reader JC asked how rebalancing changes when there are no trading fees.

Younger people with smaller portfolios typically rebalance only when they add new money to their portfolios.  This can be as simple as buying more of whichever asset class is furthest below its target percentage.  Those with larger portfolios can’t always keep balanced with new money; sometimes they have to sell an ETF that’s been rising to buy another that’s fallen behind.  One way to do this is to rebalance based on the calendar, perhaps once per year.  With this approach, having no trading fees makes little difference in how investors rebalance.

More ambitious investors may try “threshold rebalancing,” which means rebalancing whenever asset classes get too far from their target percentages.  This is best done in some automated way, such as with a spreadsheet.  Doing a bunch of calculations by hand every day to see if rebalancing is necessary isn’t my idea of a fun way to live.  In fact, I’ve set up my spreadsheet to email me if I need to rebalance, so I don’t even have to look at the spreadsheet.

Earlier this year, I wrote a post and an associated paper describing a set of rules for choosing rebalancing thresholds.  It’s somewhat complicated, but once coded into a spreadsheet, the complexity is hidden.  However, this work assumes investors pay trading commissions.  What happens when there are no trading commissions?

The first thing to understand is that commissions aren’t the only trading costs.  Traders also have the implicit cost of the bid-ask spread.  If there is a 2-cent difference between the bid price and ask price on a stock or ETF, then, on average, trading costs 1 cent per share.  For large trades, spreads effectively become wider due to the market impact of these big transactions.  The definition of a “large trade” depends on the liquidity of the ETFs you own.

For investors with sub-million-dollar portfolios who stick to popular broad-market ETFs, spread costs can be quite low.  So, if you plug in zero for the commission cost in my formulas, rebalancing thresholds will be narrow, leading to lots of rebalancing trading.

To decide whether this is a good idea, imagine that your spreadsheet tells you to rebalance three times a day.  Right away it’s clear that your time has value.  You might find rebalancing exciting for a little while, but it would feel like a job quickly.  It’s clear that you need to place some value on your time.  Once you get good at rebalancing, perhaps $5 or $10 per trade makes sense.

Another concern with frequent trading is uncertainty in the prices you’re getting.  Markets today are very efficient, but with some markets selling trade data to high-frequency traders or selling the right to make the market for the trade, it’s hard for individual investors to know if they’re getting good prices down to the penny.  If you trade infrequently, this isn’t much of a concern, but these imperceptibly small losses to market sharks add up if you trade too often.  For this reason it makes sense to be conservative in choosing a value for the typical spread on your favourite ETFs to plug into my formulas.

When I did my original rebalancing analysis, I included a factor f, which we might as well call a fudge factor.  I decided that I didn’t want to rebalance unless the expected profit from rebalancing was at least 20 times the trading costs (commissions plus spreads).  In part this is to make sure that I get to keep most of the profits instead of losing them all to costs.  But other reasons to make this factor as high as 20 are to place some value on your time, and to handle some uncertainty in the trading prices you’re getting.

So, in my formulas, you could replace the commission c with c+v, where v is the value of your time for each of the required trades.  You could also choose spread values on the high side for safety.  Then you could reduce the profit factor f to, say, 10.  This wouldn’t make much difference in the original case I envisioned where trading commissions are about $10, but these changes give better threshold levels when commissions are zero.

Something else to keep in mind is that your thresholds are most likely to get triggered in volatile markets, such as the ones we had earlier this year.  During this volatility markets remained orderly, so I went ahead and rebalanced a few times.  But if bid-ask spreads ever get very large, it’s a sign that markets aren’t orderly, and you should be cautious about trading for any reason.

It might seem like a lot of work to understand and implement threshold rebalancing, but it has a positive side effect for me beyond capturing profits during market volatility.  I mechanically follow my spreadsheet’s orders when it tells me to rebalance.  This means buying stocks after they’ve crashed or selling stocks after they’ve been on a tear.  Many investors can’t bring themselves to rebalance at these times, but my spreadsheet’s daily reminders to rebalance are hard to ignore.

Thursday, September 24, 2020

Short Takes: Foreign Withholding Taxes, Financial Happiness, and more

I wrote one post in the past two weeks:

Fortress Fiasco

Here are some short takes and some weekend reading:

Justin Bender brings us his ultimate guide to foreign withholding taxes on ETFs.  Unlike other so-called “ultimate guides” I’ve seen from other financial writers, this one really is comprehensive and useful.

Morgan Housel says being happy financially requires managing your expectations as much as making more money.

Alexandra Macqueen explains what goes into calculating official inflation figures and the controversies surrounding what is and is not included.

Jason Heath
is a Certified Financial Planner who refers to his practice as “advice-only” to try to distinguish his services from those paid by commissions or percentage of assets.

The Blunt Bean Counter explains how large gifts to grandchildren can have some unpleasant tax implications if you’re not careful.

Fortress Fiasco

A great many investors have lost money on Fortress syndicated mortgages.  The fact that investors sometimes lose money isn’t news.  But I have a more personal story concerning how these syndicated mortgages were sold.

According to Neil Gross, “thousands of Fortress investors were badly stung or wiped out entirely – losing perhaps hundreds of millions of dollars in total,” but the Financial Services Regulatory Authority (FSRA) “announced that everything’s been settled by Fortress agreeing to pay an administrative penalty of $250,000 – an astonishingly low amount in comparison to the estimated $320-million that Fortress pocketed in fees and paid its agents.”

At question is whether Fortress misled investors.  Gross says “FSRA hasn’t provided a rationale for the low penalty, or an explanation about why Fortress was given such a settlement deal without first compensating its investors.”

My small contribution to this story started with a friend (let’s call him Jake) asking for advice.  Jake told me his friend and financial advisor wanted him to invest in some mortgages.  Jake showed me the sales materials promising a 12% annual return on investment.  The advisor was pushing it hard, and Jake knew little about investing.

I explained that the high guaranteed return was suspicious.  Why couldn’t Fortress get financing from more sophisticated lenders?  If these lenders passed, Jake probably should too.  The risk was a possible default on Jake’s entire investment.  Jake remained on the fence until I mentioned commissions.

Jake was surprised when I told him the advisor was likely getting a fat commission for selling these mortgages.  He wasn’t swayed by much else, but said “you had me at ‘commission.’”  Apparently, this is what got Jake to see this advisor as a salesperson rather than a friend.

So, if Jake’s case is at all representative of Fortress’ investors, they weren’t savvy.  They were regular people pushed hard by commissioned salespeople to buy a product.  Like Gross, I’d like to know more about FSRA’s decision to give Fortress a slap on the wrist.

Friday, September 11, 2020

Short Takes: Mortgage Deferrals, Financial Optimism, and more

I wrote one post in the past two weeks in the form of a quiz:

A Quiz on the 4% Rule

Here are some short takes and some weekend reading:

Rate Spy has some statistics about Canadian mortgage deferrers who are soon to have to start making payments again.  How much this will affect the housing market is anyone’s guess.

Morgan Housel explains why we should save like pessimists and invest like optimists.  I would add that we should avoid debt like pessimists as well.

Robb Engen at Boomer and Echo asks whether he has already achieved FIRE (Financial Independence Retire Early).  FIRE gets used to mean so many different things that it’s hard to say.  To me, financial independence means not needing income from work ever again.  So, Robb doesn’t pass this test.  I define retirement as being free from demands on my time that I can’t ignore because I need the money.  Robb doesn’t pass this test either.  However, to many people FIRE means quitting the job they don’t like to work at something they much prefer.  Robb does pass this test.

Thursday, September 3, 2020

A Quiz on the 4% Rule

Reporters and bloggers write endlessly about William Bengen’s 4% rule for retirement spending, but its details are widely misunderstood.  So, I’ve created a short quiz to test your knowledge of this rule.  I give answers below, but this isn’t multiple choice, so you’ll have to decide for yourself how closely your answers match reality.

  1. Jane retired a year ago with $500,000 saved.  She is using the 4% rule, so she initially withdrew $20,000 to spend during her first year of retirement.  Today it’s time for her next withdrawal, and her portfolio has grown from $480,000 to $505,000.  Inflation was 2%, and she’s now 66 years old.  To follow the 4% rule, how much should she withdraw today?

  2. Jane pays a hefty 2.5% MER on her mutual funds.  If she reduces her costs to only 0.5% per year, how does that change her withdrawals under the 4% rule?

  3. Tom saved aggressively during his working years and retired at 45.  How does the 4% rule apply in his case?

  4. Jim is a very conservative investor.  He invests only in GICs and bonds.  Does the 4% rule apply in his case?

  5. We can’t count on getting the same returns that U.S. investors got during the period of Bengen’s study.  How does this affect the 4% rule?

  6. Is there anything we can do to increase our safe portfolio spending level, other than shortening our retirements?


Answers below:

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  1. To follow the 4% rule, Jane should withdraw $20,400, which is her original $20,000 increased by 2% inflation; the rest of the figures in the question are irrelevant.  If you answered $20,200 (4% of the new portfolio value), you’re not alone; this is a common misconception.  The 4% rule ignores portfolio performance after retiring.  The percentage of your portfolio you spend each year after the first year will depend on how much it has grown or shrunk.  You just keep spending the same inflation-adjusted amount each year and hope your money doesn’t run out.  If instead you spend 4% of your updated portfolio value each year, you’re guaranteed to leave a sizable inheritance, and your odds of having your inflation-adjusted spending decline alarmingly over the years is quite high.  If you answered $20,000 because you thought spending stayed constant over the years, you’re close.  The idea is that spending after adjusting for inflation stays constant.

  2. William Bengen’s original study took no account of portfolio costs.  He used historical U.S. stock market returns to establish his 4% rule.  So, to follow the 4% rule strictly, Jane’s withdrawals wouldn’t change.  It’s tempting to say that because Jane is saving 2% each year, she can bump up her withdrawals to 6% of her original portfolio size (rising with inflation).  However, there are two problems with this.  The first problem is that as Jane’s portfolio shrinks (in a scenario where returns are weak), the 2% MER savings on a smaller portfolio don’t fully offset 2% higher withdrawals calculated on the starting portfolio value.  On average, saving 2% on costs makes safe withdrawals only about 1% higher.  The second problem is that Jane’s high-cost portfolio couldn’t really handle spending at 4% of the starting portfolio size.  In reality, repeating Bengen’s study to account for costs would have Jane using a little less than a 3% rule.  So, by reducing her costs, she is improving the chances that she won’t run out of money with the 4% rule, but she probably shouldn’t increase her planned withdrawals.

  3. The part of Bengen’s study that produced the 4% rule assumed 30-year retirements.  This would take Tom only to age 75.  So, the original 4% rule doesn’t apply well in his case.  He expects to have a long retirement, and has to reduce the spending amount from his portfolio somewhat to compensate.

  4. Bengen’s 4% rule came from portfolios 50-75% in U.S. stocks, and the rest in bonds.  This doesn’t apply to Jim’s case.  Suppose Jim expects the returns on his GICs and bonds to match inflation.  Then he can just divide the length of his retirement into 100%.  For example, to cover 40 years of retirement, Jim can spend 2.5% per year rising with inflation.

  5. The 4% rule is based on the worst-case starting year of retirement.  In U.S. data, the worst periods include the aftermath of the 1929 stock market crash and the poor inflation-adjusted stock returns from the late 1960s to the early 1980s.  So, the important question is how likely your returns are to be worse than these periods.  The eye-popping U.S. returns in other time periods isn’t relevant.  So, the fact that experts believe future returns won’t match historical U.S. returns isn’t a positive thing for your retirement, but it’s not as bad as it seems for the 4% rule.  Adjusting down to a 3.5% rule may be sufficiently safe.  Having to reduce the withdrawal percentage further by about half of portfolio costs is a bigger concern for many Canadians.

  6. Yes.  We can be more flexible with changes to the amount we spend each year.  This means being prepared to spend less if returns disappoint.  Bengen’s study assumed no flexibility at all.  At the other extreme of very high spending flexibility, we could use something like the table of RRIF withdrawal percentages that tell you how much of your current portfolio to withdraw each year.  These percentages are probably about right for someone paying about 1% each year in portfolio fees.  However, this plan could have your inflation-adjusted spending level change drastically over the course of a few years.  Not all of us can be this flexible.  There are intermediate levels of flexibility with plans that set spending floors and ceilings.  However, the less flexible your spending plan, the lower your starting spending level needs to be.

Friday, August 28, 2020

Short Takes: Socially Responsible Investing, Future Returns, and more

Here are my posts for the past two weeks:

The Intelligent Investor


Count on Yourself


Here are some short takes and some weekend reading:

Mr. Money Mustache explains an easy way to go about socially responsible investing.  He also describes all he is doing in this area.

Justin Bender estimates future return rates for Vanguard Canada’s asset allocation ETFs (VCIP, VCNS, VBAL, VGRO, VEQT).  They’re not very high because stock and bond prices are very high right now.

Neil Gross
isn’t impressed with proposed changes to the Ontario Securities Commission’s mandate.

Big Cajun Man is getting free online access to his credit report due to a data breach.  It’s crazy that he can’t get them to spell his name right.  My TransUnion credit report swapped my home address with my brother’s home address for a few years, and I can’t get that fixed either.  They even use this address in authentication questions before they’ll send me a free credit report.

Tuesday, August 25, 2020

Count on Yourself

Author and personal finance columnist Alison Griffiths wrote the book Count on Yourself aimed at beginning investors to teach them do-it-yourself index investing.  She takes a gentle approach starting with interesting stories and working in financial material slowly.  This approach works well initially, but the final range of recommendations allows so many possibilities that many readers will remain confused about what to do with their investments.  Published in 2012, much of the detailed information about discount brokerages and index ETFs and mutual funds is now out of date.

A strong part of the book is the explanation of why low-cost index investing is better than the expensive mutual funds most Canadians own.  She makes this case with stories and case studies presented in a way that is accessible to the many Canadians who know little about investing.  Today, you could simplify the recommendations for the novice investor down to just choosing one of Vanguard Canada’s asset allocation ETFs.

Griffiths shows that she gets people’s aversion to figuring out the many financial aspects of their lives: “Have you ever compared extended medical/dental plan rates among the various insurers?  I have.  It takes days and brings on a sudden urge to clean the basement.”  She recommends trimming the list of financial things in our lives, including credit card balance insurance, retail credit cards, and extended warranties.

Much of the first half of the book is aimed at women, including some musing about “if all the world’s financial affairs had been turned over to women.”  In my limited experience, many male leaders are self-centered and ruthless, and when a woman rises to the top, she’s not much different.

One piece of bizarre advice is if you have a high tolerance for risk, “go ahead and be a day trader, dabble in foreign exchange, or play the options market.”  It’s one thing to increase your expected return with higher-risk assets, like more stocks or small-cap value stocks, but it makes no sense to do things that reduce your expected return.

Another piece of advice that makes little sense to me is to avoid owning stocks in a TFSA.  For anyone using a TFSA for short- or medium-term savings, this makes some sense.  However, some investors, like myself, use TFSAs for long-term savings.  There’s nothing wrong with owning stocks in a TFSA in this situation.

To reduce the numbers of ETF choices, Griffiths stated the criteria she used for selection.  I liked the bond ETF criteria: avoid high yield bonds, longer-term bonds, and MERs over 0.5%.  She says that “bonds have a specific job to do in a passive portfolio, and that is to provide income safety.”

One piece of advice you don’t see many places is to allow small monthly contributions to build up for a few months before investing to reduce commission costs.  For investors who pay commissions when buying ETFs, this is sensible.  The same would apply for selling investments after retirement.

Another curious piece of advice “for the math challenged” who “have trouble working out percentages”: “call up your brokerage … and tell them how much you have to invest and what your breakdown (asset allocation) is, and they’ll tell you how many units you should buy.”

In conclusion, parts of this book may be useful for novice investors who need to be eased into understanding personal finance, investing, and the rationale for avoiding expensive mutual funds.  However, the detailed recommendations are too complex and now out of date for this type of reader.

Thursday, August 20, 2020

The Intelligent Investor

Warren Buffett credits Benjamin Graham with writing “by far the best book about investing ever written,” The Intelligent Investor. It holds a mythical status among value investors. Graham produced four editions from 1949 to 1973. I read the revised edition, which is Graham’s 1973 edition with added material from Jason Zweig in 2003 to explain parts of the book and to add more modern examples.

For anyone planning to read this book, I recommend Zweig’s revised edition. Graham’s writing is at times subtle and indirect, and assumes knowledge of historical context that may be unfamiliar to readers so many decades later. Zweig does an excellent job of clarifying Graham’s meaning at critical points.

This book is filled with Graham’s widely-quoted ideas, including the distinction between investors and speculators, the Mr. Market parable, and margin of safety. I won’t explain these ideas here.

The most remarkable part of the book is in Graham’s 1973 Introduction:

“The determining trait of the enterprising (or active, or aggressive) investor is his willingness to devote time and care to the selection of securities that are both sound and more attractive than the average. Over many decades an enterprising investor of this sort could expect a worthwhile reward for his extra skill and effort, in the form of a better average return than that realized by the passive investor. We have some doubt whether a really substantial extra recompense is promised to the active investor under today’s conditions. But next year or the years after may well be different. We shall accordingly continue to devote attention to the possibilities for enterprising investment, as they existed in former periods and may return.”

What intellectual honesty! He is saying that while his methods worked in the past, they may not work any more because markets have changed. A few years later (1976), Graham was more certain about the demise of his value investing ideas:

“I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook ‘Graham and Dodd’ was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost.”

One may ask what value this book has if its author no longer believes in its ideas. One answer is that some parts of the book are relevant to investors who have no intention of picking individual stocks, particularly Zweig’s added material. Another answer is that readers who decide to pursue value investing despite Graham’s warnings will benefit. They may not beat the market, but Graham’s ideas will help them limit downside risk.

In an appendix, Buffett convincingly defends the existence of superior investors (who were Graham’s students) against claims that efficient markets eliminate this possibility. This material comes from a speech Buffett made in 1984, well after Graham gave up on his stock-picking methods. One way to reconcile this seeming contradiction is that Graham’s best students found ways to grow beyond his teachings to outperform through stock picking in later, more difficult markets.

This fact may give the modern aspiring value investor hope. However, each new decade has seen a big increase in competitiveness of markets. Even the great Buffett seems unable to outperform any more. It may be that he is working with too much money or that he’s too old now. But it might be that markets keep getting harder and harder to beat. Even if Buffett is still a superior investor in today’s competitive markets, other value investors have to question whether they are elite enough to beat the market. And if they can’t, they are getting zero compensation (or even negative compensation) for their extra effort compared to just buying index funds.

Anyone can “equal the performance of the market averages” by “owning a representative list” (index investing). But Graham warned: “If you merely try to bring just a little extra knowledge and cleverness to bear upon your investment program, instead of realizing a little better than normal results, you may well find that you have done worse.” Unfortunately, the definition of “just a little extra knowledge” has grown substantially as markets have become more competitive.

One area that Graham warned investors to avoid was Initial Public Offerings (IPOs). He said they come out in force in bull markets and investors get burned. The tech bubble in the late 1990s showed that not much has changed.

Some of Graham’s teachings are relevant to all stock investors whether they pick individual stocks or not. “It is absurd to think that the general public can ever make money out of market forecasts.” Investors shouldn’t allow themselves “to be stampeded or unduly worried by unjustified market declines.”

Some of the best quotes in the book come from material added by Zweig:

On Jim Cramer’s stock picks: “By year-end 2002, one in 10 had already gone bankrupt.” “Perhaps Cramer meant that his stocks would be ‘winners’ not ‘in the new world,’ but in the world to come.”

On the Motley Fool: “The Foolish Four … was one of the most cockamamie stock-picking formulas ever concocted.”

On asset allocation percentages: “Once you set these target percentages, change them only as your life circumstances change. Do not buy more stocks because the stock market has gone up; do not sell them because it has gone down.”

When a company is “paying a fat dividend on its preferred stock,” “you should approach its preferred shares as you would approach an unrefrigerated dead fish.”

On Peter Lynch’s “buy what you know”: “To his credit, Lynch insists that no one should ever invest in a company, no matter how great its products or how crowded its parking lot, without studying its financial statements and estimating its business value.”

“You and no one but you, must investigate (before you hand over your money) whether an advisor is trustworthy and charges reasonable fees.”

On index investing: “By enabling you to say ‘I don’t know and I don’t care,’ a permanent autopilot liberates you from the feeling that you need to forecast what the financial markets are about to do–and the illusion that anyone else can”

“Day trading–holding stocks for a few hours at a time–is one of the best weapons ever invented for committing financial suicide.”

“The single best choice for this lifelong holding is a total stock-market index fund. Sell only when you need the cash.”

“Late in his life, Graham praised index funds as the best choice for individual investors, as does Warren Buffett.”

On what it takes to pick stocks: “begin by downloading at least five years’ worth of annual reports.” “Then comb through the financial statements.” This should be enough for most individual investors to realize that they’re not really stock-pickers. “If the steps in this chapter sound like too much work to you, then you are not temperamentally well suited to picking your own stocks.”

On mutual fund studies: “mutual funds, on average, underperform the market by a margin roughly equal to their operating expenses and trading costs.” This “has been reconfirmed so many times that anyone who doubts them should found a financial chapter of The Flat Earth Society.”

On covered call strategies: “For individual investors, covering your downside is never worth surrendering most of your upside.”

“For most investors, diversification is the simplest and cheapest way to widen your margin of safety.”

Despite being revered by value investors, it’s doubtful that this book will help anyone beat today’s markets. However, anyone who intends to try to beat the markets should consider this book to be mandatory reading, if for no other reason than to limit losses. Graham gave up on his stock-picking methods, and so should almost all individual investors.

Friday, August 14, 2020

Short Takes: Seeing the Past with Rose-Coloured Glasses, Hardest Decision in Investing, and more

I wrote one post in the past two weeks:

What the Experts Get Wrong about Inflation

Here are some short takes and some weekend reading:

Rob Carrick and Roma Luciw discuss housing costs for young people today. I had to laugh at remarks in the second half by Bridget Casey. It’s true that certain aspects of modern life are more challenging for young people than they were a generation ago. Even adjusting for inflation, rents are higher, university costs are higher, and finding full-time work is harder. However, her characterization of what life was like back in the 1980s was way off. If I could be young again, I’d rather do it in 2020 than go back to the 1980s.

Steadyhand offers help to investors who sold out of stocks during the recent crash and are now faced with the hardest decision in investing: how to get back in.

Big Cajun Man has a set of heuristics for what to do with savings. There are exceptions to his rules, but you could do a lot worse than his plan.

Tuesday, August 4, 2020

What the Experts Get Wrong about Inflation

“In the following analysis, we assume future inflation of 2% per year.”  How often have you seen something like this in investment projections or other financial analyses?  This kind of assumption leads to biases that can invalidate a financial analysis.

Even the great Benjamin Graham wasn’t immune.  In the early 1970s, he wrote the following in his book The Intelligent Investor:

“Official government policy has been strongly against large-scale inflation, and there are some reasons to believe that Federal policies will be more effective in the future than in recent years.  We think it would be reasonable for an investor at this point to base his thinking and decisions on a probable (far from certain) rate of future inflation of, say, 3% per annum.”

The following footnote was added by Jason Zweig in a revised edition of Graham’s work:

“This is one of Graham’s rare misjudgments.  In 1973, just two years after President Richard Nixon imposed wage and price controls, inflation hit 8.7%, its highest level since the end of World War II.  The decade from 1973 through 1982 was the most inflationary in modern American history, as the cost of living more than doubled.”

Readers may think I’m calling out Graham for his wrong guess about inflation.  This isn’t my point.  Graham’s mistake was that he guessed at all.  Future inflation is unknown.  Just as we treat future stock returns as a range of possibilities, we should be doing the same thing with inflation. 

We might guess that annual inflation over the next decade is likely between 1% and 3%.  But we can’t say for sure that it won’t shoot up above 5%.  You may judge this to be unlikely, but do you really want your financial security to depend on inflation definitely remaining below 3%?

The biggest effect of assuming future inflation to be at some known level is to make long-term bonds seem safer than they really are.  Once we consider the possibility of rising inflation, 30-year government bonds look a lot riskier.

Because inflation affects how much we can get for our money in annual spending, it’s better to focus on investment returns after subtracting inflation (called “real returns”).  Stock markets look volatile no matter how we view them.  Their nominal returns are volatile.  So are their real returns.  Even if we just treat inflation as a known constant, stock returns are volatile.

However, a 30-year government bond looks very different depending on how you think about inflation.  The bond’s nominal return over the full 30 years looks completely safe.  If we assume inflation stays at some fixed level, the bond still looks completely safe.  But if we correctly assume that future inflation is unknown, the bond suddenly looks a lot riskier.

I have no reason to think Graham would make the mistake of investing everything in 30-year government bonds; he understood the risk of high inflation.  But many people who use spreadsheets and Monte Carlo simulation tools don’t understand the implications of fixed inflation assumptions on their simulation results.  Personally, I avoid all long-term bonds.

When we run financial projections assuming fixed inflation, we make bonds (particularly long-term bonds) look safer than they really are.  We need to get out of the mindset of trying to guess a single value for future inflation and treat it as uncertain.

Friday, July 31, 2020

Short Takes: Money Lessons from Cats, Buy Now Pay Later, and more

With my softball league restarting, some golfing, and reading The Intelligent Investor, I haven’t done any writing recently.  But I have had a chance to ask different types of small business owners (who are opening up as much as they can) whether they will be able to operate profitably.  The most common answer is “we’ll see.”  COVID-19 is increasing their costs and forcing them to take fewer customers than they used to take each day.  That’s a deadly combination in any competitive market.  Behind brave faces I suspect many are just hoping to survive long enough to get back to normal.

Here are some short takes and some weekend reading:

Morgan Housel has an interesting description of why cats sometimes survive high falls better than low falls, followed by a jarring attempt to connect it back to a financial lesson.

Preet Banerjee and Derrick Fung
discuss the rise of buy-now-pay-later in online shopping.  Making your life worse is getting more and more convenient.

Boomer and Echo compares the financial aspects of renting versus owning a home.

Friday, July 17, 2020

Short Takes: Credit Hygiene, Defending Buy-and-Hold, and more

Here are my posts for the past two weeks:

The Limits of Offering Investment Help

Think Twice Before Taking a 5-Year Closed Mortgage


A Canadian’s Guide to Money-Smart Living

Here are some short takes and some weekend reading:

Canadian Mortgage Trends explains why you should care about your credit “hygiene” and not your credit score.

Tom Bradley at Steadyhand
defends buy-and-hold investing.

Canadian Portfolio Manager explains your ETF’s currency exposure.  (This article has a second part).  Many investors get confused about buying identical baskets of stocks in different ETFs that transact in different currencies.  The situation would get even more confusing if we tried to explain that measuring U.S. companies’ stock returns in U.S. dollars is merely a convention; companies with international operations are affected by changes in many different currencies.

Big Cajun Man
looks at RESP statistics showing that lower income families aren’t opening RESPs, even though they could be getting the Canada Learning Bond without even making an RESP contribution.

Boomer and Echo
discusses the challenge of sticking to your financial goals during the pandemic.

Thursday, July 16, 2020

A Canadian’s Guide to Money-Smart Living

Learning about personal finance makes people anxious.  Combine this with all the details to learn and the process can be overwhelming.  Kelley Keehn and Alex Fisher aim to help people get past these problems with their book, A Canadian’s Guide to Money-Smart Living.  The authors introduce the reader to basic personal finance topics without getting into too much detail.

The book begins by trying to get past emotional barriers to controlling spending and getting readers motivated to learn more about personal finance.  It then covers paying yourself first, record-keeping, planning, mortgages, debts, credit scores, and investing.

There were a number of details in the book I liked.  Many financial writers like to mock the idea that small amounts add up, but not these authors.  “The few dollars you spend on muffins, eating out, or other expenditures that you’re not tracking every day, might not seem like much at the time but mount up over the weeks and months and years.”

With so many people seemingly willing to pay any price for a house, it’s important to hear the downside: “Having too big a mortgage payment for your available cash can be absolutely crippling.”  A similar message about all debt: “More debt always equals less freedom.”

I was surprised to learn that “if you don’t use your account at least every month, your [credit] score can be negatively affected.”  I’m not sure if this applies only to credit cards, or if it’s true for lines of credit as well.  I sometimes go several months using only one of my credit cards, and I haven’t used my line of credit in years.

The book contains a good section on the problem with using a supplementary credit card on someone else’s account.  One of my aunt’s did this.  When her husband died, she had no credit record at all because she was using his credit card account, even though her card had her name on it.

A good point about mandatory minimum RRIF withdrawals: “Withdrawing the money does not mean you have to spend it; all you have to do is report it as taxable income.”

There were a number of parts of the book that could be improved.  One section on how to choose and work with a financial planner needed to start with an explanation of how much money you must have before any planner would work with you.  Another section on life insurance paints a picture of a professional life insurance agent carefully looking after your interests.  In reality, people need to know how to avoid agents who try to sell them whatever product generates the biggest commission.

On the subject of breaking a mortgage, the authors say that a penalty of “three month’s [sic] interest is common,” when mortgage penalties are often in the 5-figure range.  On the subject of mortgage life insurance, the authors fail to mention that typical policies use “post-claims underwriting,” which means they don’t check if you qualify for coverage until after you’re dead.

In an example of a couple getting a mortgage, the authors say that “By paying about $456 weekly [instead of $1982 monthly], for example, they save in interest costs and pay off their mortgage faster.”  This isn’t true for these numbers.  Paying biweekly or weekly shortens a mortgage when the payments are simply divided by two or four, effectively increasing the total amount paid each year.  In this example, the weekly amount is calculated to give the same amortization period as the monthly amount.

In a discussion of whether to pay down your mortgage or contribute more to an RRSP, the authors list 4 factors to consider.  However, they miss the most important factor which is how much financial risk you want to carry forward (in the form of leverage) as you age.

In the “Get to Know Your Banker” section, the authors offer mostly obsolete advice about a personal relationship with your banker.  Curiously, they end the section with the modern reality: “Loans are approved by a computer program these days – it’s rarely a human or personal process.”

The book gives a table showing the letter grading system Transunion uses for credit scores, but goes on to say that Transunion rated a particular creditor as “fair” instead of “B” as shown in the table.  I couldn’t figure out the point the authors were trying to make here.

Among the things to consider when deciding whether to buy GICs is “where are interest rates going?”  This is bad advice.  Trying to predict future interest rates is a waste of time.  Currency experts trade trillions of dollars based on interest rate expectations.  An average person trying to outsmart them is just gambling.

“While funds with high MERs may be worth it because of the professional managers they use, it means that those managers need to work that much harder to earn you a decent rate of return.”  All the evidence says that trying to find managers who can overcome high MERs over the long run is futile.

For RESPs, you can open multiple plans, “but, as with the other tax shelters, each plan must follow the maximum contribution rules.”  A reader could easily be confused by this.  The authors mean that the total contribution to all RESPs can’t exceed the maximum per beneficiary.

The last quarter of the book contains several typos that show a lack of attention to detail.

Overall, this book might be helpful to personal finance novices.  The best parts are the early sections designed to motivate people to improve their finances and give them tools for changing bad habits.

Monday, July 13, 2020

Think Twice Before Taking a 5-Year Closed Mortgage

The internet is full of debates about whether to take a mortgage interest rate that is fixed or variable.  However, what gets less attention is whether the mortgage is open or closed.  The most common fixed-rate mortgages are closed, and this means you’d have to pay a penalty if you break your mortgage.

I can already hear most people saying “but I’m not going to break my mortgage, so I don’t have to worry about penalties.”  However, the future can surprise us.  If breaking a mortgage cost us a finger, we’d think a lot more carefully about what might happen to make us break our mortgage: job loss, job moves to another city, divorce, health problems, bad neighbours, and more.

Mortgage penalties aren’t as bad as losing a finger, but they can be bad enough.  Suppose you took out a 5-year mortgage at TD Bank 2 years ago, and it has a remaining balance of $300,000.  According to Ratehub’s mortgage penalty calculator, the cost to break your mortgage would be $16,463!

Lenders deserve some compensation if you break a closed mortgage, but a penalty this big far exceeds any reasonable compensation.  The way they justify it is to do the calculations based on “posted rates,” which are much higher than the interest rates people typically pay.  The gap between the posted rate and the real rate is highest for 5 year mortgages, and gets smaller for shorter mortgages.  This declining gap size is what pumps up the mortgage penalty calculation.

So, when you’re trying to decide whether you’ll come out ahead with a fixed or variable rate mortgage, think carefully about what might happen that would force you to break your mortgage.  A mortgage penalty can easily be larger than the cost difference between fixed and variable interest rates.

Thursday, July 9, 2020

The Limits of Offering Investment Help

Family, friends, and blog readers often ask me for investment advice.  The challenge with helping these people is that even if the advice I give is good, the results they get can end up being disappointing.

Many times I’ve agreed to look at a person’s portfolio.  The most common problem I see is high mutual fund costs with little meaningful financial advice given in return for those costs.  Another problem that’s less common is a portfolio that is too concentrated in a small number of stocks.

In most cases, it’s obvious that the investor would be better off in the long run with a very simple portfolio holding nothing but one of Vanguard’s asset allocation ETFs (VEQT, VGRO, VBAL, VCNS, and VCIP).  This isn’t the only good way to invest, but it’s better than most people’s existing portfolios.

So, if I were to give one-time advice, in most cases it would be to sell everything and buy an asset allocation ETF.  I might add some advice on not timing the market and avoiding tinkering.  However, this would leave a big problem.  Dan Hallett explained the problem well on a recent Moneysaver podcast:

“I have long been convinced that I could lay out exactly what somebody needs to do, and the vast majority of them would get in their own way.”

If the people coming to me for advice are willing to change their entire portfolios to match my suggestions, what will happen the next time the stock market is down and they ask someone else for advice?  The answer is they’d make another big change in portfolio strategy.

Jumping around from one strategy to another is a bad idea, even if we’re jumping from good strategy to good strategy.  We tend to want to make changes after our current strategies have had a bad period.  We end up in a buy-high-sell-low cycle.

These problems place limits on who I’m willing to help with their investments.  Unless I’m confident I’ll be around to stop people from getting in their own way, my advice becomes part of the problem instead of a solution.  So, I’ve only helped a modest number of people very close to me.

Some financial advisors might applaud my choice saying that financial advice should be left to the professionals.  However, only a minority of financial advisors are part of the solution rather than part of the problem.

Friday, July 3, 2020

Short Takes: Tesla, Reducing Stock Allocation, Retirement Strategies, and more

I had to laugh watching Elon Musk gloat on Twitter about Tesla’s recent success and rising stock and the effect it’s had on short sellers.  “Tesla will make fabulous short shorts in radiant red satin with gold trim.”  He’s not a fan of the U.S. Securities and Exchange Commission (SEC): “Will send some to the Shortseller Enrichment Commission to comfort them through these difficult times.”  “Who wears short shorts?”

Here are my posts for the past two weeks:

Investing Perfection

Talk Money to Me

Here are some short takes and some weekend reading:

David Aston says now is the time to reduce your allocation to stocks if you couldn’t stand the recent stock market turmoil.  The best advice is to stick to a financial plan and its asset allocation percentages, but for those who’ve learned that they just couldn’t stomach the 30% drop in stock prices, the best move is to wait until stock prices have recovered before selling off some stocks.  Today’s higher prices are giving these investors their opportunity.  Unfortunately, it was when stocks were low that social media was filled with bad advice to reduce your stock allocation.

The Rational Reminder Podcast interviews retirement expert Fred Vettese who has done excellent work on finding retirement strategies that can work for you rather than working for banks, insurance companies, mutual fund companies, and their salespeople.  I’ve written before about some areas where I disagree with Vettese, but I consider these differences to be minor.  Following his advice is very likely to give a good outcome.  The main area of disagreement concerns spending patterns as we age.  I’ve read the same studies Vettese references, and what I see is data that mixes together retirees who made their own choices of how much to spend with some retirees who were forced to spend less as their savings dwindled prematurely.  The net effect is that if we back out data from forced spending reductions faced by some people, retirees’ natural tendency to spend less as they age will start later and be less severe than the full data set appears to show.  This is disappointing news for people looking for the green light to retire with less saved and to spend freely in their 60s.  However, we need to ask ourselves whether we want to model our own retirements on the experience of others who made their own choices, or whether we want to include a component of forced spending reduction from dwindling savings.  All that said, though, Vettese’s retirement plans are better than most I’ve seen.

Christine Benz
has some excellent advice for young investors just starting out, as well as a few words for more experienced investors.

Robb Engen at Boomer and Echo says COVID has eliminated any chance of meeting his stretch goal of becoming a millionaire by the end of 2020.  But, he says “I won’t get kicked out of the personal finance blogger guild if it takes a few extra months to make it.”  The housing and stock markets may have something to say about it taking only a few extra months.  This illustrates the problem with getting too tied to net worth goals.  Robb has the right attitude of not being too concerned.  We have some control over our incomes and saving rates, but no control over the prices of volatile investments.  In the long run a net worth target can be a reasonable goal, but in the short run, it’s more of a hope.

Big Cajun Man gives an overview of the Registered Disability Savings Plan (RDSP) along with links to more details.

The Blunt Bean Counter
describes his experiences working from home.

Friday, June 26, 2020

Talk Money to Me

The best financial advice I’ve heard sounds impossible to most people.  To reach these people, you have to offer them small improvements to how they handle their finances, and you have to avoid making them feel bad about their past choices.  This is the approach Kelley Keehn takes in her book Talk Money to Me: Save Well, Spend Some, and Feel Good about Your Money.

The best car advice I know is to pay cash for cars.  The financial benefits of saving up for cars and buying modest cars are enormous.  However, most people think this is impossible.  And once they’ve built a lifestyle with debt, paying cash for a car may well be impossible.  Keehn’s focus is on steering her readers to doing research on cars and car financing before entering a showroom.  This will have her readers making somewhat less financially damaging car choices.  So, she’s looking to help people a little with advice they might follow instead of giving great advice that few will follow.

A more extreme example of good but useless advice is to not be a shopaholic.  Keehn offers practical steps to spending less money while scratching the shopping itch.  The book covers several other areas with advice designed to steer people to better choices.

Keehn mentions an interesting issue that never occurred to me.  As companies gather information about our spending histories, we could be forced to share these spending histories.  For example, we could be forced to share our spending history at the U.S. border to see if we’ve ever bought cannabis.

On the subject of asset allocation, Keehn treats your career and future income as a component of your portfolio.  How steady your income is affects how you should invest the rest of your money.  One caution I’d add is that we tend to underestimate how risky future income really is.  Few jobs and careers are as safe as people think they are.

There are a number of details in the book that I found confusing or where I disagreed.  On credit reports: “If you order a free report …, your score will not be listed, so it won’t be as useful; I’d suggest always paying for the full report.”  I think it’s better to learn how elements of your credit history affect your score, and work on improving your financial habits.  As your credit report improves, your score will take care of itself.  I don’t see the need to pay to see a score.

On making credit card and line of credit payments, I found “Always pay the minimum every month” jarring, until I realized the intended meaning was “at least the minimum.”  Apparently, some people think that if they make a payment of double the minimum one month, they can skip the next payment.  As the book explains, it doesn’t work this way.

Among the ways of holding some available cash, Keehn includes money market mutual funds.  These aren’t as safe as they seem.  A high-yield savings account is a better idea.

Despite repeated mentions of the importance of an emergency fund, we get this advice: “If you’re able, then it makes sense to invest those funds and rely on a line of credit if an emergency were to arise.”  Just two pages later we get “Your lender can even take your credit away entirely if your credit score drops dramatically.”  Counting on borrowing money in an emergency is how many people get themselves into big debt troubles.  Emergency funds matter.

In a checklist for different types of insurance, the book includes “Do you have insurance on your credit cards, and is it right for you?”  Naive readers could be left thinking that they should get credit card insurance.  In reality, the question should be whether you’ve made sure you don’t have credit card insurance.

The book refers to the “miss a payment” option on a mortgage as a “handy feature.”  This feature of a mortgage feels more like another tool for banks to keep people permanently in debt.

In answering the question about houses “What can you afford?”, the book goes through the usual explanations of gross and total debt service ratios.  Unfortunately, these ratios leave people thinking they can buy a far more expensive  house than is best for them.  Banks lend money without caring whether you’ll end up house poor.  It isn’t until a few pages later that the book mentions that you might not want to borrow as much as a bank will lend on a mortgage.

On the subject of mortgage insurance, the book fails to mention post-claims underwriting.  The insurance company doesn’t check if you qualify for insurance until after you’re dead.  Not knowing if you’re really covered is a huge negative for mortgage insurance.

Numbers in a few places didn’t seem to make sense.  In one place, the annual interest rate on a payday loan is over 500%, but only 47.71% in another place.  In another figure illustrating costs on a 14-day $300 loan, the figures for lines of credit, overdraft protection, and a credit card cash advance imply annual interest rates of 50%, 62%, and 64%, respectively.  Even if we make the loan period a month, the annual percentages are 23%, 29%, and 30%, which still seem too high.

The book includes a glossary with some definitions that seem strange.  For example, a dividend is “A financial bonus for investing in a company (when you buy a preferred share).”  This seems like an attempt to write for the masses, but it didn’t work out well.

This book is useful for helping people who don’t handle money very well, which is most people.  I found a number of things that seemed odd, but none are central to the mission of giving people practical tips for improving their finances.  For anyone looking for financial advice that doesn’t seem too extreme, this book fits the bill.

Tuesday, June 23, 2020

Investing Perfection

Perfect is the enemy of good. – Voltaire quoting an Italian proverb, 1770

In my career as an engineer/mathematician, I worked with some people who had trouble declaring a design “good enough.”  They’d want to keep tinkering endlessly.  They couldn’t stand to stop work knowing that some part of the design could still be improved.  This drive to tinker and improve things served them well in some ways and hurt them in others.

When it comes to investing, it’s a bad idea to get paralyzed seeking the perfect strategy instead of just getting started.  Perfecting your investment strategy is quite unimportant when you’re just getting started with small amounts of money.

I’ve been investing my money for decades now, and there’s never been a time when I thought I was doing it perfectly.  Sometimes I’ve just had a feeling I wasn’t doing something right.  Other times I knew exactly what I wasn’t doing well, but didn’t yet know how to improve it.

I’ve always been at ease with this situation as long as the “mistake” wasn’t too severe.  Fortunately, while my portfolio was small, mistakes weren’t too painful.  Paying high mutual fund MERs today would eat at me, but it wasn’t that big a deal when my portfolio was 5% of its current size.  I’ve given myself a pass for past mistakes and have never been in a panic to correct them along the way.

But this doesn’t mean I don’t bother to improve things.  As my savings have grown, I’ve figured out various improvements (reducing MERs with U.S.-listed ETFs, reducing foreign exchange costs with Norbert’s Gambit, improving my asset location strategy, etc.).  I learned about these things at my own pace and didn’t agonize over past inefficiencies.

This attitude makes it easier to learn new ideas.  If you have a strong emotional need to do everything perfectly, then finding a good new idea requires you to admit that your old ideas weren’t as good.  Some people prefer to defend the status quo rather than improve.  Often new ideas aren’t really improvements, but I like to remain open to the possibility of genuine improvements.

By being at ease with the fact that your investment history isn’t optimal, it’s easier to adopt good ideas.  It’s quite freeing to simply say, “what I’m doing now isn’t as good as I thought it was, and I plan to make improvements in my own time.”  For those just starting out investing on their own, it’s okay to learn as you go.

Friday, June 19, 2020

Short Takes: Billionaire Bashing, Asset location Debates, and more

A promoter sent me a press release announcing that billionaires increased their net worth by $584 billion since the start of the pandemic.  I guess I’m supposed to be outraged that they profit while everyone else suffers with job losses, sickness, and death.  Coincidentally, the “start of the pandemic” lines up with the bottom of the stock market crash.  If we use VTI as a proxy for billionaire wealth, these investors lost about $780 billion in the month before the pandemic started.  Suddenly the outrage melts away.  I’m all for improving equality of opportunity, but I don’t see how this misleading garbage will help.

Here are my posts for the past two weeks:

Questions for Your Financial Advisor


Borrowing to Invest

Here are some short takes and some weekend reading:


Justin Bender
completes his podcast series of 4 portfolios with different asset-location strategies.

Robb Engen at Boomer and Echo says that asset location isn’t worth worrying about.  I certainly agree with this conclusion if we are talking about the typical poor asset location advice telling us to put bonds in RRSPs.  This advice comes from a schizophrenic analysis that assumes tax rates are zero when calculating asset allocation, but tax rates suddenly take on realistic values when assessing investment performance.  It makes more sense to judge the value of strategic asset location based on a sensible strategy.  Roughly speaking, such a sensible strategy takes assets in the order U.S. stocks, international stocks, Canadian stocks, and bonds, and then fills accounts in the order RRSPs, TFSAs, and non-registered accounts (some variation may be needed depending on tax rates, account sizes, and position sizes).  Not worrying about asset location is certainly easier, which is valuable.  In my own case, I find that using strategic asset location simplifies my portfolio somewhat because each of my accounts has fewer holdings.  This reduces the number of trades required for deposits, withdrawals, and rebalancing.  I simplify further by not holding strictly to optimal asset location when small deviations reduce the number of trades I need to perform.

Big Cajun Man
tells us what to do with found money.  If you follow his advice, your future self will thank you.

Tuesday, June 16, 2020

Borrowing to Invest

Borrowing money to invest is like weaving through traffic.  You'll get to your destination sooner as long as nothing bad happens. – MJ, 2020

The case for leverage (borrowing money to invest) seems compelling.  You can borrow money at 3-4% interest, and invest it in stocks that will probably make 6-8%.  What’s not to like?

The answer is “the unexpected.”  Anything that forces you to sell your investments while they’re down can cost you a lot of money.  You could be forced to sell when you lose your job due to problems with your boss, your company, or the whole economy.  Or your lender could demand its money back.  You can’t anticipate every possible reason why your stocks might crash at the same time as you’re forced to sell.

It’s true that such problems are likely rare.  But they don’t have to happen often to make leverage look like a bad idea.  Selling when your stocks are down 30% gives back a decade of expected excess stock gains above loan interest.

Using just a modest amount of leverage is like a little weaving through traffic: it probably isn’t too unsafe.  But as you borrow more to magnify returns trying to make more money, the odds of blowing up increase, just as the odds of crashing increase as you weave faster through traffic.

I’m not 100% against leverage, but investors should enter into it with their eyes open.  Most analyses touting the benefits of leverage don’t include the possibility of something going wrong.  But things going wrong is normal in life.  Stock markets crash.  People lose jobs.  With too much leverage you can end up without money to invest during future good times.  To thrive you have to first survive.

Monday, June 8, 2020

Questions for Your Financial Advisor

“Don’t ask a barber whether you need a haircut.” – Daniel S. Greenberg, 1972

We’re all guilty of coming to conclusions that line up with our self-interest.  However, it’s not always as obvious as in the case of a barber who always thinks people need haircuts.  Often we don’t even recognize that we’re guilty of being influenced by self-interest.

Financial advisors, like the rest of us, have biased reasoning.  Here I answer some common investor questions from the point of view of a most financial advisors.

Do I need a financial advisor?

Yes.  How else can I make a living?  People with advisors end up with more savings than those without an advisor.

Do I need to save more for retirement?


Yes.  That way you’ll have more money invested with me, and I’ll collect more fees.  You don’t want to run out of money in retirement.

How much do I pay in fees?

You shouldn’t think about that.  It’s an obsession of mine, but if you think about it, you might insist on paying me less.  The more important question is whether you’re getting good returns.

Should I borrow so that I can invest more?

Yes.  This will increase my Assets Under Management (AUM) and I’ll collect more fees.  Your investment returns will more than cover the interest payments.

Should I keep my pension or withdraw its commuted value to invest with you?

You should withdraw the commuted value to increase my AUM.  I can invest it for you to make more money than your pension will pay.

Should I take CPP and OAS as early as possible?

Yes.  Then you’ll sell less of your investments in the next few years to keep my AUM up.  The government might cut these pensions.

All the answers serve the advisor’s interests, but it takes some knowledge to be able to tell if they serve your interests.