Friday, May 22, 2020

Short Takes: Pizza Arbitrage, Open Offices, and more

Here are my posts for the past two weeks:

How Much of Your CPP Contributions are Really a Tax?

Playing with FIRE

Here are some short takes and some weekend reading:

Ranjan Roy explains a pizza arbitrage scheme when a food delivery startup scrapes a restaurant’s website.

Big Caun Man is predicting the death of the open-concept office space.  Organizations love the cost savings of open office spaces.  These savings are very easy to measure.  Much harder to measure is the loss of worker productivity.  Concern about spreading viruses will fade, but workers who need to think deeply, like software developers, can’t get their work done efficiently in open offices.  The constant distractions make it impossible to solve a problem that requires 15 minutes of uninterrupted thought.  One of the touted advantages of open offices, that workers will collaborate better, turns out to be false.  Research at Harvard found that face-to-face interactions dropped 70% after switching to an open office.  This is consistent with my own experience.  It’s hard to talk to anyone when even a whisper disturbs other workers.

Moneysense got together a panel to pick Canadian ETFs again this year.  The list has now exploded to 42 ETFs, reflecting disagreement among panelists.  Amusingly, one panelist took a “hard pass” on another’s pick.  By my count, the article blended opinions from two index investors, three more who use factor tilts, and four active investors.  My own investing approach is between the two index investors and those who believe strongly in factor tilts.

The Rational Reminder Podcast interviews Andrew Hallam, author of Millionaire Teacher and Millionaire Expat.  Andrew is always interesting with his takes on the disconnect between income and wealth, the link between debt and misery, the ways advisors try to talk you out of index funds, and geographical arbitrage.

Robb Engen at Boomer and Echo lists five important investing rules. Don’t miss his excellent response in the comment section to the question about trying to save on MER costs by buying individual stocks.

Canadian Mortgage Trends reports CMHC’s gloomy outlook for real estate.  They see an 18% drop in home prices.  Almost everyone who makes their living from real estate transactions disagrees.  Do they have better insight or are they using motivated reasoning?  Hard to tell.

Nick Maggiulli explains why those who make pointless predictions aren’t punished for being wrong.

The Blunt Bean Counter has a guest post imploring business owners to look at their businesses from an investment perspective rather than just propping it up and risking their personal finances.

Thursday, May 14, 2020

Playing with FIRE

By now, most people have heard of the FIRE (Financial Independence Retire Early) movement. Those who embrace FIRE can be evangelical about it, and critics can be very harsh. To give people a better idea of what FIRE is, Scott Rieckens wrote the book Playing with FIRE: Financial Independence Retire Early, the story of his family’s journey to better align their spending with what they believe is important in life.

It’s easy to criticize FIRE if you see it as a bunch of young white males who have (or had) high-paying jobs and prefer to laze around all day. But FIRE looks very different to different people. Some seek complete financial independence and true retirement, while others just want enough cushion to quit the job they hate and do something they love that might pay less.

The common element in FIRE is striving for financial independence to make it possible to spend your time in a way that makes you happy. However, this requires deep examination of the way you spend your money. Most people don’t want to do this. It’s much more comforting to read an article about why FIRE is bad so we don’t have to examine our lazy and impulsive spending.

Instead of spending much time defending FIRE, Rieckens tries to inspire us by describing his journey with his wife, and giving snapshots of other people’s FIRE journeys. I have little doubt that just about anyone could benefit from better aligning their spending with their goals, even if their ultimate path doesn’t look like mainstream FIRE.

As the author explains, “FIRE isn’t about drinking cocktails on a beach for the rest of your life. It’s about spending your precious years on earth doing something other than sitting behind a desk, counting the minutes to 5 PM, wishing you were somewhere else.”

“The general path to FIRE is to save 50 to 70 percent of your income, invest those savings in low-fee stock index funds, and retire in roughly ten years.” This narrower vision of FIRE gets many people angry. It sounds impossible for any but a privileged few who have massive incomes.

The truth is that almost anyone could be wiser about their spending. Maybe 70% is a stretch, but 20% is certainly possible for most. But it’s far easier to declare such savings impossible than it is to make the changes necessary to spend on things that truly make you happy. It’s ironic that the FIRE approach to spending is most important for those with lower incomes, while FIRE critics use low income earners as the reason why FIRE is flawed.

“FIRE is significantly easier to accomplish if you’re making a higher-that-average salary.” This is certainly true if you try to stick to a fixed schedule, like reaching financial independence at age 40. “But FIRE principles can be applied at any income level. Whether you reach FIRE in five, ten, or thirty years, prioritizing happiness over material objects, and buying back your time are available to everyone.”

Rieckens points to the 4% rule as a guide to when you’ve achieved financial independence. Despite the criticism the 4% rule gets, it’s not too bad as a rule of thumb. The original 4% rule assumed you don’t pay any investment fees and you’d never cut spending if portfolio returns disappoint. If you have low portfolio costs and you’re somehat flexible on your spending, then spending 4% of a portfolio starting at age 50 isn’t too risky. A partial bailout will come around age 65 or so in the form of CPP and OAS for Canadians and Social Security for Americans.

However, very young retirees face other risks. One obvious risk is that the money has to last longer. Another is that it’s hard to have a good picture of your spending for the rest of your life if you’re well under 50. Riding a bicycle to a hardware store to cart things back is great for young people, but eventually becomes difficult at some age. Those who seek extremely early retirement might be better served with a 3% rule.

Rieckens recommends investing in Vanguard index mutual funds, an excellent choice for Americans. Unfortunately, these U.S. mutual funds aren't available to Canadians. But Vanguard (U.S.) and Vanguard Canada have exchange-traded funds (ETFs) Canadians can buy.  Vanguard Canada has a few mutual funds available to Canadians, but with MERs from 0.5% to 0.6%, they're more expensive than Vanguard U.S. mutual funds.

Paula Pant, who is well known in the FIRE community, had some interesting advice. “‘What helps me when I get anxious or scared,’ Paula said, ‘is knowing that I’m not in control of anything. When I truly accept that I have no control, I feel better.’” It’s better to anticipate a range of possible outcomes than to try to guess what will happen or control events to get a particular outcome.

To achieve FIRE, “You don’t have to do anything you don’t want to do! You merely have to align what you want with how you spend.” This alignment takes more work than it might appear. Many people would rather mock FIRE than help themselves.

Monday, May 11, 2020

How Much of Your CPP Contributions are Really a Tax?

A simple view of the Canada Pension Plan (CPP) is that it takes contributions from your paycheque, invests your money until you retire, and then pays the money back to you as a pension. However, reality is more complicated. CPP rules result in some people getting more out of CPP than they put in, and some get less. This splits your contributions into part savings plan and part tax.

Your first thought might be that the amount we get from CPP depends on how long we live. However, this is actually a good thing. I’m happy to have an income stream that reduces my longevity risk. I benefit today from the fact that once I start collecting CPP, it will last as long as I live. So, when I say we don’t all get out what we put in, I’m not talking about how long we live.

To get an idea of what I do mean, it helps to look at the short summary in CPP’s 2018 annual report. CPP paid benefits of $44.5 billion, but only $34.6 billion of this went to CPP retirement pensioners. The remaining $9.9 billion went to surviving spouses, people with disabilities, death benefits, and other amounts.

Imagine a Canadian with no spouse who worked steadily from age 18 to 65. This Canadian only has access to his or her share of the $34.6 billion for regular benefits plus the $368 million in death benefits. This is a total of about $35 billion out of the $44.5 billion paid from CPP. This person gets no share of the remaining $9.5 billion that is a collection of extra social programs baked into CPP.

To be clear, I’m not opposed to having these extra programs in CPP. We need to take care of those in need. I just think of paying for these extras as a form of tax rather than a form of forced saving for retirement, because one person’s CPP contributions get redistributed to other people.

These extra programs aren’t the end of the redistribution. When you calculate how much you’ll get in CPP benefits, you get certain “dropouts,” which means you don’t have to count some contribution months where your contribution was low. After using your dropouts, you get to use the average of your good contribution months to determine your CPP benefits.

Everyone gets to drop out 17% of their low contribution months. Primary caregivers can drop out any low contribution months while one of their children is under 7. People collecting CPP disability pensions can drop out months while they collect this pension.

It’s time for some estimates. Let’s say that about 40% of Canadians get 10 years of dropouts for children under 7. This is an extra 4 years of dropouts, on average. Out of the 47 working years from 18 to 65, this represents 4/47=8.5% more dropouts. We’re up to 17%+8.5%=25.5% dropouts.

The 2018 CPP report says that there are 338,000 beneficiaries with disabilities, which is about 1.7% of Canada’s workforce. These people get to drop out contribution months while they collect their disability benefits. This brings the total dropouts to about 27%.

Let’s guess that the average dropped out month has 60% of the CPP contributions of the remaining 73% of months used to calculate CPP benefits. So, if the dropouts didn’t exist, regular CPP benefits would drop to 73%+(60%)27%=89% of their current level.

So without dropouts, there would be a 11% drop in the $34.6 billion paid to CPP retirement pensioners, a drop of $3.8 billion. Add in the $9.5 billion in extra social programs baked into CPP, and we get a total of $13.3 billion in CPP benefits not available to our hypothetical Canadian with no spouse who worked steadily from age 18 to 65. This is about 30% of the total paid out by CPP ($44.5 billion) in the 2018 fiscal year.

So, as a rough estimate, 70% of your CPP contributions are your savings, and the remaining 30% is more tax-like. But that doesn’t mean you won’t get a slice of the 30%. All this money gets paid out. If your CPP contributions fluctuated at all over the years, or you’re married, or you have kids, or you become disabled, you’ll get some of this 30% in CPP benefits. Some people will get more than the 30% back and some less. That’s the nature of redistributing wealth through taxes.

I’ve seen analyses showing CPP giving poor investment returns for a Canadian who contributes the maximum to CPP each year. This is because these analyses assume that this Canadian gets none of the 30% of contributions that get redistributed. Another factor is that because CPP benefits are indexed to inflation, the claimed investment returns on our CPP contributions are a “real” return. This means we get this return plus the amount of inflation.

I’m quite happy with the extra programs built into CPP. I benefit a little from the 17% dropout everyone gets. My wife and I will likely benefit somewhat from the CPP survivor benefit, and our heirs will get the death benefits. Overall, we’re unlikely to get all of our 30% back; some of it will go to people with greater need.

One concern I have with CPP is that its costs are too high. Too much of CPP assets go to administration and investment management. But these costs are lower than the investment fees Canadians pay on their own savings. Another concern I have with CPP is that too many people start benefits at age 60 when they’d be better off waiting until 65 or 70 to get larger payments.

CPP is a good program. Its forced savings and redistributions to the needy do a good job of reducing the number of seniors who end up being a burden on taxpayers. Few Canadians can invest with returns as high as CPP gives. I have some concerns about this program, but I’m not concerned that about 30% of CPP contributions are effectively a form of tax.

Friday, May 8, 2020

Short Takes: Risk Tolerance, Proposed Tax Changes, and more

Here are my posts for the past two weeks:

Another Emotional Reason to Take CPP Early

Portfolio Rebalancing Based on Expected Profit and Trading Costs (Redux)

Calculating My Retirement Glidepath

Here are some short takes and some weekend reading:

Boomer and Echo has a sensible discussion about using the recent market crash to learn about your risk tolerance. I made the following comment: “I’m all for people using real experience with losing money in markets to learn about their true risk tolerance. The tricky part is when to change allocation percentages. I’d like a rule something like, you can only reduce stock exposure when stocks are within 5% of making a new high, and you can only increase stock exposure when stocks are at least 20% below the most recent high. The waves of people wanting to do the opposite are predictable.”

Jamie Golombek discusses some tax proposals to help investors in these difficult times. To the best of my knowledge none of these proposals have come from the government, so don’t hold your breath. The first one is to allow people to use their RRSPs like the home-buyer’s plan. You’d be able to withdraw funds up to some limit tax-free, but you’d have to put the money back in the future. Another proposal is to eliminate the superficial capital loss rules for 2020. So, you’d be able to sell stock to crystallize a capital loss and rebuy the stock right away. Normally, the capital loss is disallowed in this case. Another proposal is to allow people to offset regular income with capital losses incurred in 2020. I’m guessing wealthy people could make good use of the proposed capital gains changes.

Justin Bender describes his “Ludicrous” ETF portfolio, the third in a series of four portfolios. I can understand why a money manager would use this portfolio for clients who don’t understand how to measure the risk of their portfolios; they need to be tricked into taking more after-tax portfolio risk. However, I don’t see how it makes sense for a DIY investor who understands this issue to use the Ludicrous portfolio. For someone correctly focusing on after-tax portfolio risk, the Ludicrous asset location decisions send stocks and bonds to the wrong accounts. For more background on these issues, see my earlier discussion.

Doug Hoyes has an interesting take on the possibility of a debt jubilee.

The Blunt Bean Counter uses an example case to show how Alter Ego Trusts and Joint Partner Trusts work and illustrate their advantages.

Big Cajun Man is using his extra time at home figuring out the different ways his expenses have dropped during the pandemic lockdown.

Monday, May 4, 2020

Calculating My Retirement Glidepath

While some people are busier than ever during the pandemic, like health care workers, many of us have extra time on our hands. I’ve used this time to clean up my plan for retirement investing and spending. Here I describe this plan.

Top Level

I’m an index investor with a portfolio invested in stock ETFs and bonds. By “bonds” I mean any type of safe fixed-income investment, including cash savings, GICs, and short-term government bonds; I have no interest in corporate bonds or long-term government bonds. At a broad level, I maintain chosen percentages of stocks and bonds. Currently, my portfolio is about 80% stocks and 20% bonds. However, I plan to increase the bond percentage over time.

When we adjust asset allocation percentages as we age, it’s called a retirement glidepath. The idea of a glidepath is far from new, but most recommended glidepath percentages seem to be just made up numbers, such as bond percentage equal to your age. I prefer to run my portfolio with a small number of fixed rules that make sense to me. Here is one of those rules:

Rule 1: Only invest in stocks with money I won’t need for 5 or more years.

This isn’t new on its own. However, I’ve used it to guide my asset allocation glidepath before and after retirement. It’s not obvious how this rule determines my asset allocation glidepath, but it does.

Before retirement, there was enough demand for my skills that I was confident in my ability to cover my family’s needs with my income. So, beyond some emergency funds to cover a short interruption in my income, I invested all savings in stocks.

Now that I’m retired, I maintain 5 years of my family’s spending in bonds, and the rest in stocks. By “family’s spending,” I mean the safe amount we can spend based on my portfolio’s size rather than some dollar amount we want to spend.

This safe spending level is something I can calculate based on a number of factors:
  • Portfolio size
  • Holding 5 years of spending in bonds
  • Making the money last until age 100 (I likely won’t live this long, but what matters is how long I might live.)
  • Conservative estimates of stock and bond returns
  • Expected future pensions such as CPP and OAS
  • Expected future large cash flows

As I get older and closer to 100 years old, my safe spending level rises as a fraction of my portfolio’s size. The fraction of my portfolio that is invested in bonds rises as I age as well, which determines my glidepath.

My goal is to plan for constant annual spending in inflation-adjusted dollars. However, if portfolio returns don’t match expectations, I adjust spending. So, my plan gives my spending levels as a percentage of my current portfolio size. Also, I’ll spend more from my portfolio leading up to the start of CPP and OAS, and then I’ll spend less from my portfolio.

I have a full paper, Withdrawal Rates for a Retirement Glidepath, that covers the math of calculating spending levels and asset allocation percentages based on Rule 1 above and the list of other factors.

This paper differs a little from a previous description of my spending plans. The older description was based on the idea that I’d recalculate my spending level and bond allocation once per year based on a set of percentages pre-calculated for each year of my retirement, much like the mandatory RRIF withdrawal percentages. However, I now have a spreadsheet that calculates my spending level and bond allocation in real-time. I now treat my bond allocation as an amount that needs rebalancing whenever it gets far enough away from its target percentage. This can happen in response to fluctuating investments or the slow draw-down of cash as I spend my money in retirement.

The main difference this change makes is that I now maintain roughly 5 years of spending in bonds at all times. My retirement spending used to draw down the 5 years in bonds to 4 years in bonds over the course of the year before I replenished the bonds at the end of the year. With the old plan, I averaged about 4.5 years of spending in bonds, but now I maintain 5 years’ worth. Luckily for me, I made this part of the change before the pandemic, so I benefited from having less money in stocks before the crash.

Unlike many investors, I don’t plan to switch to spending exclusively from bonds when stocks crash; I just rebalance mechanically. However, as I’ve explained before, the rebalancing process naturally shifts spending to bonds when stocks are down.

Although rebalancing a portfolio can produce profits, its purpose is to control risk. The reason we don’t rebalance very frequently is that trading costs can add up. This brings us to another fixed rule:

Rule 2: Limit rebalancing trading costs to 5% of rebalancing gains.

From this rule we can calculate rebalancing thresholds that limit costs but allow us to capture rebalancing gains as asset prices fluctuate. I recently updated my description of my threshold rebalancing strategy. The biggest change is an improvement to calculating rebalancing thresholds when there are two asset classes with significantly different allocation percentages. This applies to my stock/bond allocation.

I have a script that accesses my portfolio spreadsheet to send me an email when I need to rebalance my portfolio. Until recently, such alerts were rare. But during the pandemic, I’ve received several alerts to rebalance between stocks and bonds. It’s not easy to buy back into stocks after they’ve crashed, but doing so has produced profits for me. As stocks rose again, it was easier rebalancing back to bonds, but I still found myself not wanting to sell stocks when they seemed to be rising. However, I’m confident that my mechanical strategy is better than following my gut.

Stock Sub-Portfolio

I view my stocks as a sub-portfolio that consists of Canadian and U.S. stocks. I’ve chosen to hold 30% Canadian stocks (in Canadian-dollar ETFs) and 70% U.S. and international stocks (in U.S.-dollar ETFs). I keep them in balance using the same rebalancing strategy described above for my stocks and bonds.

One of the things I’ve done with the extra time on my hands during the pandemic is to improve the part of my spreadsheet that shows me the exact trades to make in each account when rebalancing. Without the spreadsheet, this can get tricky when I adjust both the stock/bond balance and the Canadian/non-Canadian stock balance at the same time.

U.S. and International Stock Sub-Portfolio

Within my stock sub-portfolio, I think of my U.S. and international stock ETFs as a sub-sub-portfolio. The 70% of my non-Canadian stocks are split 25% in VTI, 20% in VBR, and 25% in VXUS. Before I retired and bought some bonds, I wrote about my reasoning for this allocation. However, any reasonable allocation can work if you stick to it rather than deviate out of fear or greed. Again, the recent work I’ve done on my spreadsheet to calculate rebalancing trade amounts helps here.


I remain satisfied with the investment plan I’ve chosen. Recent changes I’ve made to automate my portfolio even more than it was before should help stop me from making costly mistakes. I tend not to even look at my portfolio value much. My spreadsheet calculates our safe after-tax monthly spending amount in real time. This amount tells me how my investments are performing, and helps us plan how much we can spend on our retirement activities and travel.