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.

Friday, June 5, 2020

Short Takes: Ken French Interview, Tighter Mortgage Rules, and more

Over the past two weeks, I started four different posts, but they were all leaning too negative to publish. It’s tempting to write about the various types of bad financial advice I see, but it’s better to hold up examples of good advice. Hopefully, I’ll have something to say in the coming fortnight.

Here are some short takes and some weekend reading:

The Rational Reminder Podcast interviews Professor Ken French of the well-known Fama-French 3-factor asset pricing model.

CMHC is tightening their mortgage rules as of July 1. One change is to reduce the Gross and Total Debt Servicing ratio limits to 35% and 42%, respectively. These percentages still seem very high to me. I would never want to live that close to the edge.

CDIC has extended their coverage to foreign cash and term deposits of more than 5 years. Unfortunately, the coverage limit remains $100,000, where it’s been for 15 years.

The Blunt Bean Counter explains financial and estate issues with blended families.

Moshe Milevsky argues that COVID-19 has increased uncertainty in how long we’ll live, and that this increases the economic value of annuities. This makes sense. The risk of dying soon is higher, and it seems plausible that the dispersion in our remaining lifetimes is higher. However, the Canadian annuity market remains opaque and without options for indexing to the Consumer Price Index (CPI).