Monday, November 23, 2020

The Capitalist Code

Ben Stein has an interesting short book called The Capitalist Code: It Can Save Your Life and Make You Very Rich.  He aims it mostly at young people as a combination of financial advice and a defense of capitalism.

The advice part of the book is essentially to save some money to invest in stocks as a way to hitch a ride on the incredible wealth generation capitalism provides.  He says that when “we hook up our lives to the mighty engine of capitalism,” we’re generating wealth to deal with the wide array of uncertainties in life.

On the subject of employment, Stein “will always advise working at one loves,” and “we might as well be prisoners as work in jobs we loathe.”  I agree with this to an extent, but we have to meet the world halfway.  If all the people who love painting landscapes tried to make a living at it, 99% would starve.  You have to choose among jobs that have some hope of paying enough money to live.

To those who might doubt the benefits of capitalism, Stein says “When your professors and your schoolmates tell you that capitalism as we see it in the United States of America right now is an evil exploitive system, they’re lying.  When they tell you that you’re being consistently ripped off by Wall Street, they’re lying and they’re hurting you.”

Stein points to Elizabeth Warren as an example of a professor who is wrong about capitalism.  I think the truth is somewhere between their points of view.  Capitalism works, but we can afford to carve out a small part of the wealth to protect the less fortunate.  The catch is deciding how much wealth to dedicate to the needy.  In my view, the U.S. is crazy to allow severe medical problems to bankrupt some of their citizens.  They also need to deal with some corporations that have become so large that their effects are anti-capitalistic.

Overall, this book is worth a read.  Stein gives solid advice for young people and offers an interesting defense of capitalism at a time when many are singing the praises of socialism.

Saturday, November 21, 2020

CPP Timing: A Case Study

There are many factors that can affect your decision on whether to take CPP at age 60 or 70 or somewhere in between.  Here I do a case study of my family’s CPP timing choice.

Both my wife and I are retired in our 50s and had periods of low CPP contributions because of child-rearing and several years of self-employment.  So, neither of us is in line for maximum CPP benefits.  If we both take CPP at age 60, our combined annual benefits will be $11,206 (based on inflation assumptions described below).  

The “standard” age to take CPP is 65.  If you take it early, your benefits are reduced by 0.6% for each month early.  This is a 36% reduction if you take CPP at 60.  If you wait past 65, your benefits increase by 0.7% for each month you wait.  This is a 42% increase if you wait until you’re 70.

However, there are other complications.  If you take CPP past age 60, any months of low CPP contributions between 60 and 65 count against you unless you can drop them out under a complex set of dropout rules.  If my wife and I take CPP past age 65, we won’t be able to use any dropouts for the months from 60 to 65, so we’ll get the largest benefits reduction possible for making no CPP contributions from 60 to 65.  Fortunately, CPP rules don’t penalize Canadians any further if they have no contributions from 65 to 70.

Another less well-known complication is that before you take CPP, your benefits rise based on wage inflation.  But after your CPP benefits start, the payments rise by inflation in the Consumer Price Index (CPI).  Over the long term, wage inflation has been higher than CPI inflation.  So, when you start taking CPP benefits, you lock in lower benefit inflation.

In this case study, I’ve assumed 2% CPI inflation and 3% wage inflation.  These assumptions along with the CPP rules and our contributions history led to our annual benefits of $11,206 if we take CPP at 60.

If we wait until we’re 70, our combined annual CPP benefits will be $29,901.  However, don’t compare this directly to the figure at age 60 because they are 10 years apart.  If we take CPP at 60, it will grow with CPI inflation for those 10 years.  The following table shows our annual CPP benefits in the two scenarios: early CPP at 60 and late CPP at 70.

Age    Early CPP    Late CPP              
Age    Early CPP    Late CPP
 60    $11,206   
 75    $15,081   $33,013
 61    $11,430   
 76    $15,383   $33,674
 62    $11,658   
 77    $15,690   $34,347
 63    $11,891   
 78    $16,004   $35,034
 64    $12,129   
 79    $16,324   $35,735
 65    $12,372   
 80    $16,651   $36,449
 66    $12,619   
 81    $16,984   $37,178
 67    $12,872   
 82    $17,324   $37,922
 68    $13,129   
 83    $17,670   $38,680
 69    $13,392   
 84    $18,023   $39,454
 70    $13,660   $29,901
 85    $18,384   $40,243
 71    $13,933   $30,499
 86    $18,752   $41,048
 72    $14,211   $31,109
 87    $19,127   $41,869
 73    $14,496   $31,731
 88    $19,509   $42,706
 74    $14,785   $32,366
 89    $19,899   $43,560

It would certainly feel good to start collecting CPP benefits when we’re 60, but by the time we’re 70, we’d never notice that our payments could have been 119% higher.  That’s why we plan to wait until we’re 70 for our CPP benefits.

A good question at this point is what we’ll do in our 60s without those payments.  We’ve already begun dipping into our RRSPs, and we’ll continue this through our 60s.  We’re happy to spend some of our savings early in exchange for much larger CPP benefits later.

To see why we’ll make this tradeoff, focus on our financial position at age 70.  The choice is to have either small CPP benefits and more savings or large CPP benefits and less savings.  The math says we’re better off with more guaranteed income indexed to inflation than we are to have more savings invested in risky assets.  In fact, when we do an analysis of how much we can safely spend, the decision to take CPP at 70 instead of 60 increases our safe spending level.  It seems counterintuitive, but we can spend more safely now in our 50s because of the decision to delay CPP to age 70.

You might wonder whether you could invest the smaller CPP payments in your 60s to do better than delaying CPP benefits.  In our case, if we live to 90, our investment return would have to beat CPI inflation by an average of 6.3% per year.  If we choose to manage our savings to make sure we have enough to make it all the way to 100 years old, the breakeven return rises to 7.4% above inflation.  There is no way we can be confident of such high investment returns, particularly because much of our assets would be in taxable accounts.  My planning assumption is that our stocks will beat inflation by 4% minus taxes and other costs.  It’s clear that delaying CPP to 70 is the better strategy.

What if the government changes the rules?  That’s certainly a possibility.  The government could choose to cap CPP benefits in the future, which would be bad for those who take CPP at 70.  The government could also bring in wealth taxes, which would be bad for those who take CPP at 60.  If the government ever becomes desperate enough to take away retiree benefits or charge wealth taxes on people who aren’t very rich, I suspect we’ll have much bigger problems than whether we took CPP at 60 or 70.

Although taking CPP at 70 is the right choice for us, there are some good reasons for others to take CPP early.  One reason is if you just don’t have enough savings to get through your 60s.  But, just not wanting to spend any savings isn’t a sound reason.  Another reason is if you’re in poor health and don’t expect to live long.  But just fearing you might die young isn’t a sound reason.  If you’re so sure you won’t make it to age 80 that you’d be willing to spend down all your savings before 80, then taking CPP at 60 is likely for you.  There are other narrow reasons to take CPP early that are mainly due to technical rules about taxes and certain government benefits.

The final conclusion is clear.  We’re better off delaying the start of CPP benefits despite the strong emotional reasons for taking them early.

Friday, November 20, 2020

Short Takes: MLM Cults, CPP Timing, and more

You might have noticed I’ve written quite a few book reviews lately.  The books I had on hold at the library were taking a long time to become available (maybe because of the pandemic), so I put more books on hold.  But then they started showing up in bunches.  I’m barely staying ahead of the return dates.  You can expect more reviews in the coming weeks as several of the books I have out now are about money.

Here are my posts for the past two weeks:

Bond Quiz

Value Averaging

Mom and Dad, We Need to Talk

Napkin Finance

Here are some short takes and some weekend reading:

Preet Banerjee
interviews Multi-Level Marketing “survivor” David Pride who needed 3 years of therapy to de-program his brain when he left.  I know there’s a cult aspect to many MLM schemes but had no idea it was this powerful.

Mark Burgess has a sensible take on when to start your CPP.  He also points out the conflict of interest financial advisors have when they advise on CPP timing.

Justin Bender explains the details of the new iShares sustainable investing ETFs in his latest video.

Boomer and Echo
says that health and dental insurance aren’t really insurance.  I agree.  Instead of capping benefits at $10,000 per year, real insurance would cover anything over $10,000. 

Big Cajun Man
got his credit card company to forgive the interest that came from accidentally paying late.

Wednesday, November 18, 2020

Napkin Finance

When it comes to money and finances, it seems like everything we learn is more complicated than we hoped.  The book Napkin Finance: Build Your Wealth in 30 Seconds or Less by Tina Hay offers very short overviews of a wide range of financial topics.  The format is appealing in some ways, but it’s an American book and much of the content isn’t relevant to Canadians.

The book covers a wide range of financial topics, including compound interest, credit, investing, college costs, retirement, taxes, GDP, and Bitcoin.  Each begins with the image of a napkin with drawings overviewing the subject.  Then there are a couple of pages with further explanations.  The format felt gimmicky at first, but it grew on me.  Before people can understand the many details and subtleties of an area, they want a quick understandable overview for context.

The book contains lots of humour to help hold readers interest.  One of my favourites was “A hedge fund is a fee structure in search of a strategy.”

In most cases, it’s obvious when subjects are only relevant in the U.S., such as discussions of 401(k)s, 529 plans, and Social Security.  However, when Hay calls advisor fees “moderate” and mutual fund fees “comparatively low,” it may not be obvious to some readers that she’s definitely not talking about Canada.

For the most part, the explanations are very good.  One part I particularly liked: “Investors waste a lot of energy (and money) trying to guess when a bull market is ending so they can sell, or guess when a bear market is ending, so they can buy.  The reality is, no one can predict those turning points consistently.  Most investors do a lot better by just holding on through bull and bear markets.”

One subject area explanation I didn’t think much of was “Risk vs. Reward.”  The pyramid from low risk to high risk includes savings accounts, bonds, stock, start-ups, and cryptocurrency.  With the risk-reward trade-off, reward refers to expected returns, not possible returns.  Stocks have higher expected returns than bonds.  However, when we get to cryptocurrencies, there’s no reason to believe that expected returns are higher than those for stocks.  It’s not sensible for investors to move from stocks to cryptocurrencies because they are willing to accept more risk in exchange for a higher expected return.

If we ever get a Canadian version of Napkin Finance, I’d likely recommend it to my readers.  However, this U.S. version could mislead readers looking for basic information about financial topics.

Monday, November 16, 2020

Mom and Dad, We Need to Talk

I wasn’t sure what to expect from Cameron Huddleston’s book Mom and Dad, We Need to Tak: How to Have Essential Conversations with Your Parents about Their Finances, but I was pleasantly surprised.  It’s well written and contains lots of practical advice about the steps we need to take to make it easier to help our parents as they age.  The book is U.S.-centric, so some of the more detailed advice is less useful to Canadians, but is still well worth a read.

A common theme throughout the book is that some steps with helping your parents need to begin long before they need help.  I’ve been in the position of rooting through a house full of papers trying to figure out what accounts there are and what bills need to be paid.  I can only imagine how much worse the experience would have been if I didn’t have a power of attorney document prepared in advance.

It’s tempting to decide that there’s no need to do anything right now because your parent or parents are fine.  However, when the time comes that they need help, you’ll need to know about their various accounts, and you’ll need to have power of attorney.  However, wills and power of attorney documents have to be set up while your parents are still competent.  As for their financial accounts, you’ll want them to at least tell you which banks and insurance companies you’ll need to contact.  The more information you have, the less you’ll need to play the role of “forensic accountant.”  In my case, I almost missed an account with about $40,000 in it.  Maybe there are others I did miss.  I’ll never know.

Huddleston covers many of the reasons your parents may resist talking about their finances with you.  They may consider money a taboo topic.  They may be worried about losing their independence and don’t want to think about aging and death.  They might be embarrassed about their finances, or they may think you’re just sniffing around for an inheritance.  The book covers a wide range of ways of moving forward despite resistance.

An interesting piece of advice is to make sure you and your siblings are on the same page before approaching your parents.  You won’t get very far with a discussion about finances or moving out of a house your parents can’t manage any more if your siblings are fighting you.

In one of the book's many examples, “Jason” used the 2008-2009 recession to broach the subject of finances with his mother.  He asked whether “she had been speaking to anyone about her retirement funds and if she had moved any of her holdings into a safe harbor type of situation to prevent any negative fallout from the market crash.”  This shows the importance of knowing what you’re talking about yourself before trying to help your parents.  Jason has bought into the myth that financial advisors can steer around market crashes.  He was advising his mother to sell out of stocks after they had already fallen to lock in her losses.

Another important subject for discussing with your parents is scams.  Huddleston gives a good list of red flags for scams including fees to collect winnings, calls from government agencies, emergency calls from grandkids, free lunches, and high-return investments with no risks.

Hudleston advises being careful about reverse mortgages because “deceptive marketing is common.”  The book contains no further information other than a reference to a Consumer Financial Protection Bureau (CFPB) document.  I found the following: “since January 2012 American Advisors Group’s advertisements misrepresented that consumers could not lose their home and that they would have the right to stay in their home for the rest of their lives. The company also falsely told potential customers that they would have no monthly payments and that with a reverse mortgage they would be able to pay off all debts. In fact, consumers with a reverse mortgage still have payments and can default and lose their home if they fail to comply with the loan terms. These terms require, among other things, paying property taxes, making homeowner’s insurance payments, and paying for property maintenance.”

Overall, I recommend this book to get useful information about making a very difficult time easier.  It’s hard to see your parents or other relatives decline with age, but the experience can be a whole lot worse without proper preparation.  Wills and powers of attorney need to be in place in advance.  Siblings need to come to agreement, and you and your parents need to make realistic plans about either aging in place or moving somewhere more manageable.

Friday, November 13, 2020

Value Averaging

The book Value Averaging by Michael E. Edleson promises a simple mechanical strategy for beating the market over decades by routinely buying more stocks when they’re low and selling some stocks when they’re highest.  It was first published in 1991 and “has steadily grown to cult-classic status” according to William J. Bernstein in the 2007 edition.  Despite the impressive endorsements, the method doesn’t work.  Value Averaging’s supposed success depends on measuring returns incorrectly.

Dollar Cost Averaging (DCA)

As a warmup, the first investment strategy Edleson describes is Dollar Cost Averaging (DCA), which is the simple idea of investing a fixed dollar amount every month (or other fixed time period).  When the market is down, your money will buy more shares than when it is up, so your average purchase price over a year will be lower than the average share price over that year.

To illustrate the advantage of DCA, Edleson compares it to another strategy that he calls Constant Share (CS).  With CS, you buy a fixed number of shares each month.  As expected, DCA usually produces higher returns than the CS strategy.

It’s here that we get the first hint of a problem.  When would it ever make sense that someone would use the CS strategy?  People choose amounts to save based on what is going on in their lives.  It doesn’t make sense that the amount they choose to save would be dictated by some investment strategy.  Just because stocks are down, why would I choose to save less money?

One thought is that an investor might have a large lump sum and is trying to decide how to invest it over time.  However, in this case, investment return calculations must include the returns on the cash held back from the market.  However, Edleson calculates returns on only the money used to buy stocks; he ignores any other savings.

This criticism of an investment strategy dictating the amount investors choose to save from their pay isn’t very serious yet.  For a few years investors really could use the CS strategy and eat out once or twice more in a month when the strategy calls for saving less money because the market is down.

The CS strategy has another problem.  The market goes up faster than salaries do.  Over the decades it would become infeasible to keep buying the same (split-adjusted) number of shares each month.  However, this isn’t a serious concern because the CS strategy only exists to illustrate the way DCA lowers average purchase price.  It’s not offered as a serious contender for how to invest.

A Simple Version of Value Averaging (VA)

To introduce Value Averaging (VA), Edleson describes a simple version.  Suppose you want to have $2400 saved after two years of investing.  To achieve this goal, you set interim targets over the 24 months of $100, $200, …, $2400.  You then invest whatever amount is necessary each month to reach the next interim target.  So, you invest $100 the first month.  In Edleson’s example of a precious metals fund in 1986 and 1987, the first month’s return is a loss of $5.60.  So, you have to invest $105.60 the next month to reach the interim target of $200.  This continues until you have $2400 after 2 years.

You might wonder what happens if the fund earns more than $100 one month.  The answer is that you sell some of the fund to get down to your interim target.  Over the course of the two years in this example, the amounts you had to invest ranged from selling $483 worth of the fund one month all the way to having to save $703 in another month.  These swings are partly due to this being a volatile precious metals fund.  However, when investing over more than just 2 years, such swings will grow larger as your savings grow.

These amounts may not sound like much in today’s dollars, but imagine that your target today is to save $1000 per month.  Then in the book’s example scenario, VA asked you to take back $4830 one month and come up with $7030 another month.  It’s clear that you’re not going to spend $4830 on a couple of dinners, and you likely couldn’t easily come up with $7030 one month out of your pay.  To handle these large amounts, you must have a separate savings account where you’d hold cash that the VA strategy doesn’t want in the market.  Sometimes you’d add to this account, and sometimes you’d dip into to get cash to invest.  If this account runs dry, you might even borrow to satisfy VA’s demands.

Edleson suggests that you might put some money aside, “perhaps in a money market fund,” to deal with the big swings in how much money VA calls on you to save each month.  However, this side pool of savings is an integral part of VA.  When you have money on the side or you borrow, the interest on this money should be part of the VA return calculation.  However, Edleson ignores them.  He does an Internal Rate of Return (IRR) calculation on just the amounts that go into and out of the market.

Edleson calculates the IRR of VA in this example to be 20.1% (per year).  He appears to have taken the monthly IRR and multiplied it by 12.  I get the annual IRR to be 22.1% when it’s properly compounded.  However, returns change if we include the side savings in the money market fund and amounts borrowed.  Let’s assume that you save $100 per month regardless of VA’s demands.  You put any excess cash in the money market fund, and you borrow if necessary.  A quick search on prevailing rates around 1986 gave 7% interest in the money market fund and 10% interest on borrowed funds.  In this scenario, the annual IRR drops from 22.1% to 17.9%.  If you prefer not to borrow and save up $100 for two months before the start of 1986, the annual IRR drops to 16.2%.  Properly taking into account side savings and borrowing makes a big difference.

The VA returns are still better than the 4% you’d have received using DCA in this example.  However, when Edleson continued this investment scenario for another 25 months, the DCA return for the roughly 4 years rose to 6.8% and the VA return dropped to 13.8%.  After properly accounting for side savings and borrowing, it’s not clear whether VA is actually any better than DCA, even for this example.  Costs from the extra trading that VA requires in addition to income taxes if you’re investing in a taxable account further muddy the waters.

More Realistic DCA

As a further warmup below describing the full VA strategy, Edleson describes a more realistic version of DCA.  Over a short period of time, fixed monthly contributions to savings makes sense.  But over decades we expect inflation to allow us to increase contributions to savings.  So, unlike simple DCA, we assume that monthly contributions to savings grow over time.  Edleson gives formulas for calculating your portfolio level each month given your initial contributions, the contributions growth rate, expected market returns, and how long you invest.

Of course, markets won’t behave perfectly, and your portfolio won’t grow exactly according to plan.  To use this DCA plan, you’d have to periodically adjust your savings amount based on what the markets do.

Full VA

With VA, you use the annual portfolio level each month from DCA as a “value path.”  The idea with VA is that you adjust your contributions to savings each month to stay on this value path.  If markets disappoint, you have to increase your contributions.  If markets outperform your expectations, you contribute less or possibly sell some of your investments.

As in the simpler version of VA, “Always maintain a side fund” for holding excess contributions that the strategy dictates shouldn’t be invested yet, saving them for a future time when the strategy calls for large contributions.

Edleson performs a number of experiments using simulated market returns and other experiments with actual historical market returns.  Across each type of scenario, the average advantage of VA over DCA is always less than 1.4%.  However, this is always the result of measuring VA returns improperly by ignoring the side fund.  The drag on returns from holding cash and possibly borrowing makes it doubtful that VA actually beats DCA.


The most serious criticism of value averaging is that because returns aren’t measured correctly, there is no evidence that the method works better than simpler investment strategies.  This flaw alone is likely fatal to all variants of VA proposed in this book.

Here are other articles I’ve written about value averaging:

Value Averaging Doesn’t Work

Value Averaging Nonsense
Value Averaging Experiments

2020-11-18 A Technical Addition:

The VA recommended value path is based on DCA with a starting contribution of C and a monthly growth rate g (C, C(1+g), C(1+g)^2, ...).  Assuming monthly return r, the book gives the value path formula for the future value after t months:

V(t) = C((1+r)^t - (1+g)^t)/(r-g).

Actually, this formula only works when r is not equal to g.

When r=g, V(t) = Ct(1+g)^(t-1).

The formula for V(t) involves 5 different quantities: C, g, r, t, and V(t).  The book devotes many pages to methods of calculating one of these 5 values when given the other 4.  It also gives elaborate spreadsheets for this task.  There are much simpler approaches using common spreadsheet functions.

If either V(t) or C is the only unknown, the calculation is straightforward.  To find g or r:

g = (1+RATE(t, -C, 0, V(t)/((1+r)^(t-1))))*(1+r)-1.
r = (1+RATE(t, -C, 0, V(t)/((1+g)^(t-1))))*(1+g)-1.

Finding t given the other 4 values is trickier, but can be done using Newton's method.  Start by calculating an estimate for t (call it t_0) that ignores g:

t_0 = NPER(r, -C, 0, V(t)).

Then calculate estimates for V(t) and its derivative based on the estimate t_0:

V_0 = C*IF(ABS(r-g)>0.000001, ((1+r)^t_0-(1+g)^t_0)/(r-g),
           t_0*(1+(r+g)/2)^(t_0 - 1)).
D_0 = C*IF(ABS(r-g)>0.000001, (LN(1+r)*(1+r)^t_0 - LN(1+g)*(1+g)^t_0)/(r-g),
           (1+t_0*LN(1+(r+g)/2))*(1+(r+g)/2)^(t_0 - 1)).

Then complete the Newton iteration to get t_1, a better estimate of t:

t_1 = t_0 - (V_0 - V(t))/D_0.

The repeat these 3 formulas using t_1 to get a new estimate t_2.  Repeat to get t_3, t_4, and t_5.  I have found that just 5 iterations are enough so that t_5 is an accurate estimate of t to several decimal places.

Thursday, November 12, 2020

Bond Quiz

After my recent post arguing that Owning Today’s Long-Term Bonds is Crazy, I got a lot of thoughtful reaction, but I also found that many people are confused about how bonds work.  So, I’ve put together a short quiz to test your bond savvy.

For each of these questions, we assume that you have just invested $10,000 in a 30-year government bond paying 1.2% interest.

1. What payments will you get from this bond if you hold it for the full 30 years?

a) It depends on how the consumer price index changes over the years.
b) You get $120 each year for 30 years, and at the end you get your $10,000 back.
c) It depends on how interest rates change over the 30 years.

2. If interest rates rise, what will happen to your annual interest payments?

a) They will go up.
b) They will stay the same.
c) They will go down.

3. If interest rates fall, what will happen to the resale value of your bond?

a) It will go up.
b) It will stay the same.
c) It will go down.

4. Suppose interest rates rise over the next decade.  In 10 years you sell your bond and use the proceeds to buy a new 20-year bond paying 3% interest.  What will your 30-year compound average return over the 30 years be if you hold the new bond to maturity?

a) below 1.2%
b) about 1.2%
c) above 1.2%

Answers below












1. b) Bond payments are fixed.  There are special bonds that adjust to inflation, but this isn’t true of regular bonds.  If interest rates change, your payments stay the same.  Some investors seem to think that owning a bond is similar to a savings account whose interest payments rise and fall over the years.  This isn’t true for bonds.

2. b) Bond interest payments stay the same no matter how interest rates change.  The interest rate paid by new bonds will be higher, but old bonds don’t change.

3. a) When interest rates fall, your bond keeps paying the same interest payments.  These payments will be higher than the interest payment on new bonds.  So, investors will be willing to pay extra to buy your bond.

4. b) At any given moment, all government bonds with the same duration (number years left) are priced to be equally desirable.  The ones with high interest payments will trade for more than ones with low interest payments.  So, when you sell your bond that pays only 1.2%, you’ll get less than $10,000 for it.  The amount less will compensate for it not paying the current going rate of 3%.  So, you’re not gaining or losing much trading your bond for another bond of the same duration.  You’ll get more interest for the next 20 years, but you’ll get less back at the end.  The 1.2% interest rate you accepted initially stays with you, even if you trade for a higher interest rate bond.

It’s easy to lose sight of these bond lessons when you own a government bond ETF, but they still apply.  When you buy the ETF, you’re locking in your nominal return for the duration of each bond in the fund.  Trading between bonds of the same remaining duration can’t change this.  Trading to bonds with different remaining durations can only make a limited difference.  Prevailing interest rates when you buy into long-term bonds are hard to escape for decades.

Friday, November 6, 2020

Short Takes: Simplifying Investing, Owning Bonds, and more

My printer saga from two weeks ago ended with me replacing my HP thing (is it a printer if it doesn’t print?) with a Brother laser printer that a family member no longer needs.  The only amusing part of the installation is that the default printer driver caused black and white to be reversed so that every printed page was almost solid black.  It’s all fixed now after some wrestling with printer drivers, but the test pages drained all the toner.  I guess that works well for whoever sells toner.

Here are my posts for the past two weeks:

The Elements of Investing

Owning Today’s Long-Term Bonds is Crazy

How to Really Ruin Your Financial Life and Portfolio

Your Money’s Worth

Here are some short takes and some weekend reading:

Robb Engen at Boomer and Echo describes how he invests his own money using VEQT.  The big advantage of his approach is its simplicity.  It makes sense to spend some time figuring out how you’ll run your portfolio.  But for most of us, once we have a strategy, we’d like to spend as little time as possible maintaining it.  Robb definitely achieves this goal.  It’s tempting for me to simplify my portfolio using VEQT, but the amount I save using U.S.-listed ETFs and making careful asset location choices saves me an amount each month equal to a little less than 4% of my current retirement cash flow from my portfolio.  The modest amount of extra work is worth it to me to keep this money.  As I spend down my portfolio in retirement and the savings decrease, I may revisit this decision.

Jonathan Clements looks at the different possible reasons for owning bonds and ends up at the same conclusion I came to for retirees.

The Rational Reminder Podcast has an interesting interview with Moshe Milevsky.  On the 4% rule, Milevsky gave a very easy to understand explanation of why it makes no sense to be inflexible in your planned annual retirement spending.  It occurred to me, though, that this criticism doesn’t necessarily carry over to William Bengen’s work that led to the so-called 4% rule.  Even if you plan to be flexible in your retirement spending in case your investment returns don’t match expectations, it makes sense to do some backtests to check the likelihood that you’ll have to make painful spending cuts.  So, you may choose to see how an inflexible plan might work out, even if you plan to be flexible.

Doug Hoyes explains what joint debt means in this short video.  Hint: if you cosign for someone else, you’re not “secondary” and your liability isn’t limited to 50% of the loan.  If payments aren’t made, the lender will come after you if you seem to be a better bet to get the money back.

Morgan Housel
asks himself a few tough questions.  These interesting questions could be about investing or just about anything else.

Rate Spy takes a swipe at the big 6 banks for trying to trick people into renewing mortgages at rates 3 percentage points higher than they can get elsewhere.  They have an actual renewal letter and lots to say about it.

Canadian Couch Potato gives us some ETF pairs for tax-loss selling.  This allows ETF investors who have investments in taxable accounts to defer capital gains taxes.  In my case, it’s been a while since I added new money to my taxable accounts because I’m retired.  My ETFs have built up some capital gains so that even when the markets dip, the ETFs don’t go into a loss position.  So, I can’t do any tax-loss selling.

Tom Bradley at Steadyhand
explains why you shouldn’t believe everything you see on TV when it comes to investing.

The Blunt Bean Counter says that there may be a silver lining to the COVID-19 cloud for small businesses: a better price for an estate freeze.

Thursday, November 5, 2020

Your Money’s Worth

The landscape for financial advice in Canada is confusing at best.  There are many designations that range from essentially mutual fund salespeople to highly-skilled fiduciaries.  Author Shamez Kassam aims to explain it all in his book Your Money’s Worth: The Essential Guide to Financial Advice for Canadians.  This book has a lot of useful information about financial advice (mostly for wealthy people), but understates problems in the industry, and contains repeated pitches for readers to use a financial advisor.

The main topic areas covered are the various types of advisors, investment products and principles, insurance and estate planning, and a set of forms designed to help evaluate and choose a financial advisor.  The emphasis in this book on advising the wealthy starts early in the introduction: Advisors “offer big-picture concepts and solutions, and then coordinate with your accounting and legal professionals.”  There is some information relevant to people of modest means, but the book is primarily aimed at the kinds of clients advisors prefer: rich ones.

In discussing specific parts of the book, let’s start with some good parts.  In a discussion of bond ratings agencies: “Keep in mind that ratings agencies are paid by bond issuers.  If you’re thinking this creates the potential for conflict of interest, you are correct.”  Kassam goes on to explain how this conflict can lead to some bonds getting unreasonably high ratings.

On fee disclosure: “additional transparency requirements were implemented by regulators so that investors can see the amounts paid to dealers.  However, the actual fees charged by the mutual fund companies to manage the investments are still not fully transparent.  The move to enhance transparency by regulators is a welcome step in the right direction, but it’s only a half measure.”

Mutual funds that charge high fees for active management but are really index funds are called closet index funds.  “In the industry today, very substantial sums of money remain invested in active management strategies that are really closet-index type investments.”

On fund fees, “Expense ratios are the most powerful predictor of fund performance.”  While investors chase funds with high recent returns, they’d be better off choosing funds with low fees.

There were several parts of the book where problems with the financial advice industry were understated.  On fee disclosure, Kassan claims that the industry “has taken bold steps to enhance disclosure” with changes that were known as CRM2.  An alarming proportion of investors still think they don’t pay their advisors.  Disclosure of costs remains poor.

On embedding costs in investment products, “there is nothing inherently wrong with the embedded-fee structure, as long as proper disclosure is provided and costs are clearly understood.”  The problems are that embedded costs exist to hide costs from investors, and it’s a rare investor who clearly understands the costs he or she pays.

On segregated funds offered by insurance companies with principal guarantees and life insurance features: “The additional features result in fees that are typically higher than mutual fund fees.  Segregated funds definitely have a place in some clients’ portfolios, but I have seen instances where clients invested in segregated funds but didn’t need the additional features the funds offer, meaning the clients paid higher fees than they really needed to.”  Very few investors in seg funds need these high-cost features.  Costs are often more than 3% per year.  Over 25 years, this consumes a stunning 53% of the investor’s savings.

On fee arrangements where investors pay an explicit fee to an advisor and also pay fund costs: “if an advisor is charging an annual fee of 2% and then using mutual funds for the entire portfolio, it may be a problem.”  This describes an arrangement with outrageously high fees.  It warrants more concern than that it may be a problem.

On the impact of fees, Kassam begins with an extended commercial for the value advisors bring and complains about “articles in the media criticizing the financial industry for supposedly charging unjustifiably high fees.”  Then he gives an example of an investor making 7% (before costs) over 10 years on a $100,000 investment.  With fees of 2.5%, 1%, and 0.25%, the final portfolio values are $155,297, $179,085, and $192,167, respectively.  It’s good to focus on fees, but 10 years isn’t long enough to truly see the corrosive effect of fees.  Extending this to 25 years, the final portfolio values are $300,543, $429,187, and $511,914, respectively.

A problem mutual funds have had is that advisors want to get paid up front for selling the funds, but investors don’t like losing 5% of their money off the top.  The brilliant solution was to try to hide the up-front payment with back-end loads.  This means that if the investor sells within 7 years, he or she has to pay a fee.  Combine this with a high yearly fee, and mutual funds are sure to get the initial payment to the advisor back from the investor either over time or with the back-end load.  Kassam claims that “back-end loads can work for certain investors.”  They work best for advisors and mutual fund companies.

“Novice investors who try leveraged ETFs are often disappointed with the results.”  With inverse ETFs, “some investors may be disappointed with the results.”  The truth is that few investors understand the volatility drag of such ETFs, and they should steer clear.

There were other parts of the book I didn’t like for reasons other than understating problems in the financial advice industry.  Kassam mentions the oft-quoted Vanguard study that “concluded that the overall value of advice can be up to approximately 3% of investment assets annually.”  However, this is only for excellent advisors when matched with clients with little knowledge.  Most advisors are far from excellent.

In a section on the styles of stock investing, only active approaches were mentioned: fundamental investing and technical analysis.  The best option for most investors, index investing, wasn’t mentioned in this section.

“When markets are dropping significantly, (a ‘bear’ market), active managers can protect the downside and outperform by having more cash in a portfolio or by being in more defensive sectors of the market.”  All the research I’ve seen shows that mutual fund managers don’t achieve this.  They actually hold more cash after markets have gone down.

Kassam mentions DALBAR studies supposedly showing that investors hurt their returns through bad market timing.  However DALBAR’s methodology makes no sense.  If they are measuring your portfolio returns over the past decade, and you received an inheritance a year ago, they conclude that you used poor market timing when you failed to invest that money at the start of the 10 years.

On picking stocks, “Your returns will be directly correlated to the time you are able to put toward selecting investments and your ability to control your emotions.”  All the evidence says this isn’t true about the time you put into stock selection.  Average investors are so much less capable of picking stocks compared to professionals that their picks will be essentially random no matter how much time they devote to the task.  Typically, these investors will make less than an index due to trading costs and poor diversification.

In a discussion of annuities, Kassam classifies inflation indexation as one of the “bells and whistles” you can add to an annuity contract.  A big problem with annuities is that people often don’t understand how corrosive inflation can be over multiple decades.  They buy an annuity with an acceptable monthly payout, say $2000, and long after it’s too late to do anything about it, inflation has cut the buying power of these payments in half.  Inflation indexation is important.

While this book has some good information for investors wishing to understand the financial advice industry, there are too many questionable parts to recommend it to readers.

Monday, November 2, 2020

How to Really Ruin Your Financial Life and Portfolio

Ben Stein is an economist, movie and television personality, and prolific writer on financial matters.  I recently read his book How to Really Ruin Your Financial Life and Portfolio.  Stein has written extensively about the smart ways for most people to invest, just to watch so many of these people lose their way and lose money.  This book pretends to advise people to make these common mistakes, but is really intended to inoculate investors against these mistakes.

The book covers a wide range of bad investment ideas including trading frequently, forex trading, stock-picking, market-timing, going with your gut, hedge funds, commodities, margin, short-selling, believing financial media “experts,” and many more.  After explaining why these ideas don’t work for other people, he assures the readers that they’re special and will succeed anyway.

In discussing the excitement of commodities trading, Stein’s understatement about some personal experience made me laugh: “Your humble servant has gotten a margin call.  It can change your day a lot.”

This short book is well-written making it an easy read that helped me solidify my decisions to avoid the mistakes Stein discusses.  I suspect it would be even more valuable for those with less investment knowledge who don’t know the many pitfalls of seeking exciting ways to invest.