Friday, December 3, 2021

Short Takes: Safe Retirement Income, Buying Less Stuff, and more

BMO has expanded its marketing to me.  It used to just alternate between low-interest credit card balance transfer offers and offers to give me a few thousand dollars if I deposit a few million dollars in my account.  They seemed to figure out that I’m between those two extremes.  Now they want me to come in for a personalized financial plan because “Research shows that advised households accumulate 2.31 times more assets after 15 years!”  Of course, this research is deeply flawed.  Further, I’m not interested in their ridiculously overpriced mutual funds.

I wrote one post in the past two weeks:

A Conversation about Wealth Inequality

Here are some short takes and some weekend reading:


Morningstar Research
says the 4% rule is now more like a 3.3% rule, but that we can spend more safely if we’re flexible about adapting to market returns.  One part of the report that I disagree with is too much reliance on spending less as you age.  It’s true that you’ll probably naturally want to spend less when you’re 85 than when you’re 65.  However, it doesn’t make sense to plan for reduced real spending at too young an age.

Andrew Hallam makes a strong case for becoming happier by buying less stuff.

Justin Bender explains some key concepts about asset location strategies in both text and video.

Doug Hoyes
explains how debt settlement firms exploit people who need to file a consumer proposal.

Tuesday, November 30, 2021

A Conversation about Wealth Inequality

Please welcome a person I’ll call John Doe.  The following “interview” is loosely based on a real conversation with an acquaintance.

Michael James:  Hello, John.  Thanks for agreeing to discuss your ideas on wealth inequality.

John Doe:  I’m glad to be here.

MJ:  Let’s get right to it.  How can we solve the wealth inequality problem?

JD:  Nobody should be allowed to have more than a million dollars.

MJ:  Interesting.  Some people already have more than a million dollars.  What should we do about this?

JD:  Take it away.

MJ:  So, somebody should take away the excess above a million dollars.  Who should do that?

JD:  The government.

MJ:  I have some questions about how this would play out.  Let’s look at a specific case.  You work for the federal government, and your pension is currently worth about $1.2 million.  You also have about $400,000 of equity in your house.  It would be easy for the government to seize your bank accounts and your car, but how should they go about getting your excess $600,000?

JD:  What?

MJ:  You're a millionaire.  How should the government go about taking away the excess wealth you have in your pension and house?

JD:  They can’t touch my pension or house.

MJ:  Would that be an exception just for you?

JD:  No.  The government can’t touch anyone’s pension or house.

MJ:  Okay, so we’re refining the rule to ‘nobody should be allowed to have a million dollars, excluding pensions and real estate.’  Is that right?

JD:  Yes.

MJ:  What will we do about the housing supply problems when all the millionaires start buying more houses so the government won’t seize their assets?

JD:  Huh?

MJ:  If I had millions the government was about to seize, I’d buy a bunch of houses or maybe a big patch of land.  Then I could sell off a house or a strip of land once in a while to live rich.  Many wealthy people would have this idea.  Then people who aren't rich wouldn’t be able to find somewhere to live.  What will we do about this problem?

JD:  They can’t do that.

MJ:  What would stop them?

JD:  They can only have one house that’s not too big.

MJ:  Okay.  The next challenge would be rich people buying huge annuities or pensions to shelter their wealth.  I suppose this wouldn’t cause a new problem, but it’s an obvious workaround for the rule about limiting wealth.

JD:  They can’t do that.

MJ:  What will stop them?  Never mind.  Maybe it’s time to add some detail to your rule.  I’ll try to keep it consistent with your intent.  ‘The government should come up with a complex set of avoidance rules to limit people to a reasonable amount of real estate, a reasonable size of pension, and at most a million dollars in other assets.’  Does that sound right?

JD:  Yes.

MJ:  Most people who run medium and large businesses already have far more money than your proposed limits.  So, they have no incentive to keep working.  Having cable companies and banks shutting down would be inconvenient, but the most immediate problem would be the complete breakdown of the supply chain bringing food into cities.  What would you do about this problem?

JD:  That wouldn’t happen.

MJ:  If I already had more money than is allowed, there’s no way I’d keep working only to have my pay seized by the government.  Most rich people would simply stop working or leave Canada.  Having so many rich people who currently work in key positions suddenly quit would create chaos.  Food riots would be only weeks away.  What would you do about this?

JD:  They can’t quit.

MJ:  So everyone would be compelled to keep working?

JD:  Yes.

MJ:  That sounds like a huge political shift for Canada.  We’d be abandoning the Charter of Rights and Freedoms and moving to a communist-style state where the government tells people what jobs they have to do.  That’s a bold proposal.

JD:  I don’t want any of that.  I just don’t like seeing rich people who have more than I have.

MJ:  Everything has side effects.  We can probably find a way to reduce wealth inequality somewhat without devastating side effects, but you don’t seem to have it figured out yet.

JD:  Leave me alone.

MJ:  Thanks for coming by.

Friday, November 19, 2021

Short Takes: Commission-Free Trading, Asset Location, and more

It’s amazing how little that gets written about investing remains relevant once you’ve decided not to try to beat the market.  Even a great writer such as Morgan Housel has beating the market as the underlying motivation for much of his writing.  Once you choose indexing as an investment strategy, there’s little to do or say on a day-to-day basis other than enjoy other aspects of your life.

Here are my posts for the past two weeks:


Reboot Your Portfolio

Invest As I Say, Not As I Do

The Procrastinator’s Guide to Retirement


Here are some short takes and some weekend reading:

Preet Banerjee explains the good and bad parts of commission-free trading.  I definitely learned a few interesting things about how brokerages make their money.

Justin Bender explains key concepts about asset location decisions, including the main one that it is your after-tax asset allocation that determines your portfolio’s returns and not your before tax asset allocation.  This means that Justin’s asset location strategy that he’s named “Ludicrous” is actually a means of tricking yourself into having higher exposure to stocks than you think you have, as I explained in my article Asset Allocation: Should You Account for Taxes?  DIY investors are best off either using the same asset allocation in every account or, in rare cases, going all the way to Justin’s “Plaid” portfolio.

Jason Heath answers a question about whether it makes sense to withdraw $50,000 from an RRSP to make a lump sum mortgage payment to reduce future mortgage payments and improve future cash flow.  I found it interesting that the questioner didn’t even consider making a small RRSP withdrawal to cover one mortgage payment to free up a couple thousand dollars of cash flow and relieve the pressure.  This isn’t necessarily the best solution, but draining $50,000 from the RRSP is much more extreme.  Perhaps the questioner knows that having a couple thousand dollars available would make some frivolous spending irresistible.

Boomer and Echo explains how to make RRSP contributions and get tax reductions during the year instead of waiting until filing your taxes to get a big refund.

Thursday, November 18, 2021

The Procrastinator’s Guide to Retirement

David Trahair’s recent book The Procrastinator’s Guide to Retirement has a great title.  With so many Canadians fearful that they’re way behind on retirement readiness, this book seems like it could rescue them.  Unfortunately, the actual contents leave a lot to be desired.

The main idea is that if you save a lot of money every year during your last decade of work, you can build an acceptable retirement.  There are detailed examples overflowing with numbers where people whose big mortgage and child expenses fall away in time for a decade-long sprint to retirement.  However, if you can’t suddenly save a lot of money every year, this book offers no magic for building wealth.

Questionable Analyses and Advice

A chapter on whether to contribute to an RRSP or pay down your mortgage begins with a question whose answer “is obvious”: “Should I contribute to my RRSP or pay down my credit card, which is charging me 20 percent interest per year?”  Trahair proceeds to explain in detail that you’d have to earn a 28.6% return on your RRSP investment to do as well as paying down your credit card debt (assuming a 30% marginal tax rate).  However, he failed to take into account the tax deduction: you really need to earn ‘just’ a 20% return to do as well as paying off the credit card.  The curious thing is that he properly takes into account the RRSP tax deduction in an example on the next page.

“Contrary to what many people think, some professional money managers do consistently beat the market.”  “Simple strategies like ‘buy and hold’ may not work well.”  Steering readers to chase star mutual fund managers and market timing is terrible advice.

“Many people focus too much on fees.  Fees are a necessary part of the equation, but they can only be judged when compared to the value received.”  “That value should be measured in a performance report that shows rate of return (net of fees) compared to the relevant benchmark index.”  This just steers readers to the failed strategy of piling into last year’s best-performing mutual fund.

In a discussion of when to start CPP, Trahair says you need to ask yourself 4 questions.

1. “Do you need the money early?”  Without context, this is hard to answer properly.  It often makes sense to spend from your RRSP for a while and delay CPP, but a reader who thinks RRSPs should be preserved until age 71 might give the wrong answer for his or her case.

2. “If you don’t really need the money, are you in a low tax bracket?”  The idea is to take CPP early to boost a low taxable income, but once again, it may be better to boost income by drawing from RRSPs.

3. “Can you shelter your CPP pension from tax?”  The idea is that if you have RRSP room available, you can use your CPP to build RRSP savings.  This is often the opposite of what people should do, depending on other factors.

4. “Do you think your RRSP will grow at a higher rate than the penalty to elect early [7.2% per year] or the bonus to wait [8.4% per year]?”  Because CPP is indexed, these returns are above inflation.  Asking readers if they can beat these rates is mostly an overconfidence test.  To Trahair’s credit, he points out that “Those rates will be extremely difficult to beat after investment fees on a consistent basis.”

In an homage to one of his earlier books (that is no better than this one) Enough Bull: How to Retire Well Without the Stock Market, Mutual Funds, or Even an Investment Advisor (my review here), Trahair suggests “Maybe Simple GICs Are All Your Need.”

“In Canada, males who reach the age of sixty-five are likely to live to age eighty-four (nineteen more years), and females who reach sixty-five can generally expect to live to age eighty-seven (twenty-two more years).”  “You should assume that you need to budget for approximately twenty years of retirement after age sixty-five.”  How does that make any sense?  That leaves about half of all people completely out of savings while they’re still kicking.  I guess the other half won’t need to eat cat food.

Another section promotes the idea of leasing a car in retirement to improve cash flow.  Auto dealerships love this idea.

Some Good Points


This book has some good points.  One that stood out for me concerned mutual fund dealers.

“I once had a client who had just emerged from bankruptcy, and her advisor was strongly pushing her to take out a loan to make an RRSP contribution.  She couldn’t control her spending but was being advised to immediately load up on more debt!  It didn’t make sense, but this kind of sales advice is often the result when there is financial incentive to sell, sell, sell.”

“Which fund do you think your advisor would rather sell you: Fund A, which pays him and his firm a trailer fee of 0.75 percent a year, or Fund B, which pays them 0.15 percent a year?  Of course, it is Fund A.  Which fund is better for you?  Fund B.  It’s a total conflict of interest.”

Conclusion


This book has a great title to draw in readers, but I can’t recommend its contents.

Wednesday, November 10, 2021

Invest As I Say, Not As I Do

When I answer investing questions for friends and family, I tend to steer them to simple solutions that are consistent with their level of interest in investing.  However, I run my own portfolio differently in certain ways.  In reading Dan Bortolotti’s excellent book Reboot Your Portfolio, I noticed that the advice I give usually matches his advice, and it’s my own portfolio choices that sometimes differ from what’s in the book.  Here I see if the differences between my portfolio and Bortolotti’s advice hold up to scrutiny.

Before I go any further, I want to be clear that this isn’t a case of me having a “smarter” portfolio where I’m actively trading to beat the market.  I steer people to low-cost passive investing and that’s what I use myself.  The main difference between me and other do-it-yourself (DIY) investors is the degree to which I’ve built most of the complexity of my portfolio into an elaborate spreadsheet that alerts me by email when I need to take some action.  I’m happy to automate complexity in this way and let the spreadsheet tell me what to do.  I can safely ignore my portfolio for months without worry.

Pay Yourself First

Bortolotti says “‘Pay yourself first’ has become a cliché because it works.”  “Sure, you could wait until the end of the month and then save whatever is left after paying all your expenses.”  “People following this approach rarely wind up with any surplus cash.”  “Make your savings a fixed expense, too, and you’ll be well on your way to meeting your investment goals.  It’s impossible to overstate how important this is.”

This is excellent advice.  I recommend it to my sons.  My wife and I never followed it ourselves.  From a young age we were used to only spending money on necessities.  It’s taken us decades to get used to spending money more freely.  During our working years, our savings rate bounced around, but it was rarely below 20%, and reached 80% for a while when the family income rose and the kids cost us less.  This wasn’t a case of us scrimping or having a savings target.  That’s just what was left after we bought what we needed and wanted.

Expected Future Returns

Vanguard research showed “that most of the techniques people employ to forecast future stock returns are utterly worthless.”  “So don’t get clever when you’re trying to estimate stock returns in your own financial plan.  That average over the very long term—about 5% above inflation—is a reasonable enough assumption.”

As a retiree, I find it wise to back off from the long term average of 5% and use 4%; I’d rather spend a little less starting now than be forced to spend a lot less in the future if stocks disappoint.

Bortolotti is right that P/E ratios have little predictive value.  I made this point myself recently.  However, long-term data show a consistent weak correlation between P/E levels and future stock returns.  This effect is almost unmeasurable over a year, and is very weak over a decade.  However, it builds over multiple decades.  I model this effect by assuming that P/E levels will decline to a more normal level by the time I turn 100, and corporate earnings will grow at an average rate of 4% annually above inflation over that time.  At the time of writing, this amounts to assuming stocks will return 2.6% above inflation over the rest of my investing life.  The missing 1.4 percentage points comes from the assumed drop in P/E levels over the decades.

The difference between my assumption of 2.6% and Bortolotti’s 5% is substantial.  It’s probably not important to those still a decade or more away from retirement; they have time to try to save more, work longer, or plan a more modest retirement.  Current retirees are another matter.  If they assume their stock allocation will beat inflation by 5%, high spending in early retirement could leave them with meagre later years.

Factor Investing


Investment research over the decades has shown that stocks with certain properties have outperformed.  These properties are called “factors,” and this whole area is sometimes referred to as “smart beta.”  Some well known factors are value (“stocks with low prices relative to their fundamentals”), small cap (small companies whose market capitalization is below some threshold), and momentum (“when stocks rise in price, they continue that trend for months before eventually settling back to earth”).

Although the research behind factor investing is solid, there is no guarantee that factors will outperform in the future.  There is good reason to believe that once people routinely invest in factors, the outperformance will decline or disappear.  Bortolotti makes a number of other good arguments for avoiding smart beta.  For myself, I decided years ago that the most solid factor was the set of stocks with both the small factor and the value factor.  Vanguard has a low-cost ETF for small value U.S. stocks with the ticker VBR.  So, for better or worse, I chose to make VBR part of my asset allocation.  Of all my deviations from Bortolotti’s advice, I find this one the hardest to defend.

Glidepath


The term “glidepath” refers to the path of your stock allocation percentage over time.  Bortolotti writes “there are occasions when it is appropriate to reconsider your asset allocation.  Your time horizon gets a little shorter every year, so you will want to reassess your portfolio’s risk level as you get older.”

I agree, but rather than reevaluating my portfolio’s risk level periodically, I’ve chosen a glidepath in advance.  My allocation to stocks drops slowly over time.  The process has some complexity, but that’s all buried in my spreadsheet.  If my slowly declining stock allocation happens to trigger the need to rebalance, I’ll get an email telling me what to do.

I’ve also decided to increase my fixed income allocation (cash, GICS, and short-term bonds) in proportion to the stock market’s P/E when this level is over a fixed threshold.  This is built into my spreadsheet so that if rising stock markets trigger the need for me to rebalance, I get an alert email.  Without this adjustment, my fixed income allocation would be about 20%, but the adjustment moves it up to 24% at the time of this writing.  This may not seem like much of an adjustment, but it’s large in dollar terms.  For the stock market P/E to get up to its current lofty level, stock prices had to rise substantially.  So, 24% of a larger portfolio is a lot more dollars than 20% of a smaller portfolio.  

In a technical sense, this part of my investing spreadsheet amounts to market timing.  However, the shifts are subtle, they take place over long periods, and they are fully automated.  I see this as very different from a nervous investor who suddenly decides to sell all his stocks.  I tend to think of this added money in fixed income investments when stocks are expensive as my answer to the question “Why keep playing the investment risk game when you’ve already won?”

U.S.-listed ETFs and Asset Location

“US-listed ETFs offer some advantages over those from Canadian providers.”  “The most obvious is lower fees.”  They are also “more tax-efficient in RRSPs [and RRIFs].”  “US securities held in RRSPs are exempt from [dividend] withholding taxes, thanks to a tax treaty between [the U.S. and Canada].”  This treaty doesn’t apply for Canadian-listed ETFs, even when they hold the same assets as U.S.-listed ETFs.

One downside of using U.S.-listed ETFs in your RRSPs is the need to trade in U.S. dollars.  This creates the need for either expensive currency exchanges or cheaper but complex Norbert’s Gambit currency exchanges.  Another downside is the complexity of trying to maintain near optimal asset location choices across your entire portfolio.  My spreadsheet figures this out for me, but I’d be frustrated if I had to figure it out every time I needed to trade.  Most DIY investors would struggle as well.

“I recommend that do-it-yourself investors stick to using ETFs that trade on the Toronto Stock Exchange.”  I make the same recommendation.  Bortolotti allows that “If you have large foreign equity holdings in your RRSP, and you’re an experienced investor who is comfortable with the added complexity, then you can make a good argument for US-listed funds, but only if you have US cash to invest or you’re able to convert your currency cheaply.”

I’ve recommended to my sons that they stick to Canadian-listed ETFs, but I use U.S.-listed ETFs in my own RRSPs.  The monthly savings my wife and I get from U.S.-listed ETFs and careful asset location choices is roughly equal to half of what we pay in income taxes each year since we retired.  To save this much, I’m happy to let my spreadsheet do the work.  I’d probably just use a single asset allocation ETF in all my accounts if I didn’t have the spreadsheet.

Conclusion

I’ve taken my shot at defending the ways my portfolio deviates from the advice I give others and the advice Bortolotti gives in his book.  However, I still consider myself to be strongly in the low-cost index investing camp.  In my view, those who pick some stocks on the side or time the market based on hunches are going further afield.

Tuesday, November 9, 2021

Reboot Your Portfolio

Dan Bortolotti is well known as the creator of the authoritative Canadian Couch Potato blog and podcast.  His latest book Reboot Your Portfolio: 9 Steps to Successful Investing with ETFs is my pick for best investing book for Canadians.  The writing is clear, the advice is practical, and it anticipates the challenges readers will have in following through on his 9 steps.  Whether you work with a financial advisor or manage your own investments, reading this book will make you a better investor.

Stop Trying to Beat the Market

One of the many strengths of this book is that Bortolotti explains why his advice makes sense without being dogmatic.  While explaining the advantages of investing in index exchange traded funds (ETFs), he allows that “Some skilled (or lucky) investors have been able to” “outperform the overall market,” but “research reveals that the probability of beating the market over the long term is distressingly low.”

“The first step in becoming a successful investor is to let go of” the idea “that investing is about trying to beat the market.”  Most people think they need to pick great stocks or find an advisor or star fund manager who can pick great stocks.  Ironically, it is this pursuit of outperformance that causes people’s portfolios to underperform.  Over the long term, markets provide excellent returns, and those who choose to capture these returns with minimal fees will do well.

Stock pickers may brag about their successes, but that doesn’t necessarily mean they outperform markets.  “Individual investors almost never calculate their returns accurately,” and they rarely talk about their failures.  Even well-known successful stock pickers like Benjamin Graham and Warren Buffett think most investors shouldn’t pick individual stocks.

Not So Fast

After you’re convinced that you’re better off not trying to beat the market, you might leap to “What ETF should I buy?”  But Bortolotti says that puts “the cart before the horse.”  First you need to set your financial goals and choose an asset allocation.

Even before worrying about financial goals, there may be debts to deal with.  “In most cases, you shouldn’t even think about investing until you’ve paid off any non-mortgage debt.”  Presumably this includes car loans, which makes sense to me, but others may disagree.  I’d go a little further: if your mortgage is larger than about two-thirds of the maximum a bank would lend you, it makes sense to at least split your savings between investing and making extra payments against your mortgage.  Just in case your life and investments don’t always have a smooth ride, avoiding ruin is more important than trying to squeeze out the last dollar of upside.

Asset Allocation

An important lesson about what it means to have an asset allocation is one “that many people never fully grasp.”  When you have new money to add to your portfolio, rather than ask yourself “is now a good time to buy stocks” (rather than bonds), you should just invest the money according to your long-term asset allocation.

While explaining the benefits of diversification, the author mentions Modern Portfolio Theory (MPT), but doesn’t go very deeply into it.  This is a good thing because that’s about all that makes sense in MPT.  Discussions of mean-variance optimization can sound impressive, but it often produces highly-leveraged portfolios.  All people should remember from MPT is that diversification is a good thing.

“It’s fine to change your asset allocation if you realize you overestimated your risk tolerance.”  Unfortunately, people tend to do this after stocks take a beating.  It’s not too bad to lower your stock allocation once, but if you raise your stock allocation again later when stocks seem safer, you’re just in a damaging buy high and sell low cycle.  It’s when stocks are high that it makes sense to think about how you’d feel if they dropped 40%.  This is a much better time to permanently reduce your stock allocation.

Bortolotti says you don’t need any asset classes other than stocks and high-quality bonds.  He recommends excluding real estate, preferred shares, junk bonds, gold, and other commodities.  He also argues against real return bonds because of their extremely long maturities.  “You don’t need that kind of volatility on the bond side of your portfolio, which is supposed to be the stabilizer.”  I think this argument carries over to any long-term bonds.  I prefer to stick with maturities of 5 years or less.

Taking Action

It’s only once you’ve examined your financial goals and chosen an asset allocation that it’s time to choose some ETFs and open some accounts.  At this point Bortolotti pauses to ask the reader whether do-it-yourself (DIY) investing is the right choice and “to consider the other options: hiring a human advisor or working with a robo-advisor.”  “Few people have the skill set or the desire to manage an ETF portfolio on their own.”

Although Bortolotti discloses that “I make my living as a portfolio manager and financial planner,” he paints a grim picture of your chances of finding a good full-service advisor.  Unless you have about half a million or more, “your choices may be limited to old-school salespeople who are paid by commissions,” which “creates an obvious conflict of interest.”  Even larger accounts are needed to get a break on fees.  “Although many advisors now include ETFs in their client portfolios, the vast majority use them in active ways, making tactical moves or choosing narrowly focused ETFs, which are very different from the ones I’ve recommended here.”

The author is much more upbeat about robo-advisors for those who don’t want to go the DIY route.  He provides practical advice about what you can expect from robo-advisors, even for people with small portfolios.  He continues with practical advice for DIY investors on choosing a discount broker, opening accounts, using limit orders, ETF liquidity, not trading ETFs when U.S. markets are closed, the anxiety you’ll feel making your first trades, and being wary of your brokerage trying to train you to become an active trader.

Leaving your advisor


Another good section is on “Cutting ties with your advisor.”  “Breaking loose from your advisor can be awkward if he or she is a friend or family member,” and “most people don’t relish the thought of firing someone.”  “When you break the news, don’t make it personal.  Just explain that you’ve done the research and concluded that active management is not worth the fees.”  “You should expect some pushback.”

If your advisor challenges the “research on the benefits of indexing,” “entering a debate” with your advisor” is “futile.  No active advisor is ever going to concede that indexing is a superior strategy.”  “You don’t need to change each other’s minds.”

Some advisors may try to scare you with the claim that “Active managers can protect you during a downturn,” but even if they succeed at selling out before the bottom, “these managers are often sitting on the sidelines when the markets rebound.”  Another scare tactic is the nonsensical claim that “ETFs are dangerous.”

Rebalancing


Over time, your portfolio will deviate from your carefully-chosen asset allocation percentages.  Restoring these percentages is called rebalancing.  “Many people assume rebalancing is designed to boost returns, but that’s not necessarily the case.”  “The real goal is to keep your portfolio’s risk level consistent over time.”

The book covers the three ways of rebalancing, and rather than dogmatically picking one, “There’s no reason why you can’t use some combination of all three rebalancing strategies—by the calendar, by thresholds and with cash flows.”

It’s at this point that Bortolotti makes a strong case for asset allocation ETFs that hold all the asset classes he recommends and do the rebalancing for you.  This is likely the best and easiest option for DIY investors.  “If your equity allocation is a multiple of 20 … you can build your portfolio with a single fund.  If it falls between those numbers … then you can combine one of the all-equity ETFs with a bond ETF and, when necessary, rebalance with just two trades.”  This would work, but owning two asset allocation ETFs, say those with 60% and 40% equities to get to a desired target of 50%, would require much less rebalancing.

Staying on Track


It’s one thing to start on a sensible investing path, but staying on track is it’s own challenge.  “Analysis paralysis continues to afflict people even after they have implemented their new portfolio.  They second-guess their early decision as they do more reading or learn about more funds.”  “Investors may also feel paralyzed by the thought of investing a large sum.”

Media commentators make lots of pointless predictions designed to scare us into some sort of action.  They can’t just say the same thing every day: “investors should just stick to their long-term plans.”  “You should also keep in mind that many market commentators work in the financial industry.”  “They write for free simply to get exposure … and to make investors feel confused and uncertain so they can lure new clients.”

The urge to pick stocks can be powerful.  If you give in and buy stocks with some fraction of your portfolio, “The real risk here, in my view, isn’t that you will fail miserably as a stock picker; it’s that you will enjoy some initial success.”  If you decide your luck is actually skill, you might shift more of your savings to your risky stock picks that might fall flat later.

Other things that can knock you off course are “the urge to do something” when your long-term plan calls for sitting on your hands, “fear of missing out” on the latest big thing in investing, “overestimating your risk tolerance,” “believing the industry’s BS,” and “not giving [indexing] time to work.”

Conclusion

This book is now my number one choice for lending to friends and family who show some interest in investing.  When it comes to the investing part of personal finance, this book gives readers the tools they need to succeed, whether they invest on their own, use a robo-advisor, or work with a human advisor.

Friday, November 5, 2021

Short Takes: Cryptocurrency Experiment, Evergrande Crisis Explained, and more

I’m sometimes surprised by the things that make me happy.  Lately, whenever I look out at my pool and see that the water level is the same as it was the day before, I smile.  I didn’t realize it at the time, but a decade ago I had a repair done that left a small leak when some parts weren’t fitted together properly.  Each passing year the leak got a little bit worse.  It took me until three years ago to figure out what was wrong.  I began calling around to find someone who would replace the problem parts.  The job required cutting cement, a little digging, and patching the cement, so I needed someone with some skill and it wasn’t going to be cheap.

So far this story isn’t too surprising.  A guy who knows little about pools takes forever to find a problem.  The next part still feels surreal to me.  All the pool repair places just said no.  I called dozens over the three years, and sought recommendations from friends.  They could have asked for a high price, but they just weren’t interested.  Apparently, skilled workers were meeting high demands for new pools, and less skilled workers were handling the profitable pool openings and closings.  When the pandemic came along, these problems became worse as the demand for new pools grew and workers were understandably nervous about getting exposed to COVID-19.

As the leak got worse, I tried to stem it with some epoxy putty, but the leak reached the point where I was wasting about $1000 worth of water each season.  Fortunately, my now favourite pool company recently did the repair, and I’m still happy about it.

Here are my posts for the past two weeks:


Will Your Nest Egg Last if You Retire Today?

Saving for a Home is Possible


Here are some short takes and some weekend reading:

Andrew Hallam has an interesting take on cryptocurrencies.

Preet Benerjee
explains the Evergrande crisis clearly for nonspecialists in this video.

Dan Bortolotti has a new book out called Reboot Your Portfolio: 9 Steps to Successful Investing with ETFs.  He says “simplicity always trumps complexity.”  I agree, although I don’t mind letting a computer handle some complexity as long as my role remains simple.  Preet Banerjee interviewed Dan about his book on the Mostly Money podcast.

The Blunt Bean Counter explains some of the pitfalls in gifting money to your children to buy a house.  The main area of trouble comes if your child splits with a spouse.  In such a case, you may have been better off lending the money for the house instead of gifting it.  But even that becomes tricky because the courts often rule that a loan was really a gift.

Tuesday, November 2, 2021

Saving for a Home is Possible

It’s no secret that Canadian house prices have been rising rapidly in recent years.  Many young people feel that they’ll never be able to afford to buy a home.  However, as fast as house prices have been rising, the stock market has risen faster.

The following chart shows a decade of my cumulative investment returns compared to the rise in Canadian real estate prices.  There was nothing special about my returns over this period; the stock market was booming.  My investments were primarily in stock index ETFs, although my returns were reduced somewhat by the 20% or so I’ve had in fixed income since I retired in mid 2017. To measure real estate prices, I used Teranet-National Bank House Price Indexes for Toronto, Vancouver, and a composite index of all Canadian metropolitan areas.


The chart shows that even high-flying Toronto real estate didn’t keep up with my investments.   Vancouver real estate growth is a little further behind, and Canada as a whole is even further behind.

What is the lesson here?

Young people who began saving a down payment a decade ago could have seen their savings grow faster than house prices did.  Instead of wasting time worrying about real estate prices continuing to rise, it’s best to get down to the business of saving for a down payment.

Of course, there’s nothing wrong with renting a home.  By building savings, you are prepared to buy a home if the right conditions arise.  And if you choose to continue renting indefinitely, your savings will pay for rent in your retirement.  This is just one of many situations where taking action beats complaining.

Tuesday, October 26, 2021

Will Your Nest Egg Last if You Retire Today?

If you’re thinking of retiring today on your own savings rather than a guaranteed pension, how do you factor in the possibility of a stock market crash?  If you’re like many people, you just hope that stocks will keep ticking along with at least average returns.  However, this isn’t the way I thought about timing my own retirement.

I retired in mid 2017.  At the time, stock prices were high, so I assumed that the day after retiring, the stock market would drop about 25% or so, and then it would produce slightly below average returns thereafter.  By some people’s estimations, I over-saved, but I didn’t want to end up running out of money in my 70s and be forced to find work at a tiny fraction of my former pay.

What actually happened in the 4+ years since I retired was the opposite of a stock market crash.  My stocks have risen a total of 60% (11.5% compounded annually when measured in Canadian dollars).  If I had known what was going to happen, I could have retired much sooner.  But I didn’t know, so I have no regrets.  It’s better to have too much than too little.

If you want to retire today, you face an even worse dilemma than I did because stock prices are much higher than they were when I retired.  If I were retiring today, I’d factor in at least a 40% drop in stock prices the day after I left my job.  This isn’t a prediction; it just represents the possibility that stock prices could return to more normal levels in the coming years.

For many prospective retirees, thinking this way means they will have to save substantially more before they can retire, so this is very unwelcome news.  But simply hoping stocks keep climbing could lead to a meagre retirement if markets crash in the near future.

As usual, those who think the way I do and are already over-saving will believe this line of thinking.  Those who want to retire sooner on rosy stock market predictions will dismiss my thoughts.  In most markets, optimistic retirees fare reasonably well, but with stock prices at nosebleed levels, there is the possibility that optimists will be very disappointed.

Friday, October 22, 2021

Short Takes: Dividend Nonsense, Lingering Beliefs, and more

Recently, I saw another example of magical beliefs about dividends.  Nick Maggiulli makes the claim that the bulk of investor returns over time come from reinvested dividends.  In one 40-year example, the total return is 791% without reinvested dividends and 2417% with reinvested dividends.  Unsaid is that if you withdrew all price gains periodically (and thereby failed to reinvest them), the total return from just dividends would be far less than 791%.  

This isn’t hard to understand when you look at the situation clearly.  Suppose that over several decades dividends are responsible for doubling your investments twice, and capital gains are responsible for doubling your investments three times.  So, dividends alone would have given a 300% return, and capital gains alone would have given a 700% return.  But through the magic of compounding, reinvesting all returns gives five investment doublings, or a 3100% return.  

Dividend lovers like to compare the 3100% to the 700% and declare that the bulk of long-term returns come from dividends.  This is nonsense.  It would also be nonsense to compare the 3100% to the 300% and declare that the bulk of long-term gains come from capital gains.  The relative value of these two types of return is best viewed by looking at the doublings.  In this example, dividends are responsible for 40% of returns and capital gains 60%.  Clearly, both matter.

Here are some short takes and some weekend reading:

Morgan Housel
makes a strong case that our beliefs about the world can linger on while reality changes.  His best example is the changing demographics in China.  They are feeling the effects of their former one-child policy.

Doug Hoyes explains how people seeking debt relief with consumer proposals get scammed if they go to the wrong organization.

Justin Bender explains in detail how to track the Adjusted Cost Base (ACB) of asset allocation ETFs held in non-registered (taxable) accounts.

Robb Engen reviews Fred Vettese’s new book The Rule of 30.  Robb persuaded me to add this book to my reading list.

Friday, October 8, 2021

Short Takes: RRSP Withdrawals in Your 60s, Comparing Global Stock ETFs, and more

Here are my posts for the past two weeks:

Class Action Settlement with BMO


The Deficit Myth - Modern Monetary Theory

Here are some short takes and some weekend reading:

Jason Heath looks at reasons why it can make sense to withdraw from your RRSP in your 60s.  In my case, my simulations showed that it made sense to start withdrawing from my RRSPs shortly after retiring in my 50s.  This is true even though I have non-registered assets I could be living on right now.  The reason is that I’m best off spreading out the taxable income from RRSP withdrawals over many years.

Justin Bender compares the two main global except Canada stock ETFs: VXC and XAW.

Big Cajun Man is closing his TD mutual fund accounts after TD’s latest attempt to steer its customers away from its excellent e-series funds and toward their crappy high cost funds.

The Blunt Bean Counter
explains the implications of getting an inheritance.

Thursday, September 30, 2021

The Deficit Myth - Modern Monetary Theory

Before U.S. President Nixon abandoned the gold standard in 1971, anyone with U.S. dollars could exchange them for gold at a fixed price.  Now that the U.S. government (as well as other governments including Canada) can issue new money at will, we call it “fiat money.”  Stephanie Kelton, former chief economist on the U.S. Senate Budget Committee, claims that this ability to create money at will has profound implications that she explains in her book The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy.  Modern Monetary Theory is certainly a different way to think about government finances, but whether it really has profound implications is less clear.

Under the gold standard, government finances resembled a family’s finances.  To run a deficit, the government had to borrow.  However, today the government can just create new money.  Governments typically choose to issue bonds (treasuries) to cover deficit spending, but such bonds are really just a different kind of money conjured out of thin air.  The government could just create as many dollars as it needs, but it chooses to create bonds that pay some interest.

When we understand fiat money, we see that the government can’t go broke because it can create new money at will.  This means the government could wipe out the national debt in seconds, and U.S. Social Security (or CPP and OAS in Canada) can’t run out of money as long as the government chooses to keep paying these benefits.

According to Kelton, it’s a myth that “deficits are evidence of overspending.”  In reality, it’s inflation that we should look to as evidence that governments are overspending.  When deciding what projects the government should take on, financial constraints and deficits aren’t the real concern; it’s resource constraints in the economy.  There have to be enough workers and other resources in the economy to do the work the government wants done.

Kelton explains that our real constraints come from trying to control inflation.  However, she doesn’t address these constraints in any more detail.  She lists many projects governments could take on, including providing jobs guarantees, providing health care, improving education, fixing infrastructure, and addressing global warming.  She says we can ignore deficits in these pursuits, but how do we know we won’t end up with high inflation?

Kelton needs to make a case that we can pursue ambitious programs without causing inflation, but she leaves this unaddressed.  If it turns out that inflation is closely linked to deficits (perhaps with time lags), then our current focus on controlling deficits would be little different from Modern Monetary Theory’s focus on inflation.  They would be saying the same thing with different words.  I suspect they’re not saying entirely the same thing, but the degree to which they differ is hard to say.

Modern Monetary Theory (MMT) calls for a federal jobs guarantee.  The idea is that any unemployed person should be able to get a job with the government at a rate of pay slightly below the lowest pay in the private sector.  I see some challenges.  How do you deal with people who want to be paid but don’t want to work much?  How do you deal with aspiring workers who have physical or mental problems that prevent them from getting much work done?  If you employ such people, how do you prevent others from pretending to have such problems?  How do you avoid corruption among those who run such programs (e.g., no-show jobs)?  How do you avoid having some young people give up on their education and take a guaranteed job?  Maybe none of these concerns is a show-stopper, but I’d be interested in seeing solutions.

The best parts of this book explained the implications of fiat money.  While many people understand that governments can just create new money, the full implications of this fact aren’t obvious.  However, it’s not clear to what extent MMT is really a new financial theory, and to what extent it’s just a different way to express conventional ideas.

Wednesday, September 29, 2021

Class Action Settlement with BMO

BMO was sued in a class action lawsuit for charging undisclosed fees on foreign exchange conversions in customers’ registered accounts between 2001 and 2011.  Customers of BMO Nesbitt Burns, BMO InvestorLine, and BMO Trust Company will get their share of the settlement before Oct. 8.

A decade ago I calculated that I had spent $7374 in currency exchange costs while trading U.S. stocks since I had opened trading accounts at BMO InvestorLine.  When I heard about the class action settlement with BMO, I figured I’d only get back a tiny fraction of this money.  However, my wife and I are pleased to be getting a total of $2051 plus $955 in interest.

It would be nice if BMO’s response to this lawsuit was to charge sensible foreign exchange fees, but they are much more likely to simply be more careful about meeting some legal standard of disclosure.  Unwitting customers will continue to rack up unreasonably high foreign exchange costs.

Friday, September 24, 2021

Short Takes: European Bank Customer Abuse, Opening a RRIF at Questrade, and more

The word “millionaire” is frequently used to mean a person who doesn’t have any financial concerns and whose wealth is much greater than what the rest of us have.  However, imagine a couple whose house is now worth $750,000, they have a $300,000 mortgage, they owe $50,000 on their cars, and one has a public service pension now worth $600,000.  On paper, this couple has a million dollars, but they are hardly rich, and they definitely still have financial worries.  It’s time to start using “decamillionaire” to mean a very wealthy person.  Maybe $5 million is enough, but we don’t have a common word for that level of wealth.

Here are my posts for the past two weeks:

Debunking a Bogus Stock Market Prediction

Wilful Blindness

Here are some short takes and some weekend reading:


Andrew Hallam
explains how European banks sell some horrific “investments” to unsuspecting consumers.  He also exposes the huge downside of index-linked investments that promise no down years.

Robb Engen at Boomer and Echo explains how to convert an RRSP to a RRIF at Questrade.

Big Cajun Man
thinks it’s important to teach your kids to be frugal at back-to-school time.  I agree.  Just because some people call student debt “good debt,” it’s still better to finish school with your debt smaller rather than larger.

Monday, September 20, 2021

Wilful Blindness

Reporter Sam Cooper tells a remarkable story of the British Columbia provincial government profiting from Canada’s epidemic of fentanyl deaths in his book Wilful Blindness: How a Network of Narcos, Tycoons and CPP Agents Infiltrated the West.  Cooper’s evidence is strongest for B.C.’s cooperation in laundering money for the drug trade in return for a cut of the profits.  However, he demonstrates connections to trans-national organized crime, Canada’s housing bubble, and China’s communist party.

The book begins by carefully explaining that the evidence presented is not intended as an indictment of the people of Canada or China but rather criminal organizations within these countries and parts of government.

Cooper paints a picture of massive amounts of drug cash being laundered through B.C. casinos, and authorities happy with the huge “gambling profits” thwarting RCMP efforts to stop illegal activity.  There was a “rapidly growing narco-economy that B.C.’s government was taking a cut from.”

Part of the money laundering process involved buying and selling Canadian real estate.  According to a Vancouver developer, “$300,000 of every $1 million spent in Vancouver real estate comes from Mainland China.”  A Global News article proclaimed “Secret Police Study Finds Crime Networks Could Have Laundered Over $1 Billion Through Vancouver Homes in 2016.”

Although Cooper claims that “China’s government is in fact controlling drug cartels,” we can only guess at the extent of the connection.  “David Mulroney, Canada’s former ambassador to Beijing” is quoted as saying “The course of modern Chinese politics, from the earliest days of the Communist Party in Shanghai, has been interrelated with the rise and fall of various crime bosses and triads.”  There’s a wide continuum of possibilities from, at one end, elements within a government forming temporary alliances with criminals and, at the other end, the highest levels of a government forming and directing criminal organizations.  It’s hard to tell where in this continuum Cooper’s evidence points.

I don’t have the knowledge to form an accurate high-level picture given Cooper’s mountain of evidence, but you may be interested in reading this book just for its many wild stories of criminal activity going on inside Canada.

Thursday, September 16, 2021

Debunking a Bogus Stock Market Prediction

It would be much easier to plan for the future if we knew what stock prices were going to do.  Bank of America has a chart with seemingly solid evidence that stocks will lose a total of about 8% over the next 10 years.  I’m going to show why this evidence is nonsense.  But don’t worry; I’ll do it without making you try to remember any of your high school math.

The Bank of America chart looks intimidating to non-specialists, but I’ll summarize the relevant parts in easy-to-understand language.  The basic idea is that for each month since 1987, they looked at how expensive stocks were that month and compared that to stock market returns over the 10 years following that month.  They found that the more expensive stocks were, the lower the next decade of returns tended to be.  The hope is that we can just use the chart to look up today’s stock prices to see what stock returns we’ll get over the next 10 years.

In the chart below, each dot represents one month from 1987 to 2010.  Notice that the dots are fairly close to forming a straight line.  Statisticians get excited when they see a strong relationship like this.  If the line were perfectly straight, we could just look up how pricey today’s stocks are (using a measure called the P/E or price-to-earnings ratio), and read off the average annual stock return we’ll get over the next 10 years.

The line isn’t perfectly straight, but it’s fairly close.  One measure of how close to a straight line we have is called R-squared.  For our purposes here, we don’t need to know much about R-squared other than 100% means a straight line, and as this percentage drops toward zero, the cloud of dots spreads out.  The chart indicates an R-squared of 79%, which is a strong relationship.

Also indicated on the chart is the prediction that stocks will lose an average of about 0.8% each year over the next decade.  However, if we imagine an oval surrounding the full range of dots, this chart predicts annual stock returns between about -3% and +2%.  If we knew future stock returns really would fall in this range, most people would sell their stocks.  But can we count on stock returns falling in this range?  It turns out that we can’t because the chart is deeply flawed, as I’ll explain below.



Problems

The first thing to observe is that this chart is based on about 34 years of stock market data, a little over 3 decades.  Because we’re talking about 10-years returns, you might wonder why there are more than 3 dots on the chart.  The answer is that it uses overlapping periods.  There is a dot for January 1987, then February 1987, and so on.

Consider the ten years of returns starting in January 1987 and compare this to the ten years of returns starting in February 1987.  They are the same in 119 of 120 months.  Each decade of returns starting monthly from 1987 to 2010 overlaps with 119 other decades.  There is a huge amount of redundancy in the chart.  Somehow we went from a 3-dot chart to one with hundreds of dots.

Using overlapping data isn’t always a bad thing, but it is in this case because there is just too little independent data to have any statistical significance.  To show this, I ran some simulations.  I created random stock market data and measured R-squared values.

The method I used for creating this simulated stock market data created returns that ignored stock valuations.  This means that using P/E values to predict stock market returns is futile with this simulated data; the R-squared value of the underlying probability distribution used in the simulations is zero.  To confirm this, I generated a million years of stock market data, and measured the R-squared value.  In a thousand repetitions of this experiment, all R-squared values were less than 0.02%.

However, coincidences are common when you examine very small amounts of data.  I ran simulations of 34 years of stock market data.  I repeated this experiment 100 million times.  Amazingly, in just over one-tenth of the simulations the R-squared value was above 79%, and in 51% of the simulations the R-squared was above 50%.  These seemingly strong correlations are what you get with small amounts of random data, even though the underlying probability distribution has no correlation at all (R-squared equal to zero).

What can we conclude from these experiments?  The data in the Bank of America chart is a meaningless coincidence.  In an earlier article I showed that when we examine stock market data back to 1936, the correlation becomes much weaker (the dots look more like a wide cloud).  We can’t tell what will happen with stocks over the next 10 years with any accuracy just by looking at 34 years of stock returns, and it turns out that going back to 1936 doesn’t help much either.

Why was this error missed?

If this chart is so deeply flawed, why did Bank of America create it and why are so many people spreading it through social media as evidence that stocks will perform poorly?  The answer is that few people are good at probability theory.  Most people who use statistical methods professionally don’t understand the underlying probability theory well enough to use statistics safely.  When we use statistical tools to process data, it’s very easy to lose sight of significant problems, such as having too little data.

All the Bank of America chart is saying is that when stocks were expensive around the year 2000, the market crashed, and now that stock prices are very high again, the stock market may crash again soon.  Or it might not; it’s hard to tell.  The statistics just take this simple idea and dress it up to seem more scientific than it is.

Is this chart a deliberate deception?  Probably not.  Hanlon’s razor applies here: “never attribute to malice that which is adequately explained by stupidity.”  When people know just enough math to be dangerous, they often fool themselves first and fool others later.

Does this mean stocks will keep going up?


No.  It just means we don’t know what will happen, and the Bank of America chart sheds almost no light on the question.  There are good reasons to believe that a market crash and poor returns over the next decade are more likely today than when stock prices were lower.  But this chart isn’t one of the good reasons.

Conclusion

The crystal ball for viewing future stock returns is still cloudy.  We need to consider a wide range of possible market outcomes in our planning.  It’s important to strike a balance between being positioned to benefit from a rosy future and being protected against a bleak future.  With stock prices so high, I’ve chosen to shift my focus a little more toward protecting myself against poor market returns.

Friday, September 10, 2021

Short Takes: Gen X Wealth, Plug-in Hybrids, and more

Eight months ago, a group of friends including my wife and I took a chance and booked a PEI vacation.  Fortunately, we were able to go, and we’re just back from a great time.  I’m starting to wonder if we were lucky enough to hit a window that’s now closing as the COVID-19 Delta variant continues its exponential spread through Canada.  We just don’t have enough Canadians vaccinated yet to stop the growth without restricting our movements as they were earlier in the pandemic.  It’s been interesting to watch governments at all levels struggle with attempts to encourage people to get vaccinated and to apply lockdown rules only to those who have chosen not to be vaccinated.  All this is a work in progress and teething pains will continue.

Here are some short takes and some weekend reading:

Economist Writing Every Day says U.S. Gen Xers are now 30% wealthier than Boomers were at the same age, and that Millennials are on a similar path.  It would be interesting to see similar data for Canada.

John Robertson dives into the costs of plug-in hybrid vehicles, complete with a spreadsheet for comparing costs.  We’re in a transition period right now when plug-in hybrids make sense.  This will last until battery costs come down enough to make solely electric vehicles the obvious choice.

Scott Ronalds at Steadyhand
reports that  92% of Steadyhand employee financial assets are invested in Steadyhand funds and that employees get no special breaks on fees.  Steadyhand’s situation is one of the rare times that talk of “aligning interests” is true.

Friday, August 27, 2021

Short Takes: Changing Risk Appetite, the 4% Rule, and more

Over the past decade I’ve rented places in Florida through VRBO, and I’ve noticed an interesting change in the ongoing battle between owners and renters.  Early on, when searching for a place, filtering by price worked reasonably well.  You could count on the actual full price to be 20-25% more than the advertised rental price once they added various fees.  Then owners got clever and began to add ever-larger nonsensical fees.  In one extreme case, the added fees doubled the total rental cost.  Filtering by price became useless.  VRBO responded by calculating a full price with all the add-on fees to show to prospective renters during their search.  So, filtering by price works again, except for a new game.  Owners are very cagey about the price of pool and hot tub heat.  Because this is optional, VRBO doesn’t include it in advertised prices.  Owners try to get renters to commit to a rental and then hit them with punitive pool heat prices.  To find a place, we now have to find some suitable rentals and send queries to their owners to find out about pool heat cost.  Owners generally reply, but they avoid giving an actual price. Sometimes they eventually give a figure after a few exchanges, but sometimes they don’t.  In one case, they wanted US$40 per day, which is many times what it costs to heat a much larger pool in Canada.  It pays to understand the game and be wary.

Here are my posts for the past two weeks:


Narrative Economics

Retirement for the Record

Here are some short takes and some weekend reading:


Tom Bradley at Steadyhand
discusses ways to change your risk appetite when it differs from your risk capacity.  I’ve long believed that with the right approach, young people should be able to become comfortable with the gyrations of the stock market with their long-term savings.

The Rational Reminder Podcast
has a recent episode that gathers together expert opinions on the 4% rule for retirement spending from a portfolio.  This includes Moshe Milevsky’s entertaining demonstration of the foolishness of picking a spending level and blindly increasing it by inflation each year without any regard for how your portfolio grows or shrinks.  However, that doesn’t mean William Bengen’s original work on the 4% rule was foolish.  We can decide to adopt a flexible spending plan but choose an initial spending level that isn’t likely to have to be reduced.  We then do an analysis similar to Bengen’s to choose that starting spending level.

Robb Engen at Boomer and Echo say that what we should do about high stock prices is “If you’re invested in a globally diversified and risk appropriate portfolio, the answer is to lower your expected future return assumptions and do nothing else.”  He sees those who act on predictions of market crashes as overconfident.

Monday, August 23, 2021

Retirement for the Record

Just in case you’ve ever wanted to read a book about both retirement planning and the music of the 60s and 70s, Daryl Diamond has you covered with Retirement for the Record: Planning Reliable Income for Your Lifetime … to the Soundtrack of Your Life.  This book’s main focus is the value of an advisor (and his firm in particular) in retirement financial planning.  However, about a third of it is stories about the music most relevant to those born near the peak of the baby boom.

I expected more discussion of how to plan your finances in retirement, but the consistent message is that such planning is difficult, you need help, most advisors aren’t good at it, but Diamond and his firm do it well.  An early chapter tells us that there are no cookie cutter solutions, because the answer to most retirement planning questions is that “it depends” on your particular circumstances.  There is some truth to this, but it would certainly be possible to lay out 6 or 8 examples that illustrate the most important themes of planning a person’s retirement.  Unfortunately, Diamond doesn’t do this.

“I have seen plenty of situations where a DIY investor is trying (trying is the operative word here) to efficiently set up their income streams and in the process ends up sabotaging a preferable outcome. Unfortunately, I meet far too many ‘do-it-yourself investors’ who aren’t doing a good job transitioning to the income years themselves and, realizing this, are seeking my help at this point in their life.”  Of course, he doesn’t see any DIYers who plan their retirement well, because they don’t go to see him.  Given the repeated pitches for advisors and his firm in particular, this whole message just comes off as self-serving.

To show the complexity of retirement financial planning, Diamond lists ten questions that must be answered before it’s possible to tailor a plan to a client’s needs.  Unfortunately, he doesn’t discuss what he would do with the answers.

The Good

Before continuing with criticisms of this book, let’s look at a few parts I liked.  To avoid big tax bills in the future, it often makes sense to start drawing from RRSPs early instead of waiting for mandatory RRIF withdrawals to begin.  “To the best of my knowledge, only one of the Big Five banks allows their planners to illustrate scenarios in which RRSPs are not deferred as long as possible.”  Aside from the problem of possibly giving bad advice to clients, how can planners within big banks be considered professionals if they must do what their bosses tell them to do even if it hurts clients?

Diamond gives a good discussion of the importance of line 23600 (net income) on Canadian tax forms.  This net income figure determines your OAS clawback and the value of your age amount and age credit (for those 65 and older).  Many people don’t realize that if you carry capital losses from previous years forward to offset capital gains in the current year, it reduces your taxes this year, but it doesn’t change line 23600.  So, previous capital losses can’t reduce your OAS clawback or increase your age amount.

There’s nothing wrong with deciding to become more conservative with your investments, but too many investors do this “at precisely the wrong time.”  Investors who get conservative after stocks have crashed “lock in their losses,” “experience lower returns than if they had stayed invested,” “miss the subsequent upturn in the markets,” and “need to decide when to enter back into the markets—and this happens after they have already missed meaningful gains.”

The Not So Good

In a chart showing the “factors for successful investing,” the claimed least important factor is “fees.”  Even a 1% annual fee will consume about one-quarter of the assets you accumulate and decumulate over an average lifetime, so it’s hard to see how fees are unimportant.

Diamond is adamant that most people should take CPP and OAS as early as possible thereby “preserving your personal income-producing assets.”  Unfortunately, his reasons for this mostly come down to focusing on the possibility of dying young.  “I can tell you that over the last eighteen months we have unfortunately had twenty of our clients pass away.”  “Fifteen passed before the age of 71.”  Of course, there are many who are still alive and will live long lives.  Frederick Vettese’s take on when to start CPP in his book Retirement Income for Life (second edition) makes more sense.

One chapter warns what could happen if you’ve delayed CPP and OAS, but one spouse dies.  In this case, that spouse’s CPP and OAS get replaced with a smaller CPP survivor pension.  In one example, a widow sees her income drop 25%, an apparently disastrous outcome.  However, her expenses will drop as well.  It’s important to actually analyze a couple’s spending to see how it would change if one spouse died. Instead, Diamond treats any income drop as a calamity, and declares that almost everyone should take CPP and OAS as early as possible.  In reality, the possibility of living a long life and needing to avoid running out of money have to be considered together with other possible outcomes.

When fees are based on a percentage of client assets, “the better the portfolio performs, the better it is for the client and for the advisor.  There is an alignment of interests in this arrangement, which is why we prefer it and it is the model we use in our firm.”  The alignment of interests is pretty weak with this arrangement.  We get much better alignment when advisors hold the same assets in their personal portfolios as they recommend for their clients.

In a rant about fee disclosure and HST, Diamond writes “While the government contends that it is so interested in fee disclosure and the desire to ‘help’ investors, they are certainly not shy about carving money out of your returns in the form of taxes [HST on management fees and dealer fees].”  I’m not convinced that this HST only affects investor returns.  What if managers and dealers already charge as much as they can get away with, and they would just raise their fees if the HST went away?  Then the HST bites into their fees rather than investor returns.  In reality, this HST affects both sides: investors and managers and dealers.

An entire section of the book devoted to “investing in retirement to generate income” can be summarized as “we use income funds.”  Diamond stresses the importance of “preserving the invested capital” by spending only income and not selling units of the income fund.  However, income fund managers sell capital within the fund to make up part of the promised payments.  This is called return of capital (ROC).  The claim that your “capital can remain invested” is at best misleading.  Diamond views ROC “as a component of this managed investment process that generates regular income.”  This is just double-talk to disguise the fact that income funds don’t really preserve capital.

Diamond advocates a 5% to 5.5% withdrawal rate in retirement.  This is dangerously high, particularly when you’re also paying advisor fees, but has worked out well during the bull run in stocks over the past decade or so.  Who knows what will happen in the coming decade.  Something I didn’t see mentioned is increasing the withdrawal rate with age.  An early retiree certainly should be drawing less than 5%, and an 80-year old can safely draw more than 6%.

Conclusion


Overall, I’m not a fan of the retirement planning part of this book; I found it self-serving for the author.  He could have actually explained his process to help other advisors and maybe some DIYers.  However, it’s clear that Diamond has great passion for the music of his youth.  Readers of the right age (baby boom peak) may enjoy his many interesting music-related stories and trivia questions.  Even though I’m significantly younger than the author, I enjoyed the music discussions more than the retirement planning.

Monday, August 16, 2021

Narrative Economics

In his book Narrative Economics: How Stories Go Viral & Drive Major Economic Events, Nobel Prize-winning economist Robert J. Shiller calls on other economists to incorporate the study of narratives into their predictive models.  He believes the stories we tell each other that go viral are important factors in how economic events unfold.  The book is clearly written and makes its case convincingly, but there isn’t much for individuals to apply to their own lives unless they are economists or politicians.

A simple example of how narratives can cause future events is a viral story about deflation.  At times in the past, people have widely believed that prices were going to fall.  As a result, consumers delayed purchases expecting to buy cheaper later.  This caused spending to fall, and ultimately contributed to sellers lowering their prices.  Narratives can become reality.

Shiller gives many examples of different classes of narratives, including the morality of frugality and conspicuous consumption, the gold standard, automation replacing jobs, market bubbles, evil business, evil unions, and more.

Broadly, the book shows that “popular narratives gone viral have economic consequences.”  Shiller wants “economists to model this relationship to help anticipate economic events.”  He calls on economists to collect data on narratives to facilitate future economic analyses.  He also says “Policymakers should try to create and disseminate counternarratives that establish more rational and more public-spirited economic behavior.”

“When it comes to predicting economic events, one becomes painfully aware that there is no exact science to understanding the impact of narratives on the economy.  But there can be exact research methods that contribute to such an understanding.”  A further challenge is “distinguishing between causation and correlation.  How do we distinguish between narratives that are associated with economic behavior just because they are reporting on the behavior, and narratives that create changes in economic behavior?”

Shiller did a good job of convincing the reader that narratives matter in economics.  However, I have one minor criticism.  In one discussion of bankers and the poor choices they appear to make, Shiller says “It may be best to think of bankers’ behavior at such times as driven by primitive neurological patterns, the same patterns of brain structure that have survived millions of years of Darwinian evolution.”  This unflattering portrayal of bankers’ thinking presupposes that bankers intend to act in the best interests of their banks.  I find this doubtful.  Bankers as individuals all the way up to the CEO have periods of time where they make a lot of money doing things that look good in the short run but hurt the bank in the long run.  This is captured nicely in Charles Prince’s comment, “As long as the music is playing, you’ve got to get up and dance.”  Sometimes, apparently dumb behaviour is actually evil and greedy behaviour.

Overall, Shiller makes a strong case that the spread of narratives should be studied by economists.  However, readers looking for concrete ideas for improving their own investment results won’t find them because this isn’t the book’s focus.

Friday, August 13, 2021

Short Takes: In Praise of Small Steps

I’m not against having grand plans, but I’ve often seen them get in the way of real progress.  I recall a family member telling me about grand plans to organize his many piles of papers strewn throughout his house and eventually write a book.  I asked “would you like me to help sort this one pile of out-of-order papers right here?”  The answer was “No, no, not right now.”  A friend and I were looking in one of his closets one time, and he told me about plans to sort through everything in his overstuffed house.  As he reached to set down an item he had already declared to be garbage, I asked if he wanted me to throw it out.  The answer: “No, that’s fine.  I’m going to do it all together one day.”  

Waiting for a magical day in the future when you’ll want to do what you don’t want to do today isn’t a great formula for success.  I do better completing tasks in small steps.  My wife and I just got rid of some old paint cans.  We could have just talked about grand plans to clean up every part of the house, but instead we just cleaned up a small part and went back to lazing around.  It’s true that big projects like writing a book require spending some time thinking about the whole project, but it still has to be completed in many small steps.  It’s better to just do one of the small steps than procrastinate by convincing yourself you’ll do a lot of work some other day.

Here are some short takes and some weekend reading:


Morgan Housel makes some excellent points about how when we see others appear to make mistakes, it’s often our own lack of information that leads us to make this judgement.  In my experience, the missing information is often the other person’s motives.  If you have the wrong idea about another person’s goals, it’s easy to decide that their actions are mistakes.

John Robertson reflects on his decision a decade ago to rent instead of buy a home in Toronto.  One result of his analysis that would surprise many people is that someone who paid cash for a house in Toronto 10 years ago would have been better off renting and investing the cash in stocks.  It’s only when we consider a leveraged house purchase (i.e., with a mortgage) to an unleveraged stock investment that buying a home would have beat renting.

Robb Engen at Boomer and Echo reviews The Boomers Retire, written by David Field and Alexandra Macqueen.  The authors describe their book as a retirement resource rather than a novel, and they sought to make it as broadly useful as possible.

Big Cajun Man says that when it comes to speculation, never is better than being late.

Friday, July 30, 2021

Short Takes: 4% Rule Troubles, Factor Investing, and more

In a very small sample size I’ve noticed that owners of short-term rental places seem to be offering better than usual terms for letting renters cancel without penalty.  It’s hard to tell if it’s just a coincidence or if the owners recognize that a COVID-19 upsurge is a worry for renters.  I’m still hoping to go east to golf this fall and head south for the winter.  Fortunately, these owners have let me book without worrying about getting my money back if I can’t go due to the ongoing pandemic.

In the past two weeks I reviewed a book of a different type than my usual:

How to Retire Happy, Wild, and Free

Here are some short takes and some weekend reading:

Chris Mamula objects to Vanguard’s report on the shortcomings of the 4% rule for FIRE enthusiasts.  His objection isn’t with any of Vanguard’s technical points; he just thinks the FIRE community already knows about the problems with the 4% rule.  While it’s true that there are FIRE bloggers who have made these same points (as well as other bloggers, including me), the majority of FIRE enthusiasts certainly don’t understand all of these points.  We don’t get to define the FIRE community narrowly to only include a small number of knowledgeable people.  Like any large group of people, the range of knowledge levels is very wide, and it makes little sense to pretend they all have similar knowledge levels.  Mamula says “Vanguard has bought into the myth that this is a community of naive investors and planners.”  The FIRE community has brilliant people, naive people, and everything in between.  Further, there are plenty of people around who disagree with Vanguard’s sensible take on the 4% rule.  In particular, it’s not hard to find people who think drawing 5%, 6%, or more annually from a portfolio is safe.  I applaud Vanguard for trying to counter confusion and misinformation about how to draw down a portfolio over many decades.

Larry Swedroe
discusses how factor premiums decline or even disappear after they are identified and publicized.  I’ve tended to be skeptical of most factors, mainly because trying to exploit them increases investment costs.  You have to hope that enough of the factor premium will hang around to cover these higher costs.  I have a tilt to small value stocks, but other than that, I stick to broad cap-weighted indexing.

Preet Banerjee interviews Peter Mansbridge to discuss some of the stories behind big moments in his career.

Wednesday, July 28, 2021

How to Retire Happy, Wild, and Free

Most of the books I’ve read about retirement have focused on saving, investing, and decumulation strategies.  However, the whole point of being able to retire is to enjoy life.  Not everyone deals well without the structure of work, but Ernie J. Zelinski is here to help with his book How to Retire Happy, Wild, and Free.  If even a small fraction of this book resonates with someone who finds retirement unsatisfying, it can help.

For younger people who dream of having less time pressure in their lives, the idea that too much leisure could be unsatisfying may seem ridiculous.  However, many people end up having no good answer to the question “What will you do with your time if you have never learned to enjoy your leisure?”  Zelinski offers hundreds of ideas in categories of lifelong learning, friends, travel, relocation, and more.

Whether we choose to stop working or have it forced on us by an employer, retirement is in most people’s futures.  Finances are an important part of retirement, but so is personal fulfillment.  “It’s wise to start thinking about the personal side a long time before you actually retire, particularly if you are a workaholic with few interests outside work.”  “Individuals who have had someone else plan a major portion of their waking hours are at a loss when there is no one else there to do it for them.”

Zelinski offers some exercises for finding a path in retirement that begins with “To get a better idea of your true identity, first ask yourself what sort of person you would want to be if work was totally abolished in this world.”

It’s important to find new structure and routines for your leisure to avoid the problem that “after they have left their careers for good, some retirees are so lost that they have been known to start missing jobs they hated and colleagues who used to drive them berserk.”  The retirement “transition can seriously affect one in five individuals, leaving them in a state of mild to severe depression.”

Sadly, a common mistake among people with successful careers is to live unhealthy lifestyles.  “In the event that you are less healthy than you should be, you should put a lot more time and energy into improving your health than increasing the size of your retirement portfolio.”

Although I’ve never had any trouble finding enjoyable and productive ways to spend my free time, one part of this book resonated strongly with me.  This is best summed up by the section’s title: “Your Wealth is Where Your Friends Are: Above All, Friends Make Life Complete.”

Choosing to move to a new country or even within your own country for financial or other reasons is a big step.  Zelinski offers a comprehensive list of what to look for in a new location before making the plunge.  “If you think you’ve found where you want to spend your retirement, the best way to check it out thoroughly is to take a vacation there first.  Go more than once or twice.  Try to visit the city or country in all seasons so you can get a sense for whether you’ll be happy living there full time.”

There are a few areas where this book deserves some criticism.  One is that much of the material is about two decades old, despite the copyright of 2016.  While much of the advice is timeless, one section discusses the dangers of eating too much fat, but we now know that the greater enemy is the unseen sugar added to so many of our foods.  Another criticism is some of the claims of causation from research studies such as “people with negative views about aging shorten their lives by 7.6 years.”  No doubt the correlation exists, but having a negative attitude is often caused by having poor health.  It’s still a good idea to be upbeat, but don’t put too much pressure on someone experiencing constant pain to be positive about life.

The book contains many interesting quotes.  Here are a few:

“A career is a job that has gone on too long. — Jeff MacNelly”

“It is always the same: once you are liberated, you are forced to ask who you are. — Jean Baudrillard”

“The best time to make friends is before you need them. — Ethel Barrymore”

“Reality is a temporary illusion brought about by the absence of beer.”

In conclusion, this book will most help unhappy retirees who find themselves bored and unsure of what to do with their time.  But even readers who already have plans for a satisfying retirement may find a few ideas for making life better.

Friday, July 16, 2021

Short Takes: Inflation, Drawing Down RRSPs Early, and more

I’ve seen a lot of discussion about inflation lately.  The raging debate is whether the inflation we’re starting to see will be “transitory” or not.  The part of all this that amazes me is that so many twitterers think they know the answer.  I don’t know if inflation will be transitory, and I don’t believe anyone else does either, not even the U.S. Fed Chairman.  To be fair, the Fed has to choose some sort of action or inaction, so they have to have some sort of opinion about things they can’t possibly know with certainty.  But the truth is that they keep adapting to changes as they see them in the present to compensate for past predictions that turned out to be wrong.

Here are my posts for the past two weeks:

How to Respond to Rising Stock Markets

Responses to Emails I Usually Ignore

Here are some short takes and some weekend reading:

Alexandra Macqueen shows that even couples with modest RRSP savings can benefit (under the right circumstances) from drawing down RRSPs slowly prior to age 71.

Robb Engen
has decided that he’d rather work less hard for a longer time than hustle like crazy to retire early.  Fortunately for him, the type of work he’s doing lends itself to this approach.  He’s likely to enjoy the work more if it doesn’t dominate all his time.  I’ve certainly known people who’ve claimed to be using this type of strategy, when in reality they’re just lazy or scared of looking for work.  But this doesn’t seem to apply to Robb at all; his reasoning is sound.

Friday, July 9, 2021

Responses to Emails I Usually Ignore

I enjoy interacting with readers who have questions or comments on my articles.  I’ve benefited greatly from this joint pursuit of good ideas about investing and generally handling money well.  Here are some replies to emails I usually ignore.

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Dear Darcey,

I received your exciting “cooperation offer” to post ads on my website disguised as genuine articles.  I’m so grateful that I’d like to make a similar offer.  Please let me know when you’re available for me to drop by your home to dump garbage in your living room.

Sincerely,

Michael

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Dear George,

Please excuse the delay in my reply, but I wanted to wait a few months to see how your prediction of a “permanent” increase in bitcoin prices would work out.  So far, the answer appears to be “not very well.”  This setback has undermined my confidence in your more recent predictions.  I’m starting to think I can’t trust free unsolicited market predictions as a way to get rich.

Sincerely,

Michael

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Dear Julia,

Your client does indeed sound like a very important business in the casino and betting industry.  My blog states that I don’t take fake articles, but you saw through that and asked how much I charge.  For a big player as important as your client is, let’s make it a round million.

Wednesday, July 7, 2021

How to Respond to Rising Stock Markets

As stock markets rise to ever larger price-to-earnings (P/E) ratios, the odds of a market crash grow.  However, we can’t know when such a crash might come, so I’m not interested in trying to time a sell-off of all my stocks.  Stocks remain the best bet for future returns, but how much higher can P/E ratios go before this is no longer true?

When we examine the relationship between Robert Shiller’s Cyclically-Adjusted Price-Earnings (CAPE) ratio to the following decade of stock returns, the correlation is quite weak; the result is closer to a cloud than a straight line.  The most we can say is that when the CAPE is high, future expected stock returns appear to be somewhat lower.  There is logic to the idea that P/E ratios will likely return to some form of normalcy in the future, but this may take a very long time.  In the interim, stocks remain the best bet for future returns.

But at what P/E level can we decide that stocks are no longer a good bet?  Shiller’s U.S. CAPE is at 38 as I write this.  The highest it’s been in the last 150 years is about 45 in the year 2000.  What if the CAPE gets to 45 or higher?  At some point, the future of stocks won’t look very bright.

A few months ago I adjusted my investment spreadsheet to assume that my portfolio’s CAPE (a blended figure based on my allocation across Canadian, U.S., and international stock markets) would drop to 20 by the time I reach age 100.  I kept the assumption that corporate earnings would keep growing at an average rate of 4% above inflation each year.  The effect of this assumed slow reduction of the CAPE is that I would get lower stock returns for the rest of my life, and the amount I can safely spend in retirement is lower.  For more about the details of how I calculate my retirement spending level and portfolio allocation, see my glidepath article.

So, this change has me spending a little less money each month, but it didn’t change my asset allocation.  A minor technicality is that because I use a fixed income allocation of 5 years worth of my safe retirement spending level, this change would have had me lower my fixed income allocation.  I added some calculations to prevent this slight shift to stocks.  It would have been ironic if spending less because I’m worried about high stock prices had led me to own more stocks.  

The way I made this technical adjustment was to increase the 5-year figure to keep my fixed income allocation the same as it would have been without the CAPE-based reduction in expected future stock returns.  This led to another idea.  What if I were to increase this 5-year figure even more when the CAPE is very high?  The idea is to make a gradual shift toward fixed income as the CAPE grows ever larger.

Previously, I arbitrarily chose 20 as the CAPE level where I’d start to adjust downward the percentage of my portfolio I’d spend each month.  So, as stocks keep rising, my spending level rises as well, but not quite as fast as my portfolio goes up.  This time, I’m setting another (higher) CAPE level where I’ll gradually increase my fixed income allocation.

I haven’t decided on this second CAPE threshold, but let’s use 30 as an example.  If the CAPE is above 30, then I take my 5-year spending figure (adjusted as described earlier if the CAPE is above 20) and multiply it by CAPE/30.  So, as the CAPE rises above 30, my fixed income percentage rises.  As my stocks rise in value, the absolute dollar amount I have in stocks will keep rising, but slower than it would have risen before, and my fixed income investments would grow faster than they would have before.

Unless the stock market does something very sudden, all these adjustments will happen at their usual glacial pace.  If the stock market doesn’t crash soon, I’ll make somewhat less money with my lower stock allocation, but that’s fine because I’ve had the enormous benefit of a very long bull run.  (Why keep playing the game when you’ve already won?)  If the stock market crashes from some CAPE level above 30, I will have protected more of my portfolio than I would have before making this change.

Sharp-eyed readers may wonder whether I’m opening myself up to a bond crash.  I don’t buy long-term bonds.  My fixed income is currently in high-interest savings accounts, a few GICs, and some short-term government bonds.  So, a crash in the bond market wouldn’t affect me much.

I don’t claim that this response to nosebleed stock levels is optimal in any sense.  But I do believe it will help me in some stock market crash scenarios without taking away too much of my potential upside.  A further benefit is that I can automate it in a spreadsheet and keep my feelings out of any decisions.