Friday, January 29, 2021

Short Takes: Broken Brokers, 2020 Returns, and more

I was reminded recently that companies change over time.  Years ago, I bought a Remington shaver.  My reaction was similar to Victor Kiam’s: “I liked the shaver so much I bought the company.”  I didn’t buy the company, but I bought nothing but Remington shavers for decades.  My perception was that Remington was a company that sold a high-end product, and I was willing to pay for a better shave.

However, when the time came to replace my shaver recently, all the Remington choices were suspiciously inexpensive.  I settled on the F4 model, which turned out to be terrible.  Scraping it over my face for three times as long as my previous shaver didn’t produce an acceptable shave.

I decided to contact the company to see if I had just missed a better model.  They annoyed me by suggesting that I don’t know how to shave correctly and ultimately offered me my money back.  They didn’t seem to understand that I didn’t care about getting my money back; I just wanted them to point me to a good shaver.  They couldn’t do it.

Now I have a Braun Series 8 shaver.  It’s considerably more expensive, but it gives a good shave quickly.  My long-time impression of Remington as a top-notch company is gone.  They changed to a low-cost (and from my limited experience, low-quality) seller.  Companies change.  (Disclaimer: I have no financial relationship with the companies mentioned other than having bought their products.)

Here are my posts for the past two weeks:

Master Your Mortgage for Financial Freedom

The Psychology of Money

My Investment Return for 2020

I Will Teach You to be Rich

Reader Question on Portfolio Drawdown

Here are some short takes and some weekend reading:

Tom Bradley at Steadyhand tells the story of a broker’s customer being 51st in line to chat online with his broker, but when he came back to chat as a prospective customer, he got through right away.  Tom believes “Your most important customers are the ones you already have.”  Too bad this broker didn’t see it that way.

Canadian Couch Potato goes through the 2020 returns of Vanguard and iShares asset allocation ETFs.  He also explains why the iShares funds outperformed slightly.  Justin Bender does a deeper dive into these ETFs’ returns in his latest video.

Preet Banerjee interviews Erica Ehm on his Mostly Money podcast to discuss her career and professional reinvention.

New research says well-being rises with income, even above $75,000 per year.  This appears to contradict widely reported results claiming that income above $75,000 doesn’t improve happiness.

Kerry Taylor offers a way of thinking through spending decisions to help you curb spending.  As someone who has had to learn to spend more, I think my extremely low spending until I was about 35 was mostly based on habits.  For the most part, certain types of spending just rarely occurred to me.  So, maybe Kerry’s approach to more conscious spending will help to form new habits so that ultimately you won’t have to think through every spending choice.

Big Cajun Man finds support from Chris Rock on how a mortgage changes you.

Tuesday, January 26, 2021

Reader Question on Portfolio Drawdown

Reader N.T. asked me the following thoughtful question (lightly edited for brevity and privacy):

I was reading your article Calculating My Retirement Glidepath, and I am still a little confused on your drawdown strategy. I think I understand the broad concept but I am confused on the details on how to execute.

I was hoping you can comment on what I plan on doing with my parents’ retirement drawdown strategy. They are ETF index investors like yourself with a 60% stock/40% short-term bonds split. My dad will be 73 and my mom will be 60 when they retire. I plan on withdrawing 4-4.5% from their investment portfolio. Based on the safe withdrawal of 4% study and some of the recent research done from another great Michael, Michael Kitces, I think the success rate of my parents not running out of money is like 98-99%.

I can’t tell you how you should handle your parents’ retirement spending, N.T., but I can explain how I would handle it for myself.  There are three areas I’ll discuss: what to sell to generate spending money, how much to spend, success rate, and parameter selection for the plan in my paper.

What to Sell

It’s unlikely that your parents’ portfolio will generate enough dividends and interest to reach their target spending level in retirement, so they’ll have to sell assets periodically.  Regardless of how often you choose to sell assets, when you have a target asset allocation, such as 60% stocks/40% bonds, the choice of what to sell is fairly easy: sell some of the ETF that is overweight to get back to the target allocation.

A more difficult decision is whether to change the 60/40 mix over time.  One of my personal rules is that I don’t try to make asset allocation adjustments based on my intuition about future returns.  My plans are purely mechanical.  You might choose to think about what asset allocation will make sense in 10 years, 20 years, and 30 years.  This will guide you to how to adjust the allocation as your parents age.

How Much to Spend

Your choice to have your parents’ annual spending 4-4.5% of their portfolio initially is in the range I’d choose.  However, you need to think about how this will change over time.  I’m not a fan of the inflexible plan to adjust the dollar amount by inflation every year and ignore portfolio performance.  

It was fine for William Bengen to run experiments on this inflexible plan to try to minimize the odds of having to make painful spending cuts, but I plan to be more flexible than this in my own spending.  I have a plan for how the percentage of my portfolio that I spend will increase slightly each year (similar to the increasing required RRIF withdrawals based on age).  If my portfolio’s returns disappoint, then I’ll have to spend less, and if it outperforms, then I can spend more.

Many people have a plan that is somewhere between Bengen’s rigid spending and my flexible spending plan.  They take the previous year’s spending, adjust it for inflation, and then adjust it up or down a little depending on how their portfolio performed.  The more flexible you are, the safer it is to go for the upper end of your 4-4.5% starting range.  However, don’t overestimate your parents’ ability to tighten their belts after a stock market crash.

Success Rate

The success rate of any plan depends greatly on several assumptions about returns.  If today’s high stock market P/E ratio drops to more “normal” levels in the coming decade or two, this will have a significant effect on the probability of running out of money.

Success rate also depends on spending flexibility.  As I’ve described my plan, it’s impossible for me to run out of money, because I have a planned percentage withdrawal every year based on the then current portfolio size (but I could end up spending very little if stock markets perform very poorly).  At the other extreme, Bengen’s rigid plan will have a certain failure rate (for given return assumptions).  This failure rate is lower when we introduce some spending flexibility.

Parameter Selection

If you want to follow the exact plan I laid out in the paper referenced in the Calculating My Retirement Glidepath article, you need to select the parameters you want to use.  I don't recommend this unless you're mathematically inclined and want to automate all this in a spreadsheet or other software.

Suppose you decide that the portfolio needs to last n=35 more years, that bonds will return about 1% per year (b=0.01), and you want the starting spending level to be in the middle of the range you identified (s=0.0425).  Using equation (2) in the paper, you'll find that y=9.88 years of bonds will give you the starting 40% allocation to bonds.  Using equation (3), you'll find that a stock return assumption of r=0.0416 makes a 4.25% starting withdrawal rate sustainable.

So, N.T., I hope this helps fill in some of the gaps for you.  I’m happy to answer further questions if I can.

Monday, January 25, 2021

I Will Teach You to be Rich

There aren’t many financial gurus willing to call out financial companies by name for their bad behaviour, but Ramit Sethi is one of them.  In his book I Will Teach You to be Rich, he promises “a 6-week program that works,” and he includes advice on which banks to use and which to avoid.  The book is aimed at American Millennials; Canadians will learn useful lessons as well, but much of the specific advice would have to be translated to Canadian laws, banking system, and account types.  The book’s style is irreverent, which helps to keep the pages turning.

It may seem impossible to fix a person’s finances in only 6 weeks, but this is how long Sethi says it will take to lay the groundwork for a solid plan and automate it with the right bank accounts and periodic transfers.  The execution of the plan (e.g., eliminating debt or building savings) will take much longer.

Sethi is rare in the financial world because he will say what he really thinks about banks.  “I hate Wells Fargo and Bank of America.”  “These banks are pieces of shit.  They rip you off, charge near-extortionate fees, and use deceptive practices to beat down the average consumer.  Nobody will speak up against them because everyone in the financial world wants to strike a deal with them.  I have zero interest in deals with these banks.”  For the banks he does recommend, “I make no money from these recommendations.  I just want you to avoid getting ripped off.”

People have many reasons why they can’t save and are in debt, but Sethi sees them as just excuses in most cases.  “I don’t have a lot of sympathy for people who complain about their situation in life but do nothing about it.”  “Cynics don’t want results; they want an excuse to not take action.”  He urges readers to “put the excuses aside” and get on with the business of making positive changes.

The Program

The first step in the program is to “Optimize Your Credit Cards.”  I found it interesting that Sethi focused on credit card perks before he covered eliminating credit card debt.  He wants readers to “play offense by using credit cards responsibly and getting as many benefits out of them as possible” instead of “playing defense and avoiding credit cards altogether.”  This approach sets him apart from many other experts on getting out of debt.  While he does teach methods of eliminating debt, his focus is more on building wealth steadily.

The second step is to open “high-interest, low-hassle accounts.”  Interestingly, he wants readers to open a chequing account at one bank and a savings account at another bank.  Among his reasons are that the psychology of a separation between accounts makes us less likely to raid savings.  Some might think opening a savings account is pointless if they have no money to deposit, but Sethi insists that you need to lay the groundwork now for a better future, even if you’ve only got $50 to deposit.

The third step is opening investment accounts.  The author favours very simple investments, such as a Vanguard mutual fund account invested in a target date fund.  “Don’t get fooled by smooth-talking salespeople: You can easily manage your investment account by yourself.”  Unfortunately, Vanguard mutual funds are only available to Americans.  Canadians can find one-fund solutions with certain Exchange-Traded Funds (ETFs).

To create the cash flow to reduce debt and invest, the fourth step is about “conscious spending,” which is “cutting costs mercilessly on the things you don’t love, but spending extravagantly on the things you do.”  Achieving this involves tracking spending in different categories, but not traditional budgeting.

The fifth step is to automate money flows for your fixed costs, investments, savings goals, and monthly guilt-free spending money.  This “will be the single most profitable system you will ever build.”  Doing this step well means you won’t have to think about your overall financial situation on a daily basis.  A good automated system will take you where you need to go.  If there is money in your guilt-free spending account, then spend it on your desires of the moment.  If the money isn’t there, then don’t.

Sethi devotes a full chapter to “The Myth of Financial Expertise.”  He does an excellent job of explaining why a financial advisor can’t help you to beat the market.  “Most young people don’t need a financial adviser.”  “Some of them will give you very good advice, but many of them are pretty useless.  If they’re paid on commission, they usually will direct you to expensive, bloated funds to earn their commissions.”

The last step involves choosing how you will invest.  “Investing is not about picking stocks.”  “By even considering buying individual stocks because you think you can beat the market or it’s sexier, I want you to take all your money, put it in a Ziploc bag and light it on fire.  At least you’ll be skipping the middleman.”  “With automatic investing, you invest in low-cost funds—which replace worthless, expensive portfolio managers.”

Other Quotes

“Leasing [a car] nearly always benefits the dealer, not you.”

“Real estate is the most overrated investment.”  “Investing in the stock market has trumped real estate quite handily.”

“Student loans can be a great decision,” but “many predatory colleges and graduate schools lie to young Americans about the actual value of their degree.”  You need to do your own research into whether the degree you’re interested in will lead to a good-paying job.


This is a fun but serious book designed to teach American Millennials to manage their money well and meet their own definition of a rich life.  Canadians can get value from the book as well, but they’ll have to do some extra work to modify the aspects specific to the U.S.

Thursday, January 21, 2021

My Investment Return for 2020

Last year I said I wasn’t counting on 2020 delivering another year of double-digit returns.  Well, despite a wild ride in the stock market, I wasn’t too far from double digits with a return of 7.7%.  This almost exactly matches my 2020 benchmark return of 7.6%.

My return is somewhat lower than 2020 stock market returns because I’m now retired and have 5 years worth of my safe spending level in a combination of savings accounts, GICs, and short-term bonds.  This amounts to about 20% of my portfolio, and the rest is in stocks (see here for more detail on my holdings and how I run my portfolio).

There were two main factors that determined how well my portfolio performed relative to my benchmark.  The first is that because I’m living off my savings, the returns from early in the year are slightly over-weighted compared to later in the year.  So, the stock market crash brought my portfolio’s returns down more than my benchmark’s returns.  The second factor is that because there was so much stock market volatility, my threshold rebalancing plan gave unusually high added returns.  These two factors mostly offset each other.

The following chart shows my cumulative investment results since 1994 adjusted for inflation.

That big bump in 1999 was the result of reckless portfolio concentration that happened to work out well.  I could just as easily have been wiped out.  I won’t make that mistake again.

For about the past decade, my returns have closely matched my benchmark return because I've been committed to index investing during that time.

As usual, I have no idea what 2021 will bring, but my fixed income allocation will serve to moderate any extreme returns the stock markets give us.

Wednesday, January 20, 2021

The Psychology of Money

Morgan Housel is an excellent writer.  No matter the topic, any article of his is a compelling read, as is his book The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness.  It may seem bold to declare the lessons you teach to be “timeless,” but Housel delivers on this promise.  Thoughtful readers will learn about themselves in reading this book.

The format of the book is 20 independent essays, with just a few threads linking them together.  Collectively, though, they provide useful insight into the way we all think about money.

The introduction observes that we’ve collectively “become better farmers, skilled plumbers, and advanced chemists,” but Housel has “seen no compelling evidence” that we’re getting better at handling our money.  He believes this is because “we think about and are taught about money in ways that are too much like physics (with rules and laws) and not enough like psychology (with emotions and nuance).”  I’d like to add another reason.  Finances are a competitive business pitting consumers against sellers and everyone against banks.  Expecting collective improvement is a little like bemoaning the fact that the 50% average win rate of tennis players hasn’t improved in decades.

My favourite essay is “The Seduction of Pessimism.”  Historian Deirdre McCloskey said “For reasons I have never understood, people like to hear that the world is going to hell.”  Housel explains why this is true, despite the fact that “Optimism is the best bet for most people because the world tends to get better for most people most of the time.”

Another good essay is “Wealth is What You Don’t See.”  Flashy spending signals wealth to us, but the only thing we can be sure of when we see an expensive car is that the owner has less money by the amount of the car.  True wealth is the money you haven’t spent.

One essay tries to make the case that it’s better to be reasonable than to be rational.  I was confused at first, but it seems Housel uses a different definition of “rational” than I use.  He gives a number of examples where a seemingly rational choice doesn’t work well because of factors it fails to take into account such as pain, worry, and regret.  However, I think of “rational” as making decisions taking into account all material factors, including the cost of the time spent making the decision.  For example, it is rational to take into account the possibility that investors might lose their nerve and sell at a terrible time.  

A concern I have about the belief that “reasonable” is better than “rational” is that it can be taken too far.  Housel gives some good examples where people’s feelings and tendencies are important to making a decision, but anyone could reject any rational choice asserting that a different choice is reasonable.  For example, “I won’t be able to live with myself unless I pile all my net worth into Tesla stock, so that’s reasonable for me.”  Sometimes it’s better to find a different way to deal with feelings than to put your finances at serious risk.

The essay “Surprise!” makes the case that the world is surprising, and that while a careful study of history may be a good idea, it won’t eliminate future surprise.  Housel says the failure of the Fukushima nuclear reactor (due to it only being able to “withstand the worst past historical earthquake”) was “not a failure of analysis.  It’s a failure of imagination.”  Having spent a career in engineering, I can imagine that it might have been a failure of management as well.  Even if engineers had made the case that a powerful future earthquake was too likely, higher costs and extended timelines might have been intolerable to management.

“The more you want something to be true, the more likely you are to believe a story that overestimates the odds of it being true.”  I often see others believe things just because they want them to be true.  This makes me wonder what I believe just because I want it to be true.

The 20th essay includes an account of how Housel handles his own money.  “Effectively all our net worth is a house, a checking account, and some Vanguard index funds.”  For my own case, all I’d add is that I have a savings account as well.

Unlike most financial books that readers may struggle through, I found this book to be a page turner.  Even when I mildly disagreed with a few parts, it was consistently interesting and made me examine my own thoughts about money.

Monday, January 18, 2021

Master Your Mortgage for Financial Freedom

Many people have heard of the Smith Manoeuvre, which is a way to borrow against the equity in your home to invest and take a tax deduction for the interest on the borrowed money. 

It was originally popularized by Fraser Smith, who passed away in Spetember 2011.  Now his son, Robinson Smith, has written the book Master Your Mortgage for Financial Freedom which covers the Smith Manoeuvre in detail for more modern times.  Smith Jr. explains the Manoeuvre and its subtleties well, but his characterization of its benefits is misleading in places.

The Smith Manoeuvre

In Canada, you can only deduct interest payments on your taxes if you invest the borrowed money in a way that has a reasonable expectation of earning income.  Buying a house does not have the expectation of earning income, so you can’t deduct the interest portion of your mortgage payments.

However, if you have enough equity in your home that a lender is willing to let you borrow more money, you could invest this borrowed money in a non-registered account and deduct the interest on this new loan on your income taxes (as long as you follow CRA’s rules carefully).  A common mistake would be to spend some of the invested money or spend some of the borrowed money.  If you do this, then some of the money you borrowed is no longer borrowed for the purpose of investing to earn income.  So, you would lose some of your tax deduction.

With each mortgage payment, you pay down some of the principal of your mortgage, and assuming the lender was happy with your original mortgage size, you can re-borrow the equity you just paid down for the purpose of investing and deducting any interest on this new loan.  Some lenders offer mortgage products with two parts: the first is a standard mortgage, and the second is a line of credit (LOC) whose limit automatically adjusts so that the amount you still owe on your standard mortgage plus the LOC limit stays constant.  So, after each standard mortgage payment, your LOC limit goes up by the amount of mortgage principal you just paid, and you can re-borrow this amount to invest and deduct LOC interest on your taxes.  This is the Smith Manoeuvre.

Smith describes a number of ways of paying off your mortgage principal faster (that he calls “accelerators”) so that you can borrow against the new principal sooner and boost your tax deductions.

Compared to a Standard Mortgage Plan

Ordinarily, mortgagors pay off their mortgages slowly over many years.  Their risk of losing their home because of financial problems is highest initially when they owe the most.  This risk declines as the mortgage balance declines, and inflation reduces the effective debt size even further.

With the Smith Manoeuvre, the total amount you owe remains constant (declining mortgage balance plus LOC balance) or may even increase as your house value increases and your lender is willing to lend you more money against your house.  So, your risk level as a function of how much you owe doesn’t decline in the same way as it does with the standard mortgage plan.  You could argue that your financial risk does decline somewhat because you’ve got your invested savings to fall back on in hard times, but your risk certainly doesn’t decline as fast as it does with the standard plan.

Leveraged Investing

Smith likes to say that the Smith Manoeuvre isn’t a leveraged investment plan.  He justifies this assertion by saying that you’ve already borrowed to buy your home, and you’re now slowly converting this mortgage that isn’t tax deductible to an LOC debt that is tax deductible.

In fact, the Smith Manoeuvre is a leveraged investing plan.  Under a standard mortgage plan, you would have slowly decreased your leverage and risk over time.  With the Smith Manoeuvre, you maintain your leverage.

Smith Manoeuvre Benefit

To illustrate how you can benefit from the Smith Manoeuvre, Smith assumes that your invested savings will earn 8% per year, after income taxes.  Assuming a 1% annual cost in income taxes on dividends and capital gains, the pretax assumed return is 9% per year.

In one example with a $400,000 mortgage, the Smith Manoeuvre has you coming out ahead roughly $440,000 after 25 years.  But this is misleading because we’re talking about future dollars.  If we assume that we shouldn’t count on more than a 5% real return, then our 9% portfolio return corresponds to 4% inflation.  Discounting the $440,000 to present-day dollars gives about $165,000.

So, the question you must ask yourself is do you want to implement the Smith Manoeuvre to possibly get $165,000 extra dollars if the stock market cooperates and nothing happens in your life for 25 years to mess up this plan?  This type of question always comes up when considering using leverage.  A stock market crash, a housing decline, or losing your job are all potential risks, particularly if they happen in combination.  The Smith Manoeuvre’s risk/reward combination wouldn’t have appealed to me when I was young and buying my first house, but others may differ.


The first couple of chapters offer little information about the Smith Manoeuvre.  They are designed to give you the feeling that you’re missing out on tricks that rich people know about, that you’ll retire in poverty, and that you should be outraged by high taxes.  These chapters also contained lots of marketing for Smith’s online calculator ($70 plus $4/month as of this writing), a homeowner course ($300 as of this writing), and training programs for financial professionals to get “certified” on the Smith Manoeuvre and get “territorial exclusivity.”

I almost gave up at this point, but the book took a sharp turn and began giving clear, detailed information about the mechanics of employing the Smith Manoeuvre, its various subtleties, and warnings about mistakes that could jeopardize your tax deductions.

I am of two minds about the calculator, courses, and training.  Avoiding mistakes with the Smith Manoeuvre really is complicated enough that people could use some training (or at least some mandatory reading), but I have no idea whether the courses and training offer enough value to justify their cost, and it was annoying to see the constant marketing references throughout the book.

Another Misleading Comparison

Smith introduces two couples to show the power of the Smith Manoeuvre.  The Marshalls have an annual income of $100,000 and decide to use the Smith Manoeuvre.  The Joneses earn a whopping $300,000 per year, but go the conventional route.  In addition to the extra income, the Joneses save $700/month compared to the Marshals’ $500/month, and the Joneses start with $150,000 invested compared to only $50,000 for the Marshalls.

Amazingly, the Marshalls come out ahead in net worth 25 years later despite making $200,000 per year less.  Unmentioned is that the Joneses did almost nothing with their $300,000/year income to help themselves other than saving $200/month more than the Marshalls did.  The presumption is that the Joneses just spent almost all of their large income.  So, this difference in income was hardly factored into the comparison at all.  The Joneses could have made only $90,000 and scrimped more.

Other Observations

In one case study, “even if the Petersens only earned 2% on their investment portfolio, they’d still be better off with The Smith Manoeuvre by over $912,000.”  I can’t see how this is true when the interest rate on their mortgage is 4.5%.  I understand that loan interest is 100% tax deductible, and dividends and capital gains aren’t 100% taxed, but it seems like a stretch to get a meagre 2% investment return to overcome 4.5% loan interest.

Smith advocates getting rid of emergency funds and collapsing RRSPs and TFSAs. He says to use the money to pay down the mortgage to generate more principal to borrow against for investing.  I’m not a fan of going all in on risk and just hoping you never lose your job.

Table 4.5 compares the progress of Darren (who didn’t use the Smith Manoeuvre) and Mark (who did).  Darren ended up having to take out a lump-sum reverse mortgage, but the table of net worth progress fails to account for the remaining amount from the lump sum.

A chart of the 2019 top marginal tax rates in each province has the wrong figure for Ontario.  It lists 46.16%, but the actual figure was 53.53%.


If you’ve already decided you want to implement the Smith Manoeuvre, this book is a valuable resource for understanding the subtleties of implementation.  However, if you’re trying to decide whether to proceed, you need a more objective source of information, or at least additional sources to see all sides.

Friday, January 15, 2021

Short Takes: Behavioural Economics, Renting vs. Buying a Home, and more

I decided to check out the Microsoft software class action settlement.  They say “If you bought PC versions of Microsoft MS-DOS, Windows, Office, Word, Works, and/or Excel between December 23, 1998 and March 11, 2010 (inclusive), you may be eligible for compensation from this settlement.”  There is a link to submit a claim online.  I bought 4 computers during the relevant period, each with Windows and Office.  They assigned a claim value of $13 for Windows and $8 for Office (at least in my case).  So my claim total came to $84.  You have until 2021 Sept. 23 to submit a claim and if you get any money, it won’t be until 2022 sometime.  By then I will have forgotten about it and any money I get will brighten my day.

Here are my posts for the past two weeks:

The Myth of Simple Interest on Loans

Your Money or Your Life

The Total Money Makeover

The Right Way to Calculate Net Worth

Is Delaying CPP “Actuarially Neutral”?

The Sleep-Easy Retirement Guide

Here are some short takes and some weekend reading:

Kerry Taylor interviews Dan Ariely, well known behavioural economist and best-selling author.

The Stress Test Podcast (Episode 6 of Season 2) brings in Preet Banerjee for a sensible discussion of the rent vs. buy decision for your home.

John Robertson takes a first look at Tangerine’s new mutual funds with lower MERs than their old funds.

Thursday, January 14, 2021

The Sleep-Easy Retirement Guide

There are many big questions when it comes to retirement and David Aston meets them head on in his thoughtful book The Sleep-Easy Retirement Guide: Answers to the Biggest Financial Questions That Keep You Up at Night.  His style is to discuss the advantages and disadvantages of different courses of action which works very well for the big questions he tackles.

The main audience for this book is “relatively knowledgeable readers” and “the seasoned investor” who need help “answering the more complex and challenging questions.”  The first question sets the tone for the rest of the book: “How can I fit my retirement dreams within my financial reality?”

The Big Questions

In the chapter covering, “How big a nest egg will I need?,” the author does an excellent job making it clear that the safe starting withdrawal rate depends on how old you are when you retire, a fact that too many commentators miss.  For those retiring at 65, he suggests the default starting withdrawal rate is 4%.  But he “recommends reducing the withdrawal rate by 0.1 percentage point per year for retiring between age 60 and 64, and increasing it by 0.1 percentage point per year for retiring between age 66 and 70.”  He goes on to identify other reasons why you might adjust this withdrawal rate up or down.

In answering the question “How much do I need to save each year?,” instead of focusing on a single saving rate, Aston identifies multiple patterns of saving (steady saving, gradual ramp-up, and saving after the mortgage is gone), and shows the savings rate needed for each pattern.  This is just one example of the many ways he recognizes that different people often need different approaches.

When answering the “How long do I need to work?” question, the author gives a detailed example showing how working an extra year or two or three affects your ultimate retirement cash flow.  It’s hard to decide how long to work without such a detailed accounting of how much working longer helps.  One quibble I have is that he didn’t account for the fact that delaying CPP payments causes them to rise with wage inflation rather than CPI inflation even though he points this fact out later: “wages have grown roughly one percentage point faster on average than consumer prices, so chances are that the impact of different indexing factors will grow your CPP entitlement a little faster by deferring it rather than starting it.”

For the “How much should I plan to spend in retirement?” question, Aston gives profiles of several couples and singles along with numerical examples of basic, average, and deluxe retirements.  This gives readers an understanding of what type of retirement they can expect for a given annual spending level.

For the “How much can I draw from my savings each year?” question, the author offers a range of possible answers depending on your risk tolerance and desires in retirement.  One possibility to boost initial spending is to “commit to a real spending decrease of 1% a year every year.”  This idea is backed up by studies showing that this is what the average retiree does.  It’s easy to imagine an elderly version of yourself spending little, but you have to ask yourself if you’d really want to spend less every year, even in your 60s.  These studies average together data from people who choose to spend less as they age with people who are forced to spend less because they’ve overspent early on.

The answers to the question “How do I manage my investments in retirement to make my money last?” include the possibility of buying an annuity.  I particularly like the focus on annuities whose payments rise by 2% each year.  This isn’t a perfect offset to inflation, but it’s far better than fixed annuities (the most common type) that leave you watching your payments drop to half or one-third of their original buying power in your old age.

For the “How can I use the value of my home to help my retirement?” question, the main possibilities are to downsize early or to plan to tap into your home’s value only as a last resort.  However, the claim that “Rental costs usually far exceed owner-specific costs borne by homeowners” requires that we ignore the cost of capital tied up in a paid-for home.  Today’s high housing costs make renting look like the better financial choice.  I prefer to own, but that doesn’t make it better than renting financially.

The chapter on retirement homes, independent living, assisted living, and nursing homes is very informative and thorough.  There is a wide range of options at different price levels that are potentially better than suffering isolation in your home and paying for expensive in-home help.  “While many seniors are intent on staying in their own traditional family home as long as possible, what is often overlooked is that a retirement home can be a home too, after you get accustomed and then attached to your new locale and make friends among fellow residents.”  Aston considers the case for long-term care insurance to be dubious: “needing long-term care isn’t really a low probability event.  … That necessarily means that LTCI premiums are relatively expensive compared to the potential payouts they generate.”  Further, the existence of government supported nursing homes means that “To an extent at least, the government has your back already.”

For the “How can I save my retirement if my finances get off track?” question, Aston splits it into cases where your retirement is far off, it’s almost here, and you’re already retired.  The longer you have until retirement, the more choices you have for getting back on track.  For people making good money and who aren’t sure they have enough saved, “it’s probably a good idea to try to hold on to your career job a bit longer, because once you give it up, it’s usually tricky to find another job with equal earning power.”


The discussion about how much we can expect from CPP and OAS and when we should start them is better than I’ve seen from many other commentators, but I have some concerns.  Most people have a strong bias towards taking CPP and OAS as soon as possible for mostly emotional reasons.  It’s difficult to give an objective overview of CPP and OAS without playing into this bias.  Some obvious reasons to take CPP and OAS early are if “your health is poor” or “you need the cash flow.”  However, this isn’t the same as being worried you might die young or that you want the cash flow.

Aston says that CPP and OAS are designed to be “actuarially neutral” and that “you won’t usually go too far wrong if you start them any time after you retire and are eligible.”  I already have a post explaining that CPP and OAS don’t look actuarially neutral from the point of view of Canadians who are forced to plan for a long life because they don’t know how long they’ll live.

Another possible problem with delaying CPP and OAS to age 70 that Aston describes is for a couple who spend down their savings in their 60s but one spouse dies near age 70.  This eliminates that spouse’s CPP and OAS and replaces it with a small CPP survivor pension.  This scenario sounds scary and without any means of quantifying the change to cash flow, it’s difficult to tell if you should be concerned.  I crunched the numbers for my own case, and my wife’s standard of living would actually increase if I died at 70, but that only applies to us.  The book would serve its readers better if it contained some example scenarios to show when this problem arises and how severe it is.  Otherwise, it’s just another vague fear driving people to take CPP and OAS early.

The book cites another reason for possibly taking CPP early: “You’ve spent lots of time out of the workforce.”  For technical reasons (related to years with low CPP contributions that you’re allowed to “drop out” from the CPP benefits calculation), if you have several low income years, and you don’t work from age 60 to 65, the boost you get from delaying CPP won’t be as large as it could have been.  This applies to me.  However, I’m still much better off taking CPP at 70.  So, this situation is just a factor to consider rather than a reason on its own for taking CPP early.

The first reason cited for taking CPP later is “You have above-average life expectancy.”  This is true but somewhat misleading.  You don’t need to be healthier than average.  As long as living longer than average is a possibility you can’t ignore in your planning, then you have to stretch out your savings, and delaying CPP and OAS might help improve cash flow.

“Retirement expert and author Fred Vettese says the CPP deferral rates incorporate the assumption of close to a 4% ‘real’ return after adjusting for inflation.”  It’s important to put this into context or else investors who think they can beat a real 4% return will think they’re better off taking CPP early and investing the money.  The 4% real return baked into CPP deferral applies only if you have an average lifespan.  When you consider the possibility of living to 95, the rate jumps to 7% above inflation.  Only overconfident investors believe they are likely to beat inflation by a compound average of 7% per year for the next 30 or more years.

An excellent point: It “doesn’t make sense to consider purchasing an annuity without giving serious consideration first to enhancing your CPP pension by deferring it.  In essence, CPP is a superior form of annuity (indexed for inflation, unlike the kind available for purchase, which is not) that comes with attractive terms for deferral.”

Active Investing

The author is too optimistic about the possibility of hard-working investors outperforming the market with security selection or market timing.  The evidence is clear that in recent decades, stock picking is so competitive that few professional investors have much hope in beating the markets, except by luck.  Individual investors have less hope.

In a discussion of bucket investing (one bucket for cash and another for the rest of your portfolio), if there is a downturn, Aston advises shifting spending to the cash bucket, only “selling long-term assets when prices are favourable,” and possibly “postponing the regular rebalancing of your portfolio.”  This all sounds reasonable enough until you try to implement it and realize you’re forced to make frequent judgment calls about what constitutes a downturn.  I prefer a purely mechanical strategy where my judgment isn’t involved.

One of the investing strategies suggested is choosing dividend stocks for income.  We’re to “look for profitable, well-managed, blue-chip companies with sound balance sheets.  The proportion of profits paid out in dividends (known as the ‘payout ratio’) should be within reasonable limits for that industry.  The companies should have strong competitive positions in stable industries that are growing.”  The vast majority of investors who work at this diligently will just make random selections based on past results that look good.

A “moderately knowledgeable investor” “can adopt a … do-it-yourself approach to create a portfolio using individual stocks, bonds and GICs.”  I disagree that this path makes sense for a moderately knowledgeable investor.  Even most professional investors fare poorly.

“I believe the key to superior investment selection for many active brokers is to make effective use of a top-notch research department by closely following their recommendations on specific stocks and other investments suitable for specific types of clients.”  I don’t believe this is likely to give good results.

A good advisor “should be able to provide a comparison for you of the historical performance of the investments they use or recommend against a market benchmark.”  This is too easy for an advisor to game by shopping for benchmarks with weak results.


This book tackles head on most of the questions we have about preparing for retirement.  It covers a wide range of possible solutions to these big challenges.  Knowledgeable readers won’t get prescriptions for exactly what to do and won’t agree with everything they read, but they will learn useful ways to think about the problems and new ideas for solving them.

Tuesday, January 12, 2021

Is Delaying CPP “Actuarially Neutral”?

You can start your Canada Pension Plan (CPP) payment any time from age 60 to 70.  The longer you wait, the bigger the monthly payments.  We often hear that CPP is designed to be actuarially neutral, which means that you expect to get the same total amount from the system no matter when you start taking payments.  However, the truth of this statement changes depending on whose point of view we consider.

In his thoughtful book The Sleep-Easy Retirement Guide, David Aston writes that CPP is “designed to be ‘actuarially neutral’” and “you won’t usually go too far wrong if you start [payments] any time after you retire and are eligible.”  This isn’t true for most of us.

If we look at this from the point of view of the CPP system itself, it’s true that they care little whether you start payments early or late.  As long as their guess is right about how long the average person will live, they know how much they’ll pay out.  To be even one year off in their average longevity estimate would be considered a large error.

Next, let’s look at this from the point of view of people who are wealthy enough that they’ll never spend all their money.  Then timing CPP becomes a game of trying to maximize the estate they leave for their heirs.  For a wealthy person of average health, CPP timing doesn’t make much difference averaged across all possible lifespans.

But what about the vast majority of us who do need to be worried about running out of money in retirement?  Suppose Mary is in her 50s, has average health, and her life expectancy is about 82.  For planning purposes, Mary might decide that a reasonable range for how old she’ll get is somewhere between 70 and 95.

What should Mary do with this information?  She could decide she’s worried about dying young and make sure she spends all her savings by the time she’s 70.  This has the obvious disadvantage of leaving her eating cat food in her 70s and beyond.

Mary could go the other way and stretch out her savings until she’s 95.  This has the disadvantage that if she doesn’t make it to 95, she won’t get to spend some of her money.

Which is the more serious problem?  I’m much more worried about running out of money than leaving some money unspent.  While some people might choose to spend a little extra when they’re young enough to enjoy it, I’m guessing that most people would choose to stretch out their savings in case of a long life rather than spend it all quickly so they leave no money behind.

So, how does this thinking carry over to when we should start CPP?  If Mary has to plan for a long life to age 95, she’ll get a lot more out of CPP if she starts her payments when she’s 70 instead of starting them earlier.  The total amount of money Mary will have available to spend between now and when she’s 95 is greater if she delays the start of CPP to age 70.    Even the modest CPP payment penalty that can arise if Mary makes no CPP contributions between age 60 and 65 doesn’t change this conclusion.

Doesn’t this mean Mary will have to suffer between now and when she turns 70?  Not as long as Mary has enough savings to spend in place of the CPP payments she won’t get in her 60s.  Even though Mary is in her 50s today, as long as she has enough savings to bridge the gap through her 60s, the decision to start CPP at 70 allows her to spend more starting today.

From the typical Canadian’s point of view, the rules for increasing CPP payments when you start taking them later don’t look actuarially neutral.  We are forced to plan for the possibility of a long life, and this makes delaying CPP to age 70 look profitable for those who are healthy and have enough savings to get through their 60s.

Monday, January 11, 2021

The Right Way to Calculate Net Worth

A few years ago, Robb Engen wrote an article with the same title as this one.  He convincingly defended his method of calculating net worth.  I don’t think he’s wrong, but his method doesn’t work for me.  The reason is that he calculates his net worth for a different purpose than I do.

The idea of Assets - Liabilities = Net Worth is simple enough.  What’s the debate?  It turns out that what to count among assets and liabilities isn’t always obvious.  Robb says “The correct formula for calculating net worth is the one you use consistently over time to measure progress. That’s it.”  Implicit is the idea that your goal is to measure progress.  At my stage of life, my goal is different.

When I was younger my main purpose in calculating my net worth was to measure my financial progress.  However, as I approached retirement I became more interested in how much I could safely spend each month during retirement.  This different goal puts new requirements on how I calculate net worth.

Other goals are possible as well.  Below, I list three different reasons why we might calculate net worth, and then go through various assets and liabilities to see how they would be included in net worth for the different goals.

Personal Progress

Am I gaining or losing ground in my net savings?  Unless you add up your assets and liabilities, it’s easy to focus on your RRSP or TFSA but not notice that your debts are growing faster.  You’re not overly concerned with standardizing your net worth calculation for the purpose of comparing your net worth to that of others.  You prefer a simple calculation method that tells you whether you’re getting ahead or falling behind over time.

Retirement Spending

You’re concerned with how much you can safely spend each year during retirement.  You may be approaching retirement and want to know if you’ve saved enough, or you may be retired already.  You intend to use your net worth figure to directly calculate annual retirement spending using the 4% rule or some better variant.

Assets Under Management (AUM)

You’re a financial advisor concerned about the total assets a client brings to your practice.  Even advisors who focus mainly on their clients’ welfare still care about how a given client affects their AUM if they get paid by commissions or a percentage fee.

Now let’s go through some assets and liabilities to see how to handle them depending on your goal.


Personal Progress:  Just add the value of your RRSP to your assets.  The extra complication of discounting your RRSP for the future taxes you’ll pay on withdrawals is unlikely to give you much more insight into the progress you’re making over time.  An exception is if you’re growing RRSP assets at the same time as growing debt.  Having $10,000 in an RRSP and owing $10,000 may seem like a wash, but it’s not because of the taxes you’ll pay to get at the RRSP assets.

Retirement Spending:  You can only spend after-tax money.  To see how much you can safely spend in retirement, you can’t just add TFSA and RRSP assets together.  A dollar in a TFSA is more valuable to you than a dollar in an RRSP.  You need to discount the RRSP assets by the amount you expect to pay in taxes on RRSP/RRIF withdrawals.  You can’t know for certain what tax rate you’ll pay, but an educated guess is better than implicitly treating it as zero.  I estimate the total income I’m likely to declare in a typical year during retirement, and work out my average tax rate.  I think many people would be surprised to learn how low this percentage will be.  I’m used to thinking about my marginal tax rate while I worked.  This is much higher than the average tax rate I paid while working.  During retirement, my average tax rate will be lower still.

AUM:  Just add the full RRSP value to the client’s assets.  The fact that the client will ultimately pay taxes on withdrawals doesn’t affect the advisor fees RRSP assets generate until the client starts to make withdrawals.

Non-Registered Assets

Personal Progress:  Just add the value of your non-registered accounts to your assets.

Retirement Spending:  Once again, you need to discount the non-registered assets by the percentage you expect to pay in taxes on capital gains, dividends, and interest.  A tricky part in this case is that some retirement spending from non-registered assets will be spending capital, which isn’t taxed.  In this case, I estimate the amounts of different types of income in a typical year in retirement, add up the capital gains taxes, dividend taxes, and interest taxes I expect to pay on my non-registered assets, and divide the tax total by the total amount I expect to spend (which includes spending some capital).  In my case, this gives an even lower tax percentage than in the RRSP case.  Once again, the tax rate we use here is just an estimate, but it’s better than using zero, which is sure to be wrong.

AUM:  Just add the full value of non-registered accounts to the client’s assets.


Personal Progress:  Contributing to your children’s RESP certainly is financial progress for your family, and adding the full value of the RESP to the asset side of the net worth calculation is sensible.

Retirement Spending:  Only include RESPs (discounted for taxes) if you think you might raid them as a last resort as you run out of money in retirement.  This scenario would likely only come up if the RESP is for grandchildren, and it would be a very difficult choice to make.  In most cases, it doesn’t make sense to include RESPs in net worth.

AUM:  As long as the advisor offers RESPs and will be managing these assets, include RESPs in net worth calculations.

House and Mortgage

Personal Progress
:  Include both the mortgage and a conservative estimate of house value in net worth.  If you plan to pay off your house steadily with no extra payments, you could make a case for simplifying net worth calculations by ignoring the house and mortgage.  However, a rising house value and a shrinking mortgage are meaningful financial progress, particularly for people who choose to make extra mortgage payments.

Retirement Spending:  A mortgage must be included in liabilities.  If you would never sell your house, then its value isn’t relevant to the amount you can spend in retirement.  If you would consider downsizing or getting a reverse mortgage, you could include a fraction of the house value in net worth.  I choose not to include the value of my house in my net worth.  However, I do have a second “net worth” spreadsheet line that includes the house.  This serves little purpose other than to show me a bigger number, but it makes me happy to see this bigger number.

AUM:  Financial advisors concerned with AUM would only care about a house if the client might borrow against it to invest more money.  However, some advisors might approach net worth calculations with a blend of the AUM goal and the different goal of preparing a net worth calculation to show to a client.  In this case the advisor would likely include the value of a house because many clients would expect it.


Personal Progress:  Pensions such as CPP, OAS, and workplace defined-benefit pensions aren’t particularly relevant to whether you’re managing your household money well, so they can be ignored.

Retirement Spending:  Pensions are an important part of how much you can spend during retirement, so they count in net worth.  However, if you’re already collecting one or more pensions, it seems pointless to assign a present value to the pension just so that it can be turned back into a yearly spending amount.  You could certainly express your net worth as something like $500,000 saved plus $20,000 per year (rising with inflation) from CPP and OAS.  This becomes trickier if you haven’t already started receiving the pension.  I’m in this situation.  What I do is compute a present value of my future after-tax CPP and OAS benefits and add them to my net worth.  I make sure that I use the same discounting formula that I later use to decide how much I can spend each year.  This method automatically accounts for the fact that I’ll have to spend more from my savings until the pensions kick in.

AUM:  Pensions don’t generate fees for advisors and aren’t relevant to net worth.  However, clients with pensions may spend down their fee-generating assets slower, particularly if they take their CPP and OAS as young as possible.

Cars and Car Loans

Personal Progress:  Include car loans and any other debts in net worth.  Cars and anything else you own make a difference to your financial position, because they can be sold or at least delay future spending to replace them.  However, you need to draw the line somewhere between expensive items worth including in net worth and things that just don’t matter enough to track.

Retirement Spending:  As you near retirement, hopefully you have saved enough that almost everything you own isn’t expensive enough to make a meaningful difference in your net worth.  The cost of replacing most smaller things is easily absorbed into annual spending.  All debts matter, but only the largest personal assets matter.  If I had a cottage that I expected to sell one day, I’d include it in my net worth, but I don’t include cars.  Others can reasonably draw the line somewhere else.

AUM:  A client’s debts and personal assets aren’t directly relevant to generating fees (but do affect the client’s likely future total financial assets).  However, if the advisor is approaching net worth calculations with a blend of the AUM goal and the different goal of preparing a net worth calculation to show to a client, the advisor would include debts and possibly the value of cars.


How we should calculate net worth can get surprisingly tricky when we’re trying to estimate a safe level of retirement spending.  For most younger people who are just concerned with measuring their progress with managing their money, calculating net worth can be simple.  So, when we see others take into account different things than we do in our net worth, the reason may be that others have different goals.

Friday, January 8, 2021

The Total Money Makeover

Dave Ramsey is a very popular radio show personality who offers personal financial advice.  He captures that advice in his book The Total Money Makeover, Classic Edition.  Ramsey says the formula for financial success isn’t complex, and that there is little in the book you can’t find elsewhere.  “Personal finance is 80 percent behavior and only 20 percent head knowledge.”  As a result, his book is long on motivation, and short on specifics of how to follow his “baby steps” to financial freedom.  This focus on motivation may be what his target audience of people who handle money poorly need most.  While most personal finance experts discuss the dangers of debt, Ramsey takes debt aversion to a new level, which is also likely good for his target audience.

It’s not hard to find things to criticize about Ramsey’s approach.  Many readers may find the frequent bible references off-putting, particularly toward the end of the book.  The religious content will give some readers extra motivation to improve their financial lives, and will turn off others.  However, the religious references aren’t central to the “Total Money Makeover” methods and can be safely ignored or embraced.

Return Assumptions

A more serious criticism is his claim that “you should make 12 percent on your money over time” in “good growth-stock mutual funds.”  Part of the problem is that this book came out in 2013 and is based on some material a decade older than that.  So, the decades over which Ramsey studied stock returns likely included high inflation periods.  It’s better to think of returns in real terms (which means after subtracting inflation).  Most experts think the long-term 6% or so real return of U.S. stocks is too high to expect in the coming decades.  Perhaps 4% real on stocks and considerably less on bonds is more realistic.

The 12% stock return that Ramsey sticks with is harmless in some cases but not others.  In one example, Ramsey says that if you could avoid a $495 monthly car payment from age 25 to 65, “you would have $5,881,799.14 at age sixty-five.”  As a motivational tool this is harmless, but the numbers are highly misleading.  If we imagine a 65-year old today, there is no way the payments on a car loan 40 years ago would have been $495.  If we imagine a 25-year old today, 40 years of inflation would make that nearly $6 million figure worth far less than it seems.

We see a much more serious problem with Ramsey’s 12% stock return assumption when he writes “you can live off of 8 percent of your nest egg per year.”  Even a 4% retirement withdrawal rate can fail for young retirees.  Withdrawing 8% each year offers a near guarantee of seriously declining available spending throughout retirement.  I’ve had to witness such forced declines in spending up close with family members.


Ramsey takes dead aim at claims that debt is a useful tool.  “Debt is so ingrained into our culture that most Americans cannot even envision a car without a payment, a house without a mortgage, a student without a loan, and credit without a card.”  “Debt brings on enough risk to offset any advantage that could be gained through leverage of debt.”

“If I loan money to a friend or relative, the relationship will be strained or destroyed.”  This is one I’ve experienced personally.  If you cosign a loan, “Be ready to repay the loan.”  Again, I’ve lived through this one.  Gifts to friends and family are better than loans.

Most people think that “Car payments are a way of life; you’ll always have one.”  “Taking on a car payment is one of the dumbest things people do to destroy their chances of building wealth.”  Despite the possible tax advantages of leasing cars, “the car lease is the most expensive way to operate a vehicle.”

Ramsey’s most interesting claims are that you don’t need a credit card or a credit score.  He says he uses a debit card, but makes “credit transactions” with it that offer exactly the same consumer protections as using a credit card, and he verified this by contacting Visa for a statement.  This allows him to book flights and hotel rooms, and order things online with his debit card.  There are even some mortgage companies who will work with clients with no credit scores.

I had other questions about the viability of living without a credit score.  I’ve heard that credit scores are used by some landlords to choose tenants, by some insurance companies as an input to the premiums we pay, and by some employers in making hiring decisions.  How problematic would it be to not have a credit score?  My preference is that it be illegal to use credit scores for these purposes, but I don’t know if they do get used this way routinely.  It seems ridiculous that you have to be in debt to live somewhere or get a job.  “The FICO score is an ‘I Love Debt’ score.”

Some people can handle credit cards, but “CardTrak says that 60 percent of people don’t pay off their credit cards every month.”  “When you play with snakes, you get bitten.”  Not surprisingly, Ramsey doesn’t like the idea of getting a teenager a credit card to learn to be responsible.  “Getting a credit card for your teenager is an excellent way to teach him or her to be financially irresponsible.  That’s why teens are now the number one target of credit-card companies.”

Some fear that “If no one used debt, our economy would collapse.”  Ramsey says if everyone stopped using debt immediately, then “The economy would collapse.  What if every single American stopped using debt of any kind over the next 50 years, a gradual TOTAL Money Makeover?  The economy would prosper, although the banks and other lenders would suffer.  Do I see tears anywhere?”

Baby Steps

Although Ramsey refers to the steps of his plan as “baby steps,” only the first one is really a baby step: “save $1,000 cash as a starter emergency fund.”  The rest of the steps are much more substantial: pay off debts, finish building the emergency fund, save 15% of income for retirement, save for college, pay off your mortgage, and finally enjoy being wealthy.  Readers are warned to do the steps in order and complete each one before moving on.

Before any of the steps begin, Ramsey says you must make a budget, and if you’re married, you must agree with your spouse on it.  Further, “If you are behind on payments, the first goal will be to become current.”

Some people believe that having available credit is a substitute for an emergency fund.  “The worst time to borrow is when times are bad.”  “Emergencies are precisely when you don’t need debt.”

Although it certainly is possible to pay cash for a home, Ramsey allows that a mortgage is the one type of permissible debt.  “Never take out more than a fifteen-year fixed-rate loan, and never have a payment of over 25 percent of your take-home pay.”  I think this limit on the size of payments is important; too many people bury themselves in mortgage debt.  As for the 15-year rule instead of a longer mortgage with the plan to make extra payments, “Research has found that almost no one systematically pays extra on their mortgage.”  I guess my wife and I are exceptions.  For the first 3 years of our first mortgage, we doubled every monthly payment and made a 10% annual payment.

Throughout the 7 baby steps, “Always manage your own money.  You should surround yourself with a team of people smarter than you, but you make the decisions.  You can tell if they are smarter than you if they can explain complex issues in ways you can understand.  If a member of your team wants to do something ‘because I say so,’ get a new team member.”

An interesting take on financial advice: “When selecting and working with your wealth team, it is vital to bring on only members who have the heart of a teacher, not the heart of a salesman or the heart of an ‘expert.’”


The best parts of this book are the attack on debt to shake people away from the feeling that debt is normal, and the motivational aspects to get people going with changing their lives.  Like many books, it’s not hard to find parts that are easy to criticize, but there are enough good parts to be worth reading if you have debt problems or want more insight into how to help others who have debt problems.

Wednesday, January 6, 2021

Your Money or Your Life

The first edition of the best selling personal finance book Your Money or Your Life, written by Vicki Robin and Joe Dominguez, came out nearly 30 years ago.  In 2018, Robin revised and updated it, and added a foreword by Peter Adeney, a.k.a., Mr. Money Mustache.  The book lays out a 9-step plan to fix your finances.  Only the last two steps deal with investing, so the main focus is on transforming the way you think about spending and earning money.

Robin’s passion for helping people comes through loud and clear.  Part of her motivation for rewriting the book came from thinking about rampant student debt: “What kind of society turns its young people into a profit center for the debt industry?”  We work and waste our money so that “We are sacrificing our lives for money, but it’s happening so slowly that we barely notice.”

In the original version of this book, all 9 steps were simple to understand and perform.  In the update, the final two steps related to investing are more muddled and complex.  However, the first 7 steps remain easy to understand.  Following them requires some work, but they can’t help but transform the way you think about the money you earn and spend.

I won’t try to describe all the steps, because I think they need Robin’s words around them to explain how and why they work.  I will say that for the many of us who don’t really feel a connection between our daily purchases and how it affects our lives over the long term, Robin’s steps will close that loop.  It will become obvious which purchases are consistent with our values and long term desires and which aren’t.

I found it interesting that none of the steps involve creating a budget.  Rather, we’re asked to track our spending with “no blame and no shame.”  Instead of setting spending restraints at the start of each month, we reflect on our spending after each month which leads to making different choices in the future.

A starting point for the 9 steps is recognizing that “Money is something you trade your life energy for.”  The steps aren’t about trying to become rich: “Financial independence has nothing to do with rich.  It is the experience of having enough—and then some.”

One exercise among the steps that I found interesting was calculating your true hourly wage.  We’re used to thinking we make so much per 40-hour week which comes to some hourly rate, but this ignores many factors like commuting time, extra grooming time, babysitting costs, and much more.  Once we deduct expenses that only exist because of work and add up the time we lose outside of official work hours, the resulting hourly wage can be surprisingly low.

Many of us get used to a lifestyle that consumes all our income, and this makes us think that big life changes just aren’t possible.  Robin encourages readers to figure out what would really make them happy and to find a way to make it happen.  Among many questions, she asks “What did you want to be when you grow up?” and “If you didn’t have to work for a living, what would you do with your time?”

Even if you choose to stick with your current job, you’ll see benefits from building savings.  Knowing you’ll be fine if you lose your job can make you fearless and principled in how you do your work.  Not worrying “whether I stepped on toes … was extremely empowering.”

The bulk of the book that is designed to take the reader from unconsciously building debt to consciously building savings is excellent, but the parts on investing are weak.  The original version of the book advocated investing exclusively in U.S. Treasury bonds.  This worked well enough decades ago, but as Robin admits, today’s low interest rates makes this a bad idea now.

Rather than finding a new simple investing prescription to replace U.S. Treasury bonds, Robin offers a wide range of investment ideas, many of which seem at odds with the idea of preserving one’s life energy (time).  I’m sure some people are happy being landlords, but this isn’t just an investment; it’s a job together with an investment, and many people fail miserably at it.  The brief section on passive index investing is well done, but it doesn’t stand out among many other approaches listed that have much higher likelihood of hard work and failure.

Some of the old material related to investing still needs updating.  Robin asks us to calculate investment income based on your capital and the 30-year U.S. Treasury rate, which is only 1.65% as I write this.  Based on this definition, I’m not financially independent yet.  Fortunately, I invest mainly in stock index ETFs and I’m financially independent by a comfortable margin.

“For mathematical simplicity, we will use 4% [as the current interest rate].”  This isn’t really an interest rate; it’s an appeal to the 4% rule for retirement that assumes low-cost investing mainly in stocks.  Given that this book is aimed at readers who see time spent investing as a necessary evil, I’d say that 3% would be a safer figure for retirees under 50, and ramping up to 4% by about age 65.

It’s clear that the author thinks in terms of building capital and spending the interest in retirement without touching the principal.  This worked reasonably well decades ago when inflation was higher, so that in real terms you were effectively spending some principal.  Today, having a decent retirement lifestyle requires dipping into principal, particularly later in life.

In one person’s story, Tammy “invests the bulk of her money in Treasury bonds so she knows that no matter what the world throws her way, she has enough income to cover her basics.”  Unfortunately, this strategy would fail if we had a period of high inflation, or even modest inflation for many years.  Tammy would have to own inflation-protected bonds to be safe.

Overall, I think this book could be very helpful for readers who have tried and failed to get their finances under control.  Anyone prepared to do the work of following the first 7 steps is very likely to have a positive outcome.  However, one they get to the point where they have a meaningful amount of savings to invest, I’d suggest looking elsewhere for simple, low-cost investment ideas.

Monday, January 4, 2021

The Myth of Simple Interest on Loans

A persistent myth is that you don’t pay compound interest on installment loans, such as mortgages, car loans, and other personal loans.  I’ll show that this is nonsense.

One example of this myth comes from an Investopedia article on car loans: “Auto loans include simple interest costs, not compound interest.”  The reasoning is that if your payments cover all the interest that accrues each payment period, then there is no opportunity to build interest on top of interest.

However, money is fungible.  Why can’t we think of each payment as going against principal and leaving the interest owing?  Then there would be interest building on top of interest.  We could also think of payments applied proportionally.  For example, if a payment represents 5% of the remaining amount owed, we could think of the payment covering 5% of the remaining principal and 5% of accrued interest.  This proportional method is the most useful way to think about how payments apply, but arguing about which way of thinking about payments seems most correct won’t get us anywhere.

Let’s look at a practical question.  How much do you benefit when you make an extra payment against a loan?  Suppose you have a 4-year $30,000 car loan at 6%.  The monthly payment works out to $704.55.  After a year of payments, your remaining debt will be $23,159.31.

What if you had put an extra $1000 down on the car in the beginning, but you decided to leave the payments at $704.55 per month so you’d have it paid off in less than 4 years?  Your starting debt would have been only $29,000.  After a year of payments, the remaining debt would be $22,097.64.

The difference between the debt after a year in the two scenarios is $1061.68.  Somehow, you’ve saved $61.68 instead of the $60 that you’d expect to save with a 6% simple interest calculation.  Not coincidentally, if we compound 0.5% interest for 12 months, the annual rate is 6.168%, which exactly matches the savings you get from putting an extra $1000 down on the car.

I’ve shown that when you make extra payments against a loan, the benefits you get are based on compound interest.  This is because you are paying compound interest on the loan.  Any useful way of looking at installment loans leads to the same conclusion: the interest compounds.

Friday, January 1, 2021

Short Takes: New Year’s Edition

Ordinarily I disagree with those who follow the end-of-year tradition of complaining about the past year, but 2020 is a year I’m happy to see end.  After we pull through this COVID-19 winter, I’m looking forward to great times in spring and summer.  So far, I’ve made good use of my “lockdown” time sorting through the stuff in my house and giving away or throwing away much of it.  Each unwanted thing that leaves my house makes me smile, especially if it goes to someone who does want it.

The only post I managed in the past two weeks is a review of Annie Duke’s latest book:

How to Decide

Here are some short takes and some weekend reading:

John Robertson
compares his free CPP calculator to the one created by Doug Runchey and David Field.  He also observes that “CPP has enormous, unmatchable longevity insurance benefits,” which are maximized when you delay starting CPP payments to age 70.

Ellen Roseman interviews Fred Vettese in the latest Moneysaver podcast to discuss retirement decumulation planning and the revision of his excellent book Retirement Income for Life.

Canadian Couch Potato compares the lineups of asset allocation ETFs from Vanguard and iShares.  In another post, he adds BMO’s asset allocation ETFs to the comparison.

Robb Engen has reached millionaire status.  However, he and I calculate net worth differently.  Now that I’m retired, the fact that I can only spend after-tax money is very real to me.  So, I discount my RRSPs and taxable accounts by my expected tax rates.  However, I also add in the after-tax present value of the CPP and OAS benefits I will start collecting when I’m 70.  So, if Robb were to switch to my (admittedly more complex) net worth calculation method, he’d likely still be a millionaire.

Big Cajun Man
updates the CPP and EI rates for 2021.  Here’s one way to start a fight: “Long live CPP, expanded and mandatory!”