Friday, December 30, 2022

Short Takes: Bond Surprise and Sticking to a Plan

When people suggest topics for me to write about, more often than not I can point to an article I’ve already written, which is handy for me.  I doubt I’ll ever run out of thoughts on new topics, but it’s good to have a body of work to refer to.

Here are my posts for the past two weeks:

Car Companies Complaining about Interest Rates

RRSP Confusion

Searching for a Safe Withdrawal Rate: the Effect of Sampling Block Size

Here are some short takes and some weekend reading:

Ben Carlson
lists some things in the markets that surprised him this year.  The first thing is that stocks and bonds both went down double-digits.  Apparently, that’s never happened before.  I guess if you just look at the history of stock and bond returns, this outcome looks surprising.  However, when you look at the conditions we’ve come through, this was one among a handful of likely outcomes.  Bond markets were being artificially propped up, and the dam had to burst sometime.  As for stocks, the Shiller CAPE nearly reached 40.  We can’t know exactly when the next stock correction will happen, but the odds rise as the CAPE enters nosebleed territory.

Robb Engen sets a good example of sticking to his plan and making few trades despite a difficult 2022 for investors.

Wednesday, December 28, 2022

Searching for a Safe Withdrawal Rate: the Effect of Sampling Block Size

How much can we spend from a portfolio each year in retirement?  An early answer to this question came from William Bengen and became known as the 4% rule.  Recently, Ben Felix reported on research showing that it’s more sensible to use a 2.7% rule.  Here, I examine how a seemingly minor detail, the size of the sampling blocks of stock and bond returns, affects the final conclusion of the safe withdrawal percentage.  It turns out to make a significant difference.  In my usual style, I will try to make my explanations understandable to non-specialists.

The research

Bengen’s original 4% rule was based on U.S. stock and bond returns for Americans retiring between 1926 and 1976.  He determined that if these hypothetical retirees invested 50-75% in stocks and the rest in bonds, they could spend 4% of their portfolios in their first year of retirement and increase this dollar amount with inflation each year, and they wouldn’t run out of money within 30 years.

Researchers Anarkulova, Cederburg, O’Doherty, and Sias observed that U.S. markets were unusually good in the 20th century, and that foreign markets didn’t fare as well.  Further, there is no reason to believe that U.S. markets will continue to perform as well in the future.  They also observed that people often live longer in retirement than 30 years.  

Anarkulova et al. collected worldwide market data as well as mortality data, and found that the safe withdrawal rate (5% chance of running out of money) for 65-year olds who invest within their own countries is only 2.26%!  In follow-up communications with Felix, Cederburg reported that this increases to 2.7% for retirees who diversify their investments internationally.

Sampling block size

One of the challenges of creating a pattern of plausible future market returns is that we don’t have very much historical data.  A century may be a long time, but 100 data points of annual returns is a very small sample.  

Bengen used actual market data to see how 51 hypothetical retirees would have fared.  Anarkulova et al. used a method called bootstrapping.  They ran many simulations to generate possible market returns by choosing blocks of years randomly and stitching them together to fill a complete retirement.  

They chose the block sizes randomly (with a geometric distribution) with an average length of 10 years.  If the block sizes were exactly 10 years long, this means that the simulator would go to random places in the history of market returns and grab enough 10-year blocks to last a full retirement.  Then the simulator would test whether a retiree experiencing this fictitious return history would have run out of money at a given withdrawal rate.

In reality, the block sizes varied with the average being 10 years.  This average block size might seem like an insignificant detail, but it makes an important difference.  After going through the results of my own experiments, I’ll give an intuitive explanation of why the block size matters.

My contribution

I decided to examine how big a difference this block size makes to the safe withdrawal percentage.  Unfortunately, I don’t have the data set of market returns Anarkulova et al. used.  I chose to create a simpler setup designed to isolate the effect of sampling block size.  I also chose to use a fixed retirement length of 40 years rather than try to model mortality tables.

A minor technicality is that when I started a block of returns late in my dataset and needed a block extending beyond the end of the dataset, I wrapped around to the beginning of the dataset.  This isn’t ideal, but it is the same across all my experiments here, so it shouldn’t affect my goal to isolate the effect of sampling block size.

I obtained U.S. stock and bond returns going back to 1926.  Then I subtracted a fixed amount from all the samples.  I chose this fixed amount so that for a 40-year retirement, a portfolio 75% in stocks, and using a 10-year average sampling block size, the 95% safe withdrawal rate came to 2.7%.  The goal here was to use a data set that matches the Anarkulova et al. dataset in the sense that it gives the same safe withdrawal rate.  I used this dataset of reduced U.S. market returns for all my experiments.

I then varied the average block size from 1 to 25 years, and simulated a billion retirements in each case to find the 95% safe withdrawal rate.  This first set of results was based on investing 75% in stocks.  I repeated this process for portfolios with only 50% in stocks.  The results are in the following chart.

The chart shows that the average sample size makes a significant difference.  For comparison, I also found the 100% safe withdrawal rate for the case where a herd of retirees each start their retirement in a different year of the available return data in the dataset.  In this case, block samples are unbroken (except for wrapping back to 1926 when necessary) and cover the whole retirement.  This 100% safe withdrawal rate was 3.07% for 75% stocks, and 3.09% for 50% stocks.  

I was mainly concerned with the gap between two cases: (1) the case similar to the Anarkulova et al. research where the average sampling block size is 10 years and we seek a 95% success probability, and (2) the 100% success rate for a herd of retirees case described above.  For 75% stock portfolios, this gap is 0.37%, and it is 0.32% for portfolios with 50% stocks.

In my opinion, it makes sense to add an estimate of this gap back onto the Anarkulova et al. 95% safe withdrawal rate of 2.7% to get a more reasonable estimate of the actual safe withdrawal rate.  I will explain my reasons for this after the following explanation of why sampling block sizes make a difference.

Why do sampling block sizes matter?

It is easier to understand why block size in the sampling process makes a difference if we consider a simpler case.  Suppose that we are simulating 40-year retirements by selecting two 20-year return histories from our dataset.

For the purposes of this discussion, let’s take all our 20-year return histories and order them from best to worst, and call the bottom 25% of them “poor.”

If we examine the poor 20-year return histories, we’ll find that, on average, stock valuations were above average at the start of the 20-year periods and below average at the end.  We’ll also find that investor sentiment about stocks will tend to be optimistic at the start and pessimistic at the end.  This won’t be true of all poor 20-year periods, but it will be true on average.

When the simulator chooses two poor periods in a row to build a hypothetical retirement, there will often be a disconnect in the middle.  Stock valuations will jump from low to high and investor sentiment from low to high instantaneously, without any corresponding instantaneous change in stock prices.  This can’t happen in the real world.

Each time we randomly-select a sample from the dataset, there is a 1 in 4 chance it will be poor.  The probability of choosing two poor samples when building a 40-year retirement is then 1 in 16.  However, in the real world, the probability of a poor 20-year period being followed by another poor period is lower than 1 in 4.  The probability of a 40-year retirement in the real world consisting of two poor 20-year periods is less than 1 in 16.

Of course, by similar reasoning, the simulator will also produce too many hypothetical retirements with two good 20-year periods.  So, we might ask whether all this will balance out.  The answer is no, because we are looking for the withdrawal rate that will fail only 5% of the time.

Good outcomes from the simulator are largely irrelevant.  We are looking for the retirement outcome that is worse than 95% of all other outcomes.  When the simulator produces too many doubly-poor outcomes, it drives down this 95% point.  The result is an overly pessimistic safe withdrawal rate.

In the more complex case of the simulators discussed here, we are joining return histories of varying lengths, but the problem with disconnects in stock valuations and investor sentiment at the join points is the same.  The more join points we have, the more disconnects we create.  So, the lower the average return sample length, the lower the safe withdrawal rate result.  This is what we saw in the charts above.

In more mathematical terms, the autocorrelations in actual stock prices result in poor periods tending to be followed by above-average periods, and vice-versa. This is called mean reversion.  When we select samples from the return dataset and join them together, we partially destroy this mean reversion.  The shorter the return samples, the more mean reversion we remove.

Anarkulova et al. selected fairly long samples from their dataset (a decade on average) to try to preserve mean reversion.  This helped somewhat, but mean reversion exists on the decade level as well, and choosing 10-year blocks of returns destroys mean reversion between the decades.

What is the remedy?

Anarkulova et al. aren’t misguided in the methods they use.  There just isn’t enough available historical return data to run this type of experiment without getting creative.  If we had a million years of actual stock returns rather than just a century or so, it would be much easier to determine safe withdrawal rates.

However, we can’t just ignore the problem of properly preserving mean reversion.  My best guess is that we need to take the roughly 0.3% gap I observed between Anarkulova et al. approach and the “herd of retirees” approach (described earlier) and add it to the 2.7% withdrawal rate calculated by Anarkulova et al.  This gives a base withdrawal rate of 3.0%.  Fans of the 4% rule will still find this result disappointingly low, but I believe it is reasonable.

From there a retiree can adjust for other factors.  For example, we need to deduct about half the MERs we pay.  We also need to spend less if we retire before age 65, and can spend more if we retire after age 65.  Another adjustment is that we can withdraw more initially if we are prepared to reduce spending if markets disappoint rather than blindly spend our portfolios down to zero as Bengen’s original 4% rule would have us do.  Another adjustment for me is that my total costs (including foreign withholding taxes) on investments outside Canada are lower than the 0.5% assumed by Anarkulova et al.  We can make further adjustments if our mortality probabilities are different from the average.

Safe withdrawal rates are a complex area where most of what we read is biased toward telling us we can spend more.  Anarkulova et al. used reasonable historical returns and mortality tables to provide an important message that safe withdrawal rates are lower than we may think.  However, as I’ve argued here, I think they are too pessimistic.

Friday, December 23, 2022

RRSP Confusion

Recently, I was helping a young person with his first ever RRSP contribution, and this made me think it’s a good time to explain a confusing part of the RRSP rules: contributions in January and February.  Reader Chris Reed understands this topic well, and he suggested that an explanation would be useful for the upcoming RRSP season.

Contributions and deductions are separate steps

We tend to think of RRSP contributions and deductions as parts of the same set of steps, but they don’t have to be.  For example, if you have RRSP room, you can make a contribution now and take the corresponding tax deduction off your income in some future year.

An important note from Brin in the comment section below: “you have to *report* the contribution when filing your taxes even if you’ve decided not to use the deduction until later. It’s not like charitable donations, where if you’re saving a donation credit for next year you don’t say anything about it this year.”

Most of the time, people take the deductions off their incomes in the same year they made their contributions, but they don’t have to.  Waiting to take the deduction can make sense in certain circumstances.  For example, suppose you get a $20,000 inheritance in a year when your income is low.  You might choose to make an RRSP contribution now, and take the tax deduction in a future year when your marginal tax rate is higher, so that you’ll get a bigger tax refund.

RRSP contribution room is based on the calendar year

Each year you are granted new RRSP contribution room based on your previous year’s tax filing.  This amount is equal to 18% of your prior year’s wages (up to a maximum and subject to reductions if you made pension contributions).  You can contribute this amount to your RRSP anytime starting January 1.

Many people think that the “RRSP year” runs from March to the following February, and that you have to wait until March to make an RRSP contribution for the new year.  This isn’t true.  If you have new 2023 RRSP contribution room coming to you, you can make the contribution in January if you like.  It’s when you take the RRSP tax deduction that there are special rules for the first 60 days of the year.  I’ll explain that further below.

One complication with using new RRSP contribution room in January or February is that you won’t have your notice of assessment yet to tell you the amount of room you have.  However, if you can calculate this amount yourself, you’re free to use the room at the start of the year.

If you’re waiting for CRA to calculate your new RRSP room for you, Chris Reed suggests that you “use the Contribution Room stated on your Notice of Assessment after filing your tax return, instead of your [CRA My Account] webpage.  That webpage often has errors.”

Taking RRSP deductions

To be allowed to take an RRSP deduction for the 2022 taxation year, you have to satisfy the following  two requirements.  Firstly, you must have made a contribution based on RRSP room for 2022 or an earlier year.  Secondly, you must have made the contribution sometime before 60 days after 2022 December 31.  Some examples will help to illustrate these requirements.

Suppose you made a contribution in 2021 that was part of your available 2021 room, but you didn’t take the deduction on your 2021 taxes.  Then you can take the deduction on your 2022 taxes.

Suppose you used up all your RRSP room and deductions in 2021, and you have $10,000 of room for 2022.  Suppose further that you will get another $15,000 of room for 2023.  You are allowed to make an RRSP contribution of $25,000 in January 2023.  However, you will only be able to deduct $10,000 from your income on your 2022 taxes.  The remaining $15,000 deduction will have to wait for your 2023 taxes (or a later year if you prefer).

Early birds who use their new 2023 contribution room in January or February 2023 might become nervous when filing their 2022 income taxes a month or two later when they discover that they can’t take the RRSP deduction right away.  They might think they’ve over-contributed.  They haven’t.  They’re just way ahead of all the people making 2022 contributions just under the wire.  They have to wait until the 2023 taxation year to take the deduction.

Monday, December 19, 2022

Car Companies Complaining about Interest Rates

I don’t often have much to say about macroeconomic issues, but an article “sounding the alarm” about how interest rate increases are affecting car companies drew a reaction.

“Aggressively raising interest rates has helped create an untenable situation in car financing.”

Good.  Financing a car is usually a mistake for the consumer.  When consumers’ credit is so bad that they can’t even get a car loan, it’s even clearer that they shouldn’t buy the car.

“The auto sector is one of the victims of the aggressive interest rate hikes.”

Ridiculously low interest rates have allowed car companies to inflate prices and sell ever more cars to people who can’t really afford them.  The fact that the party is ending doesn’t make car companies victims.  Conditions are just slowly getting back to normal.

“Rising interest rates will make consumers reevaluate their decisions before quickly jumping into a car loan.”

Good.  It’s sad when people bury their financial future by buying an expensive vehicle they can’t really afford.  If you’ve got the money, go ahead.  If not, consider a cheaper vehicle or other means of transportation.

“The average annual percentage rate (APR) for financing a new vehicle purchase climbed to 6.3% in October 2022, compared to 4.2% in October 2021, the highest new vehicle APR since April 2019.”

Interest rates are just getting back to a normal range.  The rates we’ve seen in recent years were unsustainably low.  Portraying today’s rates as excessively high is misleading.

“The last time interest rates were this high, consumers could at least rely on lower vehicle prices.”

One way to return to stability would be for central banks to lower interest rates again.  A better way is for car companies to lower their prices.

“Monetary policy continues to worsen the situation in the automobile industry, and has created a crisis that could explode in 2023.”

If we get an explosion of defaults on auto loans, I have some sympathy for unsophisticated buyers who didn’t understand the risks they were taking, but for the most part, reckless consumers and lenders deserve each other.

There are reasonable ways to use debt in your life, but buying a far more expensive vehicle than you need is not one of them.

Friday, December 16, 2022

Short Takes: U.S. Equity ETFs, Index Investing Advantage, and more

There’s a whole world of retired people who play sports that I didn’t know existed until the last few years.  As I aged and was trying to compete with much younger athletes, I often wondered how much longer I could keep going.  A common mindset among older players is that they’ll have to give it up sometime, probably soon.  However, when I play sports with people my age and older, I see that I can keep going as long as I can stay healthy enough.

Rather than focusing on how much physical ability I’ve lost, I can focus on finding people who play at roughly the same level I do.  This has increased my motivation to do targeted exercise to keep my body healthy enough to play sports.  You’d think that staying healthy and strong would be motivation enough, but I find the deadline of completing rehab before an upcoming sports season much more motivating.

Here are some short takes and some weekend reading:

Justin Bender compares U.S. stock ETFs domiciled in Canada (e.g., VUN) to those in the U.S. (e.g., VTI).  He takes into account differences in currency exchange costs and foreign withholding taxes in different types of accounts.  This motivates the need to use Norbert’s Gambit for currency exchanges when using U.S.-domiciled ETFs.

Andrew Hallam presents evidence that “Over a period of 35 years, index fund investors earn 100 percent more money than those who buy actively managed funds.”

Robb Engen at Boomer and Echo evaluates his 2022 financial goals and lays out new ones for 2023.  I like that he sets targets for things he can control, such as how much he will save in various accounts from his income.  He doesn’t set targets for things he can’t control, such as investment returns, the price he’ll get when selling his house, or his overall net worth.  For others trying to follow Robb’s lead, it’s important not to run up debts on credit cards, lines of credit or elsewhere to meet savings targets.  If savings targets prove unrealistic, it’s better to re-evaluate savings plans than it is to bury yourself in debt.

Friday, December 2, 2022

Short Takes: Bond Debacle, FTX Debacle, and more

It’s no secret that bonds got crushed this year as interest rates rose.  Rob Carrick went so far as to say “Given how absurdly low rates were in 2020 and 2021, your adviser should have seen the events of 2022 [the bond crash] coming.”  I agree in the sense that the bond crash was predictable, but its exact timing was not.  I explained the problem with long-term bonds back when there was still time to avoid the losses.

It’s important to be clear that I was not making a bond market prediction.  What was certain was that long-term bonds purchased in 2020 were going to perform very poorly over their lifetimes.  The exact timing of bond losses was not knowable with any certainty.  The tight coupling between interest rates and bond returns is what made it possible to see the brewing problems; this isn’t possible with stocks.

I’ve seen a few attempts by financial advisors to justify their failure to act for their clients by talking about how if you blend poor long-term bond returns with present and future short-term bonds returns, the blend isn’t too bad.  This is like tossing some sawdust into your soup.  The blend may be tolerable, but why include the sawdust?

Many advisors just look at annual bond returns and see their unpredictability as similar to stock returns, but this isn’t true.  Bond yields tell you exactly what average return you’ll get over the life of the bond.  This is true whether you own that bond on its own or blended into a fund.

The bond debacle wasn’t just predictable, it was certain to happen.

Here are my posts for the past two weeks:

When Small Fees Equate to High Interest Rates

Quit: The Power of Knowing When to Walk Away

Here are some short takes and some weekend reading:

Adam M. Grossman clearly explains what happened at FTX and the warning signs that investors ignored.

Jackson, Ling, and Naranjo show “evidence that private equity (PE) fund managers manipulate returns to cater to their investors.”  Some private equity investors get “phony happiness” from “overstated and smoothed interim returns.”

Tom Bradley at Steadyhand was inducted into the Investment Industry of Canada’s Hall of Fame.  His speech reveals what we’ve known about him for a long time: that he cares about his clients.

The Blunt Bean Counter
explains some of the subtleties of the Principal Residence Exemption (PRE).

Tuesday, November 29, 2022

Quit: The Power of Knowing When to Walk Away

Former professional poker player and author of Thinking in Bets, Annie Duke has another interesting book called Quit: The Power of Knowing When to Walk Away.  Through entertaining stories and discussion of scientific research, she makes a strong case that people aren’t good at deciding when to quit relationships, jobs, and many types of life goals.

In one interesting story, “Blockbuster, when presented with the opportunity to acquire Netflix, refused.”  We now know that Blockbuster would have been better off focusing on streaming and giving up on renting physical copies of movies.  Of course, if they had tried to do both, their own executives responsible for renting movies might have killed off streaming to protect their own jobs and bonuses.

Other interesting and tragic stories concern those who failed to give up on climbing Mount Everest when it became too dangerous, and the many people who have finished marathons on broken bones “Because there’s a finish line” they couldn’t abandon.

If you feel like you’ve got a close call between quitting and persevering, it’s likely that quitting is the better choice.”  This is because people have a tendency to stick with failing paths too long.  So, by the time you think it might be time to quit, that time is likely long past.  “Quitting on time usually feels like quitting early, and the usually part is specifically when you’re in the losses [and still hoping to come out ahead by persevering].”

It’s hard to tell which scientific research studies of behavioural biases are likely to stand up to further testing and which won’t.  Apparently, NBA teams stick with high draft picks too long when they’re not working out.  This certainly seems plausible.  However, it’s not obvious that the reason is behavioural bias.  NBA teams don’t think with a single mind.  An exec who knows a player isn’t working out but is at risk of losing his job in response to fans’ wrath might appease the fans at the team’s expense.  We see CEOs with massive stock option grants make choices good for them but do long-term harm to their companies all the time.

One possible test of the plausibility of behavioural biases is to see if they are evolutionarily useful in some way.  For example, many people are uncomfortable flipping a fair coin to either lose $100 or win $200.  In the distant past when such gambles had higher stakes, it usually made more sense for a starving person to eat a meal in hand than to abandon that meal for a 50/50 chance to chase down 3 meals.  It’s plausible that this risk aversion is baked into our DNA in some way.  I find it easier to believe in the existence of a behavioural bias when it appears to be a useful genetic adaptation that is simply being misapplied in a modern context, such as the low-stakes coin flip bet with positive expectation.  When research studies find behavioural biases, I’d be interested to hear evidence that the bias had some usefulness for survival or procreation.  However, these are just my thoughts and not a failing of Duke’s book.

Daniel’s Kahneman’s endorsement of Quit is accurate: “Brilliant and entertaining.”  I can recall things I should have quit sooner.  This book might have helped.

Thursday, November 24, 2022

When Small Fees Equate to High Interest Rates

There are many ways to hide banking fees so that customers don’t notice them.  One way is to quietly help yourself to a couple percent of people’s mutual fund savings every year.  Another is to tack a foreign exchange fee onto the exchange rate when customers exchange currencies.  I learned about a new one recently with credit card payment plans.

Many of the big banks offer plans that allow you to take a credit card purchase and pay it off over 6 months to 2 years at a low-sounding interest rate.  The trick is that they add fees that also seem small, but they add up.

One example is TD’s credit card payment plan that allows you to pay for large purchases over 6 months at zero percent interest for a one-time fee of 4%.  This sounds way better than paying standard credit card interest rates.  However, looks can be deceiving.

Suppose you make a $600 purchase.  With the 4% fee, this grows to $624.  At 0% interest, you could use the payment plan to pay off this purchase with 6 monthly payments of $104.  Even though the fee is only 4%, the implied annual interest rate with this plan is 13.6%, which compounds to 14.5%.

This may not be a big deal for a single purchase, but if you’re routinely using this plan for every large purchase, you’ve effectively got a 14% credit card, even though it seems like you’re only paying 4%.  In a perfect world, banks would have to disclose these facts to their customers in a way they can understand, but I’m not holding my breath.

Friday, November 18, 2022

Short Takes: FTX Debacle and Foreign Withholding Taxes

It’s amazing how trivial it is to invest well, and yet we need to know a lot to be able to avoid changing course to some inferior strategy that sounds good but isn’t.  I did poorly with my own portfolio for about a decade before smartening up, and I’ve done well for my mother, sister, and mother-in-law, but I haven’t been able to help most others who ask for advice.  In most cases, I end up watching helplessly as they make choices with poor odds.  It would be easier if saying “just buy VBAL” were persuasive.

Here is my review of a book on homeownership:

House Poor No More

Here are some short takes and some weekend reading:

Marc Cohodes
holds nothing back in his analysis of Sam Bankman-Fried and FTX.  I doubted that I’d end up listening to the entire podcast, but I couldn’t stop once I started.

Justin Bender explains U.S. foreign withholding taxes (FWT) on various types of ETFs that hold U.S. stocks.  This is an important topic, because FWT on dividends can be much greater than ETF MERs.

Thursday, November 17, 2022

House Poor No More

Romana King’s book House Poor No More is a comprehensive collection of useful knowledge for all aspects of owning a home, including detailed lists of home maintenance tasks, improvement projects, and much more.  The writing is upbeat and engaging.  To the author’s credit, she quantifies the costs of just about everything.  Unfortunately, this book was written just before interest rates shot up, so several numerical examples look like they are from the “before times” (only 9 months ago).  As has been common in our society for many years now, the author is too positive about taking on large debts.  Those who took on far too much debt while ignoring the possibility of interest rate increases are now facing significant pain.

Some Positives

As a long time homeowner, I thought I had a good handle on home maintenance.  However, King’s comprehensive list of home maintenance tasks covers many areas I know little about.  The many things to check and possibly repair is daunting; some readers may see them as a reason to keep renting.  

Homeowners who aren’t prepared to inspect every aspect of their homes on King’s schedule can still benefit from understanding how various parts of a home work so they can handle problems as they arise.  For example, I’ve always known that it’s bad to have standing water near your foundation, but King goes into detail on the best ways to prevent water damage.  She is also very thorough in her discussion of mould.

“Don’t trust anyone with your own best interests.”  King says it’s a bad idea to trust bankers and real estate agents too much.  Rather than helping you decide whether buying or selling a home makes sense for you, they are often blinded by the fact that they will benefit from the transaction.

“67% of homeowners complain about their home’s lack of storage.”  King suggests several solutions to this problem, and I was pleased to see that the first solution was decluttering.  As someone who grew up with a hoarder who was constantly trying to create more storage areas, I appreciate the value of throwing worthless junk away.

“If you must use your electric [clothes] dryer, be sure to toss a clean, dry towel in with the wet load, as this will significantly reduce drying time.”  I hadn’t heard this before.  It could make a good grade school science project.

“If you have a longer amortization period left and don’t have a lot of equity in your home—especially if you’re a new homebuyer who stretched just to buy in—then consider making extra payments on your mortgage first [before investing].”  In the debate about whether to put extra money against the mortgage or invest it, too many commentators just compare expected investment returns to the mortgage rate and declare that everyone should invest.  It’s refreshing to see someone sensibly taking into account risk level in this decision.  If you can handle rising interest rates or a period of unemployment without financial panic, then invest away.  Otherwise, reducing debt should be the priority.

When making decisions about owning multiple properties, “think about after-tax returns, not before-tax earnings.  When you tally it all up, all that matters is how much you keep, not how much you spend or how much you pay to the government.”  Focusing too much on minimizing taxes leads some people to sacrifice both before-tax earnings and after-tax earnings.

Some Negatives

According to one table in the book, you can afford a home in Canada whose sale price is 8.4 times your income, but in the U.S. it’s only 4.7 times your income.  The U.S. figures come from a Bankrate mortgage calculator, and the Canadian figures are based on a 3.5% mortgage where half of your gross income goes to the combination of the mortgage and $600/month for property tax, insurance, and utilities.  Devoting 50% of your gross income to housing is dangerous, and this analysis ignores maintenance costs.  King devotes 80 pages to estimating home maintenance costs, which total between $2.49 and $9.56 per square foot per year (depending on how much you can handle yourself versus hiring a contractor).  For a 2000-square-foot home, this increases housing costs by $5000 to $19,000 per year.  After paying income taxes as well, this doesn’t leave much for food, transportation, clothing, and other necessities.  Add in today’s higher mortgage rates, and anyone following this plan is cooked.

There is a table summarizing maintenance costs that is muddled.  Its headings say “annual budget,” but the table contains 5-year figures, and one of the numbers is off by $3000.

Another table examines the return on home renovations.  In the example given, a $155,000 investment gives a 72% return over 5 years.  However, this return has little to do with the renovations.  In fact, King assumes that only 60% of renovation expenses get returned when the house is sold.  The rest of the “profit” comes from assumed rising house prices.  Further, the profit figure ignores property taxes, home insurance, and maintenance costs.  To be fair, one should count the savings from not paying rent as well.

In a discussion of the risks of using leverage, King stresses the importance of sticking to a long-term strategy.  However, becoming nervous and selling at a bad time isn’t the only risk.  If you lose your job, and your creditors force you to sell, it makes no difference if you were committed to sticking it out for the long term.

When it comes to mortgage-breaking penalties, “the idea behind the IRD [Interest Rate Differential] is to compensate the lender for any loss due to a mortgage being paid off early (and assumes the funds are being lent again at a lower rate).”  Unfortunately, the IRD calculation used by most of the big banks goes well beyond fair compensation.  They play games with posted rates that boost the IRD by artificially lowering the assumed interest rate the funds will get when re-lent.

King gives a list of “smart ways to bankroll a home renovation.”  I’m with David Chilton on this one.  Growing debt to renovate is often not a good idea.  Sadly, now that interest rates are rising, many Canadians are regretting their decisions to borrow against their homes.

“It’s important to find a good homeowner insurance policy from a reliable provider.”  This is true but unhelpful.  How many people can name an unreliable home insurance provider?  I can’t.


This book teaches the purpose of all components of a home and how to maintain and renovate them.  It includes estimates of costs and the return on investment when you sell your home.  However, readers need to think for themselves on the dangers of stretching their budgets too far when buying a home.  It’s no fun to find out you can’t afford the home you want, but living house poor or being forced to sell is worse.

Friday, November 4, 2022

Short Takes: $340k Phone Hack, Harsh Investment Lessons, and more

Early this year I got a new U.S. dollar credit card but had a hard time getting a reasonable credit limit.  After some trouble, I managed to get the bank to increase the credit limit a little.  This week I got a popup after logging in to my online banking telling me I was pre-approved for another US$4000 increase.  This happened shortly after I had maxed out the card and then paid it off.  I guess they just wanted to see more of a track record on this card before upping the limit, even though I already have a multi-decade track record with another credit card at the same bank.  I was amused when I clicked to accept the pre-approved credit limit increase and got a message saying that they would let me know whether they would “approve my request.”  Later, another automated message congratulated me on getting “my request” for a higher credit limit approved.  What I’d like to know is how often these “pre-approved” credit limit increases get rejected.

Here are some short takes and some weekend reading:

Eric Falkenstein explains how he was hacked and lost $340,000 worth of cryptocurrencies.  The hack began with a mysterious transfer of his phone, but the phone company thwarted his attempts to figure out how it happened.  Another interesting discovery in his investigation is that supposed white-hat hackers offering help are actually thieves who intend to hack you again and who know how to “keep their reputation clean on the web” by getting complaints about them removed.

Andrew Hallam explains some harsh investment lessons that we can only learn in difficult times.

Jonathan Clements is generous in saying that most news isn’t useful to investors.  He makes it clear in the body of his article that paying attention to most financial news goes beyond uselessness and is dangerous for your financial future.

Justin Bender
compares Canadian Equity ETFs: VCN vs. XIC.  In another article and video, he analyzes U.S. stock ETFs trading in Canadian and U.S. markets.

The Blunt Bean Counter
goes through the many estate and tax planning issues he sees with his well-to-do clients.

Friday, October 21, 2022

Short Takes: Homeowner Insolvencies, CRA Flouting Court Rules, and more

It’s a strange feeling to watch the beginning of the carnage in the housing market and know that it must get much worse if my sons are to have a chance to buy a home for a price they can afford.

Here are my posts for the past two weeks:

The Inevitable Masquerading as the Unexpected

Inflation Porn

Here are some short takes and some weekend reading:

Doug Hoyes explains why he does “not expect a significant rise in homeowner insolvencies until mid- to late-2023.”  

A judge has ruled against CRA in three appeals of gross negligence penalties, not based on the merits of the cases, but because of CRA’s “egregious” behaviour.  From the judge’s ruling, it seems that CRA is willing to flagrantly violate court rules in cases where they believe taxpayers are guilty of gross negligence.  A powerful government agency such as CRA has no business engaging in such gamesmanship.  If CRA is correct about the conduct of these taxpayers, they should follow court rules and argue the merits of the cases.  Canadians are justified in being upset with CRA not only for flouting court rules, but also for letting allegedly cheating taxpayers off the hook.

Chris Mamula gives an interesting account of the Bogleheads conference.  Apparently, they don’t think much of ESG investing.  I agree.

Kerry Taylor and Dan Ariely have some interesting advice on how to survive a market crash.

Wednesday, October 19, 2022

Inflation Porn

We’ve certainly heard a lot about inflation in the past year or so.  Despite the Bank of Canada’s efforts to fight inflation by raising interest rates sharply, we still see headlines blaring that inflation is very high.  What’s behind all this?

Here is a chart showing the official Consumer Price Index (CPI) for Canada since 2020.

We see that inflation was low in 2020, prices rose sharply during 2021 and the first half of 2022, and prices have actually dropped slightly in the past 3 months.  However, this is at odds with headlines still screaming that September inflation was still very high at 6.9%.  What gives?

The answer is that we often measure inflation by comparing current prices (as measured by CPI) to what they were a year ago.  So, headlines about September inflation are measuring the change from September 2021 to September 2022.  Last month’s headlines focused on August 2021 to August 2022.  If it seems like the news is churning out stories with 12-month figures where 11 of those months are old news, that’s because you’re paying attention.

The inflation we saw for about 18 months was very real, and it hurts people on fixed incomes.  Even though inflation has paused for 3 months, the percentages in the headlines were inflation at 7.6%, 7.0%, and 6.9%.  Even if prices stay flat in October, next month’s headlines will say inflation is still high.  Apparently, scary headlines are preferable to the news that prices seem to be stabilizing.  I guess frightened readers keep reading.

Does this mean our inflation problems are over?  I have no idea.  We’ll see what the Bank of Canada thinks when they make their interest rate announcement next week.  It could be that they hope to drive prices back down somewhat to erase the recent high inflation.  But that’s just speculation.  What I know for certain is that scary inflation headlines will keep coming for a while, whether they make sense or not.

Monday, October 10, 2022

The Inevitable Masquerading as the Unexpected

Rising interest rates are causing a lot of unhappiness among bond investors, heavily-indebted homeowners, real estate agents, and others who make their livings from home sales.  The exact nature of what is happening now was unpredictable, but the fact that interest rates would eventually rise was inevitable.

Long-Term Bonds

On the bond investing side, I was disappointed that so few prominent financial advisors saw the danger in long-term bonds back in 2020.  If all you do is follow historical bond returns, then the recent crash in long-term bonds looks like a black swan, a nasty surprise.  However, when 30-year Canadian government bond yields got down to 1.2%, it was obvious that they were a terrible investment if held to maturity. This made it inevitable that whoever was holding these hot potatoes when interest rates rose would get burned.  Owning long-term bonds at that time was crazy.

One might ask whether we could say the same thing about holding stocks in 2020 when interest rates were so low.  The answer is no.  Bond returns are very different from stock returns in terms of unpredictability.  We use bond prices to calculate bond yields; one is completely determined by the other.  The situation is very different with stocks.  Even when conditions don’t look good for stocks, they may still give better returns than the interest you’d get if you sold them to hold cash.  All the evidence says that most investors are better off not trying to time the stock market.

Most of the time, investors are better off not trying to time the bond market either.  However, the conditions in 2020 were extraordinary.  Long-term bonds were guaranteed to give unacceptably low returns if held to maturity.  This was a perfectly sensible time to shift long-term bonds to short-term bonds or cash savings.


The only way house prices could rise to the crazy heights they reached was with interest rates so low that mortgage payments remained barely affordable.  Fortunately, the government imposed a stress test that forced buyers to qualify for a mortgage based on payments higher than their actual payments.  This reduced the damage we’re starting to see now.  Unfortunately, there is evidence that some homeowners faked their income (with industry help) so they could qualify for a mortgage.  This offset some of the good the stress test did.

We’re starting to hear calls for the Bank of Canada to stop raising interest rates.  It’s hard to tell how much of this comes from homeowners and how much is coming from the real estate industry.  I have some sympathy for homeowners who really didn’t understand how much their mortgage payments would increase as interest rates rise, but not enough to support bailing out homeowners or keeping interest rates artificially low.

As for real estate agents, there are simply too many of them.  The size of this industry is unsustainable.  It’s never easy to be pushed out of your job, but that’s what will happen.


A common human failing is to see past events as inevitable; we call this hindsight bias.  To make sure I’m not guilty of this myself, I went through some past posts I wrote.  A common theme was that interest rates could rise at any time, and we need to protect ourselves.  I certainly didn’t know when they would rise, but the need to protect yourself and your family from interest rates returning to normal levels was obvious.  Owners of long-term bonds have paid the price, and the pain is just starting for mortgagors.  This mess is the inevitable masquerading as the unexpected.

Friday, October 7, 2022

Short Takes: Is CPP a Tax?, Credit Card Surcharges, and more

A prominent politician recently referred to CPP premiums as a tax.  This sparked a debate about this question.  Personally, I find CPP premiums look a little like a tax, but mostly not.  I once looked into how much of your CPP contributions are really a tax, but this was not intended to be like the current semantic discussion.  I don’t think this debate about whether CPP premiums are a tax is very important, but the answer a person argues for can tell you something about what they think about more important questions.  Should we scrap CPP?  No.  Should we be allowed to opt out of CPP?  No.  Can Canadians do better investing their savings on their own?  No.  Can most of the people who claim to be able to invest better on their own actually do better?  No. Do most of the people who claim to be able to invest better on their own even know their past investment returns?  No.  Should we reduce CPP premiums to reduce payroll taxes for businesses?  No.  How about just a temporary reduction?  No.  Is CPP at risk of running out of money?  No.  Should we seek to control the rising costs of running CPP?  Yes.  That list of questions and answers should make just about everyone unhappy.

Pete Evans reports on new rules allowing retailers to pass credit card fees on to customers as a surcharge.  Judging by comments online, customers are not happy about this prospect.  I’d prefer to see this done as a discount for paying cash, but that would force retailers to advertise slightly higher prices.  One thing the new law should have if it doesn’t already is that there should be some way to pay the advertised price.  If a business offers no meaningful way to pay without using a credit card, it shouldn’t be allowed to add a credit card surcharge.

has a garbage survey indicating that 53% of Canadians are $200 or less from insolvency.  It must be hard work to find a way to ask the question to get people to say that they are nearly insolvent.  Normally, I avoid giving oxygen to such nonsense, but this kind of survey comes up again and again.  There must be good money in pumping out material for clickbait headlines.  This just distracts from serious discussions about people with severe financial problems.

Robb Engen at Boomer and Echo tries to reassure investors who are ready to sell off their stocks.  It’s hard to convince a scared person that they have no idea what the near future will look like.

Friday, September 23, 2022

Short Takes: Investment Signs, Alternative Asset Class Returns, and more

I’ve been reading a lot lately about how a recent ruling in Ontario has crushed the hopes for making the designation “Financial Advisor” meaningful.  Sadly, this is hardly surprising.  The big banks want to be able to call their employees financial advisors.  Banks will always be formidable foes, and any designation a bank employee is able to hold is necessarily meaningless.  Bank financial advisors may mean well, but they are no match for the carefully constructed banking environment that forces them to sell expensive products to unwary customers.

I wrote one post in the past two weeks:

Nobody Knows What Will Happen to an Individual Stock

Here are some short takes and some weekend reading:

Tom Bradley at Steadyhand has an entertaining and important list of investment signs we should look for.

Ben Felix and Cameron Passmore come up with estimates of returns for alternative asset classes including private equity, venture capital, angel investing, private credit, hedge funds, private real estate, and cryptocurrencies.  I don’t know much about most alternative asset classes, but I do have a way of modeling investing in things you don’t understand.  Just load your cash into a device most people have in their backyards, spark it up, and feel the heat of investing for your ego.

Morgan Housel explains how incentives can bend our definitions of right and wrong, even though few of us believe this is true of ourselves.  This reminds me of discussions about Nortel after the tech bubble burst.  The CEO cashed in stock options for a 9-figure payday before the stock burned to the ground.  It was widely believed that the CEO had taken actions to enrich himself at the expense of the company’s future health.  However, when I asked these people if they could have resisted hundreds of millions of dollars themselves, they all said they would have resisted.  I guess I’m the only one in the world who doubts whether his morals would have survived such temptation.

Tuesday, September 20, 2022

Nobody Knows What Will Happen to an Individual Stock

When I’m asked for investment advice and I say “nobody knows what will happen to an individual stock,” I almost always get nodding agreement, but these same people then act as if they know what will happen to their favourite stock.

In a recent case, I was asked for advice a year ago by an employee with stock options.  At the time I asked if the current value of the options was a lot of money to this person, and if so, I suggested selling some and diversifying.  He clearly didn’t want to sell, and he decided that the total amount at stake wasn’t really that much.  But what he was really doing was acting as though he had useful insight into the future of his employer’s stock.

He proceeded to ask others for advice, clearly looking for a different answer from mine.  By continuing to ask others what they thought about the future of his employer’s stock, he was again contradicting his claimed agreement with “nobody knows what will happen to an individual stock.”

Fast-forward a year, and those same options are now worth about 15 times less.  Suddenly, that amount that wasn’t that big a deal has become a very painful loss.  He has now taken advantage of a choice his employer offers to receive fewer stock options in return for slightly higher pay.  It’s hard to be sure without seeing the numbers, but in arrangements I’ve seen with other employers, a better strategy is to take the options and just sell them at the first opportunity if the stock is far enough above the strike price.  Again, he’s acting as though he has useful insight into the future of his employer’s stock.

The lesson from this episode isn’t that people should listen to me.  I’m used to people asking me for advice and then having my unwelcome advice ignored.  What I find interesting is that even if I can get someone to say out loud “I don’t know what’s going to happen to any individual stock,” they can’t help but act as though either they know themselves, or they can find someone who does know.

Friday, September 9, 2022

Short Takes: Microsoft Class Action, New Tontine Products, and more

I finally got my $84 from the Microsoft software class action settlement.  As I predicted 19 months ago, I had forgotten about this lawsuit, and when the money arrived, it brightened my day (at least until I had to fight with Tangerine’s user interface to figure out how to deposit a paper cheque).  I’m not sure why it pleases me so much to get these small sums from class actions, but I’ll keep putting in claims when it’s convenient to do so.

Here are some short takes and some weekend reading:

Jonathan Chevreau describes Moshe Milevsky’s latest work on tontines to solve the difficult problem of decumulation for retirees.  Milevsky says “until now it’s all been academic theory and published books, but I finally managed to convince a (Canadian) company [Guardian Capital] to get behind the idea.”  Guardian Capital offers 3 solutions based on Milevsky’s ideas.  I’ve complained in the past that academic experts such as Moshe Milevsky and Wade Pfau write about the benefits of idealized products, such as fairly-priced annuities, but that these products don’t exist in the real world.  Every time I dig into the details of existing products, I find some combination of excessive fees and poor inflation protection.  Perhaps these experts feel the same frustration.  Hopefully, these latest products from Guardian are better.

Robb Engen at Boomer and Echo takes an interesting look back at what would have happened if he had invested differently back in 2015.  He tried several alternate investing strategies.  His actual investing approach fared well compared to what would have happened if he had stuck with dividend investing.  However, shifting to a U.S. stock index would have given the best outcome.  This kind of thinking is harmless as long as you treat it as just fun as Robb does, and you don’t get upset over what might have been.  There’s always going to be some choice you could have made differently that would have worked out better.

Friday, August 26, 2022

Short Takes: Portfolio Construction, Switching Advisors, and more

I haven’t found much financial writing to recommend lately, and I haven’t written myself, so I thought I’d write on a few topics that are too short for a full-length post.

Be ready for anything

I sometimes see this advice in portfolio construction: be ready for anything.  On one level this makes sense.  It’s a good idea to evaluate how it would affect your life if stocks dropped 40% or interest rates rose 5 percentage points.  Would you lose your house or would it just be a blip in your long-term plans?

However, those who give this advice sometimes use it to mean that you should own some of everything that performs well in some circumstances.  So they advocate owning gold, commodities, Bitcoin, and other nonsense along with stocks and bonds.

Just because you always own at least one thing that is rising doesn’t mean your overall portfolio will do well.  What you want is a portfolio that is destined to do well over the long term, with the caveat that you’ll survive any shocks along the way.  This means controlling leverage and risk.  It doesn’t mean you should own a bunch of unproductive assets.

Switching advisors

“My guy has done very well for me.” People think their returns come from their advisors’ great choices, but returns really come from a rising market.  When markets inevitably fall, many of these people will dump their advisors looking for something that doesn’t exist: an advisor who can steer them away from losses.  What a good advisor can do is help you choose a sensible risk level, keep you from making impulsive decisions, tax planning, and other services unrelated to portfolio construction.

How I would run my portfolio if it weren’t automated

For a DIY index investor, my portfolio is fairly complex.  I’m able to maintain it with little work because I run it with an elaborate spreadsheet that automates almost all decisions.  What would I do if I couldn’t automate it this way?  I’d own just VEQT for stocks, and a mix of VSB and high-interest savings accounts for my fixed income.  I need to be able to ignore my portfolio for weeks at a time without anything bad happening.


It’s not hard to compare the premiums of insurance policies from different insurance companies.  What is difficult is figuring out whether they’ll pay you or fight you if you make a large claim.   If I had useful information about which insurance companies are fair and which are most aggressive in denying claims, I might be willing to pay a higher premium to a better company.

Friday, August 12, 2022

Short Takes: Factor Investing, Delaying CPP and OAS, and more

I haven’t written much lately because I’ve become obsessed with a math research problem. I’ve also had an uptick in a useful but strange phenomenon.  I often wake up in the morning with a solution to a problem I was thinking about the night before.  Sometimes it’s a whole new way to tackle the problem, and sometimes it’s something specific like a realization that some line of software I wrote is wrong.  It’s as though the sleeping version of me is much smarter and has to send messages to the waking dullard.  Whatever the explanation, it’s been useful for most of my life.

Here are some short takes and some weekend reading:

Benjamin Felix and Cameron Passmore discuss two interesting topics on their recent Rational Reminder podcast.  The first is that they estimate the advantage factor investing has over market cap weighted index investing.  They did their calculations based on Dimensional Fund Advisor (DFA) funds used in the way they build client portfolios.  They also take into account the difference between DFA fund costs and the rock-bottom fund costs of market cap weighted index funds.  The result is an expected advantage of 0.45% per year for factor investing.  Others would be tempted to try to justify a much larger advantage, but to their credit, Felix and Passmore came up with a realistic figure.  As far as I could tell, this figure doesn’t take into account their advisor fees.  So they still have to sell the value of their other services to potential clients rather than claim these services come “for free” with factor investing.  The second interesting topic is a discussion of a study showing that “couples who pool all of their money (compared to couples who keep all or some of their money separate) experience greater relationship satisfaction and are less likely to break up.  Though joining bank accounts can benefit all couples, the effect is particularly strong among couples with scarce financial resources.”  Although my wife and I never joined bank accounts, we do think of all we have as “ours” instead of “yours” and “mine”.  For example, which one of us gets cash from a bank machine or pays the property taxes is determined by convenience rather than some division of expenses.  However, it appears that this study would lump us in with the group that didn’t pool their money.

Robb Engen at Boomer and Echo does an excellent job illustrating the power of delaying CPP and OAS to age 70 for certain retirees.  However, this creates what he calls the Retirement Risk Zone, during which the retiree spends down assets in anticipation of large CPP and OAS payments at age 70.  This approach makes a lot of sense for those with average health and enough assets to get through the Retirement Risk Zone, but most people are very resistant to this idea.

Neil Jensen announces that Tom Bradley of Steadyhand Investment Funds was inducted into the Investment Industry Hall of Fame.  Tom Deserves it.  He created an investment firm that focuses on client success rather than treating client assets like an ATM, and he regularly writes articles that teach important investment concepts in an age when we see so much useless commentary on stock prices.

Friday, July 15, 2022

Short Takes: Savings Account Interest, Reverse Mortgages, and more

EQ Bank says they’re “excited to announce an increased interest rate!”  It’s now 1.65%.  Meanwhile, Saven is up to 2.85%.  Unfortunately, Saven is only available to Ontarians.  It’s normal for banks to offer different rates, but the gap down to EQ is disappointing.  Fortunately, the fix is easy; with just a few clicks, my cash savings are mostly in Saven.

Here are my posts for the past four weeks:

A Failure to Understand Rebalancing

Portfolio Projection Assumptions Use and Abuse

Here are some short takes and some weekend reading:

Jason Heath explains the advantages and disadvantages of reverse mortgages compared to other options.  He does a good job of covering the important issues, but doesn’t mention home maintenance.  With reverse mortgages, the homeowner is required to maintain the house to a set standard.  It’s normal for people’s standards for home maintenance to decline as they age, sometimes drastically when they don’t move well and can’t afford to pay someone else to do necessary work.  Reverse mortgage companies have no reason to go around forcing seniors out of poorly-maintained homes now, but once they have a lot of customers who owe more than their homes are worth after costs, their attitude is likely to change.

Robb Engen at Boomer and Echo
defends some aspects of mental accounting and sees problems with others.  Here is my thinking.  I see some forms of mental accounting as a rational response to the fact that the time and effort we put into making decisions has a cost. So, if we’re trying to be rational and account for all relevant costs when making decisions, we have to limit the time we spend making decisions. This necessarily means using easy rules of thumb (or mental accounting rules) that we only examine infrequently.  However, these rules of thumb do have to be examined occasionally to make sure they’re not wrong.

Big Cajun Man
says Nortel is still paying him tiny amounts he’s owed.  He also makes a good point about clutter costing money.

Thursday, July 7, 2022

Portfolio Projection Assumptions Use and Abuse

FP Canada Standards Council puts out a set of portfolio projection assumption guidelines for financial advisors to use when projecting the future of their clients’ portfolios.  The 2022 version of these guidelines appear to be reasonable, but that doesn’t mean they will be used properly.

The guidelines contain many figures, but let’s focus on a 60/40 portfolio that is 5% cash, 35% fixed income, 20% Canadian stocks, 30% foreign developed-market stocks, and 10% emerging-market stocks.  For this portfolio, the guidelines call for a 5.1% annual return with 2.1% inflation.  This works out to a 2.9% real return (after subtracting inflation).

We’ve had a spike in inflation recently, but these projections are intended for a longer-term view.  The projected 2.9% real return seems sensible enough.  Presumably, if inflation stays high, then companies will get higher prices, higher profits, their stock prices will rise, and the 2.9% real return estimate will remain reasonable.  Anything can happen, but a sensible range of possibilities is centered on about 3%.

However, the projections document has an important caveat: “Note that the administrative and investment management fees paid by clients both for products and advice must be subtracted to obtain the net return.”  For a typical advised client, total fees for products and advice can be around 2%, leaving only a real return of 0.9% for the client.

This creates a dilemma for the advisor: to use 2.9% and conveniently forget to subtract fees, or use the embarrassingly low 0.9% that will surely make clients unhappy.  It’s easy enough to justify using the larger figure; just pretend that great mutual fund selection will make up for the fees, even though all the evidence proves that this rarely happens.

But it gets worse.  The guidelines offer some flexibility: “financial planners may deviate within plus or minus 0.5% from the rate of return assumptions and continue to be in compliance with the Guidelines.”  So, unscrupulous advisors can lower inflation by 0.5% and raise all return assumptions by 0.5% to get a 3.9% expected return assumption (if they conveniently forget about fees) and still claim to be following the guidelines.

The typical problem with sophisticated portfolio projection software and spreadsheets is the return assumption baked into them.  No matter how impressive the output looks, it’s only as good as the underlying assumptions.

Monday, June 27, 2022

A Failure to Understand Rebalancing

Recently, the Stingy Investor pointed to an article whose title caught my eye: The Academic Failure to Understand Rebalancing, written by mathematician and economist Michael Edesess.  He claims that academics get portfolio rebalancing all wrong, and that there’s more money to be made by not rebalancing.  Fortunately, his arguments are clear enough that it’s easy to see where his reasoning goes wrong.

Edesess’ argument

Edesess makes his case against portfolio rebalancing based on a simple hypothetical investment: either your money doubles or gets cut in half based on a coin flip.  If you let a dollar ride through 20 iterations of this investment, it could get cut in half as many as 20 times, or it could double as many as 20 times.  If you get exactly 10 heads and 10 tails, the doublings and halvings cancel and you’ll be left with just your original dollar.

The optimum way to use this investment based on the mathematics behind rebalancing and the Kelly criterion is to wager 50 cents and hold back the other 50 cents.  So, after a single coin flip, you’ll either gain 50 cents or lose 25 cents.  After 20 flips of wagering half your money each time, if you get 10 heads and 10 tails, you’ll be left with $3.25.  This is a big improvement over just getting back your original dollar when you bet the whole amount on each flip in this 10 heads and 10 tails scenario.  This is the advantage rebalancing gives you.

However, Edesess digs further.  If you wager everything each flip and get 11 good flips and 9 bad flips, you’ll have $4, and with the reverse outcome you’ll have 25 cents.  Either you gain $3 or lose only 75 cents.  At 12 good flips vs. 12 bad flips, the difference grows further to gaining $15 or losing 94 cents.  We see that the upside is substantially larger than the downside.

Let’s refer to one set of 20 flips starting with one dollar as a “game.”  We could think of playing this game multiple times, each time starting by wagering a single dollar.  Edesess calculates that “if you were to play the game 1,001 times, you would end up with $87,000 with the 100% buy-and-hold strategy,”  “but only $11,000 with the rebalancing strategy.”

The problem with this reasoning

Edesess’ calculations are correct.  If you play this game thousands of times, you’re virtually certain to come out far ahead by letting your money ride instead of risking only half on each flip.  However, this is only true if you start each game with a fresh dollar.

In the real world, we’re not gambling single dollars; we’re investing an entire portfolio.  If one iteration of the game goes badly, there is no reset button that allows you to restore your whole portfolio so you can try again in a second iteration of the game.

Edesess fundamentally misunderstands the nature of rebalancing and the Kelly criterion.  They don’t apply to how you handle single dollars or even a subset of your portfolio; they apply to how you handle your entire portfolio.  If you have a bad outcome and lose most of your portfolio, the damage is permanent; you don’t get to try again.  Unless you’re a sociopath who invests other people's money in insanely risky ways hoping to collect your slice from a big win, you don’t get to find more investment suckers to try again if the first game goes badly.

Warren Buffett has said “to succeed you must first survive.”  This applies here.  The main purpose of rebalancing is to control risk.  It may be true that several coin flips could turn your $100,000 portfolio into tens of millions, but it could also turn it into less than $1000.  The rebalancing path is much smarter; it will give you more predictable growth and make a complete blowup much less likely.  It turns out that the academics understand rebalancing just fine; it’s Edesess who is having trouble.

Friday, June 17, 2022

Short Takes: Dividend Irrelevance, Housing Bears, and more

A popular type of investing is factor investing.  This means seeking out companies with attributes that performed strongly in the past, such as small caps (low total market capitalization) and value stocks (low price-to-earnings ratios).  I can’t say I’ve studied this area extensively, but one observation I’ve made is that these factors always seem to disappoint investors after they become popular.

It’s hard to figure out exactly why factors seem to disappoint, but I’m not inclined to pay the extra costs to pursue factor investing beyond my current allocation to stocks that are both small caps and value stocks.  Several years ago this combination was my best guess of the factor stocks most likely to outperform.  I’m still not inclined to try others.

Here is how I think about whether someone is ready for DIY investing:

What You Need to Know Before Investing in All-In-One ETFs

Here are some short takes and some weekend reading:

Ben Felix
explains why dividends are irrelevant.  His extensive references to peer-reviewed literature make his arguments tough for dividend lovers to refute, but they can always go with “ya, well, I like Fortis.”

John Robertson
hasn’t found it easy being a housing bear over the years, but now that prices are falling, he looks at what type of buyer would enter the market at different reduced price levels.

Justin Bender examines the merits of bond ETFs vs. GIC ladders.  Investors who want to reduce duration to reduce interest rate risk can consider an ETF of short-term bonds as well.  The way I look at the bond duration choice is whether I’d be happy to hold a 10+ year bond to maturity at current interest rates.  Interest rates have improved lately, but I still prefer to stick with short duration for now.

Thursday, June 9, 2022

What You Need to Know Before Investing in All-In-One ETFs

I get a lot of questions from family and friends about investing.  In most cases, these people see the investment world as dark and scary; no matter what advice they get, they’re likely to ask “Is it safe?”  They are looking for an easy and safe way to invest their money.  These people are often easy targets for high-cost, zero-advice financial companies with their own sales force (called advisors), such as the big banks and certain large companies with offices in many strip malls.  An advisor just has to tell these potential clients that everything will be alright and they’ll be relieved to hand their money over.

A subset of inexperienced investors could properly handle investing in an all-in-one Exchange-Traded Fund (ETF) if they learned a few basic things.  This article is my attempt to put these things together in one place.

Index Investing

Most people have heard of one or more of the Dow, S&P 500, or the TSX.  These are called indexes.  They are a measure of the price level of a set of stocks.  So, when we hear that the Dow or TSX was up 100 points today, that means that the average price level of the stocks that make up the index was up.

It’s possible to invest in funds that hold all the stocks in an index.  In fact, there are funds that hold almost all the stocks in the whole world.  There are other funds that hold all the bonds in an index.  There are even funds that hold all the stocks and all the bonds.  These are called all-in-one funds.

Most people know they know little about picking stocks.  They hear others confidently talking about Shopify, Google, and Apple, but it all sounds mysterious and scary.  I can dispel the mystery part.  Nobody knows what will happen to individual stocks.  Bold claims about the future of a stock are about as reliable as books about future lottery numbers.  However, the scary part is real.  If you own just one stock or a few stocks, you can lose a lot of money.

When you own all the stocks and all the bonds, it’s called index investing.  This approach to investing has a number of advantages.

Investment Analysis

Investors who pick their own stocks need to pore over business information constantly to pick their stocks and then stay on top of information to see whether they ought to sell them.  When you own all the stocks and all the bonds, there’s nothing to analyze or track on a frequent basis.


Owning individual stocks is risky.  Any one stock can go to zero.  Owning all stocks has its risks as well, but this risk is reduced.  The collective stocks of the whole world go up and down, occasionally down by a lot, but they have always recovered.  We can’t predict when they’ll drop, so timing the market isn’t possible to do reliably.  It’s best to invest money you won’t need for several years and not worry about the market’s ups and downs.

To control risk further, you can invest in funds that include both stocks and bonds.  Bonds give lower returns, but they’re less risky than stocks.  Taking Vanguard Canada’s Exchange-Traded Funds (ETFs) as an example, you can choose from a full range of mixes between stocks and bonds:

ETF Symbol 
    Stock/Bond % 
      VEQT           100/0
      VGRO           80/20
      VBAL           60/40
      VCNS           40/60
      VCIP           20/80


Sadly, many unsophisticated investors who work with financial advisors don’t understand that they pay substantial fees.  These investors typically own mutual funds, and the advisor and fund company help themselves to investor money within these funds.  There is no such thing as an advisor who isn’t paid from investor funds.

It’s common for mutual fund investors to pay annual fees of 2.2% or higher.  This may not sound like much, but this isn’t a fee on your gains; it’s a fee on your whole holdings, and it’s charged every year.  Over 25 years, an annual 2.2% fee builds to consume 42% of your savings.  This is so bad that many people simply can’t believe it.

With Vanguard’s all-in-one ETFs, the annual costs are about 0.25%, which builds to only 6% over 25 years.  Giving up 6 cents on each of your hard-earned dollars may not seem great, but it’s a far cry from 42 cents on the dollar.

Closet Index Funds

Can’t we just find a mutual fund run by a smart guy who can do better than index investing?  Sadly, no, we can’t.  Every year, experts analyze mutual fund results, and every year, they come up with the same answer: most mutual funds do worse than index investing.  A few do better for a while, but sooner or later, they stumble and fall behind index investing.  They simply can’t overcome their high fees for long.  We can’t predict in advance which funds will beat the index in a given year, so jumping from fund to fund is a losing game.

But things get worse.  A great many mutual funds aren’t even trying to do better than index investing.  They are called closet index funds.  They hold portfolios that look a lot like the indexes, but charge high fees anyway.  They focus more on selling their funds to investors than they focus on investment performance.  They hope their investors don’t notice that they’re not really doing much.

Canadians who invest at big bank branches and strip mall offices of big investment companies typically own closet index funds.  If you take the trouble to look through the holdings of their mutual funds, you see a set of stocks and bonds that isn’t much different from Vanguard’s all-in-one ETFs.  The difference is the cost.

Fear, Uncertainty, and Doubt

If index investing is so superior to the typical mutual fund, why doesn’t everyone switch to indexing?  The answer is that there are many people who make their living from the high-fee model.  Their salaries depend on extracting high fees from your savings.

Most advisors in big bank branches and in the strip mall offices of big retail investment companies have a list of talking points to scare people away from index investing.  But the truth is that the only scary thing about indexing is the threat to their salaries.

Going On Your Own

If you chose to invest in Vanguard Canada’s VBAL, which is 60% stocks and 40% bonds, you’re probably going to own close to the same stocks and bonds an advisor at a bank branch or strip mall would recommend.  The differences are that lower fees would leave you with higher returns, but you’d have to open your own investment accounts and make some trades on your own instead of having an advisor tell you everything will be fine.

So, this would involve choosing a discount broker, opening an RRSP and a TFSA and possibly other accounts, adding some money, and performing trades to buy an all-in-one ETF with money you won’t need for several years.  It’s best not to invest in stocks with money you may need soon, such as an emergency fund.  

Handling your own savings this way can be scary at first, and it isn’t for everyone.  The main challenges are getting started with making trades with large sums of money, avoiding selling out when the stock market goes down and you’re nervous, and avoiding changing your plan when something enticing comes along like day-trading, stock options, or cryptocurrencies.

Making the Switch

Getting started with investing on your own using all-in-one ETFs is easier for the beginning investor than it is for someone already working with an advisor.  The good news is that you don’t have to make the switch by talking to your advisor.  The process begins with opening new accounts at a discount brokerage and filling out forms to move your money from the accounts controlled by your advisor.  Your advisor is likely to notice and might try to talk you out of it, but you’re not obligated to work with your advisor when making the switch.

One approach that might make the process easier is to open new discount brokerage accounts and only add small amounts of money first.  After you’re more comfortable with trading and everything else at the discount brokerage, you can then fill out the paperwork to transfer the rest of your assets over to the new accounts.

Not For Everyone

Investing on your own isn’t for everyone.  However, all-in-one ETFs make it as easy as it can be to invest on your own.  As long as you can avoid the mistakes that come with fear and greed, you stand to save substantial investment fees over the decades.

Friday, June 3, 2022

Short Takes: Finding a Good Life, DTC for Type 1 Diabetics, and more

I was reminded recently of the paper The Misguided Beliefs of Financial Advisors whose abstract begins “A common view of retail finance is that conflicts of interest contribute to the high cost of advice. Within a large sample of Canadian financial advisors and their clients, however, we show that advisors typically invest personally just as they advise their clients.”

I didn’t find this surprising.  Retail financial advisors are like workers in a burger chain.  I wouldn’t expect these advisors to understand the conflicts of interest in their work any more than I’d expect workers in a burger chain to understand the methods the chains use to draw customers into eating large amounts of unhealthy food.  It’s hardly surprising that so many advisors understand little about investing well, and that they run their own portfolios poorly.

However, this doesn’t mean the conflicts of interest don’t exist.  It is those who run organizations that employ, train, and design pay structures for financial advisors who have the conflicts of interest.  The extra layers between the clients and those who understand the conflicts make the situation worse.  It’s easier to tell someone else to do bad things to people than it is to do bad things to people yourself.  It’s even easier at higher levels to yell at underlings to create more profits and let them tell the clueless advisors at the bottom layer to do bad things to clients.

Of course, not all advisors in this sort of environment are clueless, and many manage to escape to run practices where they are able to treat their clients better.  Unfortunately, this type of advisor usually either only takes clients with a lot of money or charges fixed amounts that are large enough to scare off clients with modest savings.

Here are my posts for the past two weeks:

Taking CPP and OAS Early to Invest

Why Do So Many Financial Advisors Recommend Taking CPP Early?

Measuring Rebalancing Profits and Losses

Here are some short takes and some weekend reading:

Benjamin Felix has an interesting paper called Finding and Funding a Good Life.  He looks at the research on happiness and how to achieve a good life.   One of the reflective questions he poses is one I’ve thought about a lot: “Are there unpleasant tasks in your life that you could outsource?”  I often decide that it’s easier to clean my house myself than to become an employer, but maybe that’s just an excuse for not taking action.  Another interesting point is that “when people are told what to do they are more likely to rebel against the instruction to regain their sense of freedom.”  I think that explains why I lost any desire I used to have for working for a boss, no matter how well I was treated.

Big Cajun Man
reports that Canadians with Type 1 Diabetes should have an easier time getting the Disability Tax Credit (DTC) after recent changes.

Kerry Taylor discusses how to raise your credit score with licensed insolvency trustee Doug Hoyes.  Among the many good points Doug makes, he says that it’s your credit history over time that matters more than a snapshot of your credit score.

Thursday, June 2, 2022

Measuring Rebalancing Profits and Losses

Investors often seek to maintain fixed percentage allocations to the various components of their portfolios.  This can be as simple as just choosing allocations to stocks and bonds, or it can include target percentages for domestic and foreign stocks and many other sub-categories of investments.  Portfolio components will drift away from their target percentages over time, requiring investors to perform trades to rebalance back to the target percentages.  A natural question is whether rebalancing produces profits, and if so, how much.

A long-time reader, Dan, made the following request:

I have a topic request. On the subject of portfolio rebalancing, I have read your many posts and whitepaper [see Calculating My Retirement Glidepath]. I have actually implemented something similar (but not exactly the same) myself.  I saw in one blog post, cannot find where, that you said something to the effect of “my rebalancing trades last year produced a profit”.

My topic request is, could you detail specifically, your method for tracking & determining profitability of those rebalancing trades?

It’s true that the rebalancing I did through the brief but fairly deep stock market decline at the start of the pandemic produced nontrivial profits for me.  These profits came from purely mechanical trades I made when my spreadsheet declared my portfolio to be too far out of balance.

However, I don’t consider profit to be the primary purpose of rebalancing.  I do it to maintain a sensible risk level for my portfolio given my age and the fact that I’m retired.  In fact, I expect to lose money over the decades from rebalancing, as I’ll explain before I get to the details of how investors can measure the profits and losses from rebalancing.  

There are two different effects that can occur as the prices of portfolio components vary.  One effect creates profits, and the other creates losses.

Rebalancing profits

Rebalancing is profitable when one asset, say U.S. stocks, rises faster than another asset, say Canadian stocks, and later the Canadian stocks catch up.  By selling some U.S. stocks to buy Canadian stocks just before Canadian stocks begin to perform better, the rebalanced portfolio outperforms just holding through the whole period.

In general, when two assets grow at roughly the same long-term rate, but the lead seesaws back and forth between them, rebalancing is profitable.

Rebalancing losses

Rebalancing gives losses when one asset, say stocks, consistently outperforms another asset, say bonds.  In this case, rebalancing usually involves periodically selling some stocks to buy bonds, and the rebalanced portfolio won’t perform as well compared to buy-and-hold.

Of course, there are times when bonds outperform stocks by a wide margin, mainly when the stock market crashes.  So, there will be periods when rebalancing will produce short-term profits to offset the long-term rebalancing losses from mainly selling stocks to buy bonds.

I expect the rebalancing between different classes of stocks to produce small profits, and to occasionally get rebalancing profits from rebalancing between stocks and bonds, but I expect the long-term losses from rebalancing from stocks to bonds to dominate.

So, why rebalance if we expect losses?

There is no guarantee that rebalancing will produce losses on balance.  If there is an extremely large drop in stock prices some time in the future, it’s possible that rebalancing will produce net profits.  By maintaining a fixed percentage in bonds instead of letting the bond percentage dwindle, the investor who rebalances will be spared somewhat when stocks crater.

So, even though I expect to lose out over the decades from rebalancing because I’m optimistic about the future of stocks, it’s possible that rebalancing will save me at a terrible time for stocks.  This is the main idea behind the risk-control value of rebalancing.  I’d rather get some protection if future returns disappoint than try to become even richer in case the future is very bright.

Calculating rebalancing profits and losses

Back in 2020, my spreadsheet told me to rebalance several times as stocks dropped sharply and then rebounded quickly.  Each time I rebalanced, I took a snapshot of my portfolio holdings.  Later, I looked at the snapshot from just before the first rebalancing, and calculated what my portfolio’s value would have been if I had never rebalanced through the pandemic.  The difference between this value and the actual portfolio value I ended up with as a result of rebalancing gave me my net rebalancing profit.  This difference proved to be larger than I expected.

In general, any discussion of profit and loss comes from comparing two different courses of action.  In this case, it comes from comparing an actual portfolio with rebalancing to a hypothetical portfolio without any rebalancing over a particular period of time.

I don’t do these calculations often.  I’m satisfied that rebalancing makes sense for me for risk reasons.  I’m not waiting for the outcome of an experiment to see whether rebalancing will be profitable over the long run.  I got interested in rebalancing through the pandemic and did some calculations out of curiosity.

A more serious approach

I don’t think it’s important to track rebalancing profits and losses, but I can understand that some technically-minded investors may be interested.  So, let’s dig into how one might implement tracking rebalancing profits and losses.

The biggest complication comes from portfolio inflows and outflows.  In addition to running your actual portfolio and deciding which assets to buy or sell each time you add or withdraw money, you’d have to make these decisions for a hypothetical non-rebalanced portfolio.  An easier task is to take a snapshot of your portfolio before each rebalancing, and to track inflows and outflows.  This permits you to run a hypothetical non-rebalanced portfolio over any period of time and then compare its results to your actual portfolio’s results.

If the hypothetical portfolio isn’t supposed to have rebalancing, it’s not obvious what assets you should buy or sell when adding or withdrawing money.  The choices you make with the hypothetical portfolio could make a big difference in the measured values of rebalancing profit and loss.

When I looked at my rebalancing gains through the pandemic, I didn’t have any inflows and had only small outflows, so it didn’t make a lot of difference what assets I chose to sell for the outflows.  Over longer periods, the choice of what assets to buy or sell can make a big difference in the calculated rebalancing gains and losses.

Here are some possibilities for how to run the hypothetical portfolio:

  1. Add or withdraw from each asset class in proportion to its percentage of the portfolio.  This leaves asset class percentages unchanged.  This is what I did when I calculated my rebalancing gains through the pandemic.

  2. Add or withdraw from asset classes in a way that takes them closer to their target percentages.  This is a form of rebalancing with cash flows.  With this approach, what you’re measuring is the profits or losses from the “extra” rebalancing in your real portfolio that becomes necessary when asset classes diverge strongly enough that they can’t be kept in balance with cash flows.

  3. Perform cash flows the same way you do them for your real portfolio, and then rebalance on a fixed time schedule.  For those who use threshold rebalancing, this method compares the results from threshold rebalancing to the results of periodic rebalancing.

  4. Use one of the other three methods and reset the hypothetical portfolio to the real portfolio periodically (perhaps annually) after calculating the period’s rebalancing gain or loss.  This will give very different results from letting the hypothetical portfolio diverge from the real portfolio over many years.

No doubt there are many other possible approaches to running the hypothetical portfolio.  


There are so many choices for how to proceed to measure the value of rebalancing that whatever method you choose would be a personal customized measure of something that may or may not represent the long-term value of rebalancing.  For now, I’ll just compute short-term rebalancing gains or losses when the mood strikes.