Monday, April 25, 2022

The Rule of 30

Frederick Vettese has written good books for Canadians who are retired or near retirement.  His latest, The Rule of 30, is for Canadians still more than a decade from retirement.  He observes that your ability to save for retirement varies over time, so it doesn’t make sense to try to save some fixed percentage of your income throughout your working life.  He lays out a set of rules for how much you should save using what he calls “The Rule of 30.”

Vettese’s Rule of 30 is that Canadians should save 30% of their income toward retirement minus mortgage payments or rent and “extraordinary, short-term, necessary expenses, like daycare.”  The idea is for young people to save less when they’re under the pressure of child care costs and housing payments.  The author goes through a number of simulations to test how his rule would perform in different circumstances.  He is careful to base these simulations on reasonable assumptions.

My approach is to count anything as savings if it increases net worth.  So, student loan and mortgage payments would count to the extent that they reduce the inflation-adjusted loan balances.  I count contributions into employer pensions and savings plans.  I like to count CPP contributions and an estimate of OAS contributions made on my behalf as well.  The main purpose of counting CPP and OAS is to take into account the fact that lower income people don’t need to save as high a percentage of their income as those with higher incomes because CPP and OAS will cover a higher percentage of their retirement needs.

Unlike my approach, Vettese counts certain types of expenses like daycare, rent, and mortgage interest.  He seeks to take the pressure off people to save so much when they’ll very likely be better able to save later in their lives.

A Concern

This brings me to a concern about the Rule of 30.  Vettese assumes people will get significant pay increases over the course of uninterrupted careers.  No doubt his assumptions are a reasonable guess at the average outcome, but there is a wide range of outcomes.  Some people get laid off and have to take lower-paying jobs after a very long job search (think Nortel).  Some people can’t stand their jobs and change careers.

Building some savings early leads to more choices.  Vettese is right that if you do have a successful uninterrupted career, you will have scrimped when your children were young and you could least afford it.  However, if you get laid off and need money to live on while retraining, you’ll be very happy to have some savings.  Building savings provides protection from many risks.

All that said, Vettese’s ideas are useful.  Perhaps those who want the security that comes with saved money could follow the Rule of 30 with a minor change to set some floor on the saving percentage like 5% or 7%.

Vettese had more interesting things to say on a number of topics not directly related to his Rule of 30.

Public Sector Pensions

Public sector pensions are aimed at replacing 70% of final average pay, which is more than it should be.  This replacement level jumps to about 80% when we count OAS.  To justify such large pensions, “The minister of Finance at the time stated publicly that public sector workers had lower salaries than their counterparts in the private sector.”  But that’s no longer true.

Little is likely to be done about these high pensions because “20 percent of [journalists’] readership work in the public sector,” politicians “are not keen to alienate the public sector unions,” and pension actuaries get “much of their business from the public sector.”

Typical Retiree Spending Pattern

“The typical spending pattern for retirees is to increase their spending in line with inflation until their early 70s, after which spending will continue to increase in nominal terms but by less than the inflation rate.  This tendency to spend less (in real terms) with age intensifies in one’s 80s but then may start to rise again very late in life when retirement homes and personal support workers enter the equation.”

I don’t find this appeal to what the average retiree does very persuasive.  The average Canadian smokes about 2 cigarettes a day.  That doesn’t mean I should too.  I prefer to model my behaviour on just the non-smokers.  Similarly, data on retiree spending is skewed by the subset of retirees who overspend early in retirement and are forced to cut back rather than doing so by choice.  I don’t want to model my own retirement on data that includes retirees who handled their money poorly.

I agree that it’s normal for people to spend less by choice at some point as they age.  My concern is that the timing and size of this decrease is hard to determine when we mix in data from people who spend less because they’re running out of money.

All that said, many researchers have determined that retiree spending begins to drop in real terms almost immediately after retirement begins.  So, Vettese has already made some adjustments by delaying the assumed decrease in real spending from a retiree’s 60s to his or her 70s.

Bull Market in Bonds

Looking to the past 40 years of bond returns to see what’s likely to happen in the future is a big mistake.  “Bonds made great capital gains because yields fell from 15 percent in the early 1980s to the present level of 1 percent.  To duplicate that feat, bond yields would have to fall by that much again, which would bring the yield down to negative 13 percent.  Obviously, that’s not going to happen.”

Since this book was written, bond yields have risen a little, and we’re seeing this hurt bond prices.


The idea of varying one’s saving percentage over one’s life isn’t new, but Vettese proposes a specific rule, The Rule of 30, and makes a number of projections to test it.  His rule fares well in the testing, and it should work well for anyone whose life and career conform to the testing assumptions.  It is clear that Vettese sought to create a rule that would work across a wide range of circumstances, but some Canadians’ careers won’t go smoothly enough to justify saving too little early on.  However, even readers who don’t adopt Vettese’s specific rule will benefit from his well-explained methods of analysis.

Friday, April 22, 2022

Short Takes: Stock Splits, the New Tax-Free First Home Savings Account, and more

I’ve seen some complaining that government benefits (like CPP) aren’t keeping up with inflation the way they are supposed to.  Some people have substantive complaints about how the Consumer Price Index (CPI) is calculated, but others are simply unaware of how CPI changes get applied.

News reports generally just compare today’s CPI to what it was a year ago.  Lately, we’ve seen some big jumps in inflation.  People see that these inflation increases are larger than the CPI adjustments to their government benefits.  However, for government benefits and other CPI-indexed figures, the government averages CPI numbers from November of one year to the end of October of the following year.  

A CPI adjustment that takes place in January is based on CPI figures from 14 months earlier to 2 months earlier (and how much that average increased over the previous year’s average).  This creates about an 8-month delay in applying CPI increases.

So, assuming inflation moderates at some point, we’ll see the “pending” 8 months of higher inflation reflected in CPI-adjusted amounts the following year.

Here I discuss CPP timing in a conversation format:

A Conversation about CPP

Here are some short takes and some weekend reading:

Preet Banerjee explains the significance of stock splits.  They do make a difference in some small ways, but not in the ways many people think.

John Robertson has a different take on the new Tax-Free First Home Savings Account.

Andrew Hallam explains the danger of judging an investment strategy by just a few years of results.