Authors Tony Martin and Eric Tyson have updated their book, The Canadian’s Guide to Investing, but it certainly does not seem very up-to-date. Despite a few references to ETFs and some updated examples, most of the text seems decades old and no longer very relevant. There are some good parts, but there are better choices for investment books.
The book makes reference to many things that used to be true. Extensive discussion about “funds” is almost exclusively about mutual funds with little about ETFs. Buying stocks is “costly unless you buy reasonable chunks (100 shares or so) of each stock.” You can “call the fund company’s toll-free number” and invest by “mailing in a cheque.” “A great deal of emphasis is placed on who manages a specific fund” – this is mostly a thing of the past. “Invest in a handful of funds (five to ten).” There is discussion of real estate “declines in the late 2000s.”
There are repeated references to MERs of 0.5% to 1.5% as being “low.” Even the ETF discussion on this point says index ETFs “typically have MERs of less than 1 percent.” I suppose 0.05% is less than 1%.
The authors advise people to avoid limit orders and use market orders when you intend to hold for the long haul. They seem to consider limit orders as being only for trying to get equities for cheaper than the current ask price. A good use of limit orders is to offer a price higher than the current ask price (or lower than the current bid price when selling). This will usually give you the market price, but will prevent the trade from executing if markets move quickly against you just as you’re entering the trade.
The book advises people to rely on credit-rating agencies for bonds, which is interesting in light of the abject ratings failures leading up to the great financial crisis.
On asset allocation, “playing it safe” is to use your age as a bond percentage, “middle of the road” is age minus 10, and “aggressive” is age minus 20. They go on to break down the stock allocation characterizing owning mostly Canadian stocks as “play-it-safe,” and having half your stock allocation outside of Canada as “aggressive.” I don’t see anything safe about avoiding U.S. and international stocks.
The authors tell investors “who enjoy the challenge of trying to pick the better [fund] managers and want the potential to earn better than market level returns, don’t use index funds at all.” Chasing star fund managers is an old and losing game.
At one point, the authors promise to help investors in “spotting a greatly overpriced” market so you can “invest new money elsewhere.” It turns out that this method uses price-earnings ratios. Shiller’s CAPE10 measure of U.S. stock market price-earnings has been above 20 since 2010, a period where U.S. stocks have grown by a factor of nearly 6 (including dividends). This is not a good period to have skipped.
On the positive side, the authors advise against buying expensive cars: “set your sights lower and buy a good used car that you can afford.” When it comes to index investing, “you can largely ignore the NASDAQ.” “To find a home that meets your various desires,” taking “six months to a year [to find the right house and neighbourhood] isn’t unusual or slow.” “Begin your search without [a real estate] agent to avoid … outside pressure.”
The authors have some interesting takes. “One of the best tactics is to focus only on [retirement saving and paying off your mortgage] and ignore [saving for university or college]” until later. They also offer extensive advice concerning owning a small business and determining if readers are suited to it.
The authors would need to put extensive work into this book to bring it up to date. As it is, I can’t recommend it to others.
Friday, September 6, 2024
Book Review: The Canadian’s Guide to Investing
Thursday, September 5, 2024
Tax Rates on RRSP Contributions and Withdrawals
Recent Rational Reminder podcasts (319 and 321) have had a debate about tax rates on RRSP contributions and withdrawals. Most people agree that when you contribute, you’re lowering your taxes at your marginal tax rate. The debate concerns withdrawals. Some say that RRSP withdrawals come at your “average, or effective tax rates, not your marginal tax rate.” Here, I address this question.
With Canada’s progressive tax system, the first part of your income isn’t taxed at all (or is taxed negatively when you consider income-tested government benefits), then the next part of your income is lightly taxed, and marginal tax rates increase from there as your income rises.
A question that comes up in my own portfolio accumulation and decumulation planning is what order to stack income each year. Is it CPP and OAS that are taxed lightly and RRSP withdrawals taxed more, or should I stack the income in some other order? What about other income from non-registered savings? Maybe everything should be assigned the same average tax rate.
The truth is that this is only a struggle because we’re trying to assign tax rates to one strategy in isolation. Whether a strategy is good or not cannot be decided in isolation. It only makes sense to compare two or more strategies. When we compare strategies, it becomes obvious how to handle tax rates.
Let’s try to create two strategies that isolate the RRSP as the only difference. Strategy 1: no RRSP. This strategy might include TFSA contributions or other elements, but it does not use RRSPs. Strategy 2: everything from strategy 1 plus RRSP contributions while working, and RRSP withdrawals after retiring.
Comparing the two strategies during working years, we should think of RRSP deductions as coming off the highest part of the total income because that is the difference between the two strategies. If we apply the deduction somewhere in the bottom or middle of the income range, then the other income (that is the same in both strategies) will be taxed differently in the two strategies. We want to find the net difference between strategies, and that comes from treating the RRSP deduction as coming at the marginal tax rate.
During retirement years, we end up with a similar argument. Both strategies will have the same income each year, except that Strategy 2 will have additional RRSP withdrawal income. To isolate the differences in income and taxes between the two strategies, we must think of the RRSP withdrawal as being the last, most highly taxed part of the income. So, it’s taxed at the marginal rate.
At this point, we should comment on what we mean by marginal rate. It is usually defined as the tax rate on the last dollar earned. However, we usually aren’t discussing amounts as trivial as a single dollar. Larger amounts can easily span multiple marginal tax brackets. So, it’s possible for your RRSP deduction to give part of its tax savings at one rate and part at a lower rate.
So, when we say that RRSP contribution tax savings occur at your marginal rate, this might actually be a blended rate, not to be confused with your overall average tax rate. For example your marginal tax rate might be 43%, your tax savings rate on RRSP contributions might be partly 43% and partly 38% for a blended rate of 40%, and your average tax rate might be 25%.
This effect becomes larger for RRSP withdrawals, because the withdrawals tend to be larger than the contributions. If your income consists of CPP, OAS, and RRSP withdrawals, your RRSP withdrawals may be the bulk of your income and may span multiple marginal tax brackets. So, even though we say you pay tax on the RRSP withdrawals at your marginal tax rate, this is actually a blended rate that may not be too much higher than your average tax rate.
So, when comparing the strategies that differ only in RRSP contributions and withdrawals, the argument that RRSP withdrawals come at your average tax rate might be sort of true in the sense that they will likely be at a blended rate, but we get the correct answer when we think of RRSP deductions and income as coming at the top of your income. We can only answer such questions properly when comparing two or more accumulation and decumulation strategies rather than analyzing one strategy in isolation.
Tuesday, September 3, 2024
Picking Up Nickels in Front of a Steamroller
Suppose a casino offered the following bet. You roll six fair dice. If anything but all sixes shows up, you get $20. But if all sixes show up, you lose a million dollars. There are a number of practical problems with this game. The casino would demand a million dollar deposit in advance, and the odds are way too sensitive to imperfections in the dice and to player skill at not throwing sixes. But this is a thought experiment designed to shed light on real world financial events.
Initially, few people would play this game, because losing a million dollars is too scary. But if you watched someone playing, even all day, you’d likely never see a loss. You’d just see the player collecting $20 every 10 seconds or so building up to many thousands of dollars. The fear of missing out (FOMO) would set in for some and tempt them to play.
Over the long haul, the casino expects to pay out $933,120 for every million dollars it wins. So playing this game is good for the casino but a bad idea for the player. However, it’s easy to forget about the losses if you only see everyone winning $20 every play. Games like this are referred to as “picking up nickels in front of a steamroller.” The $20 payoffs are the nickels, and the million-dollar losses are when you get flattened by the steamroller.
The yen carry trade
So what does this have to do with real life? There are many “games” in real life that resemble this hypothetical game more than people would like to admit. When interest rates were much lower in Japan than they were in the U.S., it seemed profitable to borrow yen at a low interest rate, convert it to U.S. dollars, and collect high interest on U.S. dollar deposits.
This sounds quite profitable, so why did I say it only “seemed profitable”? Well, all was well as long as interest rates and the exchange rate between yen and U.S. dollars were stable. However, a rise in the value of the yen and higher Japanese interest rates (the steamroller) could more than wipe out any profits from the interest rate spread (the nickels).
Unlike the hypothetical dice game where the potential loss of a million dollars is prominent, it’s less obvious with the yen carry trade. You might convince yourself that the value of the yen and Japanese interest rates would change slowly enough that you could exit your positions profitably. However, many others would be trying to unwind their positions at the same time, each one trying to be among the first to get out.
Excessive leverage
Rather than just invest a fraction of your wages in stock markets, you could borrow extra money to invest more. The stock markets may gyrate, but they keep rising. If you can just wait out the gyrations, you’ll be sure to eventually make more money (the nickels) than if you didn’t borrow.
The problem is that if you borrow too much, and your creditors see that you’re in danger of becoming insolvent, they may demand their money back or impose high interest rates that eliminate your profits. A sudden stock market crash (steamroller) could wipe you out before you get a chance to wait out the market decline. Modest leverage can be reasonable, but it takes some skill to determine how much you can borrow safely.
The great financial crisis
Many Wall Street firms made apparent profits selling insurance against mortgage defaults in the form of exotic financial instruments like credit default swaps (CDSs) and collateralized debt obligations (CDOs). In this case, the nickels were the insurance premiums they collected, and the steamroller was the wave of mortgage defaults across the U.S.
It’s tempting to say that everyone involved was naive or incompetent, but employees of a firm have different interests than the firm itself does. While the party was ongoing, the apparent profits piled up, and employees collected their share in the form of huge bonuses. When the steamroller crushed their firms, these employees didn’t have to return their bonuses. It was like playing the dice game with someone else’s money. The employees would take a cut of each $20 win, and let others deal with the million dollar loss.
Long-Term Capital Management
The LTCM hedge fund employed Nobel Prize winners to beat the markets, and it seemed to work for a few years. They used complex models of how markets work to squeeze out profits (the nickels). Unfortunately for them and their investors, markets eventually stopped working the way the models expected (the steamroller) for long enough to wipe out past profits.
Conclusion
There are many financial schemes in the real world that resemble picking up visible nickels in front of an obscured steamroller. If you think you've found a way to beat the markets, try to figure out where the steamroller is.
Tuesday, August 20, 2024
More on My Tesla Model 3 Experience After 5 Years
My post describing my experience with the dual-motor long-range Tesla Model 3 I bought back in April 2019 generated further questions about battery life, recalls, and driving range in winter that I answer here.
Battery life
Recently, I was in a waiting room and couldn’t help overhearing a conversation about electric vehicles. The two people agreed they wouldn’t consider owning one, and the dominant stated reason was fear of high-cost battery replacements. It became clear after a while that they mistakenly believed EV batteries would have to be replaced as often as lead-acid batteries in gas cars. The truth is that Tesla batteries are expected to last longer than the rest of the car.
A few days ago, I was startled to receive a notification on my phone that my car’s battery needed to be replaced. A few seconds of poking around on the Tesla app eased my worries. I didn’t realize that my car has a lead-acid battery as well as its large high-tech battery. So, $164 later, my lead-acid battery has been replaced. The main battery powering my car is still fine.
Recalls
Tesla has been in the news frequently for having “recalls” of their cars. This brings to mind images of millions of cars lined up at service stations, but that’s not what’s going on. Almost all of these recall changes are just folded into the next software update.
Tesla pushes out software updates to cars every month or so. They mostly contain improvements they’ve made. Sometimes, they include things regulators want. In one case, the font size on a warning message was made larger. Quite the recall.
The only substantive recall item I can remember was something to do with cabling near my trunk. When I was having a camera realigned for US$34, the technician improved the cabling at no extra charge.
Driving range in winter
Electric vehicle batteries have an optimum temperature. Heating or cooling them draws battery power, and operating the batteries outside their optimum temperature range is less efficient. There is nothing the driver has to do about this; the car handles it all itself. However, the net result is that the car’s range is lower in winter than it is during other seasons.
The difference in range has been noticeable, but not a problem for me. One time that I looked at some numbers, the difference in range between a summer day and a below-freezing winter day was close to 15%, but I can’t say whether this is typical. I suspect the difference depends on how cold it gets and the make of electric car. To be fair, gas cars burn more gas in winter as well.
Conclusion
My conclusion remains the same: I love my Tesla Model 3’s quiet power and its well-designed features that get improved regularly through software updates. Most of what I see online about EVs is overblown or doesn’t apply to Teslas. My car is very cheap to run, but the purchase price was high. It’s been the best car I’ve owned, but until they become cheaper, I can only recommend them to those who can reasonably afford a luxury car.
Wednesday, August 14, 2024
Retirement Income for Life (Third Edition)
Actuary Frederick Vettese has a third edition of his excellent book, Retirement Income for Life: Getting More Without Saving More. He explains methods of making your retirement savings produce more income over your entire retirement. These methods include controlling investment fees, optimizing the timing of starting CPP and OAS pensions, annuities, Vettese’s free Personal Enhanced Retirement Calculator (PERC), and using reverse mortgages as a backstop if savings run out.
This third edition adds new material about how to deal with higher inflation, CPP expansion, new investment products as potential replacements for annuities, and improvements to Vettese’s retirement calculator PERC. Rather than repeat material from my review of the second edition, I will focus on specific areas that drew my attention.
Inflation
“We can no longer take low inflation for granted.” “An annuity does nothing to lessen inflation risk, which should be a greater worry than it was before the pandemic.” “We could have practically ignored inflation risk before COVID hit but certainly not now.”
It’s true that inflation is a potential concern for the future, but it’s wrong to say that it was okay to ignore inflation in the past. Not considering the possibility of inflation rising was a mistake many people made in the past. We were lulled by many years of low inflation into being unprepared for its rise starting in 2021, just as many years of safety in bonds left us unprepared for the battering of long-term bonds when interest rates rose sharply.
Inflation risk is always present, and financial planners who have treated it as a fixed constant were making a mistake before inflation rose, just as they would be wrong to do so now. This underappreciation of inflation risk is what causes people to say that standard long-term bonds (with no inflation protection) are safe to hold to maturity. In fact, they are risky because of inflation uncertainty.
People’s future spending obligations are mostly linked to real prices that rise with inflation, not fixed nominal amounts. The uncertainty in future inflation should be respected just as we respect uncertainty in stock market returns.
Maximizing retirement income
Vettese does a good job of explaining that things like CPP, OAS, and annuities provide more income now because they offer your estate little or nothing after you die. To make full use of this book, you need to understand this fact, and “you have to commit to the idea that your main objectives are to maximize your retirement income and ensure it lasts a lifetime.”
Spending shocks
Retirees should “set aside somewhere between 3 percent and 5 percent of their spendable income each year, specifically to deal with spending shocks.” “This reserve might not totally cover all the shocks that people … might encounter, but it will definitely soften their impact.”
It’s easy to plug a smooth future spending pattern into a spreadsheet, but real life is much messier than this. I’ve seen cases of retirees choosing to spend some safe percentage from their savings while also expecting to be able to dip in anytime something big and unplanned for comes up. This is a formula for running out of retirement savings early.
Retirement income targets
In this third edition, Vettese assumes that retiree spending will rise with inflation until age 70, then rise one percentage point below inflation during one’s 70s, two percentage points below inflation from age 80 to 84, then 1.8% below at 85, 1.6% below at 86, 1.4% below at 87, 1.2% below at 88, 1% below at 89, and rising with inflation again thereafter.
This plan is based on several academic studies of how retirees spend. I don’t doubt the results from these studies, but I do have a problem with basing my plan exclusively on the average of what other people do. The average Canadian smokes two cigarettes a day. Does that mean I should too?
The academic studies mix together results from retirees who spent sensibly with those who overspent early and were forced to cut back. I don’t want to base my retirement plan partially on the actions of retirees who made poor choices. Similarly, I prefer to base my smoking behaviour on those Canadians who don’t smoke.
I suspect that Vettese has already tried to take this into account with his assumed retiree spending reductions, because some studies I’ve read show retiree spending declining earlier than Vettese’s plan. It’s hard to know what would happen to study results if we excluded early overspenders, but I suspect that spending declines would tend to start later and be less severe than Vettese’s plan.
Part of the reason I believe this comes from the fact that societal spending actually rises faster than inflation; it tends to rise with wage inflation rather than regular (price) inflation. Wage inflation has averaged about 0.75 percentage points more annually than price inflation. So, even if your retirement plan assumes your spending will rise with price inflation, your spending will decline relative to your younger neighbours.
In fairness to Vettese, though, his free tool PERC embeds other assumptions that are conservative, so the fact that I find this assumption somewhat aggressive doesn’t diminish the usefulness of PERC.
Monte Carlo simulations
“Monte Carlo simulations might be good at modelling investment returns between the 5th percentile and the 95th percentile, but when you go deeper into the tails of the distribution, it is a different matter.”
This is a good point. When a simulator says your retirement plan gives you a 97% chance that you won’t run out of money before you die, it sounds wonderfully scientific, but it’s just marketing. Black swan events make it impossible to make such assessments accurately. Models of investment returns are never completely accurate, and the further we go toward lower probability outcomes, the worse these models are.
CPP survivor pension
The rules for calculating a surviving spouse’s additional CPP payments after the other spouse dies are quite complex. Vettese explains them well, except that I think one part is inaccurate, as I explained in detail in an earlier post.
At one point, Vettese calculates a quantity C that is the difference between the deceased spouse’s basic retirement pension and the surviving spouse’s basic retirement pension. Information I’ve seen elsewhere says that this should really be the difference between the maximum basic retirement pension and the surviving spouse’s basic retirement pension.
In an example for a couple Susan and Nick, after Nick’s death, “Susan’s CPP pension would be increased to the maximum CPP pension payable to any one individual.” This is because CPP rules don’t permit Susan’s total CPP to exceed this CPP maximum. However, my understanding is that this applies to the case where Susan’s CPP pension was started at age 65. If Susan had started CPP at 70, her own pension would still be 42% higher, and when the survivor pension is added , her total CPP pension would exceed what we think of as the maximum CPP pension. Similarly, if she had started her CPP at 60, her total pension would be less than what we think of as the maximum CPP pension.
OAS
If you’ve lived at least 40 years in Canada between the ages of 18 and 65, you’re entitled to a full OAS pension (that may be clawed back if your income is high). However, if you haven’t been in Canada for that long as an adult (but for at least 10 years), your OAS pension “will be reduced in proportion to the number of years of residency … between ages 18 and 65.”
If you delay taking OAS until somewhere between age 65 and 70, the extra years can be used to either increase your years of residency closer to 40, “or to adjust [your] pension upward by 7.2 percent for each year beyond age 65,” but not both.
Deferring CPP
The best reasons for not deferring CPP to age 70 are that either you don’t have enough savings to bridge the retirement gap before age 70, or that your health is severely compromised making an early death certain. Beyond that, Vettese explains why most other reasons people give are irrational or invalid.
“Deferring CPP pension to age 70 forces you to draw down your [assets] more quickly before age 70, but those same assets last longer because the CPP pension from age 70 and on is so much bigger.”
This is an important point that I find people have a hard time understanding. They imagine having to spend down their assets, and then imagine a bleak future. In reality, they will have higher guaranteed CPP income that will insulate them somewhat from stock market gyrations, and their assets will ultimately last longer.
Most of the book’s analyses are based on getting below median investment returns. In one chapter where Vettese looks at what happens if investment returns are at the median, he concludes that deferring CPP to age 70 “makes eminent sense whether future returns are poor or middle-of-the-road.”
Reverse mortgages
“With a reverse mortgage, you do not have to make any payments while you or your spouse continue to live in the home. And you cannot be forced to move out. You do have to maintain the home, however, including paying property taxes and home insurance premiums on a regular basis.”
This is self-contradictory. You can be forced to move out if you don’t maintain your home or fail to pay property taxes and insurance premiums. We tend to think of home maintenance as an annoyance, but something we can handle. However, I’ve known several old people who simply couldn’t maintain a home properly. Many old people rely on neighbours and family for help with basic maintenance, and many others simply fail to maintain their homes properly.
We are still in the early stages of Canadians taking on reverse mortgages. Financial institutions are unlikely to deliberately generate bad press while they are trying to make sales. But in a decade or two, when they have many clients who owe as much as their homes are worth after the cost of selling, the mood will change. Financial institutions will be incented to force old people out of their homes if the homes are run down.
PERC built-in assumptions
Vettese explains the assumptions built into his free PERC tool, including that “the primary spouse (the one entering the data) is assumed to die at 90 and the surviving spouse at 93.” However, in an earlier example, “Graham dies at age 85, the default assumption that is built into PERC.” I’m not sure if this is an error, or if these are somehow built-in assumptions for different types of cases.
For anyone who finds assuming death at 90 or early 90s not to be conservative enough, PERC also assumes that you want to be left with 10% of your assets remaining at this age, which is on the conservative side. So, depending on what different assumptions the reader might make, these differences might balance out somewhat.
Another thing to keep in mind is that PERC displays income in pre-tax amounts. I’ve always done my own planning with after-tax amounts, so it takes some work to compare my outputs with those of PERC.
Decumulation strategy
“Retirees are generally better off drawing down assets from multiple sources on an annual basis (in proportion to how much they have of each asset) rather than drawing down taxable assets first and trying to keep their tax-sheltered assets intact for as long as possible.”
This agrees with my own simulations. However, I’ve found that it’s generally better to draw down taxable assets before drawing down a TFSA, particularly if the taxable assets don’t have large unrealized capital gains. It’s RRSPs and RRIFs that are best drawn down gradually throughout retirement.
Financial advisors
Controlling investment costs, deferring CPP and OAS, buying annuities, and even planning to rely on a reverse mortgage all cut into financial advisor compensation. “I know a growing number of financial planners out there who do accept the ideas in this book,” but Vettese also has stories of advisors whose recommendations help themselves rather than their clients.
Conclusion
This is an excellent book about the complex task of decumulating assets in retirement. The tone of this review may seem negative, but this is because I included every case where I disagreed with the author. I highly recommend this book to anyone who is either retired or close enough that they need to consider how to create an income from their savings.
Wednesday, August 7, 2024
Tesla Model 3 Experience After 5 Years
Back in April 2019, I bought a dual-motor long-range Tesla Model 3. I had some concerns about buying an electric car, but my research showed that none of these concerns were likely to be real problems. Still, buying the car felt like a leap of faith. Now that I’ve had it for 5 years and 4 months, I can say that it’s been the best car I’ve owned, even better than my Lexus GS400.
Some concerns I had before I bought the car were its price, the charging network when traveling, home charging, battery reliability, self-driving features, and ongoing costs. Something I didn’t know about in advance that turned out to be a pleasant surprise is the one-pedal driving. A negative about owning this car is that somehow EVs have become political.
Price
Compared to other luxury cars, Teslas are reasonably priced. However, there is no lower end Tesla model suitable for the bulk of car owners. Teslas are still too expensive for most people. The lower annual cost of running a Tesla compared to gas cars helps to mitigate this problem somewhat, but isn’t enough to solve it.
Charging network
There is a huge difference between the Tesla and non-Tesla charging networks. Tesla completed full coverage of the continental U.S. and Canada with chargers a few years before I bought my car. I’ve never had trouble finding a charger when I needed one. They’re generally very close to major roads and highways. About 95% of the time, when I arrive at a charging station, there is a working charger available for me. The other 5% of the time when the chargers have been busy, I’ve only had to wait 5 or 10 minutes to start charging.
The non-Tesla charging network is a different story. While much of what you see on social media about EVs is nonsense, the problems with the non-Tesla charging network is real. Quebec is a notable exception where they’ve gone to a lot of trouble to build a decent network.
When traveling, it’s common to charge from about 20% of battery capacity to about 80%. Just as with a gas car, you generally don’t run your car to empty. However, stopping a “fillup” at 80% of battery capacity is different from how we run gas cars. The reason is that the charging rate slows down a lot as you get nearer full charge. So, it’s faster to charge up a little more often than it is to charge to the top each time.
On average on long trips, I charge for about 20 minutes every 3 hours. It was a little slower 5 years ago, but newer Tesla superchargers are faster. Superchargers are nowhere near as plentiful as gas stations, but my car tells me when to stop and it directs me to the chargers.
My wife and I are getting older, and we need the 20 minute stops to stretch our legs and find a bathroom. Extending what would have been a 10-hour trip with a gas car to 11 hours with our EV has been good for our mental and physical well-being. Others may feel differently.
Home charging
A fact that some people have a hard time wrapping their minds around is that people whose homes have garages hardly ever have to use the charging network. I had a 220V, 48A charger installed in my garage. I just leave the car plugged in whenever I’m home, and the car’s fancy software figures out the best way to charge up and stop charging when no more range is needed.
My charger can add about 60 km of range for each hour it’s plugged in, but I rarely notice. Just as you don’t stand there watching your washing machine spin, there’s no need to watch a car charge. Each day I wake up to a topped up car.
It’s possible to charge my car with a regular 110V outlet. At 12A, an hour of charging adds about 7 km of range. This isn’t much, but plugged in for 10 hours overnight when visiting friends out of town adds about 70 km. When away from home, I’m often able to stay sufficiently charged for day trips using just a regular 110V outlet. On a 5-month stay at a rental home in Florida, I only needed superchargers 3 times other than for the long drives between Canada and Florida.
Battery reliability
There’s no question that it would be expensive to replace the batteries in my car, just as replacing a gas car’s engine is expensive. Fortunately, batteries don’t tend to suddenly fail. They degrade. My experience seems to be fairly typical: my range has declined from 500 km to 460 km, or about 8% in a little over 5 years.
This loss of range was faster initially, and is about one percentage point per year now. If this persists for another 10 years, I can look forward to a 15-year old car that still has a range of 410 km, which is more than usable. It might work out better or worse than this projection, but the odds are that this car will be scrapped for some other reason before the battery gives out.
Self-driving features
My car can drive itself in most situations with the latest software upgrades, but the truth is that I generally only use these features on highways for now. Having the car drive itself for long highway stretches greatly reduces mental strain, particularly in the dark. A day of driving used to leave me wrecked, but not any more.
For short distances I don’t feel the need to use the car’s self-driving features. When I control the car myself, the safety features are still enabled. A couple of times now when I’ve needed to make a sudden stop, and the car began braking before I could get my foot to the brake.
The most important features to me are the safety features, keeping the car in its lane, and adaptive cruise control. Many other EVs and gas cars have these features as well. Talking to owners of other cars, Tesla’s technology appears to be better, but perhaps there are cars I have no information about that have good self-driving features.
Ongoing Costs
My Tesla has never had or needed regular service. All my gas cars have needed oil changes and other fluid top-ups a couple of times per year. Even my brakes last longer because my car usually slows down using regenerative braking. My brakes haven’t needed any repairs so far.
Apart from replacing tires once and swapping summer and winter tires, the only maintenance I’ve done is new cabin air filters for C$67, a camera realignment for US$34, and windshield washer fluid. I don’t get charged anything extra for the software updates my car gets every month or so.
However, the big savings come from the low cost of charging vs. the cost of gas. My car has averaged 0.185 kWh per km driven. At the 13 cents per kWh I pay on my hydro bill, this works out to only 2.4 cents/km. Tesla charges double to triple this amount at their superchargers, but I don’t use them enough to make much difference to my overall costs, and supercharging costs still end up being cheaper than gas. Some hotels offer free EV charging which saves some money on long trips.
If my Model 3 were a gas car, Tesla says that it would get about 30 MPG, or about 7.8L/100km. I’m guessing that a comparable 350 horsepower gas car would use premium gas. The current Costco premium gas price in my area is 174.9 cents/L, and my car as a gas car would cost 13.6 cents/km to run. So, I save 13.6 ‒ 2.4 = 11.2 cents/km. For the 85,000 km I’ve driven so far, I’ve saved about $9500.
One-pedal driving
I didn’t know about one-pedal driving before I bought my Model 3. When you ease up on the accelerator, it doesn’t just coast the way a gas car does; the car does some regenerative braking. So, for most driving, including cornering, you just need to use the accelerator to speed up and slow down. I only need the brake pedal for panic stops and coming to a final stop after slowing down to about 10 km/h.
It took a few days to get used to one-pedal driving, but now I really like it. Whenever I drive someone else’s car, I find the going back and forth between pedals annoying.
Politics
Most people seem to find Teslas interesting, and they have questions. However, a minority react negatively to my car for political or ideological reasons. This isn’t a problem when it’s just words, but I occasionally get other vehicles doing stupid and dangerous things around me. Fortunately, this has declined a lot since the first year or so I had the car.
Other people react negatively because they see it as a show off car, like a BMW. It may be that some others buy Teslas for these reasons, but I don’t even wash mine. I’ve never seen the point of washing cars. I tend to think more about practical matters.
Conclusion
I love my Tesla Model 3’s quiet power and its well-designed features that get improved regularly through software updates. It’s very cheap to run, but the purchase price was high. Overall, it’s been the best car I’ve owned, but until they become cheaper, I can only recommend them to those who can reasonably afford a luxury car.
Wednesday, July 31, 2024
Tightwads and Spendthrifts
In his book Tightwads and Spendthrifts, marketing professor Scott Rick promises advice for “financial aspects of intimate relationships.” What got my attention early is that his guidance “is rooted in rigorous behavioral science.” Applying the scientific method to human interactions is challenging, but it is generally better than relying on opinions. The book gives useful insights into how people think about spending money.
The introduction gives a four-question quiz designed to place the reader on a scale from 4 to 26. Those at the low end of the scale are called tightwads, and those at the other end are spendthrifts. Roughly half the respondents fell in the middle third of the range and are called “unconflicted consumers.” Most of the book deals with tightwads, spendthrifts, and their interactions; little is said about unconflicted consumers.
Demographic differences
Extensive surveys revealed some interesting demographic differences between tightwads and spendthrifts. “Tightwads are slightly older than spendthrifts,” but it’s not clear why. Do people become tighter with money over time (perhaps from getting burned by debt), or are there differences between generations?
“Women were somewhat more likely than men to be spendthrifts, and somewhat less likely than men to be tightwads. Tightwads were somewhat more likely to be highly educated, and they tended to opt into more mathematical majors, such as engineering, computer science, and natural science. The most popular college majors among spendthrifts were social work, communication, and humanities.”
How tightwads think
Being a tightwad is not the same as being frugal; “the highly frugal love to save, and tightwads hate to spend.” “The highly frugal are generally much more at peace in their relationship with money than are tightwads.”
It might seem intuitive that people are the way they are because of how much income they have available to spend, but “in survey after survey, we find no income differences between tightwads and spendthrifts.” However, “tightwads have far more money in savings and significantly better credit scores than spendthrifts.”
Having higher savings “offers no guarantee that tightwads feel financially comfortable. Subjective feelings of financial well-being are only loosely related to objective aspects of financial well-being.” For many tightwads, financial “anxiety stems from economic conditions early in life.”
Tightwads tend to think in terms of opportunity costs when considering spending some money. In one experiment where some participants had opportunity costs highlighted to them and others didn’t, “spendthrifts were twice as likely to buy the cheaper option” when opportunity costs were highlighted. “This framing did not influence tightwads.”
While tightwads spend less than spendthrifts in almost every area, “the amount of money both types had donated to charity was the same.”
How spendthrifts think
“Spendthrifts report high susceptibility to shopping momentum and what-the-hell effects. They commonly report going to buy one thing, then getting carried away.” “Spendthrifts are significantly more impatient than tightwads.” Interestingly, spendthrifts tend to understand these facts about themselves, and are not surprised when they later regret their purchases.
“Spendthrifts and compulsive buyers might spend similarly on any given shopping trip, but their underlying psychology differs significantly. Spendthrifts do not appear or report to be driven by anxiety management or mood repair.”
“Spendthrifts score slightly lower than tightwads on a financial literacy quiz.” However, Rick says that this is not a defining difference between tightwads and spendthrifts.
Is “spendthrift” an oxymoron?
The word “spendthrift” appears to blend contradictory elements: spending and thriftiness. However, “thrift here is used as a noun—meaning ‘savings’—as it was in the seventeenth century. So spendthrifts are traditionally defined as people who recklessly spend their savings.”
Compensating for financial tendencies
Rick offers ways for tightwads and spendthrifts to compensate for their feelings about money. The first is to change “payment salience.” The book offers ways for tightwads to feel the pain of paying money less, and for spendthrifts to feel it more (e.g., by using cash more often).
Tightwads can reframe high-end purchases to think of them as a means to get high quality items. They can add a line item for indulgences into their budgets to make spending a “to-do” item. They can also reexamine their finances to confirm that all is well and, hopefully, reduce financial anxiety.
Spendthrifts can be mindful of opportunity costs, try to delay spending (e.g., sleep on it), and set saving reminders for themselves. Interestingly, spendthrifts might understand “better than tightwads” that “the excitement that comes with a new product usually fades over time,” but this knowledge doesn’t appear to help them reduce spending.
Relationships
When we consider marriages among tightwads and spendthrifts, but not including any “unconflicted consumers,” 58% are between a tightwad and a spendthrift, and only 42% are between two people at the same end of the tightwad-spendthrift scale. “We tend to marry people who share characteristics that we like in ourselves. However, a key insight about tightwads and spendthrifts is that they do not particularly enjoy being tightwads and spendthrifts.”
Although some prominent people who advise their followers on personal finance topics consider any money secrets between spouses to be “financial infidelity,” Rick thinks there is room for a small amount of secrecy as long as it’s not the cause of financial shortfalls. How much secrecy is desirable or tolerable probably varies from one couple to the next.
“Latte factor myth”
Rick adds his two cents to the endless debate on whether we should engage in small indulgences by siding with those who say it’s fine to buy expensive coffee. Like most others, Rick approaches this debate as a binary choice: lattes are either universally good or universally bad.
This is nonsense. Each person needs to make a decision about small indulgences. If your latte habit costs $1000 per year, then either they’re worth that much to you or they’re not. If they’re worth that much to you, then buy lattes all year without guilt. If they’re not, then stop buying them. The main thing is to understand the monthly or annual cost of indulgences before making a decision.
I’m not a coffee drinker, so lattes are out for me, but I do enjoy playing softball. A quick estimate is that I spend about $3300 per year on gear, fees, travel, and post-game indulgences. This amount is worth it to me, so I keep playing. Others can make different choices based on their desires and financial circumstances.
Children
Researchers, including this book’s author, “developed a Tightwad-Spendthrift scale for children” and found that “most children were on the tightwad end of the scale.” They found “no relationship between children’s Tightwad-Spendthrift score and their [parents’ scores].”
However, things are different with adults and their parents. Adults’ scores are positively correlated with their parents’ scores, and “older adults look more like their parents on the Tightwad-Spendthrift dimension than do younger adults.”
For parents trying to make “family-related Spending decisions,” Rick’s advice is “when you’re debating a material purchase, usually let the tightwad [parent] win. When you’re debating an experiential purchase, usually let the spendthrift [parent] win.”
Conclusion
This book gives interesting insights into the reasons why people spend, or don’t spend, as they do. It has the potential to give readers useful insights into their own behaviour, and allow them to make positive changes. It can also help readers understand the source of financial conflicts between spouses, allowing them to better solve problems.
Sunday, June 2, 2024
The Holy Grail of Investing
Tony Robbins’ latest book, The Holy Grail of Investing, written with Christopher Zook, is a strong sales pitch for investors to move into alternative investments such as private equity, private credit, and venture capital. I decided to give it a chance to challenge my current plans to stay out of alternative investments. The book has some interesting parts, mainly the interviews with several alternative investment managers, but it didn't change my mind.
The book begins with the usual disclaimers about not being intended “to serve as the basis for any financial decision” and not being a substitute for expert legal and accounting advice. However, it also has a disclosure:
“Tony Robbins is a minority passive shareholder of CAZ Investments, an SEC registered investment advisor (RIA). Mr. Robbins does not have an active role in the company. However, as shareholder, Mr. Robbins and Mr. Zook have a financial incentive to promote and direct business to CAZ Investments.”This disclosure could certainly make a reader suspect the authors’ motives for their breathless promotion of the benefits of alternative investments and their reverence for alternative investment managers. However, I chose to ignore this and evaluate the book's contents for myself.
The most compelling part of the pitch was that “private equity produced average annual returns of 14.28 percent over the thirty-six-year period ending in 2022. The S&P 500 produced 9.24 percent.” Unfortunately, the way private equity returns are calculated is misleading, as I explained in an earlier post. The actual returns investors get is lower than these advertised returns.
The authors frequently repeat that Ray “Dalio’s approach is to utilize eight to twelve uncorrelated investment strategies.” However, if the reported returns of alternative investments are fantasies, then their correlation values are fantasies as well. I have no confidence as an investor that my true risk level would be as low as it appears.
Much of the rest of the authors’ descriptions of alternative investments sounds good, but there is no good reason for me to believe that I would get better returns than if I continue to own public equities.
I choose not to invest in individual stocks because I know that I’d be competing against brilliant investors working full-time. I don’t place my money with star fund managers because I can’t predict which few managers will outperform by enough to cover their fees. These problems look even worse to me in the alternative investment space. I don’t lack confidence, but I try to be realistic about going up against the best in the world.
I found the most interesting part of the book to be the interviews with alternative investment managers. One example was Vinod Khosla saying “Both in our entrepreneurs and who we hire, the single most important factor is not what they know, but their rate of learning.” Another was Michael B. Kim’s take on the future of China, Japan, and Korea. He has bet his career “that China will resume its economic and financial market liberalization drive.” I hope he’s right, because China’s current path seems dangerous for the world.
These managers’ perspectives are enlightening, but not useful to my investment approach. It would be easy to see these managers as part of a world I’d like access to for social climbing purposes. It’s tempting to seek to be part of the rich guy club, but that would give me feelings of status without necessarily making me more money. I’d rather stick to a simple plan that requires very little of my time instead of wasting my time chasing status.
In conclusion, I’m not persuaded to invest in alternative assets, despite the authors’ breathless pitch. The view into the world of alternative investments was interesting in places, but not enough for me to risk my capital.
Wednesday, May 22, 2024
Simple Interest Mistakes
I’ve heard a few times over the years that one of the disadvantages of making an extra payment against your mortgage, or any other debt, is that saving this way only earns simple interest rather than compound interest. This is nonsense, as I’ll show with an example.
Flawed Reasoning
The reasoning behind the claim that paying down a mortgage only earns simple interest goes as follows. Each month, your payment pays all of the interest plus some of the principal. Therefore, there is no interest accruing on previous interest, so there is no compounding.
This is a tidy little story, but the reasoning doesn’t hold up.
An Example
Suppose you have 20 years left on your 6% mortgage (in Canada where most mortgages use semi-annual compounding). This makes your monthly payment $1780.47. The second column of the table below shows how your mortgage balance would decline over the coming year.
Suppose you decide to pay $10,000 down on your mortgage, but you leave the payments the same. The third column shows your declining mortgage balance for this scenario. The last column shows the difference between these scenarios. This difference shows your returns from your investment in paying down your mortgage.
If your investment earned only simple interest at 6% per year, then the difference would be $10,600 after a year, but it is $10,609. The extra $9 comes from the semi-annual compounding. This isn’t much after one year, but after ten years, simple interest gives $16,000, but the real figure if we continued this table is $18,061. The compounding effect is significant.
Where Does the Flawed Reasoning Go Wrong?
To get the correct answer to questions such as whether paying down your mortgage earns compound interest, we have to treat money as fungible. Consider what happens when your debt accrues new interest. Think of the interest blending evenly with the former debt amount. Then when your payment gets applied, it wipes out proportional amounts of the original debt and the new interest. This leaves some interest with your debt that will accrue compound interest later.
Giving the Flawed Reasoning Another Chance
Let’s consider a simpler example. You borrow $10,000 at 12% (compounded monthly), pay off just the $100 interest each month for a year, and then pay back the $10,000. So, you paid a total of $1200 in interest.
This seems like 12% simple interest. However, it isn’t. You can’t just add dollar amounts from different times like this. You didn’t have the option to pay all the $1200 interest at the end of the year. Each interest payment had a different present value; you had to forego a different amount of interest you could have earned elsewhere if you hadn’t made the debt payment. If you had waited until the end of the year to make any payments, the total debt would have been $11,268 because of the compound interest.
Advertised Rates
Presumably there are historical reasons for how interest rates are advertised, but I find it confusing and misleading. When we say that a debt is at 12% compounded monthly, we really mean 1% per month and 12.68% per year. To take the nominal annual advertised rate of 12% and divide it by 12 to get a monthly rate, we’re treating it like simple interest. But, it isn’t simple interest. Try skipping a payment. Even if no penalty is added, the interest will compound. The annual rate is really 12.68%.
In the case of most Canadian mortgages, the compounding is semi-annual (every 6 months). So, to get from a nominal 6% annual rate to a monthly rate, we first divide by 2, falsely treating it like simple interest, to get 3%. Then we use the compounding calculation (1.03)^(1/6)–1 to go from the 3% 6-month rate to the monthly rate of 0.494%.
Using the flawed simple interest reasoning, there is no compounding on mortgages, so we should multiply this monthly rate by 12 to get an annual rate of 5.93%. So, is the mortgage rate 5.93%, or the advertised 6%, or the fully compounded 6.09%?
I would prefer to see fully compounded rates advertised. This is the most honest way because simple interest doesn’t really exist in the world. It also simplifies things because it removes the need to specify the compounding frequency.
Conclusion
The returns from paying off debts earns compound interest, not simple interest. The idea of approximating interest over periods shorter than a year as simple interest may have made sense back when interest was calculated by hand, but modern computing can easily handle the calculations necessary if all advertised rates were fully compounded.
Thursday, February 15, 2024
Private Equity Fantasy Returns
One of the ways that investors seek status through their investments is to buy into private equity. As an added inducement, a technical detail in how private equity returns are calculated makes these investments seem better than they are. So, private fund managers get to boast returns that their investors don’t get.
Private Equity Overview
In a typical arrangement, an investor commits a certain amount of capital, say one million dollars, over a period of time. However, the fund manager doesn’t “call” all this capital at once. The investor might provide, say, $100,000 up front, and then wait for more of this capital to be called.
Over the succeeding years of the contract, the fund manager will call for more capital, and may or may not call the full million dollars. Finally, the fund manager will distribute returns to the investor, possibly spread over time.
An Example
Suppose an investor is asked to commit one million dollars, and the fund manager calls $100,000 initially, $200,000 after a year, and $400,000 after two years. Then the fund manager distributes returns of $200,000 after three years, and $800,000 after four years.
From the fund manager’s perspective, the cash flows were as follows:
$100,000
$200,000
$400,000
-$200,000
-$800,000
So, how can we calculate a rate of return from these cash flows? One answer is the Internal Rate of Return (IRR), which is the annual return required to make the net present value of these cash flows equal to zero. In this case the IRR is 16.0%.
A Problem
Making an annual return of 16% sounds great, but there is a problem. What about the $900,000 the investor had to have at the ready in case it got called? This money never earned 16%.
Why doesn’t the fund manager take the whole million in the first place? The problem is called “cash drag.” Having all that capital sitting around uninvested drags down the return the fund manager gets credit for. The arrangement for calling capital pushes the cash drag problem from the fund manager to the investor.
The Investor’s Point of View
Earlier, we looked at the cash flows from the investment manager’s point of view. Now, let’s look at it from the investor’s point of view.
Suppose the investor pulled the million dollars out of some other investment, and held all uncalled capital in cash earning 5% annual interest. So the investor thinks of the first cash flow as a million dollars. Any called capital is just a movement within the broader investment and doesn’t represent a cash flow. However, the investor can withdraw any interest earned on the uncalled capital, so this interest represents a cash flow.
The second cash flow is $45,000 of interest on the $900,000 of uncalled capital. The third cash flow is $35,000 of interest on the $700,000 of uncalled capital. The fourth cash flow is a little more complex. We have $15,000 of interest on the $300,000 of uncalled capital. Then supposing the investor now knows that no more capital will be called and can withdraw the remaining uncalled capital, we have a $300,000 cash flow. Finally, we have the $200,000 return from the fund manager. The total for the fourth cash flow is $515,000. The fifth cash flow is the $800,000 return.
The cash flows from the investor’s point of view are
$1,000,000
-$45,000
-$35,000
-$515,000
-$800,000
The IRR of these cash flows is 10.1%, a far cry from the 16.0% the fund manager got credit for. We could quibble about whether the investor really had to keep all the uncommitted capital in cash, but the investor couldn’t expect his or her other investments to magically produce returns at the exact times the fund manager called some capital. The 10.1% return we calculated here may be a little unfair, but not by much. The investor will never be able to get close to the 16.0% return.
Others have made similar observations and blamed the IRR method for the problem. However, this isn’t exactly right. The IRR method can have issues, but the real problem here is in determining the cash flows. When we ignore the investor’s need to be liquid enough to meet capital calls, we get the cash flows wrong.
Conclusion
Some argue that we need to use the IRR method from the fund manager’s point of view so we can fairly compare managers. Why should investors care about this? They should care about the returns they can achieve, not some fantasy numbers. Any claims of private equity outperformance relative to other types of investments should be taken with a grain of salt.
Thursday, January 25, 2024
Retirement Spending Experts
On episode 289 of the Rational Reminder podcast, the guests were retirement spending researchers, David Blanchett, Michael Finke, and Wade Pfau. The spark for this discussion was Dave Ramsey’s silly assertion that an 8% withdrawal rate is safe. From there the podcast became a wide-ranging discussion of important retirement spending topics. I highly recommend having a listen.
Here I collect some questions I would have liked to have asked these experts.
1. How should stock and bond valuations affect withdrawal rates and asset allocations?
It seems logical that retirees should spend a lower percentage of their portfolios when stocks or bonds become expensive. However, it is not at all obvious how to account for valuations. I made up two adjustments for my own retirement. The first is that when Shiller’s CAPE exceeds 20, I reduce future stock return expectations by enough to bring the CAPE back to 20 by the end of my life. These lower return expectations result in spending a lower percentage of my portfolio after doing some calculations that are similar to required minimum withdrawal calculations. I have no justification for this adjustment other than that it feels about right.
The second adjustment is on equally shaky ground. When the CAPE is above 25, I add the excess CAPE above 25 (as percentage points) to the bond allocation I would otherwise have chosen in the current year of my chosen glidepath. Part of my reasoning is that when stock prices soar, I’d like to protect some of those gains at a time when I don’t need to take on as much risk.
Are there better ideas than these? What about adjusting for high or low bond prices?
2. How confident can we be that the measured “retirement spending smile” reflects retiree desired spending levels?
I find that the retirement spending smile is poorly understood among advisors (but not the podcast guests). In mathematical terms, if S(t) is real spending over time, then dS/dt has the smile shape. Many advisors seem to think that the spending curve S(t) is shaped like a smile. I’ve looked at many studies that examine actual retiree spending in different countries, and there is always evidence that a nontrivial cohort of retirees overspend early and have spending cuts forced upon them later. Both overspending retirees and underspending retirees seem to have the dS/dt smile, but at different levels relative to the x-axis. Overspenders have their spending decline slowly initially, then decline faster, and then decline slowly again. Underspenders increase their real spending early on, then increase it slower, and finally increase it quickly at the end.
I don’t see why I should model my retirement on any data that includes retirees who experienced forced spending reductions. The question is then how to exclude such data. I saw in one of Dr. Blanchett’s papers that he attempted to exclude such data for his spending models. Other papers don’t appear to exclude such data at all. In the end, it becomes a matter of choosing how high the smile should be relative to the x-axis. If it is high enough, the result becomes not much different from assuming constant inflation-adjusted spending.
Advisors tend to work with wealthy people who save well and may have difficulty increasing their spending to align with their wealth. So, it’s not surprising that good advisors would embrace research suggesting that retirees should spend more. However, it’s not obvious to me that all retirees should spend at a high level early with the expectation that they simply won’t want to spend as much later in retirement. It may be true that healthy people in their mid-80s choose to spend less, but I’ve seen the spending smile results applied in such a way that retirees are expected to reduce real spending each year right from the second year of retirement.
3. How can retirees deal with the gap between annuities in theory and annuities in practice?
The idea of annuitizing part of my portfolio is appealing. Eliminating some longevity risk brings peace of mind. However, whenever I compare annuity examples from papers or books to annuities I can actually buy, there is a gap. Payouts are lower, and inflation protection doesn’t exist (at least in Canada where I live).
In my modeling, I find the optimal allocation to annuities is very sensitive to payout levels. Further, when I treat inflation as a random variable, fixed payout annuities are unappealing. It’s possible to buy an annuity whose nominal payout increases by, say, 2% each year, but this is a poor substitute for inflation protection. If I had bought an annuity before the recent surge in inflation, I’d be looking at a substantial permanent drop in the real value of all my future payouts, and I’d be facing the possibility that it might happen again in the future.
I appreciated the thoughts of the three guests on the podcast. My guess is that my additional questions are not easy ones.
Thursday, January 18, 2024
My Investment Return for 2023
My investment return for 2023 was 13.0%, just slightly below my benchmark return of 13.2%. This small gap was due to a small shift in my asset allocation toward fixed income. I use a CAPE-based calculation to lower my stock allocation as stocks get expensive. This slight shift away from stocks caused me to miss out on a slice of the year’s strong stock returns. Last year, this CAPE-based adjustment saved me 1.3 percentage points, and this year it cost me 0.2 percentage points.
You might ask why I calculate my investment returns and compare them to a benchmark. The short answer is to check whether I’m doing anything wrong that is costing me money. Back when I was picking my own stocks, I chose a sensible benchmark in advance, and after a decade this showed me that apart from some wild luck in 1999, the work I did poring over annual reports was a waste. Index investing is a better plan.
The next question is why I keep calculating my investment returns now that I’m indexing. I’m still checking whether I’m making mistakes. As long as my returns are close to my benchmark returns, all is well. I investigate discrepancies to root out problems.
Some don’t see the point of calculating personal returns. Perhaps they are very confident that they’re not making mistakes. In the case of those who pick their own stocks or engage in market timing, I suspect the real reason for not comparing personal returns to a reasonable benchmark is that they don’t want to find out that their efforts are losing them money. Focusing on successes and forgetting failures is a good way to protect the ego.
I like to focus on real (after inflation) returns. The following chart shows my cumulative real returns since I took control of my portfolio from financial advisors.
I have beaten my benchmark by an average of 2.35% per year, but this is almost entirely because I took wild chances in 1999 that worked out spectacularly well. Excluding 1999, my stock-picking efforts cost me money. It was difficult to accept that I was paying for the privilege of working hard.
So far, my compound average annual real return has been 7.61%. I don’t expect my future returns to be this high, but the future is unknown.