Michael James on Money

Thinking Fast and Slow

noreply@blogger.com (Michael James) — Mon, 17 Jun 2013 04:01:00 +0000

Daniel Kahneman won the Nobel Prize in economics in 2002 for his brilliant work along with the late Amos Tversky on the way people make decisions. Kahneman clearly worked hard to make the conclusions of his research accessible to all in his book Thinking Fast and Slow. No other book as given me as much useful insight into the workings of my own mind.

I understand much better why I would hesitate before accepting a 50/50 bet to lose $200 or win $300, and why I have an opinion on the future of Apple stock even though I know I really have no idea what will happen. The key is to understand the workings of my “System 1”.

Kahneman portrays the human mind as consisting of two actors, System 1 and System 2. He’s careful to explain that they are not really separate characters inside your mind; speaking of them like they are separate entities is so useful for helping the reader understand the research results that the book would be far less useful without them.

Roughly speaking, System 1 is the fast and involuntary part of your brain. It sees potential threats and answers just about any question quickly, whether it knows a good answer or not. System 2 is slow and lazy by comparison. It usually just accepts judgments from System 1, but sometimes it kicks in and thinks things over to come to a decision different from System 1’s decision.

It is my System 1 that is overly averse to losses. It tends to feel losses about twice as intensely as it feels gains. System 1 is the reason why my initial reaction was to turn down a 50/50 bet to lose $200 or win $300. It is my System 2 that takes its time to verify that the 50/50 coin toss will be fair and decide to accept the bet.

It is my System 1 that decides quickly if Apple stock will go up or down based on available evidence. Of course, it might just substitute an easier question, such as “do I like Apple?” System 2 almost always accepts System 1 judgements; it couldn’t possibly verify every decision made by System 1. There was a time when I acted on my System 1 judgement of what would happen to Apple. Now my System 2 overrides these snap decisions and prevents me from trading Apple stock.

System 2 is good at coming up with reasons to back up the judgments that come from System 1. Most people would turn down the $200/$300 bet. When pressed they could come up with intelligent-sounding reasons for their decision. But the real reason is that their System 1 hates losses. The truth is that “you know far less about yourself than you feel you do.”

System 1 is a remarkable machine that we can’t do without, but it does tend to make certain types of predictable errors. One such error is to confuse familiarity with truth. “A reliable way to make people believe in falsehoods is frequent repetition.” This explains some of the “reporting” on Fox News.

System 1 “deals well with averages but poorly with sums.” Perhaps this explains why I’ve found that when asked about casual spending such as lunches out, most people can fairly accurately say the average cost of their lunches and seem to know how often they buy lunch, but consistently underestimate by a long shot their total spending on lunches.

The human mind tends to be bad with probabilities. When it comes to small risks, “we either ignore them altogether or give them far too much weight – nothing in between.”

The idea of regression to the mean is familiar to me, but Kahneman shows how it can be hidden. For example, a sports coach who praises good performance and criticizes poor performance can easily get the impression that criticism works and praise doesn’t. However, even without any words from the coach, unusually poor performance is usually followed by an improvement, and strong performance is usually followed by a more average effort.

If we like a person, our mind’s “halo effect” tends to make us think well of them in all respects, including assessment of their skills. It works the other way too: we judge people we don’t like to be bad at everything. Kahneman uses the example “Hitler loved dogs and little children” to drive home this point. We instantly expect someone who makes such a statement to follow it with denials of past atrocities and other offensive statements.

Kahnemen tells an amusing story where he demonstrating to a Wall Street firm that based on statistical evidence provided by the firm, they had absolutely no stock-picking skill whatsoever. However, “people can maintain an unshakable faith in any proposition, however absurd, when they are sustained by a community of like-minded believers.” At this point I’m not sure if Kahneman was talking about stock picking, religion, or both.

In an experiment showing a failing of System 1 thinking, students were given a chance to win a prize if they pulled a red marble from one of two urns. They were told that the first urn had 1 red marble out of 10 marbles total. The second had 8 red out of 100. More than a third or students chose the second urn because it contained more winners even though the better odds of winning are with the first urn.

To show that we’re susceptible to how a question is framed, consider two drivers. The first changes from a 12 mpg gas-guzzler to one that runs at 14 mpg. The second driver changes cars from one that gets 30 mpg to a 40 mpg car. Who saves more money? The surprising answer is that the first driver saves more money. If the figures were given as the number of litres (or gallons) per 100 km (or miles), the correct answer would have been more obvious.

The book summarizes the “focusing illusion” with the following interesting quote: “Nothing in life is as important as you think it is when you are thinking about it.”

Overall, I found this book very valuable to me personally. I now understand why it is so important to figure out when it is safe to trust my snap judgements and when I should slow down and think things through. I highly recommend this book to my readers.

Short Takes: Banning Advisor Commissions, Canadian Real Estate, and more

noreply@blogger.com (Michael James) — Fri, 14 Jun 2013 04:18:00 +0000

My only post this week drew some good comments:

Anchoring and Income Taxes

Here are my short takes and some weekend reading:

Canadian Couch Potato weighs in on the banning of financial advisor commissions debate and the arguments made by the president and CEO of Advocis.

Tom Bradley at Steadyhand explains what really has him concerned about Canadian real estate. No matter what happens over the next 5 years, I’m sure that his last statement will be true: “we’ll look back in 5 years and say, ‘Wow, what were we thinking? It was so obvious.’” Human brains are such that things we can’t predict in advance seem inevitable in hindsight.

The Blunt Bean Counter gives three tax-saving strategies that he says are an easier way to save money than being frugal with every small purchase.

Million Dollar Journey explains stop-loss orders. Some traders seem to like this type of order, but I don’t see how they’re any use for investors.

Anchoring and Income Taxes

noreply@blogger.com (Michael James) — Wed, 12 Jun 2013 04:01:00 +0000

My employer pays a modest bonus for each invention employees have that result in a patent filing. I had a few of these this year and recently received a letter showing me the size of this bonus. But this is a gross amount before the taxman takes his bite.

So now my mind is anchored on the gross amount of the bonus. Next week’s pay cheque will be somewhat of a let-down because I will actually receive just over half of this figure.

I don’t mean to sound like I’m complaining about getting a bonus. This should be a happy event and it is happy for me. But, I think my employer makes a mistake by giving me a piece of paper with the gross amount printed in bold.

Perhaps many people don’t really look at their pay stubs and wouldn’t be struck by the much smaller after-tax amount. However, I do look at each of my pay stubs. This incentive scheme would work better on me if the letter they gave me had a prominent after-tax figure.

Short Takes: Tax Efficiency in Fixed Income, TFSA Over-Contributions, and more

noreply@blogger.com (Michael James) — Fri, 07 Jun 2013 14:57:00 +0000

I wrote 4 posts this week that drew quite a few reader comments that are worth checking out:

Can a Raise be Bad for Your Finances?

Foreign Exchange Fees

Invest Side-By-Side with Me

Couch Potato Investors are Rare

Here are my short takes and some weekend reading:

Canadian Couch Potato explains why a new ETF based on strip bonds is tax-efficient for fixed-income investors using taxable accounts.

The Blunt Bean Counter thinks that both investors and their advisors are to blame for TFSA over-contributions.

Big Cajun Man says you shouldn’t make big financial decisions late in the day, and that people who try to sell you big-ticket items know you’re less likely to buy the next morning.

My Own Advisor explains why he’s not interested in trading futures.

Million Dollar Journey is getting close to a million dollars. I assume the blog will disappear the instant the magic million dollar mark is reached :-)

Couch Potato Investors are Rare

noreply@blogger.com (Michael James) — Thu, 06 Jun 2013 04:01:00 +0000

Passive investing using low-cost index ETFs and mutual funds is rising in popularity. The number of investors who are excited by the idea of couch potato investing is growing every day. However, in a recent conversation I had with Canadian Capitalist, he observed that enthusiastic couch potatoes usually don’t really invest passively. Sadly, I have to agree.

Let me start by admitting my own transgressions. It took me many years as a stock-picker before I finally decided that I was better off investing passively. Even then I took my sweet time selling off individual stocks and buying low-cost broadly-diversified ETFs. I still hold one individual stock (Berkshire Hathaway) for less than 10% of my portfolio. I don’t intend to ever buy more Berkshire, but this is still a deviation from index investing.

So, I’m not a pure passive investor. But, even if we adopt fairly lax standards for what constitutes passive index investing, few self-described couch potatoes meet the test. Following are 3 categories of not-really-passive investors that I’ve seen.

Stock Picker on the Side

These investors have most of their savings invested passively, but keep 10% or 20% in a side account to scratch their stock-picking itch. The trouble is that in this smaller account their annual stock turnover might be 100%, 300%, or more. This frequent trading usually leads to losses, and replenishing side accounts takes savings away from the passive part of their portfolios.

Dividend Investor on the Side

The idea of collecting fat dividend cheques is irresistible to some investors. Fortunately, most dividend investors hold their stocks for long periods. They usually suffer from too much stock concentration, but adding some dividend stocks on the side of a passive portfolio is likely to be the least damaging of the three types of not-really couch potato investors described here.

ETF Market Timer

I’m always baffled when an investor listens to my short pitch for passive investing and responds with something like “I love couch potato investing. I’ve been doing it for a couple of years. Do you think the stock market is overvalued right now? I sold out of XIU and VTI a few months ago, but I’m wondering whether now is the time to get back in.” These people just won’t believe me when I say I have no idea where the market is headed in the short term. They are very far from being couch potatoes and their long-term returns are very likely to fall a long way short of market returns.

On average, any deviation from pure passive investing is likely to lose money. There will always be those who manage to beat the market, but more will lose to the market.

Invest Side-By-Side with Me

noreply@blogger.com (Michael James) — Wed, 05 Jun 2013 04:01:00 +0000

Inspired by Larry Swedroe’s post describing side-by-side arrangements where a mutual fund invests in the same assets as a hedge fund, I’ve decided to start my own side-by-side arrangement. Just as these mutual funds give small-time investors access to the investment choices of hedge fund managers, my arrangement will give investors access to my stock-picking.

Just take a look at the chart of my 1999 portfolio return and you’ll see why this could be a great deal for investors. They will get access to a fund that contains my stock picks. The best part is that I won’t charge any management fee.

Here’s how it will work. Every 3 months, I’ll buy shares in my top 100 stock picks using a mixture of my personal assets and fund assets. After the 3 months are up, I’ll allocate a non-random set of shares to my personal account (based on purchase price) in proportion to how much of the purchases were made with my money. The rest of my purchases go to the fund. Then I do it over again with another 100 stock picks.

Fund investors are guaranteed to get results based on stocks personally picked by me. Who’s in?

In case it’s not obvious, this is a joke. I’ve exaggerated some of the abuses Swedroe described in his article on side-by-side arrangements.

Foreign Exchange Fees

noreply@blogger.com (Michael James) — Tue, 04 Jun 2013 04:28:00 +0000

Reading a review of Qtrade at Money Smarts, I was struck by the description of the foreign exchange fees as “pretty good”. They may compare favourably to foreign exchange fees at other discount brokerages, but compared to a reasonable fee, they are horrendous.

For amounts over $25,000, Qtrade charges 0.96%. This is $240 on $25,000. What is there to justify such a high cost? I can understand the need to recover costs when handling actual cash. It costs money to pay employees to give out cash, and you have to take on currency risk for days to hold onto cash. However, these costs don’t apply to electronic transactions.

A simple fee of $10 plus 0.1% for electronic conversions among major currencies would leave plenty of profit margin for banks and brokerages. This corresponds to $35 on $25,000. I understand that businesses seek profits and will charge what the market will bear, but it is time that investors demanded more reasonable foreign exchange fees.

Can a Raise be Bad for Your Finances?

noreply@blogger.com (Michael James) — Mon, 03 Jun 2013 04:01:00 +0000

A heuristic I’ve heard about a few times is that you should have 12 times your gross salary saved before you retire. I’ve always had a vague feeling of uneasiness about this rule of thumb, but the problem with it never hit home with me until I started thinking about a raise I’m expecting soon.

Suppose I currently have retirement savings equal to 11 times my salary. I’m close to being able to retire by the 12 times salary heuristic. Suddenly, through no fault of my own, I get a 10% raise. Now my retirement savings are only 10 times my salary. My retirement dream is slipping away. I probably have to work an extra year or two and pray I don’t get any more raises.

This is crazy. The ratio of savings to salary just makes no sense for me. I should be calculating the ratio of my savings to my yearly spending instead. Focusing on this spending-based ratio means that raises are a good thing because they allow me to build my savings faster.

It may be that the savings to salary ratio makes sense for people who automatically increase their spending to match any pay increases, but that doesn’t apply to my family. My raises have no noticeable effect on my family’s spending. I’m going to delete the cell in my savings spreadsheet that calculates my savings to salary ratio.

Short Takes: Mortgage-Breaking Penalties, Misguided Loyalty, and more

noreply@blogger.com (Michael James) — Fri, 31 May 2013 04:01:00 +0000

I wrote three posts this week:

Hertz in the Currency Exchange Business

Dan Solin on Investing

Return Expectations

Here are my picks for some weekend reading along with some of my short takes:

Robert McLister explains how banks play games with their online calculators for mortgage-breaking penalties to steer customers into calling customer service.

Tom Bradley at Steadyhand sees too many investors with a misguided sense of loyalty to their financial advisors. I suspect this is partially a case of investors not really understanding how much they pay their advisors. Many of us would buy an unwanted $5 box of Girl Guide cookies from a niece to avoid the awkwardness of saying no, but few of us would pay thousands just to avoid a mildly unpleasant situation. But investors do pay thousands per year for their financial advice whether they realize it or not.

The Blunt Bean Counter explains some of the problems you can run into when transferring property among family members.

Canadian Couch Potato brings some clear thinking about timing your entry into the market.

Money Smarts reviews the discount brokerage Qtrade.

Big Cajun Man says his retirement plans are “up on the roof.”

My Own Advisor updates his progress toward his 2013 financial goals. The first 3 goals would be trivial to achieve if it weren’t for sensible goal number 4 (no new debt).

Return Expectations

noreply@blogger.com (Michael James) — Thu, 30 May 2013 04:01:00 +0000

Steadyhand recently released a report on the Five Essential Elements to Being a Better Investor. It’s an excellent report that focuses on mindset and qualitative factors. I highly recommend giving it a read. However, the part on return expectations irked my quantitative side.

The report’s basic message about having realistic return expectations is sensible. You shouldn’t be too optimistic expecting 20% returns every year. You shouldn’t be too pessimistic either; you’re unlikely to actually lose money over a long period of time. Wild swings can happen in any one year, but average returns over a long period of time tend to settle down.

However, the report includes the following figure:

I had one of those moments where Daniel Kahneman would say that my System 1 kicked in and I knew that something wasn’t right even though I wasn’t sure what was wrong at first.

The left side of this figure is some sort of equity price chart or portfolio size chart. Such charts give overall returns. If you average a 6% return for 10 years, such a chart would show that this compounds to an overall return of about 79%. However, the right side of the figure gives ever tighter ranges for average yearly returns (not overall returns). Just following the figure from left to right, the reader gets the impression that returns may fluctuate, but the destination is a small point in the upper right corner of the figure to be reached with certainty. This is not the case.

It’s true that the range of average yearly returns shrinks as we look further into the future, but the range of overall returns keeps getting larger. If we changed the figure so that the bars on the right indicated ranges of possible overall returns, the bars would keep getting longer the further into the future we go.

The important thing is that even though we can’t predict a final portfolio value with any certainty, we know that the odds of a low-cost broadly-diversified portfolio outperforming safe investments goes up the longer we stay invested. Over a week or a month the probability of stocks beating short-term government bonds is little better than 50%, but over 25 years it is almost 100%.

It could be that Steadyhand are actually doing investors a service by giving them the impression that future portfolio size is more certain than it actually is. Investors are too fearful of short-term fluctuations with their long-term savings. Perhaps they need to be calmed in this way.

A small quibble I have with the numbers in the figure is that ranges do not tighten up by a factor of 3 from 5 to 10 years of investing. If the 5-year range is 0 to +12% per year, then the 10-year range is closer to +2% to +10%. A rough rule of thumb is that it takes 4 times as long for the yearly return range to tighten up by a factor of 2. So, the 20-year range would be roughly +3% to +9%.

Once again, it could be that Steadyhand are doing investors a service by presenting a safe-looking narrow range of 10-year returns. However, I’m comfortable with realistic levels of volatility as long as I’m being compensated with a higher expected return.

Dan Solin on Investing

noreply@blogger.com (Michael James) — Wed, 29 May 2013 04:01:00 +0000

I had the pleasure of hearing Dan Solin speak recently about investing. He is the author of the Smartest series of books and is an outspoken critic of the investing industry.

Solin’s main message is that if you pay attention to the science of investing, there is no conclusion to draw other than investors should invest in low-cost broadly-diversified indexes rather than chase the dream of beating the market. Almost everyone who tries to beat the market over a decade or more fails.

Some small-time investors think that rich people have some sort of secret access to better investments, but Solin says that the only difference between rich people and poor people is that rich people have more money to lose if they trust their brokers.

He says that the entire active investing industry is a “giant scam” and “there is a huge amount of money invested in keeping you ignorant.” The wealth management industry exists to “transfer your wealth to themselves.”

On the subject of alternative investments such as hedge funds, Solin says they are just a way for rich people to lose money.

Solin’s shortest answer to an audience question came when he was asked whether we should be buying gold. His answer: “don’t”.

Some of the audience questions made it clear that they did not really get Solin’s message. He doesn’t believe that anyone has any useful insight into future investment prices, and that we should all just seek to capture market returns at an appropriate level of risk. Yet questioners asked about market timing and the future of various specific investments.

Solin believes that you should ask your advisor “what besides investing are you going to do for me?” Given that advisors are useless for picking stocks or mutual funds that will beat the market, you should be getting tax planning and other useful services from your advisor.

Hertz in the Currency Exchange Business

noreply@blogger.com (Michael James) — Mon, 27 May 2013 04:01:00 +0000

I’m used to being charged at least 2.5% extra by MasterCard when I buy something in a currency other than Canadian dollars. However, I recently had my first experience with a retailer doing the conversion for me at a higher price than MasterCard charges.

I rented a car in Europe and the total cost for 4 days came to a hefty 425.70 Euros. According to the Bank of Canada, converting this to Canadian dollars at a fair rate on the day I paid would give C$560.31.

Based on credit card charges on the same day, MasterCard would have charged me $575.90 or 2.8% more. This differs slightly from their advertised 2.5% fee possibly by random variation and possibly due to choosing a favourable rate during the day.

However, MasterCard never got the chance to make an extra C$15.59 from me because Hertz did a conversion to Canadian dollars. They charged me C$586.37 or 4.7% more than a fair exchange. Hertz made an extra C$26.06 from me, which is C$10.47 more than MasterCard would have charged me.

The most amusing part of all this is the following note printed on my receipt:

“I have been offered a choice of currency and chosen to pay my rental charges in the currency of my card.”

This isn’t true. No doubt there was something buried in the papers I had to hurriedly sign when I picked up the car, but I would never have chosen to be charged in Canadian dollars if I understood the choice I was making.

So, Hertz, congratulations on extracting an extra ten bucks from me in addition to MasterCard’s money. Maybe you could have converted the charge to U.S. dollars so that MasterCard could get a piece of me as well.

The part of all this that irks me the most is that there is virtually no cost to currency conversion when there is no physical cash involved. The extra amounts are almost completely extra profit.

Short Takes: Impolitic Ads, Firing the Financial Industry, and more

noreply@blogger.com (Michael James) — Fri, 24 May 2013 04:01:00 +0000

Here are my posts for this week:

Canadian Snowbird Guide

Disagreement over investing in bonds

Here are my short takes for some weekend reading:

Freakonomics has an interesting list of old ads. If you don’t think societal attitudes about women (and other subjects) have changed much over the years, check out these ads.

Mr. Money Mustache asks whether we need to fire the entire financial advice industry. In this interesting essay, he makes the case that “that most of our modern assumptions about money are bullshit,” particularly when it comes to necessary spending.

Canadian Capitalist objects to a comparison of stock and real estate returns that ignores rental income. Of course, we also have to factor in upkeep costs such as a new roof, etc.

Million Dollar Journey looks at how new mortgage rules for HELOCs affect investors interested in using the Smith Manoeuvre.

The Blunt Bean Counter explains the importance of finding a compatible business partner.

Big Cajun Man objected to being told by Rogers’ customer service that they didn’t want to talk to him.

My Own Advisor explains his low-cost approach to a healthy lawn. My approach is a combination of neglect and low standards.

Disagreement over Investing in Bonds

noreply@blogger.com (Michael James) — Thu, 23 May 2013 04:01:00 +0000

According to CNBC, Warren Buffet “said that bonds are a ‘terrible’ investment right now because they are ‘priced artificially’ high ... and could lose people a lot of money when inevitably interest rates start to rise.” Chartered Financial Analyst Steve Lowrie says he disagrees with Buffett, but I think the two are actually talking about different things.

Buffett says he believes that interest rates are set to rise at some point and this will hurt bond prices. This is a statement about expected bond returns over the next few years. Buffett makes no claims about the volatility of bonds, just that their expected returns are poor.

Lowrie objects that investors have a limited capacity for risk and cannot handle an all-stock portfolio. This is true of most investors. However, Lowrie is talking about the volatility of bonds (specifically that it is lower than the volatility of stocks); he is not talking about bonds’ expected returns as Buffett was.

Investors who believe both Buffett and Lowrie can use GICs (or very short-term bonds) for the fixed income part of their portfolios. This avoids the upcoming hit to bond prices that Buffett predicts and avoids increasing portfolio volatility that Lowrie says investors cannot handle.

Apparent disagreement resolved.

Canadian Snowbird Guide

noreply@blogger.com (Michael James) — Tue, 21 May 2013 04:01:00 +0000

Having spent some time in the southern U.S. during Canadian winters, I understand the appeal of being a snowbird who lives in Canada during the warm months and travels south for the cold months. I respect those who choose to embrace Canadian winters with outdoor activities, but many of us, particularly as we age, prefer to avoid winter.

With this in mind, I read the fourth edition of Douglas Gray’s Canadian Snowbird Guide, revised in 2008. This book covers a wide range of topics including deciding whether you’re well-suited to snowbirding, home exchanges, financial planning, immigration, renting and buying real estate, insurance, taxes, estate planning, and permanent retirement outside Canada.

Expecting to cover all these topics in full detail is far too ambitious for a single book. For my money, the main value of this book is that it made me aware of a number of issues that had never occurred to me before. For example, supplemental health insurance won’t do you much good in a hospital that only takes cash if your policy doesn’t require the insurance company to provide a cash advance.

Few people will need all of the information in this book, but you can just read the sections that interest you to get a useful overview. Then you can do some further investigating.

It’s not too hard to criticize this book for being out of date. There are constant references to traveler’s cheques, government blue pages in the phone book, and other things that still exist but have largely been replaced by the internet and our modern financial system. But if you’re serious about wanting to avoid big mistakes in living in another country for part of each year, these references to old ways of doing things are easily ignored.

One amusing and (in my opinion) terrible piece of advice in this book is to leave your shoes on during a flight because your feet will swell “and you may have trouble getting your shoes back on if you take them off.” Taking my shoes off during a flight makes me far more comfortable. I make sure to buy shoes wide enough that I can just loosen the laces if my feet swell. Your mileage may vary.

In general, Gray uses calm language to describe problems you may encounter, but he uses slightly sharper words for timeshares: “Be wary of hard-sell marketing” and “Trying to get your money back if you suffer from buyer’s remorse is extremely difficult.” I would be more blunt: the majority of people who buy timeshares have made a terribly expensive mistake. Actually figuring out all the costs of a timeshare usually makes it clear that it is a horrible deal financially.

On the subject of supplementary health insurance while traveling in the U.S., Gray makes it clear that this is a minefield of potential gaps in coverage. One common theme is the importance of giving an accurate medical history. Failing to disclose health problems and tests either deliberately or accidentally can leave you without coverage.

On the subject of gambling, I always thought that the only reason to use a casinos gambling card is to accumulate loyalty points to get free rooms, meals, etc. However, professional poker players may use these cards to help track wins and losses for tax reasons.

Overall, this book isn’t exactly a page-turner, but it does cover a wide range of issues to consider before becoming a snowbird.

Short Takes: Market Timing, Salary Secrecy, and more

noreply@blogger.com (Michael James) — Fri, 17 May 2013 04:01:00 +0000

Being busy on a business trip, I only wrote one post this week:

Business Travel Personality

Here are my short takes for some weekend reading:

Tom Bradley at Steadyhand paints an accurate picture of the challenges involved in trying to get in and out of the market at the right times.

The Blunt Bean Counter answers the interesting question, “Should You Discuss Your Salary with Friends, Co-Workers or Family?”

Canadian Financial DIY reveals a simple test to see if you’re likely to manage your finances well into your retirement. Spoiler alert: it’s math-related.

Million Dollar Journey has some ideas for saving money on a Disney World vacation. Another idea might be to pass on Disney World and do something else.

Big Cajun Man has an interesting theory on how to avoid having his barbecue run out of propane in the middle of cooking dinner.

Business Travel Personality

noreply@blogger.com (Michael James) — Wed, 15 May 2013 04:01:00 +0000

In the middle of another business trip, I’m once again struck by how the expenses are so much different from what they are in my personal life. My personality begins to change too: “The marble in the lobby isn’t shiny enough.”

I’m part-way though a trip with only 3 full days of meetings that will cost over $5000. Yet, I manage to play golf down south for 8 days for less than one-quarter of this amount. I’m not thrilled about the strange blue light in my current hotel bathroom, but I happily endure far worse during a vacation.

I think this is more than just a case of having a different attitude when someone else is paying. I actually tried to keep the costs of this trip down, but now that the money is spent, I find myself demanding that my treatment reflect the costs.

An amusing side note: there is a big sign at the entrance to to hotel stairway that reads “Stairway Trap”. A little googling revealed that “Trap” translates from Dutch more or less as “step”, but I found it funny the first time I saw it. You’re not likely to trap anyone if you tell them about the trap.

Short Takes: Top Stocks Drive Indexes, Clueless Investors, and more

noreply@blogger.com (Michael James) — Fri, 10 May 2013 04:01:00 +0000

Here are my posts for this week:

Is a 15% Return High or Low?

Choosing the Right Index for Comparison

Real Estate Agent Contracts

Here are my short takes on some weekend reading:

Larry Swedroe explains how the majority of market returns come from a modest number of stocks.

Canadian Couch Potato asks whether investors surveyed by Franklin Templeton are as clueless as they seem. I agree that the majority who believe they can reach their financial goals without equities are mostly delusional. However, I wonder about the 52% who believe the market declined or stayed flat in 2012. It’s true that S&P/TSX Composite was up 7.2%, but perhaps these investors’ answers were influenced by expensive Canadian balanced funds in their portfolios. Many of these funds were close to flat for 2012.

Larry MacDonald reports a bear’s take on Warren Buffett’s Berkshire Hathaway.

Million Dollar Journey explains how to file your rental income taxes. Claiming all your expenses properly is a critical part of succeeding as a landlord.

Big Cajun Man saved hundreds on his car insurance by telling the insurance company his daughter was away at university.

The Blunt Bean Counter has a wild story about rental car troubles in the Caribbean.

My Own Advisor explains the details of how Canadians can get caught by U.S. estate taxes.

Preet Banerjee thinks CMHC needs changing.

Is a 15% Return High or Low?

noreply@blogger.com (Michael James) — Wed, 08 May 2013 04:01:00 +0000

Stingy Investor pointed to a set of slides from Fairfax Financial Holdings that began with the quote “We expect to compound our book value per share over the long term by 15% annually.” Averaging a 15% per year return on a stock sounds great right now, but not too long ago it would have seemed very low.

Back in the late 1990s as tech stocks boomed, expectation for stock returns were well above 15% per year. These expectations turned out to be hopelessly unrealistic, but back then many investors wouldn’t have given Fairfax a second look if the company was only shooting for 15% per year.

I find this a useful reminder of how the world and people’s expectations can change drastically. It’s hard to even imagine a world with double-digit interest rates, but they could easily come back again. It’s dangerous to make your plans expecting today’s conditions to persist indefinitely into the future.

Every time I’m tempted to mortgage my house for half a million dollars and invest the proceeds, I think back to my brother- and sister-in-law who at one time had a mortgage at over 20%. That stops me pretty quickly. I don’t really have any appetite for debt.

Choosing the Right Index for Comparison

noreply@blogger.com (Michael James) — Tue, 07 May 2013 04:01:00 +0000

Rob Carrick points to the RBC Canadian Dividend Fund as an example that “shows why we need to reform the way investors pay for funds and advice.” He makes a number of excellent points about the problem of hiding the cost of advice in mutual fund MERs in the form of trailing commissions. However, I take issue with his claim that because this fund has beaten the S&P/TSX composite index over the past 5 years it “has been such a consistently good money maker.”

The Canadian S&P composite index is not the right index for judging the RBC Canadian Dividend Fund. A more appropriate index would be the Dow Jones Canada Select Dividend Index. The iShares ETF based on this index, XDV, beat the RBC Canadian Dividend Fund by 1.1% per year for the past 5 years, which is very close to the difference in their MERs.

Another possible index for comparison is the S&P/TSX Canadian Dividend Aristocrats Index. The iShares ETF based on this index, CDZ, beat the RBC Canadian Dividend Fund by 1.5% per year for the past 5 years, which is a little more than the difference in their MERs.

What has made investors money over the past 5 years is the choice to invest in dividend stocks. Among ETFs and mutual funds that focus on Canadian dividend stocks, RBC’s fund has not distinguished itself. There is no reason to believe that dividend stock outperformance will continue. If it doesn’t, then the high MER on RBC’s fund will be less palatable.

Real Estate Agent Contracts

noreply@blogger.com (Michael James) — Mon, 06 May 2013 04:01:00 +0000

I’m no real estate expert, but I’ve noticed a pattern play out a few times, once when I sold my first house and a few other times watching friends and family members sell their houses. In these cases, the real estate agent did almost nothing until the listing was getting close to running out. There were no reasonable offers until shortly before the listing contract ended when the house suddenly sold.

From a busy real estate agent’s point of view, this makes some sense. If you’ve got more houses listed than you can work on at one time, it makes sense to work hard on the listings you’re about to lose. If other listings happen to sell in the meantime, it’s a nice bonus.

If this phenomenon is as widespread as my limited experience suggests, then homeowner’s need to develop countermeasures. Homeowners should prefer shorter contracts to longer ones. I’m used to 3-month contracts, but I’ve heard of 6-month contracts. Even 3 months is a long time to wait if the real estate agent isn’t doing anything.

The next thing to consider is contract renewal. In my case, the real estate agent began hinting about renewing the contract a little less than 2 weeks from the end of the contract. I didn’t piece it all together at the time, but I now interpret this hinting as “will you re-sign with me so I can keep ignoring your house and hope it sells on its own, or do I have to try to find a buyer quickly?” Fortunately, my wife and I decided to tell the agent we would be changing agents; our house was sold within a week.

Have readers had any similar experiences or is my view skewed by some atypical cases?

Short Takes: Tyranny of Fees, Smith Manoeuvre, and more

noreply@blogger.com (Michael James) — Fri, 03 May 2013 04:01:00 +0000

Here are my posts for this week:

When Should You Start Collecting CPP?

Getting a Handle on the Cost of Cars

Car Costs Spreadsheet

It’s a bit of a thin week for my short takes on some weekend reading. But I did find some very good articles.

John Heinzl explains the ‘tyranny’ of fees and how costs kill investment returns.

My Own Advisor gives us the benefit of his research into the Smith Manoeuvre (tax-efficient borrowing against your house to invest).

Big Cajun Man doesn’t think much of a U.S. effort to eliminate the collection of data used for economic indicators. I guess the idea is that as long as we don’t know how many people are unemployed we can all sleep well.

Preet Banerjee says it can be okay to indulge yourself financially, but not when it comes to big-ticket items like cars and houses.

Financial Crooks explains some quirks in the transaction history in Investorline online accounts.

Car Costs Spreadsheet

noreply@blogger.com (Michael James) — Wed, 01 May 2013 21:10:00 +0000

Reader AnatoliN asked me to share the spreadsheet I used to work out the fixed and variable costs on my car. So, I cleaned it up, and with great fanfare, here is the car costs spreadsheet.

Remember that garbage in leads to garbage out. Unless you have an accurate list of your car expenses, this spreadsheet cannot magically give accurate answers. In my experience, most people know they paid too much for their cars and have a hard time admitting the real costs to others and to themselves.

If you want to protect your ego from the brutal truth of how ridiculously expensive cars are, I suggest using the advertised price of $23,999 that got you into the dealership showroom rather than the actual $33,000 you paid after various add-ons and taxes. You can also just estimate your gas costs instead of looking up your credit card bill to see that you actually pay much more. Leaving out the cost of new tires or brakes might help as well.

OK, enough sarcasm. You get the point. If you don’t include all costs, then the final answer will be wrong. For those who try it out, please let me know if you find the spreadsheet useful.

Getting a Handle on the Cost of Cars

noreply@blogger.com (Michael James) — Tue, 30 Apr 2013 04:01:00 +0000

I’ve seen the cost of cars broken down to the cost per kilometer of driving, and I’ve seen it broken down to cost per year. However, neither approach seems to measure costs in the way I want. So, I set out to figure out how to model the cost of my car. I want a better idea of what it costs to have a car and how much it costs to drive it.

I began by recording all my car costs in the following categories:

– Purchase price
– Fuel
– Maintenance and repairs
– Licensing
– Insurance

I recorded the month of each cost so that I could use historical Consumer Price Index figures to adjust for inflation. For example, to adjust a cost of $100 in January 2010 when the CPI was 115.1 to March of this year (CPI 122.9), calculate

($100/115.1)*122.9 = $106.78.

Then I added up the adjusted costs in each category to get the totals in today’s dollars. The big question is what to do with this data at this point. One possibility is to work out the cost per kilometer. But this seems misleading because it overstates the marginal cost of each new km driven. Working out the cost per year is also misleading because the cost per year depends on how much you drive.

Fixed and Variable Costs

I decided to try to break the costs into fixed and variable costs. I think of the fixed costs as the cost of having a car available. Even if I never drive it, having a car costs money. Then the variable costs are proportional to the number of km driven.

The question now is how to divide up the 5 categories of costs into fixed and variable costs. The initial purchase price is partly fixed and partly variable because the more you drive a car the sooner you have to buy a new one. A guess is that a car rarely driven would last about twice as long as a car driven as far as I drive in a year. So, I split the initial purchase price 50/50 between fixed and variable.

Fuel is 100% variable, and maintenance and repairs are mostly variable, say 80%. Licensing is 100% fixed. Insurance is mostly fixed, but costs do rise the more you drive. I treated insurance as 70% fixed.

Next I divided up the 5 categories of costs into fixed and variable costs based on these percentages. I then took the fixed costs and divided them by the number of years I’ve owned my car (13). One exception is that I divided 50% of the initial purchase price by 17 as a (possibly optimistic) guess of the number of years I would have it in total.

I divided the variable costs by the number of km I’ve driven (317,739). One exception is that I divided 50% of the initial purchase price by a (possibly optimistic) guess of the total number of km I’d drive the car (400,000).

Total costs

The final costs for my car are

Fixed: $4550 per year, plus
Variable: 34 cents per km.

The way I interpret these results are that just having this car available to me costs $4550 per year, and actually driving it costs me another 34 cents per km.

How to use this information

The $4550 per year seems quite high. I guess owning a luxury car with 300 horsepower costs money. I’ll probably make a different choice when this car finally grinds to a halt.

Even the 34 cents per km is expensive when you think about it. I’ve played ball at a diamond 20 km away from my home for many years. The round trip has cost me $13.60 per game. Before I went through this exercise, this was an invisible cost. If the parking lot at the ball diamond had instituted a $2 charge, I would have complained bitterly, not realizing that I was already paying $13.60 per game.

Flying or driving to a vacation in Florida is a different decision when I think about the 34 cents per km. The return trip to Florida is about 4500 km, or $1530. So much for driving to save the flight costs for my wife and I of about $500 each.

Armed with this new information about the cost of my car will make me think differently about the cost of trips. Paying $200 for a train ticket for a 1000 km trip seems expensive until I realize that the cost to drive is $340. I’m very likely to choose my next car to have lower life-cycle costs.

When Should You Start Collecting CPP?

noreply@blogger.com (Michael James) — Mon, 29 Apr 2013 04:01:00 +0000

The standard age to start collecting CPP benefits is 65, but you may get a reduced pension as early as age 60, or get a larger pension by starting as late as age 70. A factor affecting the decision of when to start collecting CPP that I hadn’t considered before is the penalty that comes with years when you make no CPP contributions.

Most descriptions of how to calculate your CPP benefits are too hand-wavy to be useful. However, Doug Runchey wrote a great post at the Retire Happy Blog on how to calculate your CPP retirement pension. I used this post to work out my own projected CPP benefits.

I worked out 3 scenarios: collecting at age 60, 65, and 70. When you take your CPP before age 65, your benefits are reduced, and if you postpose benefits until after age 65, your benefits increase. We’re working through a transition period right now, but by 2016 and beyond, the reduction before age 65 is 0.6% per month and the increase after age 65 is 0.7% per month.

This means that if payments start at age 60, the payment amount is reduced 36%, and if they start at age 70, they are increased 42%. It’s important to understand that any reduction or increase is permanent. If you take early CPP at age 60, you won’t get back to normal payments at age 65; the 36% reduction applies for the rest of your life.

In each of my scenarios, I assumed that I wouldn’t be working past age 60. The only variable was the start date of collecting CPP. This means that the longer I delay collecting CPP, the more years I will have without making any CPP contributions. Unfortunately, this reduces CPP benefits more and more the longer I delay CPP benefits.

A very simple analysis of CPP payments takes the 36% penalty for starting at 60 and the 42% bonus for starting at age 70 and declares the benefits at ages 60, 65, and 70 to be in the ratio 64:100:142. However, when I did the full calculations for my situation, which included the penalty for years without contributing, the ratio was 72:100:129.

Based on just these factors, I should take CPP at age 60 if I don’t expect to make it to age 78, should take CPP at 65 if I expect to live to between 78 and 88, and should wait until age 70 if I expect to live past 88. However, another important factor in the timing of starting CPP benefits is the return I expect to make on my savings.

If I expect to make a positive real return on my savings, then the age cut-off ages of 78 and 88 rise. The bottom line for me is that unless the CPP rules change or my working plans change, I’m likely to start collecting CPP benefits at age 60. Each person’s situation is different, though. Your mileage may vary.