Decumulate & Downsize

Most of your investing life you and your adviser (if you have one) are focused on wealth accumulation. But, we tend to forget, eventually the whole idea of this long process of delayed gratification is to actually spend this money! That’s decumulation as opposed to wealth accumulation. This stage may also involve downsizing from larger homes to smaller ones or condos, moving to the country or otherwise simplifying your life and jettisoning possessions that may tie you down.

The Inevitable masquerading as the Unexpected

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By Michael J. Wiener

Special to the Financial Independence Hub

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

Long-Term Bonds

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

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

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

Houses

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

Retired Money: Direct Indexing has drawbacks but a hybrid DIY strategy may have merits

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Image courtesy MoneySense.ca/Unsplash: Photo by Ruben Sukatendel

My latest MoneySense Retired Money column looks at a trendy new investing approach known as “Direct Indexing.” You can find the full column by clicking on the highlighted headline: What is direct indexing? Should you build your own index?

Here’s a definition from Investopedia : “Direct indexing is an approach to index investing that involves buying the individual stocks that make up an index, in the same weights as the index.”

When I first read about this, I thought this was some version of the common practice by Do-it-yourself investors who “skim” the major holdings of major indexes or ETFs, thereby avoiding any management fees associated with the ETFs. It is and it isn’t, and we explore this below.

Investopedia notes that in the past, buying all the stocks needed to replicate an index, especially large ones like the S&P 500, required hundreds of transactions: building an index one stock at a time is time-consuming and expensive if you’re paying full pop on trading commissions. However, zero-commission stock trading largely gets around this constraint, democratizing what was once the preserve of wealthy investors.   According to this article that ran in the summer at Charles River [a State Street company], direct indexing has taken off in the US: “ While direct index portfolios have been available for over 20 years, continued advancement of technology and structural industry changes have eliminated barriers to adoption, reduced cost, and created an environment conducive for the broader adoption of these types of strategies.”

These forces also means direct indexing can be attractive in Canada as well, it says. However, an October 2022 article in Canadian trade newspaper Investment Executive suggests “not everyone thinks it will take root in Canada.” It cast direct indexing as an alternative to owning ETFs or mutual funds, noting that players include Boston-based Fidelity Investments Inc, BlackRock Inc., Vanguard Group Inc., Charles Schwab and finance giants Goldman Sachs Inc. and Morgan Stanley.

An article at Morningstar Canada suggested direct indexing is “effectively … the updated version of separately managed accounts (SMA). As with direct indexing, SMAs were modified versions of mutual funds, except the funds were active rather than passive with SMAs.”

My MoneySense column quotes Wealth manager Matthew Ardrey, a vice president with Toronto-based TriDelta Financial, who is skeptical about the benefits of direct indexing: “While I always think it is good for an investor to be able to lower fees and increase flexibility in their portfolio management, I question just who this strategy is right for.” First, Ardrey addresses the fees issue: “Using the S&P500 as an example, an investor must track and trade 500 stocks to replicate this index. Though they could tax-loss-sell and otherwise tilt their allocation as they see fit, the cost of managing 500 stocks is very high: not necessarily in dollars, but in time.” It would be onerous to make 500 trades alone, especially if fractional shares are involved.

Ardrey concludes Direct indexing may be more useful for those trying to allocate to a particular sector of the market (like Canadian financials), where “a person would have to buy a lot less companies and make the trading worthwhile.”

A hybrid strategy used by DIY financial bloggers may be more doable

I would call this professional or advisor-mediated Direct Indexing and agree it seems to have severe drawbacks. However, that doesn’t mean savvy investors can’t implement their own custom approach to incorporate some of these ideas. Classic Direct Indexing seems similar but slightly different than a hybrid strategy many DIY Canadian financial bloggers have been using in recent years. They may target a particular stock index – like the S&P500 or TSX – and buy  most of the underlying stocks in similar proportions. Again, the rise of zero-commission investing and fractional share ownership has made this practical for ordinary retail investors. Continue Reading…

Learn why you should Buy This, Not That

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By Mark Seed, myownadvisor

Special to the Financial Independence Hub

Let’s face it, saving and investing should be simple.

  1. Save, automate your savings to buy stocks.
  2. Invest in stocks and/or low-cost products that invest in stocks to avoid mutual fund salespeople.
  3. Disaster-proof your life by having some cash stashed.
  4. Rinse and repeat.

But simple is not easy.

All too often, we humans love to make things far more complex than things need to be.

We’re wired that way unfortunately. Egos often get in the way. 

Given many people continue to struggle with personal finance, every day, there are tens of thousands of books published out there on this subject – building and maintaining a responsible investment portfolio is only part of the personal finance success equation…

Learn why you should Buy This, Not That

Sam Dogen (aka Financial Samurai) knows a thing or two about personal finance success.

Sam founded FinancialSamurai.com in July 2009 during the depths of the global financial crisis.

Sam’s goal through that site was to deliver and share a cathartic way to make sense of the chaos at the time. Fast forward to today, more than 90 million people have visited Financial Samurai, and tens of millions more have read his work on publications such as CNBC, Yahoo Finance, and Business Insider.

Sam was previously at Goldman Sachs and Credit Suisse for 13 years – but he’ll share more details below!

When Sam is not writing or playing with his kids, you can find him on a tennis court or softball field in San Francisco, or on My Own Advisor giving away a book!

Sam is a graduate of The College of William & Mary and received his MBA from UC Berkeley.

I got a chance to chat with Sam recently about his new book: Buy This, Not That – How to Spend Money Your Way to Wealth and Freedom.

Here is our interview below before Sam:

Sam, welcome to the site – I know you’ve left a few comments over the years and nice to see you back!

Mark, a pleasure. I enjoy reading about your personal finance independence journey in Canada and seeing you help others with their journeys at the same time as well!

Sam, maybe not everyone is aware of your financial journey and Financial Samurai beginnings. Can you share a bit of your bio with my readers? Where do you live, what have you invested in, and “how did you get here” to writing this book?

Sure thing, Mark.

I grew up in The Philippines, Zambia, Japan, Taiwan, and Malaysia before coming to America for high school and college at William & Mary. My parents were in the U.S. foreign service.

After college, I joined Goldman Sachs in NYC in their international equities department. It was a dream job, except for the fact I had to get in at 5:30 am and often leave after 7 pm! As a result, I decided to save and invest 50% of my after-tax paycheck so I could one day have options to escape.

In July 2009, I started Financial Samurai and helped kickstart the modern-day FIRE movement. It’s been great to see so many people embrace their financial independence journey since then. My definition of financial independence is having enough passive investment income to pay for your basic living expenses.

I decided to write Buy This, Not That because I felt it had to be written. When I started Financial Samurai, there weren’t a lot of personal finance bloggers with finance backgrounds. I noticed when I first got my book offer in early 2020, there weren’t many finance authors with finance backgrounds either! So, I decided to fill this hole and provide my perspective.

Instead of scratching the surface, I decided to go deep into many financial topics. I then tackled some of life’s biggest dilemmas many of us all face.

Learn why you should Buy This, Not That! Sam Dogen

Great stuff.

Sam, in your book, you wrote:

“My first hope with Buy This, Not That is to help you let go of the fear of making a wrong financial choice. Let that sink in: there are no wrong money choices, just as there are no perfect choices, only optimal or suboptimal.”

Talk to me about your investing and wealth-building journey. What mistakes did you make? What successes did you have? What did this teach you and what do you hope to pass along to others in the book?

Mark, I made the suboptimal choice of buying a vacation property I didn’t need in 2007. I got it for 15% off, but it ended up declining by another 40% during the financial crisis! Luckily, most of its value has recovered and I’ve been taking my kids there since 2018.

Not extrapolating my income into the future was my biggest lesson learned. I was paid very well in 2007 and thought my income was just going to go higher. Life is full of ups and downs. Therefore, please be conservative with your income and return forecasts.

One of the key takeaways from the book is to encourage readers to think in probabilities, not absolutes. Don’t think you need 100% certainty to make a choice. Otherwise, you’re going to miss out on a lot of great opportunities.

In The Psychology of Money, Morgan Housel wrote effectively:

You don’t have to be a perfect investor. Getting wealthy and staying wealthy is “about consistently not screwing up.”

I agree with this/have always agreed with this and this aligns nicely to your 70/30 decision making philosophy. Can you explain that for readers and why is that framework so important to you to convey in the book when it comes to investing and wealth-building?

Use my 70-30 decision-making framework to build wealth and make more optimal choices. The framework states that if you believe there’s a 70% probability or greater your choice is the correct one, go for it, while having the humility knowing that 30% of the time, you’re going to get it wrong. And when you do, you will learn from your mistakes and get better.

Once you start approaching everything with a probability matrix in mind, you’re going to gain a tremendous competitive advantage compared to those who don’t.

I like that.

Sam, I personally equate the definition of Financial Independence (FI) as your investments generate enough passive income to cover your day to day living expenses. I’m not into this Barista FIRE, etc. What’s your take? Agree? Disagree? Why?

Yes, since 2009, I’ve stated that being financially independent means having enough investment income to cover your basic living expenses. However, I think Barista FIRE is a reasonable stop gap where you can earn extra income and receive subsidized health care while working a traditionally lower-wage job.

But at the end of the day, don’t fool yourself. If you still need to work, then you are probably not financially independent.

When I left work in 2012 at age 34, I had about $80,000 a year in passive investment income. I knew I wouldn’t starve, but I also wasn’t 100% confident I was doing the right thing. Therefore, I had my wife, who is three years younger than me, keep on working until age 34. If everything worked out with my new adventure, she could join me. In 2015, she was also able to negotiate a nice severance and hasn’t been back to work since.

So, when did you realize FI (Financial Independence)?

In 2012 when I was 34. At the time, I had a net worth of about $3 million that generated about $80,000 a year in passive income. But the biggest catalyst was negotiating a severance that paid for 5-6 years’ worth of regular living expenses. My severance paid all my deferred cash and stock compensation over the next three years. I also had a private investment made in 2010 that wouldn’t come due until 2017 that was fully paid out. Continue Reading…

The 5 most important factors In your Decision to Retire

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By Fritz Gilbert, TheRetirementManifesto

Special to the Financial Independence Hub

A few years ago, I was working through my decision to retire. I was pretty obsessive about it and documented the many factors I was evaluating on this blog (stored in chronological order for your convenience).  After doing my homework, I decided to make the jump in June 2018.

In the four years since I’ve never regretted my decision.

The decision to retire is complicated and there are many factors to consider.  Consider them you must, however, so I’m listing the factors I consider most important and one which I consider essentially irrelevant.  To make your best decision on when to retire, it’s important to recognize all of the things that matter, as well as those that don’t.  Under each factor, I’ve included links to relevant posts for those of you who’d like to dig deeper.

The Most Important Factors

1.) Do you have Enough Money?

The first thing most people think about when they’re making the decision to retire is whether they have enough money to last for the rest of their lifetime.  Fair enough, and I’ll concede it’s way up on the list.  I’d warn, however, that having enough money is a necessary factor, but far from sufficient.

I’ve written many articles on evaluating whether you have enough money to retire.  Below are four that I’d recommend:

2.) Are you Mentally Prepared for Retirement?

Almost everyone thinks about money when they’re making the decision to retire, but far too few consider the non-financial factors.  If I were to choose one point to make from all the things I’ve learned in the 7 years of writing this blog, it’s that the non-financial factors are the most important for putting yourself on track for a great retirement. Important enough that I wrote an entire book on the topic.

If you’re thinking about retirement, the best advice I can give you is to spend time thinking about what you want your life to be in retirement.  Think about it at least as much as you think about the “money stuff.”  Once you’ve retired, I suspect you’ll realize #2 is actually the more critical factor.

If you’re married, have you and your spouse talked about your mutual expectations for your life in retirement?  How are you addressing any misalignments?  Trust me, you have some.  Take the time to find them now, and discuss how you’re going to work together to live the best years for both of you in retirement.

What Purpose is going to fill your days when you no longer have a boss telling you what to do?  Where are you going to live?  What are you going to do?  Important stuff, all, and a topic on which I’ve dedicated thousands of words.  If you’re still working, do yourself a favor and take a “mini-retirement” to think about the things that really matter before you take the plunge.

3.) Have you made a Realistic Spending Estimate?

In its rawest form, the decision to retire is a simple math problem.  Multiply your assets times a safe withdrawal rate, add any expected income, and see if the total covers your expected level of spending.  Given the importance of getting the correct answer to that formula, it’s critical that you spend some time developing a realistic spending estimate for your retirement years.  Since you’ve thought about what you’re going to be doing in retirement (#2), it’s a necessary exercise to track your pre-retirement spending for as long as feasible (I did 11 months), then make any adjustments for how you think it will change post-retirement.  Too many people “take a swag” on this one, but I strongly encourage you to resist that temptation and give it a lot of focus as you’re making your decision to retire.

Best Canadian stocks are usually well-established Blue Chips with history of Stability & Dividend Payments

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Good Canadian stocks of blue chip companies can give investors an additional measure of safety in volatile markets. And the best ones offer an attractive combination of moderate p/e’s (the ratio of a stock’s price to its per-share earnings), steady or rising dividend yields (annual dividend divided by the share price) and promising growth prospects.

We feel most investors should hold the bulk of their investment portfolios in blue chip investments. And most of these stocks should offer good “value” — that is, they should trade at reasonable multiples of earnings, cash flow, book value and so on. Ideally, they should also have above average-growth prospects, compared to alternative investments.

Find a middle ground with p/e’s  

One of the biggest mistakes investors make is buying low p/e stocks, thinking that will ensure they’re getting a “bargain.” Sometimes that’s true, but sometimes a low p/e stock is a sign of danger.

As for high-p/e stocks, we generally only recommend them as buys if we feel they have above-average investment appeal and deserve an above-average p/e.

Rather than focusing on low p/e stocks and avoiding high p/e stocks, you will generally make more money in the middle ground. That is, invest mainly in well-established stocks that have an appealing long-term growth record — and a moderate p/e. These are the stocks we favour in our Successful Investor approach. In our experience, they provide above-average returns in the long run. That’s because they provide nice gains in rising markets, and they also tend to hold up well when the market declines.

Buy shares in banks, which have a history of stability 

On the whole, the best Canadian banks to invest in trade at attractive share prices. Because they are growing, yet cheaper in many respects than other stocks, they give conservative Canadian investors a near-ideal combination of pluses: above-average dividend yields and track records; low to moderate per-share price-to-earnings ratios; and above-average long-term capital gains.

That’s why we’ve continually recommended buying Canada’s top five bank stocks since the 1970s. It’s also why that advice has paid off so nicely.

Canadian bank stocks have long been one of our top choices for growth and income, and we recommend that most Canadian investors own two or more of the Big-Five Canadian bank stocks — Bank of Nova Scotia, Bank of Montreal, CIBC, TD Bank and Royal Bank. That’s in large part because of their importance to Canada’s economy.

Canadian banks stocks have been some of the best income-producing securities.

  • Look for Canadian bank stocks with consistent dividends.
  • And remember bank stock dividends are a sign of investment quality.
  • They also can grow.

Look for value stocks with a history of success to add good Canadian stocks to your portfolio

At the core of the value investing approach is the ability to identify well-financed companies that are well-established in their businesses and have a history of earnings and dividends. Continue Reading…