Building Wealth

For the first 30 or so years of working, saving and investing, you’ll be first in the mode of getting out of the hole (paying down debt), and then building your net worth (that’s wealth accumulation.). But don’t forget, wealth accumulation isn’t the ultimate goal. Decumulation is! (a separate category here at the Hub).

Opinions are like …

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By John De Goey, CFP, CIM

Special to the Financial Independence Hub

The old joke is that opinions are like noses – everybody has one. The other thing everyone says about opinions is that we’re all entitled to them.  If we’re speculating about how things that have never happened in the past might play out in the future, there’s also a bit of fun involved.  Friends can rib each other about which among them is the better prognosticator.  Adam Grant’s latest book, Think Again, encourages readers to rethink what is already known, which might just mean ‘what they believe.’

Grant says we should beware the “I’m-not-biased” bias: recognizing the flaws in other people’s thinking, but assuming you’re immune. He says the less biased you think you are, the less likely you are to catch yourself.  To paraphrase: “If knowledge is power, then knowing what you don’t know is wisdom.” It might also be handy to keep a mirror handy and question your own beliefs more often.

The next Bear market

I’ve recently completed an exchange with a friend about one of the most common financial advisor narratives and how those might play out if there was to be a prolonged and severe bear market.  To begin, although I personally think such an outcome is probable in the near term (which created a sense of urgency for the thought exercise), the important thing is to game out what we think and why we think it before the event happens.  Other than reading my thoughts into the record for posterity, the timing is inconsequential.  We may not have a large enough drawdown in the next 20 years, so we may not be able to test which hunches are closer to the mark during my career.

This exercise is especially interesting when we think of the lack of reliable counterfactuals.  Basically, advisors say they do a good job of keeping people invested in bear markets and naturally want to take credit for doing so.  The questions abound:

  • What would clients have done if they hadn’t worked with the advisor?
  • If the advice was consistent to hold and (say) 95% of clients held, is there culpability for the 5% who sold?
  • What if (say) 85% of the clients would have held if left to their own devices, anyway?
  • Combining the two hypothetical points above, the changed behaviour is felt for only 15% of clients, 10% who held when they would have otherwise sold; 5% who sold despite being advised to hold. Would that justify a narrative of ‘advisors adding value through behavioural coaching’?
  • If the drop is bigger and lasts longer, clients might behave differently, so what does this mean for advisor accountability? Taking or foregoing credit or blame regarding client conduct might change if one offered the same advice but got different outcomes as the situation dragged on.
  • Here’s a fun one: If an advisor gets credit for encouraging a client to hold through a 30% drop and then the market drops a further 30% and the advisor still encourages the client to hold, but the client sells, would it have been better for the advisor to have allowed the sell to have taken place sooner? If yes, is that advisor ‘worse’ for not allowing the client to sell sooner?

My concern in this exercise is a sort of first-derivative optimism bias.  I have a view that advisors are optimistic in general.  Continue Reading…

Q&A on Retirement Income with Finance prof and author Dr. Moshe Milevsky (part 1)

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The Retirement Quant: Dr. Moshe Milevsky

By Gordon Wiebe, The Capital Partner

Special to the Financial Independence Hub

Professor Moshe Milevsky wants us to re-think the metrics we use for retirement calculations. Instead of basing retirement income amounts on our age i.e.,  the number of orbits around the sun, Dr. Milevsky suggests we consider using our biological age.  What is your biological age?

Advances in science suggest our biological age is based on our actual physical shape or our personal physiology. Rock stars like Sting, Phil Collins and Ace Frehley were born in 1951. Their legal age is 70, but their actual condition may be substantially different from Mark Hamill (Luke Skywalker) or Dr. Jill Biden (U.S. First Lady) who also turned 70 in 2021.

The cumulative effects of genes, lifetime dietary habits, exercise, social conditions and stress levels for instance, could lengthen or decrease life expectancy and therefore provide a better indication of future retirement income needs.  Recent scientific advances are helping make this information more available to seniors, advisors, researchers and policy advisors.

Background

TCP: From where does your passion for mathematics originate?

 M.M.  I guess it comes from my life as an undergrad. I was taking various courses including one on English literature and essay writing.  I handed in an essay and received a bad grade. The professor said, “You really can’t write to save your life, you might want go into math.”

I did and I got an undergraduate degree in mathematical physics. Then, I went to graduate school and studied math and statistics, but I was really interested in gravitational physics. That was my thing, like how a golf ball moves after a drive, the arc that it makes, etc.

My thesis supervisor said, “Moshe, you’ll never find a job with that kind of specialty. You might want to go to business school.” So, I moved into business and finance and it’s where I’ve been for the past 25 years.

TCP: You also have a passion for financial history. Is there a period in history that strikes you as particularly innovative or ingenious?

M.M. There is. I’m interested in the 17th century, specifically 17th century Europe and the evolution of financial products, instruments, and economics.

Anything from the crowning of James II in 1685 until the ascension of George II in the mid-18th century.

TCP: I’m not that familiar with that era. Does it line up with the advances in math, probability, and statistics?

 M.M.  It does. There was this interesting alignment of people interested in mathematics and statistics and they developed the basics of probability theory, economics, and finance. It was an alignment of interests that led to many of the instruments we use today.

You know, nobody would say that 1690 was the origin of the i-Pad or the i-Phone or the laptop. But, many of the financial instruments we use, whether it’s pensions, annuities, stocks, bonds, mutual funds, they all kind of originated in the late 17th century. You can almost trace back a direct line. I’m fascinated by that. It interests me and I’ve spent a lot of time looking at history from that period.

TCP: Among other things, the pandemic has shown how segments of the population struggle with basic math principles. Are you surprised by the lack of financial literacy?

M.M. It is a problem the pandemic has brought home. I think it’s a problem that finance has brought home. A lot of people are incapable of mathematical reasoning and that’s not healthy in today’s very quantitative, data driven environment.

Thousands of years ago, you had to make sure to out run the dinosaurs and get home in time for dinner. What did your brain have to do? Nobody was asking you to solve calculus problems.

Now, we have to evolve to deal with these very quantitative issues and make decisions and I think the pandemic has brought that home very starkly. There’s some completely irrational decision making because of a misinterpretation of probabilities and the odds. Just look at Toronto.

There are 300 infections, and everybody is walking around like it’s Ebola and every other person has it. In some sense, you have to step back and say, “Wait a minute. What are the probabilities? Do you understand all of the things you’re sacrificing?” It’s all probabilities. Those things all come down to mathematical reasoning.

I do think the educational system should focus more on some of these statistical, data driven issues. I think financial literacy is an absolute must.

My bread and butter is teaching undergraduate students at the university.  Undergraduate Personal Finance. That’s a course I’ve been teaching now for almost twenty years.

It’s basic personal finance. You know. What’s a tax return? What’s an insurance policy? How does a mortgage work? What’s an RRSP?

Why do I have to teach this to 22-year-olds? Why don’t they know this from high school? Why isn’t this covered before I see them? And, why are only the ones that I teach in Business School getting this? What about the rest of the students who are studying something else? Why is this not considered a national emergency? People are wandering into the world without the requisite tools.

TCP: Carrying credit card balances in perpetuity, putting 5% down on million-dollar homes …

M.M. Let alone, just verify that what they’re paying is correct, right? Nobody’s able to do that because it’s all coming from calculations that are being done by algorithms that nobody wants to or even knows how to verify. So, there are a number of things that worry me.

The Mathematics of Retirement Income

TCP: I haven’t had a chance to watch the movie “The Baby Boomer Dilemma,” yet. I’ve just seen the trailer.

M.M. Yes, that’s an interesting one. I’m not sure how I got dragged into that, but I now have an IMDb movie rating. I am now officially a Hollywood actor (chuckling). Go figure.

TCP: On the trailer you say, “what’s been happening over the last few years is our accounts have been growing. It looks like we are getting wealthier. But, the income that we can get from that sum of money is shrinking.” What did you mean by that? Continue Reading…

How did the Pandemic Portfolio hold up?

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By Dale Roberts, cutthecrapinvesting

Special to the Financial Independence Hub

I was the first investment blogger to ‘jump on’ the investment risks that might be created by the coronavirus. In fact, when I first penned on the subject in February of 2020, the virus was not then known as COVID-19. And we were not yet in a global pandemic. New cases were just starting to move around the globe, and most felt that the strange new coronavirus would be contained. Today, I can’t claim that I knew it would result in the first modern pandemic. But I did address the risk, and I did offer some thoughts on how an investor might prepare, if they needed to protect their wealth. Let’s have a look, how did the pandemic portfolio perform?

Here’s the original post from February of 2020.

How to prepare your portfolio for the coronavirus outbreak.

Do nothing, stay the course

That almost goes without saying. You don’t fix a ship in a hurricane offers our friends at Mawer Investments. If you have a solid investment plan, and you are investing within your risk tolerance level —

Image by S K from Pixabay

De-risk your portfolio

This suggestion is controversial to some, but to me it is common sense. Fear was mounting in February of 2020, and the stock markets were offering a minor hissy fit. It is safe to say that most investors are not safe. They are investing outside of their risk tolerance level. These market scares offer the opportunity to discover that you are investing outside of your comfort level.

The timing from February of 2020 to de-risk was still quite favourable.

That would have allowed an investor to move to their risk tolerance level before the market corrected by nearly 35%. While that move to a lower risk portfolio might create lesser returns over time, it can remove the greater risk of permanent losses. Investors are known to too-often sell out in fear near the bottom of the market declines. Of course that’s the complete opposite of – buy low and sell high.

And a typical balanced portfolio would have delivered about 21% to 22% to date, from February of 2020. That’s a greater return compared to the Canadian stock market from that date.

Pandemic portfolio construction

I had suggested that investors consider two of the greater risk-off assets. Risk-off will refer to the defensive investments that protect your portfolio. And typically, investors run to these assets in times of trouble. That influx of dollars can drive up prices.

Gold is known as a safe haven asset.

Gold was the lead image on the original post on how to prepare your portfolio for the pandemic. The precious metal did shine in the pandemic, when needed.

I had suggested that investors consider U.S. long term treasuries. They punch above their weight as risk mangers (keeping an eye on those unruly stock markets.

You’ll find those long term treasuries in the Permanent Portfolio post.

And mostly, at the core is a sensible and well-balanced portfolio. From the original post …

. the best investment strategy is to diversify across geographic locations, asset classes and currencies to protect against the unknowns.

Ray Dalio

That said, one of the beautiful all-in-one balanced asset allocation ETF portfolios would have performed wonderfully. It’s the same story if you held a balanced ETF portfolio.

If an investor had shaded in some gold and long term treasuries, they would have experienced some greater returns, and would have been treated to better risk-adjusted returns.

The pandemic portfolio performance

For demonstration purposes I used the asset allocation offered on the ETF Portfolio page, for a balanced model. You certainly could have (successfully) held a conservative, balanced growth or all-equity model through the pandemic. But for those with a balanced model that holds some risk-off assets, the inclusion of gold and treasuries would have helped the cause. Continue Reading…

Invest as I say, not as I do

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By Michael J. Wiener

Special to the Financial Independence Hub

When I answer investing questions for friends and family, I tend to steer them to simple solutions that are consistent with their level of interest in investing.
However, I run my own portfolio differently in certain ways.  In reading Dan Bortolotti’s excellent book Reboot Your Portfolio, I noticed that the advice I give usually matches his advice, and it’s my own portfolio choices that sometimes differ from what’s in the book.
Here I see if the differences between my portfolio and Bortolotti’s advice hold up to scrutiny.

Before I go any further, I want to be clear that this isn’t a case of me having a “smarter” portfolio where I’m actively trading to beat the market.  I steer people to low-cost passive investing and that’s what I use myself.  The main difference between me and other do-it-yourself (DIY) investors is the degree to which I’ve built most of the complexity of my portfolio into an elaborate spreadsheet that alerts me by email when I need to take some action.  I’m happy to automate complexity in this way and let the spreadsheet tell me what to do.  I can safely ignore my portfolio for months without worry.

Pay yourself first

Bortolotti says “‘Pay yourself first’ has become a cliché because it works.”  “Sure, you could wait until the end of the month and then save whatever is left after paying all your expenses.”  “People following this approach rarely wind up with any surplus cash.”  “Make your savings a fixed expense, too, and you’ll be well on your way to meeting your investment goals.  It’s impossible to overstate how important this is.”

This is excellent advice.  I recommend it to my sons.  My wife and I never followed it ourselves.  From a young age we were used to only spending money on necessities.  It’s taken us decades to get used to spending money more freely.  During our working years, our savings rate bounced around, but it was rarely below 20%, and reached 80% for a while when the family income rose and the kids cost us less.  This wasn’t a case of us scrimping or having a savings target.  That’s just what was left after we bought what we needed and wanted.

Expected future returns

Vanguard research showed “that most of the techniques people employ to forecast future stock returns are utterly worthless.”  “So don’t get clever when you’re trying to estimate stock returns in your own financial plan.  That average over the very long term — about 5% above inflation — is a reasonable enough assumption.”

As a retiree, I find it wise to back off from the long term average of 5% and use 4%; I’d rather spend a little less starting now than be forced to spend a lot less in the future if stocks disappoint.

Bortolotti is right that P/E ratios have little predictive value.  I made this point myself recently.  However, long-term data show a consistent weak correlation between P/E levels and future stock returns.  This effect is almost unmeasurable over a year, and is very weak over a decade.  However, it builds over multiple decades.  I model this effect by assuming that P/E levels will decline to a more normal level by the time I turn 100, and corporate earnings will grow at an average rate of 4% annually above inflation over that time.  At the time of writing, this amounts to assuming stocks will return 2.6% above inflation over the rest of my investing life.  The missing 1.4 percentage points comes from the assumed drop in P/E levels over the decades.

The difference between my assumption of 2.6% and Bortolotti’s 5% is substantial.  It’s probably not important to those still a decade or more away from retirement; they have time to try to save more, work longer, or plan a more modest retirement.  Current retirees are another matter.  If they assume their stock allocation will beat inflation by 5%, high spending in early retirement could leave them with meagre later years.

Factor Investing

Investment research over the decades has shown that stocks with certain properties have outperformed.  These properties are called “factors,” and this whole area is sometimes referred to as “smart beta.”  Some well known factors are value (“stocks with low prices relative to their fundamentals”), small cap (small companies whose market capitalization is below some threshold), and momentum (“when stocks rise in price, they continue that trend for months before eventually settling back to earth”). Continue Reading…

How to pick US and Canadian Dividend-paying stocks

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By Ian Duncan MacDonald

Special to the Financial Independence Hub

Once upon a time there was a man who loved apples so much that he wanted to own an apple tree. So, he went to an apple-tree broker to buy one.  The man was impressed to see an apple tree one hundred feet tall with apples the size of basketballs. He asked how much it would cost to buy such a magnificent tree.

The apple-tree broker smiled tolerantly and said, “No one person can own such a magnificent tree. You can only own one tiny piece of it, a small branch a few inches long. How much do you have to invest?”

The man replied that he would like to own more than one tiny branch. Surely there must be something in your orchard that I can buy?”

The apple-tree broker said of course there is, but you must understand that for twenty years the apples that come from this magnificent tree have got increasingly bigger and even more plentiful. Even these  little twigs, in time, will produce several more giant apples than they do now.

“What else do you have?”

“Well over in this corner are 10 trees you could buy for the same amount of money; however, some years they do not produce apples and the apples are very small but if you really want a  bargain, I can give you 100 apple trees for one dollar. Hold out your hand.”

The apple broker poured one hundred apple seeds into the man’s palm who testily responded, “These aren’t magnificent apple trees?”

“No, these are speculative apple trees.  You are buying them for their potential.”

“What else do you have?”

“Well, see those fellows over there. They operate apple tree funds.  They buy 500 apple trees at a time and sell people like you a piece of their apple tree fund.”

“Are these 500 apple trees all magnificent trees?”

“No. Of course not. There are fewer than 100 magnificent trees available to buy.  The fund may have partial ownership of a dozen magnificent trees but for diversification they spread the risk of apple trees over five hundred trees. They call it their safe apple tree index.”

”Would this include some that are just seeds, some a few inches high, some a few feet higher and some fully grown ones whose production of apples may be spotty from year to year?

“It would but some might grow into magnificent trees, and you might be able to sell units in the fund for more than you paid.”

Safer to invest in 20 dividend-paying stocks than funds

This allegory is an attempt to explain why you are safer investing in 20 financially strong companies paying high dividends then investing in index funds, mutual funds, and ETFs. Why would you invest in hundreds of weak, mediocre stocks when you could invest the same amount of money in financially strong companies paying high dividends?  Strong companies with easily accessible historical records that can show their share price and dividend payments increasing yearly for decades.   Continue Reading…