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).

Whose Bias is it, anyway?

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One of the great benefits of living in a free society is that people can have legitimate differences of opinion about the meaning of information and best courses of action.  In this space and, more recently, on social media, I have taken to pointing out the small army of credible sources who concur with my viewpoint that markets are frothy and likely headed for a significant tumble.  Not surprisingly, there are plenty of folks who think things look rosy and that there are no significant storm clouds on the horizon at all.  Obviously, we can’t both be right.

What I find interesting is that I have critics who allege that I am guilty of confirmation bias, a behavioural economics term that suggests people only seek out evidence that supports their pre-existing viewpoint.  While I certainly acknowledge that that might be possible, I find it interesting that the people making the accusation don’t recognize that the same allegation could be levied against them just as easily.  Both sides of the ongoing debate about what might be in store on the capital markets horizon could be accused of looking primarily, perhaps even exclusively, at information that supports their preferred narrative.  How exactly does one prove that one’s thinking has been fulsome and comprehensive? Continue Reading…

How to use Statistics to Lie to yourself about a Stock Crash

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By Michael J. Wiener

Special to the Financial Independence Hub

Wouldn’t it be great if we could predict the future movements of stock markets so we could capture the gains and avoid the losses?  It turns out we can’t, but that doesn’t stop people from trying.

After a Twitter exchange with John De Goey, I ended up reading the article The Remarkable Accuracy of CAPE as a Predictor of Returns by Michael Finke.  He gives a chart that appears to show we can predict the coming decade of stock returns by calculating what is known as the CAPE (Cyclically Adjusted Price-to-Earnings Ratio).

For our purposes, we don’t need to know much about the CAPE other than that it is a measure of how expensive stocks are and that it was invented by Robert Shiller, who received a Nobel Prize in Economics in 2013.  In fact, we don’t even have to calculate the CAPE ourselves; it is freely available and updated daily.

Right now, stock prices are very high.  As I write this, the CAPE for U.S. stocks stands at 37.  The only time it was higher in the past century was during the tech boom and bust around the year 2000.  We seem to be repeating the boom part, and the fear is that we may soon repeat the bust part.

Here is my reproduction of a chart similar to Finke’s chart:

Finke’s chart used nominal U.S. stock returns rather than real (inflation-adjusted) returns, but they show the same thing: an apparently close relationship between the CAPE and U.S. stock returns over the subsequent decade.  Given the current CAPE, stock returns appear to be predictable to within +/- 3% per year.  That would be amazingly accurate if true.

Based on this chart and the fact that the CAPE is currently 37, we’d expect the average annual stock return in the next 10 years to be between inflation minus 4% and inflation plus 1.5%.  If true, this would clearly mean it makes sense to sell stocks.  De Goey made his position clear in an article titled Get Out!.

Sadly, there holes in this story.  Nobel Prize winner Shiller invented the CAPE, but he isn’t involved with Finke’s paper, despite De Goey’s implication when he defended Finke’s chart saying “Oh, and the guy who came up with the concept has a Nobel Prize.”

You might wonder how the chart above has so many points when we’re talking about 10-year returns and it covers only 25 years of stock market data.  The answer is that the chart uses 300 overlapping 10-year periods.  So, each point represents a starting month.  Two successive months are likely to have nearly the same CAPE and nearly the same 10-year annual returns.  So, we get lots of bunched up dots.

But the truth is that we have very little data.  We really only have two independent 10-year periods.  Despite the impressive correlation the chart shows, we’re extrapolating from little information.

To show the problem, let’s repeat this chart for another time period:

I didn’t choose this date range at random; I selected it to make a point.  If we were to devise a strategy based on this chart, we’d say not to worry if the CAPE gets high because you’ll still get decent returns.  But when the CAPE is in the 17 to 18 range, stocks are either going on a big run, or they’ll crash, and you have to be ready to get out.  This is obviously nonsense.  It’s dangerous to try to build strategies on too little information.

Here’s a chart using S&P 500 stock data from 1936 to the present:

This data still only covers seven independent decades, but we can see the real picture of the relationship between the CAPE and stock returns is a lot fuzzier than the first chart made it seem.  We can still reasonably guess that a higher CAPE reduces future expected stock returns, but the range of returns is still wide. Continue Reading…

Financial knowledge of Canada’s retirement system isn’t improving, study shows

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Financial knowledge about the Canadian retirement system fell from 2020 to 2021, says the Retirement Savings Institute.

The financial literacy of average Canadians is still low when it comes to understanding our Retirement system, says a survey being released Tuesday. The third edition of the Retirement Savings Institute (RSI) surveyed 3,002 Canadians aged 35 to 54 and found the overall RSI index measuring knowledge of the retirement income system slipped from 38% in 2020 to 37% in 2021. This, it says, is “still showing a significant lack of knowledge among Canadians.”

The RSI Index is the share (stated as a percentage) of correct answers to  29 questions posed in the survey.

The best-understood subjects continue to be CPP/QPP and RRSPs/TFSAs. Canadians still find it tougher to understand employer sponsored pension plans and Old Age Security, where the average respondents “didn’t know” the answer to half the questions.

In a backgrounder, the RSI team at HEC Montreal [a business school] says the scientific literature in several countries has established a link between general financial literacy and preparation for Retirement. However, “the level  of general financial literacy among Canadians is fairly low, although comparable to what is observed elsewhere in industrialized countries.” It also finds knowlege about narrower topics like taxes to be “rather limited.”

Starting in 2018, the RSI started to measure on an annual basis the financial literacy of Canadians in their “years of strong asset accumulation in preparation for retirement.” Those younger than 35 tend to have “other concerns and financial priorities than retirement,” the RSI says.

Knowledge rises with education and income, and as retirement nears

Not surprisingly, the closer to Retirement age one is, the more knowledgeable of related financial matters we tend to become. The RSI score was 33.9% for the youngest in the survey aged 35 to 39, rising to 36.6% for the 40 to 44 cohort, then to 37.8% for the 45-49 group, and a high of 39.5% for those 50 to 54.

Also as one would expect, the more schooling the higher the score: those with high school or less had an RSI score of 31.5%, while those with college or equivalent scored 36.9%, and those with a Bachelor’s degree or higher scored on average 45.3%. Similarly, the higher the household income, the better knowledge. Thus, those with household income of $30,000 or less scored just 26.1%, compared to $60,000 to $90,000 families scoring 37.3% and at the highest, families making $120,000 or more scored 45.6%.

Equally unsurprising is the fact that higher earners are more knowledgeable about RRSPs and TFSAs, especially when it comes to contribution room and withdrawal rules. They are less knowledgeable about investment returns in those vehicles, and score a low 12.6% on penalties for over contributions and other rules related to taxes.

Many confused about Employer Pensions

Employer pension plans seems to be an issue. At all ages, Canadians found it difficult to know the difference between Defined Benefit (DB) and Defined Contribution (DC) pension plans. In particular, they tend to be confused about which one reduces longevity risk (DB) and which depends on returns generated by financial markets (DC). Low-income individuals are even less knowledgeable.

Workers who are contributing employer pension plans had significantly higher scores (41%) than those who were not enrolled in such plans (32.9%).

The older and richer understand CPP/QPP better

Also as you’d expect, older people and more well-off people understand the Canada Pension Plan (CPP) or the Quebec Pension Plan (QPP) better. As the chart below illustrates, most Canadians are now well aware that taking early CPP/QPP benefits results in lower monthly benefits (shown in the “Penalty” bar), but there is still a lot of confusion about whether CPP/QPP recipients can collect benefits while still working (only 25% correctly answer this.)

Most Canadians know there is a penalty for taking CPP/QPP benefits early but there is much confusion about collecting while still working.

Older people also know OAS and GIS better. As the chart below shows, most people know you have to be at least 65 years old to receive OAS, but knowledge about technical matters like the OAS clawback, the Guaranteed Income Supplement to the OAS, and taxation of these benefits tends to be much scantier.

Basic OAS timing seems well understood but many are murky when it comes to clawbacks and eligibility and taxation of GIS benefits.

Mortgages well understood, bonds and debt not so much

When it comes to major financial products, Canadians are quite knowledgeable about compound interest, but as less so about debt doubling and quite ill-informed about Bonds, as the chart below indicates. ( Continue Reading…

Renting vs Buying Property while living abroad: Which is best for Financial Independence?

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By Emily Roberts

For the Financial Independence Hub

Financial independence means different things to different people. It has an impact on your life planning and whether renting is preferred over buying property. If you’re planning to go abroad and live elsewhere like continental Europe, Eastern Europe, or south-east Asia, then plans may be different again.

In this article, we look at whether renting is better than buying when you’re financially independent (or working towards it).

What Does Financial Independence mean to You?

Financial independence is possible at various levels. People refer to it by different names including Barista FIRE, CoastFIRE, FI, and others.

One approach is to reach a modest level of financial independence to provide a minimal income from investments, and to let them grow from their current level for a decade or longer while working an easier, low-paid job. Another approach is to wait until you have enough and then retire, but with the occasional freelance or consulting gig too.

Financial independence doesn’t necessarily mean retirement, which generally speaking refers to stopping working as a primary source of income. Different strokes for different folks.

Advantages of Renting

When still working, renting comes out of your paycheck and reduces what you can invest for future financial independence. Some people decide to live and work abroad to reduce their living expenses, to allow them to save faster.

Renting in the US

Americans can rent places Stateside but have to be careful of the long-term leases and associated fees along with any restrictions on tenants.

Depending on the city, renting has become quite expensive, causing some to look abroad.

Renting Abroad

Renting abroad can save you considerable money compared to back home.

For instance, PropertyGuru provides rooms for rent in Kuching, Malaysia. They have rooms for under $100 a month, studios for greater privacy, and larger multi-bedroom apartments in newly constructed buildings too. Their team can locate suitable rental accommodation close to major facilities and transport links, so whether you’re working there, planning to retire, or just on vacation, they can find something suitable.

Advantages of Buying

Purchasing real estate is something that appeals to many people. When they don’t like the idea of not owning where they live, then they lean far more towards buying.

Owning property domestically is possible when the prices are affordable. Unfortunately, cities with the most jobs typically also enjoy robust real estate markets with high prices to match. Sinking most of the next egg into a home makes retirement difficult. The ongoing ownership costs aren’t cheap either. Continue Reading…

Kornel Szrejber’s Podcast interview with me and PWL’s Ben Felix about the 2021 MoneySense ETF All-Stars

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An interesting analysis of the annual MoneySense ETF All-stars feature is now available on a one-hour podcast interview hosted by BuildWealthCanada.ca’s Kornel Szrejber, with myself and PWL Capital’s Ben Felix. Click on this highlighted text for the full session: The Best ETFs in Canada for 2021.

Initially, the interview is audio-only, available through iTunes and the usual podcast services. Later there will be a version that also shows video.

The full 2021 edition of the ETF all-stars can be found here at the MoneySense site, and the Hub’s summary here. The feature appeared early in April.

There are various links to the ETFs, including the ticker symbols (most of them trading on the TSX).

Kornel Szrejber

After kind introductions of both me and Ben Felix, both of us then added a few more details about our careers before Kornel started the formal interview. He did so by asking about the general philosophy behind the All-Stars and the mechanics of how we got eight ETF experts to agree on designating roughly 50 ETFs (from a universe of near a thousand) as ETF All-Stars.

The philosophy underlying the All-stars

As I explain in the MoneySense overview, the feature – now in its 8th year – aims to help individual investors (with or without the assistance of advisors) whittle down the overwhelming choice of ETFs now on the market. The goal has never been to whipsaw investors with change for the sake of change, but rather we strive to pick “buy and hold” broadly diversified low-cost ETFs that can be held over the years and ideally the decades.

Except for the individual “Desert Island Picks” (see below), generally the idea has been to avoid flavor-of-the-month theme funds or regional equity ETFs too narrowly focused on single countries (apart from Canada and the US). As a result, we try to keep the list to a manageable number that don’t necessarily change with every passing year. Of course, once in a while there is a “game-changer” that requires a revamp: the Asset Allocation ETFs from Vanguard Canada and subsequently its major competitors being the best example.

We also assume our readers are probably not day traders but looking for low-cost manageable portfolios that might be tweaked annually but likely won’t welcome a total revamp of their investments every year. We assume some are DIY investors buying them from discount brokerages, some have full-service advisors (including shops like PWL Capital), and some are hybrid investors who largely invest on their own but like to validate their approach through perhaps a fee-only advisor.

How the panel “votes” 

As for the mechanics of choosing the ETFs, as I tell Kornel, the eight expert panelists simply debate by email or Slack and “vote” on a spreadsheet. We have four teams of two each and once each team agrees, we try and find a consensus among the four teams. So 5 out of 8 votes would carry the day: I myself don’t vote unless there is a 4-4 tie and the tie needs to be broken.

After the introductory chat, there is a brief interlude where Kornel describes his own personal transition to financial independence and semi-retirement, and addresses his own personal ETF picks, and why he holds his emergency cash with EQ Bank (as does our family). Continue Reading…