Tag Archives: Financial Independence

No, passive investing is not in a bubble

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There have been many ridiculous statements made about passive investing over the years. None have garnered as much media attention as hedge-fund manager Michael Burry’s claim that passive investments such as index funds and ETFs are the next bubble. He said these index-tracking investments are “inflating stock and bond prices in a similar way that collateralized debt obligations did for subprime mortgages more than 10 years ago.”

“When the massive inflows into passive vehicles reverse, it will be ugly.” – Michael Burry

Such a bold claim from someone who correctly called the subprime mortgage crisis is certainly cause for concern. But when you peel back the layers, Burry’s statement doesn’t make much sense. Looking for a smarter take than that, I reached out to Erika Toth, a Director of ETFs at BMO Global Asset Management, to explain why passive investing is not in a bubble.

Take it away, Erika:

Debunking Michael Burry’s Passive Investing Bubble Claim

I may not have had Christian Bale play me in a movie, and I did not make millions during the financial crisis, but I have spent years now studying market structure and eating, sleeping, and breathing ETFs. Burry’s comments that sparked a media frenzy (and let’s all agree that the financial media loves to sensationalize) echo some of the most common myths and misconceptions I have encountered on the ETF wrapper.

This “passive investing is in a bubble” argument assumes that all the money invested in passive indices has flowed in to the same indices, that hold the same stocks, in the same proportions. However, there are many different types of passive funds and ETFs: some track the S&P 500, some track indices built around low volatility, quality, value, or momentum filters. Some track specific sectors.

Related: What’s not to love about ETFs?

Different investors have different investment objectives and motivations. Some want to buy the market. Some require higher cash flow. Some require lower volatility. Some are searching to exploit market inefficiencies in order to generate alpha. Pension funds have to make sure their liabilities are funded. Some investors are searching for companies that meet the highest environmental, social, and governance standards. Some require certain tax efficiencies or credit qualities to be met. Therefore, it is impossible that the entire world’s stock and bond markets would move to 100% passive.

It’s also important to note that individual stock ownership by households (domestic and foreign) accounts for just over half of the equity market: the largest share, by far. Mutual funds (active and passive) own about 24%; ETFs own about 6%. Pension funds would represent about 10% (government and private); and about 8% is owned in other vehicles such as hedge funds. (This is according to data put together by the Federal Reserve Board: see below).

ETFs themselves are too small a slice of the overall pie to be able to cause a crash in the prices of the stocks they hold; they simply reflect those prices. Those statistics are for the equity market. ETF ownership of the global bond market is even smaller, roughly 2-3% by most estimates.

The theory that everyone will run to the exits at the same time in the event of a major downturn is incorrect, and 2008 is a good example of that. My favourite example comes from Ray Kerzehro, who is Director of Research at independent firm PWL Capital, in the still-very-relevant white paper he published in 2016.

Kerzehro examines how high yield bond ETFs in the U.S. traded during the height of the financial crisis. Keep in mind that high yield bonds are NOT a large cap equity index made up of the largest and most liquid stocks in the world: they are a riskier asset class of lower credit quality and are less liquid as well. So, even in this riskier and less liquid asset class, there was actually no massive exodus from those ETFs.

What happened is that trading VOLUME actually spiked. Buyers & sellers of the ETF units had different views for different reasons, and the ETF structure actually provided price discovery to an asset class where many of the underlying bonds had gone no-bid. Continue Reading…

Retirement not what many were expecting, and not in a good way: Sun Life survey

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My latest Financial Post column, which is on page FP 3 of Tuesday’s paper, looks at a Sun Life retirement survey released this morning. You can find it online by clicking on the highlighted headline: Canadians finding retirement is not all it’s cracked up to be.

So if you think Retirement is about eternal sea cruises and African safaris, you may be abashed by the Sun Life finding that almost one in four (23%) describe their lifestyle as a frugal one that involves “following a strict budget and refraining from spending money on non-essential items.”

Furthermore, many can expect to still be working full-time at age 66, which just happens to be my own age. And as you can see from this blog, I’m still working, if only on a self-employed semi-retirement basis.

In fact, among the 2150 employed Canadians polled by the 2019 Sun Life Barometer poll conducted by Ipsos, almost half (44 per cent) expect they’ll still be employed full-time at age 66. Among the “frugal” retirees still working after the traditional retirement age, 65 per cent say it’s because they need to work for the money rather than because they enjoy it.

In an interview, Sun Life Canada president Jacques Goulet mentioned most of the main reasons, few of which will come as a surprise to this blog’s readers. Mostly there is a failure to plan for Retirement early enough to save the kind of sums involved. Another familiar culprit is the ongoing decline of employer-sponsored Defined Benefit pension plans, which are becoming more and more rare in the private sector. Most of us can only envy the tax-payer backed guaranteed inflation-indexed DB pensions enjoyed by most government workers, politicians and some members of labor unions: a bulletproof source of income that you can’t outlive.

47% at risk of outliving their money

The alternative for many are employer-sponsored Defined Contribution pensions (DC plans), group RRSPs or personal RRSPs and TFSAs, which means taking on market risk and longevity risk. Both are challenges in the current climate of seemingly perpetual low interest rates and ever volatile stock markets, not to mention rising life expectancy. Even then, Goulet told me Canadians with DC pensions are leaving a lot of money on the table: $3 or $4 billion a year in “free money” that is obtainable if you enrol in a DC pension where the employer “matches” the employee contributions: typically 50 cents for every $1 contributed.

Finally, there is a large group that have no employer pension of any kind, or indeed any steady job with benefits, and these people are unlikely to have saved much in RRSPs or even TFSAs, which they should if they can find the means. This group may account for a whopping 47% of working Canadians, Sun Life finds, and about the only thing they’ll be able to count on in Retirement is the Canada Pension Plan (CPP) as early as age 60, Old Age Security at 65 and probably the Guaranteed Income Supplement (GIS) to the OAS. These people would be better off continuing to work till 70 in order to get higher government benefits, a time during which they can build up their Tax-Free Savings Accounts (TFSA)s. TFSA income does not impact CPP/OAS/GIS, which is not the case for RRSPs and RRIFs.

Finally, a word about continuing to work into one’s 60s and even 70s. I know many who do, and not always for the money. I’m in the latter category myself, even though personally my wife and I could be considered the poster children for maximizing retirement savings, living frugally and investing wisely. There are worse things in life than going to a pleasant job that provides mental stimulation, structure and most of all purpose. Many of these ideas are explored in the book I jointly co-authored with Mike Drak: Victory Lap Retirement.

 

How to use your retirement plan to fund your dream business

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By Eric Goldschein

Special to the Financial Independence Hub

If you’ve decided to take the leap and start your own business, you probably have one pressing question on your mind: Where will you get the money to fund it? 

Startup costs can drain personal bank accounts, and few business owners are in a position to qualify for affordable small business financing right away. Lenders tend to prefer long-established businesses. 

If you’ve been a diligent financial planner and have been saving up for retirement, you may have access to a low-cost source of business funding: your own retirement plans. Here are three ways to use your retirement to fund your dream, whether that’s an e-commerce business or a restaurant: 

1.) Use a 401(k) business loan

Some 401(k)s and other eligible retirement plans in the U.S. — 403(b), and 457(b) plans and profit-sharing plans — allow you to loan yourself either US$50,000 or up to half of your vested balance (whichever is less). 

If you are testing out your business as a side hustle and will remain employed and contributing to your retirement plan, this is an excellent option. A 401(k) loan gives you access to low-cost funding (interest rates are usually the prime rate plus 1%) that you can use to see if your idea is worth investing in further. 

You also won’t pay any additional fees or penalties for taking out this money, unless you default on your payments: in which case the IRS will treat it as a regular withdrawal, incurring penalties. 

If you need $50,000 or less to improve your new business, contact your plan administrator to get the ball rolling.  

2.) Use a “rollovers as business startups” plan

Do you need more than US$50,000 in business funding, and are you ready to work on your business full time? If so, you can use a rollover as business startups (ROBS) to access funds from a 401(k), IRA, or other eligible retirement account without penalty. 

There are a few qualifications you need to meet to use a ROBS plan:

  • Your business must be a C-corporation (if it isn’t, you must restructure it). 
  • Your retirement account needs at least $50,000 in it, and it cannot be a Roth IRA. 
  • You must be an employee of the business and receive a salary. 

The next steps are a bit complicated, but the basics are as follows: Set up a new retirement plan under your C-corp. Roll over your funds from your existing retirement plan to your new one. Then, your C-corp sells stock to the retirement plan, and you use the proceeds from that sale to fund your business—buying new inventory, renovating your space, or any other general business needs. An accountant, lawyer, or financial service can help you do this. 

This isn’t a loan, but a constructive use of your retirement funds. The biggest risk here is losing your retirement funds in pursuit of small business success. If you think that’s a risk worth taking, this is a good bet.    Continue Reading…

Avoiding blind spots in financial advice

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By Darren Coleman

Special to the Financial Independence Hub

In my last blog, I took on those Questrade TV commercials where the client schedules a meeting with their financial advisor to tell them they’re fired. While people don’t normally schedule a meeting with an advisor to do such a thing, I think the real story is that the client does not experience value from the relationship. And if that’s the case, not paying the fee and moving on makes perfect sense.

But that doesn’t mean doing it yourself is the best idea. Investment management and financial planning is more complicated and intricate than people realize. Having access to tools doesn’t make you an expert; I can buy everything I need to renovate my house or rewire my kitchen, but that doesn’t mean I should. Better to leave this to Mike Holmes. Here are some key areas when an excellent financial advisor can add great value.

Fire Drills

We all want to plan for a happy future with a comfortable retirement, maybe a new car, or an exotic holiday. People associate these things with creating a financial plan, largely due to multi-million-dollar ad campaigns by mutual fund companies. But life is not a Cialis commercial and bad things happen.

With Christmas coming get ready for media stories about the family whose house burnt down with all their possessions, including presents under the tree, going up in blazes. Then we’re told they didn’t have insurance and donations are being taken for them at the local bank branch.

To prevent misfortune from turning into tragedy, a good Financial Advisor will first have their client pay attention to planning for things going wrong. Indeed, assessing key risks to one’s financial health (i.e., premature death, disability, loss of employment, liability, critical illness) should be the primary component of a financial plan.

We also must look at documents and processes such as a will and Power of Attorney that describe what happens when we can’t speak for ourselves. Unfortunately, these are things most people do not do on their own. And if they do, they usually don’t do them with skill and adequate preparation.

A great, and valuable, Financial Advisor does more than just inquire about insurance and other documents. They run a ‘fire drill’ on the family.

Let’s say someone doesn’t come home one day because of illness or sudden death. What happens next? Who gets the call? What documents are needed and where exactly are they? Along with all this are other important questions.

  • What income is going to come into the household to replace those lost wages?
  • What paperwork needs to be filed?
  • Who’s going to do it?

Your employer is legally bound to run a fire drill at least once a year. Shouldn’t your financial plan do the same?

Budgets don’t balance themselves

Despite Prime Minister Justin Trudeau’s statement, I can assure you that budgets do not do this. We all have multiple and often competing demands on our time, money and energy. And when we combine the wishes, desires and needs of other family members, things may and will get derailed. Continue Reading…

How to avoid the hidden costs of school

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By Tara Thompson

Special to the Financial Independence Hub

If you have school-age children, you know that when fall rolls around there will be additional costs added to your budget. Hopefully, you planned for this increase in the budget when the school year began, but as we all know there are always unexpected costs that we didn’t think of. Here are a few things to expect as well as a few ways to save.

Clothes

When we send our kids off to school we already know about many of the costs. Back-to-school shopping can be crazy. New clothes are important if we want our kids to fit in with their peers. New shoes are also a popular item and they often need multiple pairs. If you live in an area that has cold weather or rain they will need coats and jackets. If possible try to reuse some of your kid’s clothes. I know they always want new clothes but try to mix in some new with some of the old, and don’t forget to utilize hand-me-downs if you have more than one child.

Supplies

Then there are the dreaded school supplies. A long list that never seems to end and probably a new backpack and lunchbox to go with them. There are ways to save money by finding good sales and also by re-using supplies from the previous year. I keep a plastic bin with unused and used school supplies that can still be used during the year and the following year if I still have them. This saves money and is a good way to be green. Continue Reading…