Demand Destruction and Carbon Taxes

May 5th, 2022 by Potato

Oil prices have gone through the roof with the war in Ukraine, but even before that, gas prices in Toronto were about 25% higher than pre-pandemic. Despite that, gasoline consumption appeared to be hitting new highs in the fall of 2021. New cars are hard to come by, and the prices of used ones are up a lot following the pandemic for other reasons (supply chains, etc.), but still I was not seeing the interest in hybrids that we saw the last time gas prices spiked.

I was staring to think that maybe people forgot that it’s one of those things I spent way too much time learning way too much about, or maybe instead of accosting random Prius drivers in parking lots people had learned to research things on the internet themselves. I was starting to think that the price of gas didn’t matter.

Then gas prices hit ~$1.75 and it was like a tsunami of hybrid interest hit me. And it wasn’t just me and BbtP: Google trends shows that searches for Prius doubled from baseline in March of 2022, and those for PHEVs tripled. So there was a point where gas would get expensive enough that more people would get interested in burning less of it. I also noticed more people on the 404 and 400 driving the speed limit — slowing down is a good way to burn less gas (and much more immediate).

While I was expecting more to happen at $1.30 or $1.40/L, people did seem to get to a point where there was interest in change. It’s just that people seem to be able to tolerate much bigger changes in prices before getting to the point of demand destruction than we ever would have guessed before.

Which brings us around to the idea of the carbon tax. A carbon tax is an attractive idea for reducing GHG emissions: give carbon a price, and let the free market figure out solutions to reduce consumption. While I still think the approach is a good idea, after seeing how resilient demand can be in the face of sharp price increases, I think we need to increase it by about an order of magnitude a factor of ~3 to have any effect — the ~11 cents/L carbon tax is not moving the needle at all on people’s driving habits and consumer choices.

It may also be a good idea to re-think how we apply carbon taxes in a market with rapid swings in natural pricing: rather than a static carbon price, would it be better to set floor and quasi-ceiling amounts for gasoline directly? When the market is already setting a price that’s high enough for demand destruction, does an additional tax help further drive behaviour, or would it be better to cut it back as gas approaches $2/L to provide a modicum of relief? And vice versa, if gas prices start going back under $1.50/L, should a new responsive carbon tax make up the difference to keep the price high enough to maintain that reduction in use and behaviour change, or do we really think a $0.11/L carbon tax will do anything if the oil market corrects and gas drops back under $1/L?

A Different Take on the FHSA

April 13th, 2022 by Potato

Budget 2022 proposes to introduce the Tax-Free First Home Savings Account that would give prospective first-time home buyers the ability to save up to $40,000. Like an RRSP, contributions would be tax-deductible, and withdrawals to purchase a first home—including investment income— would be non-taxable, like a TFSA. Tax-free in, tax-free out.

The new Tax-Free First Home Savings Account (FHSA) is pitched as a way to save up for your first home. It’s like a super-charged RRSP: you get to put pre-tax money in, and in one specific circumstance (buying a home), you can take it out tax-free. And if you don’t buy, you can roll it into an RRIF like a regular RRSP.

There’s lots to nit-pick with this idea: the $40k lifetime limit doesn’t make it much more effective for saving for a home than the old HBP option did. And while this is even better as you don’t have to pay it back and get to keep that tax savings, that’s a benefit you only see in later years vs the HBP — the $35k HBP was already letting you put that much pre-tax money to work for the purchase itself. On top of that, the $8k yearly limit means it will take 5 years to max out (and 4 to match what you could do in 90 days with the HBP and a regular RRSP). So at least it will push demand out if some people want to max it out before buying.

It’s a bit regressive, in that people in the highest tax brackets will see the biggest advantage from using the FHSA.

However, ignore all of the talk about using it for a downpayment. The fact that they took out the age limit and let you roll it into an RRIF mean that the FHSA serves another purpose: it helps renters shelter more investment income, functioning basically as more (and with an embedded option!) RRSP room. Someone who buys a place gets any increase in equity as a tax-free gain thanks to the principal residence exemption. That’s been a huge windfall in recent years, and can push people toward buying in an environment where prices are going up double-digits every year. That tax advantage also makes it even harder for those who don’t own to keep up. Someone can choose to rent instead and save the difference in monthly cashflows, but may soon run out of TFSA and RRSP room. An extra $8k/yr will help them shelter more of those gains.

And of course, provide that option to take the whole FHSA out at some point in the future to buy, tax-free.

Imagine a world where the cap and 15-year lifespan were removed and renters continued to get $8k/yr in room until they bought or turned 71 (and rolled it into a RRIF). Someone renting in a big, unaffordable city like Toronto could prioritize their FHSA, knowing that it would make it that much more possible to eventually buy when their indentured servitude in the city was over. $8k/yr at a 5% return would leave someone with nearly $400k after 25 years*. You could make a solid plan to do your time, renting happily along the way, and know that you could — tax-free — have nearly enough to buy a place in the boonies outright when your commuting days were done. Or, have more in your RRSP to support the costs of lifelong renting in retirement if you stayed in the city.

So while I don’t think this was a necessary thing to create (indeed it adds more complication to our tax and savings account system, and yet another financial literacy hurdle), and don’t think it’s going to do a damned thing for housing affordability… I welcome the FHSA. For many people, it will be the obvious first account to fill (even edging out a TFSA for those who plan to buy eventually). However, to be truly great and to help incentivize more people to rent and invest the difference and keep open the option to buy in the future, they’ll have to remove the fairly low lifetime contribution cap.

Indeed, I’m not sure many brokerages will bother to offer registered accounts that can only ever accept $40k, and are only available to the subset of renters who save money to invest — see how few bother to offer RDSPs.

* – remember that this is a hypothetical where they remove the cap and time limit. As it stands, the 2022 Federal Budget proposes a $40k lifetime cap and a 15 year maximum term to either buy a home or roll it into a RRSP/RRIF.

Investing Apps: Just Say No

January 26th, 2022 by Potato

Perhaps Commissions Aren’t So Bad

Dan Ariely talks about the difference between free and nearly free. Nearly free and free have basically the same effect on your overall net wealth: whether you pay 14 cents in ECN fees every month or zero as you accumulate your investments is going to have no measurable impact on your ability to retire. But the difference between a few cents and free on your trading behaviour is huge — people will trade a lot more when it’s free. Plus the sales commission on the selling side for Questrade is good for investor behaviour: not high enough to actually be a real barrier to selling, but puts just that little bit of psychological stop in before selling and prevents dabbling in day-trading.

So I’m worried these days that so many people don’t ask “what’s a good brokerage to use?” but “which investing app should I use? Is Robinhood in Canada?”

And as much as lower fees are better, perhaps there’s a behavioural benefit to paying a little bit of commission and we shouldn’t encourage zero-fee platforms. Plus these companies make money somehow, which may include providing worse fills (though that doesn’t seem to be allowed in Canada).

Smartphone Addiction

Your smartphone is an ingenious device, carrying more power than the desktop computer I had in university, and able to carry out many very useful functions. It’s no wonder many of us have them practically welded to us. But they are an insidious thing: they short-circuit our brains in some of the worst ways.

Paying by mobile phone reduces the pain of paying even beyond that of using a credit card, so it’s all too easy to impulse buy something and not even notice how much you spent with that tap. And so many apps are addictive (sometimes purposefully so) that just touching your mobile phone short-circuits all of your careful reasoning faculties. [only a modest exaggeration on my part]

Do. Not. Trade. On. Your. Phone.

Investing Apps

Long before there was daytrading involved, WealthSimple bragged about how a third of their users checked in with the app daily. Daily! For a robo-advisor. There’s nothing to do! The whole point is to have a long-term investment plan that you don’t have to babysit!

From their point of view it was great: more mindshare, better odds that someone is checking on their phone and a friend goes “oh hey what’s that.” So of course they loved it. But I was horrified. Setting aside the unhealthy relationship people had with their phone and this app, it was setting investors up for loss-aversion disappointment (or panic): the more often you check in on your portfolio, the more likely you are to catch a downturn and see that you’ve lost some money.

So mobile phone investing apps had a horrifying relationship to engagement and addiction before they threw day-trading into the mix.

Do. Not. Trade. On. Your. Phone.

Dark Patterns, Advertising, and Active Investing

The trailblazer in no-commission app-based trading, the brand that has become synonymous with the product itself, is Robinhood in the US. And Robinhood has been criticized for its dark patterns, gamifying parts of the user experience to encourage people to trade more often and make more speculative bets. For example, they’d flash digital confetti up on the screen as a kind of reward/congratulations for placing a trade, and list trendy stocks.

Now WSTrade looks to be copying some (but thankfully nowhere near all) parts of the playbook, with a mobile-only [update: mobile-first, as I took forever to publish this and got scooped in some ways and they now have a desktop web version] app, offering zero commissions and fractional shares. And they’ll give you a free stock, to really drive home that idea of trading individual stocks, with a lottery-like component (will your sign-up bonus be a penny stock or a really valuable share?).

They also moved beyond stocks into an even more speculative space with crypto trading. And while not a dark pattern within the app itself, their ads are highlighting all the new speculative investments you can trade with them (rather than focusing on the good parts, like that you can do long-term investing in an all-in-one ETF with no commissions — in fact I can’t say that I’ve seen a single ad along those lines).

Screengrab of a WSTrade ad on Twitter highlighting the recent highly speculative securities you can now trade. I'll snark for posterity that anyone that bought ARKK is down 35 percent since.

Screengrab of a WSTrade ad on Twitter highlighting the recent highly speculative securities you can now trade, including a crypto coin that was explicitly created as a joke. I'll add some snark that this highly speculative thing is down 50 percent since being added to the platform, and indeed has never traded above that point.

In the US case at least, there are plenty of stories of people getting caught in things they don’t understand and losing lots of money — whether through mistakes, or through functionally a fully enabled gambling addiction. Thankfully, here in Canada investing apps don’t push users toward derivatives to add risk on top of daytrading, though they are moving toward “instant deposits” to wipe out any chance for cooling off periods and do include crypto. And the “first stock” promotion of “up to $4,500!” reinforces the gambling aspect of investing, and fractional share ownership promotes speculating in individual securities long before a user is ready for that.

And that’s not to mention fat-finger trades — how many typos have you made texting on that device?

Do. Not. Trade. On. Your. Phone.

Academic Research Backs Me Up

Two recent papers back up my instinctive refrain that you should not be trading on your phone.

First, Does Gamified Trading Stimulate Risk Taking? looks at the gamification aspect:

“We find that gamification “nudges” participants to take on more risk, particularly when trading high-volatility assets. The effect is stronger for inexperienced traders with lower financial literacy.”

You can read a more lay-friendly version here.

Their finding on the moderating influence of financial literacy gives me some hope. However, it also worries me, as people with low financial literacy are the ones now searching for “investing apps” rather than “best brokerage” – the term brokerage is almost entirely missing from new discussions on Reddit, for example, so the people using these apps are much more likely to be the low-finlit ones most susceptible to the gamification, gambling, ads, and dark patterns.

Next, Smart(Phone) Investing? A within Investor-Time Analysis of New Technologies and Trading Behavior looks at people’s behaviour when trading on their phone.

“we find that smartphones increase the purchase of riskier, lottery-type, non-diversifying assets, and of past winners and losers. […] following the launch of smartphone apps, investors are—if anything—more likely to purchase risky, lottery-type, and non-diversifying assets as well as chase winners and losers on non-smartphone platforms. […] We find evidence against investors offsetting these trades on other platforms and against digital nudges mechanically driving our results. Smartphone effects are neither transitory nor innocuous: assets purchased via smartphones deliver lower Sharpe ratios. Our findings caution against the indiscriminate use of smartphones as the key technology to increase access to financial markets.” [emphasis mine]

That reinforces my more instinctive view that even touching your phone short-circuits your self control thought: simply trading on your phone increases the likelihood of buying riskier things, and it infects your trading even off your phone. They also include a reference to another study on purchases, supporting the idea that smartphones reinforce system 1 thinking, where people ordered more unhealthy food on their mobile devices.

Conclusion

If you’re looking to start investing, do not look for a zero-commission “app”. Start by reading, and then open a brokerage account and only use your desktop/laptop to trade. Even if the brokerage you ultimately choose has a mobile app, don’t use it, as even occasional usage may change your appetite for lottery-like stocks. Controlling costs is important and a virtue, but zero costs changes our behaviour in ways that may be counter-productive. A few dollars here and there (or even $10 big bank commissions) are not going to derail your long-term plan, but may keep you from trading more than necessary. And finally:

Do. Not. Trade. On. Your. Phone.

Reboot Your Portfolio Review

January 24th, 2022 by Potato

I wasn’t sure how I would react to Reboot Your Portfolio: 9 Steps to Successful Investing with ETFs by Dan Bortolotti after his announcement post, which said “What was needed, I recognized, was a step-by-step guide to designing, building, and maintaining a portfolio of ETFs over the long-term.” My Dude, I thought, that book already exists and it is called the Value of Simple.

But that’s the reaction of someone who spent too long in Science, where you have to cite prior work and it’s hard to publish replication studies. In art there’s all kinds of room for cover songs, and RYP actually has a really nice harmony with VoS.

Preaching to the Choir

RYP fully assumes that this is not your first book on investing, and so doesn’t spend much time on the basics like “what’s a stock?”. It dives right into “stop trying to beat the market!” Which I suppose fits very well with the title: you must first have a portfolio to reboot it.

Dan clearly and convincingly makes the case for why you shouldn’t try to beat the market, and why indexing (and specifically market cap weighted indexes) are the way to go. There’s a good section on factor/smart beta and why he doesn’t go for it.

He also has much more on building your plan before you invest, and how that influences your choice of investments and your ability to stick with them. Importantly, the planning section includes some key questions you should ask yourself as you’re building your plan.

RYP includes much more detail on how ETFs are built and the alternatives (e.g. smart beta), currency implications, etc. The book spends a bit of time digging into tracking error and transaction costs: the more advanced stuff that VoS doesn’t touch — again, a great complement. He also addresses head-on the common misconception about ETFs that track similar indexes having different prices: one is not “cheaper” or “a better value” just because the price per unit is lower. The price per unit is fairly arbitrary.

He also has a section on cutting ties with your advisor, to prepare you for the common arguments they might make. One addition I like a lot is his point that “You don’t need to change each other’s minds.” “There’s no point engaging in an argument with an advisor you’re planning to fire. He or she may be using fear tactics to encourage you to stay, which is unprofessional and provides another reason for you to cut ties.”

Then he has guidelines for how to buy your ETFs. He doesn’t go into quite the screenshot-level detail of VoS (which will also save him from having to release a new edition every 3 years — smart compromise), but hits all the main generalizable points, including using limit orders and rounding down your number of units.

Nitpicks

It wouldn’t be a BbtP review without nitpicking, but I have basically none. {gasps from the crowd}

The one thing that got me was my own bugbear (which is admittedly being pedantic on one page): in the TFSA-vs-RRSP bit, his RRSP description is missing the pre-tax nature of RRSP contributions. You should not pick an RRSP over a TFSA because it gives you a tax refund — you should be re-investing that refund anyway (or getting it back after grossing up or whatever). Yet Dan says “And if your income is significantly higher–once you’re in the six figures, you’re being taxed at more than 43%–then prioritizing the RRSP is almost a no-brainer, because that tax deduction is so valuable.” [Emphasis mine] This is the thinking that gets people to not add more to their RRSP to account for that gross-up/pre-tax bit, and then complain when they hit retirement that they have to pay tax on their RRIF withdrawals.

If you’re in a high tax bracket the RRSP is usually the better choice because there’s a higher chance you’ll be in a lower tax bracket later. The current tax deduction has nothing to do with it. If you have say $5k to save today and are debating between putting $5k in your TFSA or RRSP, putting $5k in your RRSP and enjoying a tax refund means you’ve really only saved $2850 — you had to contribute $8.77k to your RRSP [at that 43% tax rate] to have an equivalent situation to $5k in your TFSA (and then your tax deduction just brought you back to the same state as the TFSA, it was not valuable on its own).

I will note that he got it right immediately before that: “if you were in the same tax bracket for your whole life, the TFSA and RRSP would be essentially the same… an RRSP is particularly useful if you make contributions when your tax rate is high, and then make withdrawals when it’s low.” And to be fair, that this is something tonnes of otherwise careful experts get wrong (sometimes on purpose — people are irrationally motivated by tax returns, so selling them on saving and investing in their RRSP to get one works to get them to save and invest something much more so than a long, carefully worded explanation about pre-tax amounts — investing the same amount in a TFSA may be better, but that’s not always the counterfactual).

So Which One Should I Get?

As much as I have a conflict of interest, get both Reboot Your Portfolio and The Value of Simple. The lessons are important and it’s good to reinforce it, and now you’ll get it from two different voices from different angles to really help drive it home.

VoS is very purposefully designed for people who are not (yet!) DIY investors. It’s main criticisms have been that it is too simple, which I eat up. So if you’ve never made a trade on your own before (or are shopping for a friend or relative in that situation), I would suggest that you start with VoS, and then read RYP to reinforce the take-home messages of indexing and the value of all-in-one funds, and get those extra details on why you should pick certain index funds.

If you are already an investor, and are confused by all the different strategies out there (growth? dividends? crypto? meme… stonks?) then get RYP. VoS has more detail on what happens next for beginners (how do you read a statement, what are taxes and what do I have to do) if you’re confused on that after reading RYP, but if you’ve already opened a brokerage account and know how to use it, and are mostly stuck on convincing yourself to go with a simple index ETF route, BYP will probably be better at convincing you of that and will likely be all you need.

Covid and School Lunches

January 23rd, 2022 by Potato

I’ve been very quiet about covid over the last two years, and I feel bad about that. I’m a science communicator, and this is one of the biggest science stories ever, yet here I am largely sitting it out. I admittedly haven’t been writing much of anything these days with my own issues on the go, plus it seems to be a topic that attracts such controversy that I just didn’t want to even go there. And besides, lots of other science communicators are on the job, and virology wasn’t my field. But still, I kick myself wondering if perhaps if I wrote and article and said “folks” enough maybe it would be the one to get through to DoFo. Anyway, the past is the past and I’ll have to sit with my private-mode ranting. Why am I finally inviting a war in my comments section?

A recent article in the Star really resonated with one aspect: how the heck our kids are dealing with this nightmare.

So far Blueberry is handling things fairly well, but as much as I love getting to spend time with her, the kid needs to hang out with kids her own age and not her parents. She’s been at in-person learning whenever the schools have been open. And for the most part we’ve been dealing with the risk of contagion there: she has decent custom-made masks (we even did a fit test with nutrisweet and recorded it all for a podcast that we then never followed-through with publishing /fail), she’s good at wearing them, her hand hygiene, and getting tested whenever she has any symptoms.

And those are the key ways to manage the risks: the kids need in-person learning, but balanced against the risks of the disease. Closing the schools in the prior waves was ~the right call (though they should have closed them earlier so the duration could have been shorter but then we get back to me raging about the mis-management or enacted other restrictions earlier to try to save the schools) because community transmission got too high and that has to stay down to keep the schools at a reasonable level of risk.

But now with the Omicron-driven wave and this most recent re-opening, we have lost two of the layers of protection: our testing system is overwhelmed, so kids with the sniffles aren’t getting tested, and we have not kept community transmission down. So the odds of someone in her classroom having covid is much higher than before, and chances are good that it will go undetected. Which brings us back to the big weakness in the in-person learning model: lunch (and snack) time.

You simply cannot maintain the layer of protection from masks and also eat (and by the same token, in-person dining should also be the first to close and the last to open). And it’s -20 in January so the school isn’t sending them outside to eat (which also has the issue of trying to eat in gloves or freezing little fingers).

Which brings us back to that Star article I mentioned:

According to Dr. Anna Banerji, a pediatrician and University of Toronto professor, lunchtime is the riskiest period of the school day for COVID-19 transmission because of the removal of masks, even if it is partial or brief.

Banerji said bringing kids home for lunch if possible is “not a bad idea.”

I had the same thought, and have been taking Blueberry out of school for lunch every day that they’ve been back. I know that most parents can’t do that: they don’t have the flexibility in their schedules, or don’t work from home in the first place, so I get to do this from a place of privilege (but also a place of necessity — Wayfare is ~immunocompromised so we have to be extra cautious even with her 3 doses). But I was surprised that I was the only one showing up at the school’s front door every day.

I don’t know if I should be trying to convince the other parents who are BbtP readers to look at take a wild guess at the rate of transmission in their community and think about whether they too should pull their kids out for lunch (or have their kids eat outside or just do intermittent fasting to skip lunch entirely), or if I should be encouraging you all to talk me off the ledge of paranoia.

For now, it’s working well for us, and we feel like our risk of catching covid is lower because of it, and the only cost is that my work day stretches into the evening to make up the time. Hopefully in a few weeks this wave will have crested and we can get our testing infrastructure back online and maybe reduce the risk that any kid in a class is carrying covid for that moment when they all take their masks off to eat.